Feature / Respect is due

The due diligence and working capital reviews are key parts of the foundation trust authorisation process. Grant Thornton believes better preparation by trusts for the reporting accountants’ visit could pay off, as Steve Brown reports

Some aspects of the foundation trust authorisation process need no introduction. The notorious board-to-board, at which Monitor’s top team goes head to head with the would-be foundation trust’s board, can give executives and non-executives sleepless nights for months before the face-to-face actually takes place. But clear understanding of other aspects of the process is patchy – the role of the reporting accountants is a prime example. Yet better understanding and preparation could have significant benefits for trusts hoping to reach foundation status.

Reporting accountants – appointed by Monitor with the fees paid by the Department of Health – perform two distinct roles, producing a historic due diligence (HDD) report and providing opinions on the trust’s working capital and financial reporting procedures.

This involvement comes in two phases. The HDD is undertaken in the first three to four weeks following the formal application and is used to inform the secretary of state’s decision to support the application or not. The working capital review comes later, with the reporting accountants typically revisiting the trust in the last couple of months before authorisation, spending up to five weeks at the trust.

The HDD review typically involves two to three weeks of fieldwork for the reporting accountants and the focus is on historical financials and financial reporting procedures. Although the financial reporting procedures opinion is not given until later, the accountants do much detailed analysis at this point and provide commentary that will be considered by the secretary of state in making a decision.

Detailed examination
The due diligence review covers historic financials, including the current year plus two prior years, as well as making a high level assessment of the financial projections included in the long-term financial model covering the next five years. The board is required to confirm the factual accuracy of the HDD.

Giles Newman, client service director at Grant Thornton, says there are a number of common pitfalls that trusts should look to avoid in the due diligence review. Many of these relate to governance issues. ‘It is not that trusts don’t know what to do, but that changes to governance processes haven’t been put through early enough,’ he says. ‘This means there is no evidence that the processes are embedded, being followed and working.’

Sean Croston, a partner in the firm, adds: ‘Ideally a well managed trust will have done this six months before we arrive. And it will have a track record of at least two to three board meetings where the policies and processes have been put into practice.’

Risk management is the stand-out example. ‘We find that clinical risk is normally done very well,’ Mr Croston says. ‘Operational risk is done less well and strategic and financial risks are not done well at all.’ He says the reporting accountants would hope to see a combined risk register where the trust board can show it has been involved with the scoring and ranking of risks and held discussions on how it can mitigate identified risks.

It is also important to show procedures are in place to review this register within the board cycle. Mr Newman says some organisations have found it hard to deal with risk in such a structured way.

The scheduling of board meetings can be another problem area. ‘You’d expect the board to meet in the month after the month end to which the reports relate,’ says Mr Newman. ‘Given that is how a foundation trust needs to operate [to sign off quarterly reports within 30 days], it is surprising how many trusts have board meetings outside this timetable and in some cases not every month.’ While this is easily fixed it can be indicative of other issues.

Board reports also often need work. ‘Take the Monitor quarterly return, for instance, which effectively requires foundation trusts to do 12-month rolling cash flow forecasts,’ says Mr Newman. ‘Board reports need to reflect what is in the return and the board needs to get used to working with that information. So it is common sense to use the Monitor reporting framework as a checklist for financial reports. Yet very few organisations are doing this.’

Mr Croston points out that this is not about simply ticking a box with Monitor. ‘Monitor expects this [way of working] because it is good business management,’ he says.

One final common problem on the governance side is the failure to follow up audit recommendations – something that should be addressed yet is often neglected. Mr Newman says the reporting accountants look at the audit letters and the audit committee minutes for evidence that audit recommendations have been acted on.

Testing assumptions
Away from the governance issues, other pitfalls include incomplete financial plans, unrealistic assumptions on activity or contracts and surpluses dependent on overambitious service developments. However, the due diligence stage is more about reporting the trust’s plans; the real testing of those plans and their assumptions comes in the second stage review, when the reporting accountants form their opinions on working capital and financial reporting procedures.

This second stage of the reporting accountants work is far more investigative, financially biased and forward looking. Work on financial reporting procedures, started during the due diligence review, is updated and the accountants stress test the trust’s financial forecasts using sensitivity analysis. While these worst case conditions might require the trust to call on its working capital facility, the reporting accountants would not expect this facility limit to be breached. A breach may not equate to an automatic red card, but it would require explanation and robust mitigation and could be seen as an indicator of more fundamental problems with the financial plans.

Again Mr Newman and Mr Croston have identified a number of common pitfalls for trusts during this second stage. ‘It is a basic error not to do something that was flagged up in the action plan from the stage one report,’ says Mr Newman. Another error is leaving the board memorandum – the focus for the reporting accountants’ opinion work – until the last minute.

Some trusts also leave it far too late to agree a working capital facility and if it is not in place, the reporting accountants can’t give an opinion. Given usual procurement timetables, tendering can often take a few weeks. The period covered by the facility is also key – 24 months being the typical period.

Any private finance initiative (PFI) can create additional issues for authorisation. Mr Newman says the problems chiefly involve affordability and Monitor’s requirement for a 10-year financial model for PFIs, which takes the trust into the more uncertain long-term aspects of the business plan. While the NHS has to date accounted for PFI off balance sheet, Mr Newman says he would expect trusts ‘as a prudent measure’ to ensure that financial models should consider the impact of the expected change to accounting for hospital PFI schemes on balance sheet under international financial reporting standards. This should cover the impact on the timing of costs within the income and expenditure account as well as the impact on the balance sheet.

Overall, Mr Newman and Mr Croston believe trusts benefit from being better prepared for the reporting accountants. Some prepare in detail for the board-to-board, often running mock sessions, but the same does not go into the visits of the reporting accountants. And as the authorisation process has moved on to include organisations with more historic financial challenges, it appears that organisations are approaching their applications in a less rounded way.

‘It would make sense to get a feel for what the reporting accountants may say,’ says Mr Newman. ‘Given that foundation trust status is often top of trusts’ agenda, the levels of preparation in some organisations is disappointing.’

Mr Croston acknowledges that you might expect consultants to encourage the use of external support to prepare for the authorisation process. But he insists there is a correlation between organisations that are prepared for the assessment and their eventual success in being authorised. And even where trusts do seek support, he says it is sometimes about where that support has been focused.

‘The business plan and the long-term financial model are usually well done,’ he adds. ‘And if trusts have support it tends to be on the production of the documents and not on the trust itself. And that is exactly where the reporting accountants focus their attention.’