Strategic Financial Management

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Strategic Financial Management

• John Ramsden
• Centre for Leadership and Management
• January 6, 2003

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Your presenter!

• D. Phil (chemistry)
• BP Research (gas conversion technology)
• BP Gas (technology appraisal, strategic planning)
• BP Exploration (contract implementation)
• University of York (Department of Chemistry)
• Bishop Burton College (Head of International
  Centre, Director of ARREC International)
• University of York (Centre for Leadership and
  Management)

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Purpose of the session

• Establish the importance of strategic financial
  planning to HEIs
• Outline a possible approach to strategic
  financial management

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Overview

• Why bother?
• The need for strategic thinking on finance
• The five principles of strategic financial
  planning
• Evaluation of financial strategies
• Case study

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Part 1. The need for strategic financial planning

• Why bother?
• because we have to!

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HEFCEs purpose

• Responsible for substantial sums of public
  funding
• around 5.07 billion in 2002-2003
• Charged with ensuring value for money (The Chief
  Executive is the HEFCE's designated accounting
  officer)
• Controls the process though the use of a
  Financial Memorandum with each university and
  college funded

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The Financial Memorandum Abridged version

• HEFCEs responsibilities
• Fund relevant activities, safeguard public funds
  (audit)
• Institutions responsibilities
• Compliance, stewardship, value for money,
  information, Principle Officer.
• Estate management
• Exchequer-funded assets (sale, lease, transfer)
• Borrowing (short-term, long-term)
• Reporting requirements
• Audit

http//www.hefce.ac.uk/pubs/hefce/1996/c5_96.htmp
ara1
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HEFCEs view

• Most HEIs have managed in the past without a
  systematic and integrated approach to financial
  strategy. This reflects the history of the
  sector as a primarily publicly-funded service and
  the fact that institutions had fewer financing
  requirements (and options), and faced less acute
  financial risks. It is increasingly clear that
  to succeed academically and financially
  institutions need to take a more proactive and
  strategic approach to managing their financial
  future.

Source HECFE report June 2002/34
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Operating surpluses
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HEFCEs strategy

• Number of HEIs forecast to be in deficit
• 2002 45
• 2003 25
• Operating surpluses too low to support necessary
  levels of reinvestment
• Cost-cutting themes continuing
• Build on institutions strengths
• Support leadership, governance and management
• Organisational development

HEFCE Annual Meeting, Nov 15, 2002
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Part 2 An Approach to Strategic Financial
Planning

• Financial strategy in higher education
  institutions a business approach
• HEFCE, June 2002

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Where the Financial Strategy Fits
Research
Widening participation
Financial
Teaching
Enterprise
Corporate Strategy
strategy
Human resources
Estates
Information
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The Five Principles

• Long-term viability and matching resources with
  objectives
• Maintaining productive capacity to meet current
  objectives
• Financing development and investment
• Evaluating strategic alternatives and managing
  risks
• Integrating financial and other corporate
  strategies

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Principle 1 Long-term viability and matching
resources with objectives

• Fundamentally a marketing strategy
• Need to anticipate income and expenditure
  (capital and operating) by segment, including
  infrastructure
• Need to anticipate levels of activity and unit
  funding to evaluate financial implications

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Principle 1 Measures

• Surplus generated
• Trading surplus
• Accumulated reserves
• Liquidity (current ratio,days cover)
• Activities
• Surplus on each activity
• Minimum economic scale
• Bench-marking
• Portfolio
• Efficiency
• Staffstudent ratios, space utilisation
• Support costs as proportion of total costs

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Principle 2 Maintaining productive capacity to
meet current objectives

• Maintain the value and contribution of all
  resources
• HR
• Physical
• Intellectual
• Information
• Systems

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Principle 2 Measures

• Estates and physical assets
• Percentage not meeting desired standard
  (benchmarked)
• Utilisation and occupancy measures
• Spend on refurbishment/renewal (5)
• Maintenance spend (1.3-1.8)
• Staff
• Skills profile
• Investment in staff development and performance
  management
• Ratio of supportacademic staff
• Academic staff time spent on non-professional
  work
• Learning resources
• Spend on IT and library

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Principle 3 Financing development and investment

• Evaluate the financial base of the institution
• Identify cash and capital requirements
• Evaluate external sources of finance
• Establish borrowing levels
• Decide on use of special initiatives funds

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Principle 3 Measures

• Analysis of assets
• Disposables, reserves, endowments
• Benchmarking with peer HEIs
• Risk analysis
• Income streams (Teaching vs. research vs.
  enterprise)
• Impact of failure on the HEI
• Detailed financial modelling
• Plans
• 10-year investment plan (prioritised)
• Cash flow forecasts
• External funding opportunities
• Servicing the debt (cost of borrowings)
• Consideration of gearing and credit rating

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Principle 4 Evaluating strategic alternatives
and managing risks

• Priorities strategic opportunities
• Make provision for increases in capacity
• Manage key financial risks
• Minimise downside risks
• Maximise value of strategic alliances and
  collaboration

