Clinical Leadership Development Programme Finance & Budgeting

1. Clinical Leadership Development Programme Finance & Budgeting James Richardson Associate Director of Finance 16th December 2011

2. Patients Agenda Economic Climate NHS Structure Budget Setting Financial Planning External Influences Financial Governance Funding Flows CIP Lean PbR Health Bill Operating Framework Financial Reporting Productivity Standing Orders QIPP Tariffs CQUIN Commissioning Board Standard NHS Contract Block NEL Threshold SFI’s Forecasting Risk Ratings Re-Admissions Business Planning Scheme Of Reservation KPI’s GP Commissioners Penalties Board Reports Best Practice Tariffs Budget Control Contract Negotiation/ Timescales Scheme Of Delegation Capacity and Demand PCT’s Monitor Non F2F Audit Choice AWP New to Review Ratios Service Development SLM / SLR Commissioning Intentions Year of Care Tariffs PLICS Tenders Business Cases Marketing New Hospital

3. Purpose of the Session • How the money flows in the NHS & PbR • Current financial climate • Corporate & Financial Governance • Budgets, Budgeting approaches & Budget setting • Board level & Directorate level Financial Information • Budget Control & reporting • Financial planning & decision making • Finance & Clinicians • Questions

4. How the money flows in the NHS • NHS Structure & Funding • PCT Commissioning • Payment by Results • Future Structure’s & Funding

5. NHS Revenue Funding Flows

6. How the money flows: Revenue • A ‘weighted capitation’ formula (3 Years) • Attempts to takes account of the scale and characteristics of each PCT – • Population and demographics • Deprivation levels • Health needs & profile • Results in a ‘target share’ for each PCT • Target not the same as allocation - gradual move towards target allocations for all PCT’s from growth! • Stockton & Hartlepool PCT’s circa £20m away from target • Allocation formula currently under review – cynical perspective change in key variables to shift resources south! • Current formula not sophisticated / sensitive enough to disaggregate to GP / GPCC level

7. PCT Commissioning • PCT’s commission healthcare for their local population. This can be from: • NHS Trusts • Foundation Trusts • Community Service Providers • Independent Sector / Voluntary Sector • Doctors • Dentists • Opticians

8. NHS Trusts and Foundation Trusts Income • Majority of income received through commissioning process with PCT’s via payment by results tariff • Other funding via • Direct allocations from Department of Health • Local Authorities • Research & Training • Charitable Donations • Catering, Car Parking, Private Patients

9. Payment by Results (PbR) • PbR introduced in 2003/04 using HRG’s as currency • Rules based approach • Links payments to activity undertaken • Intended to support NHS Plan and reform agenda during period of unprecedented growth • Reduce waiting times - 18 Weeks • Patient Choice • National Tariff set annually for each type of service / HRG • Income reflects volume and complexity of healthcare provided. Contract negotiations focus on volumes and quality

10. Payment by Results • Is it fit for purpose during period of austerity? – • Original structure & scope incentivised FT’s to deliver increased volumes • Latterly tariff tweaked for Introduction of NEL 30% threshold; recalibration downwards of tariff; move to exclude excess bed days income. • Is it results based or actually just volume based? • Direction of travel towards best practice tariffs ; CQUIN’s; Financial penalties; readmissions penalties etc

11. Health & Social Care Bill 2011 • Abolish SHA’s & PCT’s • Establish Commissioning Board • GP Consortia • New Monitor

12. Current Financial Context • UK economic climate • NHS implications – minimal growth for next 5 years (Tariff Deflation) • DH need to generate cost efficiencies of £20bn • Projected savings target for Teesside of £200m by 2014

13. CIP Performance - 2011 / 2012 2011/12 – projected view CIP target = 15.851m Risk Rated PYE recurrent delivery = (5.554m) Further management action - Rec = (2.5m) Non-recurrent measures = (7.832m) Total ‘unidentified’ CIP shortfall in year = 0m Impact on 2012/13 based on current Recurrent CIP shortfall (15.851 - 5.554) = 10.297m Further management action = (2.5m) Less fye of 11/12 schemes delivered in 12/13 = (2.991m) Recurrent shortfall of 11/12 schemes C/fwd = 4.806m

14. 2012 / 2013 CIP – Scenario 2 (Assessor) PYE recurrent shortfall on 11/12 CIP = 10.297m PYE of 11/12 schemes delivered in 12/13 = (2.991m) Corrective action undertaken in 11/12 = (2.500m) 12/13 Monitor Assessor @ 4.4% = 9.428m Likely Case Scenario = £14.234m

15. Current Financial Context In 2010/11 CIP target was £12.8m (5%), actual delivered = £9m(3.5%) National efficiency in tariff for 2011/12 = 4%,but due to 10/11 slippage, PCT financial position etc target = £16m(6.25%) CIP over next 6 years = circa £57 million (not including savings required for new hospital) New Hospital scenario – adds a further £26m of savings based on 2 to 1 site rationalisation economies

16. Current Financial Context This level of saving can only be contemplated if we look at major system transformation & radical solutions as well as tried and tested options The need for real efficiency savings!

