Financial Planning Updated

Updated October 2019 View full section
This section focuses on the financial plan, explaining why it is essential for housing associations and the key areas which should be included. It gives advice on how to challenge and analyse financial plans as well as how to set targets for the future, and includes a checklist to enable greater understanding and constructive challenge.
This section is based on a bulletin produced by the CIPFA Housing Panel, and is reproduced by permission of the Panel.

All boards of housing associations should carry out a  review at least annually to confirm how the overall strategy and objectives of their association will be delivered. Very often, the starting point will be a corporate plan which may include a review of the internal and external context to the business using tools such as analysis of the strengths, weaknesses, opportunities and threats (SWOT) to the business which can extend to the broader context of political, economic, environmental, social and technological factors (PEEST). The corporate plan will then be published and include a confirmation that the plan has been costed and tested. A separate business plan is likely to be prepared which is more detailed and less likely to be published due to the need for confidentiality.

A key part of the business plan is the financial plan which should demonstrate how the aspirations will be met from a financial perspective and translates aims and objectives into financial forecasts.

Where a housing association is undertaking new build the business plan will allow the organisation to project future costs which will be needed in decision making regarding capital expenditure and loan finance.

Regulators will expect that a robust assessment of the housing association’s future plans has been undertaken, They will expect that reasonable assumptions have been made and that these have been stress tested. This is a key requirement to meeting the requirements of the regulators Governance and Viability Standard. A business plan is not a statutory requirement but it helps organisations demonstrate good governance and viability.

The financial plan is also a key document for an association’s funders, enabling them to assess whether the association is able to meet the long term servicing and repayment costs of the current and future borrowings.

In addition the Companies Act 2006 places a statutory duty on boards (including those housing associations that are incorporated under the Companies Act) to demonstrate that when making decisions, they have considered the long term effect of those decisions on their company, their staff, their suppliers and the environment. The long-term financial plan is one of the ways in which a board can demonstrate this.

Housing associations, in line with most other businesses, will approve an annual budget each year setting out the estimated expenditure for the next 12 months and where the funds to meet that expenditure will come from. A financial plan looks further ahead and is of necessity closely linked to the strategy and objectives of the business.

Effective financial plans should be made up of two key areas. Firstly, the anticipated income related to the business’s present stock will identify whether the current portfolio is able to support the expenditure requirements for the future, including stock condition requirements, using reasonable assumptions for future inflation, interest rates etc. Secondly, estimates of any new housing development or new business initiatives need to be included.

Given the number of assumptions included, financial plans are not therefore as detailed as annual budgets. The main consideration is the forecast trends of the business rather than the detailed figures themselves.

As all forecasts are based upon assumptions it is therefore important to undertake sensitivity testing, to show the impact of various changes upon these financial forecasts. It is the outlined actions that would be taken in response to these events that are important, rather than the figures themselves.

There are many reasons why housing associations need to produce medium to long term financial plans and the key reasons are identified below.

To confirm ongoing financial viability

The long-term viability is essential for boards to understand and of key interest to the regulator and the association’s lenders. Confirmation that future income streams will be sufficient to meet expenditure requirements is critical. If this cannot be demonstrated with sound assumptions, action will need to be taken to correct any shortfalls. The board will need to assess the plan in order to sign off the association’s annual accounts as a ‘going concern’. Note that external auditors also consider such plans before signing off accounts each year, as a key indication of whether the organisation is a going concern.

To demonstrate they can finance their key objectives

Organisations should have discussed and agreed their priorities for the future and a financial forecast is required to demonstrate that they will have sufficient income to meet their objectives. These will include regulatory requirements, eg achievement of Decent Homes (or equivalent) and rent guidance, any ‘policy promises’ made to residents and repayment of loans borrowed.

To evidence ability and capacity to grow and develop

Financial plans enable consideration of various options to be modelled. This should assist in demonstrating that the business has sufficient capacity to develop or resources available for further growth in building new homes or additional services.

To demonstrate value for money

Including target efficiencies in the plan ensures that value for money objectives are embedded in the plan and can be monitored in the future.

To identify potential threats and risks to achieving objectives

Using the plan to model various different assumptions and scenarios can assist in identifying critical risks, enabling action to be taken to mitigate these. The top five key risks should be tested in the model. A political, economic, environmental, social and technological (PEEST) analysis can assist in identifying those risks. Rent reductions or lack of rental increases are likely to be key risks. This will also demonstrate an ability to withstand adverse changes in the operating environment.

To confirm that all loan covenants will be met

Where associations have borrowed substantial loan funding, there are generally key financial covenants which must be achieved. It is important for the organisation to be sure that future plans do not result in possible breaches to covenants and potential withdrawal of loan facilities.

