When early warnings fall on deaf ears

Balancing income and expenditure can be a challenge for many organisations with a social purpose, whether they are public sector bodies, not-for-profits or social enterprises. Especially in times like this, when what passes for normal is changing on a daily basis and everyone’s feeling the squeeze. It’s important that such organisations identify potential financial issues early, so that they have time to address them before things hit the fan. But even when early warning signs are evident, they don’t always get acted upon.

The ability to set a balanced budget is important for all organisations. But for local councils in the United Kingdom it’s actually a legal requirements. And if it looks like they can’t meet it, they’re obliged to issue a formal notice (a ‘section 114’ notice, after the bit in the Local Government Finance Act 1988 that sets out this requirement) explaining what’s going on. The issuing of this notice shuts down all but the most essential financial activity and means that the Council must take urgent action to rectify the underlying situation.

This is a fairly draconian course of action, and the small number of councils that have been forced to take this step have done so reluctantly. And the consequences have been severe. One council has been abolished completely (or, rather, it disappeared in a county-level restructuring programme) and the others have been subject to immense levels of scrutiny from central government, the media and others.

The surprising thing, perhaps, is that we’re still only talking about a very small number of local councils. Four, by my count, out of over 300 councils in England alone. And in each case, there have been very specific circumstances that have led to the financial issues underlying the issue of the section 114 notice, from failed transformation initiatives to ill-chosen commercial investment strategies.

It can be tempting to regard these four councils as one-offs. As products of unique sets of locality-specific circumstances that are unlikely to be replicated elsewhere. But given the financial pressures facing local councils across the board, it would be a very arrogant director of finance who considered their organisation entirely immune to such matters.

For me, the interesting thing about those councils that have issued section 114 notices is not that they have done so, but rather how long it had taken for the dire financial situation they were facing to be acted upon. Research undertaken by the Chartered Institute of Public Finance and Accountancy (CIPFA) has found that numerous warning signs were missed or ignored. And it was only when the problems became impossible to overlook that action was taken to address them.

CIPFA has identified four main reasons why things needed to get so very bad before the councils involved took action to address their financial challenges:

Firstly, the organisations didn’t recognise – or didn’t want to recognise – the reality of the situation. When red flags were raised by finance staff, auditors, peer councils or other external partners, they were glossed over or ignored. The councils continued with a strategy or course of action that was demonstrably not working. In some cases, for years. And, despite overwhelming evidence to the contrary, they continued to convince themselves that they were doing the right thing.

Secondly, there was a lack of leadership at the top of the organisation. Nobody wanted to take the difficult – but necessary – decisions, with people at lower levels of the organisation constrained by the resulting organisational inertia and unable to take action for themselves. This lack of leadership was also evident in an almost complete absence of scrutiny of or challenge to senior management’s financial plans, budgets and investment strategies.

Thirdly, governance processes were not fit for purpose. There was a lack of oversight of financial matters. And audit and governance committees failed to exercise their responsibilites as they should have done. In at least two cases, council-owned companies were a particular problem, as a lack of effective oversight allowed them to get away for quite some time with performing poorly and failing to deliver the desired results.

Fourthly, the organisations’ financial processes were weak and not up to the task at hand. The very basics of effective financial management – such as transparency, accountability and financial sustainability – were conspicuous by their absence. This allowed problems to go undetected for far longer than they should have done. Even an ongoing reduction in financial reserves – a massive and un-ignorable red flag by normal standards of financial management – failed to jolt the organisations into action.

While the issues highlighted by CIPFA relate to the councils that have issued section 114 notices, they are not unique to these councils – and, indeed, to these organisations – alone. Nobody is above reproach. All organisations can improve their financial leadership, management, scrutiny and challenge. All organisations can do more to ensure that potential warning signs are identified quickly. And that prompt action is taken to address them. The challenge is to do so now, before it is too late.

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