The Solutions Exchange
Consider these ideas for getting your institution back on a healthy financial footing.
By Ken Cody
COVID-19 has created unprecedented uncertainty and an enormous sense of urgency. Campus leaders must move quickly to leverage this opportunity to develop a sustainable operating model that builds, or rebuilds, adequate reserves. Achieving the mission for generations to come should be an institutional priority and a central goal of your strategic plan, and this is impossible without adequate reserves (in other words, spendable cash and investments).
It is essential to consider short-, mid-, and longer-term decisions. By the time you read this, you have already dealt with the most urgent issues presented by COVID-19: You have ensured the health and safety of your students and campus community, protected liquidity to the extent possible, and stabilized operations to the best of your ability. And you’ve likely already made some of the difficult choices necessary to reduce costs for FY21.
While you are undoubtedly pulling your hair out finalizing fall 2020 operations and projecting FY21 revenues and expenses under various enrollment and social-distancing scenarios, you should also consider the longer-term goal of gaining campus commitment to a plan for sustainable financial health.
Offered below are my thoughts on opportunities—presented in four steps—that you should consider now.
Step 1: Begin With the End in Mind; Now Is the Time for Big Questions
Is sustainable success realistic in the future? Before the COVID-19 dust settles, leaders need to take a step back to envision the future:
Is there a realistic pathway to sustainably accomplish the mission?
- What changes are needed to the strategic plan and campus culture to enable a laser focus on distinctive competitive advantages. What are the execution risks? What areas are unrelated to competitive advantages and need to cease?
- Do you have “the right people on the bus” to do the hard work to make those changes?
- What strategic investments are necessary?
- What resources are needed to bridge the period from today until the day the vision is realized?
- What reserves are needed to protect the institution from another crisis?
Make smart short-term decisions that won’t hurt you in the long-term. If your institution lacked financial, brand, or market strength prior to COVID-19, don’t merely pledge to survive the crisis with a mindset to return to “normal.” In normal times, some CBOs would probably promote change on campus by gently prodding others to consider incremental improvements, but these are not normal times.
Unless there is a clear plan for future sustainable success, this is not the time to make incremental across-the-board adjustments or increase spending from endowments. What was unsustainable before the crisis will continue to be unsustainable after the crisis. Some institutions need to take bold action now to preserve liquidity by reducing ongoing operating expenses by 10 percent or more. Don’t assume a bank will provide cash to you later for strategic investments or operational survival; their concerns are heightened now, and many banks have already dramatically changed lending standards due to their perceived risks.
Be honest about a realistic pathway for sustainable success. Most institutions cannot return to their pre-COVID-19 business models and expect to thrive in the future. After substantive (but expeditious) deliberations among the president, board, cabinet, and faculty leadership, if there isn’t full alignment on the need to quickly develop a plan to achieve sustainable financial health—including adequate reserves—the institution should find a viable merger candidate or develop a dissolution and teach-out plan.
For institutions operating on the edge prior to this pandemic, the hard truth is that the risk of closure must be realistically assessed now so that appropriate actions can be taken quickly. Every day that passes could mean additional loss of resources that can further limit viable options. Since you have a fiduciary responsibility to your students, it may make more sense to let a stronger institution carry on your mission at this time.
However, if you have full campus commitment to achieve financial sustainability, the next step is to develop strong financial modeling capabilities.
Step 2: Use Strategic Financial Modeling to Support Good Decision-Making
Develop or enhance a rigorous projection-modeling capability. EPM (enterprise performance management) systems and cloud-based planning and budgeting software can provide a multiyear holistic financial view of the entire enterprise, forecast an unlimited number of scenarios, simulate the impact of various strategies and assumptions, and effectively compare and communicate the results.
Alternatively, if your institution’s operations are less complicated and you are in a hurry to implement a solution with a limited budget, effective centralized budgeting and planning can be accomplished more quickly for less money by developing projections in an Excel model. In either case, your model should include all funds and the balance sheet, enabling projections of reserves and liquidity as well as the computation of various ratios indicative of long-term institutional financial health. I suggest a five-year planning model because the depth and uncertainty of the COVID-19 crisis make a longer-term planning horizon meaningless.
