Nonprofit Resources

Higher Education Liquidity: How to Fund Your Mission During an Era of Financial Uncertainty

Higher education leaders are facing a difficult financial reality. Traditional liquidity measures are proving inadequate in the face of ongoing economic pressures, shifting enrollment patterns, and increasing operational costs. At the same time, the reduction in force at the U.S. Department of Education and Office of Federal Student Aid, along with other geopolitical changes and uncertainties, requires leaders to prepare for potential delays and disruptions in federal student aid. Careful strategic planning is necessary to weather these challenges.

Liquidity may not be the most important indicator of financial health, but it is the first. Further operational and financial analysis is unnecessary if an organization fails the liquidity test. An organization with six months of operating reserves was once thought to be invincible, but today’s financial climate and rapidly evolving higher education landscape are proving otherwise.

 

Defining Liquidity

Measures of liquidity vary based on how it’s defined. For this article, we can use a simple definition:

Liquidity is the amount of financial assets available to fund general expenditures.

The Financial Accounting Standards Board Accounting Standard Update (ASU) 2016-14, Presentation of Financial Statements of Not-for-Profit Entities, requires nonprofit organizations that follow U.S. generally accepted accounting principles to disclose relevant information regarding the liquidity of assets, including restrictions and self-imposed limits on their use. The ASU requires the quantitative display of actual liquid assets (defined as financial assets) and the qualitative disclosure of the entity’s policies on managing those assets to meet general expenditures. The disclosure provides a consistent framework for assessing organizational health.

Authors John Zietlow and Alan G. Seidner emphasize that financial health and liquidity should be a top priority for every nonprofit organization, second only to the organization’s mission. They note that the financial management objective of a nonprofit is “to ensure that financial resources are available when needed (timing), as needed (amount), and at a reasonable cost (cost-effectiveness) and that once mobilized, these resources are protected from impairment and spent according to mission and donor purposes.”¹

 

Liquidity Challenges in Higher Education

For nonprofits dependent on donations, a traditional measure of financial health is cash reserves equal to three to six months of expenses. For colleges and universities, four to five months of operating reserves are considered financially responsible. However, this benchmark is increasingly difficult to meet amid operating deficits and uncertain funding streams.

Many faith-based, private colleges are asking what they can do to get immediate liquidity if there’s not enough discretionary cash. With federal funding in flux, institutions may be left without a traditional source of liquidity. Let’s explore the options.

 

Operating Margin

Programmatic activities must create a margin to support growth and flexibility. “No margin, no mission” is a well-known phrase commonly attributed to Sister Irene Kraus, founding president and CEO of the Daughters of Charity National Health System. It is certainly applicable to our current day.

Consider the following thoughts about your institution’s programmatic activities:

• Program revenues – Program revenue streams require renewed effort and attention. Many institutions focus on cutting their largest expenditures to gain immediate relief during a financial crisis. Private higher education institutions should consider investing in strategies that stabilize or grow enrollment while maintaining value. For instance, as authors Brian C. Mitchell and W. Joseph King have noted, in higher education “enrollment management is the greatest opportunity of operational liquidity.”²
• Program expenses – Institutions are reassessing budgets, aligning financial plans with core values and desired outcomes, and shedding non-core programs and activities. Expense reduction strategies should include evaluating purchasing programs, utilities, and compensation.
• Margin – Operational margin might be your institution’s best source of liquidity. Assess the potential impact of economic uncertainty and evaluate whether your programs are generating sufficient margin. During difficult financial times, it’s important to ensure that your programs meet your students’ needs and contribute to the institution’s financial health and flexibility. A program marginal revenue analysis will help with this difficult yet necessary process.

 

Capital Markets

Strategic use of debt remains a viable option. Financing long-term capital expenditures, rather than paying in cash, can preserve liquidity.

One potential application of this strategy is the use of capital leases and public-private partnerships. For example, one institution used a lease program combined with a tax-exempt bond program to finance the replacement of its entire campus heating, ventilation, and air conditioning system, with utility savings covering debt-service costs. Others have used a similar program to provide student housing.

Lines of credit may be another option if your institution has available debt capacity from both an economic and debt covenant basis. Institutions with income sources that are not otherwise encumbered may be able to secure a line of credit directly. Examples could include pledge receivables or certain ongoing grants.

