Every year, the federal government pumps more than one hundred billion dollars into the nation’s colleges and universities in the form of student loans and grants. In recent years, numerous schools have closed, sometimes precipitously and without providing students with the education and support that had been paid for with taxpayer funds. Under certain circumstances, the government discharges loans for those students who attended a school that closed;1 but in most of these cases, the U.S. Department of Education should have known of the school’s struggles, and could have responded to them before the closures ever occurred. The agency’s current system of financial oversight fails in this crucial task because it suffers from two problems: it does not forecast the future condition of an institution but rather only examines the past; and it implements well-intentioned but ineffective interventions that exacerbate rather than mitigate risk of closure.

There are better ways to protect students and taxpayers—namely, by tapping independent financial analysts or financial rating firms (like Moody’s and S&P) who can assess the relative importance of a broader array of indicators.

Here’s how financial oversight at the U.S. Department of Education currently works. The department has a framework that sounds highly scientific, and purports to employ a great degree of precision, but it is really a bunch of gobbledygook.2 The entire framework that the department currently uses for protecting students and taxpayers revolves around a single number, known as the “Financial Composite Score.”3 While a laudable effort to summarize an institution’s financial health in a way not vulnerable to political manipulation, an enterprise’s financial health simply cannot accurately be boiled down to a single number devoid of any expert judgement.

An enterprise’s financial health simply cannot accurately be boiled down to a single number devoid of any expert judgement.

Financial health is a lot like physical health: each vital sign is meaningful on its own, but none of them are determinative by themselves. Imagine if a doctor only looked at a figure that combined your pulse rate, blood pressure, and body temperature on a particular day into a single figure. A serious problem with one vital sign could easily be masked by non-worrisome rates for the other two. And the score would miss potentially meaningful changes over time in all three of those measures, or in other important trends in eyesight, hearing, or mobility, to name just three scores of equally important aspects of physical well-being.

Furthermore, the limitations inherent in the department’s composite score framework are compounded by how it uses two of the tools it has at its disposal to manage institutions that are struggling with financial health.

First, the department can mandate that a school purchase a specialized insurance policy known as a “letter of credit.”4 This insurance policy is intended to prevent taxpayers from being short-changed in the event that the school suddenly closes. If the department continues to assume liability by paying schools before they deliver educational services and cancelling federal student loans for students who are educationally displaced by unexpected closures, then taxpayers should be protected with some collateral. However, the department does not ask schools to purchase this protection until they are already near bankruptcy and lack the funds to purchase premium insurance coverage—a recipe for failure.

Secondly, the department can restrict and sometimes delay cash disbursements to schools through designations known as “Heightened Cash Monitoring.5 However, if the department waits until a school is already operating paycheck to paycheck, is unable to attract capital from any private sources, and is heavily reliant on taxpayer aid for revenue and liquidity, then even sensible monitoring that slows the flow of federal dollars can trigger a catastrophic closure that leaves students high and dry.

The upshot is that timing matters. The department should use these two corrective tools while institutions are still viable to mitigate harm to students and taxpayers. Instead, the department’s ineffective and delayed use of key corrective tools is akin to a doctor who routinely withholds life-saving chemotherapy long past the point when a cancer should have been detected, and prescribes it only when the chance of success barely outweighs the harmful side effects.

Needed: A Better System for Detecting and Predicting Financial Decline

The department’s current method for testing colleges’ financial health diagnosed only 50 percent of recently closed colleges, according to the Government Accountability Office.6 Meanwhile, finance professionals at the colleges and state regulators criticize7 the department’s system for leading to numerous misdiagnoses, sometimes resulting in unnecessary expenses that schools might pass on to students. The framework’s attempt to create a binary healthy/unhealthy indicator of financial health—based on whether the single number computed crosses a largely arbitrary threshold—was, in hindsight, misguided.8 Rather, a framework that evaluates a school’s likelihood of closure should explicitly state whether a school has a high or low degree of risk for shutting down, and provide a probability for such an occurrence over both the near term and medium term.

Beyond the cardinal error of trying to boil everything down to a single number, the current system has four additional critical flaws. The second is that the department presently does not create a forward projection of a school’s financial results and instead relies solely on historical measures. Imagine driving a car with a broken front window and relying on the rear view window to maneuver. Specifically, the department doesn’t evaluate schools on future risk, the time horizon for that risk, or the ability of schools to manage that risk. Currently, if a school has declining enrollments but a strong balance sheet, the department does nothing until the school’s financials deteriorate to the point where the school has crossed the department’s definition of “not financially responsible.” By then, the department cannot do much to protect students and taxpayers. Policymakers should redefine financial responsibility to reflect an institution’s ability to fulfill obligations over a multiyear period.

Third, trend analysis is needed to understand both the deterioration and the magnitude of the deterioration of an institution. Ultimately, change in enrollments represents the most important indicator of an institution’s financial health. An institution losing 5 percent of its enrollments on an annual basis has a very different profile than one losing 25 percent of its enrollments annually. The department’s failure to incorporate trend analysis in diagnosing a school’s viability represents the greatest deficiency of the current regulatory model.

Fourth, compounding all of the above problems, by the time historical financial statement data is calculated into a composite score by the department for regulatory use, the information is already out of date. Currently, in late 2019, the department is still relying on data from financial statements dating back to the June 2015 to July 2016 fiscal year.9 The department has recently begun to recalculate the composite score after certain “triggering” events.10 However, this will only lead to speedier updates of a flawed measure. Far more significant reforms are needed.

Fifth, and finally, government and special interests should not be in the business of dictating how one conducts financial analysis.11 Assessing risk and the likelihood of an institution’s financial collapse requires an independent, apolitical analysis of a school’s market, competition, enrollment trends, ability to serve outstanding debt, ability to raise debt, management’s competence and priorities, and other factors, analyses which financial analysts have expertise in providing. Rather, the department should enlist analysts to assess financial health, and focus government efforts on creating policy and and improving the financial health of distressed institutions.

