Financial Viability in an Increasingly Complex and Regulated Environment

By Michael T. Wherry, CPA | August 15, 2019

This article was original published in the May 2019 Career Education Review and reproduced here with permission.  Article originally posted at careereducationreview.net.

As Herb Brooks famously told the U.S. Olympic hockey team late in the 1980 game against the USSR – “Play Your Game” – these words ring true today. Herb Brooks was reminding his team to play to their strengths and worry about what they can control. As many of my staff at McClintock & Associates know, a question I like to ask after any project is how we can do better. The follow-up statement to that question, especially when a project “goes south,” is let’s focus on what we can control. How can we plan better; should we have staffed the audit differently; should we have been more proactive in advance; what could I have done better? In my opinion, Herb Brook’s words are a reminder that we need to focus on items we can control. As we enter the later stages of the current administration, we believe this advice is critically important from a financial perspective for postsecondary institutions.

With the potential reauthorization of the Higher Education Act in 2019 and with the continued political pressure to change the 90/10 regulation, maintain the now applicable 2016 borrower defense to repayment regulations, and reinstitute the gainful employment regulations, institutions of all sizes should reflect on the financial acumens needed to survive over the next decade. An article in Inside Higher Ed on April 1, 2019, by Clayton M. Christensen and Michael B. Horn, reiterated their belief that 25-50 percent of postsecondary institutions will close. While we are not academics and haven’t done research on this issue, we know that the number is something greater than one and the demographic headwind trends appear to be continuing well into the next decade. The January issue of Career Education Review had an article by Dr. Wallace Pond that highlighted trends and changes made by successful institutions. The impact of disruption, technological changes and regulatory oversight doesn’t appear to be subsiding.

With over 50 years of combined financial, strategic and operational experience in the postsecondary space, we have seen a vast diversity of institutions. These institutions range from small schools started by a husband and wife, to publicly traded institutions with institutional shareholders. The financial sophistication of employees and systems, diversity of students, breadth of programs, layers of management, and number of locations cover the gamut of most trends within the postsecondary space since 1991. However, institutions of all sizes benefit from similar financial prudence and decision making. Financial viability isn’t limited to the largest and most sophisticated of institutions. As the famous quote most likely from George Santayana indicates, “those who ignore history are doomed to repeat it.”

So, what are institutions to do to survive in this increasingly competitive and regulatory environment? Here are our 10 suggestions to give your institution the best possible financial position.

One – Focus on the student experience.

No amount of financial, operational or strategic brilliance can overcome a poor student experience. Stay close to your students, listen to what your students are saying, not only with their mouths, but with their actions. Ensure your students are receiving the best academic support, the best faculty, the best student services and the best career placement assistance possible. As educators, this is not only a moral obligation, but it is flat out good business practice. As most educators understand, the successful alumni of an institution are their most effective ambassadors.

Two – Hire the right employees.

Yes, we realize this is an obvious suggestion and it is not meant to be flippant. Institutions should ensure that employees have the skill set and competency necessary for their institution. The leadership and staff of an organization must have enough knowledge to successfully strategize and execute in all areas of operations from student recruitment to education to career services. With respect to financial leadership, we have seen institutions hire very competent personnel, but in some cases, the individual’s skill set didn’t meet the specific needs of the position. For example, an institution which needs a CFO who can drill into general ledger detail to reconcile underlying accounting errors shouldn’t be hiring a CFO whose experience is related to SEC financial filings. Institutions should clearly define the job tasks and descriptions to ensure the candidate has the skills and the desire for the position.

To hire the right financial staff, it’s important to understand the difference between accounting, controller and CFO functions. An easy way to distinguish this is accounting and controller functions tend to deal primarily with the recording and reporting of history, whereas a CFO will focus more on business operations, financing, strategy, analytics and risk management.

For smaller institutions who can’t afford numerous layers of management, they should periodically utilize outside resources for special projects on an ad-hoc basis or on a routine basis throughout the year when more specialized skills are needed. For most institutions (institutions with over $2-3 million dollars in revenue), a controller skill set is needed to assist with the annual audit or properly prepare a fiscal budget as their bookkeeper or accounting manager may not have these skills. Without employing these outside resources, an institution may incur more costs on the annual audit, along with delayed completion. But even worse the institution may not have a fiscal roadmap to benchmark the operational and financial results and miss identifying areas of opportunities and risks for the institution.

The CFO’s value goes well beyond debits and credits. A CFO can assist in negotiating contracts and banking terms, work with attorneys on legal and regulatory matters, assist in structuring effective compensation plans and in evaluating complex and expensive benefit plans. The CFO can also help every member of the organization understand the key operating metrics of their respected areas and put processes in place to monitor both financial and operational results. The CFO will be an important member of the strategic leadership of an institution, often the primary operating partner of the President/CEO. As many small and mid-size organizations do not have the need or the financial resources for a full-time CFO, consider using your CPA firm or outside advisors on an ongoing basis as they will understand the nuances specific to your organization.

