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4 July 2008
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Dividing line

A different approach to finance



Craig Pickering, consultant for the Finance & Leasing Association, discusses ways to finance public sector investment in a colder climate



There was a time after the turn of the century when it was almost possible to believe that the long-running funding crisis in the UK public sector had been solved. The broad totals of public spending rose at a level unparalleled for generations. The NHS did best, but schools were a close-run second. Scientists were doing well and even the financial Cinderellas of the public service, such as prisons, seemed to be on the up fiscally.

Of course, life was never quite that simple. Managers of individual NHS trusts, schools and prisons often felt differently, depending on their institution’s individual financial circumstances. A building in poor shape, an intake of out-stripping resources, or a local epidemic, could very easily overtake any nationally determined budget.

Changing times
The 2007 Comprehensive Spending Review signified a sea change for all public services, with the news trickling out slowly. Gordon Brown had trumpeted previous spending reviews on one Parliamentary occasion, from the budgets of all departments. In those days, all the ships were on a rising tide. By 2006, it was clear that the tide was ebbing. So by the time Alistair Darling made his announcement in October 2007, only a few Departmental budgets were left to announce.

The party was over. Instead of budgets growing steadily in real terms at significant levels, most public services were faced with growth to 2011 at levels only just above inflation, and some faced budgets below that. And when overall budgets sink that low, there will be some individual lines of expenditure that will fall in real terms. For the first time in a decade, ‘cuts’ has re-entered the British political vocabulary.

If you’re a manager in any public service, financial prospects have changed. If you’re lucky, you’re coping with the consequences of low growth. If you’re unlucky, you’re managing something worse.

So how are you going to deal with this? You have a range of options, covering management, finance and politics. I want to focus on just one approach, in the financial arena.

The financial approach
Pressure will start in year one, carrying through to the rest of the spending review period and with implications beyond. It’s tempting to go for options that postpone the financial pain, but that’s often a mistake. Successful organisations need to decide what they want and need to achieve, and then determine the financing in a realistic way. Trying to do it the other way round usually spells trouble.

So your goals are fixed for the next three years. You have some funding from the centre. Perhaps you have local sources of revenue, depending on the public service you provide.

But you may find there’s still a gap in your budget making. One useful and under-used way to fill such a gap is to enable new investments in equipment by using asset finance: leasing and related products. It can be used for equipment in its widest sense, including vehicles, IT and - increasingly - the services associated with particular assets. Fire authorities, for example, can and do use asset finance to maintain their fire engines, as well as leasing the vehicles themselves.

Shopping around
In most asset finance markets there’s lively competition. All the commercial arms of the major banks provide this kind of finance, as do many smaller banks. There are also independent finance houses in many markets. And manufacturers often have a finance arm, especially in the IT and vehicle markets. So you should certainly shop around. Brokers and advisors are also active in the asset finance markets.

One way to assure yourself you’re dealing with reputable businesses, especially if you’re new to the sector, is to check whether the finance house is a member of the Finance & Leasing Association (FLA). The FLA has a Business Lending Code, which sets out best practice for members and allows customers recourse to a formal complaints procedure should things go wrong. If you prefer to use a broker to find finance rather than go direct, the National Association of Commercial Finance Brokers has a code of conduct that regulates their members’ businesses and is worded along similar lines to the FLA’s. If you choose this route, find a broker who specialises in public sector asset finance.

Public services are very similar to private sector firms in one important respect: both find it hugely advantageous to reduce pressures on their current cash flow. Given the more uncertain economic times we now face, this benefit is likely to loom larger for many people managing budgets in the public services over the next three years. In contrast with outright purchase, asset finance is available over the period that you use the asset.

That period can be only part of the asset’s economic life. So your payments correspond precisely to the period you need the asset.

This means that you are not taking what is known in the asset finance world as residual value risk. In plain words, you are not taking a punt on how much the asset will be worth when you no longer need it and wish to sell it. Asset finance providers are providing these assets in very large numbers in many markets and can thus make informed judgments about residual values. That does not, however, mean asset finance providers always get it right. If residuals move the wrong way they can lose a lot of money - but that’s their risk, not yours. If you buy the asset, you also acquire that risk.

Options
You can tailor the finance to the asset and the financial regime that you’re governed by. In the NHS, for example, you will want to use an operating lease - for only part of the asset’s economic life. Elsewhere, you may be able to access a finance lease, available for the whole of the asset’s economic life - and you may well be able to acquire the asset for a peppercorn sum at the end of the lease, if it suits you to do so. And you will want to consider whether getting the finance packaged with related services, such as vehicle maintenance or IT servicing, would suit you better than plain vanilla financing.

The financing can come in a variety of formats. Balloon payments are popular: lump sums paid at the beginning or end of a lease, followed or preceded by regular payments. In some industries, payments related to seasonal revenues can be arranged.

Keeping up to date
Where you’re using high-technology, asset finance is a stimulus to regular reviews of whether you’re using appropriate and up-to-date equipment. Buying technology too often results in it being used long past its sell-by date. Technology refreshes can be built into the finance package.

One word of advice, however: when you use leased equipment it’s your responsibility to ensure that it’s kept in good condition. You will need to arrange for regular maintenance, unless it is part of the finance contract. The contract will specify the condition in which the asset needs to be returned. Don’t just file the lease away in a drawer until the day the asset has to go back, as this might spell trouble.

If you look around you should be able to find a competitively priced deal that will allow you to use the equipment that you need, with any services that you find useful. And the pain of the Spending Review will start to diminish.