A Strong Head-CFO Partnership, Part II

Cash flow, depreciation, and getting over the line of credit addiction

Nov 03, 2023

This is Talking Out of School, a weekly newsletter about schools, change, leadership and being a human in the 21st century. Thank you to all the subscribers who support this work!

If a subscriber passed this on to you and you’re enjoying this work, please consider subscribing! More subscribers means growth and growth increases my ability to attract interesting guests to be interviewed, more readers to send me interesting ideas, more community members to start a resourceful comments section etc.

Come join me at an upcoming webinar - “Creating a Talent Development Model for Hiring and Retention” - for a one day online summit, TransformED from founder and producer Peter Baron - November 7th

It’s the November People Talking interview - Part Two of my conversation with Tom Gorman about the head - CFO partnership (Part One here) - this time, we discuss cash flow - why it’s important, steps towards getting a handle on it, line of credit “addiction” and why “cash is king” but also why it’s important to monitor non-cash expenditures as well.

I realize the word “discipline” comes up repeatedly in this interview and every time I use that word I feel like I make a sour expression and don my black Puritan hat to become Cotton Mather. Not someone you want to hang out with at a party. But after you have invested in a strategy, and employed tactics to support the strategy, sometimes it can be so hard to maintain the multi-year discipline so it comes to fruition. Unbelievably hard and sometimes pretty boring. So celebrate the wins along the way and even when it’s hard - keep going.

Over the past year, as I’ve been networking with independent school folks, it has struck me that the anxieties I keep hearing about, even with schools I would think from outside signs - enrollment numbers or endowment size - were all about not having the discretionary funds to invest in a program or a position or a new system or outside expertise like a brand consultant. I wrote a post about the “Wheel of Misfortune” where enrollment dips, so revenue dips and then a school is trying to do more with less, which is rarely going to result in enrollment increasing.

What I hear is all “it’s not in the budget” but really, it’s managing cash so that you have some ability to make judicious investments to then help get enrollment back up. Even a small school has a multimillion dollar budget but if you’re scraping together cash for payroll every month, you have no ability to make choices. So I was wondering what your take on the state of cash management is in independent schools. And before we started recording, you mentioned that cash management is similar no matter what the industry.

We're not unique. Yes, we are unique because of the age of the students that we care for and we educate. But the business model is no different. You get this influx of cash and the temptation is to spend it as soon as you have it.

And the discipline is, how do you budget that or parse it out over the year? Part of this challenge is also when you start receiving your deposits for the next year, the temptation to spend those. Now, over time your cash flow evens out. But if you face what I think a lot of schools faced the last few years with the pandemic, if there is a change in enrollment, that cash flow you are depending on is suddenly gone or arrives at a different time or in a different amount, and then you need to be able to adapt. If you can't adapt quickly enough, you're scrambling to cover accounts payable.

Which is the most stressful situation. And I understand that if you don’t have a handle on your cash flow, it is easy to get addicted to your line of credit to get you through..

So where do you start to weaning yourself off of a line of credit? Because even if you have a good budget process and good collaboration between the head and the admins and the CFO and the Board finance committee and no conflict around goals you’re achieving with that budget, if that doesn't have a relationship to your cash flow, then there becomes a problem of leaning heavily on the line of credit. What’s your advice for a head or CFO who's dealing with situation?

History can be informative. Every business has a natural flow of cash flow and operations, and independent schools are no different. There are natural points in the year, and for independent schools, you issue your enrollment agreements starting in March, new agreements in April, May. You start getting deposits, and then if you're on any payment plan, your tuition dollars start rolling in June, July, August. What I like to do is to just look at the bank accounts and look at the general ledger just to understand the flow. At a prior school, I knew the low point of cash was mid-January to the end of February, early March, because you get the bump at calendar year end from contributions, and then everyone goes quiet. And then it's not until you start receiving your deposits for the next year that you get a net increase in cash because on a 10-pay plan, you're accustomed to getting X amount every month from those payment plans. The deposits all of a sudden start jacking up your cash receipts.

