Original language: English

Bikas C. Sanyal (India)

Senior Adviser at the International Institute for Educational Planning (UNESCO), Paris. At present responsible for the IIEP research programme on 'Improving the effectiveness of higher educational institutions: studies of the management of change'. He has previously directed the IIEP research programmes on Higher education and employment and technological development and educational planning. He is the author/co-author of a large number of books, monographs and papers on educational policy and planning.

Michaela Martin (Germany)

Programme specialist at the IIEP, working on the research programme on 'Institutional management in higher education'. Prior to working at the IIEP, she was working as research assistant at the European Centre for Strategic Management, University of Brussels, from 1988 to 1990.

Financial management in universities has undergone important structural and functional changes over the past ten years or so. The way governments finance their institutions has been widely modified in many countries: accountability and transparency are becoming universal requirements, and institutions are increasingly invited to attract supplementary external funding. This has had important implications on how institutions allocate and utilize their resources internally. Also, there is increasing pressure from governments to use funds more efficiently, due to financial constraints. As the overall functions of higher education institutions have become more complex, the functions of financial management have become more diverse. If, in the past, it had been widely concerned with the protection of finances and the execution of budget lines, today financial management also needs to be concerned with tasks such as setting up incentives for basic units to attract their own funding or placing funds in the capital market.

In many countries, both developed and developing, changes in financial management have been extremely rapid, whereas in some others its functions and structures have remained very traditional. In broad terms, radical change has often been the result of disruptive economic and political events that have obliged institutions to develop survival strategies. In other contexts, change has happened in a more co-ordinated fashion as part of major reform programmes initiated by governments and external agencies, especially international and bilateral donor agencies.

This article attempts to give a broad picture of strategies adopted by both governments and universities in the management of their finances. Since there is a broad trend of granting an increasing amount of financial autonomy to institutions, the focus will be on financial management at the university level.

The context of financial management in universities

The financial management of universities operates within constraints determined by three main factors: their mission statement, the distribution of authority over financial management, and the mechanisms through which institutions receive their finances.

FINANCIAL MANAGEMENT AND THE MISSION STATEMENT

For a large and complex system of higher education, a mission statement has the particular function of informing potential clients (students and the sponsors of consultancy and research services) and funding agencies of the government, of the special role and place of an institution within the national system of higher education. Thus, institutions—particularly those located in market-driven systems—have become increasingly obliged to determine their particular niche in the market and to clearly state which particular clients they intend to serve.

There should be a reciprocal relationship between mission and funding. A university's mission may influence the public funds it receives; however, the funds it obtains, and the way they are allocated, should also help determine its mission.

Naturally, the financial management of a university ought to operate within its mission. For example, a university with a mission that emphasizes community service will not allocate resources in the same way as a major research institution.

DISTRIBUTION OF AUTHORITY OVER FINANCIAL MANAGEMENT WITHIN THE INSTITUTION

According to Gareth Williams (Williams, 1993), even the simplest organizational structure of a university allows for several models with regard to the distribution of authority over financial management within institutions. The following list presents the most centralized to the most decentralized model:

• pure bureaucratic model: all resources are received by the centre and are allocated, managed and administered from the centre;

• decentralized bureaucratic model: strategic decisions are taken at the centre but routine decisions and their implementation are made by departments;

• political decision model: strategic decisions are taken at the centre based on consensus within the framework of collective bargaining;

• collegial model: the central administration takes a portion of the income and the remainder is allocated to departments to use in accordance with academic priorities;

• corporate entrepreneurial model: income is earned by departments but administered from the centre;

• managed entrepreneurial model: income is earned by departments, it is taxed to cover central administrative costs and the remainder is spent by departments according to the requirements of the external purchasing agency; and

• liberal entrepreneurial model: income is earned by departments and retained by them to buy central services as needed.

In reality, resource allocation procedures can be a mixture of more than one model. For example, externally funded activities often require somewhat different financial management procedures from centrally funded core activities.

