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An institution is being managed on a sustainable basis if, taking one year with another, it is:
- recovering its full economic costs across its activities as whole, and
- is investing in its infrastructure (physical, human, and intellectual)
- at a rate adequate to maintain its future productive capacity appropriate to the needs of its strategic plan and the requirements of students, sponsors and other customers.
For an activity to be sustainable, resources must be identified to meet the full costs in the long run:
- Maintenance of infrastructure
- Cost of capital and forward investment for innovation.
The issue of sustainability arose from concern about under-investment in the HE sector. Whilst the day-to-day Direct and Indirect costs were being met from various income streams, it was apparent that insufficient money was being invested in the sector’s physical infrastructure.
Sustainability in infrastructure is about operating a reinvestment policy that does not lead to (say) half of the institution’s premises becoming obsolete all at once.
The cost of capital covers the financing costs of the institution, covering the existing costs of borrowing (ie interest) and the opportunity cost of institutional net assets.
In addition, there is an element for forward investment in innovation, providing a small surplus for the rationalisation and development of the institution’s business and capacity.
Most HEIs have not costed adequately for the infrastructure and capital costs, and TRAC requires a method that is consistent across the sector. This replaces the relevant figures as reported in the annual Financial Statements (eg depreciation, interest) with TRAC-based figures. This can lead to significant adjustments to the institution's costs. These TRAC-adjusted costs are the basis of Full Economic Costing.
Institutional strategy for sustainability
There are five key requirements for securing the financial sustainability of institutions and their activities (teaching, research, etc):
- Establishing and recognising the full economic costs of activities
- Managing the activities strategically
- Securing realistic prices from public and private funders (Costing and Pricing)
- Improving project management and cost recovery
- Investing in the institutional infrastructure
Excerpt from TRAC Vol II c7
Capital infrastructure costs
Under present accounting standards, institutions are required to account for their infrastructure either on a historical cost or valuation basis, but this rarely covers the full economic costs of their premises or equipment. It is important that costs reported under the Transparency Review reflect the full long term costs of maintaining the institution’s infrastructure in a safe and productive state, and to a standard that reflects the norm required to be competitive in the sector.
Cost of capital employed
All businesses need to cover the cost of financing and to generate a minimum level of retained surplus to permit rationalisation, updating and development.
In economic theory, these surpluses are part of the costs of financing the business. The term ‘cost of capital’ is generally used to describe the total of these costs (covering both loan and equity capital: and represented through interest, dividends and retained surpluses).
These are legitimate costs of running a business, and are accepted under the Government Accounting Conventions (GAC) for this reason. The aim of the GAC profit formula when applied to private contractors is to give them a fair and reasonable profit based on a return on capital employed comparable with British industry.
Under the Transparency Review the term ‘cost of capital employed’ (COCE) is used to cover:
- the surpluses required for rationalisation, updating and development
- the costs of raising and servicing capital, including short-term borrowings
However, ‘cost of capital employed’ does not cover the costs of maintaining of depreciating assets - this is part of the adjustment for infrastructure.