Financial sustainability is for life, not just for the tricky times

Financial sustainability is about more than institutional reserves. Margaret Daher and Marc Finer set out the green flags that indicate whether a university is set up to weather financial storms for the long term

Margaret Daher is Director, Education, Skills and Productivity for KPMG in the UK

Marc Finer is a Director of Debt Advisory at KPMG.

The latest assessment from the Office for Students (OfS) of the financial sustainability of universities in England suggests that in all but a very few cases universities are not in any short term danger of collapse.

That’s cold comfort when you assess OfS’ list of medium to long term risks to financial sustainability: inflation, reliance on international student recruitment and/or optimistic projections of prospects for home student recruitment, rising cost of living for staff and students, and the need to invest in facilities and environmental policies. These challenges are not England-specific; across the UK universities are facing the prospect of continuing to achieve their missions under considerable cost pressures.

There are always potential storms on the horizon

While particular pressures on cost of living and inflation are specific to the current moment, and mean that there is wider interest in, and concern about, university financial sustainability – particularly when it comes to negotiations over pay rises for university staff – the broad picture of there being financial risks over the horizon is actually fairly standard for a sector that is majority financed from public sources, whether directly from government in the form of grants and project funding, or from subsidised student tuition fees.

The scale of inflation varies but inflation is always a factor, which means that a university that is not increasing its income, however modestly, is at some point going to have to start cutting to balance its budget. History suggests that government appetite to review the funding settlement to universities is variable at best – it’s good when it happens but it’s not to be relied upon. That’s the case whatever the nature of the funding architecture.

The secret to financial sustainability is not bracing for radical change when things get desperate – closing courses, divesting estate, or restructuring professional services. The hit to morale and reputation when universities get into serious financial trouble is far too significant for any university leader to want things to get that far. Ideally, every university should be making regular assessments of its financial sustainability and being prepared to make changes and adapt in light of the findings to sustain its mission and objectives.

While it’s tempting to defer the prospect of introducing changes that might be unpopular for another day – especially where the university is no immediate financial danger – there is a risk that issues that look small now could spiral, or that when a serious risk materialises – such as a major policy change – the university does not have the strong foundations needed to weather the storm.

One thing it’s always essential to keep a close eye on are the obligations placed on a university by its lending agreements. If there is a risk that a university’s financial performance might breach financial covenants – conditions within loans aligned to financial performance indicators – or if planned financial sustainability initiatives like asset sales are prohibited – loan terms might need to be renegotiated to enable a change in strategic direction and ensure ongoing support from lenders.

Even those universities that are very financially stable will want to think about whether the current operating model can continue to deliver income at the scale required to support the university’s ambitions, for example, to expand research capacity or achieve environmental sustainability objectives.

What financial sustainability looks like

Understanding university financial sustainability isn’t simply a question of looking at the institution’s balance sheet or HESA finance indicators – though these can give a useful snapshot of the university’s financial state at a moment in time. It’s a much more nuanced assessment of factors like how creditworthy the university is, how diverse and reliable its income sources are, the extent of its liabilities for maintaining its estate, and the scale of its investment ambitions.

No university should rely on the HESA finance indicators to generate key performance indicators for financial sustainability – these should be tied closely to the specific ambitions of the university and its own internal assessment of the scale and nature of the risks it faces to achieving those ambitions.

In our work with universities we’ve observed some “green flags” – signs that a university has thought carefully about its financial sustainability and made informed choices about its long term future.

A diverse and balanced student recruitment portfolio. This applies across home and international recruitment, and the range of modes, programmes, and subject areas on offer. Sometimes, especially in new or emerging disciplines or modes of study, universities need to place a calculated “bet” on a new way of doing things. Some will work, others will not – the key is – to continue the metaphor – to spread the bets so that the institution is not over-reliant on one or two areas being sufficiently successful to prop up all the others.

International is a particular current area of risk: the sector is arguably too reliant on international students across the board, but institutions that tend to recruit from only a few or even one country, are in a riskier situation than those that are not. One under-appreciated aspect of the risk here is that the students who may have hoped for an international experience are disappointed to find themselves surrounded by other students from their own country. Word gets around and the university’s market share dwindles.