17. Corporate Governance • Financial Governance • Standing Orders • Standing Financial Instructions (SFI’s) • Scheme of Reservation & Delegation

18. Financial governance and accountability Governance can be described as the rules, processors and behaviour that affect the way in which powers are exercised. It is therefore concerned with how an organisation is run, how it is structured and how it is led.

19. Financial governance and accountability • The Board • Accountable officer (Chief Executive) • Responsible for ensuring that their organisation operates efficiently economically and with probity and that they make good use of their resources and keep proper accounts. • Board of directors - held to account by Council of Governors! (FT’s only) • Audit committee (Non Execs – safeguarding assets / Internal control) • Annual report and accounts • Internal & external audit • Standing orders, standing financial instructions and schemes of delegation

20. Standing Orders • Translate statutory powers into a series of practical rules: - Composition of Board and its sub committees - How meetings are conducted - Form, content and frequency of reports - Voting procedures - Duties and obligations of Board Members

21. Standing Financial Instructions • SFIs detail the financial responsibilities, policies and procedures of all transactions in order to achieve probity, accuracy, economy, efficiency and effectiveness. • The role of the Audit Committee, Internal & External Audit and the role of the DoF • Procurement and tendering procedures • The SFIs allow the Chief Executive to delegate budget management to budget holders

22. Scheme of Reservation & Delegation • The scheme of reservation specifies what powers the Board has chosen to exercise itself – e.g. land sales • The scheme of delegation specifies the delegation of powers from the Board throughout the organisation

23. Budget Definition “a financial plan that sets out in clear and concise terms the resources assigned to the delivery of service and operational targets for a defined period”

24. Budgets – what they are Forward planning allows the Trust to shape its future, rather than to react to events and is critical in the achievement of organisational objectives. • Budgets are: - Financial and/or quantitative statements - Prepared and agreed for a specific future period - Designed to fulfil agreed objectives - Drawn up for separate activities/projects and for organisations

25. Reasons for preparing budgets • Quantify the organisation’s future plans and commitments • Review aims and ensure planned activities are achieved • Determine the resources needed to deliver services • Basis for controlling income and expenditure • A yardstick for measuring performance • To ensure statutory financial targets are met

26. When are budgets prepared ? • Each year – linked to Directorate business plans, the Annual operating plan and the FT Annual plan submission to Monitor • For new services • For major changes in the way in which services are delivered • Dynamic not static

27. Budgeting approaches • Historic/incremental-based • Zero-based • Activity-based

28. Historic/incremental budgeting Current year budget Less: non-recurring items Next year budget Set other reserves Add: full year effects of recurring items Create inflation reserve Adjust for changes in service Less: cost improvement programme

29. Zero-based budgeting Assume zero budget for next year Set entirely new budget Review objectives of department Identify optimum staff, materials etc

30. Activity-based budgeting Identify workload measure Flex variable budget by actual activity Estimate planned activity Identify fixedcosts Calculate budget Identify variable costs Measure actual activity Calculate marginal cost

31. Historic/incremental budgeting • Advantages • Easy to operate • Simple to understand • Uses an established base • Less demanding on management time • Can operate with weak information systems • Disadvantages • Perpetuates inefficiencies • Lack of ownership by managers • Changes in activity/objectives/working practices not readily reflected • Not responsive to changed priorities

32. Zero-based budgeting • Advantages • Identifies inefficiencies • Links budget to an organisation’s objectives and activity plans • Management ownership • Challenges existing practice • Disadvantages • Time consuming • Difficult to implement • Lack of certainty • May raise expectations

33. Activity-based budgeting • Advantages • Links finances to activity • Budgets realistic compared with activity • Encourages management to focus on efficiency and fixed costs rather than uncontrollable workload • Variances easier to explain • Disadvantages • Identifying activity levels is difficult • Total income may not flex to balance • Changes to standard costs may not be recognised • Case mix is often excluded

34. Budget setting in the NHS • Combination of incremental and ZBB but needs to move towards ABC – PLICs will provide the platform to do this • Robust timetable • Set and approved before the year it relates to • Realistic forecasts (for pay, inflation, cost pressures) • Takes account of previous year’s experience • Budget holder involvement • Profiled across the year • Balanced

