The Audit Commission's recommendations on redesigning the NHS's management of finance marks a fundamental shift in accountability, culture, planning and spending, argues Andy McKeon

The Audit Commission's recommendations on redesigning the NHS's management of finance marks a fundamental shift in accountability, culture, planning and spending, argues Andy McKeon

Our mission, if we chose to accept it, was to undertake a review of the NHS financial management and accounting regime within four months. Easy, you might think. But we are talking about a unique and complex system that covers some 600 bodies, each with their own responsibilities and operating to different financial rules and incentives.

Few people fully understand it. Major parts of the current arrangements were introduced in 1990, but new developments have been superimposed on them, probably most significantly the introduction of resource accounting and budgeting. The system has been primarily designed to ensure that neither individual bodies nor the NHS as a whole overspend. But obviously the NHS needs to do much more than that and the weaknesses in its accounting system have become increasingly evident.

Catalyst for change

The Audit Commission chose to accept the mission and the results were published on 26 July. The report - The Review of the NHS Financial Management and Accounting Regime: a report to the secretary of state for health - is inevitably long (92 pages). In terms of NHS expenditure, that is about£1bn per page. You could be forgiven for not reading it in full, but it could produce a fundamentally different approach to managing NHS finance as well as resolving some current well-publicised problems, so it is worth knowing the main points.

Three important developments have demonstrated the weaknesses in the current system and the need for change. First, individual NHS bodies have found themselves under increasing financial pressure. Many of the flexibilities (aka 'fudges') which enabled bodies to meet their statutory duties not to overspend have either been eroded or have disappeared for good reason.

Over time, there has also been less of a focus on financial management both nationally and in some organisations. A growing number of organisations have incurred deficits of increasing size, which has resulted in the NHS overall overspending by£536m, according to the unaudited accounts for 2005-06. It also appears to be increasingly hard for organisations to recover financially.

Second, the shape and nature of the NHS is changing. Foundation trusts, payment by results, practice-based commissioning and policies such as Commissioning a Patient-led NHS will have profound effects on NHS finances. The financial management and accounting regime has not kept pace with these developments. New approaches will be required.

Third, like the rest of the public sector, the NHS faces lower rates of expenditure growth from 2008-09. It must, however, continue to meet the challenges of rising expectations, new technology and an ageing population and continue to address existing weaknesses in service provision.

Our report drew on the experience and knowledge of senior NHS executives and non-executive directors, finance staff and auditors in the field, as well as organisations such as Monitor and the Healthcare Financial Management Association.

These are among the main recommendations to the health secretary:

* resource accounting and budgeting (RAB) is incompatible with the trusts' financial regime and should not be applied to those organisations. The Department of Health should instead establish a national buffer so that it can meet its obligations to the Treasury, but trusts can then operate as intended. This would eliminate the so-called 'double deficit' phenomenon which has been a cause of bewilderment to many in the service. Such a buffer will in any event be needed as the number of NHS foundation trusts grows because the DoH must cover any aggregate deficit they incur.

Like any buffer zone between countries it would not be intended to be occupied by - ie spent by or allocated to - individual organisations. So it is no good any trust or primary care trust thinking it can overspend because there is money in the buffer to bail it out.

* Individual trusts which have suffered RAB adjustments without any compensating financial support should have the funds returned to them. We do not believe there are many such cases.

* Trusts should move on to a financial regime which gives greater emphasis to cash and liquidity and has transparent arrangements for borrowing for both investment and working capital. This will help in the preparation for foundation trust status and give greater financial clarity for individual organisations.

* Planning and financing arrangements are needed to put primary care trusts in a much stronger position to manage their financial risks.

* Finance for capital development and working capital needs be provided by a separately identifiable, professionally staffed banking arrangement in the NHS. It would be the only source of such funds. It would also receive cash and pay interest on cash deposits from NHS bodies.

* The creation of a more effective and swifter mechanism for identifying and dealing with financial distress, with clear trigger points and matched intervention strategies.

