Jan. 11, 2011
Looking at Western’s statements of financial condition, seems like we are doing OK. So, how do we explain to others that the cuts – past and pending – are for real?
An important question, one recently raised by colleagues on campus as well as by a member of our Board of Trustees. The university’s annual audit of our financial condition – summarized by statements of revenues, expenditures, and changes in net assets – was on the Board Audit Committee’s agenda last meeting and it is true: looked at from the perspective of the financial statements, we would seem to be doing OK.
So, our Trustee asked, how can we help the public understand that, still, there really have had to be cuts? Really damaging ones.
I will provide such a presentation at the February Board meeting. Think of this blog as my trial run at offering the explanation. These are complicated matters so let me know if what I attempt here is making any sense.
Please also understand, this is written by me and for folks who, like me, are not financial wizards. I am choosing the words, concepts, and metaphors by which I, a fuzzy thinking social scientist, understand these matters. If you are like me, then maybe we will be speaking the same language. Financial professionals may choke on some of what they read. But, were I to turn the task over to them, I fear I would not be able to understand the result.
Let’s get to the question at hand. First, we have to understand that our financial statement and our annual operating budget are apples and oranges. A financial statement details assets (including revenues) and liabilities. It’s roughly akin, at the personal level, to a comprehensive analysis of the value of all you own – car, perhaps a house, ..., and everything you have saved in the bank, in your retirement plan – even stuff the IRS does not ask about – and your income along with an analysis of what you owe.
Basically, a financial statement answers the question: considering assets and liabilities at a given point in time, are we solvent?
An operating budget is part of that solvency check and so is part of the statements of financial condition. But, it’s a special part. The operating budget is what we have available to spend on an ongoing basis. The analogy would be to our paycheck analyzed in light of our monthly expenses.
Basically, analysis of an operating budget answers the question: Are revenues covering expenses? And that is like asking: will we continue to be solvent?
Here, whether as a university or in our personal lives, is the big difference: Whatever our overall assets, we have to live within our income. Otherwise, we go broke.
And maybe that is all I have to say. Our overall assets remain about the same, except where assets are added – e.g., a new building. However, Western’s paycheck has been cut and cut. So, our recurring expenditures have had to be correspondingly reduced. We have been fiscally responsible in so doing and that is what the financial statements show: we remain solvent, albeit at a lower level operating budget.
If you find that sufficient, then just skip to the summary. If, like me, you enjoy digging into the details, then do read on. And on and on for it is somewhat involved.
Stuff in the Financial Statements but Not in the Our Annual Operating Budget
For those visually inclined, consider Figure 1. It shows what goes into the financial statement and just where the operating budget fits within that.
For those not so graphically inclined, I will also try to paint the picture with words.
Our financial statement includes assets. Such things as the value of all our buildings (after accounting for what we may still owe on them). The value of the books in the Library are in there. So are portions of our impressive art collections. All infrastructure. Furniture, staplers, microscopes, computers, ….
There are also other assets, things we that we cannot touch for “monthly expenses.” The University (but not the Foundation) endowments are in here, all – by law or contract – tied to specific purposes: professorships, scholarships, and such. Appropriations tied to specific capital projects are another example. Footnote 1
Our institutional reserves are also among the funds reported in the financial statement. Reserves are held against unexpected one-time needs. A portion of these must be held to meet requirements of current bonding by Western. The bond rating agencies that regularly scrutinize us also require that we have certain levels of reserves in order to earn a reasonable bond rating. Our reserves are borderline but, so far, support relative good scores from the bond rating agencies. That is important: poorer ratings would greatly raise the costs of our capital projects. We would get substantially less for our money in the Miller Hall project; our students in residence halls would have to pay substantially more for projects like Buchanan Towers.
Also parked in the reserves are funds from our auxiliaries (operations that run on a cost recovery basis) – e.g., within Housing, there is a Board approved 10-year capital plan that requires building up reserves to put fire-suppressing sprinkler systems in the older residence halls (among other capital improvements). Funds are saved from residence hall income, year-after-year, until there is enough to do the projects. Do note, these reserves come from charges collected by the auxiliaries for specified purposes. When, in another state, there was an attempt to raid such funds down in the state capitol, I received a call from the Governor’s office because I was (correctly) quoted in the newspaper as calling the move “theft.” (The caller was angry but the ploy was dropped.) Point is: we cannot ethically or (in Washington) legally use such funds for other purposes.
