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Business Officer Magazine

How to Prevent a Financial Fiasco

Mention contingency plan to chief business and chief financial officers, and what probably comes to mind is a business continuity and disaster recovery plan. Yet, a financial crisis is probably the more likely event to occur on most college and university campuses. Clearly, it’s wise to have a plan for both possibilities. In the same way that a disaster recovery plan can help an institution avoid or mitigate damages caused by an event of nature, a financial contingency plan provides a framework of alternatives for addressing any number of substantial budgetary pressures, foreseen or unpredictable.

Saint Mary’s College—an all-female, Catholic residential institution in Notre Dame, Indiana, of about 1,500 students—created its first financial contingency plan in 1984. An anticipated demographic shift in the number of 18-year-olds threatened to reduce student enrollment significantly by the mid- to late 1980s. This carried substantial repercussions for an institution that relied heavily on tuition revenue. Surprisingly, the committee charged with creating a contingency plan was composed solely of faculty members, because the biggest concern was preserving the integrity of the college’s academic mission. The 1984 plan was completed and approved, but there was no need to implement it since the student numbers at Saint Mary’s remained healthy.

Fast forward to fiscal year 2003: For the first time in decades, the operating expenditures for Saint Mary’s exceeded operating revenues. While the college had enjoyed a long history of financial and academic successes (it has continued to be number one in its category in the U.S. News & World Report college rankings for 12 of the past 13 years), Saint Mary’s faced serious fiscal challenges. The financial landscape was similar for many higher education institutions, with shortfalls stemming from a downturn in the stock market and economy and a resulting drop in charitable giving. Mounting pressure to limit tuition increases reflected the growing financial need of students and parents seeking heftier tuition discounts. Internally, increased dependence on technology, escalating utility costs, and ever-growing expectations of parents and students for facilities and services likewise added financial pressure. From a human resources standpoint, approximately 63 percent of the college’s operating budget was allocated to employee-related costs; and benefits costs alone were increasing 15-20 percent per year.

The extent of the operating deficits was made less obvious by a board-approved transfer of quasi endowment funds to finance the change from a defined-benefit to a defined-contribution retirement plan (TIAA-CREF) for hourly employees, which was implemented during that time. Even so, the board and the president at the time recognized that Saint Mary’s had to deal with this fiscal situation as quickly as possible.

Back to the Drawing Board

In spring 2003, the Saint Mary’s board of trustees directed the president to update the 1984 financial contingency plan. This time, in creating the plan’s committee and process, an attempt was made to represent all constituencies of the college. The resulting 15-member committee consisted of 5 elected faculty members, 2 student representatives, and 8 mid-level administrators. The charge to the committee was: “Develop a plan that will enable the college to fulfill its mission while experiencing unanticipated change and to recommend alternative courses of action that will guide the college toward a positive, strong, and financially viable future.

Because senior administrators had their hands full addressing the bigger picture of the college’s financial pressures, they delegated primary responsibility for the plan to the committee. One benefit of charging mid-level administration with this task was that individuals whom the committee interviewed were more likely to be open with their responses, since in many instances they were talking with their peers. In reports documenting committee interactions with individuals, great care was taken to ensure anonymity for all participants.

The committee realized that, while the 1984 plan served as a good starting point, it was seriously outdated and was limited to one triggering event, a substantial reduction in enrollment. To avoid reinventing the wheel, the committee’s chair researched examples of other financial contingency plans. To her amazement, little information was available elsewhere. Most of the committee’s work would have to be done from scratch.

Committee members agreed from the outset that the final plan be based on broad information gathering and that members seek input from—and regularly communicate with—as many constituencies as possible, including faculty; students; administration and staff; alumnae; trustees; and Saint Mary’s founding organization, the Sisters of the Holy Cross. This would allow the committee to frame its work, provide open communication with the larger college community, ensure thoughtful consideration of the issues, develop creative suggestions, and help ensure buy-in of the plan by all constituencies.