Table 1
Five Fundamental Flaws with the Financial Composite Score
  1. Financial analysis is complex. A single number from a formulaic calculation cannot accurately capture schools’ financial health.
  2. The department doesn’t evaluate future risk. The composite score is based entirely on backward looking metrics.
  3. Trend analysis is needed. Tracking enrollment trends is particularly vital to diagnosing the viability of tuition-dependent institutions.
  4. The inputs are dated. By the time the department calculates a financial composite score, the financial statements on which it is based are out of date.
  5. Independent financial experts who are insulated from political pressure can provide more detailed and accurate assessments of institutions’ financial health.

Dissecting the Composite Score’s Components

Based on the issues detailed above, the composite score approach would be problematic even if it were calculated using many of the commonly used metrics and indicators for financial health—and it is not. The analysis below demystifies the department’s formula for calculating the composite score, which is simply the weighted average of three ratios, each of which is spelled out in department regulation.12

The discussion below reviews what each of the department’s three ratios was intended to accomplish and how each ratio fails to adequately capture what policymakers intended.

Additional metrics that are commonly used by financial professionals are described in this analysis, summarized in the recommendations that follow, and applied to four case studies in the appendix. The department has recently acknowledged that this composite score calculation “should be updated;”13 however, a simple update of metrics will fall short unless the department also addresses the deeper flaws in its diagnostic model and corrective actions.

The “Primary Reserve Ratio”

The “Primary Reserve Ratio”

What it purports to measure: Viability and liquidity.
How it is determined: For-profits: “adjusted equity”14 divided by total expenses. 

Nonprofits: “expendable net assets” divided by total expenses.

Biggest flaw: Metric neither reflects liquidity nor viability.

Liquidity reflects near-term access to cash to fund operations, whereas viability measures a company’s long-term ability to generate income to survive. A single figure cannot reflect both. The calculation underlying the “primary reserve ratio,” as the department calls it, attempts, rather poorly, to articulate liquidity (and it does nothing to assess “viability”).

Cash represents the most liquid asset, since a school can easily send cash to a vendor to cover any immediate obligations, like rent and utilities. Marketable securities, like publicly traded stock, which can be immediately sold and converted to cash to pay for those obligations, represents the second most liquid asset. Less liquid assets include accounts receivables, where a customer may already be receiving services but has not yet paid cash. Real estate is highly illiquid. It represents money that can theoretically be put to other uses, but it could take a year or more to sell land or a building at market value. To sell real estate quickly likely requires accepting a “fire sale” price.

Companies publish financial statements to provide disclosure to owners, investors, and stakeholders. One of those statements, a balance sheet, reflects the assets and liabilities that a company has at a specific point in time. While an asset represents the economic value a company has, a liability represents an obligation that a company owes.

In finance, the current ratio expresses liquidity most clearly.15 The term “current” refers to an asset or liability that will convert to cash within a one-year timeframe. One calculates the current ratio by dividing current assets by current liabilities. For example, an annual cable subscription that costs you a cumulative value of $1,000 could be considered a current liability. A friend agreeing to pay you $1,000 in a year’s time would be a current asset. Excluding any other savings and income, by the end of the year could pay your cable bill from what your friend owes you. But, your friend will pay you the $1,000 not immediately, but twelve months from now, while you have to pay your monthly cable bill next month. Because you don’t have cash to pay the bill, the cable company will cancel your service. You now have a liquidity crisis. Even highly profitable companies have liquidity crises because of the timing of inflows and outflows of cash. When facing a liquidity crisis, a company may need to seek financing (whether debt or equity) to fund operations.

As an expression of liquidity, the most restrictive formula for current assets would only include cash and marketable securities in the numerator and “total expenses” in the denominator. A slightly less liquid current assets definition would include accounts receivable.

Bizarrely, the numerator in the adjusted equity calculation includes debt, up to the amount of net property, plant, and equipment (PP&E). This calculation actually encourages a school to take on debt.16 Between 1994 and 1997, the Department of Education used a ratio measuring cash to current liabilities. Unfortunately, through the regulatory process, a very straightforward and commonsense financial metric became corrupted.17 There is nothing wrong with schools borrowing money, especially at today’s low interest rates, in circumstances where an investment can return an appropriate financial return. This does not require perverting a rudimentary concept like liquidity.

The primary reserve ratio as it exists today is certainly better than nothing. But it has flaws, and remains subject to manipulation. One permutation of the metric that would prove beneficial in analysis would include placing only cash, and not “adjusted equity” or “expendable net assets,” in the numerator. This ratio, called “days/months cash on hand,” divides cash by operating expenses to reflect the duration of time—in days or months—for which an institution can cover its expenses. For example, a school that has $5 million of cash on the balance sheet and $60 million of annual expenses can fund operations for one month, assuming no additional revenue comes into the organization.

The “Equity Ratio”

The “Equity Ratio”

What it purports to measure: Capital resources and ability to borrow.
How it is determined: For-profits: “modified equity” divided by “modified assets.”

Nonprofits: “modified net assets” divided by “modified assets.

Biggest flaw: Provides an incomplete picture by ignoring trends and other key metrics.

The first lesson one learns in accounting revolves around the simple concept that equity equals assets minus liabilities. “Assets” reflects what a company owns,18 “liabilities” reflects what a company owes others, and “equity” reflects the difference between the two (in nonprofit accounting, though, the term “net assets” is used instead of equity). For example, you own a home with a market value of $1 million, and you owe the bank $500,000; therefore you have $500,000 of equity in the house. The Department of Education’s “equity ratio” takes a version of equity and divides it by a parallel version of assets.19 This essentially measures how much of the college’s tangible assets historically have been financed by owners rather than by lenders and vendors.

The Department of Education suggests that their equity ratio “represents a measure of a school’s capital resources and its ability to borrow”. Yes, it certainly represents one measure; however, there are many measures of a school’s ability to borrow. Lenders rely on a range of measures and historical data to determine their investment decisions. The reliance on one measure for one particular year can prove misleading in either a positive or negative way. At minimum, a potential lender would probably want to know a handful of metrics, including the solvency ratio (the company’s ability to meet long-term financial obligations) and the interest coverage ratio (the company’s ability to pay interest expense through cash profits) within a time series. Beyond that, the ability to borrow remains dependent on the economic cycle as well as on the overall interest rate environment.

