6.1 All aspects of an organisation's work are monitored. This includes artistic activity, financial control and managerial and organisational effectiveness. Although these aspects could be reviewed independently, it is the interaction of each which is important. It is important to consider the different aspects of a grant recipient's performance jointly.
6.2 Financial management is inextricably linked with performance on the stage or concert platform. It would be as wrong to insist on increased quality without having knowledge of the financial consequences, as it would be to insist on excess caution which might lead to limited artistic vision. It is the artform departments in SAC which are responsible for this comprehensive approach to monitoring of the client organisations, with the director of that artform taking the lead. The staff, committee members and independent assessors linked and associated with those departments are aware of the need to match artistic aspiration with management skills and financial acumen, and have skills and experience which cross those boundaries.
6.3 Specific monitoring activity currently includes:
6.4 The following documentation is requested and received from grant receiving organisations and reviewed by SAC:
6.5 The wide range of people involved in the work of the national companies is noted below. This involvement extends from having a general awareness of the work and retaining an overview to detailed assessment of artistic programme and financial arrangements.
6.6 The staff of the SAC departments represented above are also heavily involved. As noted previously, the first and principal point of contact for grant aided organisations is the art form director.
6.7 The role of SAC at a board or other meeting of an organisation is to observe, comment and advise. It is not one which involves giving instructions or directing activity. In providing advice SAC officials are aware of the dangers of becoming a de facto director and of SAC itself becoming a shadow director.
6.8 The regularly funded bodies are ones with which SAC has long experience. These bodies are in the main independent companies. The boards and senior staff of these organisations have a formidable array of experience and skill which SAC expects to be employed on self monitoring. The information which SAC seeks is that which any organisation will reasonably require itself to monitor activity against budgets and plans. Strong reliance is placed on the specific expertise of those involved in this process in each of the companies concerned.
6.9 All revenue funded organisations are subject to independent audit and in the case of the national companies the audits are undertaken by major firms who review such matters as internal control and procedures. Some reliance is also placed on the involvement of these external specialists. Although it must be noted that auditors have no remit to provide any assurance to SAC.
6.10 Monitoring data forwarded to SAC has generally been considered, and often approved formally, by the boards of the organisations receiving grant, and SAC expects the boards to have applied care, diligence and skill in considering these data. In undertaking monitoring SAC applies the skills, specialist knowledge and experience of its staff to the information under consideration: it does not conduct an audit of the information provided.
6.11 The timing of monitoring is critical. As noted the relationship of SAC with organisations is such that monitoring takes place on a regular if not continuous basis. However crucial financial information such as management accounts, received as part of the monitoring process are by their very nature reviewed retrospectively. This means that problems are often identified after they have happened. The financial weakness of most arts organisations makes it difficult to recover from a problem discovered late in the financial year. (See Appendix Two for legal, financial and economic factors affecting arts organisations.)
6.12 Although forward plans and budgets have always been reviewed, to avoid serious problems recurring, SAC thinks it is important that the realism of such plans must be subject to even more rigorous scrutiny.
7.1 The aim of this report is to review the adequacy of the systems operated by SAC to monitor its financial relationship with the four national companies. The financial relationship is one whereby SAC awards grant from public funds to independent organisations to deliver and produce artistic work throughout Scotland. In doing this SAC needs to check that money is being used for the purposes for which it was intended and that the artistic provision and quality is appropriate.
7.2 In general it is considered that the range of information sought and the methods used for monitoring are appropriate in most circumstances. However, in relation to the national companies, the emphasis of review of the documentation received must change to one which concentrates even more on timing, assurances, consistency and verification.
7.3 The recommendations which follow are drawn from the various sections of this report. Many of the proposals could be applied by SAC to all of the organisations which it funds. However, they are aimed specifically at the national companies where the amount of grant puts them all in a potentially high risk category. The proposals should be subject to discussion with the national companies to ensure they are practicable and applied after a risk assessment rather than applied as a blanket policy.
7.4 Risk assessment is a process which identifies and evaluates the risks to which an organisation is exposed and considers the methods which are in place or could be introduced to control, transfer, reduce or eliminate those risks and how they are monitored.
7.5 SAC is responsible for ensuring the proper use of significant sums of public money, that is, that funds are being used effectively and efficiently and are applied to the purpose for which they were intended. However, the rigour which SAC applies to its monitoring procedures must be tempered by the knowledge that the balance between monitoring and undue interference is a fine one. It must consider the proposals but be in a position to use judgement in their application. The precise role of SAC in this regard and how it intends to implement this must be clarified and understood by all parties involved.
