Tools for Building Strong and Vital Colleges
Brown, Edwards & Company L.L.P.
Phone: 603-863-4704
E-mail: [email protected]
Presented June 6, 2003
by Michael K. Townsley, Ph.D.
Workshop Schedule 9:15 am to 9:45 am Introduction and Major Issues
9:45 am to 10:45 am Session 1 – Fundamentals
10:45 am to 11 am Break
11 am to Noon Session 2 – Diagnostics
Noon to 1pm Lunch
1pm to 2:15 pm Diagnostics and Case Studies
2:15 pm to 2:30 pm Break
2:30 pm to 3:45 pm Financial Strategy
3:45 pm to 4:30 pm Questions and Discussion
Private Colleges: Contribution & Challenges
Private colleges are the foundation for the greatest system of higher education in the world.
Challenges to private colleges include:
Changes in demographics Size Flow of resources and the economy Relationship between costs and tuition Competition
The Broad Perspective Among Private Colleges and Universities
Students Small(< than 2,000)
Moderate(2,000 to 3,000)
Large(> than 3,000)
Institutions 554 152 238
Percent of Category 58.7% 16.1% 25.2%
Total Enrollment 597,867 367,670 1,734,822
Percent of Category 22.1% 13.6% 64.2%
Typical Carnegie Class
Liberal Arts Liberal Arts Comprehensive
Percent that Grew 64.9% 71.1% 63.8%
Percent that Shrunk
29.4% 28.9% 36.1%
Percent that Closed 5.4% 0.0% 0.0%
Growth Rate .65% 1.5% 1.0%
Growth Volatility 8:1 1.9:1 2.5:1
Net Income 0.2% 1.1% 1.4%
Net Income Volatility
19.2:1 2.9:1 1.8:1
5 Years of Deficits 30.2% 13.4% 17.0%
Narrowing The Focus
Enrollment Categories
Enrollment <500501 to 1,000
1,001 to 2,000
2,001 to 3,000
3,001 to 5,000
>5,000
Average Enrollment
326 750 1,470 2,443 3,803 10,253
Enrollment Change
-9% -2.4% -0.2% 1.2% 4.9% 1.1%
Undergraduate Percent
94% 94% 90% 84% 74% 64%
Retention Rates 69% 69% 77% 79% 80% 85%
Graduation Rates
46% 46% 60% 63% 60% 67%
Student Faculty Load
14:1 18:1 20:1 23:1 29:1 36:1
Operating Margin
-11.2% -6.3% -8.62% -5.27% 4.09% 1.66%
Value Of Net Assets 1997 and 2000
$0
$50,000,000
$100,000,000
$150,000,000
$200,000,000
$0 $50,000,000 $100,000,000 $150,000,000 $200,000,000
FY 1997
FY
200
0
FY 1997
FY 2000
Major Challenges Facing Private Colleges: Money Woes
Endowments and endowment draws have declined significantly.
Wealthy donors are too stressed financially to give or are cutting their gifts.
Parents are hit hard by loss of savings or investments.
Financial aid takes more of each new dollar.
For 20 years sticker price has grown faster than inflation.
Twenty years ago sticker price took 57% of disposable income; now sticker price takes 82% of disposable income.
Net price has gone from 59% of disposable income to 72%.
Major Challenges Facing Private Colleges: Impact of Technology
In the 1980s, ratio of equipment to building expenditures was 1.3 to 1. By 1990s, ratio of equipment to building expenditures had exploded to 8 to 1. Bad news is that technology has yet to produce major cost savings in higher
education.
Building Cost/Student Vs. Equipment Cost/Student
0
50
100
150
equip/stnt
bldng/stnt
Major Challenges Facing Private Colleges: Competition
Many colleges lack the discounting power to snag high-end students.
New for-profit colleges and convenience colleges are gobbling market share.
Colleges may lose their cash cow, Continuing Education, to for-profits and convenience colleges.
Major Challenges Facing Private Colleges: Debt
Many private colleges do not have access to the public debt market.
Local financial agencies are the main source of debt financing.
Most tuition dependent colleges must rely on enrollment growth to finance debt – Enrollment declines can push them over the brink!
Colleges’ use of gifts or endowments to finance debt may be dangerous.
The Big Picture
Small colleges (fewer than 1,000 students) have more problems building enrollment and retaining students.
Small colleges tend toward operating deficits.
Small colleges have a greater chance of suffering a string of deficits.
