Financial Management in Universities
In almost every country in Europe the principles of New Public Management (NMP) which
incorporates the devolution of financial autonomy away from the state towards institutions, and then,
within institutions, down to spending units at the coal face, have taken hold. In the distant past only in
the UK and Ireland, within Europe, were universities given a block grant and left to manage
themselves; contemporaneously the Austrian universities had to operate under the funding authority of
eight lifetime civil servants in the Ministry who controlled funding streams for the whole system, for
example furniture costs, or building maintenance or library expenditure on books, and never talked to
one another – a hang over from the Prussian era that continued into the 1980s. In almost all higher
education systems now universities have budgets and have to control them even though there are
variations: for example, in Sweden the state is still responsible for buildings and building maintenance.
Independence may vary somewhat in respect to an institution’s freedom to allocate resources
internally; the freedom to borrow is restricted to only a few systems; but almost everywhere
universities are obtaining budgetary independence with the state maintaining a monitoring function and
requiring accountability, because increasingly the size and complexity of individual institutional
budgets are such that the state can no longer manage the function itself and wishes to down load the
responsibility for doing so to the institutions. In Japan the largest NPM revolution of all is taking place
where, from 1st April 2004, the state is transferring university budgets in one step from being fully
integrated into the Ministry’s own finances to individual university managements and imposing a
budget cut as well! The Japanese universities are in turmoil because they have no idea of their costs, no
history of accounting for expenditure against budget and no experience in allocating resources
themselves.
Some principles of financial management
It is not possible to say that there is a ‘right way’ to manage university finance because funding
systems differ, and in particular, institutions differ. Managing the finances of a research intensive
university which has a significant research grant income and major research facilities to maintain and,
if it has a medical school, special relations with hospitals and state medical services or, if it has an
agriculture or veterinary faculty, university farms to manage, are entirely different to managing the
finances of a largely teaching university. This is not just a question of what the accounts of the two
kinds of universities look like and the difference in the make up of their income streams but a matter of
a different organisation and structure. Thus the Physics Department at Cambridge has 23 sub-ledger
systems serving different large research groups with multi-funded portfolios. Even to pull together a
departmental set of accounts represents a major task. In such circumstances a university has to devolve
its decision-making and accounting systems which was why when the Cambridge accounting system
broke down there was such a major problem. By contrast a teaching only department which attracts
very little outside funding presents a much more straightforward picture to a central Finance Office
because its costs are all associated with one activity and while teaching may be distributed over many
courses and given to students in many departments the essential variables are simply salary costs and
student numbers. Such a department’s finances could be run from a faculty office or even direct by the
centre.
Nevertheless in spite of differences between institutions and between systems I believe there are six
principles which need to be observed:
Financial stability makes a key contribution to academic success;
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Financial management is too important to be left to the Director of Finance;
A conservative approach to institutional spending at the top sends a message throughout the
institution;
Risks should be examined carefully but when accepted the investment should be sufficient to
ensure a successful outcome;
Good financial management requires that where financial targets are not met action must be
taken immediately;
Financial monitoring by policy makers, rather than technicians, can make a significant impact
on the management of an institution.
Budgetary planning and institutional strategy
In modern conditions finance lies at the heart of academic strategy and an institutional estate strategy –
all three must be fully integrated in the planning process. It is important not to let finance dominate but
to see it as the platform on which the other components are based. A strategic plan that cannot be
shown to be financially viable is worthless, indeed worse than that, dangerous, because of the strong
possibility that it will be destabilised by financial shortfalls in year 2 or year 3 of the plan. But pulling
the various components of a plan and all the ideas for development together is a difficult process and
not one that can be undertaken satisfactorily by a single planner working away in his or her office: it
must involve a diverse group of academics and administrators, including the finance budget team
working closely together. The financial envelope needs to be determined at the outset and in the UK
context at least that would suggest aiming for a 3% surplus in Year 5 of the plan and working back
from that so that a budget with a bottom line figure is prepared for each year against the Year 5 planned
out turn. Such a plan must be reviewed and revised each year and the process of doing so represents a
critical element of institutional management. In dynamic universities new ideas for development will
come up each year, new unanticipated needs will arise, or problems will emerge on the
infrastructure/property/estates side. These need to be fed into the financial plan. Such planning must
resist ignoring unspectacular infrastructure issues: modern thinking suggests that you need to invest the
equivalent of 4 to 5% of the insured value of an institution’s physical assets on an annual basis in order
to meet the costs of renewal and upgrading of buildings and equipment. Every institution needs a long
term maintenance plan extending over 15 years if it is to have a sustainable future. All too often in the
process new ideas will compete with estimates of infrastructure costs; we know that in periods of
financial downturn universities cut the maintenance budget first and academic staff costs last. But in
an environment where increasingly the state is less inclined to subsidise institutional decline it is
essential that universities resist short termism and commit themselves to a sustainable future.
