The Hidden Economics of Independent Schools

Quite some time ago, a boarding school that had fallen on hard financial times was in search of a new head of school. One of the finalists was looked at with suspicion by much of the faculty. Though he had spent the first 12 years of his career at independent schools, he spent the next 10 in the for-profit sector. At a faculty town hall during his finalist visit he was asked/told, “You do understand this is a school and not a business?”  

I think – I hope – we’ve come a long way since then and there is more appreciation that schools are businesses and their ability to sustain reasonable financial margins is what allows them to continue their impact. Yet, far too many schools have no idea what the margin is on any particular division, program, or activity. The reality is that the economics of schools are wrapped in a complex web of hidden cross subsidies.  

As schools work on eliminating budget gaps, a common approach is to see if all divisions, programs, and activities can trim a bit or keep their budgets flat for the coming year. The challenge with this approach is that there are deeper investments that genuinely need to be made in some areas while other areas should be significantly cut or eliminated. This too often doesn’t happen because schools organize their finances around broad categories (instruction, administration, facilities) rather than specific activities or divisions.

The Broad Category Approach

This broad category approach creates blind spots:

• Entire divisions that may be operating at a deficit while being subsidized by other parts of the school
• The program started as a revenue generator actually becomes an expense or at best simply breaks even and doesn’t get sunsetted.
• Because cost increases in a given area have advanced well beyond inflation for years what once seemed to be a reasonable expense no longer is so. 

Why Cost Accounting Matters

Cost accounting is simply the process of tracking and analyzing all costs associated with running a particular activity, program, or division. Implementing proper cost accounting doesn't mean abandoning mission-driven programs. Rather, it provides transparency that allows for intentional decision-making:

1. Conscious subsidy decisions: A school chooses to cap the cost of a popular long running spring break trip intentionally subsidizing it to help keep down the cost for all families.
2. Resource optimization: Understanding true costs allows reallocation of resources to maximize impact.
3. Pricing accuracy: Programs can be priced appropriately when all costs are considered.
4. Strategic planning: Long-term sustainability requires clear understanding of financial realities.

Making Sense of Expenditures:  A Few Examples

Consider these scenarios that schools discovered through improved cost accounting:

• A boarding school found its dining services was operating at a 15% deficit when accounting for equipment depreciation, utilities, and administrative support—costs previously absorbed into general operations.
• A day school's summer camp appeared far more profitable than it was until allocating its share of summer security, summer cleaning, insurance, and its administrative support from HR to payroll to marketing – all costs that had previously been absorbed into general operations.  
• A preK-8 school discovered its middle school division required a $4,500 per student subsidy from other divisions due to high tuition discounting, low enrollment and specialized programming. 
• An annual spring musical at a 7-12 school, despite charging for tickets, was losing $13,000 annually when accounting for all production costs, marketing, and staff time.
• A K-12 school discovered its upper school substitute costs were 2.5 times higher per faculty member than the lower school. (Note: They also discovered this was due to the fact that the lower school director was filling in for teachers to keep down costs at the expense of her other work.)
• A school discovered that its after school programming for neurodiverse learners was making a contribution to overhead at twice the level of its after school rowing program.
• The spring gala and auction to raise money for the school only broke even the past two years even though it was the “biggest” fundraising event each of those years.

Implementing Cost Accounting: A Cultural Shift

Moving toward accurate cost accounting represents a significant cultural shift. Initially, there is a fair bit of work to set up the new model. People will need to really think about how they use their time and for what, something that isn’t closely tracked in schools. Many people in the community don’t understand overhead costs and those costs don’t make it into their thinking when planning new programmatic plans or assessing current work. It can be shocking when real costs are revealed. Here are some things to keep in mind as you move to getting a better handle on your school’s finances.

1. Frame it positively: This isn't about cutting programs but about making informed decisions that strengthen the school's overall health.
2. Start small: Begin with one division or program to demonstrate value without overwhelming the community. 
3. Remember, perfect is the enemy of the good: Avoid getting so caught up in the exact allocation of someone’s work – is it 9% or 14% to a given program – that you never get to implementation. Refine allocations over time. Get as close as you reasonably can and then move on. You are trying to get to the point of sensemaking. Generally speaking, does it make sense to continue to do X, Y, or Z?
4. Involve stakeholders: Include division heads and program directors in the process so they understand the purpose and can provide contextual information. 
5. Use the right tools: There is plenty of financial software out there that can simplify the process of allocating shared costs.

Leadership and the Board: Avoid Willful Ignorance

Improved cost accounting doesn't diminish a school's commitment to its mission—it strengthens it by ensuring financial sustainability. Not understanding the true economics of operations means schools cannot make informed choices about which programs to subsidize, which to adjust, and which might need reimagining. When a school chooses not to get a better handle on its financial operations – particularly a school with real financial challenges – it raises a serious question: Is the board delivering on its fiduciary responsibilities? 

No doubt, boards may ask for some level of cost accounting from their heads of schools and CFOs only to be told that to provide such information is beyond the time available to undertake the work or the skills of the current business office team. If that is the case, this is when boards need to provide the support and resources necessary to take on such work. Many board members come from business backgrounds and can provide valuable guidance on implementing activity-based costing methods. Independent school financial consultants can be hired on a project basis to assist.  

Making a switch to cost accounting can be a time consuming process, but the most mission-aligned schools are those that can maintain their values while ensuring long-term financial health. Cost accounting provides the clarity needed for both.