The summary:
In what may be a sign of tough days ahead for Michigan public schools, the state’s fourth largest school district, the Ann Arbor Public School System (AAPS), recently revised their current year’s (2023-24) General Fund budget to reflect their expectation that expenses will exceed revenues by $6.6 million
This is a $13 million reversal from the budget the AAPS adopted last June that had projected revenues to exceed expenses by $6.3 million (details from AAPS here)
This amended budget, which was adopted by the AAPS Board, would reduce AAPS’ “rainy day savings” (aka its General Fund Equity) to $6 million, which is equal to 2% of its annual budget. The average rainy day savings percentage for Michigan school districts is 20%. (Read here for more explanation and importance of rainy day funds.)
With similarities to the struggles at Wayne-Westland schools (which we analyzed here), this is now the second instance in the last several months where a large Michigan school district revealed that, unexpectedly, annual expenses would exceed revenues by millions of dollars.
With Michigan school districts required to adopt the ensuing year’s budget by the end of June, this leaves the AAPS only three months to identify several million dollars of cost reductions to avoid (or limit) state intervention in district operations which prohibit school districts from operating with General Fund balance levels below zero.
This entry explores the financial dynamics contributing to these events and what AAPS and all Michigan school districts - especially their Boards of Education - can learn from these events.
A Sad Play in Two Parts
Knowing where the figures lead us and their complexity, let's make our entry as simple as possible. Our analysis of Ann Arbor’s financial struggles can bebroken into into two parts:
Part one: From not good to bad in 2023. The AAPS' annual operating shortfall went from a $2.5 million loss at the end of 2022 to a $6.8 million shortfall at the end of 2023.
Part two: From bad to worse. From the adoption of the current (2023-24) budget to now (March 2024). When AAPS adopted the 2023 budget last June it projected that the $6.8 million problem had been solved AND that the finances had improved so much that they expected revenues to surpass expenses by $6.3 million.
So let’s take these one at a time.
The MPSERS Anomaly of 2023
But before we get into the details we need to establish as background an event we can call the “2023 MPSERS UAAL Funding Anomaly”, which you can read about here. Let’s call this the “MPSERS Anomaly.”
The short version (as it relates to AAPS and our analysis) is that in 2022-23 the AAPS received $14.1 million in state aid that they were required to immediately send back to Lansing to pay down MPSERS Debt. Every district received a similarly proportional amount in 2023. If you read the above link, you’ll see that this “revenue” had no positive or negative effect on school districts surplus or deficits. It was a “neutral” financial event because the local districts received the money and were required to send it right back to Lansing.
For this reason, we cannot compare changes in revenue from 2022 to 2023 (or to 2024) without accounting for this anomaly. And the short version of what it means to our analysis is that those MPSERS Anomaly funds did not contribute to AAPS’ operating losses in any way nor did it make anything better. (Hold that through because it comes up again later.) But for now, please know that any school district financial professional would have (or certainly should have) known the intricacies of this issue.
Part One: Ann Arbor's 2023 Expenses and Revenues
Back to our story and isolating how AAPS' $2.5 million loss of 2022 became a $6.8 million loss in 2023.
When backing out the MPSERS Anomaly, from 2022 to 2023 AAPS’ revenues increased by $3.1 million. How? The biggest reason was that the state increased the per pupil Foundation Allowance by about $450. So if AAPS had about 17,000 this alone would have given them roughly $7.6 million more revenue than 2022.
How does the potential $7.6 million increase drop to a $3.1 million increase? Well, the other factors affecting revenue are declining enrollment, lower Federal revenue (as ESSERS/Covid money dried up), and very likely lower state revenue in categories outside the per pupil allowance.
We must also remember to carry over into 2023 the $2.5 million loss from 2022. So if we combine the carryover loss and the newly received $3.1 million increase, AAPS is left with a (quite temporary) surplus of $0.6 million. (Hint: This tells us we already know we have an expense problem.)
So now we move to the expense side and how things changed from 2022 to 2023 when the operating deficit went from a loss of $2.5 million to a loss of $6.8 million:
2022 total General Fund expenses were $295.6 million
2023 General Fund expenses, after we back out the $14.4 million MPSERS Anomaly totaled $303.0 million. This means 2023 General Fund expenses were $7.4 million higher than 2022.
Add the $3.1 million of increased revenue then subtract the $2.5 million loss carryover from 2022 then add the $7.4 million of higher (non MPSERS Anomaly) expenses in 2023 and you have the 2023 deficit of $6.8 million.
AAPS Finances from 2023 to 2024: From Bad to Worse
So a $6.8 million operating deficit served as AAPS' 2023-24 starting point. Not great.
And the headwinds going into the 2023-24 fiscal/school year were clear. Enrollment was still declining (meaning more lost revenue). Legacy structural operating deficits had never been corrected. Federal revenue had returned to its pre-pandemic levels. And on top of all that, in February of 2023, the district agreed to new employee contracts.
It was amid (or right after) all this that the district adopted its original 2023-24 budget that had expected 2023’s $6.8 million deficit to be reversed into a $6.3 million surplus.
Some technical analysis will follow, but let's pause for a moment on this point. Anyone who has had to manage operational budgets would attest to the difficulty of turning that kind of loss into that kind of surplus. And for human resource intensive outfits, like public school systems, anyone with even a little experience should have been unnerved by these circumstances.
This offers our first lessons. If your district's budget development feels too good to be true, it probably is.
Nevertheless, if the AAPS expected that kind of financial turnaround, how would the newly adopted 2023-24 budget reflect it?
