Part 1 of A Sustaining Higher Ed Blog Series
Sustaining Higher Ed is a monthly blog dedicated to helping college administrators and board trustees lead their organizations toward greater financial stability so they can stay on mission during challenging times.
As colleges and universities manage resources, whether in normal times or the current extraordinary pandemic, one financial principle seems regularly to reassert itself: Cash is king. This principle holds for any industry, but it takes particular twists and turns in higher education. Indeed, cash is king, but in higher education, the king has a remarkable wardrobe. “Cash” may represent the cash line on the balance sheet, fund balances for departments (essentially a “net asset” measure), earnings on investments (whether distributed or not and whether realized or not), unexpended receipts from bond issues or capital gifts, or an internally defined measure of institutional “reserves.” Throw in the dimension of time, where measures of cash could vary based on yesterday’s results, projected receipts and outlays, and the ability to convert assets/liabilities into cash, and CFOs are left with the unenviable task of providing clear and consistent communication about their institution’s cash position and prospects.
This is the first in a four-part series of posts designed to assist CFOs as they manage and communicate their institution’s cash position. The first two posts support conversations a CFO will likely have with stakeholders outside the finance division, while the second two posts address management challenges located within the finance division. Topics for the four posts include the following:
- Setting the Table: Common Terminology and Questions for All Stakeholders
- Measures and Metrics for Budgeting and Planning
- Cash Modeling Do’s and Don’ts
- Cash versus Investments: Balancing Higher Returns with Higher Risks
Setting the Table: Common Terminology and Questions for All Stakeholders
CFOs have many stakeholders outside the finance division. Primary stakeholders include the board of trustees, president, provost, deans, vice presidents, and often selected faculty or department managers. Bond rating agencies such as Moody’s Investors Service or Standard & Poor’s are important constituents as well. Given myriad cash and liquidity definitions in higher education, it is understandable that cash-related conversations among these stakeholders are challenging and often frustrating or inconclusive. Following are definitions for some key cash terminology. We also use these definitions to respond to common questions we encounter as we work with colleges and universities. A shared understanding of these key terms and questions may shift conversations from ambiguity and misunderstanding toward more constructive dialogue about the appropriate amounts and use of cash.
At a minimum, all stakeholders should have a shared understanding of the following seven terms when discussing the cash position of an institution, school, or department.
Dollars available for operating purposes in the institution’s bank account(s)
Dollars invested in securities (e.g., certificates of deposit, stocks, bonds, real estate, private equity). Some investments may be liquid (i.e., converted into cash) within a day’s notice (e.g., common stock), while other investments may require more than a year to convert to cash (e.g., private equity). Likewise, the value of some investments may change little from day to day (e.g., bonds), while the value of other investments may change a lot from day to day (e.g., stocks).
Any gift where the donor has stipulated that the gift must be used for specific purposes.
Market value of original gifts that donors stipulated be “managed in perpetuity” plus any undistributed investment earnings on those gifts. Distributions of investment earnings on the gift are used for the purpose specified by the donor. Institutions are legally obligated to manage, invest, and utilize these funds in manners consistent with both the donor’s gift agreement and their state’s adoption of the Uniform Prudent Management of Institutional Funds Act (UPMIFA).
Market value of dollars without donor restrictions that have been invested in the same portfolio as the true endowment, including undistributed earnings. Unlike true endowment, all quasi-endowment dollars could be “spent down” during a time of crisis or for some other purpose. However, distributions of investment earnings on quasi-endowment usually support operating expenses. As quasi-endowment is reduced, so too is funding for these operating expenses.
Dollars available for spending by the “owner” of the fund—typically schools, departments, or administrative units. The balance may have originated from, and be restricted by, a donor or have been “designated” for a specific purpose by the institution’s trustees or executive leadership. Fund balances that have accumulated through prior year operating surplus, indirect cost recovery allocations, or other unrestricted sources may be spent as deemed appropriate by the fund “owner.” The institution may have policy regarding amount or timing of fund balance withdrawals. Such policy is intended to align the risk of fund balance utilization against the institution’s available cash and investments.
Generally, reserves represent the portion of an institution’s cash and investments that are unrestricted (i.e., have not been restricted by a donor). These unrestricted resources may be “designated” by the board of trustees or executive leadership for various purposes such as capital projects, faculty start-ups, provost discretionary fund, or general purpose within specific schools/departments; nevertheless, these resources can, if necessary, be used for any purpose deemed appropriate by the institution’s board of trustees. The amount of reserves will depend on the allotted time to convert invested assets into cash. For example, reserves available within one year will exceed (or at least equal) reserves available within thirty days, which in turn will exceed (or at least equal) reserves that are available tomorrow.
The definitions above can be used to address questions stakeholders (especially academic stakeholders) often ask. The definitions will also be employed in the liquidity articles that will follow this article. Three common questions are:
- Why can’t we spend more of our endowment?
- Why are we running surpluses when we are denying budget requests?
- This institution has so much money, why can’t we use more of it?
While the questions have distinct answers, they arise from the understandable perception (and reality) that an institution has more financial resources than it is choosing to deploy—even for important programmatic purposes such as faculty hires or student services. These are fair questions that warrant direct responses:
- For question one, institutions are bound legally to maintain true endowment; however, institutions have some flexibility with respect to the amount of investment earnings that are distributed for spending in a given year. The governing principle is for current and future generations of students to be treated equally. Institutions can in fact spend all their quasi-endowment.
- For question two, planned surpluses mitigate the risk that actual revenue is worse than budgeted revenue. They also provide capital to fund an institution’s strategic initiatives and demonstrate good management to debt-rating agencies. Nevertheless, institutions can develop balanced (i.e., no surplus) or even deficit budgets.
- Regarding question three, and similar to responses to questions one and two, judgment will vary regarding the amount of resources an institution should deploy.
Nearly everyone will agree that an institution ought to retain at least some amount of reserves, but some will advocate spending more while others will caution against it. The short answer to all three questions is that it is critical that an institution maintain reserves, but what is the appropriate amount of reserves given identified opportunities to invest in faculty, student services, or other programmatic or infrastructure needs?
The next post in our series will focus on two important questions: How much cash do I have, and is it enough? The responses will vary somewhat depending on the stakeholder. At the institutional level, responses to these questions will define and target the appropriate amount of “reserves.”