Kids Company – Reserves of Discomfort

150807_KCReserves

The Financial Times  provides a good understanding of some of the financial woes that beset Kid Company.

As the article shows, Kids Company had only £400k in reserves at the end of 2013 and its Trustees wrote in their audited accounts that this was a major risk.
The Founder says that she argued with Government that they should do more (i.e. give more) to help this situation but Kids Company received over £12 million in 2013 of voluntary unrestricted income. This means that Kids Company management (and the Board of Trustees) decided themselves how to allocate the money between active use and reserves. The Government (at least in this instance) had no burden upon it to allocate money to reserves – Kids Company had adequate funding to do this and should have made this allocation for the benefit of the future of the organisation, its mission and the kids that it supports.

It decided to fund short-term need (always pressing) against long-term viability and got away with that for a long time. Eventually, like a business that overtrades, it goes bust. That is making your organisation unsustainable and for an organisation of this size with this amount of voluntary unrestricted funding (a level that so many well-run charities would welcome) to commit this offence is maddening – it is anger inducing.
For the auditors to simply then sign off the accounts with no comment is appalling. The Trustees knew the situation and commented on it in the accounts in 2013. They were not (yet) insolvent but could read the runes. The auditors should have commented further.
For Government to keep putting money in without understanding the financial problems and not requiring Kids Company to allocate resources to reserves is unsettling. Surely someone in Government could have spoken to a charity finance person and understood the reserves issue (plainly in front of them) and made it a requirement of their funding to have Kids Company allocate more of their voluntary unrestricted income to reserves. Nothing appears to have happened.

This is not unusual in the sector – urgent needs are there to be met and Trustees not strong enough to argue for longer term needs. Trustees have a legal responsibility not just to write sentences in the accounts but to safeguard the organisation from collapse that they could have averted.

Six months’ breathing space at a lower level of operations could have allowed Kids Company to have resurfaced and kids and families still could be getting support in some of the UK’s hardest hit areas. Management and Trustees should look to themselves and no one else for the answers to problems in such a situation; auditors should be more pro-active; Government more discerning.

For the Charity sector as a whole, understanding the need for reserves and the prevention of “over-trading” is a fundamental need. Many Trustees are not up to understanding this requirement; many management staff are unsure how to balance the urgent needs of their beneficiaries in the short-term with those of organisational sustainability. Unfortunately, that is their job. The Charity Sector is not good at this – and every Charity is different. The mission of most charities are worthy enough for Trustees and senior management (and finance people) to try to learn something from this – reserves are not just for show, they have a place in sustaining charities and mitigating risk. It is not enough just to know you have a risk – a charity must take action.

Finally, it is a sad reflection on our times and our country that Kids Company had to undertake its mission in the first place. Its Founder was right in that she saw Government abstaining from its legitimate role in society – a 21st Century society not a 19th Century one. This abstinence then propelled Government (Labour and Conservative) into its Big Society mission – like a wealthy philanthropist giving money to the starving poor. This is Dickensian in the extreme and Kids Company should not have been needed. Many charities do work which are above what we would consider Government to be properly able to do – I suspect that some of the outcome of this will be that in this Dickensian, 19th Century Age of Austerity, we need to reflect more pro-actively on what we ask Charities to do and what we expect from the State.

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Was Tesco Corrupt?

Corrupt = “guilty of dishonest practices”, “lacking in integrity”

Tesco is in a state of some chaos brought on by real market competition and has seen its business model threatened. It has always been a fighter – a company built on a culture that customers responded to well – a “pile ‘em high” culture that sought to bring low prices and wide choice.

This success was predicated by a market where the medium wealthy within society (middle class or in-work working class)– where most people existed – wanted good value and reliable products.

This outward superiority over the competition was managed through an internal capability highly based on staff knowing their job well, a high investment in systems that could gauge customers’ needs and supply them. To many suppliers it was a desperately competitive environment – with continuously lower prices and higher quality requirements.

How Corporate Culture can lead to Corruption

This culture was also, as far as can be seen, based on internal fear of failure – a numbers culture that relied on bullying to ensure that every day’s sales and profit figures were met. The Telegraph recently wrote on this subject where it said that: “Investigation into Tesco’s £250m profit shortfall unearths ‘corruption’ of culture.”

