There may be trouble ahead

The sector has experienced unprecedented growth in recent years, with fees and overseas income boosting overall prosperity, but not all universities are in a position to keep expanding. Alan Thomson assesses the financial strengths, weaknesses and trends in higher education

April 3, 2008

The gap between rich and poor universities is growing, according to the most detailed analyses of the financial health of higher education ever produced by Times Higher Education. Put simply, the rate at which already well-off institutions are accruing wealth is outstripping the pace of income growth at less wealthy institutions.

That gap is likely to continue to grow as better-off institutions tap into higher levels of borrowing and are able to invest more in staff and student facilities. Those with higher rates of income growth should also be able to afford to pay their staff more.

All universities are concerned about the affordability of rises in pay and pensions over the next two to three years. This worry is set against a backdrop of institutional uncertainties over a number of income streams. But it is a safe bet that the more financially robust an institution is, the better it will be able to cope with a difficult trading period.

"The real risks for higher education institutions include a variable fees plateau, waning numbers in overseas student recruitment, demographic changes impacting on the UK student population and the heavy cost of sustaining good-quality final-salary pensions," says the Universities and Colleges Employers Association.

Figures extracted by accountants Grant Thornton from universities' financial statements over the three years from 2005 to 2007 show this to have been a period of relative plenty across higher education. Rising incomes combined with buoyant borrowing and declining deficit are signs of a degree of financial heath and robustness not seen in the sector in decades.

But Grant Thornton's analysis of the figures shows that during this time of prosperity, not all institutions have benefited equally.

In 2005, the total income of research-led Russell Group universities stood at just under £7.3 billion, which was 40 per cent of the £18 billion total income for higher education. By 2007, Russell Group universities earned almost £8.7 billion, accounting for 41 per cent of the total income of higher education.

Over the same period the total income of institutions in the Million+ group, mainly teaching-led post-1992 universities, grew from £2.3 billion to £2.7 billion. But as a proportion of total higher education it remained stable at 13 per cent. The income for the 1994 Group of smaller research-led universities was £2.5 billion in 2005 rising to nearly £2.9 billion in 2007, with their share of the sector's total income at 14 per cent.

Total income figures mask greater changes within particular income streams. Total research income secured by Russell Group universities grew from 65 per cent of the £2.9 billion total in 2005 to 67 per cent of the £3.3 billion in 2007. The proportion of research income held by Million+ universities stayed at 2 per cent, while that of the 1994 Group universities fell from 16 per cent to 15 per cent of total research income.

In terms of other income (including earnings from endowments, subsidiary companies, catering and residential operations), Russell Group institutions saw their share of total income grow from 47 per cent to 49 per cent. The share claimed by Million+ institutions fell from 10 per cent to 9 per cent and that of 1994 Group members slipped from 16 per cent to 15 per cent. Russell Group universities also did better at generating cash from overseas students, raising their share of total overseas income from 37 per cent to 39 per cent. Million+ universities remained at 13 per cent of the total, and 1994 Group institutions held at 19 per cent.

In absolute terms, Russell Group universities enjoyed a rise in total income of 18 per cent between 2005 and 2007, Million+ institutions of 16 per cent and 1994 Group institutions of 17 per cent. Overseas income grew by per cent in Russell Group universities, 15 per cent in Million+ institutions and 18 per cent in 1994 Group members.

Research income grew by 20 per cent at Russell Group institutions, fell by 4 per cent at Million+ universities and increased by 11 per cent in the 1994 Group. Income classified as "other" rose by 17 per cent across the Russell Group, 9 per cent across Million+ and 10 per cent across the 1994 Group.

Income from funding council grants and tuition fees followed a less predictable pattern. Russell Group universities' grant income from the higher education funding councils rose by 15 per cent, compared with rises of 13 per cent across Million+ and 19 per cent across 1994 Group institutions. Teaching income (basically tuition fees) rose by 24 per cent across Russell Group and Million+ institutions and by 26 per cent at 1994 Group universities.