Some universities are very near to the top end of this spectrum and others are at the bottom. Most developing countries still have very bureaucratic systems of financial management imposed by governments, but everywhere there is some shift towards devolution of financial management responsibilities.

MECHANISMS THROUGH WHICH INSTITUTIONS RECEIVE THEIR FUNDS

During the past ten years, many universities have experienced a shift from input-based to output-based public funding.

In input-based funding systems, public funds are provided to meet the costs of the input into the institution, for example staff salaries, equipment, consumable items and buildings. University managers are required to spend funds on the inputs for which they are provided, but within these constraints it is the institution that decides what outputs to produce.

Output-based funding pays the university for the services it provides. In effect, the government buys services from the organization. It is for the university to decide how to allocate resources between the various inputs to produce the contracted outputs.

The implications for financial managers of a shift from input specification to output specification are very large indeed. It represents a shift in the power relationship between the university and the external funding body, and also within the university between the managerial and the academic staff.

Broadly, the following methods in which government can fund universities are based on a combination of who provides the finances, the criteria used (input-or output-based) and the freedom to use the funds (Williams, 1993).

• The university submits an annual budget based on its cost estimate of its commitments to staff salaries and other essential inputs. It may bargain with the government over the percentage of this budget that is to be met. Grants are earmarked, which means that the university must spend its funds on the items specified by the government.

• The institution receives a single lump sum based on the grant received in the previous year plus or minus an increment, and is free to spend this money as it wishes within very broad legal limits.

• Funds are based on a formula reflecting past performance, but the university is able to spend its funds as it wishes once they are received. The basis of most formulae is student numbers (weighed by subject, level of study, etc.). But, increasingly, governments are trying to give 'weight' to the academic performance of students, the quality of training and the research undertaken.

• The government buys academic services from the institution. This is similar to the previous method, but funds are based on prospective future, rather than past, performance.

• The university sells its teaching, research and consultancy services to a wide variety of different customers, students, employers and public authorities. In practice, a combination of two or more of these models are used. For example, formulae may determine much of the funding while a proportion is determined by the sale of incremental student places to the government. However, it is usually possible to identify a dominant model corresponding to one of these ideal types.

In many countries the current trend in the allocation of funds is one of granting increasing financial autonomy to institutions through the allocation of block grants. Such block grants are, however, often calculated on the basis of output measures such as number of graduates. This movement goes along with the more general trend of making institutions accountable for their use of funding and creating incentives for desired results.

Functions and practices of financial management

The main functions of financial management include: the acquisition or mobilization of resources, the management of cash reserves, the allocation and utilization of resources, evaluation and auditing.

ACQUISITION OR MOBILIZATION OF RESOURCES

The majority of resources are received from governmental authorities, or raised by tuition fees plus additions from a variety of other sources (such as the community, parents, charity, etc.). While public subsidies are likely to remain the major source of funding for higher education in most countries, they are becoming increasingly insufficient to ensure the financial viability of rapidly expanding higher education systems. Even when government funding is forthcoming, it is felt to be disadvantageous for a university to rely on a single financial source.

With less State support and limited opportunities to impose or increase fees, many universities have become involved in a wide spectrum of income-generating activities. In this context, it is important that university councils include representatives from business and industry in order to form partnerships and develop marketing methods (Sanyal, 1995; Williams, 1992).

Possible sources of funding include: private students; tuition, examination and residence fees; contracts for research, courses and consulting (usually a percentage of revenue goes to the department concerned); intellectual property rights (patents and books); commercial activities (printing, software); investments in productive areas; foreign aid; and endowments (this is a tradition in the United States and in prestigious universities in the United Kingdom and Japan).

Various routes have been followed to diversify funding sources. Traditionally, income is generated by undertaking research and service contracts on behalf of public and private companies. The returns on services, such as consultancies and developmental work, are expected to cover all costs and to provide the institution with a net income.

