Monday November 11, 2024

Key indicators of stress for Independent Schools in the aftermath of VAT reform

The new Labour Government’s introduction of VAT on independent school fees from January 2025, coupled with the removal of business rates relief for those with charitable status, represents an immediate and urgent challenge for bursars. But the truth is, many schools already face underlying pressures that can be traced back to the financial crisis.

The 2008 downturn impacted the parents of many potential pupils and meant some schools had accumulated high levels of debt. Since then, there’s been a great deal of consolidation in the market, with many marginal schools being absorbed into school groups, coupled with what could now look like a relatively small number of closures. These profit-driven groups typically have a very commercial operating model, with higher pupil to teacher ratios designed to achieve better margins.

Those that have continued as independents have had to increase their fees, and fee inflation has outpaced wage inflation in recent years. This has made many independent schools less affordable for their target market, which has traditionally been local professional families. It’s a trend that has been particularly pronounced outside of our big cities. Then came the war in Ukraine, which saw energy prices rocket and the cost-of- living crisis, which put significant upward pressure on wages. Together, these represent schools’ two biggest costs.

Faced with this double whammy, many schools have had no choice but to push up fees even further – annual increases of seven percent have been fairly typical over the past three years – with an associated impact on pupil numbers.

From vulnerable to viable?

This is the backdrop against which the new Labour Government is to implement the most fundamental challenge to the independent education sector in living memory – applying VAT to fees and taking away business rate reliefs.

Though this will be offset somewhat as schools will be able to recover the VAT paid on certain business expenses, we estimate they will likely have to pass on a fee increase of 15-17 percent to parents. For a school charging £15,000 a year, this represents an uplift of between £2,250 and £2,550 a year from January 2025, which will be unaffordable for a proportion of parents.

Those schools that operate at a significant surplus may be able to absorb some of these higher fees to an extent, but marginal schools will not have that option. In many cases, these are the schools that are already the most vulnerable, with the highest price elasticity. To stay viable and avoid operating in a deficit, they will have to pass on the extra cost, whereas some of the best financially performing schools may be able to absorb some of the cost.

But it’s a Catch-22 situation; keep fees low and fall into deficit, or increase fees and lose pupils – and still fall into deficit.
However, parents whose children are already settled in their schools will be loath to pull them out and risk compromising their education. They would rather cancel holidays or cut back in other ways to keep funding higher fees.

So, it is the preparatory and pre-preparatory schools that will likely feel the impact soonest, with parents thinking twice about enrolling their children in the first place. With all this in mind, what are the warning signs of financial stress that bursars must be alert to?

Falling pupil numbers

Schools generally have very good visibility of pupil numbers that should enable them to make accurate economic forecasts for the coming years.

Lower levels of enrolment in the early years will inevitably feed through and it can be very difficult to turn this trend around. Though independent schools don’t have mandated catchment areas in the same way that state schools do, in practical terms most will only be able to appeal to parents within a certain geographical radius, so their market is limited.

Increasing remissions/bursaries

We’ve seen that once pupil numbers start falling, it can be very hard to turn the tide and one of the strategies open to schools is to offer more – or bigger – bursaries. But this is a short-term solution that will most likely store up more problems for the future.

The more discounts you give – both to parents and colleagues – the more money must ultimately be recovered elsewhere, so children who don’t have bursaries are essentially subsidising those who do. And don’t forget that parents talk to each other. Once word gets out that more bursaries are being given, there’s a danger a precedent is set that will be difficult to undo.

Governance

School board members often have to balance their responsibility to the school with their day jobs. In good times, full board and sub-committee meetings three or four times a year may be sufficient, but a far greater commitment will be needed when times get tough.

If boards start seeing resignations, that can be a warning signal that members are losing confidence in the school, or that they can’t commit to the time and effort that a turnaround will entail. And some people will not want to be associated with a failing school, so they may be inclined to seek a way out instead. This can be particularly true for professionally qualified members of the board, such as accountants and solicitors.

Be conscious too of an overly dominant chair who does not encourage debate between board members and committees, or avoids taking difficult decisions, such as opting out of the Teachers’ Pension Scheme. At times of decline, boards must take ownership of the school’s financial forecasts and integrate the assumptions they are based on into their plan. This is especially the case with pupil numbers which are often overestimated on a yea-on-year basis.

Financials

Quite simply, it’s not enough for an independent school to simply survive, it has to thrive. Without making a healthy surplus, say around at least 10 percent, a school will not be able to reinvest in capital items such as buildings, classrooms, leisure and sports facilities. That’s not viable in the longer term because the fabric of the school could become tired and fall into decline compared with its peers, with a knock- on effect on admissions.

Many schools rely on the fact that though they may be cash poor, they are asset rich, which will provide a safety net and ensure the support of their bank when needed. But the truth is that banks lend money to profitable, cash-generative institutions, so quite often medium and longer-term support is not available when it is most needed. That is unless there is a robust, viable plan to take the school forward, which should in challenging circumstances also include a contingency plan in case matters don’t work out.

In conclusion

When a school is struggling, it can be the bursar who is left having sleepless nights. While governors are undoubtedly well-intentioned, they can often lack the commercial headiness and/or time that is needed to successfully steer an independent school through difficult periods. Over many years, events have conspired so that the prospects for many independent schools have worsened and the latest government tax reforms will no doubt bring many of these issues to a head.

It’s important to arm the board with good current and forward-facing management information that can communicate the school’s situation and inform their decision-making. Gaps in management information must be quickly fixed, with early professional advice to avoid unwarranted drift that can lead to disaster. This will enable boards to take ownership of the situation and take action.

First published in The Bursars Review in November 2024.