Plot against hand-to-mouth survival

12th May 1995 at 01:00
Opening five pages on money, Brian Knight argues for a more planned approach to capital replacement. School budget surpluses are an embarrassment. They give politicians the notion that schools have more money than they need. They appear to soften the impact of budget cuts this year and so encourage similar cuts next year. They tie up funds that should be used productively. They imply unthinking financial management. Surpluses cannot be justified unless they have a specific identified purpose. So, what is justifiable?

* A development fund for a specific identified project; * A bridging fund to bridge betweentwo funding peaks across a trough, e.g. caused by a dip in enrolment; * A contingency fund for possible problems (but not a largeunallocated surplus); * A capital replacement fund.

If our present surpluses had been allocated in this way, school planning would be more explicit and our present embarrassment would be less.

Of these, the most neglected function - but the most important one in the long term - is the capital replacement fund.

Schools are becoming more capital-intensive by the day. The emphasis upon science and technology in the national curriculum, the application of information technology across the range of subjects, improvements in reprographics and computerisation of school offices all require more capital equipment and give us a glimpse of what schools may become in the information age.

Yet few schools make any measured allowance for capital replacement. Pre-local-management, they did not need to do so - they only had to hope that Auntie LEA would provide. Even local authorities did not make calculated allowance for depreciation. There was often, in good times at least, a capital replacement fund or "central fund" which met the most urgent pleas from the schools. But now such funds have dried up, and schools have to provide from their own budgets. Most do not - often because they feel there is no slack for such a luxury. But even those which could create a replacement fund do not do so, probably because depreciation is still an unfamiliar concept.

Technically, depreciation is the decline in value of an asset over time. For example furniture bought in year 1 may last 10 years, and so may be thought of as being consumed over that period until it needs replacement. So depreciation requires an accounting convention for writing off the book value of capital assets on a balance sheet, often on a percentage basis.

However, state schools do not produce balance sheets - unlike, for example, the locally managed charter schools in New Zealand, which account annually for their assets with allowance for depreciation. And schools still have to pay the whole cost of the purchase in year 1, unless they lease it. They are not yet able to borrow for capital spending, paying for it in debt charges (although there is now talk of opt-out schools doing this).

The accountant's approach to depreciation is a useful management tool, although it has little appeal for schools at present. It highlights the true cost of capital replacement, even if the school cannot make proper allowance for it, and so reveals the school's true operating costs. Without a calculation for depreciation, replacement needs are underestimated. For example, some schools are now finding that their BBC computers are becoming obsolete.

City technology colleges originally argued strongly that provision for depreciation of buildings and equipment should be included in their annual grants from the Department for Education. Presumably the CTCs' sponsors saw this as normal commercial practice. It also mirrored the practice of independent schools, who typically allow for depreciation on a full cost basis within their accounts, or by adjustment to fee-levels. But the argument cut no ice with the DFE, which like LEAs had not been accustomed to regular capital replacement (and was no doubt horrified by the financial implications). Grant-maintained schools raised a similar argument, also in vain.

Yet it is no good schools just hoping that something will turn up. That is the Mr Micawber theory of financial management. Capital equipment will depreciate and logically allowance should be made for this.

First we need to estimate depreciation systematically. So an inventory of the school's capital assets is needed. These are likely to include information technology, office, reprographics and audio-visual equipment; science, technology, art, music and PE equipment; furniture, furnishings and fittings such as blackout; school vehicles; playing fields equipment and furniture. GM schools will also be responsible for the fabric of their buildings.

The next step is to assess annual replacement costs. A pro forma can be used for this (see the simple example below). This calculates the replacement value and mean life left for each item on the inventory and so the annual replacement cost, which can then be aggregated for the whole inventory. A spreadsheet can make these calculations and its updating is quite straightforward.

Identifying replacement needs is one thing - funding them is quite another. There are several possible strategies: * Set aside a sum for capital replacement each year in the school budget. This is fine if the budget is buoyant, but under pressure it may be the first thing to go. Some items may be too expensive for a single year's budget.

* Create a capital replacement fund, fed with annual sums corresponding to the total current annual replacement costs as calculated above. This averages out peaks and troughs, and puts replacement on a more regular footing. But it is only worth while if the interest the school can earn on the fund is greater than inflation.

There is also the risk that the capital replacement fund could be raided in extremities. However it could be a better use for balances which many schools still roll forward each year. Converting these to capital replacement funds would make them more purposeful and politically acceptable.

* Live from year to year, coping with demands as they arise. This is what most schools do. It has the merit of judging each capital replacement demand against all other priorities, and it is less work. But it is really hand-to-mouth budgeting, exposed to the problems outlined earlier.

My own view about capital replacement has changed. I used to think that it was unrealistic to require such an element within a budget, as schools historically had never provided for it, and most did not have the budget flexibility to do so. However, that now seems a head-in-the-sand policy. Capital replacement will grow steadily in importance, and it is crucial that schools make provision for it.

If that provision isn't enough - and usually it will be far from enough - the school should flag up this "capital replacement gap" as boldly as possible. Governors, parents, the electorate and the Department for Education, and even the Government need to realise that schools are now climbing on to a new plateau of capital expenditure. That means earmarked capital replacement funds - not unallocated and eminently disposable surpluses.

* Brian Knight is an honorary research fellow of the University of Exeter, an educational consultant and author of Financial Management for Schools: the thinking manager's guide. Heinemann. Pounds 14.99. ISBN0 435 804812.

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