Lews Castle College UHI is facing a decrease in funding of around 4.8 per cent for 2017-18, due to a drop in student numbers.
In a report just published, Audit Scotland has highlighted the College's under-recruitment of further education students against targets during 2015/16.
The report clearly states that the College is not in immediate financial difficulty and the accounts have been given a clean bill of health.
However, financial risks to the College came from its declining performance against student activity targets, leaving it open to financial penalties and funding reductions.
The College only achieved 80.5 per cent of its target for 2015/16.
Delays in appointing board members were also highlighted, which had a significant impact on governance arrangements and committee meetings.
Iain Macmillan, Principal at Lews Castle College UHI commented: "Over recent years the number of further education students in the islands has fallen. Various factors have contributed to this trend including funding changes, demographic trends and changes in choices made by young people leaving school.
"As colleges receive funding mainly from student activity, reduced student numbers have implications and reductions in future funding are inevitable.
"However, there is a positive outcome from this: the College has already agreed with the UHI Further Education Regional Board a reduction in its credit target for 2017-18 to a level that is realistic and achievable.
"This will result in a decrease in funding for the college of around 4.8% for 2017-18. Whilst this reduction is not to be welcomed, it is manageable. The changes will enable the College to focus on achieving these targets and to be confident about its future sustainability."
Board Chair Clive Rowlands commented: “It is regrettable that Lews Castle College UHI has been the subject of a Section 22 Report.
"The College Board is however convinced that the new targets we have agreed for 2017/18 will be achievable with the continued hard work and commitment of our excellent staff."
He added: "Lews Castle College UHI will continue to provide a wide range of excellent study and research opportunities from Introductory courses through to Degree, postgraduate and PhD programmes”
Details of the Audit Scotland report can be found here.