Harvard issued its yearly budgetary look back this week, detailing in its annual financial report solid progress in strengthening the fiscal foundation of the University, even as it moves ahead in priority areas, including financial aid, House renewal, and online education.The Gazette sat down with Executive Vice President Katie Lapp and Chief Financial Officer and Vice President for Finance Thomas Hollister to talk about the 1 percent, $62 million surplus — a nearly balanced budget — at the fiscal year’s June 30 close, and the mix of positive and negative trends that made up that number.GAZETTE: What are the major highlights of this year’s report?HOLLISTER: First, we had what is essentially a balance between revenue and expenses. We had a 1 percent surplus, which is a good thing, far better than a 1 percent loss. On a $4.5 billion budget, with a lot of moving parts, it’s not easy. The net assets of the Harvard Corporation, which are in effect the University’s net worth, went up $1.4 billion, or 3 percent, from $43.2 billion to $44.6 billion, and that was driven by [The Harvard] Campaign gifts and pledges. The campaign was a wonderful contributor. We’re very fortunate to have so many caring and generous alumni and friends of the University.LAPP: With the good news, particularly on the campaign, we also have to keep in mind that many of our traditional revenue sources are under constraints. Tuition, obviously, can’t just continue to go up at significant rates, because people can’t afford it. Our federal-sponsored research dollars actually declined this year by 2 percent. That was offset by an increase in nonfederal sources, thanks to our efforts to diversify our revenues. The capital markets, obviously, are also quite volatile. While we are cautiously optimistic about how things are proceeding for the University, at the same time it does require continued efforts to contain growth in our expenses.GAZETTE: How does this year’s report compare to last year’s?HOLLISTER: The operating surplus was up, from $22 million to $62 million.GAZETTE: For years, Harvard has been facing financial pressures that are common across higher education. What are those challenges, and have they changed in the last year?HOLLISTER: Some historical context might be helpful. After World War II, higher education in this country was a growth industry, and there were many golden years. That has changed because, as Katie points out, tuition is increasingly difficult for households and students to afford. Federal research spending looks to be pretty flat. The capital market outlook is not robust, and thus the constrained revenue environment — our revenues were up 3 percent this past year — is a reality facing every university and college in the country. That is why Harvard is blessed to have so many generous donors. The endowment earnings, and current gifts from the campaign every year help to make up for the lack of funding from other sources.LAPP: What I found interesting in this year’s report is that, over the last several years, we have looked at diversifying our revenue sources so we’re not as dependent on federal research dollars, which are going down. But as I just mentioned, our nonfederal research dollars are going up. The other area where we saw an increase was our continuing education and executive education dollars — about 7 percent. We’ve expanded capacity at the Business School, with Tata Hall, the new executive-education building, coming on line a year ago. The Division of Continuing Education is expanding its offerings. We also have HarvardX and edX and a hybrid online degree at the [T.H. Chan] School of Public Health. Clearly, the Schools are thinking, the University is thinking quite broadly about how to increase revenue sources to allow us to support our mission of teaching and research.GAZETTE: You mentioned HarvardX and edX. Those are University priorities but not revenue-positive yet, are they?LAPP: Not at the moment, but we’re certainly learning a lot from those two endeavors. How does online teaching and learning happen? How can we use what we learn in our online courses to improve the teaching that happens in our classrooms? What can we do to get knowledge created here out into the world and perhaps make revenue at the same time?GAZETTE: Why don’t we talk a little a bit about the endowment? The results, which we’ve already seen, show that the endowment went up 5.8 percent.HOLLISTER: Our endowment is a great blessing, but it’s also a challenge because history has proven that the results can be volatile. One question we often get is: “If Harvard has such a large endowment, why do we still have to watch our pennies?”The endowment plays two critical roles. First, it’s 35 percent of this year’s revenue, so it’s a great resource for us in the present. And yet we have an intergenerational obligation to preserve that purchasing power for future generations. We all stand today on the shoulders of John Harvard and so many