Published Sep 19, 2024 | NBOA: September-October 2024 

The past decade has seen fundamental changes in the economics of the independent school business model. Following transitory increases in enrollment and emergency funding during the pandemic, many schools are now facing rising operational costs, demographic shifts, and ongoing economic pressures threatening their financial sustainability. A quarter of all schools operated with a negative operating margin in recent years, according to NBOA’s “Financial State of the Industry: BIIS Financial and Operational Indicators: 2021-2023.” And both NAIS and researchers at Vanderbilt University found nearly half (44-45%) of small schools operate at a deficit.

In working with schools, I’ve often heard clients wish they had identified their financial issues earlier, so that they could have addressed those issues before they worsened. Sometimes management and boards of trustees overlook or minimize warning signs. To help school leaders be aware of their institution’s financial health, I’ve listed 10 of the most frequently overlooked indicators of financial distress. This may be helpful for board members, heads of school business officers newer to the field.

One obvious sign of trouble is sagging enrollment, resulting from higher attrition, fewer incoming students or both. School leaders may rationalize a dip as a statistical anomaly, but a decline in enrolled students is a sign that internal or market factors are affecting your demand. Since tuition is the primary revenue source for schools, leaders must investigate the reason for losing students and strategize how to address it.

Schools that are in distress often resort to bolstering enrollment by discounting tuition with financial aid budgets. The warning sign is an expansion in financial aid awarded as a percentage of tuition revenue. The budgetary impact of an award extends for as long as the student remains at the school, and extensive discounting can diminish the perceived value of the program in the marketplace.

Struggling schools report budget shortfalls. Deficits may be unexpected, but some boards have been persuaded to approve unbalanced budgets. Many school leaders seem oblivious to the impact of deficits on the long-term sustainability of the business, knowing that the first or second year of a deficit does not usually result in insolvency. Ongoing deficits cannot be sustained, however, and school leadership must be committed to making difficult spending decisions to balance the books.

4. Lack of a Long-range (3–5 year) Financial Forecast

If your school does not have a financial forecast model that projects the statement of activities and statement of financial position at least three years forward, you are “flying blind.” We often see schools making bold financial decisions without looking at the long-term impact on their finances. Using a tool to look forward allows leaders to test scenarios and make data-informed choices.

Sustainable schools hold funds in reserve for operating and other purposes and make transfers into those reserves on an annual basis. Even schools without a separate operating reserve may have accumulated operating surpluses that exist in their operating cash accounts. Fiscal strain interrupts the building of reserves because the school needs the cash to fund its operating deficits. Leaders should look critically at the statement of financial position to monitor changes in reserve balances and track year-over-year changes in operating cash.

One of the critical warning signs of underlying problems is incomplete, inaccurate or delayed financial reporting. Other reporting challenges come from schools not following accounting principles on interim financial reports. Poor reporting masks issues such as budget deficits, escalating debt or misallocation of funds, preventing timely corrective actions. Business officers must commit to timely, accurate preparation of interim financial statements. Minimally, the budget status, statement of financial position and, importantly, flow projection reports must be provided. Ideally, key strategic performance metrics are also tracked. Good data will allow school leaders to make informed decisions to steer the organization to financial stability.

Nationally, fundraising donations represent up to 10% of independent school revenue. Stewardship of donors is of paramount importance, to ensure donors keep giving to the school. An obvious sign of weakness in this area is a reduction in dollars raised, but it is vital to also track the donor retention percentage, which is a signal of how effective your fundraising program is in keeping your most ardent supporters engaged.

When facing financial hardship, one of the ways schools have plugged the budget gap is to reduce spending on facilities maintenance. This tactic is hidden from view because the impact of underinvesting is not immediate; it plays out over many years. Schools that own their buildings must track investment in repairs, maintenance and improvements as a percentage of the building’s value, which should range from 2-5%, depending on the age and condition of the buildings. If your school is not at this level of reinvestment, you need to get back on track so you can safeguard your most valuable asset.

When a school’s revenue streams are insufficient to meet its financial obligations, leaders often resort to various forms of debt, including leases, credit card balances, installment payments and other loans. The growing dependence on debt can lead to escalating interest payments and a compounding debt burden, which further strain the school’s finances. School leaders must establish policies to ensure they can monitor all forms of debt, including authorization to enter into debt obligations and accounting policies that ensure debt is recorded under proper accounting principles.

Deferred tuition revenue (tuition payments collected in advance of the start of the school year) is meant to be recognized in the future when the education services are provided. Using these funds to cover current expenses creates a misleading financial picture, as it temporarily masks cash flow problems while depleting funds needed for future obligations. School leaders can determine whether this is occurring at their school by looking at unrestricted cash and deferred tuition revenue on the statement of financial position. If the unrestricted cash balance is greater than deferred revenue, the school is appropriately holding the deferred revenue in its bank account.

The signs of financial distress are interdependent, so they rarely occur in isolation. In the initial stages of economic decline, school leaders may notice only one or two of them. It is essential to develop dashboards of financial metrics that can serve as their warning lights. (See sidebar for NBOA resources that can help leaders track your school’s financial health.) If your school is experiencing any of these 10 signs, you need a strategy to realign your business model with your mission, to reach the goal of financial sustainability.

10 WARNING SIGNS OF FINANCIAL DISTRESS AT YOUR SCHOOL

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Board members and top administrators should know these rules of thumb before problems become too dire to correct.