School to school, it will be different. So I map it out. But I also want to look at what is our line of credit and what is the reliance on the line of credit? Because yes, you can become addicted to your line of credit. And in a lot of ways, a line of credit or a healthy endowment can mask a lot of fundamental problems because you could become over reliant on a line of credit, or you view the endowment draw as the bank of first resort and not last resort. And leaning on the line of credit or the endowment allows those in charge, the administration and the board, to avoid having to make difficult decisions about restructuring your program, restructuring your employee headcount, whatever it might be.

I’ve seen situations where the CFO is in the line of credit every month. Then the line gets fully extended and to make payroll they’re trying to scrape together two nickels. And that's not a pleasant way to live.

I will say that I felt quite ignorant about cash management and lines of credit and as a head it took time to really get a handle on how it all worked. I was all “budget, budget, budget” and didn’t get this whole other, very important, aspect of operations.

And I try and develop as close to an accrual budget as I can with all the non cash items like depreciation. Independent schools are a capital intensive business. We have a lot of infrastructure and a lot of buildings to support. We are human resource capital intensive. The concept of depreciation, it's just recognizing that the value of your buildings are consumed or used over a period of time. The concept of depreciation just allocates or portions the cost of those assets to your operations over the useful life. For a car, you go and acquire a new minivan. Well, that's a capital asset, and you depreciate that over usually five years. And so a portion of that minivan is used or consumed and enters into operations over those five years. The cash is out the door. Maybe you took out a loan, but the cash is out the door. But operationally, it's still an expense.

And so you need to look at not just a cash budget. And yes, cash is king, or in the world of all girl schools, cash is queen. But we also need to... You need to look at cash flow, but you also need to look at accrual. Because one of the worst things is you tell your board or your head, this is our operating budget and here’s where we're going to land for the year. Then you get your audited financial statements, and you might as well be looking at two different schools. Because all those items that go into year end accruals, your depreciation expense, your salary accrual for faculty that may be on a 10-month but paid over 12 months, all those factor into your audited statements that may not be in your internal operating budget.

I like to prepare a budget that is... I call it a modified accrual. We'll include things like depreciation expense in the operating budget, and then do a quick and dirty cash analysis or cash roll forward. And factoring in debt service, which is not an operating expense. Then we can get to how we are doing on a cash basis. But you do need to look at both accrual and cash. Because at the end of the day, I told somebody recently, it's like,we have a tremendous portfolio of pledges receivable, but I need to know when the cash is coming in. Because.we need the cash.

How long do you think it takes to wean an organization off the addiction to the line of credit?

The short answer is it depends on what your pattern is. Is the reliance on the line of credit something that's developed recently? Or if I look back over a history of three, five, or more years, have we always been in the line? If we've always been in the line, then we need to think about a recapitalization or restructuring of our debt situation. Because doing the same thing over and over again is not going to get us a different result, and we need to do something fundamentally different, either a cash infusion from contributions or an increase in enrollment. There aren't too many other levers that we have.

But I'm also a believer that incremental changes can have lasting results. One concept that I always go back to is “fractionalization” - breaking down a big problem into manageable chunks. Okay, it may be nice to be sitting on a pile of cash in our bank, but are we better off slowly paying down or reducing debt?

Your three revenue streams are tuition revenue, usually the largest, your endowment draw and contribution revenue. One of the things that can help with cash flow is to schedule the endowment draw out so that the investment manager knows when you're going to draw it, but it's also more predictable. And then you can make a cash flow forecast or a projection, because I know on this day we will draw X amount and it just smooths out your cash flow.

If you have to fundamentally restructure, the more sustainable option is to have a plan to increase enrollment, although in a volatile environment that can be dicey. Then have your director of enrollment management develop a plan, whether it's new markets, whether it's leaning into a market where there seems to be some traction, whatever it is, but it should be a realistic plan. With donations, I feel like there’s more of an unpredictable element - you can have good years and bad years.

Rule of thumb for me is you need three years if you’re planning to increase tuition revenue. We have this practice of issuing enrollment agreements or contracts to every student every year. We're needing to resell our product or service to all of our families every year. And then at a high school, we lose 25% of our kids and we gain 25%. So if you say you’re starting out with a situation where you gave a deep discount to fill the 9th grade class, I think you used to call it, “the mouse working through the snake.”

JF (laughs)

I do like vivid images.

