Doors to Academia

Financial Strategy Paradigm

by | May 21, 2022 | Financial Strategy and Operations

Financial Management – Foundation of the Paradigm

It is not uncommon in higher education that an institution should establish a balanced annual budget as its main strategic financial goal. There are several significant reasons why the “single year net income goal” is both outdated and even dangerous and should be replaced by strategic-driven financial management. First, it ignores liquidity (often known as cash flow) as the recent credit crunch has proven with little subtlety; liquidity is a sine qua non of financial viability. Even an institution with a balanced budget may face cash flow issues when debt service (principal and interest) exceeds non-cash charges, such as depreciation in the cash flow budget. Second, the annual budget ignores the impact of debt on the financial condition of the institution. Again, as the recent credit crisis shows, banks will impose stricter conditions that go beyond avoiding deficits.  Third, working only with the annual budget ignores the intent of Federal Accounting Standards Board (FASB) accounting rules that the financial condition of the college is measured through three financial reports: statements of activities, financial position and cash flow. FASB rules suggest that focusing solely on the statement of activities is inadequate and may in some cases be a false measure of financial condition because it ignores capital investments and cash flow. Fourth, a balanced budget can and may well be an artificial goal where revenue and expenses are manipulated to produce the needed balanced budget, rather than a well-planned and executed attempt to improve the overall financial health of the school. Cash, assets, and liabilities are constrained by the existing financial condition of the institution or by external agencies, banks, regulators, or the markets. They are less amenable to budget maneuvers that are designed to achieve a balanced budget and to pacify the boards need for appearance of financial stability. Fifth, the financial capacity of an institution is not solely dependent upon income flows from revenues through expenses. Financial capacity also depends on how debt, investments, liquid assets, and other capital resources are employed to generate new funds. Sixth, and maybe most important, annual budgeting tends to foster a piecemeal approach to strategy and fails to truly link overall financial health to the institution’s future plans. This means the budget is designed to solve financial weakness for only one year. If the weakness is systemic and chronic, i.e., the problem is not a single year event of excess expenses or loss of revenue, the problem will continue over many years. For example, chronic financial problems may arise from demographic changes in a college’s market that leads to a decline in enrollment from too many academic programs with low enrollments or from too many administrators and support service staff. Piecemeal strategies rolled out a year-at-a-time will not solve chronic problems. They tend to mask core problems until they grow so large that the college faces swift and calamitous deterioration of its financial condition.

The following case studies point out how piecemeal strategies can endanger a college with systemic financial problems. When a college ignores the totality of its financial capacity by simply focusing on a balanced operating budget, it increases the risk to the college during unpredictable financial crisis and long-term trends in its student market. 

The annual operating budget is only a forecast which can be substantively altered through internal politics, current circumstances, and unexpected events. Colleges must come to expect that financial markets will remain unpredictable, that large demographic shifts will distort student markets, and that capital plans with stringent debt covenants will increase the cost of capital projects. Gone are the days when colleges can simply focus on a balanced budget to maintain their financial viability. Colleges must have a broader vision of financial strategy, which encompasses cash balances, tangible assets, financial investments, debt, and income flows. In response to these financial conditions, the chief financial officer (CFO) must become an astute financial manager who understands how to build a robust financial strategy to optimize the financial resources needed to serve the mission of the college.  

 Optimizing financial resources rests on the proposition that budgets (income, capital, or cash budgets) are executable plans converting financial resources into resources that strengthen and expand the financial structure and support the mission of the institution.    Financial structure comprises monies reported in the statements of activities, financial position, and cash flow. The financial structure is not locked at the level of operational income. The financial structure has the capacity to provide resources to support the mission of the institution, to craft new strategies, to formulate creative turnaround plans, and to set the college on the road to financial stability.

Here are several examples of the resources available within the financial structure. First, investment assets generate income for operations. Second, debt capacity can expand revenue-generating capacity from new residence halls, new instructional programs, and cost saving investments in fixed assets. Third, a college can generate strategic reserves (funds used to take advantage of new opportunities or to create turnarounds) by monetizing the value available in net fixed assets (property, equipment, and buildings).  Strategic use of the financial structure can foster a recursive cycle where operational net revenue flows into financial reserves which channel the expanded resource base back through operations and so forth.  

Effectively using the full resources of the financial structure is only one aspect of strategic optimization of the financial management paradigm. Budgetary decisions must be driven by financial metrics that press the college to: a) evaluate the impact of short-term budgetary decisions on its institutional strategies; b) assess forecast performance upon critical financial ratios (such as debt covenant ratios and standard management ratios) to determine the long-term financial condition of the college; and c) track performance during the fiscal year to determine achievement of short- and long-term budgetary and strategic goals.

