Guidance

ESFA's approach to assessing the financial health of organisations

Updated 23 November 2022

Applies to England

Summary

1: This guidance sets out the Education and Skills Funding Agency’s (ESFA’s) approach to assessing financial health of organisations. It does not replace any submission requirements of guidance for any register, procurement, or invitation to tender (ITT) rounds.

2: The term “organisation” is used within this guidance to refer to all entities and is used as a generic term. Organisations are defined for the purpose of this guidance as independent training providers, special post-16 institutions, non-maintained specialist schools, and organisations applying to a register, procurement round or ITT rounds.

3: This guidance is not to be used for general further education colleges, sixth form colleges, academies, or academy trusts. If you are seeking financial guidance for any of these areas, please follow the links below:

• academies
• college financial plans
• college accounts directions

4: The ESFA uses financial health as a measure of an organisation’s financial status, in terms of its financial performance and its ability to meet ongoing financial commitments. It helps us to understand the degree of risk in contracting with organisations, either directly or indirectly. The financial health grade is used to establish the maximum recommended value of contracts appropriate to the financial resources of organisations that have a direct contract.

5: This guidance explains the ESFA’s approach to financial health assessments and the information that must be submitted to the ESFA to conduct them. If an organisation is applying to a register round, procurement round, or ITT, these may specify their own financial requirements or limitations above and beyond this guidance. It is the responsibility of an organisation to submit correct financial information in applications and to seek clarity on any specific requirements, which it is unsure of, before application.

6: Register, procurement, and ITT rounds may refer and link to this guidance. These rounds may also combine this guidance with specific application requirements or guidance relating to financial submissions.

What has changed in this edition?

7: There are a small number of substantive changes in this edition compared with the February 2021 edition:

• Clarification around use of this guidance during register, procurement and ITT rounds. (Paras 5 and 6).
• Updates on submission requirements of financial statements, including consequences of failure to submit financial statements, breakdown of creditors, and submission of amended financial statements. (Paras 11,14,17,18 and 46e).
• Clarification on when management accounts can be used and how they cannot be submitted as a replacement for financial statements. (Para 18).
• Further explanation of the use of parental organisations financial statements during the assessment process, how they are not subjected to the full financial health process and cannot be used to improve the grade of a prime organisation. (Paras 23, 24 and 46h).
• Enhancement and update of the moderation criteria that will be considered, including the introduction of new moderation criteria. (Para 46).

Status

8: This guidance replaces the previous guidance, published by ESFA in February 2021 and will remain in force until replaced.

Part 1: submission requirements

Submission of financial statements

9: Financial health for organisations is graded based on financial ratios taken from their latest available, and where applicable, published financial statements. Every organisation must submit this information to the ESFA, in accordance with its contract, or its application to a register round, procurement round, or ITT. For organisations that hold a contract with the ESFA/DfE, the latest financial statements must be sent to the ESFA as soon as they become available. The ESFA will work with the Department for Education’s (DfE) Post 16 Regions and FE Provider Oversight Directorate in receiving the financial statements, and any other relevant financial information as required by the ESFA and/or DfE.

10: Organisations with a current funding agreement or contract for services must submit financial statements each year. They must do this as soon as the statements are finalised and signed. Failure to submit financial statements on a timely basis, or when requested will result in the award of a financial health grade of ‘Inadequate’ until financial statements are submitted and assessed.

11: Failure to submit the latest financial statements as soon as they are finalised and signed may result in a grade of inadequate being awarded. If financial statements are not received within nine months of the period end, or as requested by the ESFA and/or DfE, an inadequate grade may be awarded.

12. Organisations applying to register, or procurement rounds must follow the guidance published with the round they are applying to regarding minimum submission requirements.

13. Financial statements submitted must be full accounts (not abbreviated / abridged / filleted / micro entity), and audited, where appropriate. If your organisation is a company and only abbreviated accounts are required for Companies House filing, you must still submit your full statutory accounts (in the format required by the Companies Act 2006 and relevant reporting requirements) to the ESFA, which must include, as a minimum, the following elements:

• an end of period profit and loss account, or equivalent
• an end of period balance sheet
• detailed commentary and breakdown, including all notes to the accounts
• a breakdown of amounts contained within creditors / other creditors (other creditors is determined here as any item recorded within either current or long-term liabilities that is not identifiable in its own right). For ESFA assessment purposes, “Other Creditors” is not an acceptable account classification, and it must be further explained. If your organisation does not submit a breakdown of creditors and / or other creditors, and the ESFA is unable to obtain further information from either you or your financial statements, then it will record all amounts as borrowings, and this may impact the grade awarded.