For any organisation, the culture employed for the business is critical but the headline suggests that the culture of Tesco indirectly led to corruption. This corruption came about, for instance, through accounting issues – the taking of discounts from suppliers too early (well before they could be guaranteed, apparently). The culture led somehow to the corruption – it seems that Tesco’s leadership was blind to the corruption (which, it is claimed, was only a set of accounting issues – where no-one directly benefitted).

This is the norm in some companies – especially in highly competitive markets where the differences between the competitors are hard to judge. In food retailing, the differences are price, range, full shelves, ease of use, location, quality and service. In 2014, most of the major retailers have products and services that are comparable. Tesco clearly believed that it was the best and that its strategy was right. That strategy included a culture that demanded much of its people. Overall, that is not a bad thing – until it becomes a culture that demands results no matter how achieved.

In my book “Last Line of Defense”, I described a business in a different market sector (aerospace and defense) that operated under similar cultural disciplines. It was in a business that was highly competitive and sales and bottom line results were critical. Senior management made demands on its staff. Having made those demands, senior management did not want to know how those demands were satisfied. They imposed a culture and required the response.

In the book, the CEO demanded that long-term accounting changes were made to turn losses into profits for a countermeasures system – the RWR-50:

“You have all made clear to me how the RWR-50 is going to establish Global as a world player in the defense business, at last living up to its name. Well, the first thing you have given me is a problem that must be dealt with to allow those prospects to be nourished and grow to maturity. I want your total support in my actions. Anyone that feels unable to live with this should be under no misapprehension: the only option would be to find alternative employment.”

For staff operating in such an environment, successfully meeting such demands often resulted (within aerospace and defense in the 1970’s until now) in corrupt practices. This included outright bribery of customers to buy their products. Many industries such as aerospace and defense, construction, energy have bad reputations for such methods of corruption.

In Tesco’s case, there is no suggestion that I have seen of any corruption such a bribery – at least not since the Potato bribery case of 2008 where Tesco’s potato buyer was paid millions of Tesco’s own money to swing purchases in one supplier’s direction.Indeed, The Grocer included an article only two years ago that suggested bribery and corruption remained a serious problem between supermarkets, wholesalers and suppliers.

However, just as the culture of the aerospace and defense industry directly led to corruption (with senior management often claiming denial of all knowledge of such impacts), so the culture in Tesco is highly likely to have led to accounting irregularities and the suspension of senior management. If these cases are shown to be true, then denial of knowledge is no different.

Indeed, the worst of the aerospace and defense companies, involved in long-term projects, have for many years developed ways to control accounting of such projects. Losses have been turned into profits – legally in many cases – as accounting for the future is indeterminate and unauditable. Notions of conservatism (supposedly the hallmark of good accounting) are thrown aside when senior management make different demands and shareholders need to see higher share prices and better dividends. This often led to accounting changes in that industry. It is no surprise that accounting issues are central to the likely problems at Tesco.

Governance and Culture

Of course, these accounting problems are an outcome of the culture. Bad management (misunderstanding changing market patterns and / or unable to resist them) relies more and more on a culture of threat and intimidation when things go bad or just tougher. Senior management then rely on the fact that they did not ask for accounting irregularities to be able to say that they had no knowledge – they are innocent (as innocent as Henry II was innocent of the murder of Thomas a Becket).

Some might also argue that no one directly benefitted from the corruption that is alleged to have existed at Tesco. This is also not the case. Accounting changes that improve stated profits have an impact on job security (no-one looks for “alternative employment” if they meet their targets), bonuses, share prices. Of course, unless the business then grows through increased demand, the accounting problems show up (as they have done at Tesco as the tide has gone out).

This is a serious issue for senior management. The Bribery Act of 2010 introduced tough requirements on senior management in cases of bribery. Where bribery and similar corruption is found in a company, senior management can no longer hide behind a veil of “no knowledge” of the bribery or corruption. It is now required that they are able to show that proper processes were in palace to ensure that such bribery and corruption were minimised or, better still, eradicated. Where it is clearly not the case, then senior management (Directors) can be held liable.

Good governance has now to be firmly enmeshed within a culture in a business as far as the Bribery Act is concerned. But, the absence of such good governance is shown in any company that has a culture of threat and intimidation that is likely to lead to pressure on staff to rig the statistics. In the Bribery Act, such a culture would be a sure sign of likely Director culpability. What is the difference within Tesco – if such accounting allegations are found to be the case? Although unlikely to be subject to the Bribery Act, the senior management culture at Tesco clearly led to a lack of due process that appears to be no less culpable. It is surprising that the Non-executive Directors and auditors also missed the clear links between bad culture and poor governance.

