Alan Greenspan’s definition of stable prices is an inflation rate low enough, so that it does not impact on the decisions of households and businesses. This will clearly not apply this year as schools around the world are feeling the effects of inflation. The cost of many goods and services is rising while the tight market for teachers and local hired labour is pushing wages up. In this article our Managing Consultant Russell Cooke looks at what international schools need to be doing to ensure good management during these times of rising costs and inflation.
The current situation - It is important to regularly monitor the rate of inflation that your school is facing as this is changing rapidly. For example, the Eurozone annual inflation rate was at 7.4% in March, up from 5.9% in February and 1.3% in March 2021.
In many countries people, businesses and schools are not used to inflation being at these levels (it has been remarkably low for the last 20 years) and no one knows how long the current wave of inflation will last. Some economists believe that the trend could last for years. To understand what the future may hold in your country, examine your local bond market break even rates as these reflect the current thinking of portfolio managers on inflation levels over the next years.
The chart above shows the headline rate of inflation, it also breaks-out what price increases are driving this overall rise of 7.5%. It is important to understand what segments contribute to your costs, in particular we can see that overall inflation is driven primarily by high energy prices and there is generally little expectation that energy prices will remain at these levels for extended periods.
Governments around the world will react to rising prices by raising interest rates. The size of the interest rate increases could be shocking if interest rates were to rise to match the surge in prices. That, however, seems unlikely, as central banks are apparently taking the view that most of the inflation spike is due to factors outside their control, as will be its subsequent fall, should it occur.
This higher inflationary environment raises the likelihood of the following risks:
Raising interest rates aggressively could lead to economic recession in your local economy, possibly effecting your parents' abilities to meet tuition fee payments and putting pressure on schools to keep fee increases below what they need.
Rising interest rates will increase school debt costs
Inflation will pinch profitability (reduce annual surpluses)
So what should schools be thinking about doing to mitigate these risks and address rising costs?
Maintaining your annual surplus - Commercial businesses can react to inflation by immediately raising prices or changing product mixes to maintain margins. Schools do not have this luxury, the majority of schools have already set their fees for next year and will not enjoy higher fee income for at least 12 months. As such, in the short term to maintain surpluses it will be another good time to look at cost-cutting opportunities. In the longer term, during the budgeting and fee setting process, it is important that schools create a buffer to compensate for unexpected inflationary increases in those areas where they could be impacted. (For example, energy costs, home leave and shipping of books and materials).
Work with your partner suppliers - If you outsource your catering and bus services, now is the time to support them. Their costs are also being affected adversely and they will need your help in managing communications with the parent community with regards to immediate increases in fees to maintain the financial viability of their services.
Review your financial aid budget - If your school provides financial aid to families to help them afford your school or to help them through a difficult time, then the budget that you have set aside for next school year may need to be revisited. If your local economy does become more depressed there maybe more applicants for aid and those receiving aid may ask for more money as the value of their income is being eroded by inflation. There may also be a general anxiety from some members of your parent community who pay the tuition fees themselves. They may have set aside money for their children's education, but if school fees are expected to be rising at a rate where these savings are inadequate they maybe considering looking at a lower cost solution or generally worrying about how fees will increase over the next few years.
Manage your staff proactively - During the economic downturn, that was caused by the pandemic, many schools made only minor inflationary increases to their staff pay scales. However, staff will already be noticing some impact from increased inflation on their take home pay and will be looking to their employer for support. Fortunately, with the many years of low inflation, staff have got used to modest pay rises, in a way that they were not 30 or 40 years ago. This means that they do not expect employers to match high inflation with big pay increases. For most staff, that will mean taking the cost-of-living crisis on the chin. This works, of course, for only as long as medium-term inflation expectations remain low or there is no alternative employment offering better pay. Proactively, schools should think about paying a retention bonus, to compensate staff for this hopefully short term inflation so that they hopefully stay at your school. The advantage of a one-off retention bonus as opposed to a pay increase is that it does not add more money to your pay scales that will compound costs over years to come. Also, bear in mind that whatever solution you determine it should be perceived to be fair across local and overseas hired employees. Finally, going forward now is the time to ensure that you have reliable salary survey information which takes into account cost of living differentials. Schools are finding it increasingly difficult to attract and retain good staff. In times of inflation, staff will start to gauge if there are better salaries and benefits at other schools and organisations. As an employer you should be aware of where you stand in the market and be comfortable in articulating this to your staff.
Look after your assets - If you are in the fortunate situation of having cash assets you need to be aware that their real value will be reduced as inflation takes off. With ten years of 5% inflation, cash assets with little or no interest income will have their purchasing power cut by half. The only way to inflation proof cash assets is to invest them somewhere else, where they will earn a better return. To do this your school first needs to decide what investment options it is willing to take. Schools also need to be aware that even the more risky portfolios will not have earnings to keep pace with 5% annual inflation and that asset purchasing power will be eroded. If your school keeps cash assets to cover possible short term liquidity issues, think about investing these assets to inflation protect them and instead arranging a low cost overdraft facility to mitigate any short term cash shortfalls.
Polish up your long term financial plans - A school should have a three, five or even longer financial planning document, which it uses to model strategic decisions and longer term projects. As this school year comes to an end, the final meetings with the Finance Committee and the Board are the perfect opportunity to shape up how this school year is going to end and to put it into perspective of how it fits into the next 3 to five years. This will not only help the Board understand the current situation of the school, but will also build trust that it is being well managed.
Accelerate your capital spending projects - If your school has postponed construction projects because of the pandemic, now is the time to strategically move them forward. If you can utilize your cash (or take out loan finance) and lock in costs now, it will mean that you will beat the inflationary price rises associated with construction. In taking out a loan there is a risk that the cost of borrowing may rise. However, the current levels of interest rates are comparably low and you may be able to arrange a fixed interest rate with your bank. You have a second advantage of undertaking financed construction now, in that in times of inflation the real value of your debt will fall.
Higher levels of inflation have multiple implications which schools need to be thinking about now. Sage Consultancy offers support to international schools in different aspects of finance and operations. This includes the development of forecasts and cash-flows as well as giving strategic advice in these uncertain times.