Here’s the bottom line on any reserve, though. It is one-time money. Can be used for emergencies or one-time needs. Cannot be used (for very long, at least) to cover regular, recurring commitments: e.g., those associated with what makes up 82% of our operating budget - personnel costs. That would be like paying the grocery bill from your savings account instead of from your checking account.
In a personal emergency, may have to use savings for the grocery bill. We have done essentially that at Western recently: it is the reserves we have used to buy us the time to thoughtfully make reductions in open and transparent ways. We have bought as much as a year for that purpose. It only works, though, because we know, at the end of the year, we will have permanent cuts in place and will not need to rely upon reserves any further.
Try covering groceries out of savings for too long and personal disaster would ensue. And, for a university, were we to rely on one-time money for recurring needs (e.g., a cut from Olympia) longer term, then the auditors would sound the alarm bells, I hope campus governance would be aghast, and I know our Board of Trustees would be opening opportunities for me to return, full-time, to the classroom. (Come to think of it, there are days when that prospect …. :-)
Stuff in the Operating Budget
So, all that preceding stuff appears in a financial statement. But, none of it helps us with recurring budget needs. Consequently and following well established and required budgeting principles, none of that is in our operating budget. Understanding the operating budget is critical. So, I’ve taken the operating budget part of Figure 1 and enlarged it so I can show more detail. The result is Figure 2.
Western’s operating budget, annually, is, currently, about $260 million. It is made up of two fundamentally different chunks, each approximately the same size. The two pieces are: Operating Budgets for Cost Recovery Operations and Operating Budget for the Core Academic Mission, Broadly Defined.
Operating Budget for Cost Recovery Operations
About half our operating budget involves no state dollars nor any tuition. Here, you find the operating budgets for the many “businesses” we run – in a university environment, we call them “auxiliaries” but the basic idea is that they must generate income to fully cover their costs. Examples include food services, housing, print services, parking, Extended Education and Summer Programs (EESP), and the like.
We also provide other services in return for external support. All services supported by student fees are included – e.g., Student Health Service, more and more of Counseling services, the VU, the Wade King Recreation Center. Also included are grants and contracts whatever the source: all the Federal and State financial aid, awards from National Science Foundation, private foundation grants, ….
The items in this part of our operating budget all share this principle: we are promising the delivery of goods and services for funds provided. And, we cannot use the funds for purposes other than for the contractually promised goods and services. The auxiliaries, legally, cannot be run as profit making enterprises generating funds for us to use elsewhere. We cannot use the financial aid grant money to pay faculty or staff. And as to other parts of the budget, try buying microscopes for an instructional biology lab from an NSF research grant. (I once was at a university that was caught by the federal auditors doing just that, among some other things. The penalty from the feds? A $6M fine and there was no negotiating.)
I must be candid, here, though. Under extraordinary budget pressures, this chunk of the budget has been used, to the extent we can ethically and legally stretch it, as part of our solutions to problems elsewhere in the budget. A couple of examples. When several critical student support services had to be cut from the state supported budget, our students, through their governance process and fee support, decided to step in and help. As we are less able to meet instructional preferences for more peripheral subjects, EESP has stepped in to provide classes on a cost recovery basis. And, we do charge overhead for services provided to the auxiliaries; those funds go straight to the budget for supporting academic mission; and we have made major increases (a 33% hike) in those overhead charges. Dollar for dollar, those increases had the effect of reducing the cuts that had to be made to academic and academic support programs last time around. Footnote 2
But, with those limited exceptions, note that our choices in this area of the budget are whether or not to do something. If we don’t do something or scale back something, that does not free up any dollars – not a nickel – to do something else. Why? Because with the scaling back, we also lose the revenues these enterprises must generate to cover their costs. Cut an EESP class and the income associated with it goes away; refuse to do a project supported by NSF and we don’t get the grant dollars; stop a function supported by student fees and the fees disappear. Indeed, by scaling back, our budget problems get worse because we lose the recapture of overhead assessments.
I should also note that, when there are budget reductions in state support, auxiliaries would seem not to be affected as they have no state dollars. However, the vice presidents responsible for these operations have insisted that auxiliaries go through the same budget reduction processes as the rest of us in order to keep the enterprises as lean as possible and the rates down (even as we have had to raise overhead charges to them).
Operating Budget for the Core Academic Mission, Broadly Defined
Here, we get to the budget that supports what matters most: faculty and staff involved in direct instruction as well as everything else necessary to keep the academic mission going. That “everything else” ranges from critical academic and student support services to keeping the plumbing working; the financial functions functioning; the environment healthy, safe, and sustainable; the pipe to the Internet flowing; the buildings heated; and the grounds tended.