8.1 Recommendations to improve monitoring procedures and the basic information on which they are based are noted below. It should be noted that most of the aspects of monitoring noted have always been part of SAC's procedures and by implication much of what is proposed is already taken account of in the procedures of the national companies. The recommendations refer mainly to the degree of assurance to be provided, the level of verification to be applied and timing.
SAC should ensure that any variances which arise during the year between agreed annual budgets and cash forecasts are investigated by the company concerned in appropriate depth using relevant skill and judgement, and that evidence is obtained from the company concerned that action has been taken and the board informed.
SAC should define its role clearly to ensure there is no misunderstanding between it, funded bodies and The Scottish Executive and publicise this.
The role of SAC observers attending meetings of the board and other committees should be defined and publicised.
SAC should reaffirm the designation of one director or senior member of staff as observer and main point of contact for the company concerned. That one director will draw advice and comment from other expertise available both within the Council and from independent assessors and committee members.
SAC should improve its system of monitoring of quality of artistic activity by adopting a more systematic approach. See 8.9 on page 36.
The SAC Finance Officer should prepare reports for the designated director as required.
SAC should review its staffing requirements to meet the needs posed by these arrangements.
The national companies should develop an improved system of forward planning which takes account of known resources and best possible detailed costings of future programmes in agreement with SAC and use this system to identify and resolve issues in advance.
SAC should use their expertise to provide assistance and guidance to the national companies to meeting the challenges that face them and consider the staffing resources within SAC available to do this.
11.1 In addition to about 2,000 project grants offered each year, SAC monitors grant to about 80 organisations which together absorb about 80% of the annual grant from the Scottish Executive. Most of these, in spite of the problems of lack of resources and capital input, manage their affairs within the funds available and do not get into financial difficulty of a scale from which they cannot extricate themselves by careful management of known future resources.
11.2 It would be unwise and not cost effective to strengthen controls across the board. SAC considers that in general the monitoring regime in place is effective. It would be a misuse of funds for the arts to allocate more resources to this activity than is appropriate.
11.3 The onus to manage the use of public funds effectively, to exercise controls and to identify and manage risks must be placed firmly within the grant recipients themselves. The task of SAC is to obtain assurances on a regular basis directly from the boards of the organisations concerned and when information, or the lack of it, suggests it might be required, to instruct its own internal auditors to undertake investigations.
12.1 There are many lessons to be learned by all parties involved in the financial difficulties encountered by Scottish Opera which emerged in October 1999. This Report proposes a number of solutions to clarify the relationships between The Scottish Executive, The Scottish Arts Council and the organisations themselves and to resolve the problems in monitoring significant public subsidy to private charitable companies.
12.2 The inherent problems, referred to throughout Part One of the Report and in the supplementary information in Appendix Two remain and are unlikely to alter even in the long term. SAC is, however, confident that, working in partnership, with all concerned, it can adapt and strengthen monitoring procedures to reduce the risk of a similar problem recurring.
The lessons learned from the growth of the projected accounting deficit at 31 March 2000 of Scottish Opera and Scottish Ballet and the associated cash deficiency forecast for 31 March 2000.
1.1 The national companies, Royal Scottish National Orchestra, Scottish Ballet, the Scottish Chamber Orchestra and Scottish Opera, have been the subject of detailed discussion for some years. A working party established in 1996/97 by the former Scottish Office aimed to establish a reasonable level of funding for the four companies and to consider what savings might be achieved through more effective use, including sharing or even merging, of resources.
1.2 One of the major results of this working party and its successor bodies was the agreement to increase SAC grant by £1.334 million in 1996/97, by £2.4 million in 1997/98 and, to date, each year thereafter, specifically to increase the grants to the national companies. This latter sum was calculated in agreement with the organisations concerned by an independent firm of accountants. The additional sum was accepted as providing, together with existing grant, a reasonable financial base within which the organisations could work.
The additional £2.4 million was allocated as follows:
| £ million | |
| Royal Scottish National Orchestra | 0.469 |
| Scottish Ballet | 0.300 |
| Scottish Chamber Orchestra | 0.291 |
| Scottish Opera | 1.340 |
| 2.400 |
1.3 There was an assumption that SAC would make every attempt to increase the uplifted base grants each year thereafter by the general level of inflation. In addition the companies agreed to increase earned income and, although discussions about full scale merging of orchestral resources did not result in any agreement, to continue efforts to make savings in other ways. This commitment led, ultimately, after very protracted discussion between all the parties involved, including SAC, The Scottish Office and the companies themselves, to proposals to merge a range of administrative and technical functions of Scottish Ballet and Scottish Opera.
