HEFCE Circular 15/96
Analysis of 1996 Financial Forecasts
To Heads of Higher Education Institutions
Heads of DENI-funded Universities
Of interest to those responsible for Finance
Reference 15/96
Response No response required
Publication Date September 1996
Enquiries to Regional Finance Officers
Executive Summary
1. This circular describes the financial position for the higher education sector, as portrayed by recent financial forecasts. It enables universities and colleges to compare their positions with the sector as a whole. Council officers will also be providing specific feedback to assist in this and will discuss with individual institutions their position as necessary.
2. Recent actual results indicate that the financial forecasts are a reliable indicator of future levels of surplus or deficit for the sector.
3. The forecasts indicate a downturn in the recurrent position of the sector after 1994-95. The outturn for 1995-96 is expected to be break-even, with deficits from 1996-97 onwards.
4. The number of institutions expecting to operate in deficit increases from an actual 26 in 1994-95 to 48 in 1995-96, and over 70 by the end of the forecast period.
5. Higher education institutions (HEIs) are planning to reduce staff numbers, to defer capital programmes and long-term maintenance, and to limit equipment expenditure to the level of Council funding.
6. Net current assets and cash balances are forecast to decline throughout the forecast period.
7. The proportion of reserves held as cash declines from 22 per cent to only 16 per cent over the forecast period.
8. The number of institutions with negative cash flows from their operations increases from below 10 in 1994-95 to a forecast total of 47 in 1995-96 and 50 by 1996-97.
9. Capital expenditure is forecast to reduce by 60 per cent over the forecast period.
10. The forecasts have been based on realistic assumptions. The key areas of sensitivity are pay and non-pay inflation and reductions in the Council's funding.
11. The level of financial flexibility, expressed as the number of days of total expenditure represented by net current assets, halves from 44 days to 22 days by 1999-2000. The number of days of total expenditure represented by cash balances shows a similar reduction from 27 days to 15.
12. This analysis inevitably masks a wide range of operating positions and financial strengths among different institutions.
Reliability of Financial Forecasts
13. The 'Statement of Recommended Practice: Accounting in Higher Education Institutions' (SORP) came into force in 1994 and has been the basis for the Council's financial forecasts and other financial returns since 1995. This has enabled financial information to be compiled on a consistent basis for all HEIs for the first time.
14. Annex A measures the reliability of similar financial information in previous years, comparing past forecasts with outturn. This indicates that institutions tend to forecast conservatively, but not excessively so: the variation between forecast and actual results is within the normal margins for forecasting. For 1994-95 the variation in surplus of £63 million represents a variation of less than 1 per cent of total income.
15. Annex A also compares the historical cost surplus/(deficit) in order to include the 1994 financial forecasts on a consistent basis. The variations between forecasts and actual results for the sector as a whole are not significant.
Comparison of 1995 and 1996 Financial Forecasts
16. Table 1 compares the financial forecasts produced in 1995 and 1996 for total income, total expenditure and recurrent surplus or deficit.
| Table 1 | 1994-95 | 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 |
| £M | £M | £M | £M | £M | £M | |
| Total Income | ||||||
| 1995 Financial forecasts | 8,005 | 8,373 | 8,605 | 8,858 | 9,106 | |
| 1996 Financial forecasts | 8,164 | 8,586 | 8,763 | 8,943 | 9,152 | 9,372 |
| Increase | 159 | 213 | 158 | 85 | 46 | |
| Total Expenditure | ||||||
| 1995 Financial forecasts | 7,847 | 8,307 | 8,580 | 8,837 | 9,090 | |
| 1996 Financial forecasts | 7,941 | 8,537 | 8,776 | 8,968 | 9,184 | 9,429 |
| Increase | 94 | 230 | 196 | 131 | 94 | |
| Surplus/(Deficit) after Depreciation of Assets at Valuation and Tax | ||||||
| 1995 Financial forecasts | 158 | 66 | 25 | 21 | 15 | |
| 1996 Financial forecasts | 221 | 49 | -13 | -26 | -33 | -58 |
| Increase/(Decrease) | 63 | -17 | -38 | -47 | -48 |
17. While the changes in total income and total expenditure are not large, it is significant that in each year after 1994-95 forecast income has increased less than expenditure. The position from 1995-96 principally reflects the actions HEIs have taken or are planning in response to the 1995 Budget Statement and the funding announced for 1996-97.
