Taking the financial temperature of the further education and skills sector

The Government’s response to the latest consultation on an insolvency regime for the sector was published in June. In considering whether it is likely to be used we have looked at the financial health of the sector as shown in the latest available accounts, which continues to raise concerns about the sector. Some may argue that area-based reviews and mergers have led to improvements, but on the flip side, apprenticeship reforms, uncertainty over income with devolution and Brexit, and increasing employment costs could give rise to further decline.

When ‘Reviewing Post-16 education and training institutions – updated guidance on area reviews’ was published in March 2016, it included a set of indicators/benchmarks to use in assessing options as part of the area review process. These benchmarks included financial indicators and a target range for colleges in strong financial health and, while there was a mixed reception to them, with some regarding them as unachievable, they are widely used by the sector, including general further education colleges and sixth form colleges.

RSM’s analysis of college accounts for 2016-17 (based on data published by the ESFA) indicates a sector that is struggling to meet some of the key targets. 

One of the key, and most controversial, measures, is that of surplus/(deficit) as a percentage of income, with the sector benchmark set at three to five per cent for ‘strong’ financial health. Many highlighted when this was announced that the sector has always struggled to deliver this level of return and that the continued real term decreases in core funding would only serve to make it harder to achieve. For 2016-17 this ratio shows just a very minor improvement on 2015-16, increasing from 0.1 to 0.3 per cent. Whilst there were slight variations across type of further education institution, the general picture for all was similar, with only specialist agricultural and horticultural colleges coming close to three per cent on average. Worryingly, over a third of colleges returned an adjusted deficit (calculated as set out in the guidance on area reviews) for the 2016-17 financial year as did two regions, Greater London and the West Midlands. The ESFA has moved to using an EBITDA measure in categorising financial health and this has also shown little movement year on year, with a slight decrease in 2016-17 and over 10 per cent of colleges having a negative earnings before interest, taxes, depreciation and amortization ‘EBITDA’. EBITDA is widely used in the corporate world and is generally considered to allow greater comparability of entities. For example, two colleges could be identical other than having differing depreciation policies - the old measure of surplus/(deficit) as a percentage of income would show a different position for each of these colleges, EBITDA would show a consistent picture.

The liquidity of colleges (measured using the adjusted current ratio) remained above the 1 per cent benchmark at 1.18 per cent, a small improvement from 1.11 per cent in 2015-16. Again, this masks that nearly a third of all colleges were below the benchmark, with one region, the West Midlands, being significantly under the target at an average of 0.69. The picture was healthiest for sixth form colleges, as has historically been the case, with an average of 2.20, although notably this was a decline on 2015-16.

 

With the impending insolvency regime and removal of exceptional financial support, it is even more important that colleges are able to meet their debts as they fall due. The emphasis is increasingly on the learners’ experience and value for money; not protecting individual colleges.

Stephanie Mason, Head of Further and Education and Skills at RSM

In respect of staff costs as a percentage of income (income being adjusted for subcontracted provision), the target range is to be less than 65 per cent, recognising that it will be higher for sixth form colleges. The sector failed to achieve this, the overall per cent remaining at 67 per cent with a similar outturn in each region.  The position for all types of colleges remained very consistent year on year too. General further education colleges had the lowest average at 57 per cent, however, there was an enormous range from approximately 40 to over 90 per cent. Those colleges at the higher end were generally those with a large proportion of subcontracted or partnership provision.

Stephanie Mason noted: 'High levels of subcontracted provision are unlikely to be sustainable as the funding regimes changes and tightens – loan funded provision can no longer be subcontracted, for 16-18 provision distance subcontracting is being much more closely scrutinised and for apprenticeships the lead provider now has to deliver some of the provision. We are also seeing more investigations into activity of subcontractors.' With increasing pressure on pay from several angles, including public sector settlements and recent strikes, further education colleges are likely to be hard pushed at this stage to reduce staff costs as a percentage of income whilst also maintaining quality.

Borrowing levels in the sector remain positive against the benchmark, with the average borrowing as a percentage of income showing a slight fall from 26 to 24 per cent, well below the 40 per cent target. Although this is encouraging on the face of it, the developments in the sector continue to impact on the appetite of lenders and hence colleges may find it harder to raise finance in future. It could, therefore, be argued that further decreases could be a concern for the sector.

Whilst the sector has been through significant change over the last few years and many of the potential benefits of consolidation may not yet be showing through, the 2016-17 data supports a sector which is continuing to struggle to improve its financial position. The further education sector has proved itself to be resilient for over 25 years but in the context of factors such as real term reductions in core funding, continuing demographic downturn, a developing apprenticeship regime and significant pay pressures, the next few years may be more challenging and critical than ever.

If you'd like to discuss any of the above further, please get in touch with Stephanie Mason or Dominic Blythe.

*Definitions are as set out in Reviewing Post-16 education and training institutions – updated guidance on area reviews