Feature / To have and have not

Five years after the NHS faced extensive cash problems, has a new loans system and tighter regulation improved transparency and ensured that problems will be spotted before they become widespread? Seamus Ward reports

Cash balances are an integral part of financial management in NHS England, particularly for foundation trusts. For both FTs and NHS trusts, cash balances provide rainy day money, allowing them to cover short-term cashflow problems or to invest in a capital project. But as funding tightens and reforms begin to bite, is the NHS heading for a shortage of cash, and, if so, how well prepared is it to deal with the issue?

Cash has been a problem for the NHS at various points in the past, perhaps reaching a head in 2005/06 with what was widely reported as a ‘cash crisis’. A greater focus on cash followed and an informal brokerage system was replaced by a formal system of loans. As investment in the health service continued, cash has become less and less of a worry, but trusts remain vigilant and, some would argue, are now able to spot signs of cash problems earlier.

Normally, cash balances wax and wane throughout the year with low points in September and March when public dividend capital dividends are paid. However, finance managers say it is inevitable all providers will see increasing pressure on their cash balances at other points in the year.

This is due to a combination of system rules, such as penalties for emergency readmissions, and the year-on-year efficiency gains built into the tariff. Some insist the service has too many hospital buildings and the cost of this, whether due to maintenance costs or inefficiencies because services are scattered across too many sites, is destabilising trusts’ financial position.

Acute trusts can feel particularly vulnerable. Between 2006/07 and 2010/11, the Department of Health made working capital loans to 70 NHS organisations, including one established foundation trust, totalling just over £1bn. According to Department figures, most (about £778m) were made in 2006/07 following the withdrawal of the brokerage system. All but £270m remains to be repaid.

Trust support

According to a recent Audit Commission report, NHS financial year 2011/12, four NHS trusts received new working capital loans worth a total of £34m during the year (overall, NHS trusts held cash balances of £821m). In addition, in exceptional circumstances – where an NHS trust cannot demonstrate it has surplus funds to repay a working capital loan – public dividend capital (PDC) has been provided to trusts to maintain working capital.

In 2010/11 £76m of PDC cash support was issued to two NHS trusts in financial difficulty. The commission has pointed out that its figures do not include any local financial support received by trusts.

Audit Commission head of health Andy McKeon says: 'The NHS certainly benefits from better, clearer and more transparent cash management systems than before. Our latest report records a healthy total revenue surplus of £1.5bn, the same as the previous year, with foundation trusts holding sizeable cash reserves of £3.2bn. Of course, with major reforms planned, the extent of future cash challenges facing the NHS is unknown, but our current view is that recent financial performance has been impressive.'    

University Hospitals Leicester NHS Trust is one of the biggest trusts in the country, with a turnover of £700m. It hit the headlines earlier this year when a leaked email from its chief executive to clinical leaders at the trust warned that there was a possibility it would not have enough cash to pay salaries by September if monthly overspending continued.

Director of finance and procurement Andrew Seddon says the trust had planned to break even, but was £8m in the red after three months of the financial year. Half of the trust’s services are loss making, while the rest don’t make enough to cover these losses. It has no historical reserves of cash to buffer the position, but neither does it have any material historical deficits. It has not approached the Department for a working capital loan.

Tariff changes this year mean a reduction in income of £28m, while the impact of the new rules on emergency readmission is a loss of £9m. The trust had to deliver a 6% cost improvement programme (CIP) to stand still, but this slipped during the first three months. Added to a failure to move activity out of hospital, this led to the £8m deficit.

Leicester has launched a recovery plan that includes a freeze on all but essential recruitment and a 20% cumulative reduction in corporate budgets. This would leave a year-end deficit of £5m, but the trust is aiming to break even as soon as possible.

The trust has moved to improve its cashflow – for example, by implementing improved materials management with the aim of reducing inventory. But Mr Seddon says this alone will not produce the savings needed as the trust faces a deeper issue. Spread across three sites, it has tens of thousands of square metres of surplus land and estate.

‘There is no way to access the potential of this land and buildings without borrowing in order to put some new, more consolidated buildings in place,’ he says. The trust’s private finance initiative scheme, which would have helped optimise estate use, was turned down as unaffordable three years ago.

Creditors and debtors

The trust is also reviewing its capital programme and creditor and debtor terms. While Mr Seddon is disappointed the trust’s finances went off track so quickly and it was unable to forecast the problem, positives have emerged – for instance, clinical engagement in service line reporting analysis and patient level information and costing. ‘The clinical leaders of the organisation realised how crucial their leadership was – it is absolutely needed,’ he says.

In terms of cash held, foundation trusts are generally ‘haves’. At the end of 2010/11 they held aggregate cash balances of £3.2bn, built up as a result of planned surpluses in recent years. Monitor says foundations’ aggregate cash balance is healthy, but points out it has in part been bolstered by advance payments from commissioners (for 2011/12 activity).