35. FT Annual Plan • Monitor requires FT to submit an annual plan by 31st May each year • The plan includes forward planning information over a three year period • Detailed implications i.e. development of a particular service will have implications for capital spend, tariff income etc

36. The Budget Setting Process • Comprises several basic steps: - Prioritisation of objectives identified in the planning process and formalised via the annual plan and underpinning Service Level Agreements - Assessment / quantification of total available resources, both financial and non financial

37. The Budget Setting Process - Income • Overall budget includes income from several different sources: - SLA’s with PCTs and other NHS bodies in accordance with the National Tariff and PbRs - Private patients, RTA’s - Medical and non-medical training funding via the Workforce Development Directorate of the SHA - Commercial sources of income – car parking, catering etc

38. Trust Income • Contracts / Service Level Agreements (SLA’s) • Legally binding, very detailed • Standardised national format for Acute & community services • Specified / planned levels of activity agreed with PCT’s • By Point of delivery e.g. • Outpatients – New / review / procedures • Diagnostics • A&E • Emergency admissions • Elective – day case / General

39. Trust Income • Contract types – clinical Income • Cost per case – trust paid for each treatment under the national payment by results tariff – a schedule of prices based on HRG v4 – circa 1400 prices e.g. Hip replacement = £4k • Cost & volume / Block Contract – Trust paid for a set level of service e.g. Training of junior Medical staff, community services • Non clinical Income – from catering, car parking, rents, education & training etc

40. The Budget Setting Process - Expenditure • Expenditure budgets are based on: - Forecast outturn at month 10 in 2010/2011 and cover direct costs under the control of the budget manager - Pay – detailing the agreed establishment in terms of WTE, £’s by AfC and local Trust grade - Non-pay – by subjective category e.g. drugs, M&SE, provisions, energy etc - Internal recharges for services provided / received such as pathology, radiology etc

41. Trust Expenditure • Pay – circa 68% of costs = 4,685 wte’s of which - • Medical – 11% • Nursing & Midwives - 55% • AHP’s & Scientific staff - 13% • Admin & Estates - 17% • Management – 4% • Non pay – circa 32% • Clinical supplies inc drugs ,prosthesis etc – 15% • Premises , plant & other – 12% • Capital charges – depreciation / Dividend – 5%

42. The Budget Setting Process - CIP • CIP agreed as part of the planning process and enables the Trust to set the annual plan and budget within its resources • Current economic climate, outlook and Monitor efficiency assumptions outline the need for increasing levels of efficiency savings • Due to economic climate input sought from BDO with regard to best practice & development of schemes and governance • In-year monitoring process includes a monthly report to Exec Team and Trust Board with escalation to the Finance Committee

43. Budgetary control - reporting • Monthly reports to board and management • Performance against plans and targets using key performance indicators (KPIs) • Financial and non financial information

45. Financial Risk Rating (FRR) When assessing financial risk, Monitor will assign a risk rating using a system which looks at four criteria: - achievement of plan; - underlying performance; - financial efficiency; and - liquidity  Achievement against each of these criteria is scored from 5 to 1 (5 indicates low risk, 1 indicates high risk). A weighted average of these scores is then used to determine the overall financial risk rating.

46. The Monitor Risk Rating The risk rating is forward-looking and is intended to reflect the likelihood of a financial breach of the Terms of Authorisation. The ratings of 5 to 1 indicate: Rating 5 - Lowest risk - no regulatory concerns Rating 4 - No regulatory concerns Rating 3 - Regulatory concerns in one or more components. Significant breach of Terms of Authorisation is unlikely Rating 2 - Risk of significant breach in Terms of Authorisation in the medium term, e.g. 9 to 18 months in the absence of remedial action Rating 1 - Highest risk - high probability of significant breach of Terms of Authorisation in the short term, e.g. less than 9 months, unless remedial action is taken

47. The Trusts FRR – 2011/2012 For 2011/12 the Trust are planning to achieve a FRR 3 which assumes full delivery of the £15.8 million CIP target If the Trust failed to deliver the CIP target this would have the effect of reducing the FRR from a 3 to a 2 This deviation from plan and reduction in the FRR to a 2 would trigger immediate action by Monitor who would implement special measures The Trust would move to monthly / weekly reporting with a view to implementing and monitoring a corrective action plan

49. EBITDA Margin EBITDA Margin is the metric that Monitor use to measure underlying financial performance Definition : EBITDA % = EBITDA Actual (Operating expenses) Total Income actual NTH EBITDA margin historically low in comparison to FT sector average, mainly due to structure of NTH finances – no major PFI’s Sector average over 7% , NTH position has declined from circa 6% to 4% over the last 3 years Monitor view is that it is an indication of deteriorating financial position that will lead to the Trust “burning cash”

50. EBITDA Margin