Harvard officials were upbeat about the University’s financial footing in its annual report for fiscal year 2005, but Harvard’s finance chief warned yesterday that hurdles remain on the horizon for the current year.

The University’s total operating revenue last year rose 8 percent to $2.8 billion, leaving Harvard with a $44 million surplus, a modest increase over its $37 million surplus in fiscal 2004.

In a letter introducing the report, University President Lawrence H. Summers called the surplus “a reflection of efforts across Harvard to budget and spend with care.”

For the fiscal year ending June 30, 2005, the University reined in the cost of providing benefits to its faculty and staff—a ballooning expense that has dogged Harvard’s financial administration in recent years—according to the University’s 68-page financial report.

The report summarizes the University’s financial activities, offering a breakdown of its revenue and expenses.

Benefits expenses last year rose a modest 3 percent, compared to increases of 36 percent in 2003 and 11 percent in 2004.

Vice President for Finance Ann E. Berman attributed this slower growth to the introduction of a new Medicare drug benefit and a switch to self-insurance for medical benefits.

But in an e-mail last night Berman wrote that despite this year’s more modest numbers, rising benefits costs are “still a huge concern” for the University.

Another challenge concerns research funding from the federal government, a significant revenue source for Harvard, which increased only 6 percent from last year, compared to 14 percent in 2004.

Berman said that this funding remains on the University’s radar as an area of concern, as some federal grant agencies see their budgets grow at a rate lower than the rate of inflation.

While a letter from Berman and Treasurer James F. Rothenberg ’68 introducing last year’s report singled out federal funding for research as a significant concern, their letter this year did not mention the issue.

But Berman wrote in an e-mail yesterday that since the time the letter was written in October, the possibility of declines in grant funding has reemerged as a serious problem.

“Grant funding turns out to be a bigger deal than I thought when I wrote the letter,” Berman wrote. “Federal budgets haven’t been approved, and the National Institute of Health is talking about grants being renewed at only 80 percent of current levels. This could be a big problem that we are looking at now.”

‘STRONG FOUNDATIONS’

While these challenges do lie ahead for the current fiscal year, University officials took an optimistic tone in discussing the results of fiscal 2005. In their letter introducing the report, Berman and Rothenberg called 2005 “a financially successful year” for Harvard.

And in his letter, Summers called fiscal 2005 “a strong year financially.” He cited Harvard’s high fundraising receipts and the strong investment returns of the Harvard Management Company, which grew the endowment to $25.9 billion during 2005.

Despite the $44 million surplus, costs still crept upward in several areas.

Ballooning energy costs and the expense of maintaining Harvard’s property drove up space and occupancy costs by 11 percent. The University added another 1.6 million square feet during fiscal 2005, according to the report.

“The University is actively identifying and implementing strategies to mitigate the effects of volatility in the energy markets,” the report stated.

Harvard also spent $470 million on the construction of new facilities, as well as new acquisitions and renovations. The costly process of planning Harvard’s expansion across the river into Allston helped drive up expenses for services purchased by the University by 21 percent to $274 million.

The University also incurred “certain legal settlement costs,” the report said. Harvard’s balance sheet for fiscal 2005 includes a $26.5 million payment to the U.S. government to settle a breach of contract suit.

The settlement stemmed from a civil fraud complaint brought against the University, economist Andrei Shleifer ’82, and former Harvard employee Jonathan Hay.

The annual report also revealed some of the financial plans for the Eli and Edythe L. Broad Institute, a biomedical research center established jointly by Harvard and MIT to study the human genome.

Both schools together will raise $20 million per year in gifts and non-federal grants. If fundraising efforts fail to meet the goal, Harvard will compensate MIT for the shortfall, the report states. Harvard’s will also pay $13 million initially to construct the institute’s new building.

—Staff writer Nicholas M. Ciarelli can be reached at ciarelli@fas.harvard.edu.