14: Organisations must supply full accounts, not just an extract or selected pages. If you submit amended financial statements for a financial year to Companies House or the Charities Commission these must be submitted to the ESFA as soon as they become available.

15: If your organisation, due to its legal form, is not required to produce statutory financial statements, you must submit accounts in a format like that prescribed for companies’ annual accounts. These must include the same minimum elements as prescribed in paragraph 13 above.

16: We reserve the right to use and / or rely upon external sources of information to inform our decision on your finances, such as, Companies House, Charities Commission, credit reference agencies, along with information from sites that monitor these. This may not apply during register rounds, procurement rounds and ITT rounds, where the specific requirements of those rounds override this guidance.

New organisations: submission of financial information

17: If your organisation is unable to supply statutory financial statements because it has not traded for a sufficient period, you must supply management accounts to date, showing actual activity, along with forecast figures for a remaining period. The combined information must cover a period no less than one year, with the management accounts comprising at least three months of actual trading activity. Actively trading is determined here as including income and expenditure arising as a result of trade and does not include the incurrence of set up or start-up costs. As a minimum, these must consist of:

• a profit and loss account covering a minimum 12-month period, from the commencement of trading
• an end of period forecast balance sheet
• a minimum 12 month rolling cash flow statement covering the same period as the profit and loss account and the balance sheet
• detailed narrative supporting assumptions made for both management accounts and forecast information

18: It is not permitted for management accounts to be submitted instead of full financial statements, where financial statements have been produced. If management accounts are submitted alongside financial statements, then the management accounts will not be reviewed unless they have been specifically requested by either the ESFA or DfE.

19: Any financial health grade awarded based on the submission of management accounts and financial forecasts will only remain valid until the first set of financial statements are finalised and signed. If we do not receive full financial statements as soon as they become available, this may result in the financial health grade being moderated to inadequate.

20: We will assess management accounts and financial forecasts on an individual basis. We will take into consideration their achievability, potential for delivery against the information submitted and any autoscore recorded.

21: If any of the required information is missing, we will grade financial health as ‘Inadequate’, due to insufficient information available for assessment.

Organisations subject to in-year financial monitoring

22: Some organisations may be subject to in-year financial monitoring by the ESFA. The guidance followed in these circumstances can be located in the ESFA oversight of Independent Training Providers: operational guidance. Some organisations may be subject to enhanced in-year financial monitoring as detailed in the operational guidance published in April 2019 and updated in May 2021. This can include, but not limited to, submission of management accounts, financial forecasts, and cashflows. We may also request submission of financial statements earlier than the statutory requirement.

Parent organisations

23: The parent organisation’s financial statements cannot be used as a replacement for the prime organisation’s financial statements and are not subject to the full assessment process. The financial health of any parent organisation, regardless of where it is in the world, will not serve to improve the grade of a prime organisation or applicant to a register or procurement round. The ultimate UK parent organisation’s financial statements are requested to assess whether the parent or group may adversely impact the financial stability of the prime organisation the Department contracts with.

24: If your organisation is part of a wider group of organisations / companies, classed as a subsidiary, or has another organisation as a significantly controlling party in your organisation, you must submit full financial statements for the ultimate UK parent organisation / company. You must also submit those of the contracting or applying organisation. If you are in any doubt regarding whether your organisation is a parent organisation / company or a subsidiary organisation you should refer to either the Companies Act 2006 which defines, at sections 1159, 1162 and relevant schedules, what constitutes a holding company, a parent company, and a subsidiary organisation, or the Charities SORP (FRS 102), section 26 – Charities as subsidiaries.

25: If an organisation fails to submit its ultimate UK parent organisation / company financial statements, this may result in the award of an ‘Inadequate’ grade.

26: If your ultimate UK parent organisation / company does not produce consolidated financial statements, you are required to supply the financial statements for their non-dormant subsidiaries.

