Charles Clarke, the Education Secretary, has told colleges that his department cannot continue to stump up 80 per cent of colleges' running costs while bills continue to rise.
Last year Mr Clarke hinted to colleges that they would need alternative funding.
This week, at the annual conference of the Association of Colleges in Birmingham, he said that the Learning and Skills Council's difficulties in funding 16-19 expansion have revealed the seriousness of the problem.
The Department for Education and Skills is committed to ensuring colleges are paid to increase the number of 16 to 19-year-olds and adults achieving level 2 (GCSE-equivalent) qualifications.
Speaking at the AoC's conference this week, Mr Clarke told principals they need to "diversify" their sources of funding.
Colleges should also look at generating more income through commercial activities such as consultancy and hiring out facilities. These currently account for 9 per cent of their business in cash terms.
He said: "To really make a lift we need to get more people to say we are going to contribute and we are going to provide resources, as employers, as individuals or what ever it may be.
"It means diversifying income, finding new business and collecting more from fees. The proportion of income from fees and other services needs to increase. Employers need to pay more for the training from which they benefit."
The urgency of the situation was revealed this week when the LSC was told in a letter from Mr Clarke how much money it would be getting for the next three years. The letter, to LSC chairman Chris Banks, shows colleges will need to raise more cash from students or the private sector. Much of the spending planned up to 2008 is being brought forward to pay for the rapid growth in numbers of 16 to 18-year-olds.
There will be 8.1 per cent more cash available next year but only 2.8 per cent in 20067 - an average annual increase of 5 per cent.
Mr Clarke told the AoC that colleges will be expected to work more closely with employers to make sure vocational training improves productivity in the workforce.
He said the new sector skills councils, which represent employers, will have an important role to play in this area. He told the AoC: "These (the sector skills councils) will have greater importance in your work and society as a whole than many people will acknowledge."
Julian Gravatt, finance director of the AoC, said the funding figures for FE compared poorly with universities.
He told FE Focus: "This compares poorly with universities who will get 7 per cent a year. Nearly all of what we get will be required to deal with the 100,000 extra 16 to 18-year-olds. And it will not go very far, particularly if it's spent on the more expensive sixth forms that cost pound;1,000 a student more than colleges. The work of colleges will remain under the microscope for some time to come."
The National Audit Office is looking into college governance while Sir Andrew Foster, chair of the bureaucracy-cutting taskforce, will head an independent FE review.
Mr Clarke's letter puts the LSC under notice to act to make sure that colleges find other funding.