In summary, the purpose of the financial management paradigm is to formulate strategy that effectively utilizes the financial reserves embedded in the financial structure of an institution to achieve its mission, augment its financial condition, and employ a system of metrics to build and monitor its financial condition. 

Failed, Single-Focus, Piecemeal Financial Strategy

This section discusses a case illustrating a financial strategy where year-to-year survival depended on converting financial and tangible assets into cash, while ignoring the long-term metrics needed to keep the college solvent. It will become evident that this approach not only restricts strategic options but also has the potential of pushing a college over the brink into bankruptcy.

Although the case only presents financial information for the last five fiscal years, the financial condition of the college deteriorated during the past ten years with larger deficits, shrinking cash balances, and depleted net assets. During the last five years, attrition was 30%, new student enrollment fell 25%, and the tuition discount rate grew from 25% to 45%. Cash reserves were drained and off-campus real estate sold and the only result was ever larger deficits. The string of deficits meant that the college was in default of its bond covenants; however, the bondholder agreed to forego calling the balance owed because he/she had no immediate use for the property. The impact on the financial condition of the college is readily evident in the five-year summary presented in Tables I and II. 

The deficit reported for the first of the five fiscal years was relatively minor compared to the remainder of the years. Nevertheless, it represents another in a long line of deficits that eroded its net assets. By the end of the most recent fiscal year (year five), only 6% of the net assets remained from the first fiscal year. Further indication of what had happened is evident below: cash declined 43% or $1.3 million; investments lost 50% of their value or $9.8 million; and property, plant, and equipment lost 35% or $7.8 million.

Table I

Summary Statement of Activities

Revenue    Fiscal Year #1Fiscal Year #2Fiscal Year #3Fiscal Year #4Fiscal Year #5
  Tuition$16,790,000 $16,565,750 $15,974,204 $15,257,890 $11,592,875 
  Unfunded financial aid4,197,500 4,804,068 5,373,722 5,953,995 5,247,629 
  Net tuition12,592,500 11,761,683 10,600,482 9,303,895 6,345,246 
  Investment gains/losses1,200,000 800,000 500,000 (300,000)(750,000)
Investment income450,000 481,500 491,760 391,430 227,088 
  Gifts and grants1,250,000 1,312,500 1,378,125 1,447,031 1,519,383 
  Auxiliary income8,030,000 7,591,100 7,013,610 6,418,678 4,608,430 
  Other revenue125,000 122,500 107,800 102,410 92,169 
  Total Revenue23,647,500 22,069,283 20,091,777 17,363,445 12,042,315 
Expenses
  Compensation14,207,425 15,233,648 16,290,657 15,913,218 13,967,103 
  Materials and supplies1,736,980 1,763,035 1,586,731 1,269,385 634,692 
  Auxiliary expense6,642,000 6,246,990 5,727,249 5,191,811 3,562,587 
    Interest expenses650,000 650,000 650,000 650,000 650,000 
  Depreciation665,357 632,089 600,485 531,461 482,388 
  Other expenses285,760 291,475 297,305 303,251 309,316 
  Total Expenses24,187,522 24,817,237 25,152,427 23,859,125 19,606,086 
Change in Net Assets($540,022)($2,747,954)($5,060,650)($6,495,679)($7,563,770)

Table II

Summary Statement of Financial Position

AssetsFiscal Year #1Fiscal Year #2Fiscal Year #3Fiscal Year #4Fiscal Year #5
  Cash$3,000,000 $2,820,000 $2,650,800 $2,491,752 $1,705,450 
  Investments19,560,000 22,398,920 18,994,877 16,073,850 9,748,000 
    Property, plant and equipment22,178,571 19,287,050 16,016,161 13,915,353 14,469,585 
  Total Assets44,738,571 44,505,970 37,661,838 32,480,955 25,923,035 
Liabilities
    Current liabilities3,150,000 3,581,246 5,305,152 6,526,374 9,365,479 
    Bonds16,250,000 15,925,000 15,606,500 15,294,370 14,988,483 
    Total Liabilities19,400,000 19,506,246 20,911,652 21,820,744 24,353,961 
Net Assets
    Current unrestricted net assets20,270,857 19,999,779 13,400,148 8,528,169 1,255,259 
    Restricted net assets3,330,714 3,369,404 3,382,788 2,075,458 154,926 
    Total Net Assets$25,338,571 $24,999,724 $16,750,185 $10,660,211 $1,569,074 

By the fifth year, all the easy places to find cash to make payroll and pay vendors had disappeared. At the start of the next fiscal year, current liabilities exceeded current assets by $7.6 million. Just covering its unpaid commitments from the prior year (current liabilities) would have completely drained its cash. The college had lost its financial reserves (assets) and strategic flexibility. It no longer had off-campus property to sell, expenditures were cut to the bare minimum, and delaying payment on bills was no longer an option as vendors stood in line demanding to be paid. 