Engage cabinet members, faculty leaders, and others to help refine and own the model. Forecast multiple financial scenarios, from best to worst case, based on current plans to demonstrate the potential severity of the challenges. Then perform real-time “what if” analyses while working in a collaborative team setting with leaders of enrollment, student affairs, academic affairs, advancement, and so forth. Inclusion of the president and provost would be most appropriate once you have confidence in the model’s predictive capabilities and know that all material inputs are accurate and realistic. (For example, although many on campus may argue for preserving liquidity by further deferring facility maintenance for the duration of the plan, do not allow such an irresponsible plan to be presented to anyone. And don’t fall for overly optimistic and unrealistic estimates when budgeting future year revenues.)
Multiyear, enterprise-wide presentation promotes understanding of the full ramifications of a new strategic initiative, particularly if there are multiple initiatives in various stages of implementation at the same time. Buy-in to difficult decisions by faculty and campus decision-makers can be vastly improved by providing them with full understanding of the issues and potential solutions via live use of the model. Stress-test the critical assumptions and estimates in your five-year plan to gain confidence that it reasonably represents expected results, even if presidents and faculty are initially resistant to hearing unpleasant truths.
Use strategic financial modeling to enable data-driven decisions. Especially in periods of crisis, it is essential for management to have at its fingertips the ability to do continuous contingency planning so it can react with agility and confidence. Decision-making will necessarily have a large degree of ambiguity due to the dynamics of the current crisis, but strategic modeling enables the best data-informed decisions available.
The model will provide clarity for understanding how a short-term action may affect mid- and longer-term financial health, as well as determine the financial trade-offs of competing priorities. In short, strategic financial modeling can provide the information that institutions need to create and manage nimble, attainable, and sustainable strategies.
Step 3: Be Intentional and Disciplined to Build Sustainable Financial Health
Expect initial push-back from the campus community as you help them see the big picture. Whether you plan to achieve full adequacy of reserves over one year or three years, it will be hard work since it will likely come at the cost of you empathetically saying “no” to many immediate requests for expenditures. As such, steadfast support from your president and board are crucial for success (and your sanity and career longevity). You should be able to convince them and the campus community that the survival and future vitality of the institution depends on disciplined execution of the plan. Everyone has a stake in sustainable financial health.
Develop key financial ratios and targets to achieve financial sustainability. Targeted values should be developed for a few key financial ratios (strategic indicators) based on the institution’s risk profile. The objective is to ensure that all future financial decisions support the vision of sustainable success you committed to in Step 1.
I suggest using ratios recommended in Strategic Financial Analysis for Higher Education or in Moody’s Rating Methodology for Higher Education. Then set targets based on Moody’s medians for your rating category or competitor institutions.
Use the strategic financial planning model to drive operating and capital budgets. Reserves will be partially or totally depleted at many institutions due to COVID-19. Create a realistic and workable plan to rebuild reserves through careful planning and budgeting policies as quickly as possible so the institution can survive whatever emerges as the next crisis. The long-term financial consequences of the pandemic are still unknown, so FY21 budgets must be conservative and flexible.
However, in future years, the strategic financial plan must seek to rebuild reserves to an appropriate level. Therefore, the plan needs to drive the budget. In other words, the financial plan should set the parameters for the maximum operating expense and capital budgets allowable. Use the financial plan like a ladder to climb out of the hole of inadequate reserves over a period not to exceed three years. A new expense today may fit within the current year’s budget, but if it causes projections in year three to miss your targeted strategic indicators, take action today, not in year three. Budget proposals for FY22 onward should only be brought to the board after ensuring that they will not cause realistic projections to miss targeted strategic indicators in the five-year plan.