27: If your ultimate parent organisation / company is registered outside of the UK, you must supply the full financial statements for your ultimate UK parent organisation / company.

Exemptions

28: The following organisations are exempt from this financial health assessment process, and do not need to submit annual financial statements to the ESFA:

• central government departments, executive agencies, or non-departmental public bodies
• local authorities, including local education authority (LEA) schools
• free schools
• NHS trusts, fire authorities and police authorities, including Police and Crime Commissioners
• Higher Educational Institutions financially monitored by the Office for Students
• rail franchise operators, licensed and acting on behalf of the Department for Transport

29: Further education (FE) colleges, sixth form colleges (SFC), academies and academy trusts are subject to a separate monitoring regime as organisations operating under a funding agreement with the DfE/ESFA and have separate reporting requirements. However, they may still be required to submit accounts for register application purposes as described in paragraph 12.

Exemptions: large organisations

30: We may also consider established public limited companies, other registered companies, charities, and voluntary organisations to be exempt from this financial health assessment process, if they have a consistent annual turnover more than £75 million, where total current Department funding to the organisation constitutes, or is expected to constitute, less than 5% of the organisation’s annual turnover.

31: Organisations which are considered to fall under this category must still submit their financial statements as part of a register round for validation purposes. Failure to submit financial statements may result in an ‘inadequate’ grade being awarded.

32. Financial statements for organisations under this category will be reviewed to ensure the organisation remains financially stable; and that total Department funding is incidental to their business (that it is no more than, or expected to be no more than, 5% of annual turnover).

33: We may use external sources of information to inform our decision on your finances. If we become aware of any financial risk to an organisation, we reserve the right to review the exemption status at our discretion.

34: Once we confirm status and financial stability, no further formal assessment would normally be required other than an annual review. We will access or request the latest financial statements. We will confirm organisational status and that no change has occurred which could affect the organisations status.

35: An organisation may be removed from this category if:

• total Department funding becomes material, that is, exceeds 5% of annual turnover;
• annual turnover reduces to below £75 million; or
• we become aware of concerns over the financial health of the organisation

Part 2: assessing financial health

Financial health scoring and grading

36. Financial health for organisations is graded, based on the following three financial elements:

• Profitability (sustainability)
• Solvency (current ratio)
• Gearing (debt ratio)

37: We assess profitability based on profit after tax (for continuing and discontinued operations) as a percentage of turnover, defined as:

• Profit after tax / turnover x 100

38: For this purpose, depreciation and amortisation are added back to profit after tax and dividends are subtracted.

39: We assess solvency using the current ratio, this being the ratio between current assets and current liabilities.

40: We assess gearing based on debt as a percentage of reserves and debt.

41: Debt is defined as all long-term and short-term borrowings, which include, bank overdrafts, finance leases and hire purchase contracts, credit cards, directors’ loans to the company, ‘inter-company’ and group loans to the organisation, personal loans to the organisation, directors’ current accounts and amounts owed to the directors’.

42: We may include creditors / other creditors within the debt figure, if we are unable to identify the scope of borrowings contained within this figure. A breakdown of creditors / other creditors must be supplied alongside the submission of your financial statements.

43: Each of the financial elements is given a score out of 100, using the scoring system set out in Annex C.

44: We make an initial grade assessment of the financial health grade by comparing the aggregated points score with the assessment criteria set out below. This may then be subject to moderation.

45: Reserves are defined for this purpose as shareholders’ funds less intangible assets. If this is a negative figure, an automatic score of 0 is given.

Grade	Points
Outstanding	240 to 300 points
Good	180 to 230 points
Satisfactory	120 to 170 pints
Inadequate	<= 110 points

Definitions of financial health grades and their financial indicators are included at Annex A.

Moderation

46: We reserve the right to moderate any initial grade either up or down. We consider each moderation criteria on a case-by-case basis. We will only consider one moderation criteria for each assessment and will not combine multiple moderation criteria. Moderation criteria may include, but are not limited to, the following:

(a): We will not grade higher than ‘satisfactory’, if an organisation scores 0 points for any one of the three ratios.

(b): We may moderate to ‘inadequate’, where auditors have given the financial statements a qualified or adverse opinion. This may include an ‘emphasis of matter’ or ‘going concern’ opinion.