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Principle 4 Measures

• Evaluation
• Balanced scorecard approach
• Full lifetime costing (not marginal costing)
• Flexibility
• Exceed immediate surplus requirements
• Maintain surplus borrowing capacity
• Avoid management constraints
• Minimise downside
• Scenario planning
• Use milestones/performance indicators to monitor
• Built contingencies into the planning
• Strategic alliances
• Sharing resources or activities
• Franchising
• Commercial activities
• Federal relationships/mergers

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Principle 5 Integrating financial and other
corporate strategies

• Base financial strategy on rigorous and objective
  analysis
• Integrate financial strategy with output
  strategies
• Gain understanding and acceptance from senior
  academics and managers
• Review implementation and amend strategy
  appropriately

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Principle 5 Measures

• Analysis approach
• Involve managers in the strategic decision-making
• Use external advisors to gain insight and
  objectivity
• Gain understanding and acceptance
• Train managers (participation)
• Communicate ideas to the institution
• Monitor implementation and outcomes
• Systematic process for review

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Strategic Financial Measures A Summary

• Operating surpluses
• Discretionary reserves
• Liquidity
• Borrowings
• Capital investment
• Income targets in key operational areas, such as
  research and commercial activities
• Rates of return on commercial activities

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Part 3 Evaluation
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The Evaluation Process

• Define the objectives
• Consider the options
• Identify, quantify, and were possible, value the
  costs, benefits and risks and uncertainties
  associated with each option
• Analyse the information
• Present the results

The Green Book Appraisal and Evaluation in
Central Government Treasury GuidanceSecond
edition (1997), HM Treasury, HMSOISBN
0-11-560034-5
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Analysis Terminology

• Cost effectiveness analysis
• Cost benefit analysis
• Compliance cost assessment
• Environmental appraisal
• Cost utility analysis
• Matrix (impact statement) approach
• Financial appraisal
• Exchequer cost analysis
• Commercial appraisal

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Risk Analysis

• Sensitivity analysis
• What if?
• Expected values (probability-based outcomes)
• Scenario planning
• Different worlds different outcomes
• Advanced analysis
• Monte Carlo simulation

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Part 4 Case StudyA Review of Campus Energy
Costs
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Case Study - Background

• 1960s centralised heating system reviewed.
• Based on interruptible gas, with fuel oil at peak
  times

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Case Study

• Objectives
• Minimise campus energy demands
• Reduce environmental impact of energy consumption
• Options considered
• Retain the existing high pressure hot water
  (HPHW) system (do-nothing)
• Complement the existing HPHW system with combined
  heat and power (CHP) generation (526k)
• Decentralise the heating system (1802k)
• Other energy-saving initiatives continue.

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Metrics

• Simple measures
• Payback period
• Expenditure exposure
• Discounted cash flow analysis
• Net present value
• Internal rate of return
• Discounted payback period
• Discounted expenditure exposure
• (Profitability Index)

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Modelling

• Step 1 Generate comprehensive cash flow profile
  of the existing system for a 15 year period

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Modelling

• Step 2 Analyse historical energy demand patterns
  to develop a causal model

• Step 3 Define probability distributions of all
  variables (consultants, consultation)

?
Value
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Modelling

• Step 3 Generate modified cash flow profiles for
  the other two options (consultants, suppliers)
• Step 4 Agree scenarios to test the robustness of
  the economic outcome (consultants)
• Step 5 Build cash flow model to allow input of
  parameters in order to calculate the difference
  between do nothing and the other options
• Step 6 Develop probability profiles for all
  parameters to enable Monte Carlo simulation.

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Causal Model Drivers
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Evaluation and Results

• Model runs for 1000 iterations
• Output is a frequency distribution of the NPV of
  the project

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Results

• CHP option shown to be significantly lower cost
  over 15 year period, assuming plant operates to
  provide base-load heating requirements
• Outcome was independent of economic scenario
• Calculations showed payback in 4.5 years (c.f.
  3.2 and 3.5 years from consultants)
• Significant economic advantages in operating in
  heat-dumping mode

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Outcome

• Decision made to proceed with CHP in accordance
  with recommendations
• Installed on schedule and to budget
• Plant achieved payback in 18 months
• Significant further savings from environmental
  tax allowances
• Operation policy reviewed

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Conclusions

• Strategic financial management is a survival
  issue
• Longer-term financial viability
• Compliance
• The five principles provide a useful starting
  point for the development of financial strategies
• Emphasis on benchmarking and collaboration
• The evaluation process follows logical
  decision-making approach.

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Support from York

• Leadership in Administrative Management Programme
  (LAMP)
• One-year programme to address the needs of
  leaders and senior managers in HEIs
• Project-based learning in action sets
• Content covers planning, management tools, and
  leadership skills development
• Supported on-line and through intensive
  residential courses
• Next intake Spring 2003
• Diploma in Management Studies in Higher Education
  
• Starts Spring 2003
• Contact Stephanie Marshall (sjm21_at_york.ac.uk)

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And finally

• Have a Happy and Prosperous 2003
• From all at the
• Centre for Leadership and Management