That does not mean the regulator or foundation trusts have no concerns about cash. In Monitor’s review of foundations’ annual plans for 2011/12, FTs are predicting a significant decline in cash. The aggregate cash balance is forecast to fall £556m to £2.7bn.

Some of this is due to the tougher operating regime and one-off items such as planned capital expenditure. This is why foundations have been encouraged to build up a buffer and of itself may not be a cause for concern. ‘If they deliver their plans, on aggregate cash will not be an issue,’ says Monitor portfolio director Jason Dorsett.

The regulator has picked up problems in the small number of foundation trusts that have got into financial difficulties through reduced operating profit rather than liquidity.

‘If there is a short-term decline in operating profit – say a year – before recovery, it generally doesn’t create a real problem with cash or liquidity. But if recovery takes a lot longer they will have to manage their liquidity very carefully. We have FTs that are managing their liquidity and, looking forward, I’d imagine there would be a further small group that will get into problems. They’ll have to watch their liquidity while they recover,’ says Mr Dorsett.

While foundations’ cash balances appear healthy on the whole, Monitor introduced a small number of financial risk indicators as part of the 2010/11 compliance framework (see box page facing page). While not formally part of the financial risk rating regime, they may pick up early warning signs of cash problems.

Monitor says generally problems with liquidity show up first as an increase in debtor balances. In recent years a small number of trusts have over-performed on their contracts and PCTs don’t automatically pay them for the activity. At the same time, the trust could be stretching its creditors so the creditor balances are going up.

Balancing act

Warrington and Halton Hospitals NHS Foundation Trust (which gained foundation status in December 2008) has a turnover of about £200m and at the end of 2010/11 held a cash balance of £12m – 6% of turnover, which is less than the foundation average of 10.5%.

Deputy director of finance Steve Barrow says this is a consequence of the trust’s history of financial difficulties. It did not enter foundation status with a large cash balance – £9.5m when it became a foundation trust. Cash did not appear to be an issue for the regulator at the time, he adds – while less than other FTs, the trust had an adequate cash balance.

The trust has taken steps to improve its cash position and ended 2010/11 with a balance of £12.2m. ‘It will have grown about £2.7m since we became a foundation trust,’ says Mr Barrow.

‘Part of it is that we made a conscious decision to reduce our capital programme in 2010/11 by half compared with previous years and take the cash benefit. We made fairly moderate surpluses over that time – this year we are planning for an operating surplus of £1m. We are not planning large surpluses as we recognise the economic environment.’

Mr Barrow says the trust is alive to the early warning signs of cash problems and monitors its cash position on a weekly basis, comparing it with the previous 12 months. He adds that unplanned falls in cash balances would show before the problem emerged in its I&E position.

‘Provided we keep ticking over and make our planned surplus there won’t be a cash issue this year. We invest modest amounts of the cash balance on an instant-access basis. This is prudent because in the financial climate cash is key. It’s a triangulation between I&E, cash and capital. We have a capital programme at the beginning of the year based on the trust’s position and the amount of cash we have. If, during the year, cash was not as good as we’d planned we would consider our capital programme and how it might change to give us a bit of breathing space without compromising clinical quality or health and safety.’

All trusts have been asked to work towards foundation status by 2014, but there is some concern cash shortfalls could affect the foundation trust pipeline. University Hospitals Leicester, for example, says it decided to defer its application while it rebalances its finances.

Cash is a component of Monitor’s assessment of applications – it looks at ability to sustain a financial risk rating of 3, 25% of which is based on liquidity. And it stress tests income assumptions over five years, with the forecasting model also showing the cash effect during this period.

‘We don’t know what the balance sheets in applicants to come will look like, but broadly speaking if you are viable in terms of operating profit, you should be viable in terms of liquidity,’ says Mr Dorsett.

Foundation trusts’ liquidity is calculated for the purposes of the financial risk ratings and includes unused working capital up to 30 days’ expenditure. Average liquidity days (liquidity expressed as days of operating expenses) across all foundation trusts is forecast to fall from

35.7 in 2010/11 to 31.7 in 2011/12. This is largely due to Transforming community services transactions, which have resulted in FTs taking on additional operating expenses without a corresponding increase in cash.

With many foundation trusts boasting substantial cash balances, some have questioned the need to hold working capital facilities. A number have reduced their working capital facility, while there are suggestions that some have none at all. Those that do, even if they do not use the facility, are charged a percentage of the amount they have arranged. The banks argue this is because they have to set aside money for a working capital facility so it is immediately available.

Early results of an HFMA survey conducted over the summer (see box on p17) show foundations had arranged working capital facilities of between zero and £60m in 2011/12. While most respondents paid around 30 to 35 basis points for their facility, some are paying double that figure. One trust showed the value of shopping around – paying 20 basis points this year by moving to a new provider.

Warrington’s liquidity averages 25 days. ‘It’s healthy and though it could be better we are reasonably happy with the liquidity rates we have in the current climate,’ says Mr Barrow. It has a working capital facility of £15m, which it has yet to use as it generates enough headroom from its current activity. He adds that if the trust were considering a big capital project, it would probably have to apply for a loan.