 

Donor-Restricted Investments

Using restricted endowment assets to fund operations is not a prudent practice and may violate donor restrictions. Nonprofit entities have a fiduciary responsibility to comply with donor wishes and restrictions on fund and earnings use. Use of endowed investments for purposes other than donor wishes and restrictions requires approval and legal counsel from an attorney familiar with trust laws and endowment regulations in your jurisdiction. Each state’s attorney general also has a legal interest in protecting these assets.

While not ideal, some institutions may consider the following, with careful legal and fiduciary oversight:

• Increasing endowment spending rates (within prudent limits) – Most versions of the Uniform Prudent Management of Institutional Funds Act (UPMIFA) deem spending rates over 7% to be imprudent. Additional limitations may exist in your state regarding the number of quarters to consider when determining average market value. Actual market returns during that period should also be considered. A fundamental fiduciary question to ask is whether you are preserving the purchasing power of the endowed gift over the long term.
• Debt collateralization – Emergency short-term funding from capital markets will often require collateral. Some states allow restricted investment securities to be pledged as collateral for operating debt. Be sure to ask if debt covenants have a negative pledge on these assets. Additionally, the risk associated with the pledged investment securities should be considered in the context of any possible default on the new debt.

 

Liquidation of Non-Missional Assets

While the liquidation of missional assets generally is an indicator of financial stress, strategic sales of non-missional assets during a crisis may be a viable solution for your institution. However, current market conditions may impair your most marketable non-financial assets. You should assess the impact on your institution’s balance sheet and statement of activity when considering liquidating assets during a crisis.

 

Donors

Donor support remains a vital source of liquidity. The objective is to request and receive significant support free from donor restriction, which can be difficult even in the best of times.

Before approaching your institution’s most loyal and wealthy donors, determine your liquidity gap. Start by determining future operating scenarios and then develop a financial model for each. Include triggers that will inform management about the timing and nature of decisions that you need to make. These triggers could include economic data, financial benchmarks, and program activity.

You can then use the models and triggers to calculate the liquidity gap. The liquidity gap is your ask. You should connect that gap to a fresh and compelling mission for your organization. Donors will respond if the ask is supported by activities described previously in this article.

 

Planned Giving Opportunities

Also consider planned giving opportunities, which could include:

• Donor-advised funds – This may be the time to reach out to donors with large balances. Develop a compelling call to action to use with these donors.
• Charitable gift annuities – Annuity agreements may have excess reserves that are available for withdrawal. Be careful to monitor state reserve requirements. This may be the time to ask annuitants to sever contracts.
• Charitable remainder trusts – Consider asking donors to terminate all or part of the trust early.

These tools can unlock new sources of liquidity with proper stewardship.

 

Next Steps

Liquidity is crucial in today’s uncertain financial environment. Institutions must engage in activities that generate liquidity, manage it aggressively, and preserve it for long-term stability.

Please contact us with questions or to discuss how we can help support and empower your institution.

 

Recommended Resources:

Financial Management for Nonprofit Organizations: Policies and Practices, Third Edition by John Zietlow, Jo Ann Hankin, Alan G. Seidner, and Timothy O’Brien, 2018

Cash & Investment Management of Nonprofit Organizations by John Zietlow and Alan G. Seidner, 2007

Short-Term Financial Management, Sixth Edition by John Zietlow, Matthew Hill, and Terry Maness, 2021

Strategic Financial Analysis for Higher Education: Identifying, Measuring & Reporting Financial Risks, Seventh Edition by Lou Mezzina, Ron Salluzzo, Fred Prager, Chris Cowen, and Phil Tahey, 2010

How University Boards Work:  A Guide for Trustees, Officers, and Leaders in Higher Education by Robert A. Scott, 2018

How to Run a College by Brian C. Mitchel and W. Joseph King, 2018

 

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¹John Zietlow and Alan G. Seidner, Cash & Investment Management of Nonprofit Organizations (Hoboken, NJ: John Wiley & Sons, Inc. 2007).

²Brian C. Mitchell and W. Joseph King, How to Run a College: A Practical Guide for Trustees, Faculty, Administrators, and Policymakers (Baltimore: Johns Hopkins University Press 2018).

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