1.4 Independent reports on the possibilities of this type of merger resulted in setting up of a joint working party comprising the chairs, vice chairs and chief executives of each of the two companies to consider the detailed implications of merging these aspects of each company. This process was assisted by an independent arts consultant.
1.5 The arguments put forward by the independent consultant for such a merger, including forecasts of potential savings, formed the basis of an application by Scottish Ballet and Scottish Opera to the SAC Lottery Funded "Advancement Programme". The arguments were considered by SAC to be persuasive and entry to the Advancement Programme was confirmed. This is a scheme which is designed to assist organisations to manage and implement change.
1.6 The financial models for the joint operation of Scottish Ballet and Scottish Opera were prepared by the independent arts consultant in association with the joint working party. A number of options were prepared based on differing levels of activity, different assumptions on cost increases, repertoire and growth of SAC grant.
1.7 One of the options submitted, which involved offering funds for a three year period with increases on average of 2.5%, was accepted by SAC in May 1999 as providing a difficult but workable solution. It was clear that the proposal was based on a number of assumptions covering a three year period. This financial plan should have been completed before the beginning of the financial year, (1 April to 31 March,) and in future SAC must ensure that this is in place.
1.8 One of the major factors in the accepted option was that the companies were starting with an accumulated accounting deficit and that further deficits would be incurred in the financial year 1999/00. In addition, there was a cash deficiency which exceeded the accounting deficit at the beginning of 1999/00 mainly because of the reasons outlined in Appendix Two of Part One of this report, including for example, use of revenue grant to support capital expenditure. However, the forecast submitted by the joint working party indicated that, if the plan was adhered to, savings arising from the merger of the administrative and technical functions would grow and, within the three year period covered by the plan, bring the operating of the joint company into a break even position. At the end of the three year period a significant accumulated deficit would remain, but would from year two of the plan start to reduce. The principal flaw in this long term plan was that years two to four were not planned artistically or operationally in detail and were therefore not costed.
1.9 It should be noted that year one of the plan required the input of funds from the Lottery Advancement Programme. See 1.5 above.
1.10 It was on the basis of the plan leading to a break even position and in the context of the relatively recent major increase in grant arising from the recommendations of The Scottish Office working party referred to above, that the plan was accepted. It was also understood by SAC that the plan in the current year, 1999/00, would be extremely difficult for the boards of the two companies to achieve, but based on recent experience of reasonable cost control and achieving budget targets, the risks were not considered to be unreasonable. Although the long term forecast seemed viable, in future any plans based on a deficit being recouped in later years should be avoided.
2.1 Part One of this Report outlines the regime of monitoring applied by SAC. The specific activity and action in relation to the monitoring of the financial position of Scottish Opera and Scottish Ballet is outlined in detail in Appendix Four. This provides a chronological list of the various contacts made with these organisations in response to receipt of monitoring information.
2.2 The chronology of events indicates that monitoring was frequent. What is apparent is that the relatively passive monitoring applied, i.e. based on the assumption that material supplied to SAC is complete and consistent with the company's plans, was not adequate in the circumstances. It is arguable that monitoring, in the generally accepted sense of the word, would not have revealed the serious flaw in the financial models agreed by all parties. This was that there was a lack of consistency and co ordination between the long term financial model, the budgets to which the companies were operating, the cash flow forecasts and the artistic plans.
2.3 What would have been required to reveal these inconsistencies was a more rigorous examination, akin to an audit, of the information than SAC has employed hitherto. It has been argued in part one of this Report that it is not SAC's role to act as auditor.
2.4 In 1999/00 the financial plan to which the Opera and Ballet companies were proposing to work was based on an accounting principle whereby expenditure on productions which would not be brought into the main repertoire until the following financial year would also be deferred until that later year. It is recommended that the companies review the application of this method of accounting.
2.5 The calculations of the cash needed to sustain the plan were also based on this accounting treatment rather than on the actual expenditure and income which would flow from it. The cash position was exacerbated by some unforeseen expenditure at levels higher than those budgeted, by lower income than forecast and by timing differences in the expected receipt of co production income.
2.6 The problem which emerged later in the year was inherent in the accepted plan. It was exacerbated by the increased expenditure and lower income but the latent problem would have developed and become apparent in any event.
2.7 The regular management accounts would have identified eventually the problems associated with missing budget targets for income and expenditure. However, the cash forecasts which changed frequently in the relatively early part of the year could have given warning and more time for assessing options and managing decisions on action to address the problem. Again it could not have eliminated it. The lack of a Finance Director in Scottish Opera at a crucial period in the year, pointed out as a weakness several times by SAC, contributed to this aspect being missed until it became more obvious and more urgent.