Action on fees

Warrington did examine reducing its working capital facility in order to save on fees, but decided against it when it discovered the reduction in fees was not commensurate with the reduction in the facility.

‘If we wanted to reduce the working capital facility by half, the fees would not have been reduced by half,’ says Mr Barrow. With provider income likely to fall, working capital facilities are set to increase in importance. Whether aspirant or existing FTs, there are many reasons why providers will continue to keep a close eye on their cash position.

Foundations hold on to working capital

The vast majority of foundation trusts have a working capital facility with a commercial lender, even though most have not needed

(and do not expect) to draw down their facility, according to the early analysis of a recent HFMA survey.

The survey, which was conducted over the summer, received more than 60 responses. It found all but two of 58 trusts that responded to a question on the actual levels of facility held in 2011/12 had arranged working capital facilities. Those with no working capital facility in place had received a prudential borrowing limit for working capital from Monitor.

Working capital facilities ranged from around £2m to £60m, though only one trust said it anticipated having to draw down the funds this financial year.

More than two-thirds (38%) said they had considered stopping their working capital facility and, while a small number did reduce or stop the facility, most kept it.

While 47% said the facility provided protection against cash shortages, trusts who reviewed the need for access to working capital said it was deemed a Monitor requirement or it was needed to maintain their trust’s financial risk rating (FRR).

However, some questioned the value of retaining facilities. One finance manager said: ‘It is not considered the best use of public monies. Monitor should consider changing the FRR calculation or the Department of Health should provide access to a facility.

‘This would considerably reduce the cost of most foundation trusts paying an arrangement fee, particularly when the vast majority of FTs are not using their facility.’

Portsmouth loan stabilizes cash status

Short-term loans are accepted practice in the private sector – a prudent way to avoid cashflow issues – and NHS trusts are no different (though the money will come from a Treasury source). But when an NHS organisation does borrow to support its cash position, it is more likely to receive publicity.

Portsmouth Hospitals NHS Trust faced such a situation earlier this year, when a local paper claimed the trust was struggling to pay its bills. Director of finance and investment Robert Toole says the action was taken as part of good financial management.

As with many other parts of the NHS, the trust faced significant financial challenges in 2010/11, he says. Over the year it took steps to ensure its financial sustainability and had a cost improvement plan to save £37m. The trust recognised it could end the year in a deficit position, as a consequence putting pressure on its cash balances.

In February, the trust received a cash allocation of £9.5m via NHS Portsmouth. Mr Toole says: ‘This was a consequence of the trust’s deficit position at the time, a precautionary measure to ensure it had sufficient cash balances to meet all of its financial commitments. This is an accepted procedure for any hospital trust in this position.’

However, the trust’s financial position improved during the final quarter of the year and it recorded a break-even position at year end. It did not need the cash allocation, so could repay the loan to NHS Portsmouth before the end of the financial year.

Mr Toole says the trust’s business plan for 2011/12 is to achieve break-even and managing within its available cash income. ‘For foundation trust status it will be essential to achieve an annual surplus and generate cash reserves in accordance with Monitor's applicable financial risk rating. Increasing cash balances is critical whether under FT status or current trust status,’ he adds.

Monitor’s indicators of forward financial risk

Monitor requires trusts to submit each quarter a limited set of indicators of forward financial risk to highlight the potential for

any future material financial breaches of authorisation. Where trusts inform Monitor that one or more of these indicators are present, Monitor will consider whether it is appropriate to meet with the trust. Following this meeting, the regulator may request the preparation of plans, or the provision of other assurances as to the trust’s capacity to mitigate any potential risk. The indicators, which do not of themselves affect Monitor’s risk ratings or trigger formal escalation, are:

• Unplanned decrease in EBITDA margin in two consecutive quarters
• Quarterly certification by trust that FRR may be less than 3 in the next 12 months
• FRR 2 for any one quarter
• Working capital facility used in previous quarter
• Debtors more than 90 days past due account for more than 5% of total debtor balances
• Creditors more than 90 days past due account for more than 5% of total creditor balances
• Two or more changes in finance director over 12-month period
• Interim finance director in place over more than one quarter end
• Quarter end cash balance more than 10 days’ operating expenses or more than £4m
• Capital expenditure more than 75% of plan for the year to date.

Liquidity ratio

The liquidity ratio accounts for 25% of the weighted average of the four criteria used to derive the financial risk rating. It is defined as cash plus trade debtors (including accrued income) – (creditors + accruals) plus unused committed working capital facility (up to a maximum of 30 days and excluding overdraft agreements) expressed as the number of days operating expenses (excluding depreciation) that could be covered.

A foundation is rated 1 for liquidity if it has less than 10 days’ liquidity, 2 for 10-14 days, 3 for 15-24 days, 4 for 25 to 59 days, and 5 for 60 or more.

If an FT has an FRR of 3 and liquidity less than 15 days, Monitor may require a forward liquidity analysis. With an FRR of 2, a liquidity recovery plan may be required.