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Diagnosing Fiscal Fitness

The Council of Independent Colleges developed a financial indicators tool that distills an institution's data to arrive at four core ratios. The report can provide an overall image of financial health, pointing out specific strengths and weaknesses. See how it works.

By Karla Hignite

Feature Article ImageHow can a busy college president without a background in finance or accounting get an accurate picture of the institution's overall financial health and identify areas of concern or weakness?

Is there a meaningful way to present complex financial information in an easily understood form to trustees and senior campus leaders?

Can comprehensive financial data for hundreds of colleges and universities be collected in a way that does not place a heavy reporting requirement on campus personnel; is presented in a comparative format that is individualized for each institution; and is still meaningful for all institutions?

These were some of the questions the Council of Independent Colleges considered when developing its Financial Indicators Tool (FIT), an annual benchmarking report prepared exclusively for CIC member institutions, says Harold Hartley, senior vice president of CIC, Washington, D.C.

The tool—which uses the Composite Financial Index (CFI) developed by Prager, Sealy & Co.; KPMG; and BearingPoint—provides an overall picture of an institution's financial health (see figure for an example of how the tool can be used). To allow comparability, CIC relies on data from the U.S. Department of Education's Integrated Postsecondary Education Data System (IPEDS) and the IRS Form 990 made available by GuideStar to arrive at the four core ratios primary reserve, viability, return on net assets, and net operating revenues—used to calculate the CFI. (See sidebar,"Benchmarking Tool Provides National Comparisons.")

FIT, first launched in 2005, distills the complex financial operations of a college or university into one concise report that helps presidents understand and explain the institution's fiscal state to others, says Hartley. "Many presidents report that they have walked through this financial benchmarking report with their CFOs and other senior staff members for planning purposes. A number have also shared the report with their trustees as an accountability tool." While some CFOs have long calculated the CFI score for their institutions, many have not had the advantage of the comparative data this tool provides, notes Hartley. CIC's FIT is the first financial benchmarking tool using the CFI to provide national comparisons for any group of American colleges and universities.

Kent Chabotar is president of Guilford College, Greensboro, North Carolina. In his current position and previously as a faculty member at Harvard University, Cambridge, Massachusetts, and then as CFO at Bowdoin College, Brunswick, Maine, Chabotar has been teaching and writing about ratios for two decades, searching for practical ways to help financial analysis make sense to a wide audience whether trustees, alumni, donors, or academic officers. He advocates the CFI as a standard gauge of institutional financial conditions, a point he conveys in his book Strategic Finance: Planning and Budgeting for Boards, Chief Executives, and Finance Officers (Association of Governing Boards of Universities and Colleges, 2006).

When Chabotar arrived at Guilford in 2002, he wanted something he could use with his trustees to better understand factors affecting institution resources. "We knew the primary reason the college was experiencing financial difficulties was because of the $30 million in debt we had incurred through various bond issues in the 1990s and earlier. Yet, we needed something to help us see, firsthand, the effects of that debt on our overall financial health," says Chabotar. In his view, too many institutions focus on balancing their budgets from year to year without engaging in a broader, systematic review of institution finances for the long term.

While higher education has certainly increased its use of ratios since the 1990s, without a standard set to provide a simple way to look at financial health, an institution can't really answer whether it is in trouble, warns Chabotar. The CFI not only captures an overall snapshot of financial health, but also allows an institution to set priorities going forward, he adds. For example, an institution might decide to take on more debt to build student housing so that it can expand its student population. The CFI allows leaders to project the impact of that debt from multiple perspectives of financial readiness, notes Chabotar.

In this article, interviews with a handful of CIC member institutions reveal how leaders are using the CFI to assess financial health and bolster budgetary decisions and planning efforts.

Analyze and Adjust

Both presidents whom Bobby Young worked with during his eight-year tenure at Atlanta-based Clark Atlanta University supported the use of ratios. That was welcome news to Young, former vice president for finance and business services. "The reality is that as college costs have continued to increase, parents and prospective students have become more sophisticated in seeking information about an institution's financial viability," says Young. Presidents especially have to be fluent when it comes to institutional finance so they can convey to various constituents' donors, alumni, students, parents, accrediting agencies, and governmental entities—how the institution is responsibly using resources, argues Young.

When the university started using the CFI in 2003, it came as no real surprise to campus leaders that the institution's composite score fell below the index threshold of 3, says Young. (On the CFI scale from 1 to 10, a score of 3 or above indicates that an institution has sufficient and adequately managed resources to fulfill its mission objectives.) The score suggested the need to reengineer the institution, says Young. That put in sharp focus for everyone the priority to manage operations within available resources.