3.1 The lessons learned by SAC are that certain aspects of monitoring must be made more robust to ensure that companies are meeting the standards expected of them. However, it is as noted in part one, the responsibility of the companies concerned to ensure that financial management is robust. The following matters in particular must be addressed by the boards with SAC seeking verification that they have been applied:
3.2 The task of SAC in monitoring would be to ensure that the additional requirements noted above are carried out. This could be done in the main, by seeking appropriate written assurances from the companies themselves. In cases where investigation is required it would seem appropriate for independent experts to undertake work and report to SAC.
Proposals by Scottish Opera and Scottish Ballet for changes in their budgetary control and reporting systems designed to prevent a recurrence.
Shortly after his appointment the new Chairman of Scottish Ballet and Scottish Opera commissioned a 'due diligence' review of the two companies from an independent firm of accountants. This review identified a number of internal control weaknesses, which the companies will address as a matter of urgency. Although these weaknesses, and other control issues, are important, it is considered that they did not contribute directly to the particular problems encountered during the current year.
The lack of a Finance Director throughout much of the current financial year at Scottish Opera and accounting staff shortages in each company are referred to as weaknesses in the report. These issues will also be addressed by the companies in the very near future.
The report itself is the property of Scottish Opera and Scottish Ballet and the firm responsible for the work has included the usual proviso that the contents should not be released to third parties. As most of the report is detailed comment on technical accounting procedures it is considered unnecessary to request release of this report or any section of it. However, SAC will monitor implementation of the recommendations for improvement and will seek the assurance of the board that all issues will be addressed.
The report submitted by Scottish Opera and Scottish Ballet is attached.
1. It is suggested that the following are amongst the lessons that might be learned from the financial crisis that arose between May and October 1999. Sections Two to Seven relate to paragraph 1.1.2 of the remit to this report and Section Eight relates to paragraph 1.1.3. (The remit is reproduced in Appendix One.)
2.1 Scottish Opera adopted a budget for the financial year 1999/2000 that was "year one" of a four-year plan. Year one was costed in great detail and earned income estimates for that year were equally thoroughly researched. The accuracy of this part of the budgeting exercise has been proved by actual results conforming closely to expectations in the year so far.
2.2 However, years two to four were not based on costed programmes. Expenditure and income were set at "year-one" levels adjusted for inflation.
2.3 This is of particular significance because "year one" was budgeted to produce a deficit, to be recovered in future years. In addition, certain expenditure (production and rehearsal costs for Macbeth) which might have been accounted for as a charge on the 1999/2000 budget were deferred to be a charge on 2000-2001.
2.4 Thus a situation was countenanced where a budget for the first year of a four year plan was approved when it would only be viable (in P&L terms) if future years, and in particular "year two", could be made to produce very large savings. At this time the costs of years two to four were unknown.
2.5 One should conclude that multi-year plans, particularly if later years are planned to recoup known losses in earlier years, are only valid if all years' estimates are based on the best possible, detailed costing of programmes. Multi-year budgeting should be carried out on these principles, and planning to incur deficits in early years to be recouped later is a practice to be avoided.
3.1 Forecasting cash flows, and assessing liquidity requirements, has been treated as a secondary budgetary activity. It has been practice to examine and approve budgets in terms of their expected P&L effect, but without a detailed assessment of the liquidity implications.
3.2 For as long as overall deficits remained within certain margins, this approach sufficed. Later negotiation of cash in-flows proved possible to meet payments as they were, subsequently, predicted to occur. In particular, grant payments from SAC were loaded heavily towards the beginning of each year and advance payments for subsequent year's grant were obtained in the last two or three months of each financial year. These arrangements, together with a bank overdraft, provided the ability to pay bills as they fell due.
3.3 A problem would inevitably arise if a combination of a planned deficit budget and a decision to incur substantial cash payments budgeted (in P&L terms) for a later year pushed the borrowing requirement beyond what could be satisfied from grant advances and bank overdraft. This is what happened in 1999/2000.
3.4 The conclusions to be drawn are that cash-budgeting must be as thorough as P&L budgeting, and must be done in time to inform decisions as to whether a budget is feasible and might be approved. Information about cash flows must be available to management and Boards alongside Income and Expenditure forecasts.
4.1 Not the main, but nevertheless a very significant, element of the financial problem of 1999/2000 has been failure to meet income targets. This is true of fundraising and sponsorship targets for both Ballet and Opera, box office receipts for Ballet and co-production income for Opera.
