Key Financial Metrics in Higher Education

Boards focus on the most important and inter-related institutional issues, such as mission, quality, outcomes, and financial sustainability. In that latter category, the key questions for board members are:

• Do we have the financial resources to fulfill our mission and array of programs?
• Are our resources focused on our top priorities?

Financial matters can be especially confounding for board members accustomed to the for-profit sector. Accounting is far more complex in higher education than in the commercial sector, making it harder to assess resources and resource utilization. The industry does not always have consistent definitions for data, and the data received is often late, making comparisons with other institutions, while important, more limited in value than is ideal. There are many stakeholders in higher education who want a voice, and each may have a different interpretation of the information available. Some interpretations of data can lead to wrong conclusions about what needs to be done. Most importantly, data about outcomes is incomplete because achieving a mission is harder to define than the single measure of profitability common in the for-profit corporate world.

Some types of data are more reliable than others:

• Information from audited financial statements is the most reliable, because these forms use standard definitions and an external third party (your institution’s auditor) confirms the accuracy.
• Information generated from your own institution is the next most reliable if the definitions used are consistent over time (or changes are noted). Even within your own institution, however, there is the temptation to revise data to make the institution look as good as possible (even though that is a disservice to you as a board member).
• Information from other institutions (other than audited financial information) is the most suspect because data definitions vary widely from place to place.

Despite these limitations, there are metrics that will help you to monitor financial performance over time. They are not the entire answer to the questions noted above, but they raise important questions that can generate important conversations within the board and its key committees.

Diversity of Revenue Types
It is important to understand trends over time in the institution’s reliance on particular types of revenue: net tuition and fees (after deducting for institutional aid but including room and board from students), state support, grants and contracts, fundraising, and other revenue sources. Most institutions see a growth in tuition’s share of total revenue, which can be alarming. Diversity of revenue assists in long-term sustainability as circumstances change, and lowering tuition dependency puts less of a financial burden on students themselves. Ideally, you would want to view such a metric over a five-to-ten-year period.

Primary Reserve Ratio
This ratio measures the depth of financial assets available to support the institution’s operations. For good reason, it is a favorite of bond ratings agencies, accreditors, and auditors. It is the best financial ratio for determining whether your financial resources are growing or shrinking. The ratio compares expendable net assets to total expenses. Expendable net assets represent those assets that the institution can access quickly and spend to cover costs and to satisfy its debt obligations. It answers the hypothetical question: If no additional revenue came in, how long could the institution continue to operate?

The primary reserve ratio is a measure of liquidity, an important factor in financial health, especially for institutions that are financially vulnerable. Board members should also ask questions about cash flow itself. The most common reason that colleges close is that they are about to run out of cash.

The primary reserve ratio also effectively differentiates between restricted and unrestricted endowment, since only unrestricted endowment is accessible for unexpected purposes or to support new institutional initiatives when a donor or granting agency is not involved.

Return on Net Asset Ratio
The return on net asset ratio measures whether the institution is experiencing positive financial results over time. It measures the change in net assets compared to total net assets. It is more comprehensive than “operating results,” which in many institutions does not cover all activities.

Physical Asset Reinvestment Ratio
The physical asset reinvestment ratio is one way to measure whether you are investing sufficient resources in plant maintenance and renewal. Deferred maintenance, for instance, is a hidden cost not usually reflected in budgets or balance sheets. The physical asset reinvestment ratio calculates the extent to which capital renewal is occurring compared with the usage of physical assets represented as depreciation expenses.

Net Tuition and Fees Revenue (per Student and for the Institution Itself)
Net tuition and fees per student (including room and board from students) tells you how much cash your institution receives per student, on average. It demonstrates your real pricing power in the market because it tells you how much students are willing to pay to attend your institution. Although you want to consider whether increasing that net number affects your equity commitments, in general you want to see net tuition revenue per student increasing. This indicator is far more helpful than the discount rate, which is artificial (you can set the sticker price arbitrarily).

Net tuition and fees for the institution as a whole is also a very important metric, since it is a measure of whether your enrollments produce the revenue needed to maintain the programs that the institution offers. Head-count enrollments alone can be misleading, but the cash those enrollments produce is very meaningful.

Student Retention Rates
Attrition and retention rates are critical indicators of student satisfaction and academic outcomes. From a financial perspective, improving attrition improves enrollment levels in a less costly way than recruiting new students. High attrition rates represent revenue losses. Boards should analyze these rates to identify underlying issues and implement strategies to improve student retention and success. This information is most valuable when shown by class year.

Mapping Your Strategy to Your Operating Budget
Your budget should be aligned to your operating budget. Ask the administration, in submitting its budget for next year, to show how the budget accomplishes the institution’s strategy and what choices the administration made to achieve the strategy. Budgets often enshrine the present and the past, rather than charting your future. The board should expect data showing that the institution’s resources are positioned to help the college, university, or system focus on what it seeks to become.

Viability Ratio
The viability ratio measures an institution’s capacity for debt. It takes expendable net assets and divides by long-term debt. Debt is an important tool for financial viability, so it is not necessarily a problem. Media coverage of institutions that have closed often cites their large debt burdens, but often the institution would have closed sooner without incurring debt for facilities upgrades that improved its attractiveness to students. Too much focus on levels of debt can lead to decisions that are harmful to the institution’s sustainability.

Management Discussion and Analysis (MD&A)
It is a leading practice for the audited financial statements to include, as supplemental information, an MD&A that reports on key trends and financial factors that may not be included in the audited financial statements themselves. The MD&A, prepared by the administration, can make some of the financial information in the audit more understandable and can include additional information not in the audit. This can include information about enrollment, faculty and staff numbers, risks the institution faces and how those risks might be mitigated, as well as core financial information over time, such as the ratios described above.

Board members should ask how many of these indicators are a regular part of the reporting to the board and how often the board and its committees discuss the questions raised by the data.

These suggested metrics apply to all institutions, but your board should supplement or interpret them based on the type of institution being served. In addition to getting advice from the administration on what metrics might work, also seek advice from your bond rating agency and the auditor preparing your financial statement, each of whom has specific financial expertise, is more independent than the administration, and sees a broader range of industry practices. AGB also has resources that can assist you, especially regarding the appropriate role the board plays in financial oversight.

Larry Ladd is an AGB Subject Matter Specialist.