There are numerous situations in which the equity ratio would fail to reflect important aspects of a school’s ability to borrow, including:

  • Timing of debt due. School A and School B both have $100 million in debt and the same financial characteristics in terms of profitability. School A has a payment due next year, and School B has a payment due in fifteen years. Arguably, School B has less risk than School A, as School A may not secure debt in the near term.
  • Changing (tightening and relaxing of) lending standards. School A has a payment due next year, but the United States faces another recession, and investors have increased their lending standards as a consequence. School A may have been able to raise debt in the prior year, but in the current year it cannot because lending standards have increased.
  • Enrollment trends are negative. Over the last five years, School A has witnessed a 50 percent decline in enrollments. While still profitable next year, if this trend continues, the school will become unprofitable and will have to fund operations with cash on hand. So the bank likely will lend to School A but would charge a higher interest rate that reflects the risk. School B has the same static financial characteristics as depicted on the balance sheet for School A, but has seen enrollments grow by 50 percent over the past five years. The bank will likely see School B as less risky and will charge a lower rate. If School A and School B have public debt, they likely have credit rating agencies like Fitch, S&P, and Moody’s who assign ratings to the debt. These ratings will determine the interest rate that the banks will charge.
  • Inability to pay interest with profits. School A has a strong balance sheet and wants to borrow to expand its campus’ footprint. However, the school cannot service its existing debt interest payments with cash flow.
  • Balance sheet does not reflect true market value of assets. The value of land and buildings on a postsecondary institution’s balance sheet (particularly for non-profit colleges) are likely understated, as accounting rules require colleges to report “book value,” or the cost for real estate at the time of purchase, rather than “market value,” or the cost of the real estate today. For colleges that own buildings for many decades, the book value does not reflect the appreciation of the value of these assets.

Ultimately, the department’s equity ratio falls short because an institution’s ability to borrow—which is critical to whether a cash-strapped school can survive periods of financial distress—requires a multifaceted analysis in order to be determined, and cannot be determined by a single indicator. Certainly a potential lender to a school will not rely on the department’s indicator when evaluating a debt issuance.

The “Net Income Ratio”

The “Net Income Ratio”

What it purports to measure: For-profits: profitability.

Nonprofits: operating gain.

How it is determined: For-profits: income before taxes divided by revenue.

Nonprofits: change in unrestricted net assets divided by total unrestricted revenue.

Biggest flaw: A school can be profitable by this measure and still be unable to pay its bills. Alternatively, a school might be unprofitable and yet be able to pay its bills.

Profitability seems like an obvious metric when assessing the financial health of a school. However, if the objective relates to assessing the risk of closure, cash flow generation would represent a better measure. Cash is king. If a school has cash, it can continue to survive and thrive. A school can generate cash while posting operating losses. This goes back to the concept of accrual versus cash accounting. In accrual accounting, revenue and expenses are recorded when incurred, regardless of when an institution receives cash. In cash accounting, inflows and outflows of cash are recorded.

Profitability seems like an obvious metric when assessing the financial health of a school. However, if the objective relates to assessing the risk of closure, cash flow generation would represent a better measure.

Imagine the following scenario: a school has $10 million in revenue and $10 million in expenses, meaning the school generates zero profit. It receives a $100 million one-time gift, which the school uses to buy a new building that generates no economic value that would result in revenue gains. The building has a useful life of thirty years. To reflect this transaction on the income statement, the school will need to expense $3.3 million annually for the next thirty years for the depreciation of the value of the building. Again, the school made an up-front investment, but will see a non-cash expense on the company’s income statement because of the rules of accrual accounting. From a profitability perspective, the school now loses $3.3 million of profit annually because of this non-cash depreciation. As for the $100 million one-time gift, that only shows up on the income statement in year one.

Typically, mature institutions have high depreciation and amortization reflecting significant historic investments. Remember, a school closes because it cannot generate cash, not because it can’t generate the accounting concept called net income.

A reasonable person might suggest that the above critique represents nitpicking and that, for the most part, schools generating profit are doing well and those that are not must be financially challenged. But generalities like this introduce the risk of misdiagnosis, particularly when the usage of accrual accounting potentially misstates a school’s true condition, which ultimately comes down to cash coming in and out of the organization.

When the Department of Education’s composite score overstates risk, the department may cause the school to secure a letter of credit from a bank, which results in an increased expense for the school. Conversely, when the composite score understates risk, the department’s lack of preparation sets up students, taxpayers, faculty members, and other stakeholders for a more sudden and calamitous closure.

Five Ways to Improve Diagnosis and Treatment of Financially Struggling Schools

Department of Education officials have signaled the need for a lengthy and expensive rulemaking process to “update” its review of institutions’ financial health.20 The system, however, needs more than a band-aid style “update.”

The department should completely revamp its approach to diagnosing problems and prescribing corrective actions in order to better protect students and taxpayers. To reduce the frequency of sudden school closures, improve student outcomes, and reduce taxpayer costs, the department should adopt the following five recommendations.

1. Engage financial experts for independent review and assign ratings based on a school’s risk profile. Third party agencies that contract with the department would provide their methodology for analysis that would inform ratings. Rating agencies like Moody’s, Fitch, and S&P publish and, when appropriate, update their ratings methodologies for the general public to see for themselves. Companies are well aware of how they will be evaluated and lack a playbook for gaming the system. The department should not mandate a formula, metrics, or thresholds for establishing each rating. Contracting with qualified professionals also insulates financial analysis from political pressure and lobbying from special interests.21

We invite consideration of Table 2, which provides a representative sample of metrics that financial analysts might use. By no means are we suggesting that these metrics should be used to create a new financial composite score: an assessment must be holistic and without artificial or strict boundaries on the sources of information. Rather, the table has been included to show some of the many of the tools that should be used in assessing an institution’s financial health and risk of closure.