Income and Expenditure Account
Table 2 summarises the income and expenditure position set out at Annex B.
| Table 2 | 1994-95 | 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 |
| £M | £M | £M | £M | £M | £M | |
| Total income | 8,164 | 8,586 | 8,763 | 8,943 | 9,152 | 9,372 |
| Total expenditure | 7,941 | 8,537 | 8,776 | 8,968 | 9,184 | 9,429 |
| Surplus/(deficit) after depreciation at valuation and tax | 221 | 49 | -13 | -26 | -33 | -58 |
| Percentage of total income | 2.71 | 0.57 | -0.14 | -0.29 | -0.36 | -0.62 |
| Historical cost surplus/(deficit) after tax | 278 | 113 | 42 | 29 | 24 | -5 |
| Percentage of total income | 3.41 | 1.32 | 0.48 | 0.32 | 0.26 | -0.05 |
19. On the basis of these figures, the recurrent position of the sector shows a rapidly deteriorating position from the actual results in 1994-95. The expected surplus for 1995-96 of £49 million represents just 0.6 per cent of income. The sector is forecasting deficits from 1996-97 onwards. Institutions should plan to generate additional cash (over and above depreciation) to fund capital and other developments. Compared with a prudent 3 per cent annual surplus, the shortfall is some £200 million in 1995-96 rising to over £300 million a year by 1999-2000.
20. Where institutions made unrealistic assumptions in preparing their forecasts, Council officers have taken this up with them directly. The great majority were realistic. Across the sector, assumptions on pay and non-pay inflation were around the level of the GDP deflator. In many instances HEIs have offset increases in pay rates with reductions in staff numbers. They have also assumed reductions in Council funding in line with the 1995 Budget Statement.
21. The total staff reductions quantified by institutions exceed 1,200 posts. Others have predicted staff reductions, but not given precise numbers. HEIs also indicated a range of reductions in non-pay expenditure. These include cancelling or deferring capital programmes; cutting back on long-term maintenance; and limiting expenditure on equipment to the levels of funding now being provided by the Council. Since such expenditure is still likely to be needed, this simply represents deferral which may lead to a higher requirement for funds when the expenditure is finally incurred.
22. These figures are aggregate amounts for the sector as a whole and disguise the wide range of forecasts between HEIs. The number of HEIs forecasting that they will be operating in deficit increases from an actual 26 in 1994-95 to 48 in 1995-96, and 78 by 1999-2000.
Balance Sheet
23. Table 3 summarises the balance sheet for the sector as a whole at Annex C.
| Table 3 | 1994-95 | 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 |
| £M | £M | £M | £M | £M | £M | |
| Fixed assets | 7,624 | 8,261 | 8,661 | 8,844 | 8,798 | 8,787 |
| Endowment assets investments | 1,386 | 1,427 | 1,463 | 1,499 | 1,536 | 1,575 |
| Net current assets | 949 | 850 | 698 | 559 | 572 | 574 |
| Creditors due after 12 months | 1,772 | 1,938 | 2,115 | 2,124 | 2,064 | 2,097 |
| Provisions | 407 | 409 | 372 | 346 | 339 | 340 |
| Deferred capital grants | 1,767 | 1,772 | 1,863 | 1,923 | 1,960 | 1,945 |
| Total net assets | 6,013 | 6,419 | 6,472 | 6,509 | 6,543 | 6,554 |
| Endowments | 1,435 | 1,478 | 1,515 | 1,549 | 1,589 | 1,631 |
| Reserves | 4,578 | 4,941 | 4,957 | 4,960 | 4,954 | 4,923 |
| Total funds | 6,013 | 6,419 | 6,472 | 6,509 | 6,543 | 6,554 |
24. The only increase in total funds after 1994-95 comes from endowments. Capital investment is largely funded through increased borrowing and deferred capital grants, rather than retained surpluses. Net current assets - and cash balances in particular - decline. External borrowing continues to increase, and provisions for long-term maintenance are reduced. Liquid funds are being consumed and inadequate sums being set aside for future expenditure.
25. The additional information provided with the forecasts shows uncommitted, cash-backed reserves declining from around £500 million in 1994-95 and 1995-96 to below £400 million by the end of the forecast period. Thus the proportion of reserves held in the form of available cash declines from 22 per cent in 1994-95 and 1995-96 to only 16 per cent by 1999-2000.
