Who pays?

The ifs published a briefing note on the impact of the changes to student finance announced in the budget. There was plenty of media coverage, but as always, there’s more in the report than has yet been covered.

Firstly, the background. In his budget the Chancellor announced two specific decision, and three proposals for consultation relating to higher education:

Decisions

• Increasing the maximum loan to £8,200
• Replacement of maintenance grants with loans 

For consultation:

• Freeze the £21,000 repayment threshold (ie let inflation reduce the real value)
• Allowing institutions with high teaching quality to increase the £9,000 fee in line with inflation
• Review the discount rate applied to student loans and other transactions to bring it into line with the government’s long-term cost of borrowing.

The coverage of the ifs report rightly – because they are the certainties – focuses on the two decisions. But the ifs report also analyses the effect of the three proposals for consultation, and its two things about these that I want to highlight.

Firstly, the effect on government borrowing. The RAB charge is the measure of how much student debt the government expects to have to write off. At the moment the RAB charge stands at 39.2% - the government expects almost £2 in every £5 it lends to students to be written off as un-repayable. If all five measures are introduced, the ifs expects the RAB charge to reduce to 21.9% - effectively halving the amount of debt write off. This is all to do with changing the discount rate. In the ifs’s own words:

The proposal to reduce the discount rate is essentially an accounting ‘trick’: it will not change the real resources going to students or universities; nor will it increase repayments from graduates. Instead, it means that future repayments will be valued more highly today. This has the effect of increasing the value (but not the cash amount) of repayments made in future, hence making it appear that the cost of the system (in net-present-value terms) is lower than it was before.

And secondly, a change in the balance of who pays for higher education. To quote from the budget document:

The government must therefore ask graduates to meet more of the cost of their degrees once they are earning.

Using the ifs data it is possible to work out the graduate’s share of the costs of their education, as in the following table.

So, at the moment the costs are shared roughly equally between the taxpayer and the graduate. If all of the budget reforms are implemented, the graduate share increases to 75% of the total cost. What looks like a technical accounting decision has real consequences for individuals.

Higher Education KPIs #2 – EBITDA

I posted a couple of weeks ago about staff costs as a proportion of income. Another performance indicator which has become common in Universities over the past few years is EBITDA.

No, not an obscure Scrabble word (although BAITED for 9 points is do-able with the same letters), but an acronym for a financial indicator, which helps you understand the underlying financial strength of a university.

Earnings
Before
Interest,
Tax,
Depreciation and
Amortization

There’s some jargon in there. Let’s unpack it a little.

Earnings is just what it sounds like. Total income minus total expenditure.

But, accounting isn’t as easy as looking at what’s in your wallet at the end of the day. It’s about keep track on real cost and values of assets and income, and recognising that there’s a difference between what you use once and once only and what keeps being usable. (So, I’ve just had a cup of coffee. The coffee granules are gone and used; the mug I can wash and use again.) And that‘s where some of the other terms come into play.

Interest means interest that is payable on debts owed. It’s a cost, for sure, but it’s a cost that can vary because of decisions taken by the borrower (how long do you borrow for? Fixed or variable interest rate? Secured or unsecured? Wonga or the Co-op?). So interest payments don’t necessarily tell you much about financial strength – but they might tell you a lot about the financial acumen of the management team.

Tax, sad to say, is similar. Not for universities – there isn’t often a university tax scandal (but see here for an exception!) – but remember that EBITDA is from the commercial world. And then think of Starbucks and Amazon and realise that tax, if you’re rich and powerful enough, is optional. So tax costs measure the skill of your accountant.

Depreciation and Amortization are both accounting concepts.

Depreciation is a way of measuring the value that’s left in an asset which is reusable. Imagine a whiteboard in a classroom. The lecturer can write on the whiteboard, get value out of it for teaching, and then wipe it clean at the end. It’s got value, but it hasn’t been used up by the class. But over time, it becomes less clean: people use the wrong marker pens; the shiny surface dulls with being cleaned too often. After a few years you need a new one.