More than likely, during the sixth fiscal year, the college would slip into bankruptcy because the bondholder, who earlier had ignored violations to bond covenants, such as continuing and growing deficits, could not ignore the college’s inability to make prompt and complete debt service payments. Strategically, the college had backed itself into a corner years earlier because it had failed to develop a multi-year strategic plan to optimize its remaining financial reserves and to stem its swiftly deteriorating financial condition.

The continuing deterioration of the college over the prior ten years was not an impenetrable riddle to the board and president. Deficits were, as noted previously, a permanent fixture; and every year the chief financial officer and the president scrambled to find cash for operations and debt service. Rather than taking a long hard look at where they were going, they compounded their mistakes. For instance, even though they desperately needed cash, the board of trustees kept 70% of their investment portfolio in equities. In the year prior to the college’s demise, the investment committee of the board was forced to sell into a plunging equity market to get enough cash to survive the year.  By not foreseeing their cash needs, they depleted the investment portfolio by 45% for the cash draw for the fiscal year,  and another 30% vanished due to equity losses in the market. The remaining value of the portfolio, coupled with the sale of the last piece of off-campus property and severe decline in enrollment, meant that the college just did not have the cash to make it through another year. 

The board and president amplified the financial problems of the institution by focusing solely on balancing the annual budget and by ignoring financial metrics (debt covenants, composite financial index (CFI) and the U.S. Department of Education financial score) that would have forced them to deal with the continuing deterioration of the college’s financial condition. Amazingly, each new budget saw the same old solution to the same old problem — a piecemeal strategy to sell off real estate and investment assets to generate sufficient cash to survive to the next year. As each year passed, the college dug itself into a deeper fiscal hole, but senior administrative officers always assumed that next year would be different. By the end of the fifth year, their assumption was proven true because they faced immediate bankruptcy. They failed because early in the downward slide they ignored the possibilities that they could create a strategic reserve to climb out of their continuing slide into oblivion. Rather than managing their financial reserves for the long term, they burned through them and effectively destroyed the flexibility needed to develop strategic options.

By the sixth year, the college’s piecemeal strategy of teetering on the brink of bankruptcy had forced its regional accrediting agency to acknowledge that the college was no longer viable. The accrediting agency had warned the president over the years they would be forced to make a “termination of accreditation” decision unless the college got its finances in order immediately. Since the college no longer had any financial reserves, the accrediting agency determined that it had no other choice but to issue the dreaded “termination of accreditation.” The notice of termination from the accrediting agency triggered a letter from the U.S Department of Education, cancelling the college’s authority to distribute Title IV funds. Auditors drove another nail into the college’s coffin when they included a statement in the audit that the college was no longer a “going concern” because it was unable to make its debt service payments. This statement ended any hopes for borrowing money to survive another year. Enrollment collapsed with the withdrawal of most students as they enrolled in other colleges. When the DOE notice arrived, it was simply the last sad note in a symphony of errors that saw the closing of the college. The accreditor’s termination order, the DOE cancellation notice, and the auditors’ statement combined to end all hope for the college. It disappeared into the murky history of failed institutions.  

The board and president should have devised and implemented a strategy that involved more than simply burning through their assets. The next section will show how strategy-driven financial management could have provided more flexibility and more time to devise and implement a new strategy for survival.

A Different Outcome to the Case 

The budget process was woefully inadequate for the college in the preceding case study. While clearly an extreme example, it is not uncommon in higher education. Too often, budgets are based on rosy assumptions that disguise a slow slide into financial crisis.  Once budgetary plans are placed into operation, the real limits of these assumptions come into play, forcing the president, CFO, and others into a mid-year scramble to keep the institution’s fiscal condition above water. These budget schemes do not address the underlying issues that are shaping the long-term financial condition of the college and fail to optimize current operations and financial reserves to strengthen strategic options.  