There were deficit years preceding this wake-up call that certainly contributed to the low score. As a result, the university started tightening its belt in terms of budgeting and planning, says Young. That meant close scrutiny of operational overruns and some tough decisions on cost containment, reductions, and elimination of services not core to the academic program. Within a five-year period, the university pulled above the threshold to an index score of 4.

Following these results, the university began using the CFI with board members. One outcome was a priority set by the board to remain at or above the CFI threshold. That meant that before moving forward with a particular project or initiative—even something like providing additional scholarships—leaders would always determine whether the institution had the resources to do so, says Young. In this way, university leaders began using the index as a tool to help the institution refrain from overspending.

A primary initiative of the comprehensive strategic planning process that Ripon College launched in 2004 has been to strengthen the financial position of the Wisconsin institution—something about which leaders have been very public, notes President David Joyce. In the process, use of the CFI ratios has become an important tool for communicating progress to the board, faculty and staff, and other key stakeholders. Additionally, use of CIC's FIT along with CIC's Key Indicators Tool (KIT)—which includes 20 performance measures covering students, faculty, tuition, revenues, and expenditures—have helped Ripon's leaders create two aspirant groups for comparison and to monitor improvement over time, notes Joyce.

Measuring progress has increased in importance following several years of overspending the annual operating budget, explains Mary deRegnier, Ripon's vice president for finance: "In response to our focus on student first-year classes and enrollment issues as well as the cost side of our income statement, we've taken some cost-cutting measures in recent years that have yielded a positive impact on our index score." College leaders have also used the ratios to monitor financial stability since incurring some debt in 2000 and 2001, says deRegnier. "We're using the CFI to help us assess when we could responsibly assume additional debt based on our financial standing, market conditions, and our endowment performance."

Demonstrating a capacity to manage debt has provided a comfort level for board members and instilled their confidence in institution leadership, adds Joyce. He uses a dashboard of indicators culled primarily from CIC's FIT and KIT tools to develop an annual presentation to staff and for engaging in more in-depth analysis with senior staff throughout the year to determine what adjustments should be made to ensure operational surpluses, says Joyce.

Compare and Forecast

Financial Benchmarking Resources

The following NACUBO resources are available from www.nacubo.org:

  • Strategic Financial Analysis for Higher Education, Sixth Edition, a collaboration of Prager, Sealy & Co., KPMG, and BearingPoint, is considered the definitive source for the CFI methodology for both public and independent institutions (NACUBO, 2005).
  • The Small College Guide to Financial Health: Beating the Odds, by Michael Townsley (NACUBO, 2002).
  • "How to Assess and Enhance Financial Health," by Lawrence R. Hudack, Larry L. Orsini, and Brenda M. Snow (Business Officer, April 2003).
  • "Ratios That Really Work for You" (NACUBO 2005 on-demand program, available free to members at www.nacubo.org/distancelearning).

Additional books and journal articles:

  • "Benchmarking in Higher Education," by Jeffrey W. Alstete (ASHE-ERIC Higher Education Report, No. 5, 1995).
  • "Financial Ratio Analysis Comes to Nonprofits," by Kent Chabotar (Journal of Higher Education, Vol. 60, No. 2, 1989).
  • "Reporting Higher Education Results: Missing Links in the Performance Chain," by J. C. Burke and H. P. Minassians (New Directions for Institutional Research, No. 116, 2002).
  • Strategic Finance: Planning and Budgeting for Boards, Chief Executives, and Finance Officers, by Kent Chabotar (Association of Governing Boards of Universities and Colleges, 2006).
  • Strategic Indicators in Higher Education: Improving Performance, by Barbara E. Taylor, Joel W. Meyerson, and William F. Massy (Petersons, 1993).
  • "Using Performance Indicators to Guide Strategic Decision Making," edited by Victor M. H. Borden and Trudy W. Banta (New Directions for Institutional Research, No. 82, 1994).

Randall Doerksen, vice president of administration and finance at Friends University, Wichita, Kansas, has employed a variety of enhanced budgeting decision tools and ratios over the years to get the most accurate picture of his institution's financial health. He is an early adopter of the CFI, which his institution has used primarily for internal historical comparisons. Doerksen is currently developing a comprehensive budgeting model that will calculate the university's CFI 10 years out.

