As we eagerly await autumn’s cooler temperatures, the administration sucks air from conference rooms to hold their collective breath in anticipation of the external auditor’s answer to a question: Did we have a surplus or deficit budget last year? The familiar cycle of tension from the counting and recounting of the beans is nearly completed. If there were a poem about the process of fiscal accountability, it might read thus:
Ode to the Financial Statement
Business office hassling
Now a dime repressed memory
Closing books slamming ceased
External auditors long descended
On ivy-clad stone facades
Khakis and satchels leather worn
Instilling God’s fear, some say.
Presidents wonder, badgering tones
Final numbers trustees need to know
CFOs’ beleaguered annoyance
As soon as I know, you’ll know
VPs of communication hold steady
For the printer awaits one page
Just a single page, such import, woe!
Financial health undecipherable
Surplus deficit surplus surplus
Questions arise, thought bubbles
Budget cuts, no increases, why
One wonders, all wonder, sigh
Isn’t there millions to spend
Can one be rich and poor?
Alas, answer responses
Endowments never spend
Corpus, corpus must remain
Mornfully only spent gain
And here we are once more
Budget cuts without, but why
Must be answers nigh.
Deciphering financial statements and an institution’s fiscal health can sometimes be as obtuse as comprehending a poem (especially like the one above). Lousy poetry aside, how can some institutions with large endowments, representing tens of millions or more, not have enough money to pay expenses?
Let’s walk through the types of institutional revenue. Sources include government (state and federal) appropriations, student tuition/fees/room and board, auxiliary services, sponsored agreements (ie, funds in exchange for research), and charitable (also called “philanthropic”) giving. Most revenue sources have restrictions, meaning the monies can only be used for certain expenses by law, policy or legally binding agreement. The complexities of these restrictions often tie up revenue in unexpected ways, creating challenges to establishing a balanced budget.
Under the charitable giving category, various vehicles enable people to contribute—cash, stock, real property, personal property and gifts in kind. People may agree to give a certain amount over time or through their will (also known as a pledge). People may provide without restrictions as to how and when their gifts are spent. Others choose to place specific restrictions on how and when their contribution can be used; one such example is when a donor establishes an endowment.
Endowments can represent millions and even billions of dollars in assets held by an institution. How endowments work can be perplexing. Many people think, “Hey, we have all this money; why can’t we spend it and fix the budget?” But there are numerous things to know about how endowments work and why there isn’t as much money to spend freely as it might appear.
Here is some crucial information about endowments:
Institutional endowments (the large total often referred to) are comprised of smaller, individual endowments.
Endowments are created through charitable gifts given by donors for the explicit purpose of investing the funds in perpetuity. The amount given for the purpose of investing is known as the corpus. A legally binding agreement between the institution and the donor establishes the terms.
In accepting the funds for an endowment, the institution agrees to
- Never spend the amount given for the purpose of investing (the corpus),
- Invest the funds according to the institution’s investment policies,
- Only spend a certain percentage of the annual earnings based upon the institution’s spending policy (typically 3 to 4 percent),
- Reinvest the earnings over and above the allowable spend to grow the corpus (and hopefully keep pace or exceed CPI), and
- If the investment loses money and the endowment becomes less than the original corpus (known as being “under water”), no funds are disbursed until the endowment corpus is restored (or “above water”).
A donor can give any amount to the institution’s general endowment funds without restriction, but very few do.* (See below.) Many donors wish to have a fund specially named and/or used for a specific purpose. Institutions generally have minimum threshold amounts for named endowments. For example, the threshold for a named scholarship might be a $25,000 minimum, while a professorship might be a million dollars or more. By naming and setting a purpose for the endowment, the donor and institution limit the use of the corpus and its investment earnings. The allowable spendable earnings may only be used for the stated purpose.
Are you still following?
In very simplified and favorable terms, considering the current economy, let’s say an institution invests its $50 million endowment, and the spending policy allows the institution to spend 4 percent of annual earnings. If 8 percent was earned (or $4 million) in a particular year, then $2 million can be spent, and $2 million will be added to the $50 million endowment. As a result, there is $52 million to invest the following year, and if the return is equal to the previous year, then there will be $2,080,000 to spend, and the endowment grows to $54 million, and so on.
OK. So now you understand that an endowment of $50 million may only add $2 million to the annual budget. You think, “Hey, $2 million is nothing to sneeze at. I can think of a lot we could do with $2 million.”
But one must remember that the original $50 million endowment is made from a bunch of smaller endowments. Most of these smaller endowments have restrictions about what the money can be used to fund. Theoretically, the breakdown could look like this: 50 percent is restricted to scholarships, 25 percent to programmatic support, 15 percent to athletics, 8 percent to specific positions and 2 percent to unrestricted general purposes. In this scenario, that would mean there is only about $40,000 that is unrestricted (can be used for any purpose).
The idea that having a sizable endowment means an institution has a great deal of budgetary flexibility can be a misconception. It depends on investment return and the type of donor restrictions on those funds. One shouldn’t assume an institution doesn’t need resources because of a large endowment or that the institution has latitude in how it uses endowment revenue. It just depends, and it’s more complicated than you think.
*It is somewhat rare for a donor to make a gift to the endowment without other restrictions. When and if it happens, it may come as a bequest (a gift designated in a last will and testament). Sometimes a donor may leave assets to an institution in their estate without any restrictions at all. In those cases, the trustees generally follow policies designed to deal with the gift, such as a threshold amount whereby a quasi endowment must be established. Meaning, that the board treats the gift as if the donor intended it to be an endowment, invests it and uses spendable earnings as policies dictate, but at any time, the board could, by vote, use the funds (in part or whole) for other purposes.