The college in this case study could have taken another tack well before the college tumbled over the cliff into fiscal insolvency. Even though it was spawning sizeable deficits, the college did enter the five-year period with $25 million in net assets (i.e., financial reserves), which included cash, property, equipment, and buildings. The net asset position stayed fairly intact into the second fiscal year of the period. Since the college leadership was well aware, as noted in the case study, that its financial situation had deteriorated over the prior five years, prudence should have dictated that they take the condition of the college seriously. Simply put, this means that they should have started early and examined how net assets could be employed to set-up a strategic reserve. Money from a strategic reserve could have been used to develop new programs that penetrated new sectors of the student market, to increase operational efficiency (government regulations and potential legal liabilities have worked together to decrease operating efficiency by adding a protective layer of new administrators and support staff), or to look for a merger partner before the college lost most of its financial and market value.

Index of Strategic Options 

This section suggests strategic alternatives that could have produced a different outcome in the preceding case or could be employed by colleges seeking to strengthen their financial condition.

  1. Change the investment mix so that most investments are in cash.
  2. Explore the option of a sale-leaseback of the campus with a payoff of bonds and allocate the net from the sale to the strategic reserve.
  3. Eliminate or cut-back administrative and staff positions that do not directly contribute to recruitment and marketing.
  4. Cut out low priority perks, such as cars, expense allowances, conventions, or other trivial activities that do not lead to the production of income.
  5. Postpone all major capital projects.
  6. Create additional space by restructuring class schedules, reassigning classrooms, and reorganizing administrative departments so that the empty building space could be rented out.
  7. Use employees and volunteers (for example, students, alumni, and other interested parties) for fundraising campaigns during evenings and on weekends.
  8.  Package off-campus properties and offer them to real estate developers.
  9. Outsource as many service functions as possible, such as administrative and academic computer systems, the bookstore, payroll department, custodial and maintenance services, and/or food services. Even specialized student support services like tutoring, counseling, and health services should be considered for outsourcing. (Some outsourced services may pass back to the institution after the crisis passes and/or as part of a larger strategic plan.)

In this case study, key leaders, such as the board of trustees and the president, had to stop dawdling while the college’s financial reserves were frittered away. The actions incorporated in the list are not difficult to understand, but they do require the wit and will to act early and decisively. Decisive action is contingent upon a chief financial officer working in consort with the president to extract every morsel from operations and its financial reserves to build a strategic reserve. They cannot waste an opportune moment because once it passes, the financial condition of the college may no longer be recoverable. 

Strategy-Driven Financial Management: General Principles of the Paradigm

The general principles of the paradigm are based on these assumptions: (1) colleges must efficiently use all sources of wealth and monitor the allocation of its scarce resources to accomplish its mission; and (2) the president and chief administrative officers must have the skills and the understanding of the dynamics of their institution and the higher education market to effectively use the principles that make-up strategy-driven financial management. 

There are several steps that an institution needs to take when operating within the paradigm. Before anything else happens, senior administrative officers need to assess the financial condition of the institution so that they can determine the financial strengths and weaknesses of the institution. Decisions about the financial actions and metrics that best serve the college will come from this assessment. Next, the president and board members must establish policies and procedures that hold all offices accountable for working within the financial boundaries of the institution.   

Strategy-Driven Financial Management Principles

Once the preceding conditions are in place, the college can build a strategy-driven financial plan with these core principles:

Principle One:  Returning from the brink of fiscal disaster requires the leadership of the board of trustees and the support of the president. This president must have the wisdom and dynamism to determine the direction and magnitude of change in consort with the administrative leadership team. The board must insist on action and if the current administrative staff cannot do the job, new administrative leadership is needed immediately. In addition, the board must be willing to pay for good leadership; mediocrity may save money, but it does not breed success.

Principle Two: The board of trustees should seriously consider the use of consultants. Too often, consultants are seen as a drain on scarce cash. However, a reputable consulting team can often speed up change and take the heat off the administration as change is tested and introduced.

Principle Three: CFOs must be grounded in accounting principles; they need financial skills to effectively deploy the full range of financial resources embodied in revenue and expense flows, the statement of financial position, and cash flows. In addition, they should be secure in the possibilities and limitations associated with all forms of debt; for example, loans, bonds, leases, or leasebacks.

Principle Four: The chief marketing and academic officers should have the skills (professional and interpersonal) and experience to employ the resources generated by this paradigm to expand existing markets and to develop programs, products, and/or services for new markets. 