Three – Ensure financial systems are vetted thoroughly in advance of implementation.

It seems that most institutions don’t love their student information system. However, in defense of the student information system vendors, these are complex systems, which track thousands of transactions on an annual basis, and for which each institution has its personal preferences. The most expensive or the largest system may not be the proper answer in all cases. As with any software system, it looks great on paper until implementation is complete. Employees from all departments (admissions, financial aid, business office, registrar, etc.) need to have buy-in and input on the system. The implementation team should determine what the critical processes and procedures which the institution is attempting to solve. I have seen larger institutions spend hundreds of thousands of dollars on the implementation of software which then didn’t fully meet their needs. In one case, a system was implemented and then for many years it wasn’t utilized to compute deferred tuition. This calculation continued to be performed manually in Excel. This added more time and risk to their monthly closing process as well as required more resources. We strongly recommend finding other institutions which have implemented a system being considered and talk to all levels of users. Do as much research as possible. You will learn the good, the bad and the ugly before making a decision that will impact your organization for years or decades to come.

Again, for smaller institutions, hiring a full-time project manager for a software system implementation may not be necessary or financially feasible. However, your third-party CPA may be able to help you develop key questions to ask and to vet information produced in the implementation stage. Due to independence rules, outside CPA firms can’t design and implement the system, but they are a potentially valuable resource to ensure the system provides the proper information in the format you need on a daily, weekly and monthly basis. A part-time project manager or part-time CFO can help greatly in this area.

Four – Create and distribute key financial and operational data.

Once the right employees are hired and the right systems are in place, institutions need an internal process in which monthly financial statements and key operational data are generated on a timely basis. Facebook has an expression that 95 percent and done is better than 100 percent. The idea is that to get anything 100 percent correct takes exponentially more time than getting it 95 percent correct. This is definitely true for the generation of monthly financial statements. If the monthly statements are 95 percent accurate and issued on time, this is significantly more important than being 100 percent correct and issued 30 days after month end. I was talking to a CFO within the last year and he believes an institution should be able to close within 2-3 days. His point is that closing accounts receivable, deferred tuition and revenue is the key transaction cycle along with adjusting the allowance for bad debt. With online banking, bank reconciliations can also be completed in this time frame. Finally, accrued salaries are easily estimable as payroll costs are fairly constant and any large nonrecurring accruals can be estimated (i.e., inventory purchases, legal claims, bonuses). His process is then to true-up prepaid expenses, depreciation expense, accounts payable and recurring accrued expenses over the next month so these numbers are never more than one month in arrears. Since these items are less significant than the payroll and the revenue transaction cycles, delaying the monthly close by 10-15 days to get these numbers 100 percent accurate is detrimental to providing timely financial statements. These numbers can be trued-up quarterly on a “tighter” close especially if reporting is necessary to a creditor and certainly at year end when these numbers are reconciled in more detail in advance of the annual audit.

In addition, institutions should be tracking financial results by location and educational program. Some institutions allocate general and administrative costs to each program. In other cases, institutions evaluate programs on a direct cost basis only. Either methodology is proper, and the most important step is to set benchmarks and measure consistently over time. What are the expenses as a percentage of the institution’s revenue, what is the profitability of each program and location, what is the headcount cost of each employee, what is the teacher to student ratio, what is the cost per lead and the cost per new start, what is the average tuition lost for each drop student? The old adage from Peter Drucker is “if you can’t measure it, you can’t improve it.” These key metrics should be captured on a monthly basis and preferably on a monthly dashboard for senior management to have the most critical information on a one-page snapshot.

The speed of information and the necessity of decision making is only going to increase in the future, and, as such, institutions must be producing monthly financial statements which are available on a timely basis for senior management with the key metrics captured in an easily readable format.

Five – Understand key financial and operational data.

We have seen many institutions do an excellent job in providing the right raw data to the right members of the organization. Unfortunately, too many individuals do not have the skill set to properly interpret the information to make the best decisions. Just as we know students learn differently and have different skill sets, school leaders and staff have different strengths and weaknesses as well. If you want to see eyes glaze over quickly, provide a series of numbers on a spreadsheet to your institution’s personnel.

Providing relevant information, in an easy to understand format combined with providing the proper training, insight and critical thinking skills to interpret the information within the context of the organization and operating environment is vital. This may mean providing data in charts, graphs or geographical maps to ensure the information is quickly understood so appropriate decisions can be made. While larger organizations may have the dedicated talent on staff to assist in this area, this is another manner in which an outside CFO consultant can provide significant value to the organization.

Six – Stay on top of compliance and regulations.

