Colleges are to have their budgets for September slashed at the eleventh hour as the Learning and Skills Council runs out of cash to meet funding commitments.
Despite record levels of investment in further education, colleges face what the Association of Colleges says is the toughest financial situation since the Tories were in power.
Colleges are towards the end of the first year of the new three-year funding regime, which was introduced to provide extra stability and reduce bureaucracy.
But local Learning and Skills Councils are being forced to reduce college budgets and, in some cases, are making late payments for courses which are already running.
The LSC and and AoC both acknowledge that the problem is caused by colleges recruiting more students than expected, particularly among 16-18-year-olds, and in some cases the cash is not there to pay colleges on time.
Julian Gravatt, director of funding and development at the AoC, said the increase in funding from the Department for Education and Skills is failing to keep up with increased college activity.
He said: "This is the toughest position colleges have been in since Labour came to power. Too many colleges are hitting their targets and the targets themselves are set too high, so the LSC is over-committed."
Some colleges have been asked to submit "models" of how they would go about reducing their budgets by 3, 5 or 7 per cent, as local LSCs look for savings.
Colleges could be faced with reducing staff costs, possibly through redundancies, or scrapping courses for which students have already enrolled.
As the scale of the crisis emerges, Ivan Lewis, the skills minister, said talks are taking place with the LSC.
He told FE Focus: "There has been a record level of investment, a 19 per cent real terms increase in three years. We are in talks with the Learning and Skills Council about the financial pressures for 20045. Beyond that we have not decided how much money will be allocated."
At the AoC lobby of Parliament last week, he said: "I'm not asking people to say thank you but it is not right to dismiss the most significant investment in further education that we've seen for a generation.
"Of course you need more money but also the sector has got to get off its knees and stop being the victim, stop being the Cinderella, because if you carry on perpetuating that, it will happen.
"You also have to come to the table as a partner."
The AoC says West London colleges have only a third of the funding they need for the expected increase in the number of students in 200405.
Two of them are expected to provide pound;1.8m of courses which will not be covered by LSC funding.
Rob Wye, director of the LSC's chief executive division, said: "What we are suffering from are the problems of success. Colleges have increased student numbers, in 16 to 18 in particular."
An LSC source said money released from cuts in college budgets would be moved around the country, although Mr Wye denied this, saying funding will remain in the same region, even if it moves between local LSCs.
She added that there is a feeling of "frustration" in her local LSC that board members have put their names to a strategy which they cannot fund.
Principals are also concerned that students with disabilities could effectively be dumped - as ministers concentrate colleges' tight resources on getting more people into university.
An LSC circular to colleges in the West Midlands, including Birmingham, last week set out the approach to prioritising courses which fall outside the national qualifications framework.
Of this so-called "other provision", it says, higher education access courses are listed as a "priority" and courses for SLDD (students with learning difficulties and or disabilities) are to be "discouraged", unless there are "very specific reasons to justify their use".
Peter Pendle, general secretary of the Association for College Management, said: "It's an absolute fiasco. Heads need to be on the block over this.
"When they start making cuts in SLDD, that's when they will have people protesting in the streets.
"We were told we were having three-year funding as part of a new world of trust. Now we are told we are not getting our indicative allocations.
"Someone has got their sums wrong. We are talking about someone at the very highest level. And they need to take responsibility."
Ray Ellis, deputy principal of Grimsby college, said: "Effectively three-year funding doesn't exist any more."
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