Another key point of consensus: The contingency plan had to be in sync with important documents, such as the college’s charter, bylaws, mission statement, and governance manual. For instance, the legal documents of Saint Mary’s did not allow for the committee to consider offering undergraduate degrees to men as a response to declining enrollments. Likewise, Catholic social justice principles played an important role in fashioning contingent responses, particularly with regard to the financial plan’s impact on employees.

Anecdotal Intelligence

The richness of Saint Mary’s financial contingency plan stems in large part from the work of committee members in gathering input from all stakeholders. Here’s what they did, whom they contacted, and what they discovered.

  • Canvassed each administrative and academic department of the college. Committee members asked for input regarding internal and external forces impacting departmental mission and goals, strategies for dealing with departmental cuts, and ideas for generating revenue.

Intelligence gathered: Internal forces cited included staff turnover, expiration of grant funding for specific programs, faculty retirements, increasing need for technology, and change in senior leadership. Significant external forces noted were the economy, the job market for graduates, government support of financial aid, price increases, and world events. Recurring themes from these conversations included an overwhelming preference for revenue generation versus cuts. Departments wanted to be consulted before determining which specific department cuts would be made. Many felt there should be a sense of “shared pain” from the top down, and that the contingency plan should not compromise admission standards, teaching effectiveness, and—not surprisingly—salaries or benefits.

  • Surveyed student leaders to determine what they valued most about their Saint Mary’s experience. Students were asked to identify “the most important aspects of student life at Saint Mary’s” and characteristics they find “indispensable to the Saint Mary’s experience.”

Intelligence gathered: Student leaders noted a number of important elements, including a close-knit, friendly community; quality, accessible faculty; small class size and a low faculty-student ratio; high admission standards; strong academics; numerous student clubs and organizations; traditions; the beauty of the campus; and the college’s spiritual dimension. (These responses were consistent with data reported in ongoing research of continuing students and newly admitted students.)

  • Sought input from others. The committee queried the institutional research director and other individuals with valuable information, including the director of human resources, the faculty chair of the strategic plan committee, and the director of public relations.

By collecting anecdotal intelligence from a range of sources, the financial contingency plan committee had a much greater understanding not only of the operations of the college, but also of the attitudes of campus constituents.

Crash Course in Finance

An added pressure on the committee that first year was the need to push ahead in the absence of a permanent chief financial officer and during a time of transition to a new president. Individually, committee members understood institutional finances from their unique perspectives within the college, but no single member understood the full financial picture. On the downside, this meant that the committee could not immediately begin crafting a new financial contingency plan, because members first had to become educated about the financial workings of the college. The upside was that the members would ultimately learn how all parts of the college worked, from admissions and financial aid, to academics and information technology, to human resources and the endowment—and everything else in between. A silo approach clearly would not work.

As part of this education process, the committee surveyed each administrative and academic department and met with department heads to learn about each department’s mission, scope, and activities. Specifically, the committee asked each department leader for input on these questions (see sidebar, “Anecdotal Intelligence” for more on this information-gathering process):

  • What internal and external forces might affect the department in the future, and what are the potential implications of these forces?
  • How might enrollment changes impact the department?
  • What strategies would work best if cuts must be made?
  • What ideas do department staff have for cutting costs, generating revenue, and developing the contingency plan process?

During this time, the committee chair regularly communicated the group’s progress to the then president, her cabinet, and the board of trustees—all of whom provided input and suggested changes to plan drafts. The chair also met in open forums with faculty, administrators, and staff to provide updates. These sessions became a vehicle for educating constituencies about the financial workings of the college, provided opportunities to answer common questions—such as why the college couldn’t simply take money from the endowment or borrow money to solve the situation—and helped reduce fear of the unknown.

