“It doesn’t mean a thing, but even so, after twenty-five years; it’s nice to know.”
The words from the song, “Do you Love Me?” are sung by Tevye and his dear wife Golda in “Fiddler on the Roof” as they grapple with yet another generation of would-be husbands and wives, each testing tradition in uncomfortable ways. The idea is that, though Tevye and Golda were introduced on their wedding day a quarter century ago, they have adapted to each other to the point where each “supposes” they love the other.
Some things we just have to adjust to.
Bringing this closer to home, “We can’t seem to budget for depreciation,” is a common refrain we hear in our visits to over fifty institutions. Rather than cow-tow to the FASB-mandated enterprise form of accounting, some capital spending and principal on debt are inserted into the operating budget, hoping that, by some miracle, the audit will show a positive result.
Twenty-five years ago, we were preparing for the FASB-mandated forced marriage between a new form of accounting and non-profit organizations. Prior to that, a widely-variable application of fund accounting made comparisons and gauges of health difficult. Today, we stand at the threshold of of yet another change, albeit evolutionary. Higher education can be slow to adopt new practices – but twenty-five years? I’m not feelin’ the love.
In defense of those who continue to act as if the mid-nineties never occurred, if what is spent on debt principal and capital items exceeds depreciation, it really doesn’t matter. But that tends to be mere coincidence. Too often, when cuts are needed, capital spending is put on the block, as if it will help in “balancing” the budget. In those cases, an internal operating budget can show a surplus while the board hears from the auditors that the college had a deficit. You might get away with, “The audit doesn’t matter,” with an unsophisticated board but the DOE and your bank …
Because depreciation expense is the ratable allocation of an asset’s historic cost, it makes sense that the eventual replacement of that asset will be more expensive. This is particularly true of facilities. For this reason, the CFO Colleague standard for capital spending and principal on debt stands at 120% of annual depreciation expense. If you are not spending more than depreciation expense, you are not keeping up. If you are spending less, deferred maintenance will eventually consume you.
Incorporation of depreciation expense is but the beginning, however. Step two is a contingency of at least two percent so that changes in demand, unanticipated increases in costs or one-time opportunities for investment can be covered. Then, there is the Standard and Poor’s expectation of a three percent surplus.
But wait, there’s more.
What will the DOE financial responsibility ratio be at the end of next year? What are the required debt service coverage ratios or cash balances by our bond trustee? Are our revenue-driving activities supportable and owned? All of this enters into a well-crafted budget that benefits a college for years to come.
We call this the “budget performance matrix.” Rather than a false sense of security brought on by cash-based plans, a comprehensive approach of this kind ensures that the budget accomplishes the primary expectations of each evaluator/stakeholder.
Our COMP4cast model incorporates each of these measures, generating in real time the projected surplus or deficit, cash position, debt service coverage and DOE ratios. The leadership team interacts with this model while sitting around the table, conversing about various “what-ifs.”
And it’s available for free from our website: cfocolleague.com/free-resources
After twenty-five years, it’s nice to know.