Challenging the financial narrative

Andrew McGettigan

It is daunting. Your management have presented you with forecasts for student recruitment that see your institution facing budget shortfalls of tens of millions of pounds. Alongside that management are ‘proposing’ a suite of emergency measures: pay freezes, suspension of increments, pay cuts, redundancy schemes (voluntary and compulsory), plus a ‘hiring freeze’ that will see hourly paid and fixed term staff unemployed at the end of their contracts. The numbers are big, the measures intimidating, it’s all couched in jargon… How do you push back against it?

Understanding/challenging the financial narrative

First, you want to make sure you have as much information as possible.

You want the 2020/21 overall budget (not just a summary) that management is putting (or has put) to its governing body for approval.

It’s not enough to be presented with a projected ‘loss’ to income, you have to be able to see: whether that results in overall losses; whether that drop in income is offset by an original plan to run a sizeable surplus; whether that ‘loss’ is based on projections that were originally sound.

Budgets are the result of a series of decisions, based on judgments and interpretations: those are all open to challenge. They are the result of debates behind the scenes. You need to ask questions to get at those.

What assumptions underlie the forecasts that underlie the budget? How up to date are they?

What constraints is the institution operating under? Are your management trying to make a surplus or generate a certain level of cash? Are they worried about breaching agreements made with lenders about how to run the institution?

Do they have cash on hand to absorb losses or have they been ‘running hot’ for the last few years and failed to build up rainy day funds?

How many of the offsetting measures are really needed? What percentage of those is being levied against staff? Could savings come from elsewhere?

Will the proposed cuts affect the ability of the institution to bounce back in future years? Have management modelled any changes to future income or just assumed that the original plans they sketched for 2021/22 and beyond will be suitable? Your institution may be underplaying the future consequences of cuts made today. They may not even have assessed them properly in the rush to get as close as possible to balance next year’s budget.

What’s the cash position?

Cash is the key issue. How much does your institution currently hold? How much is in the coffers to absorb a hit? What levels are they forecasting over the next 24 months?

Did you know, for example, that as charities, universities are advised to hold cash and equivalents sufficient to cover 90 days’ expenditure (excluding depreciation and movement in pension provision). Many universities stipulate a minimum of 60 as ‘working capital’ and – in England – the Office for Students (OfS) now specifies a drop below 30 days as a ‘reportable event’.

In these instances it is important that you can see how much ‘headroom’ the university has and what emergency funds might be called upon. At 31 July 2019, over half the UK’s HEIs met the Charity Commission guidance. If yours doesn’t, have you got an explanation from management as to why? Have they had to report themselves to the OfS?

Note that one of the most common confusions in accounting is that between ‘reserves’ and ‘cash reserves’. If your institution cites the size of its reserves, then make sure you know the exact reference. You don’t want to confuse cash with restricted endowment funds, money sunk into investments in joint ventures or subsidiaries, and the historic cost of buildings recorded in the accounts.

Universities (and most colleges) are solvent: they own (or are owed) more than they owe. What they own though is mostly land and buildings that might not be easy to sell and a sale may not raise what the accounts say it should. You want to be able to assess liquidity: the ability to meet demands that arise as they fall due. What does the institution own that is cash-like or can be turned into cash relatively easily at the value recorded in the accounts?

The budget should also set out separately how much capital expenditure is planned for 2020/21. Are large-scale undertakings still in progress, while staff are being asked to take cuts? Is all that work essential? What rationale has been given for continuing each project? Suspending or deferring work will preserve cash over the next year and provide a buffer against further shocks.

How does debt restrict the institution?

Now let’s talk about debt, external borrowing in particular. Firstly, it’s not size that matters for the current crisis unless a large repayment is imminent. Institutions with interest-only mortgages, bonds (any mention of ‘bullet payments’?) or expiring overdrafts and revolving credit facilities may face large multimillion demands in the next few years. These will show up in the notes to the annual financial statements (look for ‘creditors amounts falling due after more than one year’ and look for the repayment schedule for the next five years).

You should be more concerned about ‘covenants’, the agreements management sometimes make with lenders. These will not be listed in the accounts and you may find it hard to get the details on them. Persist!

For example, lots of universities have sufficient cash reserves to absorb the losses to income in September, but are worried about breaching covenants. Institutions effectively give away some of their autonomy when they take out large loans. Lenders may require a veto on additional borrowing, but they also stipulate some parameters for the running of the institution (they want to maximise their chances of repayment!). There are various forms of covenants in play and you should make sure that you know the exact wording and how the definitions that underpin yours are calculated.

I will discuss a key one here. Most covenants stipulate that the institution should meet a certain level of business performance each year. That might require them to run a ‘surplus’ (that is, it makes more income than expenditure in a year) or it might specify a ‘debt cover’ ratio: the institution has to make a certain amount of cash from ‘operations’ to cover the annual costs of servicing its borrowing (interest and repayments).

In effect, management may be asking individuals to bear additional real cuts, not because they can’t meet the shortfall from reserves, but because a cut to staff expenditure will count towards the 2020/21 business performance stipulated by the covenant.

Different institutions give different answers when asked what breaching a covenant means. Some have good relationships with established banks and so a covenant might be waived given the circumstances; others may have tapped non-bank money funds, whose behaviour at this time may be less predictable. Lenders may want tighter covenants in future in return for a waiver today, or higher interest rates, or more of their money back more quickly. These are costs that an institution will ideally want to avoid. But there are also costs associated with trying to meet the covenants. These have to be weighed up. Again there are judgments are play and that means there are always alternatives.

Finally, make sure you are actually talking about covenants and not self-imposed key financial indicators or planning frameworks. This might make sense in normal times but there’s little obligation to worry about them at the moment.

Further reading

 

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