Unless it has a massive endowment fund, a university's biggest asset is its reputation. If it loses its reputation and students stop coming and paying, a university has only got a bunch of buildings that often aren't well-suited for any alternative use.
That asset is not on the books.
Unless it has a massive debt, a university's biggest liability is the future salaries of its tenured professors. It's hard to just lay them off and stop paying profs if students stop coming and paying for them.
That liability is not on the books.
Even those assets and liabilities that do appear on the books aren't always recorded in a useful way. My university has the campus land valued at what we paid for it in 1947, IIRC.
So take a handful of salt with the balance sheets and income statements that university accountants present.
In my experience (n=1) the Board of Governors and the University Administration are guided by some vague notion of sustainability. "If we keep on spending like we have been spending, are we going to be forced to tighten up our spending some time in the future? If yes, we should tighten a bit now, so we don't have to tighten even more drastically in future. If not, we're doing OK". It's fuzzy, because "like" and "tighten" could be defined different ways. Total spending? Spending per student? Relative to other universities?
Even if we did define "sustainability" precisely, it all depends on what happens in future, which we don't know. What happens if we hire a lot of profs and build more classrooms and residences and then kids stop wanting to go to university? Demographics can give you a good forecast of how many 18-year-olds there will be 17 years ahead, but participation rates are a lot harder. And predicting which particular university will be fashionable for future high school students to apply to is even harder. And government funding, and the fees they will allow us to charge, aren't very predictable either.
Faced with the dark forces of time and ignorance, it is understandable that university decisionmakers (and their critics) should pay too much attention to the pretty, polite techniques of balance sheets and income statements. (That's Keynes, in case you missed the reference.) Or as my mother says, the accountants always end up running things.
So the Board of Governors (unless the debt is "too high") tells the University Administration to bring it a budget with a planned surplus of zero.
Here is an oversimplified model of the problem the University Administration faces when it makes that budget. It needs a name, so I will call it "Duncan's Problem".
[Yes there's a real-world Duncan, a very good VP Finance and Admin who retired recently from Carleton. But this post is about a model with a single decisionmaker personifying what is a more collective process. It's a stick-figure caricature, like all economist's models.]
The first thing that makes Duncan's Problem interesting (to an economist) is uncertainty. Duncan knows what total costs will be for the coming year, because he chooses them when deciding how much to spend. Duncan knows what revenue per student will be for the coming year, because the government tells him what it will be. (Yes dammit, I know that is oversimplified; I'm an economist!) What Duncan does not know is how many students there will be.
Budget Surplus = (number of students x revenue per student) - total cost
The bolded bits are the uncertain bits.
The number of students is uncertain because Admissions offers a place to many more students than will actually come. It's like airline overbooking only more so, and we can always squeeze a few more in if it's really needed. We never know until classes begin how many will actually register and pay fees. And even then, some will drop classes before the Provincial count date that determines nearly half our revenue per student. And we don't know how many upper year students will return. And even when we do actually see a shift in the demand curve, we might not want to adjust the grade cutoff by enough to keep the number of students exactly constant, because student quality matters too.
By the time Duncan knows the number of students, it's too late to revise his choices about total costs. So Duncan knows he cannot hit his surplus=0 target exactly, except by sheer fluke. He will always miss, either above or below.
The second thing that makes Duncan's Problem interesting is irreversible investments. Profs and buildings. It is hard to lay off a tenured prof. It is hard to sell (for a good price) a specialised building in the middle of campus.
Profs and buildings are alike; they both stick around for a long time and are useful for teaching students. But profs and buildings are also different. When you hire a new tenure-track prof, no asset and no liability appears on the balance sheet. Profs only appear on the income statement as an annual expense. Unlike profs, buildings are paid for up front, and appear as an asset on the balance sheet (and any mortgage used to help buy them appears as a liability).
The third thing that makes Duncan's Problem interesting is that new first year students are both an asset and a liability. Most first year students tend to stick around for 4 or so years, so we get 3 or so years of extra revenue past the current budget. That's an asset. But they will need profs and buildings and other expenses to teach them too. (And class sizes get smaller in upper-year courses, so it gets more expensive in upper years than in first year.) That's a liability. That asset and liability do not appear on the balance sheet.
I can't do the math to solve Duncan's Problem formally (nor, I think, can Duncan). But I can sketch out the intuition (so, I think, can Duncan). But it's a hard problem to get your head around, even with my oversimplification.
The first result is that the irreversibility of investment in profs and buildings means it is rational to present a budget based on a conservative estimate of number of students, especially new first-year students. If student numbers come in higher than the budget estimate, you run a surplus this year, but it is easy (and politically popular) to hire more profs and build new buildings to bring down that surplus in future years. If student numbers come in lower than the budget estimate, you run a deficit this year, and it is hard (and politically unpopular) to lay off profs and sell off buildings to bring down that deficit in future years. There are only so many expenses you can easily cut quickly, and you might not want to cut those expenses any more. Duncan's loss function for missing his surplus=0 target ends up looking asymmetric even if it starts out symmetric.
The second result is that what look like budget surpluses really aren't budget surpluses. It's just an artefact of GAAP, and some assets and liabilities not being on the books. Because new first year students are a future liability as well as a source of current and future income. We have an obligation to teach them in their second, third, and fourth years. And those upper years cost more than first year. (Revenue goes up a bit too, given the provincial formula, but not as much as costs).
Mum and Dad are expecting a new child, and carefully budget including the baby bonus. The new child turns out to be twins, the baby bonus doubles, and so they now have a surplus. The older kids argue that Mum and Dad can now afford to pay them more pocket money, just like if they had found a surplus behind the sofa cushions. But if Mum and Dad are sensible they stick the surplus in a fund to cover the extra expenses for the extra kid.
The third result is that the budget problem for a growing university is qualitatively different from the budget problem for a static or shrinking university. If the university is growing quickly enough on average, the irreversibility constraint is never binding. It is always hiring new profs and building new buildings; the only question is how many and of what type. And because it is an easier problem, both theoretically and politically, it creates an additional incentive for university administrations to want to grow their universities. The planned optimal size of the university is always at least as big as its current size, and never smaller. There's a one-way upward ratchet effect.
The fourth result is that there's a "Peso Problem" in adding up budget surpluses over time. Since Duncan rationally plans his budget with a conservative estimate of the number of students, you might think that surpluses would be positive on average. That will only be true for small samples that include only "normal times". If and when there's an enrolment "crisis" -- if student numbers drop below expectation by a large enough amount, so the irreversibility constraint is strongly binding ex post, the Board of Governors will be forced to temporarily allow a planned deficit. Because it's hard to reduce the number of profs and buildings in line with reduced student numbers. You have to wait until the profs retire or student numbers recover. So in normal times there are small "unplanned" surpluses on average, but when a crisis hits there is first an unplanned deficit, followed by a few years of planned deficits, followed by a few years of planned surpluses (to reduce the debt), then back to normal.
I wish I could get my head around the implications of the fact that buildings and their mortgages are recorded on the books as assets and liabilities, but profs aren't. Even though both are irreversible investments. But I can't.
[My previous post on university economics "Confessions of a Central Planner" was better than this one. It dealt with the cross-section "Micro" resource allocation problem. This one deals with the time-series "Macro" resource allocation problem.]