(c) We will grade financial health as ‘inadequate’, if Companies House shows your organisation has entered liquidation, insolvency, a Company Voluntary Arrangement, or is shown as dormant.

(d) We will grade financial health as ‘inadequate’ if financial statements are overdue for filing at Companies House or the Charities Commission.

(e) We may grade financial health as ‘inadequate’, if organisations do not submit the most recently filed full financial statements to us when they are finalised and signed, or within three weeks of a request being made for these unless the request stipulates a set timescale.

(f) We may grade financial health as ‘inadequate’ if organisations do not submit additional financial information to us when requested.

(g) We will grade financial health as inadequate; where we are unable to open the information submitted; the information submitted does not appear complete, contains errors, does not match the information presented on Companies House or the Charities Commission websites; or where in our view, doesn’t evidence a minimum of three months active trading.

(h) If there is a group / parent organisation / company whose financial position could significantly adversely impact the financial health of the organisation, we may moderate the grade downwards.

(i) Where information other than the latest available financial statements, supported by factual evidence, indicates that the financial health is significantly different from the autoscore. ‘Significantly’ is defined as sufficiently different to generate an autoscore at least one grade lower. Examples might include (but would not be limited to):

• a court ruling which has financial consequences
• the loss of a material contract or area of provision
• a contingent liability crystallising
• recall of debt by the bank or investor
• a significant recovery of funds following a funding audit or investigation
• loss of key personnel
• cessation of trading

(j): Where an organisation’s financial health is calculated as ‘inadequate’, solely because of a deficit on the pension scheme which reduces the level of reserves, the grade may be moderated to ‘satisfactory’.

(k): If long-term borrowings are high but are predominantly and demonstrably secured on long-term fixed assets, for example a mortgage on property; if this significantly affects the financial health (by at least one grade), and finances suggest that sufficient cash is being generated to cover the associated repayments, we may moderate a calculated grade of ‘inadequate’ to ‘satisfactory’. For this moderation criteria to be considered the financial statements submitted must clearly detail this to be the case.

(l): Where an organisation’s financial health, in an isolated year, is calculated as ‘inadequate’ solely due to making a distribution of several years’ accumulated profits through a dividend, resulting in a zero score for profitability. In such circumstances, we may moderate the financial health score to ‘satisfactory’, if we consider that the underlying business is profitable and removal of dividend payments above the current year’s profits would improve the grade.

(m): We may moderate organisations graded ‘inadequate’ to ‘satisfactory’ upon receipt of a fully completed guarantee, where the use of a guarantee is deemed suitable by the ESFA.

(n): We will not grade higher than ‘satisfactory’ if an organisation’s score is based on management accounts.

(o): We may consider moderation where an organisation can clearly demonstrate that there has been an exceptional loss of income and/or has incurred exceptional expenditure, due to a rare / unusual event(s), for example, COVID-19, which will result in an ‘inadequate’ autoscore. This moderation will only be considered when financial statements are supported with evidence demonstrating that there will be a return to an improved financial position in the following financial statements.

(p): Where an organisation has received government loans, e.g. Coronavirus Business Interruption Loans, during the COVID-19 pandemic, these will be classed as borrowings. We may moderate organisations, graded ‘inadequate’ to ‘satisfactory’, where this government loan is the only reason for the inadequate grade and the business still appears viable. The value and details of the loan must be clearly identifiable within the financial statements.

(q): We may consider moderation where profits from sale or disposal of assets, exceptional items, and profits from discontinued operations increase the grade of an assessment, but where the underlying business is loss making, and would, without these one-off profits result in a lower grade.

(r): The ESFA may consider moderation where an organisation that is in a group structure with a higher education institute as the parent body, by taking into consideration the subsidiary / parent relationship. Special moderation procedures will apply, and considerations will include (but are not limited to) the financial health of the parent organisation, any financial guarantees or letters of comfort provided by the parent organisation, the pattern of any financial support provided and the nature of the relationship and / or transactions between the bodies. ESFA will moderate the autoscore grade by assessing both the underlying financial health of the organisation and its medium to long term sustainability. ESFA may require the organisation to provide bespoke information.