This gives a problem if you want to measure how much the whiteboard costs for a particular class. If you put all of the cost against the first class in which it is used, that class seems expensive, and the continuing value of the whiteboard isn’t recognised. If you only charge the cost to the class where it finally needs a replacing, then again it isn’t right: the wear and tear occurred over years, not in one hour. And so you take the cost of the whiteboard and allocate it, a bit at a time, to the activities for which it is used.

Now in accounting this is done over time, so if the whiteboard cost £50 and is estimated to have a lifetime of five years, then you charge £10 per year, for five years, as the accounting cost. (You still need to pay up front, of course – as I said, accounting isn’t about what’s in your wallet but about true costs and values.) Critically, there is judgment involved in how depreciation works. And every university will have accounting policies which set out the rules of thumb applied.

Amortization is a similar concept, but refers to the cost of intangible assets. (A white board is tangible – you can see it, and if it drops off the wall onto your foot it will probably hurt. A university’s reputation is intangible: it can fall without hurting anyone straightaway: the pain take a while to appear.) Universities do have intangible assets – intellectual property, for instance. Again, there’s judgment involved in identifying how much specifically to allow for amortization.

(As a cheery footnote, the mort in amortization is the same as the mort in mortgage, and both come from the medieval French mort=death.)

So EBITDA is a measure of earnings which is free of financial and accounting wizardry. It’s a very Gradgrindian measure, for fans of Dickens. Or for fans of twentieth century politics, it’s like Sir Alec Douglas Home and his matchsticks.

For universities it has become a favourite of funders and regulators. HEFCE use it to decide whether a university needs to get permission to borrow (take a look at Annex C): if a university’s total financial commitments are more than five times its average EBITDA then written permission from HEFCE is required for the borrowing. And so it has a practical consequence, which helps to explain why university governing bodies are interested in it. EBITDA is defined for HEFCE’s purposes by BUFDG (link downloads a word document). Quite a technical subject!

EBITDA can be a cash amount (useful if you want to see if you’re over the HEFCE ratio) or it can be expressed as a percentage of income. An EBITDA of £1m might be brilliant if your turnover is £5m, but if your turnover is £100m then perhaps you’re running a little close to the wire.

Disclaimer: I'm not an accountant. If you want to understand EBITDA then the above might help. If you want to pass a CIPFA exam read a CIPFA textbook!

The money lenders

It does rather seem that David Willetts won’t stop being universities minister. The BBC reports today on the idea, promoted by said former-minister on Newsnight yesterday, that universities take on some of the student loans debt. This will reduce the RAB charge for Treasury (and therefore make student loans more affordable for the public purse) and also make it easier for universities to argue that they could charge higher fees if the Treasury is insulated against the risk.

I was struck by two particular quotes from the BBC write-up.

Here’s the first:

The costs of the debt - currently assumed by officials to be between 30p and 40p in every £1 that it lends - are paid by the Treasury.

The italics are mine.  Did you see the word “assumption”? This is an accounting question, and it’s all about what, today, we think that graduates will be doing in 20-30 years’ time.  Do we really have confidence in these assumptions? On that time horizon we’re almost into personal jet packs, holidays on the moon and ten hour working weeks (I wish!)

And here’s the second:

Cambridge graduates have a 4.3% unemployment rate in the first year out of study; for Staffordshire leavers, it runs at 13.9%.

My italics again. We know about the first year’s outcomes. But we need to know about 20-30 years’ time. Think how much the structure of the economy can change in 20 years. I don’t know for sure what skills are needed then. (Though I would agree that a Cambridge degree probably gives you a head start for reasons other than the quality of education …)

I don’t deny that the Treasury has a real problem to contend with – you can’t ignore or wish away accounting conventions. But to make up long-term policy on the basis of short term economic data seems slightly dangerous to me – like a farmer in Somerset changing from wheat fields to rice paddies on the basis of a rainy week in April.

For a more uplifting take on accounting here’s Monty Python’s money programme (opens in YouTube) …