Tools for Building Strong and Vital Colleges

Brown, Edwards & Company L.L.P.

Phone: 603-863-4704

E-mail: Info@StevensStrategy.com

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?