Small colleges see more volatility in net income and enrollments.
Basic Strategic Principals Robert Lenington: A strategic plan must be “ . . . market-
oriented and . . . contain alternatives to a market position that goes awry.”
George Dehne and The Noel Levitz Group: “A college must know itself and its competitors.”
Colleges must understand the following basic principals:
Potential students and their parents want quality education.
Students depend on colleges to know the labor market and offer relevant training.
Potential employers want skilled employees.
Colleges must integrate academics and market strategy with financial strategy.
Diagnostics What is the financial condition of the college?
What tools can the college use to determine financial condition?
Trends show how the financial or operational conditions of the college change over time. Is the college building, depleting, or maintaining its financial resources?
Ratios indicate how two or more financial factors are related.
Benchmarks act as references against which to compare the financial condition of the college. References can include goals, peers, or competitors.
Sources of Benchmarks – John Minter & Assoc., NACUBO, Moody’s.
Simple Trend Diagnosis: Operations
Trend in operating net Trend in total net assets Trend in net tuition Trend in revenue and expense growth
rates Trend in compensation How is each new dollar spent? Trend in auxiliary net income
Enrollment, graduation & attrition by level & program
Average class size and student/faculty ratio Number of classrooms and space Employee census by type Cost per employee by type Expenditures on instructional equipment Deferred maintenance
Simple Trend Diagnosis:Operational Drivers
Cash and short-term investments Cash/expenses Uncollectible receivables Short-term liabilities/expenses Questions:
Are students billed monthly? Do you have a collection policy? Do refunds fit government regulations? Are vendors, taxes, and benefits paid on time?
Endowment, debt, and components of net assets
Simple Trend Diagnosis:Working and Permanent Capital
Ratios, Questions, and Benchmarks: Operations
Operating Ratios (five-year trend)
Net Tuition = net tuition divided by total tuition
Annual Operating Margin = total unrestricted revenue minus gains and lossesplus 4.5% of prior year
investmentsminus operating expenses divided by operating
revenue
Operating Ratios Questions or Benchmarks
Is the net tuition ratio increasing or decreasing? Is the annual operating ratio slope positive or negative? Is the annual operating ratio equal or greater than 1.7%?
Ratios, Questions, and Benchmarks: Working Capital
Working Capital (Five Year Trend)
Cash Expense Ratio = cash and short-term investments
divided by total expenses
Current Ratio = current assets divided by current liabilities
Uncollectible Receivables = uncollectible receivables
divided by receivables
Working Capital Questions or Benchmarks
Is the cash/expense slope positive or negative? Is the cash/expense ratio equal or greater than 8.0%? Is the current ratio equal or greater than 2:1? Is the uncollectible receivables ratio more than 1.5%?
Permanent Capital
Debt Leverage Ratio = net assets divided by total long-term
debt
Free Expendable Resources to Net Assets = unrestricted net assets
plus temporarily restricted net assets
minus net plant minus direct debt divided by total net assets
Permanent Capital Questions or Benchmarks
Is debt leverage growing or declining? Why? Is the debt leverage ratio equal or greater than 2.0:1? Is the free expendable resources ratio growing or declining? Why? Is the free expendable resources ratio equal or greater than 2.0:1?
Ratios, Questions, and Benchmarks: Permanent Capital
Consolidated Financial Index (CFI)
The CFI Monitors Four Critical Measures of Financial Risk
Operational Risk Short-Term Risk Risk to Production of Wealth Long-Term Debt Risk
CFI Ratios Primary Reserve Ratio measures Operational Risk
Ratio: expendable net assets divided by expenses Benchmark: greater than .15
Net Income Ratio measures Short-Term Risk Ratio: net operating income divided by operating revenue Benchmark: 2% to 4%
Return on Net Assets Ratio measures Risk to Production of Wealth
Ratio: change in net assets divided by total assets Benchmark: greater than inflation
Viability Ratio measures Long-Term Debt Risk Ratio: expendable net assets divided by long-term debt Benchmark: 1.25% to 2%
Computing CFI:Primary Reserve Ratio = A/B
Where A = Total Expendable Net Assets
+ unrestricted net assets+ temporarily restricted net assets- property, plant, equipment (net of depreciation)+ long-term debt
And B = Total Expenses
+
+
-
+
A B
Computing CFI:Net Income Ratio = A/B
Where A = Operating Income
+ unrestricted operating revenue- unrestricted operating expenses
+
-
A B+
++ total unrestricted revenues and gains+ net assets released from restriction
And B = Total Unrestricted Operating Income
Computing CFI:Return on Net Assets Ratio = A/B
Where A = Change in Net Assets
And B = Total Net Assets (beginning of year)
A B
Computing CFI:Viability Ratio = A/B
Where A = Expendable Net Assets
+ unrestricted net assets+ temporarily restricted net assets- property, plant, equipment (net of depreciation)+ long-term debt
And B = Long-Term Debt
+
+
-
+
A B
Computing CFI:Strengths and Weights
Ratios
To Find Strength, Divide
Ratio by
To Find Weight, Multiply Strength
by
CFI Scoring
Primary Reserve
0.1333 0.35 +
Net Income- Operations
0.007 0.10 +
Return on Net Assets
0.02 0.20 +
Viability 0.417 0.36 +
CFI SCORE
Computing CFI: Scoring Scale
Scale Level
CFI Scoring Range
ACTION
One -1 to 1 Assess viability – Can the college survive?