Table 2
Key Metrics for Financial Analysis
Metric Definition, Explanation, and Calculation
Annual Enrollment Change Measures the trajectory of the financial health of tuition-dependent institutions. The catalyst for declining enrollments in year 1 could potentially cause declining enrollments in year 2 and beyond.

(enrollment Year 1 / enrollment Year 0) – 1

Cash Reserve / Days Cash on Hand Measures an organization’s ability to pay operating expenses with cash, perhaps expressed by the number of days or months in which cash can cover expenses. This becomes important when assessing schools on the precipice of closure. A reserve of at minimum 6 months, if not longer, represents a good target.

Unrestricted cash and marketable securities / (total expense, not including non-cash expenses / 365)

Debt Service Coverage Ratio Measures cash flow available to pay debt obligations. The debt service includes cash required to pay for principal and interest for debt, sinking fund payments, and lease payments. A debt service coverage ratio of 1.15 to 1.5 represents a good target.
Note that this metric is slightly more robust than that of the interest coverage ratio (see below) because it includes more items in the denominator.Calculation:
For-profit: net operating income / total debt service
Nonprofit: change in unrestricted net assets before interest / total debt service
Interest Coverage Ratio Measures the ability of an institution to pay the interest expense of debt. If the interest coverage ratio is less than 1, that means that operations cannot keep up with interest payments on its debt, which could lead to default and bankruptcy.

For-profit: (earnings before interest, depreciation, and amortization / interest expense)
Nonprofit: (change in unrestricted net assets before interest, depreciation, and amortization / interest expense)

Current Ratio Measures an organization’s liquidity in its ability to pay off its short-term obligations. It is a purer ratio than the primary reserve ratio in calculating liquidity. A good current ratio would exceed 1.5, a bad current ratio would fall below 1.

assets / current liabilities

Solvency Ratio Measures an institution’s ability to meet its long-term financial obligations.
The lower the ratio, the greater the likelihood that an institution will default on its debts and go bankrupt. Generally speaking, a solvency ratio higher than 20 percent represents a financially solid organization.
For-profit: (net income + non-cash expenses) / liabilities
Nonprofit: (change in unrestricted net assets + non-cash expenses) / liabilities

Improving the department’s ability to diagnose financial risk while a school is still relatively healthy is the sine qua non for an improved approach to school closures. The remaining four recommendations speak to how the department should prescribe corrective actions for institutions that begin to show signs of financial distress.

2. Create hard and fast rules that require increased collateral from institutions that have an increased risk of closure. Any private sector company, insurance provider, or investment firm receives value for incurring risk. When the department advances payments for educational services that may not be delivered,22 student refund obligations that may not be paid, 23 or loan cancellations that would ultimately be underwritten by taxpayers,24 it is entirely reasonable for the government to also require increased collateral. Moreover, the most useful standards would limit the government’s flexibility or discretion to discourage lobbying from special interests, and incentivize institutions to proactively manage for long-term financial viability within the confines of a clear, predictable system.

Table 3
Financial Diagnoses and Treatments in a Revised Risk Analysis System
Analyst’s Rating Risk-Based Intervention
Strong Outlook

No serious danger signs over a five-year horizon

No collateral required. No management intervention by the U.S. Department of Education.
Watch List

School has unfavorable financial characteristics (such as a weak balance sheet), but does not face significant risk of closure within the next five years.

School provides the department with collateral25 equal to 25 percent of the prior-year’s federal funding (or an equivalent letter of credit). No management intervention by the U.S. Department of Education.

School faces a significant risk of closure within the next five years due to unfavorable financial characteristics.

School provides the department with collateral26 equal to 50 percent of the prior year’s federal funding (or an equivalent letter of credit).  The department appoints an outside director to the board who has financial expertise and whose duty is to protect federal interests.
At Risk

School faces a significant risk of closure within the next two years due to unfavorable financial characteristics 

Claim on a school’s assets equal to 50 percent of the school’s prior-year federal funding (or an equivalent letter of credit). The department appoints an outside director to the board who has financial expertise and whose duty is to protect federal interests, 


The school’s CEO and CFO must certify a planning document detailing how the school will fund operations for the next academic year.27

3. Make all schools’ financial ratings and profiles public and easily accessible to schools’ current and prospective students and employees. Students and employees should not be the last to know when the institution faces a precipitous closure.

Financially distressed institutions may worry that having to disclose a negative rating can become a scarlet letter—students will avoid enrolling in a financially precarious institution, where closure remains a risk. However, the department should not protect failing institutions to the point of intentionally withholding critical information from students and other key stakeholders. More research is needed on how financial risk analysis can best be presented to students and employees without causing undue panic. However, normalizing such disclosures and setting educators to the task of making these disclosures accessible to students with varied degrees of financial literacy will surely prompt innovative approaches that improve on the current policy of keeping students in the dark.

4. Mandate that all schools have a minimum level of cash and liquid assets. If a school does not have a minimum level of liquidity, then the department should not provide prepaid funds to the school. A careful balance must be struck, as increased liquidity requirements could result in the closure of some financially distressed schools. One student-centered approach would require institutions to have enough cash to fund operations through the end of the academic year, such that students can complete coursework and receive credit. A mandatory and universal liquidity requirement would realign incentives, prompting schools to pursue strategic alternatives, including mergers or wind-downs while they have cash.

5. Prioritize the public’s claim on a school’s assets in the event of closure, up to the amount of taxpayer liabilities associated with the school’s closure. Under current bankruptcy laws, investors with certain types of debt or hybrid securities get paid first, even though taxpayers fund up to 90 percent of the cash schools rely on before bankruptcy, and are left paying for the student loans that are eligible for discharge when schools suddenly close. If the government funds the working capital of these institutions and has the greatest risk among all stakeholders given the potential for student loans at a closed school being cancelled, the government should have first dibs on a school’s assets in the event of bankruptcy or sudden closure.


As a major financier of colleges, the federal government can have a tremendous impact on how schools manage their operations. By introducing analytical rigor into the assessment of financial health and providing greater transparency, the department can increase school accountability and financial responsibility. These changes would reduce the harm and disruption that comes from closures that today’s system has failed to detect or prevent.


