Is Financial Oversight Broken at some Independent Schools?
.....or will it soon be when the next round of trustees take over?
Schools fail more frequently than the data suggests, since many failing schools simply stop reporting their data
According to this study of 15,000 private K-12 schools, more than 22% closed over a 12 year period, and if Catholic and Christian schools are excluded from the study, then the percentage that closed rises to about 34%. The tragedy is that many of these school failures could likely have been avoided if they had addressed their financial imbalances before catastrophic changes to their business models were required. I've lived thru a couple of school financial crises, including the first school that my children attended, which went from appearing solid, to closing 2 years later due to a sudden drop in revenue. That failure was so avoidable if they had done some basic scenario forecasting,
Our audited financials looked great a couple of years ago, and now we are closing? What happened???
As business models go, school's aren't very complicated, but they carry a few risks that can sink even well-established schools with administrators and trustees possessing the best of intentions. Below are some of the more general risks, starting with what may be the biggest financial risk for some schools - the people responsible for financial oversight:
1. School administrators may not have experience utilizing business model and risk forecasts, and therefore may be unaware of small issues brewing that can snowball into an avalanche of problems a few years down the road.
2. Trustees often don't have experience utilizing, or don't fully understand the assumptions behind business model forecasts, and therefore primarily rely on their treasurer's opinions. Furthermore, trustees that do develop an understanding of their financials after a few years of service are regularly cycled off, only to be replaced by new trustees who probably lack their understanding. This perpetual turnover of trustees can cause schools with sound financial policies (established from the hard knocks of previous financial scares) to lose their risk inoculation and pursue financially unsound policies that can come home to roost years later.
3. Treasurers may be highly experienced financial professionals in the for-profit world, but may lack insights into why schools succeed, or may fail to appreciate how much harder it can be to change a school than a business . If treasurers miss a key insight, or simply make a spreadsheet error (not uncommon!), and if their board is primarily relying on their opinion, then the resulting policies can cause real problems down the road.
It's also risky for boards to place too much faith in any one person's expertise. With fewer eyes on the process, there's a greater risk of errors, confirmation bias, and overconfidence in solutions. Overconfidence can bring critical thinking to a halt prematurely, and cause us treasurers to subtly pursue our chosen solution by tweaking what information we provide to the board, either consciously or subconsciously. For example, a treasurer who was overly confident in a particular solution could present three business models to the board:
Our audited financials looked great a couple of years ago, and now we are closing? What happened???
As business models go, school's aren't very complicated, but they carry a few risks that can sink even well-established schools with administrators and trustees possessing the best of intentions. Below are some of the more general risks, starting with what may be the biggest financial risk for some schools - the people responsible for financial oversight:
1. School administrators may not have experience utilizing business model and risk forecasts, and therefore may be unaware of small issues brewing that can snowball into an avalanche of problems a few years down the road.
2. Trustees often don't have experience utilizing, or don't fully understand the assumptions behind business model forecasts, and therefore primarily rely on their treasurer's opinions. Furthermore, trustees that do develop an understanding of their financials after a few years of service are regularly cycled off, only to be replaced by new trustees who probably lack their understanding. This perpetual turnover of trustees can cause schools with sound financial policies (established from the hard knocks of previous financial scares) to lose their risk inoculation and pursue financially unsound policies that can come home to roost years later.
3. Treasurers may be highly experienced financial professionals in the for-profit world, but may lack insights into why schools succeed, or may fail to appreciate how much harder it can be to change a school than a business . If treasurers miss a key insight, or simply make a spreadsheet error (not uncommon!), and if their board is primarily relying on their opinion, then the resulting policies can cause real problems down the road.
It's also risky for boards to place too much faith in any one person's expertise. With fewer eyes on the process, there's a greater risk of errors, confirmation bias, and overconfidence in solutions. Overconfidence can bring critical thinking to a halt prematurely, and cause us treasurers to subtly pursue our chosen solution by tweaking what information we provide to the board, either consciously or subconsciously. For example, a treasurer who was overly confident in a particular solution could present three business models to the board:
- A too cheap model
- A too expensive model
- Right where the treasurer wants you to vote
Simplified Forecast Built in Excel with a few VBA Controls Added
|
Furthermore, the finance committee should adopt the practice of software development and have financial models vetted by a committee member who was not involved in the model's creation (if you made the mistake, you are less likely to discover it!) |
|
Below are a few more general risks of schools.
4. Schools tend to have "fixed" costs and variable income, which constrains their abilities to react to financial crises:
4. Schools tend to have "fixed" costs and variable income, which constrains their abilities to react to financial crises:
- The wage pool is the school's primary cost, but firing teachers to reduce costs is a great way to lose students and revenue, requiring further staff cuts.
- Raising tuition too quickly can actually slow revenue growth due to students leaving and financial aid requirements rising.
- Taking on debt exacerbates risks by adding to the fixed (interest) costs while exposing the school to the risk of default.
- While large gifts to the operating budget are almost always welcome, they can also be a siren song that can tempt schools into increasing their "fixed" costs in an unsustainable way. It's almost always wiser to direct large gifts to the school's reserve fund or endowment.
