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Granting a Better Bottom Line

Focusing on grants and endowments, the Kansas City Art Institute moved from a history of accumulated deficits to a steady record of balanced budgets.

By Ronald Cattelino

Although the college had undertaken several financial initiatives before Collins’s arrival, she and the board of trustees became true champions of fiscal discipline. As a result, KCAI—one of 35 private colleges of art and design in the United States—moved from a position of instability and debt to one of sustained financial stability and strength in little more than 10 years.

As a result, by FY07—with an all-time high of approximately 665 art and design students from all over the world—KCAI’s enrollment had increased nearly 20 percent since FY96. During that same period, the operating budget grew 54 percent (see Figure 1, Kansas City Art Institute Financial Snapshot) and total net assets registered a 370 percent increase.

Another bright spot: cash flow. The institute ended FY07 with nearly $6 million in cash, compared to nearly $1 million in cash 11 years earlier. In addition, the college invested $27 million in campus improvements, while building its endowment from $9 million to more than $30 million. 

Painting this brighter financial picture called for tough decisions, innovative thinking, and persistence—not to mention leadership from the board and staff. In particular, Charles J. Egan, Jr., a local business executive and the board’s treasurer for nine years, joined Collins in keeping the college focused on finances.

KCAI’s leaders took systematic actions to strengthen the institute’s financial position, with an initial grant as one of the first strokes on the canvas.

Eliminate Accumulated Deficit

In 1994, KCAI had an operating budget of $9 million and an accumulated deficit that resulted in a net current liability position of almost $2 million. That bleak financial reality prompted the college to apply for a grant from the former National Arts Stabilization Fund (NASF). (Now known as National Arts Strategies, the organization today focuses on leadership development and executive education for arts and cultural organizations.)

KCAI received the maximum award of $1 million. The amount came in the form of a challenge grant: $500,000 to eliminate the college’s net current liability position and—provided the college met the challenge—an additional $500,000 to establish a working capital reserve fund.
 
The NASF grant came with other stipulations. It required the art institute to prepare and periodically update a five-year strategic plan; reduce its net current liability position from $1,943,000 to $500,000; maintain its net current asset position after the first year of the grant; and provide monthly and annual financial reports.
 
The challenge grant proved a critical first step in building credibility with local funders. Throughout 1994, the trustees solicited donations from a small circle of individual donors and foundations, emphasizing the college’s opportunity to retire its deficit by meeting the NASF challenge. The grant also triggered a $1 million match from a local foundation.
 
In total, the college raised $1.5 million in extraordinary restricted gifts from local foundations. This not only met the NASF challenge but also enabled KCAI to reduce its net current liability position to $500,000. By meeting the financial goals stipulated by NASF, the institute received the additional $500,000 in grant money and reduced its net current liability position to a net current asset position.

Operate With a Balanced Budget

Collins built on this momentum by spearheading revisions to KCAI’s strategic plan in 1997. A key part of the strategy: The institute embarked on a belt-tightening mission, one that ultimately reduced expenditures by $1.1 million—10 percent of the operating budget—over five years. This was accomplished by reducing departmental budgets across the institution, both for salary and nonsalary items, all with an eye toward preserving the quality of the academic product. Administrative areas took larger cuts than academic areas.
 
In addition, KCAI restricted increases in faculty and staff salaries. For six years, from 1997 to 2003, annual salary increases ranged from 2 to 3 percent. In one year, the increase came in the form of a lump sum and wasn’t added to base salary; in another year, the institute eliminated salary increases altogether.

During this same period, the college doubled—and met—its annual fund goals. In the mid-1990s, the annual fund generated between $650,000 and $700,000 per year. In 2001, proceeds broke the $1 million mark; and, since 2002, the annual fund has generated approximately $1.4 million each year.
 
The commitment and active involvement of the college’s trustees helped bring about this transformation. Board Chairman Charles Sosland was relentless in soliciting gifts from fellow board members, who responded to Sosland’s—and the college’s— requests for increased gifts. A local foundation provided an additional incentive: If KCAI significantly increased its annual fund in FY02 and FY03, the foundation would provide a $250,000 topping grant in each of those years. The college met this aggregate $500,000 challenge.

