Further education colleges face a potentially crippling loss of income from reductions in European funding and falling returns on investment.
A review of college financial forecasts by the Scottish Funding Council reveals that European income is expected to halve from pound;22.6 million in 2006-07 to pound;11.4 million in 2008-09. And the fall in interest rates is likely to cut investment income from pound;14.4m in 2007-08 to pound;2.7m in 2009- 10.
The news gets worse when growing pension commitments and the "unprecedented demands" on student support funding are taken into account. The position on both these fronts deteriorated after the colleges returned their 2009 financial forecasts, and the funding council believes the final figure for the year will show a "significant deterioration on forecast".
The colleges are also awaiting news of their annual grant from the funding council, due in April, which many principals fear will squeeze their budgets further. Already, the funding council has had to bail out colleges with a series of million-pound packages to help them cope with the surge in applications for student places and the consequent demand for bursary and childcare support.
The council seems to be preparing colleges for the worst. It has asked every college to undertake scenario planning "in the light of possible reductions in public funding and the wider implications of changing economic conditions, and developed strategies to manage the most significant risks".
It is the combined effect of a decline in both government and private sources of funding that colleges will find most worrying. The funding council notes that colleges had expected to earn pound;118.7m from fees and contracts in 2008-09, but the actual figure was only pound;112.7m. This was attributed to "difficult trading conditions" and the loss of contracts.
The considerable modernisation of the college estate over the past few years has also landed the sector with major borrowing commitments. These are expected to reach a record level of pound;62.7m in 2009-10, compared with pound;56m in 2007-08, with 13 colleges projecting borrowings of more than pound;1m by the end of July this year.
Ray Harris, chief executive of Scotland's Colleges, said: "The need to respond to the recession means that colleges which have been flexible must become even more flexible."
He suggested, for example, that students could complete some of their training on employers' premises, using their equipment and so avoiding the need for colleges to invest in expensive kit.
The pressures on colleges come at a time when, ironically, they have never been in better financial health. In 2000-01, the sector as a whole had an operating deficit of 3.1 per cent of total income, and 34 out of the 43 colleges were in the red.
The funding council was then forced to mount a "financial security" campaign to prevent colleges going out of business, as a result of which the sector recorded an operating surplus of 3 per cent in 2007-08 when only two colleges were in deficit.
The position worsened slightly the following year, when 10 colleges forecast operating deficits. But this was largely the result of one-off restructuring and estates renewal costs, and only four colleges are projecting deficits by 2011-12.
The funding council review acknowledges the challenge facing the colleges "to maintain financial and institutional sustainability in light of the economic downturn".
Mr Harris, former principal of Edinburgh's Telford College, warned: "What the sector has to do now is to demonstrate the value which communities and the country are getting in return from the investment in colleges."
Linda McTavish, who leads the FE principals' convention, said: "Colleges have taken on a very important role during the economic downturn and these reports highlight why there is a need for continued investment in colleges by the Scottish Government and the Scottish Funding Council. We look forward to working with them on this in the coming months."
The funding council has issued similar warnings to the universities, which face a deterioration in their surpluses, increased staff costs, greater borrowings and additional pension commitments. Investment income is expected to drop sharply from pound;58m in 2007-08 to pound;28m in 2009-10, as a result of falling interest rates.
The council also warned that the funding it allocates to higher education institutions, which rose by a little over 1 per cent in 2009-10, will decrease by 1 per cent in 2010-11.
The universities, however, have some earning power not available to colleges. Tuition fee income is forecast to rise more quickly than total income, partly due to growth in overseas students; and research grants and contracts are also expected to increase "significantly".
Both Labour and the Conservatives reacted to the university report by renewing their call for an independent review of higher education in Scotland in order to find "long-term solutions" to institutional funding and student support.