Principle Five: The institution should annually produce a rigorous five-year financial forecast for the statement of activities, financial position, and cash flow that is shared and discussed in depth with the board of trustees. The forecast should establish upper- and lower-sensitivity boundaries for major revenue flows to identify what could happen if unexpected events have an adverse impact on financial performance. The college should then establish priorities on what to do if actual performance exceeds or falls below the forecast. The president and chief administrative officers should meet to discuss the implications of the forecast on the budget and other factors that the forecast may have failed to take into account.  The annual forecast is a critical element in the paradigm. 

Principle Six: Cash needs to be sufficient to support operations and to cover debt payments (such as a ratio equal to 30% of expenses plus an amount needed to cover debt payments).

Principle Seven: Operational revenue should grow at the rate of operational expenses plus several additional percentage points to provide net assets surpluses and significant additions to cash reserves.

Principle Eight: Middle administrative expenses (administration, staffing, and non-personnel expenses) should be cut significantly and should grow less than the rate of growth for instruction.

Principle Nine: A strategic initiative fund should be established to support the development of new revenue sources or major expense reductions. The fund can remain within investments but should be sufficiently liquid to permit withdrawal within thirty days of the demand for investment funds. The fund should invest in projects that generate the largest net present value among the set of project options.  

Principle Ten: The statement of financial position should be regularly reviewed to determine the best structure for assets and liabilities so that they can yield a) the greatest return for the college given the cash demands faced by the college subject to protecting their principal; b) provide for a strategic investment fund; c) employ assets to their best uses; and d) balance debt so that debt ratios either established by debt covenants or by standard ratios do not place stress on operational performance.  

Principle Eleven: The president, CFO, and other senior administrative officers should establish metrics that are used to develop and to monitor the performance of the budget. Basic revenue metrics should include yield rates, attrition rates, enrollment growth rates, rates of growth for total revenue and expenses, yield boundaries for investments, tuition discount rates, net tuition growth rates, and a proportion of revenue for net tuition, investment income, grants, gifts, auxiliary income, and other revenue. Basic expense metrics should include rate of growth for compensation, non-compensation expenses, auxiliary expenses, interest expenses, and depreciation. Expense metrics should also include rules for adding new instructional, administrative, and staff personnel. Additional metrics should include change in net asset ratio, cash ratio, net asset growth rates, and the composite financial index.

Principle Twelve:  Financial management should find a way that the revenue stream from the endowment fund becomes a reliable and predictable income source.

Summary

The twelve principles of the strategic-driven financial management paradigm are designed to change the way in which colleges and universities use and revise their current financial condition. The specific intent of this paradigm is to improve operational performance, to reduce expenses, to employ assets to their highest use, to create a strategic investment fund, to respond to strategic opportunities, to guide budget development, and to monitor budgets so that performance conforms to specific performance metrics. Keep in mind that the board of trustees is a critical and necessary element of strategy-driven financial management.

How many colleges and universities could avoid being included in the list of institutions that failed to make the threshold value of the U.S. Department of Education’s test of financial responsibility if they had operated under the principles of the strategic-driven financial management paradigm?

Take Away Points
CFOs need to understand the value embedded in the Statement of Financial Position of their institution.CFOs need to know how to use and protect the values in the Statement of Financial Position.Financial management is more than producing a positive net income. It must incorporate management of income flows through the statements of activities, financial position and cash flow. The president, CFO, and other chief administrative officers need to annually review the financial condition of the institution.The CFO needs to develop a five-year forecast model that shows how budgets and other financial decisions affect the financial statements and significant financial metrics for the college.

Supplemental Readings

Townsley, Michael K. (1991). “Brinkmanship, Planning, Smoke, and Mirrors”; Planning for Higher Education; (Summer) Volume 19: 2 pp. 7-32

Townsley, Michael K. (1993). “A Strategic Model for Enrollment-Driven Private Colleges”; Journal for Higher Education Management;  (Winter/Summer) Volume 8, Number 2

Townsley, Michael K. (1994). “Deficit Prevention: Budget Control Model for Enrollment Dependent Colleges”; Business Officer; (October) National Association of College and University Business Officers: pp. 40-44

Townsley, Michael K. (2003)   The Small College Guide to Financial Health (second edition); National Association of College and University Business Officers; Washington, DC

Townsley, Michael K. (2007). “Leveraging facilities for competitive advantage”; In Fennell, M. & Miller, S.D. (Eds.). Presidential Perspectives; Aramark; Philadelphia

Higher Education

Townsley, Michael K. (2007)   Strategic Turnaround Toolbox; National Association of College and University Business Officers; Washington, DC

Townsley, Michael K. (2009) Weathering Turbulent Times; National Association of Colleges and Business Officials: Washington D.C

Salluzzo, R. E., Tahey, P., Prager, F. J., & Cowen, C. J. (1999) Ratio Analysis in Higher Education (4th ed); KPMG & Prager, McCarthy & Sealy, Washington D.C.