Generate an Annual Surplus and Maintain Reserves

Strategic planning sessions in 1997 also pointed to the need to operate the college with a consistent surplus—thereby matching operating revenues with operating expenditures—and to slow the growth of the operating budget. The college aimed for this financial goal: The working capital reserve fund should equal 10 to 25 percent of operating expenses.

Thanks to operating surpluses since 2000—plus a balanced operating budget and no more accumulated deficit—the college’s cash flow has improved significantly. In fact, KCAI has not borrowed any funds for operations from its $3.5 million line of credit since November 1999. It ended FY 2007 with just under $6 million in cash—a $5 million increase since 1996 (see Figure 2, Statement of Financial Position).

Issue Tax-Exempt Bonds

Investing $27 million in campus capital projects seems unlikely to happen during a period of financial recovery. Yet, KCAI was able to upgrade its facilities while finding its financial footing by taking a dual approach—dovetailing a capital campaign with tax-exempt bond issues.
 
Like many colleges, KCAI in the 1990s needed to replace or renovate many of its campus facilities to stay competitive and to serve the students it was working so hard to attract. In FY93, the college received a $75,000 grant from a local foundation to create a campus master plan. This grant served as the impetus for securing some immediate funds for deferred maintenance and set the stage for major replacements and renovations.

By 1999, the college embarked on a capital campaign that raised sufficient funds to give the college enough financial strength to issue tax-exempt bonds. Based upon its 75-year relationship with KCAI, a local bank provided a letter of credit that enabled the college to issue $10 million worth of tax-exempt bonds with a 30-year bullet (payment of interest only for the first 29 years). KCAI paid off these bonds, issued through the Health and Educational Facilities Authority of the State of Missouri, four and one-half years later.
 
The bond issue and capital campaign did not conflict with one another. They were, in fact, complementary. The very existence of the capital campaign permitted the bond financing to proceed on extremely favorable terms. In our experience, the capital market (investors, credit enhancement providers, and rating agencies) looks favorably upon borrowers who conduct capital campaigns in conjunction with a bond issue.

Financing major capital improvements through tax-exempt bonds offers at least three advantages. In our case, this approach:

  • provided the lowest interest rates available. The interest rate was tied to a daily floater, which historically had averaged around 4.5 percent, including ongoing annual mandatory fees.
  • required the payment of interest for the first 29 years, with the principal amount of $10 million due in the 30th year. (In fact, the college paid back the principal in less than five years.)
  • accelerated the completion of campus improvements. KCAI did not have to wait for the receipt of funds from multiyear pledges.

In 2005, inspired by the positive outcome of the 1999 bond issue, the college embarked on another capital campaign. Donors’ generosity provided the financial strength for the college to again issue tax-exempt bonds, this time in the amount of $10.5 million with a 30-year bullet.

Set Goals for Endowment Growth and Spending

When KCAI revised its strategic plan in 1997, several budgetary issues identified during the planning process related to the college’s endowment. One of the financial goals articulated at that time was that the endowment fund should equal 200–400 percent of operating expenses.
 
Another goal was to develop an endowment spending policy, to provide for both short-term and long-term viability of the endowment fund. Specifically, the adopted policy calls for spending 4 percent of the trailing 12 quarters’ market value.

Once it had an endowment spending policy in place, KCAI focused on increasing its endowment beyond the 1994 total of $9 million.

Significant growth had already taken place in 2005, when, during the tenure of board chair Herb Kohn, KCAI approached a longtime trustee about making a significant gift to the endowment. The trustee suggested making the $10 million gift a challenge, which called for the college to raise an additional $10 million by 2010.

By June 30, 2007, thanks in large part to the endowment challenge grant and donor response, the college’s endowment totaled more than $30 million. When the match is complete, the college’s endowment will reach $40 million, approximately twice its previous amount. Trustees involved in raising the matching funds—from nearly 50 individuals, foundations, and corporations that already had a relationship with the institute—believe KCAI’s strong financial picture was a key factor in their ability to persuade donors to participate.