"This is a long-term decision-making tool that will allow us to incorporate various ratios into our strategic planning. For instance, we can input different scenarios with regard to enrollment, discount rates, tuition increases, gift income, investment returns, spending rates, debt loads, and so forth, to gauge the impact on our finances based on the movement of the CFI," says Doerksen.

So far, his university has not engaged in much benchmarking with peer institutions, though leaders are looking to do more of that, notes Doerksen. "While our use of FIT has been limited, I certainly see considerable potential. Especially for institutions that have tagged and validated a set of peer or aspirant institutions, I think the tool offers good high-level comparison information."

The benchmarking component of FIT is what Janet Hallman considers a key benefit of the tool. The University of Puget Sound, Tacoma, Washington, has identified approximately 25 peer institutions and 13 aspirants, says Hallman, associate vice president for accounting and budget services and controller. "For us, the composite calculation mostly affirmed what we knew. We have strong statement of financial position ratios and a strong net operating revenue ratio. We have opportunities for growth in fundraising, which is reflected in our return on net assets ratio."

If the FIT report had been available at the time, Hallman would have used it in financial modeling for the university's most recent capital campaign. "I could have plugged in pro forma financial statement numbers to facilitate projections for our president's cabinet of the potential impact of different size goals on key financial ratios," notes Hallman. "Now that we have this tool, we can use it for a variety of future planning efforts, including modeling the impact of new debt or fundraising efforts on our financial statements and the financial ratios that make up the CFI."

To date, university leaders have used the reports and data internally and informally with senior staff members, primarily finance officers, but plans are underway to introduce the tool to their board finance committee later this spring. "A key value I see with the CFI is that there is good interpretative data that accompanies it," says Hallman. "We think graphical representation of the CFI can provide an effective means to demonstrate the impact of strategic financial decisions."

Track and Reflect

In fact, because the annual CFI is a picture of financial health at a given point, it is important to look at your performance from year to year to see trends, along with your institution's progress against set targets, income, and so forth, says Chabotar. He started using the CFI and FIT internally with his CFO and plans to present a full analysis to his trustee finance committee next year.

"It's best to think of this as a means to an end—to understand how your financial health is affecting your core mission, and whether your strategic decisions are appropriate given your current financial health," explains Chabotar. For instance, are you in a position of financial strength to enter a new construction phase? Should you focus on growing your endowment, or on increasing enrollment? Can you safely provide more student financial aid?

As a forecasting tool, FIT allows you to consider how your overall score might be affected by reducing debt, increasing gifts, or improving investment performance. And, it allows institution leaders to understand why scores go up or down, says Chabotar. "We have been surprised by the fact that, despite all the progress we've made, we still hover around 3 with our composite score. For us, it is an important reminder of the dramatic effect significant debt can place on an institution's financial viability, and it has underscored for us the need to consider how much debt is safe to take on in the future," adds Chabotar. "There are valid reasons an institution decides to assume significant debt, but the value of a tool such as this is that you can see the impact and better understand the long-term implications for budget planning so that you don't get complacent about managing that debt."

Use of the FIT has given Chabotar and his CFO a greater sense of urgency, serving as a reminder that the institution has not yet reached its desired financial equilibrium even though its budgets are balanced. "We still need to focus on turning the ship," says Chabotar. "I think many who are using the tool are using it in the manner we are, which is to understand our vulnerabilities so that we can work in an organized way toward improving our financial health."

While at first glance the tool may appear complicated, at a time when everyone is showing greater interest in and scrutiny of institutional finances, use of the CFI can be a great way to simplify matters, asserts Chabotar. "It won't necessarily make decisions easier or people less anxious, but it is a starting point and, used consistently, provides an important trend line."

Build a Common Language

Benchmarking Tool Provides National Comparisons

The Council of Independent Colleges (CIC) Financial Indicators Tool (FIT) is both a diagnostic tool—providing useful information about institutional financial performance—and a resource to assist college leaders with critical campus planning and decision-making tasks. Customized for each member institution, the annual report provides an assessment of financial performance that is tracked over a six-year period and benchmarked against similar institutions. (The benchmarking project was established thanks to grants from the William Randolph Hearst Foundations and is now underwritten by TIAA-CREF.)

In developing FIT, CIC had to overcome two challenges. The first was to determine an acceptable measure of overall institutional financial health to guide campus leaders. The second was to find a public source of financial data for hundreds of colleges and universities that would make the project practical and cost-effective.

