Bursaries and liabilities

August 2009

Nick Sladden examines how independent schools are funding public benefit

The last Data series article on independent schools (see Nick Sladden's article 'Feeling the crunch?' in Caritas, Issue 10, September 2008) explored the impact of the adverse economy on capital expenditure through an analysis of financial information over the three academic years to 2006/07. This article highlights some key financial ratios of independent schools at the start of 2008/09 academic year as preparations were being made to endure the current recession. Financial instability does not tend to happen overnight so it is useful for schools to consider accounting ratios over a period of time in order to identify trends where it may be possible to take corrective action or change strategies in order to prevent financial difficulties.

Debits on the left, credits on the right

Before detailing the number crunching and data that have been collected from 477 entities operating one or more independent schools in 2007/08, it is useful (at the risk of sounding like John Major) to go back to basics. And where better to start than with Frank Wood’s 1989 edition of Business Accounting? The claim made on the cover of the book (back then in its fifth edition) was that it was the ‘most widely-used accountancy textbook in the world’ and a quick visit to the Amazon website some 20 years later confirms that the book is still selling as well [1]. It is safe to say that there is something about Frank Wood’s financial fundamentals that has without
question stood the test of time.

At the outset he suggests that there are two main questions facing managers – whether or not an operating profit is being made and the ability of an organisation to meet its commitments as they fall due. These questions are equally pertinent for bursars, financial accountants, finance managers and, of course most definitely, governors of
independent schools. It all starts with a simple accounting equation:

Assets = Capital + Liabilities

This is the basis for the whole of financial accounting and is best expressed in the balance sheet being the natural starting point for determining whether commitments can be met as they fall due. It is this question that is of interest and the importance of a strong balance sheet was well illustrated by the injection of funds from the public purse into the banking system in the past year. Without this action the banks would not have been able to continue as going concerns. For any organisations, including independent schools, having a strong balance sheet is essential to survive difficult economic conditions.

Conversely, if it all goes wrong it can be difficult to establish precisely when an organisation has become insolvent but being able to meet commitments as they fall due forms ‘the cash flow test’ in making such an assessment.

Cash is king, but reserves may be the ace

The main measure of liquidity is the current ratio (being current assets divided by current liabilities). This compares assets which will become liquid in approximately 12 months with liabilities which will be due for payment in the same period. It is possible for two independent schools to have similar operating surpluses but their liquidity and current ratios may be entirely different. In other words, one school can be financially strong whilst the other financially weak regardless of the most recent operating results. By way of example, one school in the latest data had reported an annual surplus of £233,000 whereas another had a surplus of £235,000. The former had a current ratio of 0.4 and net assets of £889,000; the latter had a current ratio of 3.4 and net assets of £2.5m.

There are certain essentials required to define a school - pupils, teachers and property as a minimum! As such, it is not surprising that tangible fixed assets, particularly land and buildings, feature as a significant element of a school’s balance sheet (83 per cent and 93 per cent of net assets in 2006/07 and 2007/08 respectively – see figure 1 below).

However, school reserves tied up in land and buildings are effectively ‘locked’ and do not assist with liquidity. The existence of a freehold or leasehold property does not assist a school in being able to meet its debts as they fall due although it can be helpful in providing security for borrowing. Be warned though, many schools have failed because they have relied on the equity in land and buildings which is no remedy to poor ongoing financial performance. In recognition of the high proportion of tangible fixed assets to net assets, many charitable independent schools have chosen – as part of their wider reserves policy – to designate a capital or property reserve as an amount equal to the net book value of land and buildings.

The benefit of this approach is that it is clearer as to how much of the school’s reserves are available as liquid resources.

Understanding this concept and getting this approach right is essential and forms one of the tools in governors’ armoury through an effective and, importantly, regularly reviewed reserves policy. Two key questions directly linked to this point appear in the June 2009
Charity Commission publication The Economic Downturn: 15 questions trustees need to ask [2] being:

1. Are we financially strong enough to sustain our operations?; and
2. Do we have any reserves?
Designating reserves is considered in more depth in CC19 Charities’ Reserves published by the Charity Commission (March 2008) [3]. The act of designating reserves is only an administrative act by which the governors may earmark unrestricted funds for a particular use and does not restrict or commit the funds legally. The designation may be cancelled by governors at a later date if they decide that the designation is no longer relevant. However, the act of designating funds does not itself provide a justification of their use for the designated purpose and charitable schools will not be justified in creating, or transferring resources to, a designated fund where the main purpose of doing that is to show a reduced level of reserves. A clear explanation of the reserves policy is also required by SORP 2005 in the trustees’ annual report to quantify and explain the purpose of any material funds which have been designated.

Public benefit, or giving it all away?

Although subject to much debate and press speculation since the turn of the century, the reality now is that a charitable independent school must be able to demonstrate that its aims are for the public benefit if it is to be recognised and registered as a charity in England and Wales (the public benefit requirement). The benefit itself must not be unreasonably restricted by the lack of ability to pay any fees charged, for example, by excluding those in poverty from the opportunity to benefit.

In Scotland, the Office of the Scottish Charity Regulator (OSCR) has already carried out public benefit assessments and has focused on the arrangements in place at some schools to facilitate access for those unable to pay the full fees charged. One school that passed the OSCR public benefit assessment provided 7 per cent of means tested bursaries (as a percentage of its annual income). One school that failed provided 2.1 per cent. (See also news review in Caritas, issue 13, December 2008).

The widely quoted statistic in assessing bursaries is the annual value of bursaries provided expressed as a percentage of fee income. This is a similar approach to the percentages quoted above for the two schools with differing outcomes in the OSCR assessment. Figure 2 below shows the top 25 schools from the data ranked under this measure. However, as the statement of financial activities/income and expenditure account only shows financial performance in any one year, it is the balance sheet that shows financial strength (and perhaps the ability to pay bursaries). Therefore, a further measure would be to calculate the cost of bursaries provided as a percentage of net assets (see figure 3 below). This produces a completely different top 25 schools with only seven of the schools featuring in figure 3 appearing again in figure 2.

As an overall indication of bursaries provided, taking into account both the annual financial performance measure (figure 2) and the apparent ability to pay measure (figure 3), a top 50 is shown in figure 4 below. This takes the rankings from both figures 2 and 3 and gives an overall ranking.

Going back to the original equation therefore (Assets = Capital + Liabilities) any bursary provision will form the liabilities component. Whilst appreciating the need to deliver a public benefit, charitable independent schools will also need to ensure that sufficient capital exists to keep the equation balanced.

[1] Latest editions published April 2008 (Part 1) and July 2008 (Part 2) by Pearson Education: www.pearsoned.co.uk
[2] www.charity-commission.gov.uk/tcc/ccnews29check.asp
[3] www.charitycommission.gov.uk/publications/cc19.asp

Author: Nick Sladden

Nick Sladden is head of Baker Tilly's Charities and Education Group in the south-east and responsible for a portfolio of charities, independent schools, academies and other not-for-profit organisations. Nick has written and lectured on sector regulation as well as governance issues and is also a trustee for a hospice.

www.bakertilly.co.uk

Click here for other articles written by Nick Sladden

Comments

There are no comments on this article. Be the first to comment.

Comment on this article
Email this article to a friend

Data & Research

Bursaries and liabilities

Debits on the left, credits on the right

Cash is king, but reserves may be the ace

Public benefit, or giving it all away?

Author: Nick Sladden