The 2024 Projections: Trying to Make Sense of the Inaccurate Forecast
In broad strokes, for a $13 million turnaround, all engines would need to be fired. Increase revenue and and decrease costs. In AAPS' case, the original budget’s expected revenue to increase by $7.8 million and costs to decrease by $5.3 million. Combined, these two improvements would have turned 2023's $6.8 million deficit into 2024's $6.3 million surplus
To even entertain this possibility, we have to take the MPSERS Anomaly issue head on:
If we are gracious enough to accept that the MPSERS Anomaly revenue expectation was an oversight, then we can approximate the expectation of a $7.8 million increase by multiplying the $458 per pupil funding increase by AAPS’ roughly 17,000 students. In reality the revenue calculations are more complex. But for now, let’s just grant that AAPS officials (a) mistakenly carried over the MPSERS Anomaly revenue and (b) that the district assumed that the $458 per pupil increase delivered $7.8 million more in revenue from 2023 to 2024. That’s it for the revenue side.
Starting again with a $6.8 million carry over loss, we add the $7.8 million of increased revenue and we arrive at a baseline $1 million surplus. This means that expenses would need to decrease by $5.3 million. Add those together and we would arrive at a $6.3 million operating surplus for 2024.
Indeed the originally adopted budget expected expenses to decrease by $5.4 million. They expected that Instructional costs (the bulk of which would have been teaching staff salary and benefits) were going to be reduced by $7.7 million and that all their non-instructional costs (combined staff and non-HR costs) were going to increase in cost by $2.3 million. (Figures taken from AAPS' budget.)
But this is where the MPSERS Anomaly explanation gets hard to swallow.
2024 Original Budget Fails the Eyeball Test
Why?
Because the most logical reason why Instructional costs could ever possibly decrease so much ($7.7 million) would be if the MPSERS Anomaly was in fact accounted for and those costs taken out of the budget. Backing out those pass through costs associated with instructional staff would come very close to that $7.7 million.
But that reduction is so large, it would have caused an uproar - probably in the neighborhood of 70 and 80 teachers would have been cut. These are the kind of “eyeball tests” Boards and community members should be looking for in these situations.
Beyond that, I don’t see the benefit of further diagnosis of why the original 2023-24 budget was so horrendously miscalculated. Let's not get lost in the numbers. The district somehow expected a $13 million turnaround...and there's not a peep about cuts?
The number and degrees of the errors in the original 2023-24 budget are too many to capture and the conclusion should be this:
The AAPS must re-evaluate every element of its budget development process and, just as importantly, perform an overhaul of their financial oversight and control mechanisms - because any that were in place completely failed.
Everything should be on the table
Lessons Learned for All Michigan School Districts
On to some key lessons other Michigan Boards of Education can learn from based on Ann Arbor's travails:
Boards must demand that district financial administrators “show their math” for how General Fund budget numbers change from one year to the next and for how - specifically - General Fund budget's are developed. While the process and algorithms can vary in complexity and precision, there’s never a reason to be as far off as Ann Arbor was. Michigan Benchmark can help with our Budget Modeling Service.
Ann Arbor, like others, made the mistake of waiting too long into the new fiscal year to validate their budget assumptions. Too many districts wait until they amend their budget to identify the variances. In Ann Arbor they did not discover the discrepancy until March even though the budget season began in July. Had the Board of Education been receiving proper monthly reporting, they would have seen this issue far sooner. Again, Michigan Benchmark can help with our Budget Navigator Service.
Boards of Education should require that all budget development assumptions are memorialized any time a budget is approved or amended. This too is a good candidate for a Board of Education policy. In this fashion, Boards can assess the variance between the actual figures and the assumptions about enrollment, per pupil revenue, healthcare costs, and other variables.
Both district administrators and Boards of Education should establish policies that define the processes and timeline for budget development, reporting, and validation. With tenure of Board of Education service under constant pressure, communities can lose valuable institutional knowledge that protects against problems like these. Michigan Benchmark can assist with the policies you should have.
Boards of Education should require that the budgets they are asked to approve be presented in both Function and Object views. These are technical terms that we will address in future publications, but the short version is that most districts ignore the Object views, which presents data in more understandable terms such as salaries, benefits, supplies, services, and capital costs. The combination of Object and Function views help taxpayers and Boards of Education visualize district finances in a more useful manner which allows for improved ability to track actual spending against the budget plans.
Human Resources costs account for 75% to 80% of school district General Fund budgets. Boards of Education should receive regular reports on staffing and headcount levels and changes to them from year to year or over the course of a year. These kinds of reports offer another useful control for Boards to discharge their responsibilities.
Boards of Education should keep record of their district’s operational characteristics (e.g. ratio of pupils to teachers). In an ensuing post we will share how Ann Arbor, like many districts, missed the signs that their staff levels were out of alignment with the enrollment. Michigan Benchmark can help with this style of reporting and control as well.
The Buck Stops with the Board of Education
Yes, this is a prime example of hindsight's perfect vision, but for those among us who spend way more time than they are willing to admit studying Michigan school district's finances, this situation should not have been this bad or painful.
The tools and procedures exist to improve your district's financial forecasting accuracy - and we are blatantly offering our services to help.
But more broadly than tools and calculators and reports, situations like this should remind our communities, particularly those willing to serve on Boards of Education in increasingly unpleasant circumstances, that sometimes trustees DO need to dig deeper. They can abide by the adage: trust but verify. Administrators can and do make mistakes. This can happen.
So what's the lesson?
Do we just pay the price, which can mean loss of credibility in our foundational institutions?
Or does your community and your Board of Education take the necessary and prudent precautions that financial projections and budgets must be tested and validated by those entrusted to make decisions about millions of taxpayer dollars and that sometimes Boards of Education need independent eyes to successfully discharge their duties.
At Michigan Benchmark, that's where and how we help.