4.2 Both companies set very high targets for fundraising and sponsorship. Nothing in previous years' results gave reason to be confident that these targets would be achieved, although if previous best-ever results could be repeated there was some hope of reaching them. In the event, 1999-2000 has proved to be very far from being "best-ever" territory.
4.3 There is an important general lesson to be learned from this. Fundraising and sponsorship budgets should be set at the levels of what can almost certainly be achieved, even in a very ordinary year. This is not to say that targets for the fundraisers should not be somewhat higher - there is a difference between what they can be asked to aim at and what it is prudent to rely on. There is an important morale effect to be considered here - beating realistic budgets is much more motivating for fundraisers than falling short of optimistic ones.
4.4 There is a second lesson: that financial problems, when publicly discussed and commented upon, as they always must be in the publicly funded arts industry, are self-reinforcing. Bad news about an organisation does not make donors or sponsors more inclined to give, quite the reverse. At least part of the shortfall in donated income is due to the fact that Scottish Opera was known to be in crisis. (In this respect, audiences are quite different - there is no evidence of any negative effect on ticket sales from the adverse publicity received by the company).
4.5 Co-production income targets also proved to be a source of disappointment. Co-producers do not contribute more than a fair share of the physical elements of a production, and some part of the creative team's fees. They cannot be expected to share in rehearsal costs. Additionally, co-producers tend to become firmly contracted either before a definite decision to make the production (because they understand that their involvement is necessary to its happening at all) or when they are sure, after having seen it, that they want it in the near future. Between these occasions they have little incentive to commit, still less to pay.
5.1 At least one key post, Finance Director of Scottish Opera, was vacant throughout the period during which the financial crisis developed. It is at least probable that the signs would have been recognised sooner, and the nature of the problem been brought to the attention of the Board and SAC, if this post had been filled. The danger of operating a complex arts organisation without a senior finance executive is plain. That person should be assured of access to the Board of the company.
5.2 This is not to say that the problems would not have occurred, or that their solutions would have been easy, or even possible, with a finance director in place - but they could most probably have been understood better and much sooner. Preventing the problems would have required different actions at a very much earlier stage - when programmes and plans for 1999/2000 were being developed. At this time there was a Finance Director. The fundamental reasons for the programme being, in the event, unfinanceable have more to do with item (2) above, and the issue covered in item (6) below.
6.1 All participants in the management of Scottish Opera and Scottish Ballet through the years since 1993, and especially since 1997, report a continual and growing demand on their attention by the various proposals, all perceived as being imposed on the companies from outside, to reorganise and merge them. One can expect that this would have some effect on the management of even the most important of other issues.
6.2 It seems likely that when major decisions about the organisation, management, and even the missions of the companies, were being taken in conjunction with outside bodies, this might weaken a sense of truly being in control of a company's plans and future. This would be particularly the case when those bodies were the exercisers of financial power in relation to the companies. Even more so when decisions were taken in the context of a forum for "the National Companies", suggesting some superior framework in which the operations of Opera and Ballet had to fit.
6.3 This climate of management should not be allowed to develop. All parties need to improve their understanding of the quite different roles of SAC, the boards and management.
7.1 The quantity, range and standard of Scottish Opera, and the extent of its service throughout Scotland, is not matched by financial resources. The crisis of 1999 was a demonstration of this, made much more dramatic by late appreciation of the situation. Costing of future years' programmes shows that 1999/2000 was not an atypical year. A series of past financial problems indicates that the underlying problem is not new.
7.2 The sources of public funding for Scottish Opera have changed in recent years - growth in SAC support, headlong decline in local authority contributions and near elimination of ACE funding as touring to England has been replaced by growth of activity within Scotland. The net effect of these changes has left the overall level of support too low to maintain a company with the levels of achievement to which it is currently committed.
7.3 A complementary situation exists in respect of Scottish Ballet. That company has reduced activity levels in response to the squeeze on its financial resources. The reduction now requires to be reversed - and the impetus to do so is present with a new Artistic Director. An appropriate re-establishment of a working relationship between finance and artistic objectives is imperative for both companies. This will require some very effective partnership planning between the companies and the funders and, if it is necessary to revise artistic objectives, a very difficult transitional period that will require quite exceptional management techniques.
8.1 The following proposals are made to improve systems. Many of these suggestions follow from a report on the companies carried out by independent accountants. The list is not exhaustive. A most important lesson from recent events is that all systems are liable to deterioration and failure. They need to be reviewed, renewed and improved regularly. Responsibility for this is allocated to the finance director, but is an issue also for the Chief Executive and board.