The pressure to make results no matter what resounds throughout a company. No one in the company could be immune from that pressure nor would they (at senior levels) be in any doubt of the repercussions that ensue. Accounting irregularities are an outcome of bad culture and bad governance. The Bribery Act has shown that senior management (the Board) has a direct responsibility for ensuring that culture must include good governance where bribery is a risk. There is a direct link between culture and governance and, where corruption exists, all senior management are normally culpable – processes should have been in place to minimise the risk of such “accounting irregularities”.

Bad culture leads to bad governance and potentially to corruption – the links are known and understood.

If the allegations are proven, then Tesco was corrupt. Probably not alone.

Go to:

Was Tesco Corrupt? – II

Schools get fleeced – and we all watch

The Bureau of Investigative Journalism recently published an article (http://www.thebureauinvestigates.com/2012/09/25/schools-fleeced-by-it-scammers/comment-page-1/#comment-9117) following the exposure on Panorama (BBC 1) that schools in the UK had been “fleeced” by IT companies (“scammers”). The article and Panorama drew attention to schools which are burdened by the need to run themselves as businesses and are often ill-equipped to do so when set against the complicated requirements of funding, procurement, suppliers and the like.

 

The BIJ summed up the problem with the thought that the FMSiS (Financial Management Standard in Schools) had been wrongly abolished and that the Government should think again. It was abolished after it had become a paper ticking exercise as reported by the Government in 2010 in their White Paper – “The Importance of Teaching” – http://www.education.gov.uk/inthenews/inthenews/a0067711/government-announces-end-of-complex-school-financial-reporting-tool.

 

The BIJ article missed the fact that most of the schemes that Panorama reported on were entered into while the FMSiS was in place!

 

Why is Finance so hard for non-profits (public and private sector)?

 

This does not just happen in Schools – it happens wherever greater knowledge is brought to bear.

 

So, the banks have run out of control and, five years’ later, we remain stunned that the financial regulators did not see this coming – or even understand the huge range of sub-prime schemes, poor management controls, over-leveraging, bad morality, lack of risk aversion, inability for banks to fail, dislike of customers and similar.

 

In the same way, companies like Enron fooled their highly paid auditors (some of whom connived with them) – we never learned much from that or from the countless, other financial scams that have been served up on unsuspecting publics since at least the south Sea Bubble in 1720 and for thousands of years before.

 

But, we expect more from public sector and the third sector organisations that supposedly guard our taxes and donations. What makes it so hard for them to adequately ensure that the financial and support arms of those organisations are able to be a good as all those they work with?

 

Where the incentives are

 

Of course, much has been written about how the wealth potential of banks suck in those with the highest intelligence and motivation (and maybe those with the lowest ethics) and that the regulators are filled with those who cannot compete – maybe those who failed to make it in banking themselves.

 

Enron was full of highly motivated and driven people who bought into a scheme (or schemes) and worked like fury to implement their scam / scheme. The manipulation of an energy market was not understood by the regulators and auditors just as auditors and clients failed to understand how Bernie Madoff was making such returns on their “investments”.

 

In a money-driven economy, which has created tremendous wealth for society, there are, at the margins and even more in the centre, incentives provided to people that lure those who are massively motivated and driven to participate – to work 24 hours a day, to spend their time working up schemes to make money and their companies profitable. Business is a money-driven part of the economy in a way that the non-profit sectors (be they public or private sector) are not. The latter are full of people driven (and maybe just as motivated) by other things – a passion for human rights, for education, for people, for society – but not for the thing that drives those they may meet at the interface of private sector and the non-profits.

 

As Galbraith wrote in The Affluent Society, public goods are always at a disadvantage in a market-driven economy and the crucial problems always exist at the interface between the two.  I tackled this is a previous post – https://jeffkaye.wordpress.com/wp-admin/post.php?post=192&action=edit – and the inability of societies to establish how to provide the “social balance” to which Galbraith refers enables the problems to persist – such as the fleecing of schools in the UK.

 

Enabling the “social balance”?