To meet funder and rating agency requirements

Many banks and building societies have built into loan documents that financial plans should be updated annually and submitted to them by a specific date. The board must be aware of these requirements and ensure that business and financial planning work is completed in sufficient time to submit an approved plan.

To meet regulatory requirements

Registered providers have to comply with the Regulatory Framework for Social Housing in England from April 2015 from the Regulator of Social Housing (RSH).

Within this framework, the economic standards apply to all registered providers except for local authorities; the standards convey specific expectations around governance and financial viability that are relevant to good practice in business planning.

The standards include strategic planning and control framework, monitoring, timely internal/external reports and returns, fraud reporting, meeting regulatory standards, security of assets, proper use of public funds, risk management, liquidity, financial forecasting and compliance with covenants.

The RSH’s current reporting arrangements are based around the viability review that it issues annually. The Financial Forecasting Return (FFR) is produced annually and is based on the approved business plan. The Financial Viability Assessment (FVA) is based on the audited annual accounts. The Quarterly Survey is primarily based on funding facility. See the RSH website for further information on reporting. All returns should be consistent in their outputs.

The regulatory requirements for maintaining long term financial forecasts and financial planning are contained in the Regulation section; see this section for the full details.

As a rule of thumb, financial plans should be prepared for at least the next five years to evidence ongoing viability and to demonstrate how the business plan’s objectives will be met. This should cover all ongoing day to day income and expenditure as well as planned developments and capital projects over the period.

Because housing is a long-term business with lengthy cost cycles, most associations also produce 30–35 year plans. Most housing associations have long-term bank, bond or private placement debt which can extend to 30 years or more. In fact the regulator requires all developing associations to produce and submit such plans every year via an FFR return.

For stock transfer associations (LSVTs), the length of the financial model is often dictated by funders, who wish associations to demonstrate that they have sufficient net income to enable repayment of loans within agreed timescales.

It is important to note that while the first five years of a financial plan should reflect the organisation’s current business plan, 30–35 year plans are clearly broad estimates as they comprise a significant number of assumptions. However they are valuable to demonstrate trends and in particular to identify any potential refinancing or reinvestment needs for the future.

Where possible, plans should start from actual brought forward balances extracted from the association’s audited financial statements. The first year of the plan should therefore be the current year and should reflect the approved budget for the year. Note that it is important for this first year to be as realistic as possible as generally future years’ income and expenditure will use this as the base. It is therefore helpful to review previous plans and assumptions – how well did these compare with actuals and did the association deliver what it aimed to?

To this base, reasonable assumptions should be applied eg CPI, RPI, LIBOR, increases in staff costs, maintenance, house prices, new build costs etc. Minor changes can have a material impact in future years so should be carefully selected. Members should be involved in the approval of these key assumptions which should be reviewed annually. The financial plans should explain the basis of these assumptions, and any external source or benchmark which has been used.

The impact of any proposed development should then be added and care taken to ensure that all relevant costs are included. Smaller associations will probably include specific known schemes but larger developing housing associations may use average numbers and costs. If assumptions are going to be made about future unknown developments, average costs, grants and sales income should be used. The basis of these assumptions should be explained.

Many associations have approved sales and development programmes which should be included and thoroughly stress tested against external market factors. In addition it is important to consider whether there is a need to include any additional capital expenditure – for example replacement IT systems or office refurbishments. Finally the impact of any grant rate changes or any proposed increases in services should be costed and included.

In an environment of minimal grants for developing new homes the assumptions about how any development programme is funded need to be explained. Where any grant income is included in the assumptions the impact of any changes to grant rates should be considered.

Where an association is proposing any increases in services these should be costed and included. Equally, where service reductions are being sought, these should be costed and included in the financial plans.

A key check on the plan is to question whether any material items have been excluded. Where group structures exist, it is particularly important to have a financial plan for all subsidiaries to ensure a complete overall picture. More complex groups will have a financial plan for each company with a summary financial plan for the group.

Smaller organisations should liaise with other organisations on financial planning. They could benchmark assumptions and share resources and good practice.

Most housing associations now use dedicated financial planning software. These allow for standard assumptions to be quickly entered into the plan and allow for scenario planning to be quickly undertaken. Although this approach helps with consistency, it should be remembered that  any plan is only as good as the raw data and assumptions entered.

If external advisers are used to build a financial plan, the organisation needs to ensure staff understand how it works, how it can be amended and how changes can affect outcomes.

In terms of risk, the complexities of a business cannot be devolved to a junior member of staff just because a tool is easy to use. Checks should be built in to ensure outcomes and trends relate to the inputs and expectations from the business plan.

