And the Financial Tools You Need to Answer Them
They always say the first step to fixing a problem (or a budget) is to recognize that you have one. As such, my list comes from many years of experience working with both struggling and healthy institutions and taking the best of what I have learned from these experiences.
This list provides information you’ll need to understand if you have a problem and if so, how significant it is. If I were the president or on the board of an institution, I would expect to see every piece of information listed here within the next three months, especially before passing a budget.
- Did we base the budget on the entire picture?
- How much money do we think will come in the door next year?
- How much are we planning to spend?
- Will the combination of these cause us to break even or run a deficit?
It is astounding to me that many institutions only budget and report based on a single ‘operating activity’ fund. This means that they are not looking at all spending, including in restricted funds or other special purpose funds.
If you look at your audited financial statement, focus on the column that says without donor restriction and consider the total expense line. This should be close to what you budget annually and if it is not, you need to understand why.
- Have we reconciled operating net income to cash flow? Will we bring more cash in the door than we are paying out?
This brings me to the next topic — depreciation.
We love to budget for operating activities, excluding depreciation because it is not cash. However, when you report to the outside world, whether it is an audit or the Department of Education, you include depreciation, so you need to understand whether you will be reflecting a deficit or not at your end.
We manage by cash flow, so we add depreciation back in after net income. At that point, we need to subtract other items that cause cash to go out the door, including normal repair, replacement, and payments related to debt principle.
Once you adjust for these items, you should understand whether you have negative or positive cash flow on an operating basis.
- Have we forecast to year’s end? How are we likely to end this year? You should expect to see a forecast to the year’s end on at least a quarterly basis. We spend a lot of time talking about budget to actual variances. Many of those are temporary timing differences or will cause a larger impact by year end. The conversation should be flipped to focus solely on the forecast to year’s end. That way, everyone has a collective understanding of where the institution is likely to end the year. This allows conversation about actions you can take now to change the outcome.
- Did we build out 5-year projections? What will the next five years look like if we continue to do what we are doing now?
With so much enrollment uncertainty, projections for five or more years are critical. I know we get pushback because these are estimates and not exact, but many schools are in a delicate financial situation because they did not look at their future.
These projections should not be at the same level of detail as the budget. You will need to apply inflation factors and cost of living adjustments to most items. You’ll also use the enrollment model from your budget and roll it forward 5 years. This should consider enrollment numbers based on high school graduation predictions and discount rates, overlaying some assumptions around endowment growth and capital purchases. Only then will you get a good sense of your bottom line.
You can refine this along the way, but it’s a real conversation starter when the leadership team and board discuss enrollment and why you believe it will grow despite a decline in high school graduates. Most importantly it helps you orient around the magnitude of the problem rather than focusing on just one year.
- Did we calculate cash and cash reserves (operating liquidity)? Will we have enough cash to fund operations for the next five years?
If there was one number that I would want to know right now as a board member or a president, it would be this number.
This does not need to be an exact calculation. In general, if you take the net assets without donor restriction, and subtract any capital assets and related debt you will have your unrestricted operating liquidity. Think about it, can you sell your campus tomorrow and convert it into cash, likely not. From there, you can separate board restricted (quasi) endowment from funds available for operations to determine if you have already started borrowing without realizing it.
Using this simple mathematical equation enables you to understand why you have cash flow issues. Unfortunately, many small institutions have already begun to borrow from their restricted funds as reflected by negative unrestricted operating liquidity.
This calculation is critically important for any institution that runs deficits because it helps you understand how much runway you have left.
Institutions often reach out to me for help with restructuring. One of the hardest messages I deliver is when I let an institution know they have already borrowed 50% of their endowment without realizing it. It is almost impossible to recover from this unless there is a major donor investment or some other windfall. This can easily be demonstrated by some of the current and recent closure announcements. The time to focus on restructuring the institution is before you start to dip into the endowment.
The biggest flaw with the Department of Education calculation is that it allows us to add back the temporarily restricted unspent funds related to endowment. This is why so many institutions end up closing suddenly. They didn’t realize they were spending against this restricted balance.
- Can we right-size our institution?What can we startdoing now to be financially sustainable five years from now? This is where the real work begins.
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Photo by Laurin Steffens on Unsplash