I’ve written about what job candidates should know about endowment spending and its effect on a college’s or university’s overall budget. In these difficult and complicated financial times, candidates must understand the basics of institutional finances to avoid stepping into a disastrous situation and to become effective campus citizens who, once on board, can contribute to governance and planning in an informed way.
Beyond endowments, another key component of institutional finances is debt. In this post, I am primarily talking about small and midsize private institutions, though there is some general applicability to certain types of public institutions, too.
Private colleges and universities take on debt for a variety of reasons. Most commonly, they borrow for capital projects (buildings, large equipment purchases, and similar expenditures) in much the same way families do. For example, residence halls are often financed through bond debt that can be repaid through the income generated by housing fees. Academic buildings, too, can be financed through bonds, though such buildings do not directly generate income, so the process is more complicated.
Sometimes institutions borrow money to temporarily finance projects or buildings that ultimately will be paid for with donations that have not yet matured. That approach enables the colleges to benefit from projects or buildings before the gifts are in the bank. (There are specific and rigorous accounting rules about how this must be done, and when donations are used, care must be taken to observe the directives and wishes of the donors.) Obviously, there is some institutional risk in this strategy—e.g., when a donor defaults or reneges on a gift—but if handled cautiously, this kind of bridge debt can be helpful.
Institutions may use debt to finance network infrastructure, computing equipment, university vehicles, and other tangible needs—again, in much the same way individuals and families might finance a house or a car, though on a much larger scale. Such debts can be a cash-flow management tool, allowing institutions to spread costs over more than one year and meet strategic needs in a timely fashion.
In my experience, institutional debts, particularly the larger ones, are financed through bonds, though institutions often maintain lines of credit as well, particularly for smaller projects or operating expenses. States often have an organization that provides bond financing for nonprofit colleges and universities, enabling such bonds to be issued as tax-exempt obligations.
Private institutions have bond ratings (issued by Moody’s Investors Service and Standard & Poor’s) just like other corporations, and those ratings, coupled with various financial statements, cash-flow analyses, enrollment health, endowment size, and other factors, determine the availability of bond funds and the interest rates. A nonprofit institutional borrower may be asked to pledge a portion of its endowment or to create a reserve of liquid funds in order to improve the security and ratings of the bonds, steps that in turn can lower the interest rate.
Institutions also have an array of leasing arrangements, which are effectively debt but which are secured by equipment and tend to have short terms. In addition, institutions sometimes borrow from themselves, from their endowment funds, or from reserve funds that are kept on hand for diverse purposes. Those internal arrangements are very difficult to discover from public documents, however.
The use of debt for cash-flow management may indicate that an institution has financial challenges. Private colleges and universities tend to have two very large inflows of money, one at the beginning of each semester, with much smaller income at other points during the year. (Imagine getting only two paychecks a year, one in August and one in January.) Since semesters are about four months long, it’s not unusual to allocate those funds over a four-month span, leaving only marginal funds for the summer.
Such a scenario is common in institutions that operate very close to the edge financially, that can meet their financial obligations for a semester with a semester’s income but don’t have much left over at the end.
Thus some institutions borrow each year to cover their summer cash-flow obligations—e.g., payroll, utilities, and various other bills. That obligation then carries over into the next academic year and either needs to be repaid when tuition and fees arrive or begins to accrue and move into the category of longer-term debt. It’s easy to see how that practice can cause additional challenges over time and ultimately lead to serious financial problems for an institution.
Next time, I will discuss how potential applicants can find the hard numbers they’ll need to understand an institution’s basic financial situation relative to its debt profile.
(Thanks to Suzette Radke and Courtney Berg, controller and assistant controller at Buena Vista University, respectively, for their advice on this entry. All errors are mine.)Return to Top