Feature / Introduction to….FT finance risk ratings

Monitor uses finance risk ratings (FRRs) in several ways, principally in the assessment of applicant foundation trusts and as indicators of foundations’ financial health.

Whether applied to aspirant or authorised foundations, the calculation is basically the same – and similar to the risk rating for NHS trusts as part of the performance framework. It gives trusts a rating of 1 to 5, where 5 is the lowest risk.

Foundation trusts submit their financial projections in their updated three-year plan each May – the regulator reviews these and assigns an FRR to each foundation during the summer. This rating indicates an FT’s risk of breaching its authorisation during that financial year. FRRs continue to be important throughout the year as Monitor checks on trusts’ financial performance (based on returns) against plan.

Monitor sets out the method for calculating the FRR each year in the compliance framework. Ratings are assigned using a scorecard that compares key financial metrics in four categories. These are: achievement of plan; underlying performance; financial efficiency and liquidity.

Each is given a rating (1 to 5, where 1 is high risk) and the final FRR is derived once the appropriate weighting is applied (10%, 25%, 40% and 25%, respectively).

Achievement of plan is based on the EBITDA (earnings before interest, tax, depreciation and amortisation) achieved, expressed as a percentage of plan. Anything less than 50% means an FRR of 1 for this category.

The underlying performance category is based on EBITDA margin as a percentage of total income (less than 1% means an FRR of1, while11% or more is a 5).The liquidity ratio is expressed as the number of days operating expenses that could be covered.

Financial efficiency is the only category with two metrics – net return after financing and I&E surplus margin net of dividend. They are given an equal weighting (20% each) in the calculation of the overall FRR.

Net return is calculated by subtracting a number of costs from the I&E surplus – these are public dividend capital dividend, interest and finance lease costs (including private finance initiative financing) – and then dividing this by total debt plus PFI and finance leases and taxpayers’ equity.