Financial challenges for independent schools
The economic environment for independent schools has changed rapidly over the last few years and the pace of change shows no sign of abating. This has followed the impact of Brexit, COVID-19 and ongoing political pressures.
There has been sustained cost pressure for energy and other everyday school supplies for several years. The war on talent and resulting pressures on pay must also be considered. Additionally, there remains a need to upgrade or simply maintain existing school buildings to remain competitive and retain a healthy and safe environment.
The looming general election later this year, with the threat of the VAT exemption being removed, for the majority of schools this will impact a school’s financial prospects, especially when compounded with the cost of living crisis for parents meaning places may become unaffordable for many.
While many schools will be able to navigate through these challenges a number are already struggling and may need to consider their options.
This is particularly relevant to those smaller in size and heavily reliant on fee income.
It is important to fully understand the reason why funding gaps and cashflow problems exist. Governors often look to sell a school’s most valuable asset, land and buildings, to plug a funding gap and maintain educational activities. This can provide additional reserves but the issues that caused the school’s financial difficulties, such as a poor business operating model need to be understood before a decision to 'sell the family silver' is taken. Without understanding the reason why funding issues exist, the additional reserves may just be delaying the inevitable.
What are the early signs of insolvency?
There are a number of key signs that would indicate a need for possible recovery measures. The list below is by no means exhaustive:
- declining student enrolments
- declining profits
- cashflow difficulties and increasing bad debts
- breach of bank covenants
- inability to borrow
- operating at the limit of banking facilities
- a lack of investment in essential services
- delays in cyclical repairs and maintenance
- high staff turnover due to concerns about financial viability
- exceptional increases in fees, over and above the local market
- fundraising to cover general operating costs
- non-payment and delays in paying deductions to HMRC
- sudden switches in the business strategy
- delays in filing accurate financial information to the Registrar of Companies.
Is the school insolvent?
To deliver a good surplus, most schools need to be operating at or near full occupancy. Reductions to student numbers can result in losses as the costs can be difficult to scale down quickly and need to be covered. If unexpected losses are reported, it is paramount that Governors regularly review management accounting information and forecasts for the coming term and the next school year, taking action quickly to reverse their position where possible.
If financial issues are identified, Governors must scrutinise the school’s financial position. They have both responsibilities as Governors and where a school is incorporated, as Directors. Further information on these responsibilities can be found here The essential trustee: what you need to know, what you need to do and Being a company director.
Whilst Governors’ and Directors’ responsibilities are to act in the best interests of the school, they do need to consider the impact of potential insolvency and will instead prioritise creditors’ interests, to ensure that their position is not worsened by their actions (or failure to act). Failure to consider creditors’ interests can leave Governors at risk of claims being made against them personally by an administrator or liquidator and they are at risk of disqualification from acting as a director. If a school is at risk of insolvency and therefore closure, it is even more important that decision-making processes should be fully documented and minuted by Governors. This should include reference to the available financial information that they based their decision-making on.
When a school is facing insolvency, a number of additional costs or asset write-downs can arise that may not be shown on a balance sheet or in a cashflow forecast.
Those costs can be significant and create a much higher deficit for the school than may be shown in management accounts. It is important that the financial information used for decision-making is as accurate as possible. Some items that may be overlooked include:
- redundancy pay
- notice pay
- write down of intangible assets and tangible assets
- breach of contract for ending a school term early
- termination charges due under contracts
- professional fees (insolvency practitioners, accountants, asset valuers and solicitors).
A school is insolvent or at risk of insolvency, on either a cashflow basis (where liabilities cannot be paid as they fall due) or a balance sheet basis (where the value of assets is less than its total liabilities). When an insolvent school is a charity, it should submit a serious incident report to the Charity Commission. The same rule applies if a school is likely to become insolvent or close permanently within the next twelve months. The Charity Commission’s guidance on managing an insolvent charity can be found here .
The Charity Commission provides in its guidance a list of considerations for Governors/Trustees and recommends that advice be sought from a licensed insolvency practitioner or other professional advisor.
What can be done?
An insolvency practitioner can help Governors understand their responsibilities and legal duties, they can also create and implement a recovery plan with the support of key stakeholders to deliver a fair and beneficial outcome for all. The options available are usually dictated by the cash position of a school and the level of creditor pressure it is facing. The sooner concerns are raised about financial stability and help requested, the more options for the future of the school will be available.
Governors would be well advised to instruct an insolvency practitioner to prepare an options paper for their consideration, this may include formal insolvency options, together with the following:
- assistance with cashflow and stakeholder management
- working alongside management to reduce creditor pressure
- increasing understanding among stakeholder groups and negotiating a recovery plan with key stakeholders such as lenders, HMRC, other major suppliers and stakeholders
- sourcing alternative funding solutions
- advising on a cost-cutting exercise to reduce the burden on fee payers
- advising on the appropriateness of a sale of assets
- offering guidance on a link/ merger with another school
- any instruction would need to be carefully managed, news of a school being in financial difficulty could impact student retention which could render a recovery plan worthless or difficult to implement.
Future challenges
In May 2020, The Times Educational Support estimated that 30% of the UK’s independent schools could face insolvency and risk of closure, other sources estimate a lower figure of 15%. These schools are mainly smaller preparatory and day schools. Whilst no more recent estimates have been published, given the current economic and political threats there is potential for significant distress in the sector that could disrupt the education of many students.
The Labour Party have repeatedly stated their intentions in relation to independent schools. If they form the next government, there is a risk that the exemption of VAT on school fees will come to an end. Schools should be looking at the impact of these possible legislative changes on their income, their future trading activities and adapt their business plans accordingly.
If these changes come to fruition, school fees will inevitably increase when there is already significant pressure on household disposable incomes. Alternatively, schools may opt to reduce the call on fee payers by making cuts to their service provision, by reconsidering their offer proposition. This is a challenging task if a school is to maintain its unique offering and attract pupils. Some schools will already be at a stage where Governors are considering taking professional advice, others will be planning for change but will need to be adaptive.
The sector is aware of its risk environment and whilst these risks affect schools at different points and levels, there is an opportunity to plan and identify if there is a solvency risk for your school. Identifying these risks early enables the school to plan for the best outcome. One action should be to discuss the impact and options for the school with a licensed insolvency practitioner. This will enable Governors to plan and have options, for example an orderly wind down, sale or merger.
How Crowe can help
At Crowe, we have an experienced team of restructuring and insolvency professionals who can advise you on the best course of action, depending on your business’s circumstances. Please get in touch with either Steven Edwards, Mark Holborrow or Vince Green who lead the team, or your usual Crowe contact.