In many countries, public institutions are free to make use of these earnings, but in many others, it has been necessary to amend the regulations governing the finances of institutions, or to make other special provisions to enable them to retain their outside earnings. However, it is obvious that countries that are predominantly agrarian or that have a small, modern industrial sector, have limited scope for service contracts.

Another traditional way of raising financial support from industrial and commercial firms is in the form of grants or scholarships for specific academic or professional programmes. As far as developing countries are concerned, direct donations have been strongest in Asia, where the establishment of foundations offering financial support for students has been common. Private foundations, for instance, have developed in Indonesia, Thailand and the Republic of Korea. However, even in the most favourable scenario, these additional resources are not likely to represent a high proportion of an institution's budget.

Any income-generating activity should be demand-oriented, locally specific and applicable to the modalities of a university. In addition, it should be tested by means of an experimental phase.

Encouraging departments to generate income is one of the newer functions of financial management. There are two ways in which individuals can be rewarded for undertaking activities that produce extra income:

• treat such activities as part of the normal work programme of the university and enable consultancy work to count as a criterion for promotion or senior posts; or

• more commonly, allow individuals to retain a part of the income that is generated, either for themselves, or for the department or centre in which the individual has a specific interest. Most often, income is shared among the institution to cover overhead expenses, the department and the individual or the team that did the work.

MANAGEMENT OF CASH RESERVES

The extent of this function depends largely on the overall legal framework within which the institution operates.

In countries where institutions have no financial autonomy and no cash reserves, this function is obviously non-existent. However, as more countries move in the direction of decentralization and devolved budgets, this function will become a very crucial one.

In countries with a well-developed banking system, properly managed cash reserves can generate significant income for the institution through interest and other benefits.

THE ALLOCATION OF RESOURCES

The allocation of resources reflects the priorities of the university. In the short run, these decisions are determined by the resources the institution has already acquired, but over time more options for changing allocations may become available. The current resource constraints and decisions are reflected in the budget plans drawn up for the coming financial year.

A basic budget plan shows the amount of funds to be raised and the proportion that is expected to be spent on each of the individual budget items. Some institutions are now keeping a proportion of 5-10% at the centre for strategic uses, such as incentives, innovations and information system development. Also, some institutions are separating teaching and research funds.

Other measures that have been adopted include:

• devolving financial responsibility and accountability closer to the operating units, as far as expertise and the information system permit—but not at the expense or abdication of all central control; and

• adopting formula funding, often based on enrolments, output of graduates and other performance indicators. Where governments use formulae for funding purposes, institutions often follow the same procedure for internal allocation and it may be necessary, when instituting formulae funding, to put aside some resources to assist certain faculties in the transition phase.

THE UTILIZATION OF RESOURCES

Resource utilization is the phase where the budget plan is put into operation. Broadly interpreted, this task encompasses all of the management activities of staffing, running the premises, ordering supplies and so on, which incur expenditures. Other activities that bring in additional income, such as running a bookshop, hiring school premises or selling courses for a fee, may also be included.

The utilization of resources is also concerned with the protection of finances from fraud. Of all of its functions, this is the basic control function: it is the most traditional and by far the most widespread role of university financial managers. All of the other activities are, at least to some extent, dependent on this task being satisfactorily performed. As management information systems and auditing procedures improve, financial irregularities will be detected more easily and the regulations can be made less onerous.

Another crucial task for financial managers is monitoring the budget regularly throughout the year in order to compare actual income and expenditures under various budget items with planned expenditures. If there are differences between the real income and expenditure, as is likely, it is the job of management to correct them. This may involve adjusting certain expenditure plans or exerting better financial control over internal budget holders, such as the heads of departments, in order to either curtail or stimulate spending. An efficient management information system is important in keeping university leaders and administrators up-to-date on the academic and financial performance of the various segments of the institution.

Some special training in budgetary competence for all administrators and heads of units can prove extremely useful. Most higher education personnel have very little background in financial management, as may be indicated by:

• patterns of tardiness in meeting deadlines;
• mistakes in completing forms or in computation;
• failure to prioritize the uses of discretionary monies; and
• failure to communicate appropriate budgetary information to those concerned.

