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Financial Aid: Does It Matter Whether It's Funded?

No one would dispute that grants and scholarships assist many students in financing their education. But how that institutional aid should be characterized and provided remains open to debate.

By Ron Allan

YES

As the diagram illustrates, an institution’s tuition discount encompasses all three components. By itself, unfunded aid—sometimes called the simple tuition discount—gives academic finance officers an indication of the limitations on the funds available for maintaining academic programs. That is, the more unfunded aid, the less funding available for programs. Presidents and governing boards must keep that in mind when establishing tuition policy.

During the 1980s, failure to recognize that financial aid and the simple tuition discount are on opposite sides of the same coin led to frustration for many institutions. Even after raising tuition significantly, those institutions discovered that the increase in net revenue was much less than anticipated because so much of their financial aid, although recorded as an expense, was actually paid for by foregoing tuition. As tuition increased, the amount of tuition foregone required to pay for financial aid also increased. (This conundrum led to the promulgation of FASB 116 and 117, which reclassified institutional student aid from an expense to a “contra revenue” to make the impact of tuition discounts on revenue more visible.)

Components of Tuition DiscountNACUBO defines scholarship allowance as the sum of funded aid and unfunded aid. The scholarship allowance, sometimes referred to generically as institutional student aid, is what most finance officers refer to when speaking of tuition discounting. Subtracting this sum from gross tuition yields net revenue. Higher education policy analysts, however, use a different definition of the student tuition discount. They add together other external grants and the scholarship allowance when considering the net price to the student in the context of access and affordability.

Why Funding Matters

With this information as a basis, consider the budgetary process of specifying institutional priorities and projecting what they will cost to accomplish. As an example, say the total revenues available, restricted and unrestricted, equal the total of the costs. At first glance, the institution would appear to be in good shape. But what if more of the revenues are restricted to a specific purpose—such as faculty salaries, athletics, or financial aid—than the college or university wishes to spend on that purpose? Then the institution would be forced to spend more on that activity than it wishes and, accordingly, compensate by reducing expenditures on other activities regardless of its priorities.

Some people argue that the funds restricted to financial aid behave just like the funds restricted to faculty salaries or athletics. In other words, the distinction between funded and unfunded aid doesn’t matter because both have the potential to limit an institution’s options. According to this argument, because no college or university has more funds restricted to financial aid than it would choose to, whether the scholarship allowance is funded or unfunded has no impact on institutional priorities.

Here’s the problem with that analysis: Restricting funds to financial aid is not the same as restricting funds to other activities. While the portion of funded aid within the scholarship allowance may not change institutional priorities, those priorities have a greater chance of being met if they have more funding. For example, once the financial aid department finds a student who qualifies for a donor’s scholarship, the proceeds of that scholarship enter the operating fund; there, they become indistinguishable from tuition revenue (all money is “green”). The fungibility of the funded scholarships permits an institution to “offset” the shortfalls superficially created by the “restriction” of funds to financial aid. The budget officer can allocate those funds to faculty salaries or athletics as the institution sees fit, just as if the funds were general revenue.

What about enrollment planning? A college with most of its scholarship allowance funded would be in a much better position than a similar institution with the same number of admitted students and the same—but largely unfunded—scholarship allowance. Again, once the proceeds of the funded scholarships enter the operating fund, they behave just like tuition revenue. In fact, other things being equal, the better funded college would have more revenue and could be more selective about the students it admits: It could obtain the same revenue as the college with less funding at a lower yield.

Finally, consider what happens when the parents of full-pay students complain to the provost’s office (then to the financial aid director, through the academic finance officer) that their hard-earned tuition money is being used to subsidize other students’ tuition. They are, in effect, complaining about directly supporting students with need. If the institution’s student aid is unfunded, the full-paying parents do, indirectly, provide a subsidy to those students.

Difficult as it may be to explain the situation, an institution with funded financial aid can assure full-pay parents that their tuition money is definitely not being used to pay the tuition of others; there is no subsidy. Rather, the student with need is simply being permitted to pay a little less. Additionally, if the institution’s student aid is fully funded through endowed scholarships and annual gifts, the institution can legitimately demonstrate that the students with need are being directly supported by donors who wish to provide such financial assistance.

Does it matter whether an institution’s financial aid is funded? You bet it does.

Author Bio Ron Allan is assistant to the dean for research and data services in the office of student financial services at Georgetown University, Washington, D.C.
E-mail allanr@georgetown.edu

NO

Through the budgeting process, an institution determines its priorities and allocates its resources accordingly. Connecting the strategic plan to the budget and then to institutional operations is primarily the responsibility of the president and CFO. But how this strategically developed budget is ultimately financed is left to the CFO. He or she must bring together the streams of revenue—unrestricted tuition dollars and other revenues, restricted funds available for spending, and endowment spending— with the plans of the institution, matching donor intent with actual spending in support of good stewardship and with fidelity to the gifts’ requirements.