Two years in, a plan to increase tuition revenue will get you halfway there, with becoming more mindful with your financial aid distribution to returning families and new families. By year three, you have enough critical mass on that trajectory, you start to see the impact of increasing enrollment revenue on your cash flow.

It seems like you get into an enrollment hole overnight, but you don't. It's a slow erosion.

And if you don’t stick to or buy into a realistic plan, from the head on down, you can backslide very quickly. I think once you’re seeing some results, it can be easy to take your foot off the pedal because it’s hard work and it takes a ton of discipline, especially when everyone is still in pandemic recovery mode. It’s hard to not give families a little more merit aid if they ask for it beyond what their financial aid application dictates. It’s hard to keep hitting those markets where there’s a bit of traction and not give up. But if you wander off the path, it’s a slippery slope.

And I think there is not enough appreciation for buttoned-up admissions office practices with re-enrollment that can have an impact on cash flow. Such as timing re-enrollment contracts and having discipline with enforcing the deadlines you set for families to respond.

But I think the hard thing for the situation in 2023 is that if you put all that hard work in before the pandemic, then for some schools the landscape changed radically. New York City lost 600,000 people! You can't just say we’re going back to that strategy from 2019. Talk about exhausting! And I also wonder if the calculus shifted in ways that our industry literally can’t wrap our minds around. Maybe it is an impossible task because the ambiguity is so great.

I think for many schools, the power dynamic shifted. They no longer hold the power. Many schools pride themselves on their selectivity. A lot of families have realized they have a lot of power and control.

And just from a demographics perspective, in many parts of the country there are more seats open than there are students to fill them. That's also not easy to accept. In an ideal world, you’re full in mid-April with a wait list. Then you can really fine tune a budget. But for a lot of schools you can’t finalize a budget until opening day in September.

So what about those schools with good stats - enrollment, endowment? Why do they sometimes struggle with cash management?

I think some of it is remission policies. There are policies that were created when both expenses and tuition were much lower. Now in 2023 that can be brutal and you can have a lot of employees working mainly for the remission.

You're giving this benefit that no longer makes sense. On the other hand, it is interesting to think about how a remission policy can factor into a larger strategy for hiring given the teacher shortage. But that’s another conversation.

I just find it curious that you see these schools where they shouldn't have a cash problem, but they say they have no funds to make even modest investments that could in a few years really pay off in terms of enrollment. I guess like enrollment problems, this reliance on a line of credit can creep up on you If you're not paying attention and your practices are relaxed. You really have to have discipline and strategize consistently. And I’ve also heard consistently about very high profile colleges where it turns out that their business office practices are way more sleepy than one might imagine.

Their reputations produce the illusion of sophistication and efficiency. And often there is a large amount of cash sloshing through the system that can cover up problems. Don’t forget, colleges and universities have all that federal student loan money coming in. Independent schools don’t have that revenue stream.

But to refer back to the first part of our conversation, you need to be honest about what’s in front of you because the problems won’t fix themselves. And often very “do-able” adjustments we discussed - scheduling out the endowment draw and putting effort into enforcing deadlines for re-enrollment - can really make a material difference. It’s always easier to create a little momentum and sense of achievement to then take on the bigger issue. And once you have the momentum, you can then start to chip away at the bigger, structural deficits.

Our message to you is this - there are things you can do to change your situation if you look at it carefully and identify the immediate opportunities and the longer range challenges. And as Tom and I discussed in Part One of this conversation, if you have a clear, overarching strategic approach, there are going to be opportunities you will want to take advantage of - like that game-changing hire whose salary requirements are outside of the budgeted amount or a program with demonstrated demand that could bring in more students if it was expanded even slightly or that specific improvement to a dormitory parents keep mentioning. And the ability to take advantage of these opportunities depends on having a strong handle on all parts of your financial picture so your CFO can be nimble and clear, collaborative communication between the head and the CFO.

And to the heads out there - another plea to not let finance intimidate you. Ask the questions. Use NBOA as a resource. This area is of crucial importance so build your knowledge so you can navigate it with confidence. No one should expect a career academic to be fully fluent in accounting and you should have grace for a learning curve. But make it your business to learn. You’ll be so glad you did.

Wishing you all a wonderful weekend -

Julie