Four Case Studies: Composite Score vs. Financial Analysis with Additional Key Metrics

The following case studies—two of them nonprofit and two of them for-profit—illustrate a professional review that incorporates the concerns and recommendations highlighted in this report, and compares the resulting findings with the risk assessment reflected in the department’s composite score. The case studies show that if a financial analyst had been able to review all of the information available at the time, the analysis of each school’s viability and risk would have resulted in a more accurate assessment of the school’s financial situation. More important for future cases, a school might consider strategic alternatives like a merger, sale, or teach-out if its management knew that the department’s analysis would be more robust than a simplistic formula.

Case 1—Mount Ida College: A Clear but Undiagnosed Closure Risk

(Click here for Mount Ida College’s 2016 financial statements.)

In May 2018, Mount Ida College, a small private nonprofit college outside of Boston, closed on a schedule that was unusually sudden for nonprofit schools.28 According to press accounts, the closure of Mount Ida came as a surprise.29 Based on a review of the school’s 2016 financial statements, this should not have been the case.30

For Mount Ida, barely passing 1.8 for the fiscal year ending in 2014 to a solid 2.2 in 2016, before dipping to a 0.8 score in the most recent review year, placing it in the probationary zone for schools that neither pass nor fail the department’s financial responsibility review. Interestingly, Forbes, with its own proprietary method to evaluate the financial health of schools, rated Mount Ida with a D rating in 2016.31 What explains the gap between Forbes’s negative assessment of Mount Ida and the department’s rosy outlook?32

A cursory examination of Mount Ida’s financials reveals a school massively in debt and operating at a cash loss. In 2015, Mount Ida had only $7 million of highly liquid cash and securities.33 Meanwhile, the school had $45.8 million in debt (notes payable and bonds payable). The school’s statement of activities (the nonprofit version of an income statement) saw a $6 million decrease in unrestricted assets.34

Mount Ida received a generous donation by a “related party”, the largest that the school had ever received in its history.35 Excluding a one-time gift of $8 million that Mount Ida received in 2016, the school saw a decline of $1.5 million in change in unrestricted net assets that year. Unfortunately for Mount Ida, in 2017, donors were not as generous as they were in 2016, with the school receiving only $300,000, as opposed to $8 million in 2016. As a consequence, total revenue declined by about $5 million year over year with cash from operations declining by $7.8 million due to increasing costs.

Additionally, in in 2015 and 2016, Mount Ida’s statement of financial position (balance sheet for a nonprofit) and statement of unrestricted activities (income statement for a nonprofit) benefited by $4 million and $4.6 million, respectively, from an appreciation in the value of real estate.36 Traditionally a balance sheet records real estate at cost, but because Mount Ida stated that its real estate was held as an “investment”, the school could record real estate at its alleged market value (determined by independent external appraisals). This appreciation in real estate held as an investment and the benefit to assets and change in assets (net income for a nonprofit) allowed Mount Ida to score a higher financial composite score than the underlying operations of a tuition-dependent school would suggest.

A school already in debt, operating at a cash loss and dependent on large annual gifts, represents a financially challenged school, but the department’s financial composite score was not able to diagnose the problem.

Case 2—ITT Educational Services (ITT): The Department Wasn’t Allowed to Read the Footnotes

(Click here for ITT’s 2015 financial statements.)

ITT closed in 2016, and the company actually blamed the Department of Education for its misfortune.37 ITT posted a passable composite score of 1.8 in 2012 before dipping below the threshold of financial responsibility with a 0.9 probationary score in 2013.

ITT’s closure relates to a liability not originally included in the school’s balance sheet and thus not originally applied in the financial composite score. Back in 2009, ITT organized a group of credit unions to fund a private student loan program called Student CU Connect (CUSO) that originated $141 million in loans to ITT students. Soon after, in 2010, ITT organized the funding of a trust called PEAKS, which would sell securities to investors in order to fund an additional $300 million of private student loans to ITT students. To entice investors, ITT provided guarantees that limited risk of loss from the student loan pools.38 However, ITT’s balance sheet did not reflect the risk it assumed by guaranteeing CUSO and PEAKS loans.39

Since the department’s financial composite score only includes data points directly taken from the balance sheet, ITT’s off-balance-sheet obligations for CUSO and PEAKS had no impact on its financial responsibility score. The sell-side equity research analysts that covered publicly traded education companies raised questions about PEAKS from the financial instrument’s inception.

In 2014, ITT agreed to consolidate the PEAKS trust and CUSO loans on the company’s balance sheet. The department then indicated that for this reason (and others)40 ITT failed to comply with the financial responsibility standards and would be placed on Heightened Cash Monitoring 2 (which impacted the company’s liquidity). This and other events resulted in the company’s closure.41

Financial analysis requires a close reading of the details contained in the audited financial statements. In the case of ITT, the existing regulatory framework focuses on a single formulaic calculation and didn’t allow the Department of Education the opportunity to fully evaluate the company’s footnotes, management discussion, analysis section, or off-balance-sheet items.

The lesson here is that financial statements alone do not provide the full picture of financial health and responsibility. Footnotes matter. The footnotes clearly explained ITT’s loan programs and ITT’s guarantees on those loans. At minimum, regulators should have had the flexibility to consider these details when evaluating ITT’s financial health.

Case 3—Newbury College: Enrollment Trends Matter

(Click here for Newbury College’s 2017 financial statements.)

Newbury College, a private nonprofit college located in Brookline, Massachusetts, announced in December 2018 that it would close at the end of the academic year due to financial challenges.42 Newbury’s accreditor, the New England Association of Schools and Colleges, placed the school on probation in August 2018 because of the school’s financial condition.43 But the school’s most recent composite score was a passable 1.8, for the fiscal year ending June 2017.44 Newbury’s auditor expressed “substantial doubt about the college’s ability to continue as a going concern,” pointing to the violation of debt covenants, operating losses, and the placement of the school on probation by its accreditor.

