The Fallacy of the Budget and the Concept of Staying Power*

It is a tradition that unfolds on every college campus across the country every Fall. Just months into the fiscal year, people get to work on the budget for the next year. After months of work, the proposed budget is presented to the Board. After an hour or two of presentation, the budget is approved. And when the next year is underway, months are spent preparing reports to the Board on actual results. And the Board asks the inevitable question: "Why was the budget wrong?"

Well, what would you expect for a plan prepared, submitted, and approved months before the prior year had even ended? And leaving that aside: If the expectation is that the budget will accurately predict all revenues and expenses, it will always be wrong because the budget is simply an authorization to spend up to a point in relation to anticipated revenues based on history and anticipated needs. But past performance is not necessarily indicative of future results and needs can change.

But the more important lesson here is that the time spent on the budget focuses on only one piece of a larger and far more important puzzle, which typically gets little no attention outside of the finance office: Cash. And the real question is whether a school will have enough cash to pay for what it spends when it needs or chooses to spend it.

8 of the 44 schools in The 2024 New England Survey had extraordinary events - primarily new debt or a significant sale of assets - that affected cash in the most recently reported year. Here are some data on the major sources and uses of cash—or "cash flow" - on average for the other 36 schools in the Survey.

There are four major factors affecting cash flow from operations over the course of a year: The operating budget surplus or deficit, depreciation, debt retirement and, most significantly, the use of cash to finance "PPE". PPE is short for "Property, Plant and Equipment" and it refers to acquisitions, repairs and improvement of the physical plant and other major cash outlays - as opposed to debt financed projects - that will be capitalized and only recognized as an expense in the form of “depreciation” in the operating budget in future years.

What also shows as sources of cash in financial statements from investment activity can dwarf cash flows from operations per se. But those are typically gains or losses on restricted endowment investments and they remain in the endowment as a matter of law. And unless the Board decides to remove funds it has transferred to endowment without restriction, which are known as “quasi endowment,” those gains remain in endowment as a matter of institutional policy.

On average, the 36 schools summarized here that did not add debt or record a significant sale of assets reported a $2.8 million budget surplus - about 2% - on average revenue of $144 million. But actual cash flow from operations, leaving endowment investment gains or losses aside, averaged negative $3.5 million.

Now, an average $3.5 million drain on cash is entirely manageable for schools with an average of $34.2 million in cash to begin with. So the average school is certainly not "at-risk". But remember: This is before potential declines in enrollment,

The Concept of Staying Power*

To get past the limited utility of the budget as a measure of the financial performance and health of a college or university, The 2024 New England Survey focuses, instead, on an original copyright and pending patent protected concept: "Staying Power".

In simple layman's terms, Staying Power* is ...

... the amount of time a college or university would have to put its financial house in order if enrollments fall. And "having one's financial house in order" simply means generating enough cash from normal operations to pay the bills.

To begin: Let's just assume for illustration purposes that any school would be considered to be "at risk" if its normal cash flows from operations, as measured above, would cover normal expenses for less than 3 years if its enrollments fell by 15%. For example: If a school has $20 million on hand and its annual cash flow is a negative $10 million, its "Staying Power" would be 2 years.

And by this standard, the financial specifics for each school based on their most recent financial statements indicate that 31 of 44 colleges and universities studied in The 2024 New England Survey would be deemed to be "at risk". In short: On average, cash receipts from normal operations would cover cash disbursements in the course of normal operations for something less than 3 years.

Anticipating the objection: The survey takes an in depth look at the extent to which schools might hope to maintain a positive cash position for operating purposes using endowments, debt, and by putting austerities in place. But it does so with a fact-based focus on the practical constraints and ramifications of efforts of that sort based on a range of assumptions about possible declines in enrollment that will be discussed shortly. And, as you will see, a 3 year threshold may seem like a high bar. But most "at risk" schools have Staying Power that is significantly below 3 years. Indeed the average for the at risk group as defined here is 1.2 years!

Staying Power, as measured in The 2024 New England Survey, is based on a "present value, all things being equal" assumption, which, if recent trends are a guide, is, arguably, optimistic. The growth in operating expenses for the 31 schools deemed initially to be "at risk" over the past year was 4.8%, while the growth in operating revenues from all sources was 3.7%. And remember, at 76% on average, these are all tuition dependent schools. Without attempting to be specific, an allowance for tuition, room and board increases is already baked into the "all things being equal" assumption, along with salary increases, inflation, and the like. But it also assumes that investments in fixed assets that occur outside the operating budget - noted as "PPE" above - also continue at each school's most recent level.

So How is Staying Power Calculated?

If a school has cash on hand to begin with and its measured cash flow – as outlined above - at year-end is positive and can reasonably be assumed to stay positive, its Staying Power would be, at least in theory, infinite. As noted, 8 of the 44 schools in the Survey had extraordinary events in the last year in the form of new debt and/or a significant sale of assets. But for the remaining 36, the average net cash flow was negative $3.5 million at year-end, And this is how Staying Power is calculated for these averages:

- Cash on hand at year end ($30.7 million) divided by annual net cash flow (-$3.5 million)

And the result is a healthy Staying Power average of 8.8 years, assuming future cash flows align with the outcome of the most recently reported year.

To the extent that the specifics metrics for each school may be anywhere within range of these averages, this might help to explain why colleges and universities may not really be dialed into the financial risks they face down the road. After all, the financial planning horizon for many schools is simply this year and next, which is the narrow focus of the budget cycle. But remember, this is before any decline in enrollment.

Staying Power is a straightforward indicator of the financial health and well-being of a private college or university. It does not say that a school is headed for insolvency or bankruptcy. But it does say that the school will have to find ways to generate more hard cash to pay the bills. And, as you will see shortly, that will often be more easily said than done. And the priority should be to anticipate possible declines in enrollment and take steps in advance to bring cash receipts and cash outlays in the normal course of business into balance.

Months of Cash ("MOH") - A Quick Diagnostic Metric

For most stakeholders, the calculations of net cash flow and Staying Power are a bit technical. But there is one financial metric that correlates highly with a school's Staying Power that can be determined easily from a school's published financial statements. That is the number of months of cash it has on hand in relation to annual operating expenses. ("MOH") -a standard some schools do use as a benchmark.

In The 2024 New England Survey, Staying Power and MOH are both measured at the end of each school’s fiscal year, which, for all but a few, is June 30 - the time of year when cash is typically at its lowest point. And the data show very clearly that schools with a minimum of 3 months of cash on hand in relation to annual operating expenses at year end have much greater Staying Power than those that do not.

This is not to suggest that the amount of cash on hand at a moment in time determines the Staying Power of a school. But with a .72 Pearson correlation coefficient, school-specific MOH calculations correlate highly with school-specific calculations of Staying Power.

The Fallacy of the Budget and the Concept of Staying Power*

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