Reading about Western Connecticut State University’s financial trammels and its president’s ouster provoked thought and questions. How much do people understand about higher education finance? An investigation took place at Western Connecticut with much finger-wagging by the system, state government and campus constituents asking: Who and what was to blame? Lack of government support? Lack of oversight? Alignment of revenue and expenses? Changing demographics? COVID?
Ultimately, the focus rested on the institution’s reserves being nearly wiped out (there had been $25 million in 2012), and the president was to blame.
While I’m not here to speak about the intricacies of what happened at Western Connecticut or add fuel to that fire, I can say that the desperation to balance the budget at all costs has been experienced at numerous institutions. Many institutions have found themselves in the position of not having enough revenue to cover operating expenses because of dwindling enrollment, rising fixed costs, et al. No administration wants to cut programs and lay off employees, though maybe they need to do so.
Instead of addressing the real problem, some administrations have kicked the proverbial can down the road by filling the gaps with money reserved for one-time financial occurrences. They hope beyond hope that a miracle will happen, and additional revenue will appear somewhere down the line (a.k.a., the Jed-Clampett-shotting-for-some-food-up-from-the-ground-comes-a-bubbling-crude-oil-that-is-black-gold-Texas-tea-becomes-a-millionaire scenario). But using reserve funds to fix a structural budget deficit isn’t a long-term solution. It’s a bad idea. At some point, the money will run out. Or a real crisis will occur, and there won’t be funds available to handle it. The whole institution may collapse (or teeter on collapse) because loans can’t be secured without financial assurances for lenders.
Let’s start with the stupid simple part. Reserves (also known as contingency funds, fund balance, operating reserves and strategic investment reserves) are what they sound like: monies saved and held for certain financial occurrences. I know what you’re thinking: “Like, duh, thanks, KJB. Genius. Inside Higher Ed gave you a platform to tell us that? Hold my chardonnay. I need to write a missive on Twitter about my feelings. Then I’ll get back to grading.” The definition of reserve funds may be self-evident, but what can happen and why they are necessary may be more complex than you think. On the other hand, maybe you have never thought about reserve funds before. Perhaps you didn’t know they existed at every institution (or should exist or, in some cases, for public institutions must exist by state law).
As you come to expect in the land of higher ed bureaucracy, institutions have numerous policies and procedures about reserve funds, how much, as well as how and when they can be spent. I won’t go into all the details. But basically, the monies can’t be used for permanent expenses (like salaries and benefits). The amount held in reserves is relative to the institution’s operating budget. A typical target for the amount held in reserve is 40 percent of the operating budget or five months of cash on hand to pay operating expenses. That’s important, especially in higher ed, because of how money flows in and out of institutions. (Revenue comes in by semester; not a great deal comes in during the summer months. Institutions often must wait for disbursements from state and federal governments.) That’s the goal; some meet or exceed the five-month threshold, but many institutions don’t even have that much in today’s challenging climate.
I’m going to let that sink in for a moment while you recall what happened during COVID. Think about all the costs for supplies like Plexiglas, testing kits, masks and signs. Consider the necessary technological infrastructure changes and the cost of training personnel to conduct business online. Think about the lost room and board revenue, but how debt service needed to be covered, contracts with vendors had to be paid and the support staff that needed to be paid who work in facilities, athletics, student and campus life, food services, etc. COVID lasted a lot longer than five months.
Why Does an Institution Need Reserve Funds?
Institutions must be prepared for emergencies, planned capital projects, strategic investments and borrowing money.
- Bad things happen. While every institution has insurance policies, there are always immediate expenses after catastrophic events, and not everything will be covered and reimbursed. An institution needs resources to respond. How will the institution attend to the needs of students and employees? Also, what if the event involves civil or criminal liability and lengthy litigation? Here are a few very real and horrific examples:
- A hurricane levels the campus, and most employees lose their homes.
- A snowstorm takes out power to dorms and dining halls. Roads are closed.
- A spark from a welder’s equipment smolders, and eventually the fire spreads and a block of campus burns to the ground.
- Computer systems are attacked by ransomware. Campus business systems have been inoperable for weeks.
- A mass shooting occurs on campus.
- Admissions miscalculates and overawards scholarships for the incoming class by several million dollars.
- Stuff happens. Things break, wear out or need to be fixed, upgraded or replaced because they have become dangerous. Sometimes these are planned expenses; sometimes, they are not. Here are a few examples:
- Business systems relevant to telecommunications, cybersecurity, accounting, registration, enrollment management, advancement and instruction must be upgraded.
- Capital infrastructure such as heating and cooling plants, HVAC systems, elevators, lighting systems, and the like need repair, replacement or upgrades.
- Asbestos is discovered in the library. It will take four years to secure funds, tear it down and rebuild it. Trailers must be rented for library staff offices and for the students to use as study space.
- The pool is shut down because cracks have been discovered in the walls, and there is a risk of structural failure. Student athletes must be bused to other facilities for practice.
- Investment funds to generate additional revenue. These one-time expenditures will not be ongoing, permanent additions to the operating budget. They are expected to have a financial return, making the investment worthwhile. Possibilities include:
- Start-up costs for a new program.
- Creation or expansion of program-related ventures (hospitals, clinics, etc.).
- Start-up costs for commercial ventures (retail, housing, conference centers, hotels).
- Consultants to manage a major fundraising campaign.
- Redesign of marketing materials for admissions.
- Institutional rebranding.
- Assurances for lenders. Institutions, like individuals, sometimes need to borrow money. An institution may want to borrow money to construct dormitories, parking garages, roads, etc. Essential to securing loans at affordable rates is an institution’s credit rating. One important factor affecting an institution’s credit rating is cash on hand (liquidity). Moody’s Investor Services explains how they arrive at credit ratings here.
Ultimately, it’s everyone’s responsibility to ensure these types of funds exist, are utilized wisely and according to policy, and are replenished. One should scrutinize how that revenue gap is addressed if enrollment is down. Are permanent expenses being reduced? Or is spending the same or greater? Also, one should consider what strategic investments are being made to create new programs and enhance capacity for growing successful programs and other ventures for enhanced revenue. Does the campus infrastructure operate effectively?
These are questions directly linked to reserve funds’ effective and responsible use. Reserve funding is a simple concept but super important for an institution’s longevity, success and financial stability.