Two 0 to 2Reengineer the institution.
Three 1 to 3
Four 2 to 4Direct resources toward transformation.
Five 3 to 5
Six 4 to 6Focus resources to compete in the future.
Seven 5 to 7
Eight 6 to 8 Experiment with new initiatives.
Nine 7 to 9Experiment with initiatives. Design a robust
mission.
Ten > 9 Deploy resources to achieve a robust mission.
Sample Trends and CFI Scores -Hot Shot College
Ratios Benchmarks
1998 1999 2000 3-year change
1-year change
Enrollment and Class Size
Enrollment Growth Rate Positive 712 902 945 15.2% 4.8%
Financial Operations
Net Tuition Margin 21 Positive 6,327 6,891 7,722 10.5% 12.1%
Annual Operating Margin 17 1.69% 6.6% 0.3% 1.7% -5.0% 1.4%
Revenue/Expense Equilibrium
Positive 1.07 1.00 1.02 -0.05 0.01
Working Capital
Cash Income Ratio 22 7.54% 2.8% -4.3% -4.7% -1.9% -0.4%
Uncollectible Receivables 27 <1.5% 0.0% 0.0% 0.0% 0.0% 0.0%
Debt
Debt Leverage Ratio KPMG >2:10 1.61 1.24 1.3 -0.31 -0.31
Long-Term Assets
Composition Ratio 35 >1.00 0.48 0.41 0.46 -0.02 0.05
Return on Net Assets 40 2.0% 7.3% 1.5% 5.3% -2.0% 3.8%
CFI Ratio Summary: Strengthsand Weights - Hot Shot College
RatiosStrength
Divide Ratio
by
Weight Multiply Strength
by
CFI Scoring
1998 1999 20001998
1999
2000
Primary Reserve
30.6%
17.7%
50.0%
0.1333 0.35 0.81 0.47 1.31
Net Income-Operations
6.6% 0.3% 1.7% 0.007 0.10 0.95 0.04 0.24
Return on Net Assets
7.3% 1.5% 5.3% 0.02 0.20 0.73 0.15 0.53
Viability78.7
%44.2
%1.4% 0.417 0.36 0.69 0.39 1.24
CFI SCORES 3.18 1.04 3.33
Sample Financial Trends and CFI Scores - Bear College
Ratios Benchmarks
1998 1999 2000 3-year change
1-year change
Enrollment and Class Size
Enrollment Growth Rate Positive 1,971 1,806 1,766 -5.3% -2.2%
Financial Operations
Net Tuition Margin 21 Positive 11,259 11,396 11,190 -0.3% -1.8%
Annual Operating Margin 17 1.69% 17.5% 3.6% -0.1% -17.7% -3.7%
Revenue/Expense Equilibrium
Positive 1.21 1.04 0.89 -0.32 -0.15
Working Capital
Cash Income Ratio 22 7.54% -7.8% 1.1% -2.2% -10.0% -3.3%
Uncollectible Receivables 27 <1.5% 22.2% 19.6% 26.7% 4.5% 7.2%
Debt
Debt Leverage Ratio KPMG >2:10 33.87 34.90 1.99 -31.88 -31.88
Long-Term Assets
Composition Ratio 35 >1.00 3.14 3.02 0.85 -2.29 -2.16
Return on Net Assets 40 2.0% 23.8% 3.9% -12.7% -36.5% -16.6%
CFI Ratio Summary: Strengths and Weights - Bear College
RatiosStrength
Divide Ratio
by
Weight Multiply Strength
by
CFI Scoring
1998 1999 2000 19981999
2000
Primary Reserve
88.0% 76.3% 70.7% 0.1333 0.35 3.64 3.16 1.86
Net Income-Operations
17.5% 3.6%-
12.4%0.007 0.10 3.76 0.76 -1.77
Return on Net Assets
23.8% 3.9% -12.7 0.02 0.20 3.58 0.59 -1.27
Viability n/a n/a 1.6 0.417 0.36 0.00 0.00 1.41
CFI SCORES 10.97
4.51 0.23
Building Your College’s Strategic Plan
Basic rules Use trends to identify what is changing, favorably or
unfavorably. Use ratios components to identify where change is taking
place. Use CFI as a guide to determine the depth of necessary
changes. Use benchmarks to compare and identify relative standing. Identify gaps – Where are you now and where do you want to
be?