As one analyst at Grant Thornton put it: "A gap has opened between older, wealthier institutions and the others that may be difficult to close. Their ability to raise research income, attract overseas students and good research staff is superior and likely to increase.

"A lot of smaller and newer institutions are at greater risk unless they find themselves a niche."

BANK BORROWING: INDEBTEDNESS COULD BE A GOOD SIGN

The first thing to bear in mind about bank borrowing is that it tends to be a measure of an institution's financial strength rather than an indication of financial weakness associated with indebtedness.

The second thing to realise is that universities, like other large organisations, borrow to invest in projects that will generally produce a return. So high borrowing usually equates to a high level of investment.

There are two useful ways looking at debt.

The first is an institution's ability to service it. One way to assess this is to look at cash flow from operations. (Basically, this reflects an institution's operational strength - if it's making money doing what it does, good; if not, perhaps not so good.)

If an institution is making money, then it should have no difficulty persuading a lender that it can service an appropriate level of borrowing. When assessing a university's borrowing request, a bank would also consider other factors not included in cash flow from operations, such as reserves, endowment income and capital sales.

A second useful way of looking at borrowing is to calculate the ratio of bank borrowings to total income. This gives a gearing of borrowing to income, which serves as a measure - albeit a rough one - of indebtedness. Such a simple gearing ratio says nothing about an institution's overall financial strength or weakness.

The reason most universities borrow is to invest in new buildings or facilities. Banks lend only to institutions that have good credit ratings and show that they can finance the debt. Fortunately, most higher education institutions are a safe bet in lenders' eyes. But generally speaking, the more solid financially an institution is, the more banks will be prepared to lend. The result is that some of the country's wealthiest universities owe the most money.

The University of Manchester recorded bank borrowing of almost £200 million in 2007, while having a total annual income of £637 million. This gives a borrowing-to-income gearing ratio of almost 31 per cent.

In 2007, Imperial College London owed £125.5 million and had a total income of £556 million, giving a ratio of 23 per cent.

Others that owed the banks more than £100 million in 2007 were the University of Surrey (£111 million, giving a ratio of 61 per cent), King's College London (£105.6 million, ratio of 26 per cent) and the University of Sheffield (£100.8 million, ratio of 30 per cent).

Of the 20 institutions with the highest bank borrowing in 2007, 19 were pre-92 universities. Only one, the University of Plymouth - which owed the bank £62.5 million - was a post-92 institution. Its borrowing-to-income ratio was 39 per cent.

Generally, institutions with high bank borrowing tended to have healthy surplus cash flows.

One exception was Manchester, which, in addition to the £197 million it owed the bank, recorded a cash outflow (in effect a loss on operations) of £1.7 million. Still, Manchester had reserves (not shown in this table, but recorded for each institution by Grant Thornton as part of the analysis) of nearly £150 million.

By contrast, Imperial (which owed the bank £125.5 million) made £35.8 million from its operations, Sheffield (owing £100.8 million) made £23.2 million and King's (owing £105.6 million) made £10.5 million in 2007.

The total value of bank borrowing for the sector as a whole rose from £3.1 billion in 2005 to £3.8 billion in 2007, a 23 per cent increase. But crucially the ratio of bank borrowing to total funding remained roughly constant over the period, increasing from 18.56 per cent in 2005 to 18.75 per cent in 2007.

THE 4 PER CENT RULE

The "4 per cent rule" limits the amount that UK universities can borrow from banks and other lenders.

It is based on a calculation of the total annual cost of servicing and repayments to all outstanding loans. If this sum is above 4 per cent of a university's total income, then the institution must get borrowing approval from funding chiefs.

INCOME: REVENUES ARE UP, BUT SPREADING THE RISK IS STILL A PARAMOUNT CONCERN

The Holy Grail for any university finance director is to ensure that his or her institution raises income from as many different sources as possible.

As Phil Harding, chairman of the British University Finance Directors Group and finance director at the University of Westminster, puts it: "It's about spreading risk. For example, I have not met a finance director yet who would not like to reduce his or her institution's reliance on the state for funding."