Part 3: recommended funding limits

47: A key aspect of the financial health assessment process is the setting of a maximum Recommended Funding Limit (RFL). It is a measure of an organisation’s financial capacity to deliver. The funding limit will also vary depending upon whether the organisation is new or has an existing contract with the ESFA and/or DfE. There are other constraints that may impact an organisation’s capacity to deliver, such as its infrastructure.

48: The concept of a RFL is not applicable to FE colleges, sixth form colleges, academies, academy trusts or organisations, considered to be exempt from financial health assessments.

49: We calculate the RFL as a percentage of the organisation’s turnover from their latest annual financial statements. The relevant percentage is determined as follows:

Grade	Organisations that hold an existing ESFA/DfE contract	Organisations that do not hold an existing ESFA/DfE contract but have financial history	Organisations that do not hold an existing ESFA/DfE contract and are assessed based on management accounts and forecast
Outstanding	150%	100%	N/A
Good	125%	75%	N/A
Satisfactory	115%	50%	See below
Inadequate	0%	0%	No contact

50: We consider organisations that do not hold a contract with us at the time of assessment a greater risk. We will calculate the RFL on a reduced percentage; the maximum RFL awarded is £2 million.

51: We will assess management accounts and forecasts individually on their own merits. We will allocate a financial health category of ‘satisfactory’ to management accounts and forecasts, we consider viable. We will set the RFL at the turnover in the accounts and forecasts to a maximum of £1 million.

52: If management accounts are specifically requested and reviewed for organisations that hold a current contract with us, these will not result in an amendment of their grade or RFL.

53: Before contracting, the financial health score and RFL may be used to inform contract negotiation.

Annex A : financial health descriptors

This Annex provides the definition of each financial health grade and their financial indicators.

Grade	Definition	Indicators
Outstanding	An organisation that appears to have robust finances to fulfil its contractual obligations and to respond successfully to opportunities or adverse circumstances.	Normally an organisation with outstanding / good indicators for profitability, solvency and gearing.
Good	An organisation that appears to have sufficiently robust finances to fulfil its contractual obligations, and to respond successfully to most opportunities or adverse circumstances.	Normally an organisation with at least two good indicators for profitability, solvency and gearing.
Satisfactory	An organisation that appears to have sufficient resources to fulfil its contractual obligations, but also appears likely to have limited capacity to respond successfully to opportunities or adverse circumstances.	Normally an organisation with at least two satisfactory indicators for profitability, solvency and gearing.
Inadequate	An organisation that is in financial difficulty and very likely to be dependent on the goodwill and/or financial support of others. There is a significant risk of organisations in this group not being able to fulfil contractual obligations because of weak financial health.	Normally an organisation with at least two inadequate indicators for profitability, solvency and gearing.

Annex B: definition of financial elements

This Annex sets out the definitions of the financial elements used to determine the financial health grade.

Element	Definition
Profitability	Profit after tax as a percentage of turnover, defined as: Profit after tax / turnover x 100 For this purpose, depreciation and amortisation are added back to profit after tax and dividends are subtracted.
Solvency	Current ratio defined as: Current assets / current liabilities
Gearing	Total debt as a percentage of reserves and debt. Reserves are defined for this purpose as shareholders’ funds less intangible assets. If this is a negative figure, an automatic score of 0 is given. Debt is defined as all long-term and short-term borrowings, which include, bank overdrafts, finance leases and hire purchase contracts, credit cards, directors’ loans to the company, ‘inter-company’ and group loans to the organisation, personal loans to the organisation, directors’ current accounts and amounts owed to the directors’. We may include other creditors within the debt figure if we are unable to identify the scope of borrowings contained within this figure. A breakdown of other creditors must be supplied alongside the submission of your financial statements.

Annex C: financial health scoring

Score	Profitability	Solvency	Gearing
0	< 0	< 0.5	>= 90 or negative
10	>= 0	>= 0.5	< 90
20	>= 1	>= 0.6	< 80
30	>= 2	>= 0.7	< 70
40	>= 3	>= 0.8	< 60
50	>= 4	>= 1.0	< 50
60	>= 5	>= 1.2	< 40
70	>= 6	>= 1.4	< 30
80	>= 7	>= 1.6	< 20
90	>= 8	>= 1.8	< 10
100	>= 9	>= 2.0	= 0