Financial Health of the Higher Education Sector

HEFCE's recent publication reporting on institution's financial forecasts has been rather misreported, it seems to me. The Higher leads with 'sector braces for fall in numbers', the Guardian with 'half of universities predict student numbers will fall'. These stories show naivety (whether feigned or real) about how these projections are prepared, and what their purpose is. As I have spent many years working with colleagues in Finance (primarily) on annual accountability returns, I'd like to provide a slightly different perspective.

The annual accountability returns consist of a long list of separate returns:

• annual assurance return 
• annual monitoring statement 
• corporate planning statement 
• audited financial statements 2009-10 
• financial results and forecast tables (2010-11 to 2013-14) 
• financial commentary on past performance and future prospects 
• audit committee annual report 
• external audit management letter
• internal audit annual report 
• Higher Education Students Early Statistics return (HESES)
• Research Activity Survey (RAS)
• Transparent Approach to Costing (TRAC) return.

Of these, HESES and RAS are the most important, as they directly drive future funding at your institution. Next come the financial forecasts (which are what the two press stories mainly relate to), and the rest gradually decrease in importance until you get to the Corporate Planning Statement which is so useless and uninteresting that even HEFCE have now agreed to stop asking for it.

The financial forecasts are prepared mainly by the Finance team, usually with some assistance from their planning colleagues. HEFCE require that they be agreed by Governors, and VCs tend to watch very closely anything that goes before the Governors. What emerges as the financial forecast, then, is not the institution's best estimate of its financial future, but the picture Finance want to show the Governors and/or HEFCE, less those things that the VC won't stand for.

Every management accountant I have ever worked with has been 'prudent' in his or her approach to forecasting. 'Prudence' in this context means 'borderline absurd' - the aim is to have the most cautious possible estimate that you can manage without actually being laughed at. This is wholly right and proper: if income is higher than expected, VCs will find a way to spend the extra money, but if it is lower people may lose their jobs. One of the institutions in HEFCE's report is 'planning' on the assumption of a 20% fall in undergraduate numbers in 2012 - i.e. they 'expect' their entering cohort in 2012 to be less than half the size of the 2011 cohort. The point of the scare quotes is that no-one either plans or expects this to happen, it is just a worst-case projection.

Most institutions use a projection rather less cautious than this. The main reason for doing that is to protect the capital spending profile. If you frighten the Governors too much, they may want to cut funding for new buildings. VCs tend to love new buildings, so the financial forecast must not be so cautious as to put them at risk. The small group of institutions projecting increases in student numbers in 2012 almost certainly have major capital expenditure planned. If I were HEFCE I would be looking at them very carefully - and I am sure that is what HEFCE have done. In these cases either the accountants were like no accountants I have ever known, or the least optimistic projection the VC was willing to settle for was really quite optimistic. And that is a warning sign.

The accountants also want to make cautious estimates about expenditure - that is they want to assume it will be high. But they don't want to project high staff costs in case that becomes a self-fulfilling prophecy. Hence we tend to see financial forecasts with very low staff costs in them (see paras 48-51 and Figure 5 in the HEFCE report). In reporting to HEFCE, higher staff cost projections would make more sense, but as the numbers are also used internally we cannot allow the departments (or even the VC in some institutions) to think there is money available for staff.  Instead, the money is hidden under depreciation, interest payments, and contingencies. Once the year in question is well under way, these hidden reserves will be released into the profit and loss account, where they will bolster the reported surplus. Again this is entirely right and proper. If we release extra money late in year then it can't do much good, but if we have to make unexpected savings late in year we can do a lot of harm. Far better to run one risk than the other.

A good example of this is table 2 of the HEFCE report which compares the projected figures for 2010-11 in December 2010 and April 2011. Although the forecast income has actually dropped slightly (from £22,736M to £22,721M), the projected surplus has increased (from £402M to £600M). By April 2011, of course, the 2010-11 year was almost over.

So the real lesson to take from the HEFCE publication is that institutions are still planning for very significant levels of capital expenditure in 2010-11 and 2011-12. Even the 2012-13 projection is for capital expenditure very much higher than it was in 2002-03. Most institutions will be able to meet this expenditure even on very cautious assumptions about student numbers, HEFCE funding, and the like.

This, incidentally, is why Sir Alan Langlands says "The notion that there are going to be high-level, high-profile failures in the early stages of this change I think is daft." He knows that most institutions are in a  strong position financially, able to make significant capital investments even on cautious assumptions. As (if) things get worse, we can expect to see institutions' projections get more optimistic: that will be the real warning sign.