What Do You Think?
Do you agree with the points made on either side of the debate? Do you have comments about the authors' arguments? Send your thoughts to Carole Schweitzer at carole.schweitzer@nacubo.org.

To say that the funding source makes an appreciable difference in the institution’s spending tips the budget process on its head. The argument that institutional financial aid must be funded makes the egregious and classic mistake of confusing the sources of financing with prioritization of actions.

Let’s face it, all institutions want more endowment. Large or small, more is better. All institutions make the case that they could do X with more endowment—X being the confluence of institutional priority, or an area of significant spending, with the interest of the donor. By this means, the savvy president both maximize s the aggregate funding for the institution and increases the donor’s connection to it.

It is, of course, possible for an institution to have so much endowment or restricted giving that it is forced into action in a certain area. Such exceptions, however, are rare and therefore relatively insignificant in the overall scheme of higher education finance. As a rule, endowment dollars do not drive decision making. Certainly, most institutions have at least one restricted fund or endowment for a purpose so obscure or specific that it can’t be considered part of the overall flow of funding. The insignificance of such funds is the exception that proves the rule: Mission, strategy, and tactical priorities come first; the funding source comes second.

Why Funding Doesn’t Matter

When establishing a budget, an institution must decide how to allocate funds to support its faculty, programs, and physical plant and how much to allocate to financial aid. Institutions should engage in this exercise unfettered by the constraints of having restrictions placed on certain sources of revenue.

After reviewing their sources of revenue, institutions should see if any revenue is restricted to certain purposes, such as financial aid, and then see if the budgeted allocation of funds for financial aid is greater than the restricted funds. As long as the budget allocation for financial aid exceeds the amount of funds restricted to this purpose, it makes no difference if some of the financial aid is “funded.”

Although most money is “green,” restricted funds may have the effect of allowing budget owners in those areas to escape the competitive fray for resources that other programs without restricted funds must enter. This does not necessarily enable an institution to maximize its resources.

For example, assume Program A and Program B each has a budget of $1 million. Program A receives $500,000 of its $1 million from a restricted endowment, while Program B receives all of its support from the institution’s general fund. If the institution needs to reduce all budgets by 10 percent, Program A could end up with a budget of $950,000, while Program B could be cut to $900,000 (assuming the 10 percent reduction would come only from the general-funded budget). This discrepancy would not occur if the budget reductions were based on the budget macro and if both programs were equally valued in terms of the resources they should receive.

Thus, programs that have significant amounts of their budget supported by restricted funds may gain a competitive advantage when budget reallocations occur. These areas may find it much easier to preserve a greater share of their funding—which is not necessarily in the best interest of the institution as a whole. Financial officers have a mandate to responsibly link mission, strategy, budgets, and assessment, without allowing their thinking to become confused by the changing exigencies of funding source.

Another issue is how to explain the source of financial aid revenue to full-pay students. It is nice to say, “We have endowed funds that support our scholarship program, so you are not paying for other students to attend our university.” This, however, is nothing more than public relations at work.

Suppose you have two universities with the same budget, the same tuition, and the same amount of financial aid. University A’s endowment is primarily restricted to financial aid, while University B’s endowment is primarily restricted to faculty salaries. University B would have to tell parents that its general funds—in other words, its tuition revenue—is being used to support its financial aid budget. But this is all simply smoke and mirrors.

Until colleges and universities have more funds restricted to financial aid than their desired allocation to financial aid, it simply doesn’t matter if that financial aid is funded. Many universities have some obscure example of restricted financial aid dollars—say, for the student with green eyes who is from Alaska and was a Boy Scout. Restricted donations like these just make it harder to operate an institution. Fortunately, most presidents and development offices are able to steer donors toward providing gifts that allow an institution to reach equilibrium with its expenditures.

Here’s the bottom line: We need to maximize our use of resources to operate the most effective institutions. We achieve this when we apply our managerial expertise to the direction of the institution’s activities. Should we really allow that responsibility to be sidetracked by ebbs and flows of restricted funding?

We should focus first on student achievement and scholarship and second on finding, directing, and redirecting revenue streams toward those ends. Certainly a tenet of good stewardship is that an institution uses its funds with fidelity to the payers’ and donors’ intents. But an institution also has the responsibility to develop plans for education first and then figure out the application of funding.

Whether financial aid is funded or unfunded isn’t the issue. What matters is whether the institution has the resources to accomplish its goals and how effectively it employs those resources.

Author Bios Lucie Lapovsky served as president of Mercy College, Dobbs Ferry, New York, from 1999 to 2004 and remains on the faculty as a professor of economics. Loren Loomis Hubbell served as senior vice president of finance at Mercy College from 2002 to 2005.

E-mail llapovsky@mercy.edu; llh@suscom.net