In the case of Newbury, one does not need to apply rigorous financial statement analysis to understand the school’s challenge. The school witnessed a 29 percent decline in enrollments over a two-year period, according to federal data.45 A tuition-dependent small liberal arts school with less than 1,000 enrollments cannot experience a loss of that magnitude without undertaking substantial cost reductions and increasing cash through fundraising.

The case of Newbury College’s decline highlights the importance of accounting for enrollment trends in forecasting future viability.

Case 4—National American University Holdings: The Financial Composite Score Missed What the Market Saw Clearly

(Click here for National American University Holdings’s 2018 annual report.)

National American University Holdings (NAUH), a publicly traded for-profit company, operates National American University, a regionally accredited multi-campus postsecondary institution. The university offers diploma, associate, baccalaureate, master’s, and doctoral degrees in a number of disciplines, including business and health care. The stock market at one time valued the company at hundreds of millions of dollars.46 The stock now trades on a penny exchange, because its market capitalization fell below the $5 million threshold required for businesses to be listed on NASDAQ. In January 2019, NAUH expressed “substantial doubt regarding the company’s ability to continue as a going concern” in securities filings. At present, NAUH has a market cap of less than one million dollars, with a stock price of $0.03.47

Like Newbury College, NAUH presents another example of an operator struggling with a meaningful decline of enrollments. Enrollment declined 31 percent over the two-year period from May 31, 2016 to May 31, 2018. Since NAUH, like many for-profit schools, depends on tuition and fees from student enrollments for 100 percent of its core revenues, eventually, declining enrollments would result in a weak financial condition.48

Unlike the Newbury College case, however, NAUH’s publicly traded status provided regulators, accreditors, faculty, and other stakeholders the luxury of a stock price that broadcast investor sentiment on the future prospects of the company. NAUH’s challenges and investors’ lack of confidence in its future are clearly reflected in the company’s dismal stock performance.

However, NAUH’s stock price performance seems inconsistent with the department’s determination that NAUH eked out a just-passing composite score of 1.5 for the most recent round of financial responsibility review.49 Based on the composite score, which looked back at NAUH’s finances as they stood on May 31, 2017,50 the department lacked authority to seek additional collateral from NAUH until May 2019.51

Unfortunately, in this case, the regulatory framework for assessing financial health had to catch up with investors. It illustrates that, in general, the department has to wait for a school to cross an arbitrary financial threshold even when investors have clearly demonstrated the magnitude of risk that exists with a school.