Fuel for the Plan

In the midst of the committee’s work, several key staff transitions added synergy to overall financial contingency planning efforts. Saint Mary’s hired a new president, who began her tenure in June 2004. One of her first priorities was to hire a new vice president for finance and administration. Prior to accepting the position and joining Saint Mary’s in July 2004, the new CFO reviewed the institution’s comparative financial statements for 2002-03 and found that the long-term balance sheet ratios for Saint Mary’s were strong and stable. What did raise some concern were potential problems with the college’s operating ratios and working capital ratios if deficit spending continued. (See sidebar, “Revealing Ratios.”) Yet, if the current financial situation were addressed early and effectively, it was projected that no long-term damage would occur.

Later that year, as the budget was prepared for fiscal year 2005, the college did experience some difficulty balancing expenditures with the $40 million in available resources. Substantial cuts had previously been enacted in several areas, which had helped reduce the increase in total costs overall. Virtually all non-academic discretionary funds, conferences, travel, promotion, and training were cut, as was most overtime pay. While all operating budgets were frozen in 2004 and raises were limited to 2 percent, expenditures continued to rise faster than revenues, due in large part to increases in utility costs and in health-care costs for current employees and retirees.

In addition to the deficits of the previous two years, the decrease in enrollment of first-year students (from an average of about 425 to 350 for fall 2003) created a significant projected deficit for fiscal year 2005. The president, CFO, and other members of the cabinet began analyzing every facet of the college’s operational costs and revenues to determine as quickly as possible where reductions in expenditures and enhancements in revenues might be made. While all involved understood the immediacy of certain financial decisions that had to be made, the connection between enrollment and the college’s long-term financial success was deemed critical.

During this same time frame, Saint Mary’s hired its first vice president for enrollment management, who immediately began implementing a number of initiatives for the 2005-06 recruitment cycle, including the following:

  • Placing stronger focus on forecasting qualified applicants so that staff can concentrate energy on the inquiries that are most likely to result in applications.
  • Expanding campus visitation opportunities to allow more students to experience the college’s scenic and well-maintained campus. (This objective caused the college to re-examine the important role that campus tour guides play in this process, resulting in creation of the Student Ambassadors Association.)
  • Encouraging alumnae to host receptions for accepted students in approximately 20 cities across the country.
  • Making campus diversification a top institutional priority by increasing visits to high schools with a high minority presence, engaging current multicultural students in the recruitment process, and seeking them out as student ambassadors.
Revealing Ratios

Saint Mary’s College relies on about 40 ratios to judge its financial status and progress, including key operations ratios such as tuition dependence and general support. Working capital ratios have likewise become critical areas to watch, since these determine if there are sufficient current assets to support current liabilities. Overall, Saint Mary’s ratios show continuing strength in financial position despite a downturn in enrollment and the resultant pressure on operations and working capital. Ratios from FY06 reflect significant improvement due to more efficient operations rather than a substantial increase in enrollment. (See “Figure 1 Financial Ratios—Fiscal Year End 2006.”)

Working capital ratios remain under pressure. Short-term working capital ratios for Saint Mary’s have declined since FY02. Ideally, cash and short-term investments should equal about 25 percent of total expenses. For FY06 this increased to 17.8 percent, slightly above the 16-percent watch point. The current ratio indicates whether there are sufficient current assets and enough liquidity to support current liabilities. The college’s current ratio increased to 2.3 in FY06, after dropping further below the benchmark of 2.5 in FY03.

Debt ratios stay sound. For most small institutions, the area of greatest financial risk is in permanent capital (debt, endowment, and plant) and its support for future operations. The viability ratio measures the ability of the college to cover its debt with expendable net assets as of the balance sheet date, should the college need to settle its obligations. A ratio of 1.25 or greater indicates the college has sufficient expendable assets to satisfy debt requirements. The viability ratio for Saint Mary’s was 2.6 at year end FY06. The college’s debt leverage ratio (similar to the viability ratio except that it uses all unrestricted and temporarily restricted net assets) is 3.2 for FY06, well above the benchmark of 2.1. These ratios remain sound for Saint Mary’s.