The Right Measure

CIC met the first challenge by using the Composite Financial Index (CFI), developed by Prager, Sealy & Co.; KPMG; and BearingPoint. The CFI is based on four core financial ratios, each representing a particular domain of financial operations: (1) the primary reserve ratio, indicating resource sufficiency; (2) the viability ratio as a gauge of debt management; (3) the return on net assets ratio to track financial asset performance; and (4) the net operating revenues ratio measuring operating results. These ratios are then standardized, weighted, and combined into a single index score, the CFI, to indicate the financial health of the institution.

Using a scale from -1 to 10, the CFI approach links financial strength with accomplishment of mission. The threshold for financial health and stability is a score of 3, indicating that an institution has sufficient and adequately managed resources to fulfill its mission objectives. Scores should be viewed over a three- to five-year period. An average score of 7 or 8 indicates that resources are flexible enough to permit experimentation with new initiatives. An average score below 0, however, is a concern, suggesting that drastic measures may be necessary to ensure institutional survival. Balancing financial performance with accomplishment of mission is key to the utility of FIT.

The Best Data

The second challenge—finding a public source of data—required some ingenuity. Prager et al. specify that data for the CFI should be drawn from audited financial statements. Imagine, however, the daunting task of requesting six years of financial statements to be voluntarily submitted by nearly 800 institutions—all baccalaureate and master's-level private institutions. For CIC, this was a nonstarter. CIC's first annual benchmarking report, the Key Indicators Tool (KIT), includes 20 performance measures covering students, faculty, tuition, revenues, and expenditures drawn from the U.S. Department of Education's Integrated Postsecondary Education Data System (IPEDS).

Unfortunately, IPEDS contains data sufficient to calculate only one of the four core ratios (return on net assets) of the CFI. Michael Williams, president of the Austen Group and engineer of CIC's FIT, suggested using GuideStar, which makes available the Form 990 required by the Internal Revenue Service for all not-for-profit colleges and universities, as the source for the other three CFI ratios.

CIC next tested a prototype FIT report in a pilot project in 2005 with 70 member institutions. A key to the success of the pilot FIT was confirmation that the data from IPEDS and GuideStar were comparable to the data from institutional financial statements. An unexpected challenge arose in discovering that 10 percent of the institutions had external foundations (legacy fundraising groups or alumni associations), auxiliary enterprises, or branch campuses submitting separate Forms 990 (though in many cases reported in combined financial statements). Once identified, however, data from these entities were easily combined to produce the report.

Relevant Comparisons

An additional point of distinction of CIC's FIT is worth noting. FIT provides nationally normed benchmarks of institutional performance with comparisons based on region of the country, financial resources, enrollment size, and Carnegie Classification. The CFI methodology with its prescribed, criterion-referenced thresholds for each of the four component ratios, along with the CFI score, provides performance measures that answer the question: "Do we meet the standard?" CIC's FIT, using the CFI in a benchmarking report with normative comparisons for similar institutions, also provides position measures, answering the question: "How do we compare with our peers?"

Presidents and CFOs need answers to both questions. For busy campus leaders, this financial benchmarking tool is proving to be a good fit.

HAROLD V. HARTLEY III is senior vice president, Council of Independent Colleges, Washington, D.C.

Hallman believes the tool can prove highly beneficial for use with a president's cabinet or board members to determine opportunities and to help guide deployment of resources—that is, once an initial investment of time is made to help everyone understand what the scores suggest. Without sufficient background about the ratios, the numbers may not be as relevant to some external audiences, notes Hallman. For them, other measures may be more important, such as the level of endowment per student, for financial aid.

"Most CFOs have long paired financial ratios and balance sheet and income statements, but this tool presents the information in an easier fashion so that it's not as onerous to arrive at comparisons for decision making," says deRegnier. Joyce adds that for those without a financial background, the FIT provides a good macro view and a way to chart a course for significant improvement, something especially important to donors. "It is a straightforward explanation of a manageable amount of information in human language," says Joyce. From his experience, consistent use of the same data is also important for getting board members to focus on the big picture and to use the same language in setting goals and priorities.

That shared language is critical in the context of discussions about enrollment targets, tuition pricing, and a host of other policies and priorities, adds Young. Chabotar concurs. Meeting admissions goals plays a big role in the composite score for his college, as it does for many private institutions. "Seventy-eight percent of our budget is based on enrollment. Even at public institutions, where many are drawing as much revenue from their students as they are from their states, I think we'll see ratios become increasingly important as a marker for financial health," says Chabotar.