What has to change? operational drivers, i.e., enrollment, faculty ratios, staffing net income, working capital, or structure of permanent capital systems, i.e., academic delivery, administrative, services,
maintenance
Building Your College’s Strategic Plan
Lay out your strategic action plan. Determine what must be done, who should do it, and when
changes should occur. Integrate academic, marketing, and capital strategies with
the larger strategic plan. Have contingencies in place. Implement the plan.
Determine the major components of your monitoring plan.
Be sure the strategic action plan is endorsed and supported by the President, the Board, and your colleagues.
Convey your plan to the college community.
Guidelines For Financial Strategy
Generate positive operating margins—including depreciation.
Balance revenue and expense growth rates. Build financial and cash reserves. Track uncollectible receivables. Minimize debt by funding all or a major portion of
capital expenses. Require that auxiliaries generate positive net
income after depreciation. Maintain a CFI greater than three. Institute a disciplined budget and accounting
system. Use trends, ratios, and benchmarks to spot
changes in financial or operating conditions.
Competitive Analysis A competitive set of colleges will shape market demand,
costs, and pricing. Understand your college’s place in the market.
Know the competition.
Interview applicants who chose competitors.
Get intelligence on the competition’s pricing and tuition discounting practices, marketing strategy, advertising tactics, new programs, and financial and cost structure (Form 990).
Anticipate how competitors could distort your college’s plans and forecasts.
Monitoring Systems Develop a dashboard of critical financial and
institutional data. Track trends quarterly and annually Install tough budget controls Know the danger signs:
increasing debt load declining enrollment shrinking cash reserves expanded use of credit lines loss of market share budgets that fail to match actual performance taxes or benefits not paid on time
How To Avoid Strategic Mistakes
Do the data. Good data is a prerequisite for good strategy.
Involve critical segments of the college. Instruction, student services, and finance
departments must interact. Be realistic about goals.
A poor or invisible college cannot become a Cinderella overnight.
(It just might need a rich prince to transform it.) Find alternatives, and test them.
Explore way beyond the obvious, resisting the urge to implement the first plan that comes to mind.
Make managers accountable. Passing the buck will impoverish the strategy.
How To Avoid Strategic Mistakes
Measure performance. Establish criteria for measuring performance in all
departments. Back up criteria with a timetable.
Monitor progress. Assume nothing—establish formal monitoring
systems. Review and revise regularly.
Annual strategic review meetings should be supplemented as necessary throughout the year.
Support the plan with policies and procedures. A toothless plan is a worthless plan.
Include options in the plan. Allow for the unexpected.
Suggested Readings
Ronald E. Salluzzo and Philip Tahey, Frederic J. Prager, and Christopher J. Cowen. (1999). Ratio Analysis in Higher Education. 4th edition. KPMG and Prager, McCarthy & Sealy, LLC.
Moody’s Investors Service. Moody's Rating Approach for Private Colleges and Universities. New York.
Moody's Investor Service. Private Colleges and Universities: Outlook and Medians. New York.
Townsley, Michael K. (2002) The Small College Guide to Financial Health: Beating the Odds. Washington, DC, NACUBO.
Questions & Discussion
What effects has the three-year economic downturn had on your college?
Where do you see your college in five years? What are the biggest challenges facing your
college over the next five years? What are the biggest challenges facing the
finance office over the next five years? What are the biggest challenges for the next
fiscal year? Will you have to make changes? Do you now conduct strategic planning? How successful is your strategic planning
process?