Staying solvent: as more and more districts face serious financial problems, it is important to understand how the decisions school leaders make every day have lasting economic impacts on their districts, and to recognize the signs that may predict failure.

More and more school districts each year are facing financial challenges for myriad reasons. One of the most pervasive among these reasons is the condition of California's economy; school agency fortunes must inevitably rise and fall in tandem with those of the state. Add to this the economic realities of the state budget, low cost-of-living increases and increased costs for maintaining the status quo for programs, and we believe that a large number of districts will face serious financial problems and, without effective and informed leadership, the possibility of fiscal insolvency.

The number of qualified and negative certification districts has grown substantially in recent years and will likely double during 2003-04. A qualified certification means a district may not be able to meet its economic commitments for the current and two following years; at the time of certification of the 2002-03 Second Interim Report, 56 districts were qualified. A negative certification means a district will not be able to meet its obligations for the current and one additional year; the 2002-03 Second Interim certifications showed that eight districts were negative. If a district submits a positive certification, the county superintendent has responsibility for review and must lower the certification if it is not supported by the financial data.

Although district finances are heavily dependent upon the statewide economy, many financial failures are caused by factors unrelated to the fiscal health of the state of California and are predictable well in advance of the actual failure. School boards, superintendents and other staff members make decisions every day that have lasting economic impacts on the district. We will discuss some of these conditions and, more importantly, how to avoid them.

Indicators of emerging problems

Over a period of many years, a collection of indicators has emerged that are common in districts experiencing financial distress. No single district experiences all of the indicators simultaneously; however, some collection of the following list of problems routinely exist in troubled districts. FCMAT offers the following list of problem indicators on its Web site, www.fcmat.org:

* Poor leadership

* Ineffective communications

* Flawed budget development processes

* Lax budget monitoring processes

* Lack of controls on positions

* Inaccurate management information systems

* Lax monitoring of categorical programs

* Pay raises over COLA

* Poor management of long-term debts 

* Personal and professional attacks

* Exits by staff and students

* Lawsuits

* Employee group unrest

* Community misperceptions

We believe comparison to this list provides a very accurate first impression of the general condition of the district. It should be noted that many of these factors are not financial indicators per se, but lawsuits, personal attacks and employee turnover provide a breeding ground for problems that will sooner or later find their way to the financial statements.

For characteristics of districts that are failing financially, see box above.

Characteristics of successful districts

Another way to assess the propensity for financial problems is to look at four fundamental areas that well-managed districts get right. We think the organization can be analyzed by looking at leadership, people, systems and resources. They are presented in order of importance below.

** Leadership

Leadership is the first and most important element of organizational financial success. The leadership qualities found in failing districts are often very different than those in successful districts and may aid in the eventual demise of fiscal health. In successful districts, the leadership team sets standards that define what is acceptable within the organization and those standards become part of the culture of the district. Standards become well known and are self-policed by everyone in the organization.

Well-led districts also engage in strategic planning, which results in a road map to guide both operational and financial decisions. Good, acculturated standards and well-laid plans provide well-led districts with a continuity of purpose that is often lacking in troubled districts.

Finally, integrity and ethics are valued in every aspect of district operations. People are rewarded for identifying problems early and reporting them while they are still manageable. They do not fear breaking bad news to district leaders and are not tempted to cover up or avoid problems.

** People

Competent people are the heart and soul of any organization. Competent employees with integrity, energy, enthusiasm and motivation are a must to ensure the fiscal health of a district. Financially failing districts often lack these employees or do not listen to them. In order to have competent employees, districts must create a shared vision and a sense of purpose in each and every employee. School districts should have only two kinds of people: teachers, and people who support teaching. Staff development is essential to ensure all employees are engaged in a meaningful way with the fundamental mission of the district.

** Systems

Systems provide good business practices and accurate and timely financial information that is critical to staying out of financial trouble. It is important that systems be designed to minimize mistakes, maximize productivity, and allow processes to produce good products with little intervention.

Systems failures, both automated and manual, have often accelerated the fall in financially troubled districts. The district may have multiple systems for financial information, student records and attendance, human resources, payroll, position control and other ministerial functions. When these systems fail, the district finds itself acting on inaccurate information, often at the very time that accuracy is most critical.

** Resources

"Resources" is the final assessment area, and we think it deserves a lower priority than the others. Giving more resources to districts that have poor leadership, an unstable workforce and poor systems and accountability rarely solves problems. In fact, an abundance of resources can serve to mask pervasive problems until it is too late. In contrast, well-managed districts do tend to manage in a way that minimizes the occurrence of career-ending financial surprises.

In well-run districts, for example:

* Budget cuts are made when necessary to avoid deficit spending and the erosion of reserves.

* Early action, however painful, is taken to ensure the district spends only what it has.

* Enrollment and average daily attendance are estimated accurately and revised often to ensure revenues and staffing are not overstated.

* Settlements with employee bargaining units represent a sharing of available resources, and no more.

* Position control is effective in limiting staff to the number that can be supported by the budget.