In terms of spreading the risk, institutions such as the University of Manchester appear to do well. Manchester is the only institution to make it into the top five in all six of the income categories in the Grant Thornton-Times Higher Education financial tables.

It earned the most in fees from students from outside the UK and European Union in 2007 with an income of £56.8 million. This put it ahead of the London School of Economics, which earned £54.4 million, the University of Nottingham (£50.4 million), University College London (£49.1 million) and the University of Oxford (£41.9 million).

Manchester came third in terms of funding council grants, which includes all grants from the higher education funding councils for England and for Wales and the Scottish Funding Council, receiving £182.2 million in 2007. It was ahead of Oxford on £178.9 million, but lagged behind the University of Cambridge (£183.2 million) and The Open University (£212.1 million).

Oxford topped the table in terms of research income earned from all sources other than the Higher Education Funding Council for England, the Higher Education Funding Council for Wales and the SFC. It earned £248.2 million in 2007; Imperial College London was next, with £230 million, followed by Cambridge (£211.5 million), UCL (£201.7 million) and then Manchester (£173.6 million).

The Open University received the most in teaching income, mainly in tuition fees from home and EU students as well as other income relating to teaching contracts. It earned £105.6 million in 2007 compared with Imperial's £81.6 million, Manchester's £80.9 million, Leeds's £63.9 and Nottingham's £62 million.

Cambridge was by far and away the highest earning university in the "other income" category. This includes income from things such as endowments, subsidiary companies, catering operations and residences. In 2007, it earned £495.7 million compared with Oxford's £155.3 million, Manchester's £143.8 million, the University of Edinburgh's £120 million and UCL's £119 million.

The "big five" universities - Cambridge, Oxford, Manchester, UCL and Imperial - dominated the "total income" category, each earning well over half a billion pounds in 2007.

Cambridge fell just short of becoming the first UK university with a billion pounds in income. It earned a total of £958.2 million, followed by Oxford on £676.4 million, then Manchester's £637.3 million, UCL's £597.1 million and Imperial's £556.2 million.

But not all institutions display such a balance in income streams. In fact the financial data reveal considerable variation in income concentrations, which often denote institutional strengths, but can also suggest potential vulnerabilities.

For example, funding council grants made up 55 per cent of the total income of the University of Plymouth but accounted for only 25 per cent of total income at the University of Warwick and just 17 per cent of that at the LSE. It means that, broadly speaking, Plymouth was three times more reliant on state funding than the LSE.

Yet the LSE is the institution most reliant on international fees. Overseas income accounted for a third of its total income. This would appear to make the LSE more susceptible to a fall in the number of overseas students than, say, an institution such as Imperial, where overseas income amounted to just 0.7 per cent of its total budget.

But Imperial would be more susceptible than most to changes that affected the money available for research, excluding that from the funding council. Two fifths of Imperial's total income is research income from sources other than Hefce. Compare this to London South Bank University, where research income was 3 per cent of total income.

However, if there were a fall in home undergraduate numbers, an institution such as London South Bank might feel it more acutely than others, since 46 per cent of its total income came in the form of tuition fees and other teaching income. At UCL, fee income accounted for just 8 per cent of total income and at Oxford for just under 8 per cent.

Total income for all UK higher education institutions in 2007 was £20.8 billion, up by 16 per cent on 2005. Funding council grants accounted for 38 per cent of this figure across the entire sector.

Research income accounted for 16 per cent of total income. Tuition fees, including overseas, and other teaching income accounted for 24 per cent. Other sources accounted for 22 per cent of total income.

PAY: A POTENTIAL DRAIN, BUT ALSO A POTENTIAL ATTRACTION

Pay is the single biggest cost on any university's balance sheet, and analysis of the figures show that the pay bill is rising.

The average staff cost - total wages and salaries plus pension contributions and social security costs - per employee increased from £33,610 in 2005 to £39,840 in 2007, a rise of 18.5 per cent. Typically, in 2007, universities spent between 55 per cent and 60 per cent of their total income on staff costs.

More worryingly for the sector is the fact that the Grant Thornton figures cover 2005-07, the period immediately before the full implementation of the new pay framework.