A series of short workshops or courses held internally can significantly increase cost consciousness and financial competence.

EVALUATION AND AUDITING

Evaluation and auditing are currently the least-developed aspects of financial management. With increased autonomy, higher education institutions have to be accountable for their academic and financial performances. While considerable educational evaluation is undertaken, very little of it relates the value of resources used to the resulting educational outcomes.

Despite the fact that educational outcomes are not easily measured, decisions have to be made, so there is certainly merit in quantifying where possible. There is no one absolute and correct way of costing. But when there are several ways to achieve an objective, if the same costing principles are adopted, relative costs can be measured. Cost analysis should aim at summarizing the net resource implications of an educational activity over a period of time, particularly if a change is involved. Cost per student per annum is a common measure, as is cost per student hour.

At present, educational evaluation is usually undertaken by government advisers and inspectors. Quite separately, auditing is normally restricted to checking the justness of transactions undertaken by educational administrators. Ideally, the auditors should assess the efficiency and effectiveness of resource utilization by relating service outcomes to policy objectives (effectiveness) and resource utilization (efficiency). Since the major operating cost in education is teaching staff, cost-effectiveness is usually related to staff hours used and number of students benefiting.

In addition to the above, it is becoming more common for an institution to conduct its own self-evaluation, comparing performance both within the institution and with set strategic targets. It is advantageous to involve staff in setting targets and measuring actual performance.

Accountability exercises may be carried out by staff assessing work in other parts of the institution, so as to engender a sense of corporate responsibility. The objectives of each course have to be clearly defined, the percentage of students expected to succeed set, as well as optimum teaching hour investment in each course, and the education processes to be used (for example, audio-visual and practical aids increase cost-effectiveness). Once this task is completed, the information provides a stable database that may be reviewed each year.

The generation of useful performance indicators is becoming more important. Modern management systems depend upon comprehensive information, and a large proportion of the information needed concerns the direct or indirect use of financial resources. Any new financial management system must take on the routine production of financial effectiveness and efficiency indicators.

In the framework of accountability procedures, it is becoming common practice for institutions to publish an annual report that includes comparative data to show present and past results and budgets. Such reports are circulated not only to government departments but also to local authorities, industry and students.

Performance indicators can serve a useful role in the evaluation of the financial management of an institution, although it is clear that they do not tell the whole story.

Strategies for financial management

As mentioned in the introduction, national administrative systems have an important impact on the financial management strategies deployed by institutions.

On the one hand, even in systems with a high degree of administrative autonomy in its institutions, governments are concerned with particular institutional outcomes and performance. On the other hand, many governments in centrally planned systems have started to devolve administrative autonomy to the universities. In both cases, universities are expected to be accountable and to set up evaluation mechanisms that demonstrate that funds are used effectively and efficiently. One may therefore conclude that the trend in both self-regulated and formerly centrally planned and controlled systems is towards governmental steering at a distance (Sanyal & Martin, 1996; 1998).

NATIONAL STRATEGIES

Within this context, governments have applied different strategies to create a framework to facilitate creative financial management at the institutional level.

Mechanisms for resource allocation

With regard to resource allocation mechanisms, the following strategies have been attempted:

• line item budgets are replaced by lump sum budgets with a view to making those who are close to the primary activities of higher education responsible for decisions;

• resources are allocated on the basis of funding formulae that include built-in output parameters (e.g., number of graduates) in order to give clear signs of expected outputs and outcomes, and to create an incentive for performance;

• a suggested set of performance indicators is developed by the government to indicate the criteria used to evaluate institutions, and to establish a monitoring instrument for the higher education system; and

• incentive budgeting and special-purpose funds are made available whereby government money is re-allocated to achieve certain impacts or to stimulate innovative projects in priority areas.

All of these governmental strategies try to combine the need for national co-ordination and the setting of guidelines with the aim of stimulating innovative behaviour within universities.

