The NCUA's financial literacy regulation for board members seeks to ensure that those delegated to carry out the operations of the credit union have the necessary skills, knowledge and experience.
In addition, directors must understand essential accounting principles and correctly interpret their credit union's balance sheets and income statements. These financial documents are an important gauge to measuring the success and performance of the credit union.
A good starting point is to review two of the most important financial statements: the balance sheet and the income statement.
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The balance sheet is a snapshot of a credit union's financial strength on a given date. It comprises assets, which represent what the credit union owns (such as member loans and investments), and liabilities and members' equity, which indicate what the credit union owes, such as member shares and certificates of deposit, as well as capital–also called net worth–which represents the members' equity position.
The balance sheet provides a picture of the credit union's business capabilities. Understanding it can help directors address important questions related to managing the credit union. Is the credit union is in a position to expand? How is it handling the normal flows of revenues and expenses? Should steps be taken to strengthen cash reserves?
A credit union's income statement (also called profit and loss statement) differs from the balance sheet in that it summarizes the credit union's profits or losses during a given period of time, typically monthly, quarterly or annually.
It records all credit union revenues during the selected timeframe, such as interest on loans and investments. It also outlines the credit union's operating expenses. It is important to note that much of the credit union's income is directly related to rates, while many of its expenses are rate-neutral.
The final line item in the income statement shows the credit union's overall income or loss for the reporting period.
Directors must understand the key ratios and measurements used to gauge the credit union's performance. Most of these measurements can be calculated using data found in the balance sheet and income statement. Here are some examples.
Return-on-assets. Net income divided by total average assets equals return-on-assets ratio. This determines how efficiently management is deploying assets.
Loan-to-share. Total loans divided by total shares equals loan-to-share ratio. This measures the ability of the credit union to make loans versus the level of shares on deposits. A higher loan-to-share ratio usually is positive for earnings.
Net worth to assets. Total capital divided by total assets equals net-worth ratio. This represents all of the credit union's retained earnings accumulated since its chartering. The level of net worth in relation to assets indicate the safety net available to absorb losses.
Operating expense to income. Operating expenses divided by operating income equals expense ratio. This measures the level of expenses associated with the operations of the credit union versus the income generated. It is impacted by the size of the credit union and the strategic service levels.
Member growth is a function of strategic decisions made by management and economic decisions made by nonmembers. It is generally desirable because member growth provides the credit union a larger pool of potential borrowers and users of services.
Share growth represents the resources needed by the credit union to fund loans. Credit unions strive for balance between share growth and loan growth to maintain a stable loan-to-share ratio.
Loan growth represents the earning assets of the credit union to pay share dividends and build retained earnings. Balance is sought between share-growth levels and loan-growth levels.
The role of director carries significant responsibilities. Among them are setting credit union policies and strategic direction, providing oversight and accountability, ensuring compliance with rules and ethical standards, and monitoring and evaluating the credit union's progress. In addition, part of the financial literacy rule states that credit union directors need to be able to ask substantive questions of their credit unions' management, as well as internal and external auditors.
How does the credit union generate earnings?
How are credit union assets used and funds generated?
Have the credit union's operational costs gone up? If so, why?
Has the credit union raised or lowered fees and rates? How does this affect margins?
Are there competitive issues affecting the credit union's performance?
Are there ways to improve the credit union's operating efficiencies?
Being able to interpret and question the financial statements helps directors to determine how well the credit union is performing. While it has always been an important skill for volunteers, now it is a requirement for board members of any federally insured institution.
Directors carry a great weight of responsibility in their leadership role. Today, understanding the nature of financial statements and their relationship to business decisions not only is vital to the credit union's success but to the director's as well.
Bruce Six is the SVP, chief investment officer at Mid-Atlantic Corporate Federal Credit Union. Contact 800-622-7494 or [email protected]
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