As a bare minimum, the financial plan should include an income and expenditure account and estimated cash flow; a balance sheet would complete the picture.

Although some boards with financial expertise may welcome the opportunity to review the figures, it is not essential for board members to see the detailed figures to approve the plan. The finance director should however prepare a report on the plan which identifies the following key areas:

  • the key assumptions used in the construction of the plan
  • annual surpluses or deficits – this can be shown in a graphical format to ease understanding
  • balance sheet trends for assets, loans and reserves
  • a cash flow forecast highlighting annual loan drawdown requirements
  • an assessment of the cash being generated by the business and the ability to repay the loans – this can be shown in a graphical format to ease understanding
  • cash balances
  • whether loan covenants are met for each year of the plan (and if not what action can be taken to correct this)
  • whether the association’s current loan finance will be sufficient to meet objectives (and if not, when new monies are required)
  • an analysis of the stock profile at the end of each year
  • stress testing covering a range of sensitivities, outlining the impact of various changes in assumptions
  • if the lenders stopped any new loans, whether the current loans could be repaid within the terms by stopping growth/new development and how much leeway (capacity) there is within the plan
  • if properties built for sale cannot be sold, whether loans can be repaid and covenants complied with
  • any other performance indicators which the board have stated they wish to see (eg surplus targets, asset ratios, debt repayment etc).

Housing associations should agree parameters which can be used to demonstrate viability. Typically these will include interest cover, gearing and minimum level of surplus, but the actual indicators will depend on an association’s loan covenants and critical success factors.

Organisations may identify no more than three or four targets which can be tracked in all future budgets and financial plans. Careful thought needs to be given to the targets, which could be determined from covenant requirements, by comparison with other similar organisations (using benchmarking data) or accounting ratios. The following list gives examples of the types of indicators that may be helpful but this is not a definitive list.

Individual housing associations will set targets and parameters for these indicators based on their business plan, agreement with lenders and benchmarking with peers:

  • gearing
    • loans to grant and reserves
    • debt to asset values
  • interest cover
  • average interest rate
  • maintenance/investment costs per unit per annum
  • cost per unit
  • return on investment
  • management costs to turnover
  • general reserves to turnover
  • operating surplus to turnover.

It may be desirable to set traffic light indicators in order to assess performance against targets. Where the plan fails to achieve the ‘green’ targets and is highlighting some amber areas, the board would wish to question how to strengthen the overall financial position. If the plan is showing ‘red’ areas, the board may decide not to approve the plan but carry out further analysis or review before proceeding further.

As the financial plan is made up of a large number of assumptions over a lengthy period, it is important for the impact of these assumptions to be understood. Sensitivity analysis demonstrates the impact of different assumptions on the plan (and in particular on the annual surplus/deficit, cash generated and loans borrowed). It should test both income and expenditure.

Each association must determine the areas it needs to see analysed and this will depend on the nature of its own business. It is particularly useful to use the five key risks which have been identified as areas for modelling. For example a housing association involved in shared ownership or outright sale may need to see the impact of delays to sales or reduced valuations, while an association with a significant proportion of variable rate debt will need to assess the impact of changes in LIBOR or bank base rate.

An organisation should evaluate the dependency of its rent income on housing benefits and the impact universal credit changes may have. An organisation with significant amounts of supported housing may want to model reduced grant income.

Other areas to model could include increases in staff or maintenance costs, changes in inflation (CPI and RPI), reductions in rent levels, reduced grant or increased maintenance requirements. In addition, the impact of no further development (beyond that already committed) is often asked for by funders and the regulator.

It is considered good practice, and a regulatory expectation, to carry out multi-variant stress testing on financial plans. Ideally, this should be group variables which are likely to be effected by a movement in external factors, such as inflation or house price demand. While altering a single variable gives the best indication of risk for that variable, altering interrelated issues perhaps gives the best and most likely outcomes.

As organisations evolve and increase their mix of tenure, it is important to test the assumptions used: growth may differ between markets, as will the life cycle and maintenance of a product. Scenarios can be built to include exit strategies from shorter term markets or to reflect longer term strategy.

It is useful to know which assumption has the smallest change with the greatest impact and which change in assumption can ‘break’ a plan (ie make a plan break its covenants). Funders often ask for sensitivity tests with higher assumptions than the ordinary to check the solidity of a plan. Through such inputs, it is also possible to identify if a plan is behaving as expected and test for potential errors in setting up the plan or inputs.

In addition to understanding the effect of changes to the assumptions, it is also worth modelling the ‘unexpected loss of income, or higher expenditure’. What level of ‘loss’ can occur before the association is in breach of its covenants?