Economic Equilibrium

by | May 21, 2022 | Economics and Higher Education

First Published on Stevens Strategy Blog

Strengthening the Financial Condition of an Institution of Higher Education

Abstract: This article explains how to use the principles of economic equilibrium to rebuild, strengthen, and maintain the financial condition of institution of higher education.

Economic equilibrium is a state that defines the long-term financial viability of an institution of higher education. Richard Cyert[1] defined the conditions needed to achieve economic equilibrium as:Introduction

  • The organization fulfills its mission with adequate quality and quantity.
  • The organization maintains the purchasing power of its financial assets.
  • The organization maintains needed facilities in satisfactory condition.

Cyert’s statement of equilibrium is mission driven, which means that the mission can only be assured if an institution can achieve a state of economic equilibrium. How does an institution achieve the Cyert state of equilibrium? Equilibrium requires a financial system that produces sufficient excess revenue so that the purchasing power of financial assets are equal to or greater than inflation and the quantity and quality of plant and equipment accommodates foreseeable changes in their use.

Economic equilibrium requires more than understanding that dollar flows from operations will change net asset balances. Equilibrium is a fragile state that can be lost because of the following: the high cost of operations, uncompetitive tuition rates, loss of revenue from endowments and gifts, imposition of new government regulations, or major changes in student markets.

Boards of trustees must expect more from presidents and chief financial officers than a simple budget that only responds to current financial and economic conditions. They need to insist on financial strategies that achieve a dynamic state of equilibrium which responds to continuing and powerful changes in student markets, competitive forces, technology, government regulations, inflation, financial markets, and other internal and external stresses.

When an institution’s financial condition has eroded to the point where it has very little in the way of cash or financial reserves, developing a strategic plan for dynamic equilibrium is especially difficult. At those institutions, easy decisions such as raising tuition or cutting faculty can be counterproductive if it pushes the college outside its competitive boundaries[2]. As Richard Cyert noted …

“[t]he trick of managing the contracting organization is to break the vicious circle which tends to lead to disintegration of the organization. Management must develop counter forces which will allow the organization to maintain viability.”[3]

Cyert asserted that institutions need to achieve a continuing or dynamic state of equilibrium regardless of size or financial condition because even positive changes like large increases in enrollment can lead to further deterioration or upset a state of equilibrium.

Identifying the Equilibrium Gap

The first step is to identify the gap between the current financial state of the college and a dynamic equilibrium by doing the following:

  1. Close the Purchasing Power Gap for Financial Assets:
    1. If the college is running a deficit, the net present value of deficits for the next five years should be determined (This estimate will entail a forecast of future revenue and expenses adjusted for: internal and external inflation using a compounded rate for the past five years, accrediting requirements, government regulations, and any plans that could increase/decrease costs or revenues.)
    2. If enrollment has been declining and this is expected to increase the deficit, then the estimated value of lost tuition adjusted for inflation should be included.
    3. The net present value of cash and short-term investments that can be easily converted into unrestricted cash should be considered (This estimate needs to be increased for maximum draws on credit lines, and the discount rate would be the rate of change in inflation over the past five years.)
  2. Close the Gap in the Condition of Facilities (three alternative measures):
    1. Measure one: If the college has a maintenance schedule, then adjust each of the gap closing years; let’s assume a five-year plan; then multiply the five-year compounded rate noted in 1(b) times the current gap and follow this pattern by multiplying the rate times the preceding year’s gap closing amount for each of the subsequent years.
    2. Measure two: If the college has an accurate estimate of replacement values for buildings and equipment in its insurance policies, then estimate the future value of the sum for five years, and divide the total by five. This number provides the gap estimate for one year.
    3. Measure three (least accurate): The college takes its depreciation and organizes it by type, identifies the number of years depreciated, estimates the current (i.e., future value) of the items, sums the depreciation for the next five years, and divides by five. This step is the least accurate measure because adjusting depreciation may not fully account for current cost of replacement. Besides, this process is time consuming and assumes that there is an accurate record of when each item was purchased.

Here is a simple template for identifying an equilibrium gap; to discover a dynamic equilibrium gap, the cells in the template must be adjusted for inflation. The adjustment should cover inflation through the five-year compounded inflation rate.

