Feature / Stock take

The economy appears to be picking up, but providers should check the financial health of their suppliers of goods and services, Jill Boggan says

Amid reports that Bank of England governor Mark Carney says Britain's economic recovery has finally taken hold and is stronger than expected, it may sound a little 'glass half empty' to be calling on trusts to ensure their suppliers are financially healthy. While we all hope that we've seen the last 'Woolworth moment', business failures are still making headlines - Blockbuster and Comet (again) to name but two.

We might not consider it an issue that there may still be a few people trying to find an alternative supplier for blank cassette tapes since the demise of 'Woollies', but the failure of, say, a key supplier of gastro endoscopic products to many trusts in the UK, could be catastrophic.

As NHS finance professionals we're aware of the level of monitoring of our organisation's financial position. For trusts and foundation trusts this includes a range of indicators, including: EBITDA (earnings before interest, tax, depreciation and amortisation) margin; achievement of plan; return on capital; income and expenditure surplus margin; liquidity; and since 1 October 2013, Monitor's continuity of services risk ratings, liquidity and capital servicing capacity.

We're aware of how sensitive these risk metrics are to changes in our financial position and the corrective actions we can take if problems arise. But, leaving aside commissioning for healthcare, do we apply the same level of attention to the suppliers and contractors we rely on to provide goods and services to our organisation?

Many NHS organisations mention the requirement to review the financial health of suppliers and contractors in their standing financial instructions (SFIs) or corporate governance manual, with significant numbers referring to arrangements around a list of approved suppliers.  Responsibility for evaluating suppliers is often led by procurement colleagues for new suppliers and the techniques and extent of evaluation varies widely across the NHS.

The financial evaluation process that NHS Supply Chain follows is a good starting point (see box for a summary).

There is a strong case for finance teams to support procurement and operational colleagues in assessing and monitoring risks to the financial health of key suppliers. Finance teams will be able to readily interpret and analyse financial information provided by suppliers and will be well placed to pick up some of the early tell-tale signs that a supplier may be facing financial challenges. We may be envious of the energy and zeal with which a supplier's credit controller pursues payment ahead of agreed terms. And we may be tempted by offers of 'too-good-to-be-true' discounts for significant prepayments. But this may also be an indicator that a supplier may be facing cash flow difficulties.

Of course, supplier behaviour is not always a good indicator of their financial health. For example, at the end of last year one fashion retailer reportedly sent out invitations to the press around the same time as journalists were speculating the retailer had been forced into liquidation because of unpaid debts to its financial backer.

It's important that the approach taken to supplier financial appraisal is proportionate if it is to be effective. There are, however, some key circumstances where it is essential. These are:

• When purchasing significant strategic, high-risk items, particularly if these directly relate to the delivery of new patient care pathways or redesigned pathways to improve outcomes and efficiency. An example might be the purchase of a robotic surgical system.
• When purchasing customised or non-standard items - an example might be a bespoke software or IT solution
• Construction and capital schemes, including buildings, plant, equipment and computer systems
• When entering into just-in-time (JIT) arrangements
• When entering into collaborative arrangements and joint working
• When negotiating outsourcing arrangements - examples might be outsourcing hotel services, facilities or payroll
• Before agreeing sub-contracting arrangements by a main supplier in respect of important components
• When negotiating service level agreements
• When establishing e-procurement arrangement with long-term strategic suppliers.

One of the key situations that may be worthy of evaluation is JIT arrangements for stocks items. Pressure to achieve savings and preserve cash balances has inevitably led to focus on reducing stock levels within NHS organisations. The ability to confidently rely on JIT suppliers has become more critical. It is also important to consider the implications of stockpiling items, including medicines.

A 2013 National Audit Office report revealed that between 2009/10 and 2012/13, 2.4 million units of Tamiflu were consumed, primarily in the influenza pandemic in 2009/10. Over the same period 10 million units were written off. The report states that given the likely long periods between pandemics it is inevitable that stock will be written off without being used due to reaching end of shelf life. But six and a half million units were written off at a cost of £74m (2011/12 prices) due to poor record keeping by the NHS about their storage environment during the 2009/10 pandemic.

It must be noted, that stockpiling of antivirals in anticipation of an influenza pandemic is in line with World Health Organisation (WHO) guidance and is likely to be justified even with cautious assessments of their efficacy, The Department of Health's business case factored in the desire to maintain public confidence in the pandemic response by being able to make antivirals available to all those who might become ill in a pandemic.

The NAO report highlighted the need to ensure all providers of antivirals in a pandemic have robust antiviral storage and quality control in place during a pandemic to reduce the risk of unnecessary write-offs.

It is important to consider that financial appraisal and ongoing monitoring have limitations. They will not completely eliminate but rather reduce risks by enabling considered decisions to be made around entering into contracts with suppliers and ongoing management of those relationships.

The following checks are not exhaustive but intended as a guide from which to select the most appropriate tools depending on the individual circumstances. Possible checks on suppliers from external sources are:

• Liquidity and cash position
• Value of borrowings and the ratio of debts to assets
• Credit reference agency reports such as Dun and Bradstreet supplier evaluation reports on:
  • Sales volumes
  • Financial profile including how the supplier is doing compared with others in the same industry
  • Supplier risk score - this provides an indication of the general financial status of a supplier and acts as a benchmark to allow comparison with other suppliers
• Credit reports, including bankers or trade credit references
• Details of the supplier's other customers and whether reliance is placed on a small number of large customers
• Annual turnover over the last three years
• Profitability and relationship between gross profit and net profits
• Value of capital assets and the return on capital assets and on overall capital employed
• Whether the supplier belongs to a group of companies or a parent company
• Possibility of developments and restructuring of the company including takeover and merger and the impact on future supply
• Nationally provided supplier information repositories such as Sid4Gov

Further ratio analysis may be performed in house as outlined in the box, below.

Monitor's Risk assessment framework uses two robust financial indicators to assist in the assessment around risks around provider continuity of services, with strict criteria around the calculation of the risk rating. NHS providers could learn from the rigour of these tests when examining their own suppliers of goods and services. How does your organisation seek assurance that your suppliers' financial health supports continuity of supply to you? 

Jill Boggan is assistant director of finance (financial accounts) at Royal Liverpool and Broadgreen University Hospitals NHS Trust and a member of the HFMA Accounting and Standards Committee.