  1. For analysis of the Department of Education’s loan discharge obligations, including recent regulatory changes, see Yan Cao, “How DeVos Is about to Make Life Harder for Victims of School Closures,” The Century Foundation, July 23, 2019, https://tcf.org/content/report/devos-make-life-harder-victims-school-closures/.
  2. Unsurprisingly, a cottage industry now exists to advise institutions on navigating the department’s convoluted framework. Leading guides include accounting firm KPMG’s “Ratio Analysis in Higher Education” series, including “Measuring Past Performance to Chart Future Direction,” fourth edition for independent institutions, KPMG LLP, 1999, available at https://www.prager.com/Public/raihe4.pdf, and “New Insights for Leaders of Public Higher Education,” fifth edition for public institutions, KPMG LLP 2002, available at https://www.prager.com/Public/raihe5.pdf.
  3. The department adopted an August 2017 recommendation from the Government Accountability Office, and recently began to post annual updates on financial composite scores. “Financial Responsibility Composite Scores,” Office of Federal Student Aid, U.S. Department of Education, https://studentaid.ed.gov/sa/about/data-center/school/composite-scores.
  4. Senator Dick Durbin (D-IL) recently obtained from the Department of Education a list of institutions that submitted a letter of credit to the department between January 1, 2016 and November 30, 2017: “Durbin Releases Questions For The Record Responses From Department Of Education,” press release, Office of Senator Dick Durbin, June 17, 2019, available at https://www.durbin.senate.gov/download/department-of-education-qfr-responses-to-durbin.
  5. The department publishes quarterly updates of a list of institutions designated for either of its two levels of Heightened Cash Monitoring. See “Heightened Cash Monitoring,” Office of Federal Student Aid, U.S. Department of Education, available at https://studentaid.ed.gov/sa/about/data-center/school/hcm.
  6. The score “has been an imprecise risk measure, predicting only half of closures since school year 2010-11.” “Education Should Address Oversight and Communication Gaps in Its Monitoring of the Financial Condition of Schools,” Government Accounting Office, GAO-17-555, August 21, 2017, https://www.gao.gov/assets/690/686709.pdf.
  7. David A. Tanberg, “Monitoring and Assessing The Financial Health and Risk of Colleges and Universities: Recommendations for SHEEO Agencies,” State Higher Education Executive Officers Association, October 2018, http://sheeoorg.wpengine.com/wp-content/uploads/2019/03/SHEEO_HealthRiskWP.pdf.
  8. Composite scores are scaled from -1.0 to 3.0. The department considers a school financially responsible for scores greater than or equal to 1.5; a score below 1.0 is failing; and a score from 1.0 to 1.4 is in the “zone.” The scores have no independent meaning other than their consequences: scores of 1.4 or below trigger departmental authority to prescribe corrective actions, while scores of 1.5 or above restrict departmental authority to seek further assurance of an institution’s financial responsibility. See 34 CFR.
  9. The most recent scores were calculated for “Fiscal Years Ending Between 7/1/2016 and 6/30/2017.” “Financial Responsibility Composite Scores,” Office of Federal Student Aid, U.S. Department of Education, available at https://studentaid.ed.gov/sa/about/data-center/school/composite-scores.
  10. The department recently provided guidance to schools on compliance standards with the so-called “Borrower Defense” rules that detail the events, actions, and conditions that trigger a review of an institution’s financial responsibility composite score. “Guidance Concerning Some Provisions of the 2016 Borrower Defense to Repayment Regulations,” Office of Postsecondary Education, U.S. Department of Education, March 15, 2019, https://ifap.ed.gov/eannouncements/030719GuidConcernProv2016BorrowerDefensetoRypmtRegs.html. Regulatory standards are available at 34 CFR 668.171(h).
  11. Inappropriate communications between department officials and executives of distressed schools that seek favorable treatment can lead to disastrous results for students, as illustrated by the recent catastrophic closure of the for-profit Art Institute schools. Erica L. Green and Stacy Cowley, “Emails Show DeVos Aides Pulled Strings for Failing For-Profit Colleges,” New York Times, July 23, 2019, https://www.nytimes.com/2019/07/23/us/politics/dream-center.html.
  12. While the department does not reveal the weight it assigns to each ratio, the ratios’ formulas and specifications are detailed in the regulations at 34 CFR 668.172 and Appendices A, B, and C to Subpart L of 34 CFR Part 668, available at https://www.law.cornell.edu/cfr/text/34/part-668/subpart-L.
  13. U.S. Department of Education, “Rulemaking: Borrower Defense and Financial Responsibility, Final Regulations,” U.S. Department of Education, August 30, 2019, https://www2.ed.gov/policy/highered/reg/hearulemaking/2017/borrowerdefense.html.
  14. Adjusted equity for a for-profit school is calculated as follows: (total owner’s equity) – (intangible assets) – (unsecured related-party receivables) – (net property, plant, and equipment) + (long-term debt) + (post-employment and retirement liabilities). Adjusted Equity for a nonprofit school is calculated as follows: (unrestricted net assets) + (temporarily restricted net assets) – (annuities, term endowments, and life income funds that are temporarily restricted) – (intangible assets) – (net property, plant, and equipment) + (post-employment and retirement liabilities) + (all debt obtained for long-term purposes) – (unsecured related party receivables).
  15. Will Kenton, “Current Ratio,” Investopedia, updated May 30, 2019, https://www.investopedia.com/terms/c/currentratio.asp.
  16. This may sound confusing, so an illustrative example may be helpful. Imagine a school has a $10 million building and no debt. The school wants to improve its primary reserve ratio. A school can borrow up to $10 million, up to the value of the building, and get credit for this in the numerator. It effectively treats real estate as a liquid asset, even though earlier we noted that real estate represents an illiquid asset. Remember, the school likely can’t sell the building tomorrow for its market value. It might take a year or possibly two to get market value. If a school faces a cash crunch, it can’t sell land or property at market value.
  17. According to GAO, the department “included long-term debt in the formula for the primary reserve ratio (which measures whether a school has sufficient resources to cover its expenses) to address concerns that schools would be discouraged from making investments in capital improvements if these funds were not counted in the ratio.” “Education Should Address Oversight and Communication Gaps in Its Monitoring of the Financial Condition of Schools,” Government Accounting Office, GAO-17-555, August 21, 2017, 23, https://www.gao.gov/assets/690/686709.pdf.
  18. At a nonprofit, the equity belongs to the public, under the guardianship of the trustees on the board.
  19. For-profit definition: modified equity = (total owner’s equity) – (intangible assets) – (unsecured related-party receivables); and modified assets = (total assets) – (intangible assets) – (unsecured related-party receivables). Nonprofit definition: modified net assets = (unrestricted net assets) + (temporarily restricted net assets) + (permanently restricted net assets) – (intangible assets) – (unsecured related-party receivables); and modified assets = (total assets) – (intangible assets) – (unsecured related party receivables).
  20. “Borrower Defense Final Rule,” U.S. Department of Education, August 30, 2019, 462, https://www2.ed.gov/policy/highered/reg/hearulemaking/2017/borrower-defense-final-rule.pdf.
  21. Recent reporting uncovered extensive communications between DeVos representatives and executives of a for-profit chain that sought to curry favorable treatment before ultimately closing precipitously and displacing thousands of students. Erica L. Green and Stacy Cowley, “Emails Show DeVos Aides Pulled Strings for Failing For-Profit Colleges,” New York Times, July 23, 2019, https://www.nytimes.com/2019/07/23/us/politics/dream-center.html.
  22. Yan Cao, “How Betsy DeVos Got Schooled by the Education Corporation of America,” The Century Foundation, Sept. 14, 2018, https://tcf.org/content/commentary/betsy-devos-got-schooled-education-corporation-america.
  23. Ashley A. Smith, “Missing Federal Aid Payments,” Inside Higher Ed, March 4, 2019, https://www.insidehighered.com/news/2019/03/04/argosy-students-lose-out-millions-dollars-federal-aid-goes-missing.
  24. Andrew Kreighbaum, “ Feds to Cancel Debt of Thousands of ITT Students,” Inside Higher Ed, September 23, 2019, https://www.insidehighered.com/quicktakes/2019/09/23/feds-cancel-debt-thousands-itt-students.
  25. Claim on a school’s existing asset
  26. Claim on a school’s existing asset
  27. Such a certification would be similar to the Sarbanes–Oxley Act, which requires CEOs and CFOs of publicly traded companies to certify that financial statements and disclosures fairly present the operations and financial conditions of a company. CEOs and CFOs could potentially be sued for misrepresentation in the event that the planning document contains false or misleading statements.
  28. “Information on Mount Ida Closure,” Massachusetts Department of Education, last updated June 25, 2018, https://www.insidehighered.com/quicktakes/2019/09/23/feds-cancel-debt-thousands-itt-students.
  29. Katie Lannan, “After Mount Ida’s surprise closing, official supports more warning,” Wicked Local—Newton, May 14, 2019, https://newton.wickedlocal.com/news/20190514/after-mount-idas-surprise-closing-official-supports-more-warning.
  30. “Financial Statements and Single Audit Compliance Reports, Years Ended June 30, 2016 and 2015,” Mount Ida College, December 29, 2016, available at https://harvester.census.gov/facdissem/Main.aspx.
  31. Matt Schifrin, “2016 Forbes College Financial Grades: E Through M,” Forbes, July 6, 2016, https://www.forbes.com/sites/schifrin/2016/07/06/2016-forbes-college-financial-grades-e-through-m/#188c340c4c34.
  32. One has the impression, when reading their 2016 financial report, that the school had a plan in place with evident results on the basis of improving enrollments. According to that report, “the President and board of trustees made an important decision in the 2013-2014 academic year to implement a multi-year strategic plan. The plan utilizes the College’s financial resources to make strategic investments in financial aid, programs, and infrastructure. This investment has continued in the 2015-2016 academic year, resulting in an anticipated deficit for the year. The college has built financial resources for this very reason which has allowed us to invest in our future. Because of this investment, the College continues to track or exceed its enrollment targets. For the fall of 2016, the number of full time undergraduate students is approximately 1,295, the highest of the last four enrollment cycles.” “Financial Statements and Single Audit Compliance Reports, Years Ended June 30, 2016 and 2015,” Mount Ida College, December 29, 2016, available at https://harvester.census.gov/facdissem/Main.aspx.
  33. The school had $1.9 million in cash and cash equivalents and $5 million of liquid investments (money markets, stock, and mutual funds). While the balance sheet lists $16 million in investments, $11 million of this was illiquid real estate held as an investment.
  34. Change in assets is the non-profit equivalent of net income for a for-profit corporation.
  35. Lauren Fox, “Mount Ida receives record $8m gift,” Boston Globe, October 15, 2015, https://www.bostonglobe.com/metro/2015/10/15/mount-ida-receives-largest-donation-school-history/lkq8nCytTmIZV2JtDAhrUM/story.html.
  36. This increase in the real state value boosted Mount Ida’s financial composite score and is reflected in the school’s statement of financial position (balance sheet for a nonprofit) and statement of unrestricted activities (income statement for a nonprofit).
  37. In a press release, the company suggested that, “The actions of and sanctions from the U.S. Department of Education have forced us to cease operations of the ITT Technical Institutes, and we will not be offering our September quarter… This action of our federal regulator to increase our surety requirement to 40 percent of our Title IV federal funding and place our schools under ‘Heightened Cash Monitoring Level 2,’ forced us to conclude that we can no longer continue to operate.” “ITT Educational Services, Inc. to Cease Operations at all ITT Technical Institutes Following Federal Actions,” ITT Technical Institute, September 6, 2016, http://www.ittesi.com/2016-09-06-ITT-Educational-Services-Inc-to-Cease-Operations-at-all-ITT-Technical-Institutes-Following-Federal-Actions.
  38. ITT would fund payments in the event student loan defaults passed a certain threshold.
  39. The company did not consolidate the CUSO or PEAKS loans on the company’s balance sheet, meaning that no liability existed on the balance sheet for these financial instruments.
  40. “Consumer Financial Protection Bureau Settles with Student CU Connect CUSO over ITT Private Loan Program,” Consumer Financial Protection Bureau, June 14, 2019, https://www.consumerfinance.gov/about-us/newsroom/bureau-settles-student-cu-connect-cuso-over-itt-private-loan-program/.
  41. Patricia Cohen, “ITT Educational Services Closes Campuses,” New York Times, September 6, 2016, https://www.nytimes.com/2016/09/07/business/itt-educational-services-closes-its-campuses.html.
  42. “Massachusetts college to close amid financial challenges,” Boston Herald, December 14, 2018,
  43. Rick Seltzer, “2 New England Colleges Placed on Probation,” InsideHigherEd, August 22, 2018, https://www.insidehighered.com/quicktakes/2018/08/22/2-new-england-colleges-placed-probation
  44. “Financial Responsibility Composite Scores,” Office of Federal Student Aid, U.S. Department of Education, available at https://studentaid.ed.gov/sa/about/data-center/school/composite-scores.[/note] In Newbury’s 2017 financial statements, the auditor did not express any doubt about the college’s ability to continue as a going concern. However, as of June 30, 2017, the school only had roughly $2 million in liquid assets (cash and investments). Operating cash flow decreased by $400,000. Unless the school could increase its enrollment base, assuming existing operations, the school would have had at best two or three more years to operate.