other donors. Consequently, the endowment is not a $38 billion checking account. It’s really not even a single endowment. There are actually more than 12,000 individual funds in the endowment. The donors expect and require that their original principal be maintained — in many cases into perpetuity — for purposes they chose. So, even though we have $38 billion, and it plays a huge role today, preserving it for the future is part of our fiduciary responsibility.GAZETTE: So there are constraints to guard the future of the institution, but aren’t there also constraints on how the money can be used today?HOLLISTER: Seventy percent of our endowment is restricted by the donors’ intentions, and we are obligated to put the money where they want it. It may be aimed at one particular research project or some other initiative and can’t be used in some other category. I think the popular press has misunderstood: “Harvard has all this extra money that Harvard can use at any time for any purpose.” It’s not the case.GAZETTE: How has the campaign influenced Harvard’s financial picture?HOLLISTER: Well, 10 percent of our revenues come from annual donations for current use by our alumni and friends. In addition, this past year the net assets of the University went up $1.4 billion. The increase arose from new donations, pledges, or earnings on the endowment in excess of the distributions. So those increasing resources — both for current use and for the future — were driven by the campaign.GAZETTE: Let’s talk about the expense side of the ledger. How have we done with expenditures? What does the financial report show?LAPP: Expenditures went up 4 percent over the fiscal year, and 50 percent of our costs are related to salary and wages, including benefits. Salary and wages went up 5 percent, and benefits went up 4 percent. Of that 4 percent, the active health care went up 6 percent, so obviously there’s pressure there. Some of the increase, in terms of salary, wages, and benefits, had to do with hiring more people in areas where investment was needed, for example our online initiatives and new programs supported by the Campaign.HOLLISTER: Select academic expansion as well …LAPP: … And particularly in IT. We rolled out a new student information system, for example, so we had to hire people to help with that. However, the balance of it was increases in wages as well as benefits for existing employees.GAZETTE: Is there much flexibility in that half of the budget related to personnel costs?LAPP: Obviously, we have to continue to monitor personnel costs and make sure we hire people who are either generating revenue or are related to specific expansions we want to undertake on the academic side or administrative side of the University. So, Tom and I — and others across the University — watch the hiring numbers very closely to make sure that we’re not incurring costs that we can’t sustain.HOLLISTER: That’s a key message for all of us who care about Harvard, and it’s true for any university or college. In this constrained revenue environment, we all need to pay attention to costs of all kinds.GAZETTE: What about growth areas, initiatives that the University is undertaking?HOLLISTER: One entrepreneurial example is in the area of continuing and executive education. Our activity in that area is two or three times that of other comparable universities.LAPP: One of the other exciting things we are working on is the John A. Paulson School of Engineering and Applied Sciences. Thanks to his generous gift of $400 million, we’re now underway planning a full expansion of the School. We are working on the design of the new building that we’ll be constructing for the School in Allston starting next year.GAZETTE: House renewal clearly has been a big focus of the University. Where are we with House renewal?LAPP: The Dunster House renovation was on time, on budget. I think anyone who goes through that House is amazed at what has been achieved … and we’ve also done Stone Hall. We’ll start next year on Winthrop, with full renovation of that House and continuing through the Houses. We’re trying to make sure that the renovations are achieved as soon as we possibly can.GAZETTE: And Smith Campus Center …LAPP: Very exciting. We just finished all of our approvals for the city of Cambridge, and we’re on schedule to start construction next spring. There’s work going on right now on the façade of the building, but the true Campus Center renovations and alterations will happen over the course of 2016 and 2017, with the goal to open in the fall of 2018.GAZETTE: We talked earlier about the broader pressures affecting higher education, and I wanted to follow up on that and ask whether those are changing at all?HOLLISTER: I don’t think so, I think the near-term and even the mid-term outlook for revenues — for the reasons we described — are pretty constrained. I believe the universities that will outperform others are the ones that make wise choices with resources in