Allow for flexibility in the utilization of resources

Nowadays universities tend to find themselves in relatively unstable environments. They have to be able to react quickly to upcoming opportunities and threats. As a consequence, the rules pertaining to the utilization of public resources need to be flexible and to allow for creativity. Especially in systems using line items for input steering, governments have to create a legislative framework that will allow for flexibility in the disbursement of funds and budgeting, in carrying over funds at the end of the year, and in moving money from one budget line to another.

Create a framework conducive to diversification of resources

The legislative framework also needs to be conducive to the generation of supplementary income and the diversification of resources. More and more governments allow institutions, their departments or individuals to retain a part of the financial revenue that they have generated. Some institutions even supplement the income from their universities with the revenues from their services to new clientele. The autonomy to use the money thus gained on institutional projects, or to invest it in the market, constitutes an incentive for resource diversification.

Make new resources available through student loans

The introduction of student loans as a means of cost recovery for higher education is a measure that is increasingly being implemented to generate new resources at the systems level. Student loans are expected to make students more responsible for their programme of study. They are also expected to contribute to equity considerations since students of higher education benefit from a relatively high private rate of return on public investment in education. However, a student loan system requires an administrative framework to ensure that the loans are repaid with a reasonable default rate.

Develop a private higher education sector

Countries are encouraging the establishment or the development of universities in the private sector in order to reduce the financial burden on the State. This is expected to alleviate the pressure from secondary school leavers demanding places in public universities. This allows for expansion of higher education without lowering the quality of the education provided in the public sector.

Allow for financial planning at the institutional level

In the previous sections, it has been made clear that universities need to plan with a medium-term perspective. Strategic planning has been discussed as one of the approaches to systemize institutional development. In order to co-ordinate institutional and national planning, it is important to have a framework for joint negotiation and multi-year contracts that formalize the results of this negotiation.

Universities need to have funds released on a regular basis in order to allow financial managers to work properly.

INSTITUTIONAL STRATEGIES

Integrate financial management and institutional policies

Our research points out the importance of conceiving financial plans and budgets as a management tool for the co-ordination, control and evaluation of a university in the present context of financial crisis. It is also important that financial management aims and procedures be subordinate to overall institutional policies. Financial management should be a means for the implementation of strategic goals and objectives. Therefore, there needs to be close integration and joint planning of academic and administrative affairs. Programme-linked budgeting can be an instrument for the translation of institutional policy into a budget. Zero-based budgeting, which allows for the consideration of alternative patterns of expenditure, may create the flexibility for cutback and growth during the budgetary year.

Facilitate the generation of income and cost recovery at the basic unit level

If there has been a major shift in the functions of financial management, it is with respect to the new and increasingly important tasks of income generation and cost recovery. These tasks can be achieved through a variety of means:

• the commercialization and marketing of university programmes and activities;

• creating university-owned enterprises, commercializing patents and innovations;

• renting out of university facilities and space;

• increasing student fees for tuition and examinations, or fees for board and accommodation;

• attracting employer sponsorship of students or trainees;

• attracting overseas students at differential fees or on a full-cost basis;

• managing the cash reserve in such a way that it generates as much interest as possible;

• investing in the stock market;

• attracting endowments for institutions, staff or residence halls by industry, commerce or philanthropists;

• bringing in gifts and endowments from alumni; and

• attracting research grants from national or international resources.

If a university intends to promote the generation of income and cost recovery, it is necessary to encourage the basic units and staff to do so, and to be willing to return an appropriate amount to the university. Consultancy work should be encouraged, and individuals or basic units should be allowed to retain a part of the income generated. Such work should be looked upon favourably in applications for promotion or senior posts.

A strategy geared towards income generation might also imply the need to create or strengthen those structures in the university concerned with marketing university services, such as the department of communication or extension services.