    Sure enough, one year later, in the school’s 2018 financial report,[note] Newbury College, 2018 financial statements, obtained by TCF from Federal Audit Clearinghouse (FAC), https://harvester.census.gov/facweb/ ], on file with TCF at https://drive.google.com/drive/folders/1QGwNHfSlEO5oCX1xd45P1fzuTpi-eMcS?usp=sharing

  45. Data from 2015–2017 collection year, full-time equivalent fall enrollment, Integrated Postsecondary Education Data System (IPEDS), National Center for Education Statistics, U.S. Department of Education, available at https://nces.ed.gov/ipeds/datacenter/InstitutionByName.aspx
  46. “National American University Holdings, Inc. (NAUH), Yahoo Finance, accessed September 26, 2019, on file with TCF at https://drive.google.com/drive/folders/1QGwNHfSlEO5oCX1xd45P1fzuTpi-eMcS?usp=sharing
  47. “National American University Holdings, Inc. (NAUH), Yahoo Finance, accessed September 26, 2019, available at https://finance.yahoo.com/quote/NAUH/history?period1=1199682000&period2=1569470400&interval=1d&filter=history&frequency=1d.
  48. “2016–17 Provisional Release Data, Finance Survey Data for National American University,” Integrated Postsecondary Education Data System (IPEDS), National Center for Education Statistics, U.S. Department of Education, OPEID: 436483, available at https://nces.ed.gov/ipeds/datacenter/InstitutionByName.aspx.
  49. The department posted NAUH’s composite score for fiscal year ending May 31, 2017. “Financial Responsibility Composite Scores,” Office of Federal Student Aid, U.S. Department of Education, https://studentaid.ed.gov/sa/about/data-center/school/composite-scores.
  50. NAUH had a published composite score of 1.5 for 2017 and, according to the company’s 2018 annual report, NAUH’s management team believed it would have a 1.3 financial composite score for 2018.
  51. Since the company posted its 2018 financials in securities filings, NAUH has received (in March 2019) a letter from the department requiring it to post collateral in the form of a letter of credit. U.S. Securities and Exchange Commision, EDGAR, https://www.sec.gov/edgar.shtml, financial statements, on file with TCF at  https://drive.google.com/drive/folders/1QGwNHfSlEO5oCX1xd45P1fzuTpi-eMcS?usp=sharing