a constrained environment. That means paying attention to where we spend every dollar, not waste any, and make sure it goes into the core academic and research mission of the University.GAZETTE: That doesn’t mean we don’t spend more money, but we make sure it’s spent on the University’s priorities, like edX and some of other things we’ve already addressed?HOLLISTER: The greatness of Harvard begins and ends with its faculty and its students. From a priority standpoint, from a mission standpoint, we need to support the faculty with resources and endowed chairs and other monies in order to do research and teach and change the world, which they do so well.We also have this remarkable commitment to affordability to the most promising students from around the globe. This past year, close to 60 percent of undergraduate students received grant aid. Those who received aid paid on average $12,000. In a time of concern about affordability and student debt, in many ways Harvard continues to lead the world in this category.LAPP: When the financial aid initiative was introduced in 2004, we spent $73 million. Ten years later, we spend $170 million, and that’s just for undergraduates. If you take all of the aid for undergraduates and graduates, you’re talking north of $500 million, a significant investment. It is important to the institution to attract the best students for our faculty to teach, which they have been doing — led by the president and the provost — using innovative teaching and learning methods.We have the HILT initiative [Harvard Initiative for Learning and Teaching], funded by the Hauser family, that has been doing wonderful things throughout the University. You can overlay HarvardX and edX, which have really engaged and catalyzed new thinking by our faculty on how to teach differently and better, whether it be to people around the world or to our students in a flipped classroom. It’s really been amazing. I’d say over the last five years the conversation around teaching and learning and innovation on this campus has just been fascinating.GAZETTE: How does the financial aid program dovetail with the University’s priority to increase economic accessibility for students who are qualified?HOLLISTER: It goes to the heart of it. If students on financial aid pay an average of $12,000 and the University underwrites some part of the cost of attending — on a sliding scale — even for middle-income families, up to $150,000, that’s a very substantial commitment. Also, considerable numbers of undergraduates in families with incomes above $150,000 receive aid based on their individual circumstances. Harvard is, in many ways, more accessible and affordable than any private university in the world.GAZETTE: While we’re talking about expenses, where do institutions like Harvard’s museums, libraries, parks fit in?LAPP: Universities, including Harvard, make their collections available to the public to enjoy as well. The Harvard Art Museums, for example, is just a wonderful jewel, not only for our students and faculty who do research on our collections, analyze, and write about them, but it’s also a wonderful asset for Cambridge and the Greater Boston area. People come from all over the world to see our collections. I think that holds true for libraries as well. We also have a responsibility to the city of Cambridge and to the city of Boston, where our campuses are located, to contribute to the public realm in the communities that surround us. So we do maintain parks, we do open our Yard to the public to come and sit in the chairs, to enjoy the Science Center Plaza, to stroll the grounds of the Arnold Arboretum. We feel that is part of our responsibility as a neighbor.GAZETTE: What would be an example of that, of Harvard reaching out into the community itself?LAPP: We built Ray Mellone Park [in Allston] and donated it to the city of Boston and the community. We maintain it on behalf of the city. That’s just one such case. As we look to build out Allston, one key focus of our master planning is the places we will make available to the public. Around the building for the John A. Paulson School of Engineering and Applied Sciences, there will be green spaces for the public to enjoy.GAZETTE: What does all this say about the future?LAPP: We have a very good foundation for the University to stand on going into the future. Over the last eight or nine years under the leadership of President [Drew] Faust and the Corporation, we have policies, procedures, and practices in place to make sure we are properly stewarding our resources. We are investing in targeted ways, we are reinvesting in our physical plant, House renewal just being one of those initiatives.So, taking stock of what we have, taking care of what we have, being resourceful with our dollars, making targeted investments — online learning, innovative teaching, areas such as that — I think the University is very well-positioned, thanks to its leadership, for its next century.