Reduce costs and increase efficiency

Given the financial crisis within many public sector budgets, universities are expected to increase the efficiency of resource utilization. They are expected to achieve the same level of effectiveness with fewer resources. This necessarily implies a reduction in their costs—but this should not be done at the expense of the quality of services provided.

The major expenditure in higher education is staff costs. These costs are relatively inflexible, since salary scales are normally decided by a public authority outside the university, or in negotiation with a trade union at the institutional level. For this reason, institutions usually try to cut back on non-academic costs such as capital investment, administrative costs, building and maintenance. However, it should be noted that some of these budgets, at least in the longer term, are essential for the quality of the academic services provided. Some strategies worth considering include:

• evaluating the cost of services provided by the university and considering if subcontracting (e.g., for cleaning and maintenance) is more cost-effective;

• setting up mechanisms for cost analysis and trying to link costs and benefits, separating costs related to teaching and research; and

• developing costing norms and other standards, also with a view to fully establishing the cost of service activities offered by the institution to outside clientele.

Develop appropriate administrative structures

The above-mentioned strategies relating to the new functions of financial management imply that the supporting structures and mechanisms of financial management change. The following strategies adopted by universities have been identified:

• devolving financial responsibility and accountability to those units who are in charge of major decisions at the academic level;

• developing the concept of an internal resource allocation authority, e.g., a resource planning committee to mobilize, allocate and monitor the utilization of resources;

• regrouping basic units to act as cost centres and restructuring the university's activities and financial accounting records around cost/profit centres;

• making cost centres sensitive to cost implications by charging all programme costs to them (e.g., cost of renting and maintaining space and equipment);

• upgrading the role of the financial manager within the university hierarchy;

• strengthening the internal audit department; and

• centralizing the purchasing function in one department in order to exert better control on all purchases.

A sensitive question for most institutions relates to the desired degree of financial autonomy to be given to the basic units. It is advisable for the central administrative level to retain a part of the budget for innovative and exploratory initiatives, in order to keep a margin for the implementation of initiatives in the common interest. Thus, seed money may be made available for projects deemed important to the institution as a whole.

Develop an appropriate management information system

Many of the strategies already mentioned imply the availability of timely and accurate data, be they related to a new type of relationship between the institution and its national authority or related to the need for institutional monitoring of policies. With the complexity of administrative procedures, a management information system (MIS) becomes a necessary tool to produce such timely information on a regular basis. However, a MIS must be adapted to the degree of devolution of administrative authority prevailing in the institution. It should inform everyone with the authority to commit funds about the main indicators relating to the financial health of the institution. Therefore, it should generate financial effectiveness and efficiency indicators and assist in the production of the annual report by providing university management statistics and performance indicators.

A MIS should also fulfil the following purposes:

• make available transparent information at all institutional levels on all incoming resources;

• contribute to the development of a clear picture of all costs and benefits derived from programme activities (evaluation); and

• provide information on who suffers and how bills are paid if government funds are insufficient.

Provide adequate training

The changes in structures and procedures in the area of financial management can only take place if the persons in charge are willing and able to implement, on a daily basis, the necessary changes. Institutions committed to devolving administrative responsibility to basic units will have to combine change in procedures and techniques as well as introduce new or different tools such as a MIS, as well as promote an integrated programme of training for academic decision-makers.

References

Sanyal, B.C. 1995. Innovations in university management. Paris, UNESCO.

Sanyal, B.C.; Martin, M. 1996. New strategies for financial management in universities: the experience of OECD Member States and Latin American countries. Paris, UNESCO. (International Institute for Educational Planning Contributions No. 27.)

Sanyal, B.C.; Martin, M. 1998. Management of higher education with special reference to financial management in African institutions. Paris, UNESCO. (International Institute for Education Planning Contributions No. 28.)

Williams, G. 1992. Changing patterns of finance in higher education. Buckingham, U.K., Open University Press.

Williams, G. 1993. Financial management: its context and role in attaining university goals. Paper presented at the sub-regional workshop on Institutional Management in Higher Education, Mauritius, 6-17 September 1993.