The need to control PFI costs is of paramount importance to any public sector organisation, yet often those responsible for PFI finance and the contract arrangements can work ‘in silo’ creating (inadvertently) a lack of cost control. Collaborative working, therefore, is crucial to encourage greater cohesion and awareness of cost differentials and lead to proactive, rather than reactive working environments.
Experience of the positive difference which can be made through effective team working between both the PFI finance and PFI contract personnel has led me to draw up a list of 7 recommendations for establishing sound financial monitoring systems to help an organisation control its PFI costs.
How to Control PFI Costs – Have a Common Understanding
In some organisations there can be too greater disconnect between those responsible for finance and the team in charge of the contract. The PFI manager deals mainly with client/contractor relationships, while the finance manager, usually working in a different department, deals with payments to the contractor and, where relevant, collection of contributions from end users.
This split can result in multi-million deficits, as the payments get out of sync with actual costs of on-going service and contract changes. In addition, in many cases, the finance managers have little understanding of the contract. This makes it difficult for them to correctly calculate indexation, interest, deductions and cost increases, as PFI payment formulas tend to differ from standard (and simpler) payment provisions in other public sector contracts.
To keep firm control of PFI-related costs, therefore, it is critical that both contract and finance managers have a common understanding of all the components of the unitary charge and robust, shared systems for dealing with the financial aspects of the PFI contract. It is also important that they understand all the formulas and triggers for any cost increases or credits due to the client and have regular communication to keep abreast of any changes.
Recommendations to Help Establish PFI Financial Monitoring Systems
Effective financial monitoring of a PFI contract is founded on three main principles:
- Understanding of the financial provisions in the contract
- Sound financial control systems
- Collaboration and good communication.
Based on these fundamentals, follow these 7 recommendations to help control your PFI costs…
1. Understand the Financial Provisions
It is essential that both the client finance manager responsible for authorising PFI payments, along with the operational contract manager have a sound understanding of the contractual provisions on which these payments are based. The main PFI provisions both the finance and contract managers need to understand are:
- Unitary charge – components of the charge, payment profile for duration of the contract, conditions for payment and provisions for any over/ undercharging to be adjusted in the following month’s invoice
- Indexation – what it applies to, when it applies and how it is calculated
- Variations – triggers for payment, whether they result in one-off payments or changes in the ongoing unitary charge, related indexation and the formulas used for calculation of management and other fees
- Cost share (insurance, utilities etc) – including underlying formulas and the timing of payments
- Benchmarking and market testing – potential cost implications and how these are calculated
- Ad hoc payments – for additional hours of use, vandalism, and the like.
- Ad hoc credits – income sharing provisions, availability and performance deductions, etc.
2. Create Stand Alone Systems to Track PFI Transactions
Although general financial information is usually centrally stored on corporate systems, such as SAP, the complexity and scope of PFI financial transactions necessitates additional financial controls. These are best kept on separate systems, e.g. in the form of spreadsheets. As a minimum, it is advisable to put the following systems in place:
- Sinking fund tracker – projecting PFI payments and receipts up to the end of the contract, to ensure there is no affordability gap, either overall or in a particular year. This is a subject of a separate article to be released shortly – Key Steps to Keep Control of PFI Affordability.
- Monthly unitary charge profile– adjusted to reflect:
i. Indexation (usually based on RPIX); again, a separate article (to be published in due course) will focus on this subject – 5 Tips for Cost Control by Keeping Track of Indexation.
ii. Changes to payments following benchmarking/market testing.
iii. Adjustments to annual payments relating to variations (including additional or reduced FM and lifecycle costs). Click here for more detailed information.
- Variations register (click the link in point iii. above for further information).
- End user contributions profile if such contributions are due, adjusted in the same way as the unitary charge, and which may also be subject to ad hoc charges like vandalism and additional use.
3. Adjust PFI Financial Profiles Regularly
PFI financial profiles require regular adjustments to reflect changes to income and expenditure streams. Such adjustments fall within two broad categories – scheduled (indexation, benchmarking, cost share, etc.) and ad hoc (variations, vandalism, etc). To keep firm control of costs, it is advisable to include all of the scheduled cost and expenditure adjustments in a monitoring calendar.
4. Maintain an Operations Manual
As PFI contracts tend to run for 25-30 years, it’s extremely unlikely that the same officers will be responsible for financial monitoring of the contract for its duration. To ensure that all the knowledge and good practice relating to the management of PFI costs is retained, it is advisable to include the relevant information in the Operations Manual. As a minimum, this should include references to monitoring documents (see tip 3 above), as well as formulas and contractual references for the following:
- Calculation of indexation
- Benchmarking and market testing
- Variation fees
- Cost share provisions (e.g. insurance, utilities)
- Availability and performance deductions
- Conditions for payment and payment adjustment provisions.
5. Be Collaborative
As previously stated, collaboration between the PFI finance and contract managers is critical to keeping down PFI costs. Putting the following systems in place will provide a firm foundation for such collaboration:
- Regular meetings between finance and contract managers, particularly near the end of the financial year and following major changes to the unitary charge due to market testing, variations, etc.
- Regular meetings with the contractor, focusing on financial issues, with the client’s finance manager in attendance (this is particularly important as PFI contractors tend to bring their financial managers to meetings, which puts clients at a disadvantage if they don’t do the same)
- Shared, clear and up to date financial information, as listed in tip 2 above, available to both financial and contract managers.
6. Have a Common Awareness of Financial Formulas
To avoid unexpected charges and on-going disputes, it is also critical that the client and the contractor have a common understanding of the financial formulas used for calculating PFI costs. It is particularly important to reach such a common understanding before the first occurrence of any cost share events (such as cost adjustments for utilities) and prior to benchmarking and/or the market testing of services.
7. Watch Out For Contractual Payment Deadlines
It is equally important that the accounts payable department is aware of the contractual deadlines for PFI payments, with a payment profile set each year. This ensures that the unitary charge invoices are paid on time, avoiding interest being incurred. At the same time it is key that invoices are not paid without authorisation from relevant managers to ensure they are accurate and reflect the services that have been delivered and any related deductions.
If, for any reason, the contractor’s invoice contains incorrect charges or credits, these should be captured in formal correspondence, within specified contractual deadlines, and adjusted in the following month’s invoice.
A Quick Reference Summary
- Finance managers responsible for PFI contracts need to have a sound understanding of relevant contractual provisions. Operational contract managers need to have a sound understanding of the principles and formulas underlying PFI income and expenditure
- Sound financial monitoring systems need to be put in place
- All scheduled activities with a financial impact should be included in the monitoring calendar
- The operations manual should include formulas and contract references for key financial elements of the contract
- Finance and operational contract managers need to collaborate to control PFI costs
- Client and contractor need to have a common understanding of the financial provisions in the contract
- The client’s accounts payable department need to have robust systems for making payments in accordance with contractual timescales, while ensuring that they have been authorised.
For support and advice in relation to financial management of PFI contracts, please contact us on T. 0845 345 0130 or email advice@bestpracticegroup.com
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