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Parents and Students Need to Do Their Homework

Itís wise to examine a collegeís financial condition before making a decision about which school to attend.

By Robert A. Blumenthal

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November 20, 2009

Editor’s note: Robert A. Blumenthal is chair and professor of mathematics at Georgia College & State University in Milledgeville, GA.

Americans are generally very careful when it comes to making large purchases.

When considering the purchase of a home, for example, we hire an inspector to check for structural weaknesses and to evaluate the condition of the basic systems. When contemplating the purchase of an automobile, we have a mechanic inspect the vehicle and evaluate its condition. We turn to Consumer Reports for information on the quality of all sorts of products.

Why then, when it comes to one of the largest investments we make, namely the choice of a college for our children, do we do practically no meaningful research? (Sorry, but looking at the U.S. News rankings doesn’t count.)

There are two kinds of research that need to be done. Of course, students and parents should examine the academic programs offered and try to assess both the overall academic quality of the institution and the quality of particular programs the student might wish to pursue. The latter part is especially hard, but I want to move along to the second point.

An equally important but usually overlooked area is the underlying financial condition of the institution. It is this aspect of the college search process which I want to address, and the focus will be on small private colleges.

Before investing in a company by buying its stock, we look at the underlying financial fundamentals to see if the organization is sound and likely to thrive. We should do the same thing before making an investment in a college. Parents and students must ask such questions as: Does the institution have sufficient financial resources to deliver the education it promises? Does it have sufficient operating funds to provide essential academic support services and meaningful student life activities? Is there a chance that the school won’t be around in 10 years?

This last question is particularly relevant for you if you are considering a small, private, liberal arts college. Many such institutions are now in serious financial difficulty; a number have closed their doors while others continue to function close to the edge.

The problem is that many of these colleges have very modest endowments and are almost totally dependent on tuition revenue to meet expenses. It’s difficult to fund the range of academic programs, academic support services, and co-curricular programs necessary for a healthy academic environment just from tuition dollars, and without the cushion provided by an endowment, if enrollment drops it’s impossible to avoid deep program cuts.

Parents, perhaps aided by their financial adviser, should study the financial statements of the college. By that, I do not mean the Form 990 which colleges are required to file with the IRS. That document contains incomplete financial information and is woefully out of date by the time it is made public on GuideStar.

Rather, they need to look at the three most recent sets of the school’s financial statements, including the balance sheet, income statement, statement of cash flows, and auditors’ notes. This is the information which serious investors study when considering the purchase of stock in a publicly traded company. Students and parents who are about to make a large investment in their education should do no less.

This sounds simple, but there’s a serious problem. You cannot go to a college’s web site to find these documents because most private colleges don’t publish them. Nor are these documents available anywhere else on the web. I have argued elsewhere that this information should be available to the public by virtue of the fact that these institutions receive millions of taxpayer dollars in the form of federal financial aid. Moreover, the tax-exempt status enjoyed by these institutions should carry with it the responsibility of financial transparency.

It is possible to obtain these documents. Every college that receives $500,000 or more a year in federal funds is required to submit a complete audit to the Federal Audit Clearinghouse which then transmits the audit to the Department of Education. Unfortunately, these audits are not posted. You can, however, obtain them by sending a written request to the Federal Audit Clearinghouse.

There is no reason why it should be so difficult to obtain this information.

Every college should provide its audits to a parent or student who inquires. One model school in this regard is Davidson College. It has set the standard to which other colleges should be held. Davidson posts on its web site its complete audits for the last five years.

I am tempted to recommend that one avoid any institution which does not post this information. However, that would rule out practically every private school in the country. So, what I suggest is that you simply contact the schools you are interested in and ask for the three most recent financial audits. Schools should be able to send these almost immediately thus giving you the opportunity to study them as part of your overall college search process. If an institution refuses to send these documents, I would have serious reservations about pursuing that school.

Once you have the audits there are a few red flags you should be alert to. On the balance sheet, take a look at the trend in total net assets to make sure this line is not steadily decreasing. The same goes for the unrestricted net assets. Also, look at the ratio of total debt to total assets to see what proportion of the assets is leveraged. Pay particular attention to line of credit debt. If this figure is consistently high in relation to total expenses (found on the income statement), it suggests an institution which is having difficulty meeting basic operating expenses such as payroll and utilities. A further indication along these lines is found on the cash flow statement. If net cash provided by operating activities is consistently and significantly negative, this is further evidence of insufficient available cash needed to fund basic operations. Finally, near the bottom of the income statement, look for any reported gains from the sale of assets such as artwork, land, etc. as this may well be indicative of a school which needs a quick infusion of cash in order to meet debt obligations and expenses.

I am not suggesting that you eliminate a school from consideration if you find that its financial health is questionable. Indeed, you may find that there are compelling reasons to attend a particular school in spite of its financial problems. But it is important to at least be aware of the strengths and weaknesses of the choices under consideration. To that end, it is imperative to do the research necessary to make an informed judgment about the financial condition of any school you are considering.

 


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