Long-term assets ratios show improvement. All of the college’s long-term ratios for FY06 remain stable or have improved. The return on net assets ratio measures the ability of the institution to increase its wealth and flexibility in times of shrinking resources and compares the annual change in net assets to the total net assets. The return on net assets ratio should be at least twice the rate of inflation. For Saint Mary’s, this ratio has improved significantly for FY06, at 8.7 percent compared to 2.9 percent in FY05, and is consistent with the benchmark of 8.5 percent. The primary reserve ratio measures the financial strength of the institution by indicating how long the institution could function using its expendable reserves to cover operations, should additional net assets not be available. A positive ratio and an increasing ratio over time denote strength. The primary reserve ratio for Saint Mary’s for FY06 is 2.3 versus 1.9 in FY05.

Capital structure ratios gain strength. The capital structure ratios examine the relationship between long-term debt and other financial components of the annual statements. The growth of the Saint Mary’s endowment and its positive investment performance has contributed substantially to the annual decrease in the long-term debt to total revenue and long-term debt to total asset ratios. The college’s endowment has more than doubled during the past decade—from $48.3 million on June 30, 1996, to $110.1 million on June 30, 2006—and our five-year return (annualized) is a healthy 9 percent. The resulting non-operating revenues from realized and unrealized gains have provided increased total revenue and total assets, while the debt of Saint Mary’s has not grown significantly over the same period.

A Plan for All Contingencies

As senior administrators grappled with the college’s immediate financial pressures, the ongoing concerted efforts by the committee to learn from and incorporate the suggestions of all campus constituencies resulted in the draft of a solid financial contingency plan offering a two-pronged approach:

1. Cost reduction. This is perhaps the more obvious response to fiscal distress and in many ways is easiest to implement in the near term.

2. Revenue enhancement. Usually a longer-term approach, raising revenue can help prevent a fiscally challenging situation in the first place or reduce the severity of a crisis once encountered.

The committee decided it was important that the plan not only address both approaches but also be applicable to a variety of triggering events. Such events might include a significant drop in enrollment, a substantial decrease in the market value of the endowment and its related returns, a considerable increase in a liability and/or liability insurance cost, a sizeable increase in benefit costs, or a political or world event that seriously impacts revenues.

Structurally, the body of the Saint Mary’s proposed financial contingency plan provided a philosophical framework and a kind of how-to manual for responding to a financial crisis. Appendices listed specific ideas for cost reduction and revenue enhancement. The plan also included an educational component such that employees and other key constituencies could better understand the framework for financial contingency planning.

Before submitting the draft plan to the president and board, the committee presented it to the faculty. While faculty members understood that they did not have veto power, the president and committee members saw value in receiving at least unofficial faculty endorsement prior to finalizing the initiative. They did obtain overall faculty buy-in, which ensured that any major concerns would be addressed prior to plan implementation. The president and cabinet approved the plan, followed by the board’s approval, in February 2005.

Prescription for Reality

The comprehensive financial contingency plan for Saint Mary’s was now the president’s plan to enact, while a specific response fashioned for the current reality was the CFO’s to identify. The nature of the plan provided several benefits. Since the president and CFO were new to Saint Mary’s, the document provided helpful background in a more timely fashion than would otherwise have been available. It also equipped them with information from the campus community’s perspective regarding which cuts would be most acceptable and in what priority order. For instance, rather than immediately cut benefits, consensus was that it was important to show the campus community that less serious cuts were considered first.

Through careful reflection on the suggestions offered by campus constituents, the president and CFO arrived at key actions the college could take to address its current fiscal situation.