So, I call this the academic core budget “broadly defined” because it includes all the other support services necessary for us to fulfill that core academic mission.
As we get down to this academic core budget, do note a convergence. For the first time, we have actual freedom to make budget decisions about recurring commitments. That does not apply to the rest of the fiscal matters we have been journeying through: at least not in the sense that we can take funds a donor or a granting agency or purchaser of services gives us and use those funds in ways we believe are more pressing.
Since it is this part of the budget where dollars can be reallocated, this is the budget we build through the bottom up, transparent processes now in place.
The other part of the convergence is this. We finally, for the first time, encounter some state general fund operating dollars. In these times, it is not a happy convergence.
These are the funds that are shrinking and the consequences fall in the one place we have available to make cuts: the part of the budget that supports core academic mission, broadly defined.
So What is Happening Over Time
Figure 3 tells part of the story. Viewed from the perspective of a financial statement, our combined assets and revenues have been growing. But, the growth has been primarily in assets (largely capital additions and improvements) and not revenues. The revenue increases that are there come from auxiliaries – e.g., modest but annual increases in student fees, housing charges, meal plan costs.
Please look, though, at the bottom two boxes in each bar. Those, taken together, are our operating budget.
Within that operating budget, looking more carefully at the two composite chunks, what is the pattern? Revenues associated with auxiliaries and such have been, more or less, holding their own and even growing as we do become more entrepreneurial in seeking additional revenues. Support for the broadly defined academic core mission has been shrinking.
Given the scale necessary to graph an entire financial statement, though, it is hard to see just how much shrinkage there has been. So, Figure 4 looks at what has been happening to support for that bottom box: support for the broadly defined core academic mission. We combine state support with tuition so that you can see the net effect on our budget when state support is cut while tuition is increased.
The base or “zero” line is what budget folks call the “maintenance level” budget: what it would take from the state to continue to do what we are doing, nothing more and nothing less. As Figure 4 shows and even after accounting for tuition increases and federal stimulus dollars, the hole in what I have been calling the budget for “the academic core mission broadly defined” is $17.7 million. In the Governor’s proposed 2011-13 budget, the hole, again after counting the tuition increases proposed by the Governor, would be an additional $18.2 million cut to that budget for the academic core mission.
Hidden within this shrinkage is another dramatic trend. When I arrived 2 ½ years ago, state was providing over 60% of the operating budget for the broadly defined academic core mission. As you have seen, that overall budget has shrunk. And, the state’s share of that smaller budget? Under the Governor’s proposed budget for the next biennium, state’s share will drop to 31%. Makes one wonder: is that just tough cuts or is it a fundamental shift in Washington’s political ethos, an abandonment of the people’s universities? But, that’s a question for a different blog.
So, folks have asked how it is that our financial statements look OK over time yet we are constantly cutting. How do we explain the discrepancy?
- First part of the answer is to understand the apples and oranges problem: assets are not (just) revenues.
- Second part of the answer is that we cannot sell off the assets (the library collection, our classrooms) to cover operations. Would be fiscally irresponsible to use assets, including one-time funds like reserves, to cover recurring obligations.
- Third part of the answer is that, when we zero in on the actual operating budget, half involves auxiliary and similar enterprises where costs generate revenues. That part of the budget has been holding its own. However, it can be of only very limited help with the part of the budget that is shrinking.
- And that is the fourth part of the answer:
- Revenues that support the broadly defined academic mission of the university come from two sources: tuition and from state general fund appropriations.
- Counting the coming biennium, we are in a five-year period of seeing state support relentlessly diminish and diminish at a much more rapid rate than the state-established tuition increases then partially back fill.
Footnote 1 I know it seems to make no sense for us to be doing capital projects when we are stretched in ways much more critical to our mission. But, capital and operating budgets are separate. We can say “no” to a capital appropriation. But, that does not mean we then have a penny more in operating budget to pay for people. It would just mean that the capital budget money goes to build somebody else’s (Heaven forbid, Central’s) next-in-line project.
Footnote 2 You find those dollars in Figure 2 in that $8M “Other” box at the bottom of the column. Also in that box are the 1-time dollars allocated from reserves so that, as has already been mentioned, we could buy a year to implement identified permanent cuts with the least disruption: e.g., providing notice, waiting for a pending retirement, letting a lease expire, ….