Positive Indicators

By taking the actions described, the college steadily progressed toward a stronger financial position. In fact, seven years of balanced or surplus budgets enabled the board of trustees to designate a reserve fund for unanticipated expenditures. This recently established fund is equal to 10 percent of the college’s annual operating budget. Intended as a cushion for a financial shock—such as an enrollment drop-off or a complete technology breakdown—the fund cannot be used for compensation or capital purchases.
 
Once it had achieved the turnaround, in 2006 the college commissioned a compensation study. In 2007, the board of trustees approved an ambitious, three-year compensation plan for faculty and staff. The allocation of $1.2 million of new money for faculty and staff salaries demonstrates a commitment to recruiting and retaining dynamic faculty who contribute to the college’s learning community. This includes efforts made not only during studio or classroom instruction but additional dedication to professional scholarship and community service and outreach.

Created in collaboration with consultant Marc Wallace of Teacher Excellence through Compensation, the plan:

  • establishes explicit salary ranges for each faculty rank;
  • sets the minimum faculty salary at the middle of the market (that is, the 50th percentile of benchmark competitive institutions);
  • allows for growth in faculty salaries within range based on merit; and
  • maintains competitiveness of faculty salaries over time.

With this plan in place, the average salary of KCAI faculty will move to the 75th percentile (that is, the upper end of the market).

The college pursued a similar process to review and upgrade staff compensation. In communicating the new compensation plans to faculty and staff, the college emphasized that the plans are contingent upon “affordability assumptions.” Those assumptions include the market value of the endowment fund; achievement of the annual fund goal; and the amount received in net tuition and fees (specifically, the college must maintain a two-semester average enrollment of 642 students).

The Kansas City Art Institute’s Composite Financial Index (CFI)—a measure of overall financial health based on sufficiency and flexibility of resources, the management of debt, the performance of assets and the results of operations—now exceeds both the national median and the 75th percentile among Kansas City area private colleges and private colleges in Missouri. These findings appear in the March 2007 “Comparison Group Report” prepared for the Council of Independent Colleges by The Austen Group, a higher education consulting firm. The report also provides benchmarking information for the primary-reserve, viability, return-on-net-assets, and net-operating-revenues ratios.

“Over the six-year period of the report, 2000 through 2005, the Kansas City Art Institute improved significantly in financial strength as measured by the CFI compared to the national median for all Carnegie B.A. and M.A. private [institutions],” notes Mike Williams, president of The Austen Group.  

“The average of the 2000 and 2001 CFI scores for both KCAI and the national median,” says Williams, “was 4.2. The average of the past two years in the report, 2004 and 2005, was still 4.2 for the national median—and 8.7 for the Kansas City Art Institute,” he notes. “The CFI score for KCAI increased incrementally from 2001 through 2005 and more than doubled over the four-year period.” The primary reserve ratio, says Williams, remained fairly constant; but there was marked improvement in the viability, return-on-net assets, and net-operating-revenues ratios.

A Work in Progress 

No one at the Kansas City Art Institute would say our job is finished, when it comes to achieving and maintaining financial stability. Like any other college, we remain vulnerable to variations in enrollment, annual giving, facilities management issues, and all of the other factors that wax and wane on the balance sheet.

In his book The Small College Guide for Financial Health (NACUBO, 2002), author Michael Townsley warns that, as the pool of prospective students dwindles over the next few years and colleges use financial aid to compete for students, declines in net tuition, net revenues, and cash may ensue. He writes, “…that’s going to be a major issue, exacerbated by the ever-increasing expectations of students to provide amenities, technical support, and services.” Townsley contends that small colleges are challenged not only to produce cash but also to build up reserves so they have something to fall back on if (or, perhaps more realistically, when) a downturn occurs in enrollment.

Wrestling with such concerns during a recent strategic planning process, all departments at KCAI considered best practices and came up with a means of illustrating the steps required to achieve the apex of operating excellence (see Figure 3, Financial Leadership Pyramid). KCAI has not yet achieved the two topmost steps of operational excellence, which call for an endowment fund equal to four times the annual operating budget and the ability to fund annual depreciation from the operating budget. Still, we feel our canvas is well on its way to completion.

Ronald Cattelino is executive vice president for administration at the Kansas City Art Institute, Kansas City, Missouri.