Five year financial planning places great importance on forecasting, always a difficult exercise when so
many uncertain factors need to be taken into account and when variations of 1% or 2% in income or
expenditure can make all the difference to generating necessary surplus levels. It is good practice to
monitor with graphs the main components of the financial plan to test out over a period of years how
accurate the forecasting had been. Forecasting is inevitably not an exact science and optimism and
pessimism may influence a plan even more than circumstantial changes. A forecast of overseas fee
income or external research income that is always over optimistic can then become a factor to be taken
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into account. Equally if maintenance expenditure is less high than budgeted it may alert one to
efficiency failures in the management of the estate.
Resource allocation
Resource allocation takes effect at many levels in all institutions. At the macro level, as envisaged in a
five year financial plan choices will have to be made between, as we have seen, maintaining
infrastructure levels, capital costs for new buildings and new academic developments. Sometimes
these choices may involve setting savings targets for particular areas as well as investment targets.
Allocations for capital development, such as, for example, for an expanding business school, may be in
the expectation of expanding recurrent income. Strategic resource allocations of this type are an
essential feature of a strategic planning process and require sophisticated judgement operating on the
basis of sound financial information. Such decisions will, in an energetic university, be competitive –
how much of the cash flow or borrowing capacity can be committed to project X as compared with
project Y? What is in the best interests of the institution – a new capital development for department X
or resources to improve staff/student ratios across the university or to reinforce a hard pressed
administration? Most such allocations have both recurrent and capital implications.
Once an overall recurrent allocation has been made for direct academic purposes a second resource
allocation process normally takes over to distribute resources to academic departments or faculties.
Many universities now rely on highly formulaic Resource Allocation Mechanisms (RAMs) which
allocate resource against a mix of student and staff data, evidence of research success or other quality
indicators, and the costs of individual disciplines. RAMs are the subject of a great deal of technical
literature but we should note that the technical side can conceal important policy and organisational
decisions which are often not fully debated:
RAM formulae contain incentives for academic units to develop in particular ways.
Does the RAM simply mirror state allocation formulae or has the university imposed its own
policy judgements?
RAMs may reward success e.g. in research (and therefore penalise lack of success) or may
attempt to provide reward to all academic units equally.
What is included in the RAM formula and what is decided judgementally may vary
considerably e.g. does the academic unit have the power to create new posts or is that reserved
to the allocating body?
Is the academic unit to which funds are allocated a faculty/school or a department? If the
former there are organisational implications for the powers of deans and the existence of a
further faculty/school based resource allocation process; if the latter there is a presupposition
that the departmental structure is sufficiently strong and well administered to manage the
budgets thus created.
Are the academic units empowered to build up reserves (or deficits) and how do they share
income e.g. from overheads on research, or from ‘profits’ on short courses with the centre.
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How transparent is the RAM and what implications does this have for academic discussion of
policy?
The characteristics of a financially healthy institution
There are six key characteristics of the financially healthy university:
Short term solvency;
Retention of reserves;
The effective management of long term debt;
The effective management of the estate;
The ability to generate non-state funding;
Consistency of budgetary strategy with mission.
Higher education systems vary in the amount of financial data which they publish about institutions
and the UK is probably the most advanced in Europe in the way it publishes comparative financial data
and indicators of financial performance. Such data is extremely valuable because they allow a
university to monitor its performance against a selected group of similar institutions (e.g. universities
with medical schools) as well as against national averages. With the increase in borrowing a number of
universities world wide have sought ratings from Standard and Poors which provides an internationally
recognised financial rating framework. From this we can learn that Yale is rated AAA/A-1, the
University of Virginia AAA and Bristol and Nottingham AA/stable/- (figures significantly better than
some household names in the retail trade). Obtaining such ratings may represent a form of reputation
seeking; more discreet universities may decided that they would prefer greater flexibility in negotiation
with banks and other finance houses than is provided by such publicly available information.
Nevertheless the fact that universities are seeking to brand themselves in this way tells us a great deal
about the extent to which their financial management has become inextricably linked with their ability
to sustain their academic performance in an increasingly competitive global environment.
Michael Shattock