- If your reserves are all in restricted endowment, then this is a risk for the school since you won't be able to spend the capital to get thru a financial crisis. Ideally, in addition to a restricted endowment, you should also have long-term reserves or board-designated quasi-endowment, which can be invested along side the restricted endowment, but less aggressively since the capital may well be needed in the nearer term - such as during the years following a recession like the 2008 financial crisis:
Can your school handle the next big recession?
Forecast to help with setting goals for un-restricted reserves
5. Financial crises can hit a tipping point and cause schools to go under quickly, if enough families start to loose confidence in the management of the school. It can start with a few families deciding it would be prudent to switch to an alternative local school now rather than wait to see if the problems can be fixed later, which can cause more patient families to also choose to leave before the alternative schools fill up, which can cause even more families to consider leaving in a positive feedback loop. Faculty will experience similar, job security-based stress during financial crises, which can cause schools to loose their top teaching talent to competitors, even if the staff would prefer to stay.
6. Schools can be difficult to change rapidly, especially if the change impacts well-established expectations. While "no money, no mission" is ultimately true, looming crises must be reacted to proactively before the problems hit a tipping point. Hence, sharing the new understanding of financial realities in an empathetic, yet solution-focused manner with all constituents in the early stages of a looming crisis is critical, especially at more progressive schools where community involvement is greater, Such discussions will help to illuminate what types of solutions are feasible for the school's culture, as well as help with getting buy-in for solutions. As indicated by this old joke: "you'll know your proposed solution is optimal if it manages to get everyone pissed-off", effort should be made to get as much buy-in as possible before executing significant changes.
“Like almost all other complex traditional social organizations, the schools will accommodate in ways that require little or no change… The strength of the status quo – its underlying axioms, its pattern of power relationships, its sense of tradition and therefore what seems right, natural, and proper, almost automatically rules out options for change.” -- Seymour Sarason
|
7. Vetted financial models that transparently and intuitively communicate forecasts are also critical for helping everyone to understand the trade offs of potential solutions. However, this financial forecasting component can sometimes lead trustees to think of a financial crisis as primarily a math problem, requiring primarily a math solution. Of course, solutions will also have an emotional impact on the constituents that bear the brunt of the change, and they will probably require multiple meetings, as well as a lot of time to process and accept particularly significant changes.
8. Difficulties with financial decisions are often more about politics and trust than about accounting. The solution, of course, is greater transparency, but transparency won't help if trustees don't understand and trust your financial forecasts. Training everyone to understand your financial model is therefore critical for getting buy-in for difficult decisions, otherwise some people will view your treasurer as Anton Chigurh from No Country for Old Men, a not-to-be-trusted person armed with a strange tool intent on doing them harm. Fortunately, it's easy to train even non-experts with intuitively built financial models and avoid dysfunctional politics. |
A Treasurer Armed with a Misunderstood Financial Model?
|
"In addition to mission and leadership transition challenges, financial collapse — not surprisingly — can be a leading cause of death in independent schools. This can occur when any of four factors prevail (or when two or more coalesce): The school burns through its reserves (or has never established a reserve fund in the first place), it becomes overwhelmed by deferred maintenance, it experiences precipitous and sustained enrollment declines, or it borrows money for land or facilities in amounts that turn out to exceed the school’s eventual capacity to pay back its loans in a timely way. Economic trends from the broader society often buffet schools heavily and conspire to make these factors extremely potent." - from What Dead Schools can Teach Us by Jim McManus
The good news is, the need for painful changes like austerity plans can often be avoided by incorporating Collaborative Forecasting into your board's decision making processes, which is the subject of the workshop I hosted at NAIS's 2019 annual conference.
If the cost of private school continues to rise at twice the rate of household incomes as graphed below, then diligent financial planning and oversight will be even more critical in the future.
The good news is, the need for painful changes like austerity plans can often be avoided by incorporating Collaborative Forecasting into your board's decision making processes, which is the subject of the workshop I hosted at NAIS's 2019 annual conference.
If the cost of private school continues to rise at twice the rate of household incomes as graphed below, then diligent financial planning and oversight will be even more critical in the future.
Household incomes vs. the median tuition price of NAIS day schools
Below plots the major costs of NAIS day schools from 2002-2016
Medians of (major costs/tuition) of NAIS day schools
The vertical rectangles plot the 25%-75% range of costs/student of NAIS day schools (the IQR). The center line is the median.
Below plots the major sources of income of NAIS day schools from 2002-2016
|
|
The vertical rectangles plot the 25%-75% range of incomes/student of NAIS day schools (the IQR). The center line is the median.
Wade Vagle, CFA, CAIA
Get in touch at Wade@SchoolsThatLast.com
Wade Vagle, CFA, CAIA
Get in touch at Wade@SchoolsThatLast.com
©SchoolsThatLast.com, 2017-2020. Unauthorized use and/or duplication of this material without express and written permission from this site’s authors and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to SchoolsThatLast.com with appropriate and specific direction to the original content.