Table I

Equilibrium Gap Template

Gap Category

Gap

Tuition Lost to Attrition

  

Operational Deficit

  

Cash Flow Requirement

  

Credit Line (total amount borrowed)

  

Replacement Value: Infrastructure

  

Replacement Value: Buildings

  

Replacement Value: Instructional Equipment

  

Total Gap

  

Reaching Dynamic Equilibrium

Attaining a dynamic equilibrium calls for a plan that a) avoids an annual gap between the equilibrium state and the actual financial performance of the institution and b) for the long-term, the plan avoids a gap each year for a five-year period. As a rule, colleges and universities should build short-term equilibrium plans that lead to long-term dynamic equilibrium.

There are six critical areas – enrollment, endowment, gifts and grants, auxiliaries, and cost controls – that typically form the framework for building a strategic plan that yields a state of equilibrium. [4] [5] Determining which area or areas should be the basis for a strategic equilibrium plan will depend on what the leadership believes are internal and external opportunities and constraints that shape the options available to the institution.

Enrollment, Recruitment, and Retention is a critical barometer of the financial condition at 75% of the private colleges because it generates more than 60% of their revenue.[6],[7] For most public institutions, enrollment is the single factor that determines their financial condition. Therefore, enrollment is an essential element of any strategic-equilibrium plan that is designed to eliminate the gap between actual performance and equilibrium. The structure of the plan will depend upon the college’s student market, competition, financial aid resources, academic offerings, and upon the willingness of state and accrediting authorities to let it redesign or add new programs to the curriculum.

There are three components (admissions, retention, and alumni) to an enrollment strategy that follow the flow of students through marketing, academic performance, and graduations. The success of admission strategies is contingent upon attracting potential students to apply, pay deposits, enroll, and begin classes.

Attracting new students is subject to a careful communication plan based on a mix of reputation, academic offerings, income, prior academic performance, parental and peer pressure, posted cost, financial aid, and degree of competitive demand for students. Aggressive enrollment campaigns are becoming the norm as colleges and universities pursue new students and “woo” them until they enroll.[8] These hard-hitting campaigns are taking the form that athletic coaches have used to recruit student athletes. Enrollment campaigns identify, track, call, visit, and generally stay on top of potential students until an inquiry is converted into an admitted student who makes a deposit. The campaign does not end there but continues until the prospect is sitting in the classroom.

Keeping students once they enroll and attend college is imperative given the cost of finding and admitting new students. Every student lost before finishing a full course of study forces the college to find a replacement. The result is that new student campaigns have to be devised to produce excess enrollment to offset attrition during the period that the cohort is enrolled. Most students who leave will do so sometime by the end of the first year. There are volumes of studies, plans, and methods for keeping students. Keeping students usually requires a close fit between the student and the institution (student personality, expectations, fears, costs, and needs). Unfortunately, evidence suggests that retention is a function of prior history for incoming high school seniors. If a student did well in high school and has parents who believe that a degree is essential for success in life, then the probability of graduating in a reasonable time is high. If a student did not do well and college is a holding period until they are forced to earn her/his keep, then persistence is low. Unfortunately, for many colleges and universities (public or private), the unmotivated students (the latter group) make up a significant portion of their enrolled students.

Keeping unmotivated students in college is costly and often unsuccessful. In the stream of life, these students may become good students someday when they have worked, begun a family, and now understand the value of a degree and the work needed to earn the degree. Therefore, a good non-traditional program attracting older students can balance the loss of younger, unmotivated students.

Endowment, Gifts, and Grants can play a critical role in most institutions even tuition-dependent colleges because endowments, gifts, and grants may provide extra income to reach budgetary breakeven.

Endowment, gift, and grant plans need to consider the source and cost of eliciting new funds such as, alumni, friends of the college, corporate or foundation grants, and indirect costs from government grants. Calling potential donors or completing a grant application is insufficient; the institution must spend money to make money in these areas.

Auxiliaries cannot be ignored in a strategic-equilibrium plan because they should provide excess revenues to support the institution and cover any debt associated with their fixed costs. Too many colleges and universities overlook net revenues from auxiliary operations. Part of the problem lies in the separation of auxiliary revenue from auxiliary expenses in audits and budget reports, which obscure if they produce gains or losses in net income. It is always surprising to find colleges where residence halls, food services, or bookstores regularly yield deficits.

At a minimum, auxiliaries should cover their direct expenses plus related interest expense and principal payments. If the auxiliary cannot achieve this elementary financial goal, the CFO should devise a plan to align operational performance with this goal. If the institution does not have the resources to effectively manage its auxiliary operations, it should quickly take steps to outsource them without delay.