Cost reductions. The following steps were taken to lower expenses:

  • Work directly with each division vice president to pinpoint further reductions in operating budgets.
  • Temporarily hold vacant positions open, including retiring faculty positions. The president’s cabinet must approve any new hire before a search can begin.
  • Eliminate several positions, mostly through attrition.
  • Reduce legal and other administrative costs through required approval processes. For example, the vice president for finance and administration must approve use of legal counsel.
  • Renegotiate or put out for bid existing contracts, and increase the use of consortia and cost-sharing arrangements. For example, Saint Mary’s and its neighboring school, the University of Notre Dame, entered into a new contract with a local bus company to create a route for the two campuses, saving Saint Mary’s $50,000 annually (about 50 percent) while allowing faculty, staff, and students to ride free of charge. The college also put its health insurance out for bid, resulting in level costs for fiscal year 2006, a 10.8 percent decrease in premiums for 2007, and a rate cap for the following two years.
  • Involve the entire campus, including students, in energy-saving campaigns, such as turning off unnecessary lights.

While these cuts saved Saint Mary’s more than $1 million, they were not sufficient to deal with the entire fiscal situation. More serious cuts were required, including reducing TIAA-CREF contributions by 2 percentage points and the dental subsidy by 50 percent. Obviously, these were not popular decisions, but they were made more palatable because the inclusive planning process had increased campuswide understanding of the college’s operations and finances.

Revenue builders. Beyond cost-cutting measures, the new plan called on the administration to consider specific revenue-enhancement ideas, including the following:

  • Change summer interim session dates to immediately follow graduation and allow resident-hall occupancy, thereby increasing enrollment and room revenue.
  • Hire a new bookstore manager to increase profit margins and to open a new convenience store.
  • Add a student fee to help pay for operating the new student center.
  • Transfer $4 million from long-term investments to the endowment to provide an additional $200,000 annually (calculated on a 5 percent spending rate) to the operating fund. (Earnings on these investments were previously reinvested for asset growth.)

Activation Elements

The contingency plan also prescribes an implementation process consisting of key actions.

Communication. One of the most important components of the process is ongoing communication. The president and CFO routinely met (and continue to meet) with the board—and separately with faculty, administrators, and staff—to communicate the college’s fiscal situation, responses required, and progress made.

Ongoing updates. With all the hard work invested in the plan, it is critical that it be kept current. The plan recommends that strategies implemented during a contingency situation be reviewed after an appropriate period to determine whether these steps remain in the best interest of the college. Hence, the CFO is charged with reporting annually on the status of the plan to the president and the president’s cabinet. In addition, the CFO holds budget meetings at least once annually to update the full campus community on the status of the financial situation at Saint Mary’s, including detailed information on the alternative measures implemented and their impacts. These meetings are offered at three different times to accommodate as many schedules as possible and are considered part of the ongoing education for each new generation of employees and faculty regarding the financial operations of the college.

From Deficit to Surplus

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Saint Mary’s is happy to report that the college is currently projecting a budget surplus for fiscal year 2007. This was accomplished without a significant increase in total enrollment, proving that the structural deficit has been effectively addressed. At the same time, enrollment management strategies are already paying off. For fall 2006, Saint Mary’s welcomed its largest first-year class since 2001, with 426 new students who reflect the highest average GPA ever recorded for the college. Additionally, 10 percent of this class came from historically underrepresented groups—the highest representation for Saint Mary’s during the past 15 years. The college’s financial success also received a boost from the fundraising efforts of the office of college relations, which exceeded its $16.5 million fundraising goal by more than $1.1 million for a new academic building that began construction in fall 2006.

No matter an institution’s size or type or the scale or nature of the fiscal dilemma at hand, financial contingency planning offers a valuable process for addressing any of higher education’s potential or real budgetary challenges. While any effective plan must ultimately be subject to the guiding principles of an institution’s mission and be based on the gravity of the situation, Saint Mary’s experiences throughout the past three years can make the case for other institutions about the real value of concerted financial contingency planning.

LAURIE STICKELMAIER is vice president for finance and administration, and SUSAN VANCE, financial contingency plan committee chair, is a professor of law and accounting at Saint Mary’s College, Notre Dame, Indiana.