Over the last year, the FE funding body has made some doom-laden predictions about the state of college finances. First, as the Learning and Skills Council (LSC), it commissioned a report from KPMG which concluded that about 50 colleges were deemed “struggling” and at risk of merger or closure. A further 50 were breaking even but were considered “vulnerable”.

The message improved only slightly when Geoff Russell, chief executive of the LSC’s successor body, the Skills Funding Agency (SFA), told a conference of governors earlier this year that the number of colleges in financial difficulty could double “sooner than you may think”.

Later, the agency expanded the point: there are currently 15 general FE colleges rated financially inadequate and this number could rise to the mid-20s, a slightly more optimistic prognosis than KPMG’s. The SFA also judged that the 86 assessed as outstanding could be reduced to a figure in the mid-40s, as colleges face a cut of up to 25 per cent in real-terms public funding over the next four years.

The rating of financial inadequacy comes from a self-assessment, so these colleges are at least aware of the problems they face. But the agency said the figures reflect likely changes if colleges do not take action to cope with reduced funding from Government, and make fundamental changes to increase their income and reduce costs.

An analysis of college accounts carried out for FE Focus by W3 Advisory, a consultancy offering advice to colleges on finance and governance, suggests that many have already taken action to improve their financial standing.

W3 director David Williams said: “The first thing that was surprising was that the position was better than we expected and many colleges appear to have taken early measures to position themselves to deal with funding reductions.”

Mr Williams said that the figures for 200809 showed some concerns, with colleges running deficits. But much of this seemed to be prompted by spending on estates, either because colleges had won Government funding for ambitious new projects that needed match funding from the college, or because they had lost money developing projects that would not be funded after the capital budget ran out.

“But what we weren’t expecting was that in 200910 there would have been quite such a recovery on overall financial performance,” Mr Williams added.

On average, colleges reported an operating surplus of about pound;300,000 last year, after two years of deficits. This came despite the lowest rate of income growth for five years.

Much of the improvement has come from a reduction in the proportion of income spent on pay, colleges’ largest bill by far. That fell from 65.7 per cent in 200809 to 63.9 per cent, a change that is likely to have saved colleges as a whole almost pound;140 million.

Cash balances last year increased by 30 per cent, to an average of pound;3.4 million - more than at any point in the last five years.

However, this is balanced by a similar level of increased borrowing, with the average college taking on an extra pound;700,000 last year - a figure that may have been caused by a 40 per cent increase in capital spending in 200809.

The analysis also highlighted some potential disparities of funding and performance between different types of college.

Tertiary colleges, for example, stood out as some of the most financially efficient. They saw the slowest growth in income over the last five years - 1.7 per cent per year on average, compared to more than 8 per cent in colleges as a whole and 17 per cent at some specialist institutions - but they successfully controlled costs to create some of the largest increases in surplus.

While tertiary colleges received below-average funding per learner, suggesting their good financial performance is not due to generous Government grants, specialist institutions such as land-based colleges made double the average surplus per learner, and at art and design colleges it was triple the average.

This year W3 estimated that colleges would make a total surplus of pound;103 million, based on the published budgets of the SFA and the Young People’s Learning Agency, and assuming that other costs and income streams increase in line with the Government inflation target of 2 per cent.

But in 201112, cuts to Government funding mean colleges face a total deficit of pound;114 million, equivalent to 10 per cent of their cash balances as of last year. To maintain their surpluses, W3 said, colleges will need to reduce costs by about 3 per cent. And there are years of further cuts to come.

The cost of the cuts needed to maintain their financial position is being counted mostly in job losses. The University and College Union (UCU) claimed that colleges were cutting faster than they needed to last year, a claim that has some support, given the marked improvement in the bottom line even as income growth slowed in 200910.

UCU head of FE Barry Lovejoy said colleges faced further cuts this year. “As of a month ago, we had around 2,500 job losses which we had been notified formally about in England alone,” he said.

“Last year we were pretty successful at ensuring that the vast majority of job losses were voluntary, not compulsory. But there is an unfortunate feeling of history repeating.”

Mr Lovejoy said several colleges appeared to be making significant cuts despite an apparently strong financial position. Some colleges had multi- million-pound surpluses but were still forcing through cuts, he said.

Colleges find themselves exposed to criticism on both sides, however: when they cut costs, it usually means job losses, since more than 60 per cent of their income goes on the payroll. If they do not, they find their financial viability publicly questioned.

Julian Gravatt, assistant chief executive of the Association of Colleges, said: “Colleges are already taking action because the way they are managed and regulated means they have to.”

He said capital investment had made college balance sheets look worse than they would have been otherwise, going into a period of cuts.

“The really important factor was the capital crisis, and the crisis of over-development, the capital expenditure that preceded it,” he said.

“When you have a capital project it makes your financial position worse in the short term. But in the long term it makes you more efficient and attractive.”

While the proportion of spending on pay and other costs fell by 2.4 per cent last year, interest costs rose by 1.6 per cent, wiping out much of the savings.

Colleges were mostly unable to benefit from historic low interest rates of 0.5 per cent, because they usually seek low-risk long-term deals.

Mr Gravatt said it could be damaging to FE to overplay the financial risks and said colleges were likely to find additional income elsewhere. The accounts analysis shows that last year dependency on Government funding of FE fell by 2.6 per cent from a high of over 80 per cent in 2006.

Mr Gravatt said: “It’s important to maintain the confidence of all parties. But equally we can’t deny that there will be consequences from the spending cuts.”

The SFA said it was not trying to talk down the sector, but to ensure that colleges took the challenges seriously. SFA chief executive Geoff Russell said in a statement: “The FE sector is the most cost-effective part of the education system in England and is successfully playing a key role in delivering the Government’s growth and social engagement agenda.

“The sector’s success does not diminish the need to adapt to the new funding circumstances, which I believe the sector accepts will create challenges for some colleges.

“But I am very encouraged that many colleges and providers are not only rising to meet the challenge, but are using it as a catalyst to further increase their growing role in building the economic recovery and in influencing the skills agenda in England.”

W3 ANALYSIS

Key facts

- College income rose by 35.5 per cent over the five years from 200506.

- The rate of growth slowed in 200910 from more than 8 per cent to 5.7 per cent, ahead of cuts this year.

- But colleges cut costs to show the first operating surplus for two years and, at an average of over pound;300,000, the highest since 2005.

- Earlier deficits were partly driven by capital spending, which rose by 40 per cent in 200809.

- The average college increased its cash balance by 30 per cent last year, to pound;3.4 million.

- Based on W3‘s analysis, colleges have to reduce costs by pound;114 million this year to maintain surpluses and will need to make 3 per cent cuts in 201112.

Original headline: Are colleges mastering the financial balancing act?