Amid the COVID-19 pandemic and ensuing economic uncertainty, the higher education sector faces a systemic crisis. Even before the pandemic, many small private colleges already witnessed declining enrollments and strained finances. With campuses closed, revenue shrinking, and enrollments up in the air, the pandemic will accelerate the end for already financially distressed institutions.
The pandemic is presenting challenges broad enough to transform the landscape of higher education, and so the U.S. Department of Education desperately needs new tools to evaluate the financial health of colleges and, see which schools have the resources to survive these challenges. While school leaders and lawmakers struggle to determine if and how they will reopen in fall 2020, the department is set to release scores that grade institutions’ financial health—but the scores are based on flawed data from 2017. These lagging scores bear little relevance in today’s environment, in which a profound shock to our higher education system has substantially reduced revenue and increased expenses, and may continue to destabilize institutions in the months ahead.
Schools are seeking additional financial relief, from donors and from the government, in hopes of keeping their doors open. Meanwhile, students will seek assurances that their schools can provide the education they are enrolling and paying for, or at the very least, will not close so abruptly that students are left out in the cold. To balance these interests as the world changes in real time, the department and other regulators need to assess which schools have the greatest risk of closing in the near future. In order to make these assessments, regulators should rely on an accounting concept known as liquidity—envision money flowing out a spigot—that reflects an entity’s ability to pay its bills using the various easy-to-access resources it has at its disposal.
Liquidity reflects the availability of an institution’s financial resources to meet cash needs for expenses within one year, whether that means money in a checking account, lines of credit that can be accessed, or assets that can be quickly and easily sold to produce cash. In higher education, elements of liquidity include:
- Cash, usually in a bank account, that can be accessed almost immediately to cover general operating expenses.
- Marketable securities, such as stocks, bonds, and certificates of deposit, that can be exchanged for cash within the year. At nonprofit schools, a portion of endowments (typically 5 percent, often invested in stocks and bonds), is frequently committed to spending within any given fiscal year. Further, although endowments typically include restrictions placed by donors on the use of such funds, there are usually portions of an endowment that can be made available, if needed.
- Accounts receivable. Money owed to a school by students and other customers, and likely to be collected within the year. This amount of these accounts receivable reflects not simply the anticipated or hoped-for future customers, but amounts actually owed for services or products provided. For example, this item may include the anticipated receipt of federal aid and private scholarships for enrolled students.
- Pledges receivable. Donations that have been promised for the coming year but have not yet been made. Like accounts receivable, these pledges are vulnerable to disruption, since a donor may no longer have the funds or assets they planned to contribute.
- Lines of credit. To meet cash flow needs, schools frequently have a flexible line of credit from a bank (or another entity) that they can tap when needed.
Without liquid assets, a school cannot make payroll, pay its bills, or serve its students.
No clear and obvious standard exists for the amount of liquidity that a school should have. Experts recommend a nonprofit entity to hold three to six months of operating expenses in cash reserves—a narrower measure than liquidity. We recommend that if a school’s liquidity—a broader measure—falls below six months of expenses, students and regulators should worry that a school may be operating too close to the edge. No one knows how enrollments may change in the fall, or the likelihood that a second wave of COVID-19 deepens or extends this crisis. In a pinch, a school should be able to fund at least a semester of operations.
The department should require schools, as a condition of continuing to receive federal aid, to provide real-time reporting on their liquidity level, starting no later than June 15, 2020. The formula for our proposed liquidity metric is liquid assets, measured at a snapshot in time, divided by annual operating expenses from the most recent audited financial statement. This formula calculates a period of liquidity describing the portion of a year that each school can fund its prior level of services with the resources on hand.
Liquidity data provides a quick and simple way for policy makers to group schools based on the financial risks they face in the year ahead. Reporting should not be onerous. From small business owners to the executive teams of the largest corporations in the world, responsible leaders are routinely reviewing their liquidity and analyzing various scenarios as to the impact of COVID-19 on their cash position.
Using an initial round of liquidity data, regulators can group schools into three tiers, with student protection requirements increasing for less liquid institutions.
- Liquid. Schools that have at least six months of liquid assets are best positioned to withstand near-term financial shock. These institutions should report any meaningful contractions in liquidity.
- Watchlist. Schools that have three to six months of liquid assets as of June 15 should plan for the worst—a scenario where they must wind down operations using only available liquid assets—even as they seek to expand liquidity. Prior to receipt of federal funds in the fall, the governing body for each school must certify an updated liquidity level and a Student Protection Plan. The plan details minimum “wind-down” services that the school can provide to reduce harm to students if the school must permanently close. How many students could complete their degrees before the school runs out of liquidity? What budget is available to secure student records and establish alternative paths to degree completion for students who would be displaced by a closure? This plan would assume that the school maintains a bare-bones cost structure that prioritizes essential academic and wind-down functions. Additionally, federal aid released to these schools should be held in trust for the benefit of the students enrolled with those funds.
- At-Risk. Schools that have less than three months of liquid assets face the greatest risk of closure, and may lack the resources to provide an orderly wind-down if a closure does occur. Student Protection Plans should be submitted with initial liquidity statements, reflecting June 15 assets. Regulators should review whether to permit new enrollments if students are likely to be stranded without a clear path to degree completion. For-profit institutions in this category should face restrictions on distribution of funds to owners and investors.
These tiers provide a starting point for regulators to quickly sort schools based on the risks students and institutions face in the coming year. The current situation is urgent, and requires simplifying the nuance in each school’s financial condition. Fortunately, even schools in the “at-risk” set have many levers to raise capital and increase liquidity. Schools can sell physical assets (art work, equipment), seek gifts, or mortgage properties, to name a few activities. All of these activities are likely being pursued by school leaders today.
After an initial screening, regulators should continue to assess liquidity, refine the screening process, and improve interventions. Independent financial analysts can help comb through complex or unusual circumstances. If the crisis drags on, schools once deemed liquid may become at-risk, and vice versa, requiring regulators to adjust student protections.
header photo: Students at the University of Washington are on campus for the last day of in-person classes in Seattle, Washington. Source: Karen Ducey/Getty Images