In our current blog series, we have been exploring the essential role of unrestricted financial reserves for colleges and universities. In this month’s post, we look at the relationship between financial reserves and strategic financial planning.
As we noted in our May blog, unrestricted financial reserves are the foundation of an institution’s resilience: its ability to withstand periods of operational disruption and financial distress. But they are also the foundation for the institution’s future stability and growth. To the extent financial reserves are drawn upon to respond to periods of distress, they must be rebuilt to ensure that the institution has a firm foundation and capital capacity for investment in its future.
This is a crucial point that finance teams must communicate to institutional leaders, trustees, and other key constituencies: unrestricted financial reserves are not just “cash on hand” that can be used to fund capital projects or strategic initiatives. They must be maintained or enhanced, or—if drawn upon—restored, for a number of reasons:
- As a safeguard against future, unanticipated disruptions. If unrestricted cash reserves are used as a buffer in periods of financial distress, a priority must be to rebuild that buffer to provide financial flexibility in the face of future disruptions.
- In support of an institution’s credit position. Unrestricted financial reserves play a significant role in determining an institution’s credit rating, and by extension, the ease with which it can access capital when needed and the affordability of doing so. As we noted in our June blog, an institution’s credit rating is not a hill to die on if maintaining the rating comes at the expense of necessary spending on capital projects or strategic initiatives. At the same time, if the need to draw upon financial reserves leads to a rating downgrade, it will likely be in the institution’s best long-term interest to rebuild its reserves as part of its effort to restore its former rating to support optimal access to external capital.
- To provide ready liquidity for strategic investment. If an institution wants to expand its debt capacity—or avoid assuming debt—building unrestricted financial reserves can provide the liquidity needed to support additional debt issuance or to support investment in key strategies without incurring additional debt.
A well-designed strategic financial plan can help the finance team communicate these considerations to leadership and trustees and inform and enhance decision-making. Further, by integrating an institution’s strategic and operational planning directly with its financial plan, the institution’s leadership will promote understanding of the institution’s credit position and its ability to access external capital. Sound strategic financial planning takes a capital markets approach, with a focus on the institution’s credit rating and overall creditworthiness. By doing so, the institution can quantify its potential to access external capital. A key implication of this approach will be to determine the extent to which the institution’s unrestricted financial reserves will be required to provide liquidity to cover capital needs, as well as provide “cushion” to address internal and external risk factors. This information can help leadership define an appropriate “floor” for unrestricted financial reserves.
By quantifying the institution’s current resource position relative to its strategic requirements, integrated strategic financial planning can define the resources available to support desired spending (e.g., issuance of debt, operating income, endowment income, and unrestricted financial reserves). Furthermore, the direct integration of potential strategies and financial realities supports enhanced communication and understanding of the trade-offs among internal and external resources and how they might impact the institution’s credit and risk position.
Developing a realistic financial plan that supports execution of the institution’s strategy within an established credit and resource position also enables leadership to assess the risk associated with alternate strategic portfolios. The strategic financial plan should incorporate risk and sensitivity analyses and project the potential impact of various scenarios on the institution’s financial position and resources. These analyses and projections may require a recalibration or prioritization of future spending levels to, among other things, maintain a targeted level of unrestricted financial reserves to support optimal access to capital.
A key component of successful strategic financial planning is the communication of the results and associated risks. The metrics and key performance targets generated through the planning process form the strategic “road map” for the institution and define the coming year’s operating budget requirements to support the institutional strategies. Through transparent and continuous communication of the plan, the ability of leadership to maintain rigor around implementation of the plan is enhanced, as is the “financial IQ” of the institution. Given the increasing pressures that many higher education institutions face, financial discipline—including meticulous adherence to the details of the financial plan—is paramount. The plan must be revisited and updated, if needed, on at least an annual basis (if not more frequently). With rigorous discipline and ongoing updates to the plan’s details, the institution will be better positioned to avoid setbacks that may require an unanticipated need to draw upon its unrestricted reserves.
Maintenance or growth of unrestricted financial reserves is essential to the long-term stability and sustainability of any college or university. By integrating that goal to the institution’s strategic planning through development of a strategic financial plan, finance leaders can help ensure that these reserves will be available to meet planned—and if necessary, unplanned—needs, and fully support successful implementation of the institution’s strategic plan.
We are pleased to welcome Gaby Hawat, Senior Vice President, and Erik Kahill, Vice President, as new members of our Higher Education practice and co-contributors to this blog.
