Tom Wilson highlights the vital process of financial modelling for independent schools
Covid-19 has caused significant challenges to all businesses, and independent schools are no exception. There has been a huge amount of work across the sector over the last few months from creating online methods of teaching to providing a safe environment for staff and students.
However, there are still significant unknowns regarding the actual impact this pandemic has had on school finances, and for how long it will last.This has added to the already significant challenges faced by the sector including affordability, rising costs, declining local markets, and political threats. These complex and compounding issues mean that significant planning is required to ensure the future of your school, both short-term and long-term. Financial modelling is an essential part of this process.
Establishing a base model
Focusing on coronavirus specifically, the impact is likely to vary across the independent schools sector. Geography, whether you are a prep or senior school and the demographic of your pupil base, are all likely to create different challenges.
Some schools will be able to ride out the financial impact of the pandemic with relative ease, whereas others will face an existential crisis – and every school needs to know where it is on the spectrum. Good financial modelling starts with good planning – understanding how you are going to build your model, your anticipated end product, and the expectations of your stakeholders are key at the outset.
This prevents time-wasting amending of the base model at a later stage. Whilst a good model can provide invaluable insights, it is only as good as the composite data. It is absolutely essential to understand your data and the sources of it, as well as document your evidence and assumptions where possible, prior to starting the process.
Modelling has never been more important in recent years than during this Covid-19 crisis, and it is recommended that modelling includes different types of scenarios, one of which should be “worst case scenario”. Schools must be able to see the extent of the risks they face and where key decisions must be made, especially during times of increased volatility and financial hardship.
Financial modelling is most often used by schools for forecasting income and expenditure or cash flows and balance sheets. Cash flow should be the immediate priority in the short-term and consideration must be given as to how cash flow may be impacted under different situations. Financial models allow you to test your assumptions and to understand how adjusting key financial levers can influence financial performance.
Some of the assumptions and impacts that financial modelling may expose include:
• Pupil numbers – likely the biggest variable. This will be very difficult to predict, but a range of models showing outcomes and timeframes will be helpful in planning for each scenario.
• Parental hardship – we have heard various stories about parents who are, in some cases, unable to afford full fee charges. How will you handle this? Will you support them and what is the financial impact? Modelling the amount of bad debt you could face will help shape your policies and manage cash flow.
• International students – there may be significant impact from Covid-19 on income from international students, perhaps even a complete halt on income from international students into 2021. With Brexit also on the horizon, is your school exposed to ongoing decreases in international students?
• Insurance – there are conflicting stories from schools regarding insurance cover for business interruption. We think it is unlikely that schools will be covered in full. From a modelling point of view, you should not rely on coverage. Even if you are covered later, payments are still likely to be significantly delayed and won’t help cash flow in the short term.
• Cost review – it is a good time to review all budgets and try to strip out extra costs wherever possible. Due to the nature of schools, significant savings are unlikely without looking at the staffing structure and this may be a serious consideration for some organisations.
• Capital work – consider all planned capital and maintenance projects and evaluate their urgency in the current economic climate. Priorities may need to change, particularly from a digital transformation perspective, so that funds can be reallocated.
• Financing – there may be schools who need an element of financing to see them through this period of uncertainty. You should model the amount of funding necessary and approach your bank early. Don’t forget about bank covenants, as these can be easily breached, and if you find yourself with a particularly restrictive covenant, you should model the impact of a breach. Much focus has, quite rightly, been on the short-term, but schools tend to show delayed impacts from an overall downturn in the economy. Depending on the length and severity of the downturn, schools may see registration decline, and forecasting those potential shortfalls will be pivotal to medium and long-term survival. Other impacts that should be included in your modelling considerations over the medium term should be:
• Teachers’ pension planning
• Potential removal of business rates relief
Review and react
It is also recommended that you have a robust independent review of your model. The model will be used to make key strategic decisions and if the data isn’t correct, or if important possibilities are missed, it could be disastrous. In simple terms, ask an independent reviewer to try and break it. If the modelling is showing an unfavourable position, then it is worth considering your options quickly; one of the biggest mistakes boards of governors make is not reacting to the models with decisive action.
Some of the current strategic options schools are considering or have implemented include:
• Limiting year groups – years seven and eight at prep schools, for example
• Co-educational provision instead of single sex
• Diversifying boarding/day makeup of the school
• Investing in areas of weakness: facilities, specific education provision etc
• Mergers and acquisitions of complementary schools
• International expansion
Modelling also has the benefit of allowing boards to complete their fiduciary duties of regularly reviewing the “going concern status” of the schools they run. This is particularly important in the current environment when trustees are signing the financial statements. A formally documented review of the going concern assumption is recommended in conjunction with the modelling review process. It is also best practice to formally record this in minutes of a relevant board meeting. It is an area the school’s auditor will be paying close attention to this year.