Tools for Building Strong and Vital Colleges

1. Tools for Building Strong and Vital Colleges Brown, Edwards & Company L.L.P. Presented June 6, 2003 by Michael K. Townsley, Ph.D. E-mail: Info@StevensStrategy.com Phone: 603-863-4704

2. 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

3. 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

4. The Broad Perspective Among Private Colleges and Universities

5. Narrowing The Focus

6. $200,000,000 $150,000,000 FY 1997 FY 2000 $100,000,000 FY 2000 $50,000,000 $0 $0 $50,000,000 $100,000,000 $150,000,000 $200,000,000 FY 1997 Value Of Net Assets 1997 and 2000

7. 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%.

8. 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.

9. 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.

10. 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.

11. 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.

12. 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.

13. 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.

14. 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

15. Simple Trend Diagnosis:Operational Drivers • 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

16. Simple Trend Diagnosis:Working and Permanent Capital • 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

17. 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 losses plus 4.5% of prior year investments minus 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%?

18. 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%?

19. Ratios, Questions, and Benchmarks: Permanent Capital • 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?

20. 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

21. 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%

22. 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

23. Computing CFI:Net Income Ratio = A/B Where A = Operating Income + unrestricted operating revenue - unrestricted operating expenses + total unrestricted revenues and gains+ net assets released from restriction And B = Total Unrestricted Operating Income

24. Computing CFI:Return on Net Assets Ratio = A/B Where A = Change in Net Assets And B = Total Net Assets (beginning of year)

25. 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

26. Computing CFI:Strengths and Weights

27. Computing CFI: Scoring Scale

28. Sample Trends and CFI Scores -Hot Shot College

29. CFI Ratio Summary: Strengthsand Weights - Hot Shot College

30. Sample Financial Trends and CFI Scores - Bear College

31. CFI Ratio Summary: Strengths and Weights - Bear College

32. 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

33. 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.

34. 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.

35. 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.

36. 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

37. 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.

38. 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.

39. 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.

40. 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?