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Good enough for a $40 trillion banking system – Good enough for your school?

By Michael Willis

‘If five years is an unwisely long time for a person to skip a proper checkup, it is an eternity for a $40 trillion banking sector displaying many signs of ill health.’

With this blunt summary, a New York Times article reported on the thirteen major banks that failed the European Central Bank’s testing of their capacity to survive a crisis. At a time when school boards around Australia are approving budgets, buildings and business plans, this story comes as a timely reminder of the importance of a rigorous budgeting process for school boards and principals.

The bank regulator obtained financial data from all the major European banks and put them through hypothetical tests based on realistic but major crises – similar to what the banks experienced in the financial crisis of 2008. Thirteen banks, including the world’s oldest, Monte dei Paschi di Siena, failed the stress test. Imagine being on their boards now, and having to find your share of an extra $2.7 billion in capital.

So it is a good time to consider whether your school board asks for similar stress testing of the school’s business plan for 2015. A strong school budget is not just a plan to survive the year, or to prove that our estimates mean we can pay our bills.

A strong budget should include some testing results, that show what might happen if the estimates are not met. For example:

  • What if a natural disaster hit the school’s community, and ten percent of families had to withdraw enrolments? The Brisbane floods of January 2011 showed such an event is entirely possible.
  • Or if a banking crisis like 2008 recurred, sending interest rates up dramatically, and bank margins blow out again? This event was a major factor in the troubles of the Centro group, which became a celebrated case of director liability.
  • Or if the school’s major building project is not filled with the planned new enrolments, because a lower fee competitor expanded at the same time? And you are left with big vacancies and a high debt level?
  • Or a scandal hits the school – imagine a much loved principal being dismissed with a large cash settlement, and the reputational damage causing enrolments to drop?

A sound business plan and budget will provide the board with some scenario analysis, enabling them to assess the school’s capacity to withstand unexpected shocks. An ideal plan would provide a five-year financial model, with a summary of the impacts on the plan of some key measures going awry. Examples of major stress testing in schools would be a 10% enrolment drop, a 5% interest rate hike, or a major uninsured payment.

As well as testing the financial health of the school, it tests the school management’s capacity to plan and adapt to emerging circumstances. Competition from low-fee independent and Catholic schools, and the ‘independent public’ schools is increasing. This means that your school management must become more flexible, ready to recast the school’s operations to suit the changing economic and educational climate.

Schools cannot tread the old path of ‘fees up 7% again’ in this more competitive market. Parents are becoming both more frugal and savvy in their school selection, while the end of the ‘age of entitlement’ means governments of all types will look for savings in every corner of school funding.

A more agile approach to school planning and budgets is required, ensuring schools’ management are looking to operate efficiently, meet financial targets (such as an EBIDA margin) that provide some buffer against unexpected shocks, and build sufficient capacity to reinvest in essential capital resources.

Sound budgeting, with stretch targets and stress testing, is an essential part of enabling your school board to make good decisions that ensure the long-term sustainability of our school. It sure beats having to be on a school board that announces to its community that we have to close or sell off the farm to keep us afloat!