Consistent measures of an institution's financial well-being are likewise sought by key external audiences, including accreditation bodies. Chabotar and Young are both reviewers for the Southern Association of Colleges and Schools and see firsthand the benefits for institutions that engage in ongoing ratio analysis, and the drawbacks for those that don't.

Use of the FIT provides a common language for institutions to characterize their financial condition and for visiting teams to judge financial viability, argues Chabotar. The tool can be used as evidence of responsible financial decision making, adds Young. "I've reviewed a number of institutions that would have benefited from consistent use of these ratios to help explain what happened in a particular year—for instance, why cash was appropriated from institution reserves," says Young. "A minor blip doesn't automatically signal something negative if you can show that the occurrence was the result of a conscious decision or unforeseen circumstance and not the result of leaders who weren't minding the store."

Assess the Unexpected

Chabotar acknowledges that the systematic use of the CFI or of dashboards in general may be a leap for some boards. And, he concedes that there is understandably some resistance from presidents and CFOs to attempt to explain financial conditions using only five numbers, perhaps fearing that board members will then focus only on those numbers. "There is a balance to strike between simplifying, but not oversimplifying, financial conditions," notes Chabotar. "That's why it is important to provide narrative—the story behind the numbers—to help others understand what is going on within your institution."

Part of that narrative includes explaining conditions that may be outside the control or influence of the institution. For instance, when looking at fundraising performance, many institutions experience spikes—perhaps when a donor passes away and leaves a large gift, notes Joyce. In that regard, the FIT performs as a retrospective tool, providing a glimpse of how certain factors influence financial viability.

"Most of us look at financials more closely when times are bad than when they are good," says Chabotar. "With the current economic crisis, everyone is nervous. Perhaps now more than ever is a good time for higher education to get boards to focus generally and broadly on the financial health of our institutions."

Doerksen's concern is one of relevance for the CFI in such turbulent times. "Interestingly, the CFI ratio could likely become much less valuable this year given the huge investment losses being incurred by many institutions, especially those that have large investment portfolios," says Doerksen. "In addition, new accounting standards may require institutions to make up 'underwater' endowment funds using unrestricted resources." He suspects the CFI methodology will need to be revisited, as these two elements could impair the validity of the CFI. "Our institution would face an $11 million investment return-related deficit if we were to close the books today," explains Doerksen. "Our budget is $43 million and our endowment and invested resources totaled $55 million at year end. The deficit would flow through the current financial statements as a huge loss resulting in an overall negative CFI." That negative score would follow a CFI of 5.8 at the end of FY08, notes Doerksen.

Even if using multiple-year averages to arrive at the composite score, the extensive losses experienced by institutions with large investment portfolios will skew comparability, argues Doerksen. "In essence, investment portfolio size and performance would become the dominant element for the CFI. This will also have an impact on how accrediting bodies evaluate financial viability, since many use the CFI or a similar type of calculation."

With that in mind, users of the CFI may need to step back and revalidate the model, asserts Doerksen. One thing to consider is how unrestricted funds are reflected in financials and incorporated into the model. "What do you do when endowments and unrestricted investments are down 30 percent? This will have a huge impact on return on net assets," notes Doerksen.

Leverage the Outcomes

Joyce agrees that when the 2008 data are available, they won't present a pretty picture, especially for those institutions that may have recently taken on significant debt and then been surprised by serious additional losses on paper of institutional investments. DeRegnier expects that many, if not most, institutions will show a hit to their composite score as a result of the current economic crisis. "It is what it is," notes Joyce. He underscores the importance of establishing a trend line to capture the impacts of anticipated and unexpected factors. Still, many higher education institutions won't make long-term decisions based on one year, argues deRegnier. "What is important is to understand what is causing fluctuations in your overall score."

Whether meeting with their faculty advisory group or executive committee, Joyce and deRegnier use key indicators to convince others of the need to stay on course. "This kind of tool can help ameliorate the inclination to make knee-jerk decisions," says Joyce. "In monitoring our data over time, we know that we won't understand the true impact of our current situation for another year or two. Yet, the added value of monitoring our performance is that we will be able to tell if our trend is more or less severe than those institutions with which we compare ourselves," says Joyce. "This is an important way not only to inform current decision making, but also to validate decisions we've made so that we can learn from the outcomes."

KARLA HIGNITE, Kaiserslautern, Germany, is a contributing editor for Business Officer.