* The NHS manuals for accounts should be reviewed, made less prescriptive and more principle-based and brought more closely into line with UK generally accepted accounting principles (GAAP). This would also have the benefit of making NHS finance staff less reliant on specific DoH instructions and more reliant on their own professionalism.

* The DoH and strategic health authority oversight and management could be improved by addressing the way in which policy initiatives are costed. The PbR tariff is developed and given greater certainty over the medium term, and relevant guidance is issued promptly to the service. This is all about giving trusts and PCTs greater confidence. It would also put them in the best position to manage their affairs properly and therefore provide no excuses for not doing so. There should also be reductions in the quantity of data required while at the same time improvements are made to its quality.

A number of our recommendations may entail additional cost, particularly in establishing the buffer and eliminating trust deficits due to income reductions under RAB. We also identified a number of areas for further work, particularly in relation to the proposed banking arrangements and the regime for PCT finance and financial recovery. PCTs are relatively new. They are also facing a new commissioning environment, including the introduction of PBC, which is likely to have a significant impact on the way they operate, including their ability to commission services jointly with local authorities.

Dealing with deficits

One of the most challenging areas of our review was how trusts with significant cumulative deficits should be dealt with. Our conclusion was that these deficits should not be written off. The main task is to ensure that any cash shortages are addressed and that each trust is financially viable over the longer term. This may involve some difficult decisions on restructuring services or explicitly deciding to pay above the tariff in order to preserve them.

Three themes run throughout our report. First, there is a tension between the performance of individual organisations and the overall performance of the NHS, either in a local health economy or nationally. Individual organisations can, for example, find that their surpluses are taken and used to support others with deficits. Those with financial problems can find them obscured within complex local financing arrangements. Both can dilute accountability.

We believe that organisations' sense of accountability will increase if the financing regime is made simpler and more transparent and the individual bodies are made more self standing and less affected by others' performance.

Second, many of the issues and problems raised with us have been cultural. These include, for example, late setting of budgets or service level agreements, long drawn out and poorly managed arbitration procedures, submission of reports to strategic health authorities and the DoH which are inconsistent with reports to the organisation's own boards, the belief that finance is the sole responsibility of the finance director and the way in which failure has been dealt with. Our recommendations will help to tackle these points, but they will only be fully resolved by determined leadership in each and every organisation and across the NHS.

It will also be important for us all (including MPs, the media and the public) to recognise that some modest level of underspending is both essential and inevitable. No organisation can operate prudently without some reserves.

Third, there is a need for much better medium-term planning to make the best use of resources. This requires the support of all staff. The engagement of frontline clinicians in planning and finance is crucial. PBC is the vehicle for achieving this in PCTs and is key to its development. But the same is true in trusts as well.

The health secretary and the DoH will consider our report over the next few months and we expect a response later this year. In the meantime, NHS bodies should not make decisions in anticipation of changes being made to the financial regime. Some of our proposals will take time and money to implement.

However, there are a number of recommendations that individual NHS bodies can begin to address now, particularly those relating to improving governance arrangements, internal financial reporting, and ensuring that financial management skills are spread throughout the organisation.

Perhaps unsurprisingly the main focus of the news coverage so far has been on our RAB proposals and our views on cumulative deficits. But it would be a mistake to focus purely on these issues. Our report sets out a challenging and wide-ranging agenda.

Our recommendations offer the prospect of individual organisations and the NHS as a whole operating on a sound and sustainable financial footing and in a more business-like way. They would give greater clarity, but demand higher standards as a result.

They would not of themselves prevent deficits, but they would put trusts and PCTs in a better position not to incur them and, importantly, give them a better prospect of recovery if they do.

They should also put trusts and PCTs in a better position to achieve value for money for the taxpayer and consistent reliably funded services for patients. Mission accomplished? More like mission just beginning.

Andy McKeon is managing director, health, of the Audit Commission.