Budget and plan conservatively for an appropriate operating margin and replenishment of reserves. Regardless of the added budget pressure you feel from the impact of COVID-19, you need to continue to build conservatism into the budget and plans by budgeting for depreciation and contingencies. The budget and plans also need to include a responsible excess of revenues over expenses (operating margin) that will cover the principal portion of debt service, pay for future capital projects and strategic initiatives, and rebuild reserves.
Many institutions today might say that budgeting for depreciation, contingencies, and an operating margin would be exceedingly painful and untenable, especially given how constrained budgets already are due to COVID-19. I agree it could be very painful, but you don’t have a sustainable financial plan if you don’t invest for the long term.
Balancing resource allocation between today’s and tomorrow’s needs is an essential job of a fiduciary. We may be “not-for-profit,” but we still need to plan for an annual operating margin to invest in the future of our institutions. This is necessary if we view our institutions as going concerns. In my experience, openly budgeting for an appropriate operating margin and patiently explaining its purpose can ultimately create greater understanding and trust within the campus community.
Formalize the strategic financial planning process and parameters. Once you have determined your financial strategic indicators, targeted values, and reasonable time-frame to achieve those targets, you should not stop until you gain strong conviction in the plan from the president and the board. The budget and planning process, parameters, and targets need to be documented and widely communicated, preferably in a formal policy approved by the board. As such, this policy will provide spending parameters for the strategic plan and annual budget development. You will likely need to refer many people at your institution to these policies over the coming months and years, as they may tend to forget that setting aside funds to ensure achievement of the mission for future generations is an institutional priority and a board edict.
Step 4: Promote Transparency, Understandability and Accountability
Use an audited financial statement format for budgets and plans. Budgets and financial models should be based on all funds and presented in a format that is easy to understand and compare to condensed and simplified audited financial statements. This approach is important for full and complete transparency and accountability, and it eliminates the confusion that boards and other constituencies often have with the relationship of the budget and plans to the audit.
The use of all funds and financial statement format builds trust with the campus community by eliminating nay-sayers’ claims that “you must be hiding money somewhere” since the budget and plan can be directly compared to the independently audited year-end financial statements. You may find that change management challenges, created by the difficult decisions needed to meet financial targets, will be significantly lessened by creating a culture of full transparency and trust.
Monitor progress toward the budget and long-range financial plan. Be disciplined in making certain the institution adheres to the established key ratios and targeted values under normal scenarios. Variance analysis of audited results to the budget and plan should be presented annually to the board and campus community. Update the financial plan at least annually to create a rolling five-year plan.
Use these recurring opportunities to remind the president, board, cabinet, faculty, and staff of the commitments you all made to achieve sustainable financial health and why it is important to stay on task. Each of them owns a piece of the decision and, like you, they will probably have suffered bumps and bruises along the way from all the difficult changes, so they will be eager to see progress.
Hold the campus community accountable to the plan. In the process of meeting financial planning goals for sustainable success, you will likely engage in major changes that can be challenging. The migration from incremental budgeting to a more strategic resource allocation model will lead to many other changes. Maybe you have determined the need to invest in new instructional technologies or to expand an academic program with untapped market potential; perhaps these new investments can best be funded by eliminating some underperforming academic programs. Perhaps you see that operations can be streamlined through consolidating departments, outsourcing, implementing shared services, or centralizing IT. Or maybe a full rightsizing of the institution is necessary, requiring major reductions in force or the jettisoning of significant operations.
All of these changes can cause significant upheaval for the campus community and test the resolve of the institution to remain focused on the overarching goal: attainment of sustainable financial health to achieve the mission for decades to come. It will often fall to the CBO to remind faculty and staff of the purpose of their sacrifices, sometimes for years to come. Stay strong and disciplined; students depend on you.
KEN CODY is a NACUBO consultant. He recently retired as vice president for administration and finance and CFO/COO at Bentley University, Waltham, Mass. Prior to that, Cody served nearly 30 years at the University System of New Hampshire where he was vice chancellor and treasurer.
How does Ken Cody convince others that reserves are absolutely necessary? Read more.