However, understanding the financial impact of the sensitivity testing is only part of the testing. What becomes more important to board members, funders and the regulator is the corrective action the association would undertake to mitigate any negative effects of ‘lost income or extra expenditure’. Mitigation actions should be realistic and costed. They should also be tested against a housing associations ability to meet its, loan, regulatory, legal, and importantly customer safety obligations whilst maintaining its stock to a lettable standard. Having these mitigating measures approved by the board, in advance of problems arising, gives the regulator confidence that boards are in control.

There are a number of areas where board members should question officers to ensure that they fully understand the plan before it is approved. If these have not been included in the finance director’s report, members should ask the following.

  • Does the plan reflect the overall direction in which the association wishes to move, ie is it a financial interpretation of the objectives and vision?
  • How has the plan been constructed; have finance staff worked closely with business staff and does the proposed plan have the approval of all directors?
  • Have the outputs been checked, ie has the model been audited or checked?
  • Do costs and income reflect the current position, and if not, why not?
  • Have all income and expenditure streams been included?
  • Are assumptions reasonable without being too optimistic or pessimistic? What external benchmarks and professional advice have been used? What changes in assumptions will ‘break’ the plan (make the plan unviable) and what is the likelihood of that?
  • Where improvements are assumed in current costs, what evidence is there to back this up? Similarly, where reduced voids and bad debts are forecast, how will this be achieved?
  • Are all income streams contributing to the bottom line? If not what action is being taken to address this?
  • What tolerance or headroom is built into the plans to enable the housing association to deal with new requirements or adverse changes?
  • Does the model reflect accounting practice, eg have auditors agreed any proposed capitalised repairs and is the impact of any changes in accounting practice included?
  • Is there a need to consider any impairment to assets given the economic climate?
  • What are the key sensitivities which could throw the housing association off course?
  • How likely are they to occur?
  • What were the outcomes of testing the sensitivities?
  • What is the impact of the key risks and opportunities identified by tools such as SWOT and PEEST analyses on the financial plan and what is their probability?
  • How easily does the plan meet the required loan covenants and if it is close, what headroom is there in place? This is particularly important for associations which have high levels of debt funding.
  • Is there sufficient loan finance in place to meet the needs of the plan and if not when will new funds be needed and is there sufficient spare security to attract loans?
  • Is there anything included in the plan which cannot be funded from the housing association’s current borrowing? For example, certain types of expenditure may be excluded from some loan facilities.
  • Are there any tax implications to the plan which need to be included or considered?
  • What growth opportunities can be funded from available funding capacity or headroom within the plan?

As a medium to long-term plan with high level assumptions, the plan should generally need to be updated more than once every year. An in-depth review once a year should be sufficient. However, there are some instances when the organisation may wish to report back on the plan to the board on a more regular basis:

  • where a major change is proposed in the plan such as a proposal for a new development which will have a material impact on the plan
  • in times of economic and financial volatility, such as where there are significant changes in interest rates or CPI, particularly where these were not anticipated in the original assumptions
  • where achievement of loan covenants is known to be tight (or the association is working to amber targets)
  • where actual performance for the year is showing material adverse variance against budget which is likely to be ongoing
  • where there is material external change which could affect the plan such as taxation changes, reduced grant rates or changes in rent policy.

Not amending the plan during the year does not mean not using or reviewing it. As a dynamic document, it should reflect the business in the changing environment and be used as a monitoring tool. As business decisions are proposed, these should be tested against the financial plan assumptions and forecasts to check how expected outcomes will be affected (beneficially or not).

It is usual for development programmes to fit within an overall envelope; changes in scheme timing can be as significant as changes in tenure mix or schemes and these will be tested in the financial plan either at set times (eg quarterly) or at trigger points (variances of specific outcomes over x%). Changes in treasury forecasts should also be tested in the financial plan and reported to boards (at least quarterly).

The financial plan should be reviewed annually to ensure it is an efficient tool for the business, reflecting its business plan. External benchmarking will assist with the scrutiny of the assumptions. Comparing actuals to forecasts should ensure better forecasts going forward. Outputs should be reconciled to financial statements for the past year.

If in any doubt, an external validation of the financial plan should be carried out to reassure boards that the financial model is reliable for their purposes.

Board members can make a real contribution to the financial plan by being critical friends. In particular, they should understand the importance of the financial plan and be clear on the links between the business plan objectives and the financial forecasts. This will provide assurance that the business is viable now and in the foreseeable future and enable them to confirm that the organisation is a ‘going concern’ to auditors and funders as required.

The financial plan should be ‘owned’ by the board as it is ultimately their responsibility. To achieve this, organisations should ensure boards have the ability to challenge and understand how their business plan is translated into the financial plan.