Cash Flow
26. Table 4 summarises the cash flow forecast for the sector at Annex D.
| Table 4 | 1994-95 | 1995-96 | 1996-97 | 1997-98 | 1998-99 | 1999-00 |
| £M | £M | £M | £M | £M | £M | |
| Net cash inflow/(outflow) from operations | 490 | 181 | 90 | 166 | 170 | 178 |
| Return on investments and servicing of finance | 80 | 61 | 19 | 11 | -1 | -15 |
| Tax paid | -2 | -1 | -1 | -1 | -1 | -1 |
| Acquiring tangible assets | -880 | -898 | -772 | -616 | -466 | -366 |
| Other investing activities (net) | 289 | 349 | 309 | 270 | 313 | 168 |
| Net cash inflow/(outflow) before financing | -23 | -308 | -355 | -170 | 15 | -36 |
| Financing | 241 | 197 | 172 | 88 | -35 | 38 |
| Increase/(decrease) in cash and cash equivalents | 218 | -111 | -183 | -82 | -20 | 2 |
27. The ability of the sector to generate funds for reinvestment from its operations declines dramatically after 1994-95. The number of HEIs with net cash outflows from their operations increases from only seven in 1994-95 to 47 in 1995-96 and 50 in 1996-97.
28. The limited ability of the sector to reinvest was highlighted in the review of the 1995 financial forecasts. These latest forecasts show the level of affordable capital expenditure declining by 60 per cent between 1995-96 and 1999-2000. This constraint on reinvestment is not influenced by the procurement options available to HEIs: direct purchase, borrowing and the Private Finance Initiative all have to be financed from positive cash flows.
Sensitivity Analysis
29. Table 5 analyses the impact of variations in different key assumptions for the sector as a whole, taking account of institutions' own sensitivity analyses.
| Table 5 | 1996-97 | 1997-98 | 1998-99 | 1999-00 |
| £M | £M | £M | £M | |
| 1% greater reduction in Council funding each year | 16 | 43 | 68 | 93 |
| 1% increase in pay inflation each year | 38 | 75 | 116 | 160 |
| 1% increase in non-pay inflation each year | 22 | 43 | 66 | 90 |
| 1% increase in interest payable each year | 8 | 12 | 16 | 20 |
| 2% shortfall in recruitment of full-time home and EC students in 1996-97 | 22 | 25 | 29 | 30 |
| 5% shortfall in recruitment of part-time students in 1996-97 | 11 | 13 | 14 | 15 |
| 5% shortfall in recruitment of overseas students in 1996-97 | 16 | 17 | 20 | 21 |
| 10% shortfall in contract research income in 1996-97 | 23 | 24 | 28 | 31 |
| 5% reduction in contract research recovery rates in 1996-97 | 18 | 19 | 22 | 23 |
30. This analysis confirms that the financial position of the sector is most sensitive to levels of inflation and Council funding. Salary settlements are within HEIs' control whereas inflation and assumed efficiency gains within HEFCE funding are not. The impact of shortfalls in student recruitment and the contributions from income-generating activities, while serious for some HEIs, would have less impact across the sector as a whole.
Financial Indicators
31. The Council uses a number of financial indicators to monitor the financial health of HEIs. Some of these are applied to the sector as a whole at Annex E.
32. The level of financial flexibility, expressed as the number of days of total expenditure represented by net current assets, halves from 44 days to 22 days. The number of days of total expenditure represented by net cash balances similarly falls from 27 days in 1994-95 to only 15 days after 1996-97. Prudent financial management would suggest that most HEIs should have sufficient cash reserves to cover 30 days of total expenditure so as to manage change and allow for unforeseen events.
33. The level of borrowing for the sector as a whole is not excessive. However, a number of institutions do have substantial borrowings which have been taken into account in assessing the financial health of the HEIs in question. In most cases the borrowing is related to an activity that has an associated income stream.
Variations between Institutions
34. The analysis above covers the sector as a whole and inevitably masks a wide range of operating positions and financial strengths across the sector.
35. Much of the financial strength of the sector is concentrated in a small number of comparatively wealthy institutions. Similarly, a large proportion of external borrowing is undertaken by a limited number of institutions.
Further Information
36. Enquiries should be addressed to Regional Financial Officers.Appendices
These will be available shortly.