* Class-size and enrichment programs are geared to the needs of children, but are prioritized to fit within the budget.

* Facility needs and funding are anticipated and do not deliver surprises to either the instructional program or the budget.

* Cash is King, and the district ensures that it has an adequate supply of cash on hand to meet its obligations as they mature.

* Good communication keeps parents and employees informed as to the financial condition of the district and helps get cooperation in creating realistic expectations.

Solutions and available assistance

The state's budget crisis has left school districts responsible for all or nearly all of annual cost increases with negative revenue changes. There are ways districts can control, reduce, shift or share costs, but many districts don't know how to structure changes or to negotiate those changes with unions. Those that fail to do so will face the possibility of becoming wards of the state.

But help is available for those who seek it. The first and primary source of assistance is the county office of education. There is nothing the COE likes less than to see a good district go under; it will do all it can to help--and its assistance is generally free. The COE may feel that additional resources are needed and may ask FCMAT or another consultant to augment the recovery effort. FCMAT can be contacted either through the COE or directly by the district.

ACSA, CSBA and CASBO can help with leadership, policy and staff development issues. And it may be that a private consultant can provide the specialized services needed to correct the problem. In any event, help offered in the early stages of intervention is the least intrusive. For those who are quick to assess their problems, the solutions are more numerous and flexible.

If a district reaches the point where it has a qualified certification, the COE may appoint a fiscal advisor or fiscal expert to assist the district. If the certification is negative, the COE will appoint a fiscal advisor. At this point, the problem is critical, but generally can he solved with quick, decisive action. Interventions tend to be more intrusive in this phase, but the solutions can still be collaborative.

As you can see, there are plenty of warning signs and avenues for assistance before a district "goes down for the count." Be sure to take advantage of the ones you need as early as possible.

What if the problem is not solved?

If, for whatever reason, the problem is not solved and you need a loan from the state, your problems are just beginning. First, under AB 1200, a loan of any amount will result in some loss of local control. If the loan exceeds 200 percent of the required reserve, a state administrator will be appointed and the board will lose all powers, authority and compensation. The administrator assumes the combined responsibilities of the superintendent and board and will have broad discretion to run the district.

After the district has stabilized, or if the loan is smaller, a state trustee will be appointed instead of a state administrator. A trustee has the power to stay and rescind any action of the board, but the board retains its powers and the trustee generally does not assume the day-to-day responsibilities of the superintendent.

Either way, a state loan will cause the board to lose the authority to select an independent auditor. The audit will be performed by the state controller, but at district expense. And the district will have the unpleasant task of budgeting the repayment of the loan, often for many years into the future.

In the end, all of the difficult actions necessary to solve the problem will be taken--if not by the present board and administration, then by those who succeed them as the problem escalates.

Children bear brunt of burden

Over the years, a number of California's school districts have failed to operate within the constraints of their financial realities and have received loans from the state. With those loans comes semi-permanent state oversight that may include setting aside the powers of the board and replacement of the superintendent and senior staff. Invariably, the brunt of the burden is borne by the children within the community, who, for perhaps a full generation, receive less than their due because of the need to make payments on loans that represent the sins of the past.

We predict that the Legislature will be asked to grant additional loans (plural) this year. It is our hope that we have stimulated some thoughts that will result in early actions so your district will not be among that number.

CHARACTERISTICS OF FAILING SCHOOL DISTRICTS

In a typical district that is failing financially, we often see the following picture:

** A breakdown in leadership that affects the board, the superintendent, the staff and the community.

** Rapid turnover of key personnel generally resulting in an erosion of competence.

** Collective bargaining settlements that are far beyond the norm in terms of cost and that cannot be sustained without budget and program cuts.

** A breakdown in systems and business practices that results in major breaches of effectiveness, efficiency and internal control.

** Overly optimistic projections of enrollment, average daily attendance and revenues.

** Inaccurate budgeting and poor financial planning.

** Poor or non-existent position control resulting in staffing levels in excess of budgeted dollars.

** Poor financial reporting and flawed decisions based upon that faulty information.

** A reluctance to get help early or a denial of the seriousness of the problem.

** A blaming mentality that destroys confidence and divides the leadership team.

** And, finally, an undeniable cash crisis that brings the whole mess to light.

Remember, not every troubled district has all these characteristics, and some well-run districts have a few of them from time to time. But if your district seems to have more than its share, it is time for early action.

Ron Bennett, president and CEO of School Services of California, has been the chief business official for Long Beach Unified School District, Fresno Unified and ABC Unified School District. As president of SSC, Bennett focuses on position control, staffing, financial comparison and negotiations issues.

Joel Montero is deputy executive officer for the Fiscal Crisis and Management Assistance Team. He is responsible for the oversight of FCMAT operations including AB 1200 / management assistance, professional development, California School Information Services, the Educational Data Web site and more.

John Gray is director of management consulting services for School Services of California. He conducts fiscal health analyses; performs multi-year financial projections and school district efficiency studies; and conducts internal control reviews, district office organization reviews and Associated Student Body fund reviews.