 

The “social balance” (Galbraith ibid) is about how society reacts to private enterprise. The most obvious example is the automobile – private industry propels the development of cars but it is the public sector that provides the roads, traffic control and policing, emergency services and hospitals (usually), pollution control and similar. India is a great and recent example – http://uk.finance.yahoo.com/news/india-car-sales-soar-where-054302682.html. But, the ability of the private sector runs well ahead of the ability of the public sector to react.

 

Nowhere is this lack of social balance clearer than in the provision of expertise in “back office” areas in the public sector and in the third sector. While their front of office capabilities may be excellent, the non-profit sector cannot, in the main, recruit the best people (it cannot offer financial incentives to match anything like the private sector) and therefore its systems and processes fall well behind.

 

This is compounded by the continuous belief by government that they have to “do something” directly (like the FMSiS above) and in the third sector that anything spent outside of front end is a waste of money. Donors (whether governments, trusts and foundations, companies or individuals) suddenly have a different mindset as soon as they donate. How many would ask companies to stop spending on finance operations – yet, many donors insist that their donations can only be applied to front end work – the cause – and nothing to overheads. While it is good to keep overheads low, governance and financial management dictate that these “enabling” areas of any organization (like people management training) are as good as the front end operations so as not to stymie the work of the charity, NGO or pubic sector organization.

 

Having worked in all sectors (with most of my working life in the private sector) it is clear to me that the non-profit sectors are continuously starved of capability and expertise in the areas that could make them far more efficient and capable – not just to survive but also to enable far better work to be accomplished. If they work well it is in spite of the problems put in their way. Most don’t manage and the failures of the public sector to manage large IT projects, for example or the non-profit sector to survive continue.

 

So, how can the non-profits develop a response to the needed social balance so that they don’t get fleeced?

 

Pro-activity in the social balance

 

Governments and those who provide central governance to the non-profit sectors have undertaken so many actions and some have provided stability. But, each sector and those within it are challenged continuously.

 

What is needed is first, recognition that there is a problem. Each sector should assess where the main problems lie and government has to step up and signal that it will not do everything but begin to be the chief enabler for the non-profits. For example, restrictive funding for charities, whereby donors only provide money for front-end purposes, should not be allowed. The practice is akin to shareholders telling companies which part of the business their funding is allowed on. It is not a loan – it is a donation and restrictions mean more bureaucracy and less ability for the charity to manage itself.

 

If a donor believes that a charity spends too much on overheads, it can withhold donations just like a shareholder can invest elsewhere – but restricting funding in this way is counter-productive.

 

In the UK, this is something for the charities Commission and government to act on.

 

Second, there has to be a stepping up on ability – which will lead to improved processes and systems (although improvements in each need money as well and the proposal above is one way of directing more into this area).

 

This stepping up of ability should be driven by government who should require firms of accountants to do what the legal profession does – provide at least 2% pro-bono capability into non-profits. I have been highly impressed by law firms’ ability to do excellent pro-bono – less so by the finance industry.

 

CSR divisions of companies should also be driving their best finance people into non-profits – in a meaningful way to address the social imbalance.

 

Governments should look to reward those who go from the private sector into the public or third sector (even for a time) with tax incentives (much like students having to repay their student loans). It is not a great time to do this, but it would indicate a lot.

 

Third, the big accounting organisations should ensure that they focus more attention on public sector and third sector – understanding the problems and devising exams and maybe alternative paths to accreditation rather than the one-size-fits-all approach. Certainly, the CIPFA and IPSASB provide the basics for the public sector but the incentivisation for the best to go into that sector let alone education or charities / NGO’s is far less and the number of accountants that enter the charity sector (for example) with the same skill levels and drive as those in the private sector is small.

 

Fourth, trustees from private sector organisations have to become involved – not just from a governance standpoint but setting examples and putting the bar as high as it needs to go to make the enablers work. This is hands-on stuff not just remote governance.

 

Separate sectors, common interests

 

Except in a society where the three sectors don’t exist (e.g. communist states), the challenge is greatest at the intersections of society – where the sectors clash. Yet, as in the example of automobiles above (or any other transportation systems), different sectors live off each other – and the charity sector fills many of the gaps that society does not see fit to fill in private or public sectors.

 

The sectors need to be different, of course, but there does need to be a far better understanding of the problems that our economic structures throw up and how to deal with them or fleecing of our schools will recur but be seen to be a mere tip of the social iceberg.