Management/owners need to ensure they understand the key compliance regulations and accounting standards. This is probably an area which can be more difficult for owners of smaller institutions who have a passion for education and for running their own business, but don’t have a financial/accounting background. I realize that accountants often speak in a jargon which can be confusing to those who don’t have our knowledge. (This is an area where third-party advisors need to have strong communication skills, so we can relate to different levels of institutional owners/managers to thoroughly explain items in an understandable manner. There is room for improvement and maybe the basis for a future article). However, don’t be hesitant to push us and insist we explain significant financial and accounting ramifications, so you fully understand. Owners and managers can’t just rely on their third-party CPAs to ensure the composite score ratio will be passed or how this ratio will change in the future due to pending regulations/accounting standard changes. Be willing to stretch yourself to understand the financial statements and the key operating metrics (i.e., composite score ratio). Be prudent to have a thorough annual update, at a minimum, on regulatory and accounting changes from your CPA and other advisors so you have a basis for understanding key operating risks for your institution.

Similarly, the compliance regulations create risks for the institution if Title IV aid is being incorrectly computed. Financial aid directors need to have annual training and owners/management must be involved in industry associations to understand the new regulations. Don’t assume because past audits have been “clean” that this is still the case. Regulations change on an annual basis and an institution’s Title IV team needs to be kept up to speed. In addition, while owners/senior management doesn’t need to understand all the Title IV nuances, you must understand the higher-level risks and provide the proper resources to your team.

Seven – Planning and projecting go together.

Data and information are only worthwhile if used prudently. Thus, this is where financial projections must be “married” with institutional planning. Often organizations will have plans for expanding facilities, starting new programs, or hiring new staff that are not reflected in financial projections. In addition, contingencies should be contemplated for unforeseen drops in revenue or increases in expenses, essentially, plan for the unexpected. A good process is to “stress test” your projections for enrollment drops or unforeseen expenses. Again, a good CFO (full or part-time) or your CPA can assist in this process.

Eight – Protect the balance sheet.

A critical step to ensure financial viability is to protect the balance sheet. In regard to the U.S. Department of Education (ED), the composite score ratio is the most important ratio related to your financial statements. This ratio is driven mostly by the level of equity in the institution. As such, destabilizing the balance sheet by being overleveraged (too much debt), paying large dividends, and using the institution as your personal “piggy bank” can create a significant financial risk in the event of a downturn. Service-based businesses tend to have a significant amount of operating leverage. As such, they experience significant increases or decreases in profitability with relatively small changes in customers and revenue.

This is mainly due to the fact that a material amount of a service-based business’ expenses are fixed costs in the form of salaries, benefits and facility costs. Thus, profitability is realized when your enrollment is above the breakeven line while significant cash flow problems can occur when you are below the breakeven line. We have seen extremely profitable companies shutter their doors or have a “fire sale” within 2-4 years of their best year ever. Thus capital needs to be maintained in the institution to support the following strategic plans: closing of programs or locations which are draining resources (hence the comment above), continued marketing efforts even as profitability has decreased, educational changes for restructuring of teaching platforms or content, locations needing to be relocated and right-sized based upon demographic shifts, and utilizing third-party vendors (systems, strategic, accounting) to ensure the institution is positioning itself for future growth. Capital can be irreplaceable if a creditor cut off lending or if you have spent the previous profits on personal items. Title IV aid is a significant portion of aid for all institutions and ED does have a right to ensure taxpayer funds are protected.

We have seen institutions close locations while they were still profitable or only have smaller losses as their long-term projections showed continued losses. They close these locations to protect the balance sheet and the financial stability of other locations owned within the corporate entity. To do this, an institution must have timely and complete financial information.

Nine – Appreciate every member of your team.

A school is only as good as its staff, faculty and administration. In addition to ensuring you hire the right staff be sure to focus on their needs and appreciate the talent and dedication they bring to the classroom every day. Working in a school should be a fun and rewarding experience, but it can be extremely challenging and frustrating. If the staff and faculty of an organization are frustrated, uninformed and don’t feel appreciated, the students and the results will suffer.

Ten – Focus on the student experience.

See number one. The “business” of education isn’t for the faint-hearted and all institutions (private and for-profit) are in the business of education whether they choose to believe this or not. Regardless of your tax status, “no money, no mission” is a fact. The days in which institutions can operate quietly in their community without outside pressures and market forces are over. Changing demographics, technology disruption, and greater public and regulatory scrutiny have changed the sector forever. Postsecondary education had an insular expansion over the past half century due to the WWII GI Bill, the baby boom generation, relatively slow technological changes, and the lack of global competition. This has all ended and only institutions that manage their financial operations as a business will survive over the next half-century. With the swirl of news articles and potential regulatory changes, some items will be outside an institution’s control. Thus, all the more reason for institutions to ensure they take control of their financial resources and processes.

This article was original published in Career Education Review (https://www.careereducationreview.net)

References

Christensen, C and Horn, M. (2019). Perilous Times. Inside Higher Education. Retrieved from https://www.insidehighered.com/views/2019/04/01/many-private-colleges-remain-danger-opinion

Pond, W. (2019). Who Will Survive the Downsizing of Higher Education? Career Education Review. Retrieved from https://www.careereducationreview.net/2019/01/who-will-survive-the-downsizing-of-higher-education/