Financially sustainable universities have recruitment strategies that span a range of countries and programmes, and maintain a watching brief on the current performance and prospects of each of the constituent parts of their portfolio so that if one area becomes more challenging others can pick up the slack.

Growth plans that account for costs and do not compromise quality. Pursuit of increases to income are not sufficient to generate sustainable growth – the cost of growth has to be taken into account as well. Apprenticeships are a good example of a relatively new income stream that comes with high overheads in terms of set up costs, regulatory oversight, and ongoing administration. The margins do not have to be enormous to be sustainable – and there may be good reasons relating to less tangible value for doing some activities, or they may be understood as mission-critical and worth a long term subsidy – but it’s important to recognise this. Top-line growth at scale – for example through rapidly increasing student recruitment – can generate headlines and a good-feeling sense of momentum, but if growth is pursued at risk to quality, or student outcomes, then the reputational hit may end up costing the university more than was brought in through growth.

Manageable growth targets. There’s no shame in setting stretching targets or occasionally falling short due to unanticipated circumstances – nobody is omniscient, and targets can be adjusted if new information comes to light. But if a university is consistently failing to hit its targets then there is a deeper issue with the quality of the forecasts – the university may be over-estimating the strength of its own brand, or unaware of a specific drag factor that means its targets just aren’t deliverable – for example, a lack of resourcing somewhere in the system that’s slowing things down. Far better to set modest targets and meet or exceed them – there’s no imperative to grow if the university is able to achieve its ambitions within the current operating model.

Operational clarity supporting evidenced decisions. It should be possible to define the unit of analysis when calculating the financial sustainability of different parts of the institution and have a well-understood way of making that calculation. For example, a university might want to assess whether each of its programmes is generating a surplus. That’s surprisingly hard to do when units or modules might feed into lots of different programmes, or administrative costs might be counted in some contexts, but not others. This needn’t be about targeting programmes for closure – again, there could be some very mission-critical reasons for choosing to subsidise a loss-making programme – but the occasionally-ingrained habit of hiding or moving around expenditure to make some aspect of university activity look more healthy than it actually is doesn’t enable informed decisions to be made.

Granular, costed plans with clear objectives. Everyone is familiar with the project that ends up costing twice what was anticipated – sometimes because of external factors like the rising cost of materials for building work – but often because as more and more people get involved and hope the investment will deliver on their particular concern the objective shifts and the brief gets revised. Financially sustainable universities know exactly what they are trying to achieve, have taken into account the costs of delivering it as far as possible, have a clearly communicated vision of how the project relates to the institution’s wider objectives, and are ruthless about sticking to that. Managing change, the coordination of decision-making around plans and change projects, and the evaluation of benefits and return on investment requires resourcing – it’s not something that can be built into business as usual.

Deep analysis of emerging issues. When part or whole of an institution looks financially wobbly, the university community looks to its leaders to explain what’s happening and how the university will be put on a more sustainable footing. Kneejerk reactions such as a temporary hiring freeze or tweaks to operations or local strategies might mask the issues for a bit longer, but only in-depth analysis of the nature of the sustainability challenge and the scale of the risk involved can create the conditions for university leaders to align on and commit to a set of priorities for addressing it. Sometimes this can be painful, as it involves challenging long-held assumptions about value(s), and navigating power dynamics among the various influential people and groups inside an institution. So it’s always better to do the work when the challenge is emergent and (hopefully) more manageable than when it has become overwhelming.

Every institution faces difficult financial headwinds, and risks to financial sustainability rise and fall with the policy environment, student demographics and demand, and the state of the economy. Safeguarding financial sustainability is therefore not a sign of concern as much as it is a sign of strength.

Debates on campus may focus on whether a particular decision is appropriate or necessary within the context of the university’s current financial circumstances. But the reality is that long term sustainability means making decisions in light of careful assessment of future risks. Waiting until a risk has manifested to implement a change of direction is too late.

This article is published in association with KPMG. Click here to find out more about how KPMG can support your university on financial sustainability.

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