More than one in ten further education colleges is now in "inadequate" financial health, according to a new report by the spending watchdog.
Responsibility for funding further education colleges is split between the Department for Business, Innovation and Skills (BIS) and the Department for Education (DfE).
Colleges are granted significant freedom to manage their own affairs, but the BIS-sponsored Skills Funding Agency (SFA) oversees the financial health of the sector, while Ofsted assesses the quality of education.
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In a report published on Monday, the National Audit Office said the financial health of the FE sector had been "declining since 2010/11", and called on both departments to come up with a more "strategic" approach to tackling the problems facing colleges.
"In 2013/14, the sector was in deficit for the first time and 110 colleges recorded an operating deficit, up from 52 in 2010/11," the watchdog said. "In the same period, the number of colleges assessed by the SFA to have 'inadequate' financial health rose from 12 colleges (5% of colleges) to 29 colleges (12%)."
The NAO said that the deterioration in the sector's finances had been "quicker than indicated by colleges' plans" and warned that the number of institutions struggling financially looked "set to rise rapidly".
"Reductions and changing priorities in public funding, falling numbers of 16- to 18-year-olds, and more competition from schools and universities have combined to create a challenging educational and financial climate for many colleges," the report said.
While the NAO acknowledged that struggling colleges had taken "tough decisions to avoid financial difficulty", it found that some had been overly-optimistic about their financial prospects, and said the SFA's formal interventions – triggered once a college is deemed to be in trouble – had "often lacked sufficient impact".
"Colleges said they have generally found the SFA helpful and supportive, but the effectiveness of intervention at this stage can be hindered by: the ability of college management teams to prepare robust recovery plans; the change-management skills within management teams and governing bodies to address problems; and the SFA's capacity to judge, with the limited resources that it has, whether a college's recovery plan will be sufficient to put it on a sustainable footing."
The NAO calls on BIS and the DfE to come up with a more joined-up approach to the "fundamental structural problems" faced by the further education sector, and says the SFA must get better at identifying problems "at an earlier stage".
The report says: "BIS and the SFA have taken steps to improve their analysis of risk in the sector. Also, the introduction of a Further Education Commissioner has filled a significant gap in the intervention arrangements.
"On their own, however, these actions are not likely to be sufficient to address a growing structural problem. BIS and the SFA now need to take a more strategic look at the implications of rapid growth in the number of colleges in poor financial health, bearing in mind that without advances of funds and additional grants some would be in an even worse position.
"What is needed is a more comprehensive and enduring approach. Without this, the oversight and intervention arrangements for further education cannot yet be regarded as value for money."
Meg Hillier – the Labour chair of parliament's Public Accounts Committee – described the NAO's report as "deeply alarming" and said the sector appeared to be at risk of "financial meltdown".
She added: "Too often further education is seen as the Cinderella of education when the reality is that it plays a vital role in equipping young people and adults with the skills to contribute to a growing economy.
"The FE sector must be put on a more stable financial financial footing. The independence of FE colleges doesn't mean the Department and the SFA can abdicate their responsibility to get best value for the taxpayer from the public funding to colleges."
Martin Doel, chief executive of the Association of Colleges, said the sector had been "battered by a swathe of funding cuts over recent years".
"Whilst the further education sector is resilient, it cannot endure anymore cuts without impact on the local communities it serves," he added.
"Today, we’ve noted the government’s area reviews of post-16 education and training which we hope in turn will bring greater security to the sector."
A spokesperson for BIS said the government was "committed to developing a further education system which creates a productive, innovative and competitive workforce for the 21st century."
The spokesperson added: "The NAO report correctly highlights where we have already taken action to provide young people with the skills they need and to deliver greater value for money within the sector.
"Furthermore we are already implementing many of the report’s recommendations and will be going even further to strengthen the system by giving local areas a greater say over how and what young people are taught.
"These ongoing reforms are focused on achieving the best return on investment and we will provide an additional £25 million this financial year to help support the creation of 3 million apprenticeships by 2020.
"Only by providing businesses with the skilled workforce they need can we boost economic growth and drive productivity and prosperity for the whole country.”
SFA accounts qualified
In a separate report published on Monday, the NAO also confirmed it had qualified the 2014-15 accounts of the Skills Funding Agency because of an "irregularity of expenditure" in the way it had allocated capital grants to colleges.
The watchdog found that the agency's College Capital Investment Fund (CCIF) had made £49.9m of payments "in advance of need", in spite of government-wide guidance prohibiting such practice apart from in exceptional circumstances.
"The agency did not seek approval before making these payments," NAO chief Amyas Morse said. "It subsequently sought retrospective approval from HM Treasury and this was refused on the grounds that the agency had not sufficiently demonstrated the benefit or value for money from making these payments."
According to the NAO, the payments were made to colleges before responsibility for FE capital funding was transferred to local enterprise partnerships in April. LEPs are overseen by the Department for Communities and Local Government.
Responding to the NAO's report, the SFA said it would be launching a review of its financial management arrangements.
A statement from the agency read: "The NAO has said that our accounts have been properly prepared and show a true and fair view, and that except for the capital grant payments, in all material respects the expenditure and income of our accounts has been used for the purposes intended. There is no suggestion that these payments were not for agreed capital programmes.
"We will be commissioning reviews of our internal financial management and control arrangements and the compliance by colleges with the financial programme management arrangements for the CCIF. If this review identifies that colleges secured funds in advance inappropriately the SFA will, as is our normal process, seek to recover those funds."