The headline issue this summer is pay. National negotiations appear to be more difficult than usual - a 1.5 per cent offer from the employers’ side generated a two-day strike from the lecturers’ union NATFHE.

The offer is low but takes account of the increase in employment-related costs - pensions and national insurance. If the employers’ side offered more, some colleges would be unable to implement the deal without making job cuts or running large deficits. Weak college finances caused patchy implementation of previous deals.

But if the employers’ side doesn’t offer more, staff recruitment and retention will become even more difficult, particularly in the South-east. The pressure is increased by the pay settlements for school teachers, NHS and local government workers. All exceed inflation. In the longer term, economists predict that the slowdown in private-sector pay will hold back public-sector pay as people switch sectors. This may happen elsewhere but how attractive will the post-16 sector be to potential recruits ?

Pay is an important issue in college budgets because it is so large. Sixty-five per cent of the average budget is spent paying directly employed staff. Another 10 to 15 per cent goes on services delivered by people. Colleges differ in what they contract out but typically buy in temporary staff, cleaning services and a small army of professionals. Contracting out transfers responsibility but does not insulate the college from pay inflation.

Contracting out teaching and training was popular in the 1990s in the form of franchising and lecturing agencies. Funding rules and employment law have rightly made both much more difficult. Direct employment is obviously the preferred model but leaves colleges with the problem of pay costs. Despite the hype associated with e-learning, there is no cost-effective alternative to using people to deliver teaching and training.

The upward pressure on pay costs is not just a matter of pay levels. Workload is also an issue. Audit and inspection are just two of the forces which increase costs by adding to workload. Earlier this year, auditors told hundreds of colleges to work harder on their student data. This generally means more people or more highly-skilled ones. Meanwhile, the inspectors pile on the pressure to raise standards. Although the Office for Standards in Education and the Adult Learning Inspectorate both have a remit covering value for money, you rarely see a report suggesting that a college should do less of anything.

The pay crunch for colleges comes at the same time as uncertainty about the main income line. 20023 is the year when the Learning and Skills Council introduces new funding and data collection systems. The LSC has to take care to minimise the disruption through its safety net, its 2.5 per cent funding increase and its carefully modelled formula.

The LSC has worked hard to ease the transition and has moved the college sector on from its bizarre obsession with units. But the change has created uncertainty because it is unclear how the LSC will measure volumes. Is it interested in numbers of learners or full-time equivalents? If the LSC does not work out a measurement system, we will have a confusing situation where a college delivering pound;105 of activity gets pound;103, less an unknown deduction because it delivered the wrong kind of pounds.

Uncertainty is a mild word to describe the typical reaction to the LSC’s budgeting process. There have been three different explanations of responsive growth funding in as many weeks. And the process has taken longer than planned, leaving little time for colleges to spend their growth money in sensible ways. The LSC needs to win support for its future plans because its reputation depends on its efficiency.

Looking ahead, 20023 is only the start of three years of change to funding. Changes scheduled for 20034 include some major revisions to the formula following reviews of programme weightings, disadvantage, area costs and additional support. And once these are embedded, a completely different approach is promised for the year after that.

What the 20045 funding system will look like is anyone’s guess. The current system pays for trained lecturers by using them to teach groups of learners and thereby contributes to national targets. The current financial stress results from the costs of higher targets and higher pay and the lack of income to pay for either. The Government must decide whether to find more money, compromise on quality or lower its targets.

Julian Gravatt is finance director at the City Lit, London