Setting the Record Straight
Our response to the Royal Commission's Examination of Sector Profitability and Viability.
The Royal Commission released independent research last week into Aged Care Finances – “Report on Profitability and Viability of the Australian Aged Care Industry”, which infers that the aged care sector is profitable and lacked transparency. The media was quick to respond:
“Little Transparency as Nursing Home Companies Rake in the Profits”, The Australian
These conclusions contrast to other benchmarking work done by the Federal Government through the Aged Care Financing Authority (ACFA) and that of specialist accounting firm, StewartBrown. Both have been presenting deteriorating financial conditions since the 2016 Budget cuts to aged care subsidies and have warned that the sector is no longer viable. So, we looked a little further.
The research uses information for FY2018 to assess the financial strength of the sector using the following approach:
The methodology for assessing profitability and viability seems suitable under the circumstances but there are concerns with the measures and accounting treatments. In addition to the outdated FY2018 financial information, the following matters are critical:
The correct measure of profitability is Accounting Profit (Net Profit before Tax). The report acknowledges that residential aged care (RAC) is a capital and infrastructure intense business, but then use earnings before interest, tax, depreciation and amortisation (EBITDA) as the primary “profit” measure, excluding the material cost items of depreciation.
Had the correct measure been used, 45% of RAC providers would have been identified as making a loss. This reconciles more closely to the ACFA report, which reported in that 42% of providers were making a loss in the year ended 30 June 2019. StewartBrown places that number at 60% of providers in the 2020 financial year.
Core to evaluating sector viability is the evaluation of balance sheet strength and the capacity of the operator to service debt. To undertake this, the research reclassified 80% of Refundable Accommodation Deposits (RADs) as non-current liabilities.
Based on the average resident length of stay, the RAD proportion allocated to non-current liabilities under this methodology should have been 60% and therefore only 43% of providers would have been deemed “viable” (disregarding the incorrect adoption of EBITDA for the profitability/serviceability test).
Accountability and Transparency
The report commentary suggests that related party transactions were not transparent and this made the assessment of profitability and viability difficult.
Aged care providers are required to furnish audited financial statements to the Federal Government every year. The vast majority of these providers do not have complex corporate structures – they are predominantly charitable bodies – and those that do are consistent with normal business practices.
Further analysis found that the level of “related party management fees” is immaterial (around 2% of expenditure) and even less for related party rent.
Part of the challenge in leveraging General Purpose Financial Reports is in uncoupling this heavily summarised data from a highly disparate set of providers. Perhaps more useful analysis would have been gained using data from the listed providers which have consistent reporting and accountability obligations to ASIC, the ASX, shareholders and the Australian Tax Office. The use of more current, consistent data may help to present a more accurate state of the aged care sector – Listed Company Results 2020.
Most recently, COVID-19 also has serious implications on the viability of the sector which were considered by ACFA in May 2020 and have subsequently become a reality – ACFA Report 2020.
We hope that the Commissioners take into account the considerable body of benchmarking work which leverages more contemporary financial information and accounting measurements.