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10.09.20

Metrics for Evaluating Institutional Health

BY Michael J. Cooney

Higher education governing boards require accurate and timely information in order to make prudent business decisions. Often, the decisions are hard to reverse, or even irreversible, so it's essential to make informed decisions today, understanding the longer-term implications of those decisions. When the extent and pace of change increase dramatically, the informational needs of boards of trustees shift accordingly. At the same time, however, it is essential for the board to remain in a governance mode and not stray into management, which is the responsibility of the president and staff.

So what are the metrics that board members commonly rely upon for an assessment of institutional health? Has the board been given the benefit of understanding the shortcomings of various metrics, despite their continued use? How can an institution adequately gauge the resources and timing required to adapt and change for the new challenges ahead?

Board practice in this arena is not a perfect science. The basic legal standard is one of business prudence, free from conflicts. That being said, there are a number of industry resources and approaches that are best entertained in the context of meeting that prudence standard, ultimately assuring that the institution is optimized for accomplishing its charitable mission.

Financial ratios

Since its publication in 1980, Strategic Financial Analysis for Higher Education is now available as an update to its seventh edition. The work holds a commanding place in the market for dependable financial analysis in higher education. While the governing board might be tempted to relegate the detailed analysis of the publication to the finance committee, the framework in which the analysis is provided—and thus the ability of the finance committee and the full board to rely on it—deserves strong consideration.

The National Association of College and University Business Officers and its four regional affiliates – note that I am a former board member of the Eastern Association of College and University Business officers – offer timely and relevant guidance on subjects of importance to the institutional trustee, including creating a system to measure the financial results of academic and other programs, using multi-year forecasting to assess financial strength and engage stakeholders, and constructing relevant dashboards for financial decision-making. Frequently, dashboards will include some, if not all, of the following metrics:

  • Trending analysis
    • Enrollment trends
    • Student-faculty ratio
  • Liquidity ratios
    • Days cash on hand
  • Profitability ratios
    • Operating margin
    • Operating expense per student
    • Salary and benefit expense as a percentage of operating expenses
  • Activity ratios
    • Age of plant ratio
  • Capital structure ratios
    • Debt service coverage ratio

This is not a comprehensive list as there are many other ratios that could be considered and included in a dashboard. Additionally, many of the ratios listed can be derived or interpreted in different manners, so for comparison purposes, it is essential to understand how your organization is calculating certain ratios as compared to comparable organizations.

Federal reporting

Well-known to private (and for-profit) college and university trustees, the impact of the annual United States Department of Education's (USDOE'S) assessment of financial responsibility operates as a suitability test for participation in federal student-aid programs. Institutions with composite scores below 1.5 are subject to special scrutiny and requirements, in addition to disclosure to the public of the institutions' challenged financial conditions.

Equally well-known are the shortcomings of this process. The USDOE's Financial Responsibility Composite Score does not appear to correlate well when considering the list of institutions that have recently closed and their composite scores. The applicable standards and the department's application of them have come under criticism. As a result, while fiduciaries need to be aware of the USDOE composite score and its potential effect on the institution, the analysis itself is not necessarily very reliable as a governance tool.

Admissions and retention

Tuition-dependent institutions are particularly vulnerable to market shifts. Patterns of student recruitment which have been stable for decades are now squarely at risk. The capacity to increase the institutional discount rate has become strained at some institutions, and the potential impact of online learning as a viable alternative to a campus-centric experience is still unknown. What is known is that enrollments were under pressure before COVID-19 and are certainly experiencing challenges at an overall industry level at the current time. While some institutions have received a positive influx, future challenges continue to exist, including the upcoming enrollment cliff and/or increased competition and a shifting higher education landscape.

Even as first-year students are admitted, institutions need to be mindful of retention throughout the degree program.

Relevant indicia the board might be looking at here include the number of students matriculating against budget, discount rate, net tuition revenue per student, cost per student, retention rates, zip codes covered, and number of transfer students. Additional consideration must be given to the student mix, including international vs. domestic, in-state vs. out-of-state, and even discipline of study and margin by school/program. Each of these indicators warrants review over time for identification of positive or negative trends.

Financial covenants

Colleges and universities are frequent participants in the debt markets and assume a number of obligations in connection with such borrowings. Assessments by financial rating agencies can provide a vital part of an institution's financial condition. Board members should be familiar with the application of these rating standards and how modifications might be relevant to their institution.

Institutions must continuously monitor and forecast performance relative to financial covenants, even if your institution is only tested against the covenant once or twice annually. Changing the future financial performance of most higher education institutions requires identifying and implementing changes months, or even years, in advance. If you have violated a covenant, your relationship with your lender may be frayed, and it may be a sign that you waited too long to act. Identifying potential covenant violations in advance, developing a plan to maintain compliance, and being transparent with your lender may optimize the outcome, as well as strengthen your relationship and credibility.

A final thought on external benchmarks

Commonly, higher education governing boards may seek externally benchmarking to provide a perspective on their own institution, only to claim, "but we are unique," when data is collected, and variations are identified. In reality, internal, year-over-year benchmarks may be more actionable than focusing externally when one is not certain of the other institutions' unique circumstances or whether they are operating at high levels of efficiency and effectiveness. This is not to say that external benchmarks and metrics are not valuable, but instead to reinforce that the appropriate context needs to be used when making comparisons.

Additional factors

The governing board needs to establish the most pertinent range of metrics for its consideration, continually analyzing its relevance and accuracy. Investment performance and charitable giving are two areas of importance, often a point of concentration of resources by a committee of the board. These also relate to cash flows necessary to support institutional operations. Some institutions need to be mindful of proximity to the zone of insolvency, and the burden that poses. In the end, boards do need to focus on a series of metrics but must ask a series of hard questions of management, regarding current/future operations and strategy. In unprecedented times such as these, it can be hard to extrapolate historical metrics on a going-forward basis, so holistic strategic analyses should be considered in parallel.

The point here is that no one size fits all, and while there is a strong tendency toward peer comparison in higher education, the successful institutions going forward will be those who are innovative and willing to take calculated risks their peers might rather avoid.

Many thanks to our friends Matt Unterman, Practice Lead & Principal, and Brian Bonaviri, Managing Director, at Grant Thornton's Not-for-Profit and Higher Education Advisory Services for their input.

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Michael J. Cooney

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