The pay framework has tended to push salaries up across the board, so the pay bill is expected to rise this year and the following year as a result. Added to this is the uncertainty of the pay bid for 2008-09. The unions may push for a substantial increase on the basis that top-up fee income will have increased the total income of English universities considerably.

But a rising pay bill is not necessarily bad news - if income keeps pace or outstrips increases in salary. If future pay rises are affordable, then there will be no problem. Indeed, in an increasingly competitive higher education market, the institution that can afford to increase the pay of its staff gains advantage.

However, there are no guarantees that university income will continue to grow at the rate it has recently. Unless the current £3,000 cap on fees is lifted (something that can happen in 2010 at the earliest), income from fees will level off. Add to this a drop in the number of home students beyond 2012 and continuing volatility in the overseas student market, and the recent period of rising university incomes could become a distant memory.

The Grant Thornton analysis also reveals tremendous variation in the proportion of total income that goes on pay at individual institutions. The figure ranges from almost 70 per cent to below 50 per cent.

At the top end there are institutions such as Birkbeck, University of London (69 per cent), Thames Valley University (68 per cent), Glasgow Caledonian University (66 per cent), Nottingham Trent University (65 per cent), Keele University (65 per cent), Sheffield Hallam University (64 per cent), University of Northampton (64 per cent) and the University of Chester (64 per cent).

At the lower end there is the University of Cambridge (45 per cent - although Cambridge's system of central and college pay may help to explain this low proportion), the University of Greenwich (49 per cent), Liverpool Hope University (49 per cent), the University of Bedfordshire (49 per cent) and the University of East London (50 per cent).

There are many reasons for the considerable variation in these proportions, including the staff demographic at individual institutions. Some may have more older, senior and highly paid staff than others.

SURPLUSES: TOTAL INCOME IS UP, HELPED BY THE SALE OF PROPERTY

The good news is that the proportion of UK universities in deficit fell from a third to a quarter in the three years from 2005 to 2007.

There were 51 UK institutions (33 per cent) in deficit in 2005, but this number had shrunk to 38 (24 per cent) by 2007. Net surplus (the difference between income and expenditure) improved by 35 per cent between 2005 and 2007.

The improvement in the level of institutional surplus is due largely to the fact that total university income grew by 16 per cent in that period. This was attributable largely to better state funding - funding council grants grew by 13 per cent between 2005 and 2007 - and to a growth in private contributions to the sector. Tuition fee income rose by 22 per cent and overseas fee income grew by 19 per cent.

The improvement in surpluses could also be explained by the sale of assets such as buildings and by a trimming of costs, such as staffing, up to and just beyond 2005.

An institution with a surplus may still be spending more than it earns in a given financial year. Yet it may record a surplus if, for instance, it sold a city-centre building for £10 million in that financial year. The funding councils would begin to ask questions only if an institution had been running a deficit for a number of years.

Nonetheless, the drop in the number of institutions in deficit is welcome and denotes a robustness not seen in the higher education sector for many years.

Those in deficit covered the full range of institutional types from wealthy specialist institutions to the large teaching institutions.

The London Business School recorded a deficit of £1.8 million in 2007, but then it made £3.8 million from its operations (basically a measure of operational strength and listed in the column "Cash flow from operations").

The universities of Surrey and Liverpool recorded deficits of £2.6 million and £2.5 million respectively. But then the latter earned £11.3 million from its operations while the former made £3.9 million.

Although deficits were recorded by many different types of institutions, more post-1992 universities (18) had deficits in 2007 than pre-1992s (12). Post-1992s also tended to have larger deficits.

The University of Central Lancashire had the largest deficit in 2007, just over £10 million. But it also earned £12.7 million through its operations.

The next two highest deficits belonged to Nottingham Trent University (£9.2 million) and Leeds Metropolitan University (£9 million). However, Nottingham Trent made £4.8 million from its operations in 2007 and Leeds Met gained £3.2 million.

Other institutions recorded significant surpluses. The University of Birmingham's surplus in 2007 stood at £55.7 million. It owed the bank just over £1 million.

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