Cost Controls are essential because institutions can no longer support the assumption that its cost structure and its internal rate of inflation are beyond its control or they will soon discover that finding enough revenue to cover an expanding equilibrium gap is neigh impossible. There are several cost control solutions that are now being used and have proven effective: a) form consortia or outsources to reduce service costs; b) cut down on upper- and middle-level management; and c) monitor costs and identify high expenses that cannot be justified. Colleges will need to become more adept at managing costs if they expect to close equilibrium gaps and maintain a dynamic state of equilibrium.

New Initiatives are vital to devising a successful strategic-equilibrium plan, especially if they promise sufficient scale to quicken the pace to economic equilibrium. Too many presidents and chief administrative officers waste their scarce time tinkering around the edges to get small results from many little ideas when they should focus on projects that can yield large, positive financial results.

A new initiative can take many forms by either producing revenue or cutting costs. For example, major cost saving plans may include outsourcing information technology where a consortium holds the hardware and software, spreads capital costs, and bridges the learning curve for servicing the system that some colleges cannot afford.

A simple list of new initiatives which produce new revenue could include[9]:

  1. Joint ventures, (for instance, between community and four-year colleges);
  2. New legal entities cutting across for-profit and not-for-profit structures;
  3. New sites embedded in a local mall with high volumes of traffic;
  4. Re-engineering administrative processes by replacing offices with administrative networks;
  5. Refinancing debt to reduce interest expenses; or
  6. Devising new academic programs that fit emerging labor markets.

Summary

Strategic-equilibrium plans require constant and regular monitoring of key activities by the board of trustees and president.[10] Monitoring should include monthly reports and benchmarks for admissions, retention, endowment performance, gifts, and new initiatives. Whether plans are working well (and especially when they are not working well) key leaders must be ready to explain how a plan can be revised to reach a dynamic state of equilibrium. In some instances, a “Plan B” must be kept on the back burner, as when the original plan fails to produce results to eliminate the equilibrium gap.[11] A “Plan B” is particularly important at colleges struggling to survive. Their “Plan B” may require soul searching to determine if they can best serve their mission and, in particular, their students through a merger.[12]

Equilibrium is the boundary level for colleges and universities seeking to prosper. By reaching and maintaining equilibrium, the institution should be producing excess revenues that will permit the college to survive unexpected and financially destructive events and to grow to better serve its mission and its students.

  1. Endnotes

    Ruger, A., J. Canary, and S. Land.; (2006); “The President’s Role in Financial Management” in A Handbook for Seminary Presidents; edited by G. Lewis and L.; William B. Erdman Publishing Company; Grand Rapids, Michigan. ↑

  2. Competitive bounds refer to a square in a matrix with price and quality as axes. A specific market is depicted as a smaller square within the matrix which includes potential students who prefer to enroll at a college with a particular level of price and quality. ↑

  3. Cyert, R. (July, August 1978); The Management of Universities of Constant or Decreasing Size; Public Administration Review; p. 345. ↑

  4. The Association of Theological Schools and the Auburn Seminary have made practical contributions on how to reach a state of equilibrium. Several of the six areas – enrollment, endowments, gifts and grants – are recommended by them as paths for developing strategic – equilibrium plans. ↑

  5. Ruger, A. (February 12, 2010); Institutional Viability and Financially-Stressed Schools (unpublished); presented at a conference conducted by the Association of Theological Schools. ↑

  6. JMA Higher Ed Stats (2003); Management ratios 2002 private colleges, universities, catalog #3690103. Boulder, CO: John Minter and Associates. ↑

  7. JMA Higher Ed Stats (2008) Strategic higher education trends at a glance: F2 2002.csv and F2 2007.csv financial data. Boulder, CO: John Minter and Associates. ↑

  8. Hoover, E. (April 30,2010) The Sweet and Subtle Science of Wooing the Admitted; The Chronicle of Higher Education; pp. A1and A17-A18 ↑

  9. Townsley, M. (2002); The Small College Guide to Financial Health. Washington, DC: NACUBO; pp. 157-182. ↑

  10. Ruger, A. (February 12, 2010); Institutional Viability and Financially-Stressed Schools (unpublished); presented at a conference conducted by the Association of Theological Schools. ↑

  11. Ruger, A. (February 12, 2010); Institutional Viability and Financially-Stressed Schools (unpublished); presented at a conference conducted by the Association of Theological Schools. ↑

  12. Townsley, M. (2002); The Small College Guide to Financial Health. Washington, DC: NACUBO; p. 180. ↑