Financial Forecasting Simplified
(it shouldn't be hard)
Two Tweaks to Improve Financial Oversight
Tweak #1: Build a trusted and simplified financial forecasting model
- Boards usually only require financial summaries to support budget decisions. Similarly, financial forecasting models usually don't require financial details from separate departments, and instead can be built using the aggregated budget categories that your business office uses to summarize financial data for your board (more details can be added as needed of course)
- Simpler models make error-checking, and vetting easier
- Simpler models make training new trustees easier
- Graphing the results can make forecasts more intuitive, and make trends easier to see.
- To avoid errors, follow best-practices when building, using and updating models
Tweak #2: Train Everyone
Intuitive financial models coupled with a one hour interactive training session for new trustees can empower the entire board to look at issues through a risk management lens, and:
- give trustees the tools they need to help to keep your school out of trouble in the near and more distant future
- avoid non-productive boardroom debates on issues that are financially infeasible
- show how risky taking on debt can be, and how critical financial reserves are, by forecasting plausible negative scenarios (e.g. what if the next recession is similar to 2008's? Can our debt payments be met? How long will our reserves last?)
- help ensure that capital campaigns address the most urgent needs of the future
- promote generative discussions by allowing for live "what if?" scenarios to be forecasted in meetings (or allow multiple scenarios to be easily produced and emailed to trustees before meetings), empowering trustees to strategize with risk/reward in mind
These two tweaks may seem like extra work - well, they do require some upfront work - but once these practices are established at your school you will have way less work since you'll avoid financial crises, avoid dysfunctional or misinformed boards directing heads to do foolish things, have less worry about the future keeping you awake at night, etc. In the long run, it's smart and lazy.
Best-Practices are Critical
Spreadsheet programs were invented for these types of financial models, and they are usually what schools choose to use since:
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Preserve Your Institutional Wisdom To avoid future errors, re-training, and loss of trust in the models or process, don't re-invent the wheel when volunteers turn over, or staff leave. Instead, "evolve" your models and financial policies in the finance committee, and have them "live" in your business office. The head of school should actively support this process by making sure new board chairs and treasurers understand that they should use and evolve your proven models and policies, and that their improvements will be preserved as well, allowing them to make a positive impact in perpetuity. |
Need Help?
Implementing such changes can be challenging since school cultures often resist change. Outside expertise can help with showing the long-term benefits, and with getting buy-in for change. For example:
Back to forecasting......
Below steps thru some of the major components of school financial forecasts, starting with some financial data of NAIS day schools and finishing with a simplified interactive forecasting model (along with a downloadable Excel version).
Implementing such changes can be challenging since school cultures often resist change. Outside expertise can help with showing the long-term benefits, and with getting buy-in for change. For example:
- Some business office managers may think they lack the skills or time to be responsible for annually updating financial models. If they can enter an equation into Excel, then they will be able to do this easily, quickly, and errorlessly with a model built with best-practices and an hour or two of fun, collaborative training. And they will quickly start loving and relying on the insights it gives them.
- Some highly-experienced new treasurers may prefer to do things their way, and create and use their own models. However, without a commitment to financial oversight continuity, there's no guarantee that the next round of volunteers won't do the same thing and ignore the new treasurers' valuable models and insights. Instead, if treasurers focus their talents on evolving the school's models and policies, then their positive impact can endure long after they step down.
Back to forecasting......
Below steps thru some of the major components of school financial forecasts, starting with some financial data of NAIS day schools and finishing with a simplified interactive forecasting model (along with a downloadable Excel version).
1. Major costs of NAIS day schools (2002-2016)
2. Major sources of income per student of NAIS day schools (2002-2016)
2. Major sources of income per student of NAIS day schools (2002-2016)
3. Major budget levers that need to be balanced
4. Impact of changing major budget levers over time
5. Future Campus Expenses?
These simplified models do not include a category for future campus maintenance and improvements, which can be substantial. If you don't have estimates of these future costs, then consider hiring a firm to do an assessment of likely campus improvement and maintenance costs over the next decade so that your school can be prepared to handle these future expenses. These estimates should also give you more accurate forecasts based on cash-accounting (rather than accrual-accounting which uses depreciation - see last section).
6. Avoid the icebergs - interactive forecasting model
Below is a simplified 10 yr forecast of a school with 500 students paying $20,000/yr in tuition. All salaries, benefits and taxes are lumped into the "wage pool", and other, less significant budget components are ignored to focus on the big picture.
As can be seen in the middle graph of Net Income, the school is currently losing about $100,000/yr, and is projected to lose more. Can you cut the losses by changing the major levers of the budget? Adjust the levers with the slider bars on the right so that the bottom graph of Cumulative Net Income is $0 for all 10 years.
Excel-Based Models
Excel-based models that include all of your school's departments can be built efficiently using the output format of your business office's accounting software, at the level of detailed needed to support the board's and finance committee's decisions. This makes annual updating of the model easy and error-free since the new year's data is simply copied and pasted into the model.
Also, since the future is uncertain, consider including some uncertainty in your model. For example, you could plot 3 net income forecasts on the same plot - 1. likely, 2. pessimistic, 3. optimistic, by varying parameters like future enrollment.
As noted above, Excel models need to be built with care since mistakes are easy to make, can be hard to find, and can lead to budget decisions that can harm schools in the future (trust me!).
Recommendations:
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An Excel version of above simplified forecast can be downloaded here: |
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Capitalized Expenses and Depreciation 101
As noted above, cash-based accounting that doesn't involve depreciation is usually more accurate for financial forecasting models, but requires estimates of future expenses for facilities, etc. If you don't have estimates of these future campus costs, then consider hiring a firm to do an assessment of likely campus improvement and maintenance costs over the next decade so that your school can be prepared to handle these future expenses.
The alternative to cash-based accounting is accrual accounting, where the cost of items like a new roof aren't accounted for as an expense, but are instead "depreciated". Depreciation in the accounting sense can be confusing for trustees who don't have financial backgrounds, but the core concept is fairly simple: depreciation spreads the cost of long-lived items (vehicles, buildings, etc.) across the years of their useful lives.
Here are a few more details, along with the associated accounting jargon
- When long-lived items are purchased they are capitalized
- The useful lifespan of capitalized items is estimated by their depreciation schedules, which are assigned under GAAP.
- Straight-line is the simplest method of depreciation, and assumes the same percentage of the asset is "used up", or "spent" during each year of the depreciation schedule.
- Upon purchase, cash is debited by $2,000, which will be reflected on the balance sheet and the cash flow statement.
- However, this $2,000 outlay is not treated as a cost on the income statement, and it will not affect net income.
- Instead, the annual depreciation expense incurred will be $400/year ($2,000/5 years), which will lower net income by $400 for each of the next 5 years.
- The assumed value of the computer over time, or book value, starts at $2,000 and declines by the $400 depreciation expense each year. The computer's book value is represented on the assets side of the balance sheet.
The below table summarizes the impact of purchasing this $2,000 computer at the beginning of 2018. Notice that when the computer's book value declines to $0 in 2022, the accumulated depreciation rises to the computer's original $2,000 purchase price.
Wade Vagle, CFA, CAIA
Get in touch at Wade@SchoolsThatLast.com