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PROGRAMME NAME: EDP 2012

MODULE: Financial Strategies

FACILITATOR: Prof Dave Flynn

DUE DATE: 25 September 2012

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REPORT AND RECOMMENDATIONS

PREPARED FOR CONSIDERATION BY THE EXECUTIVE MANAGEMENT COMMITTEE:

WESTERN CAPE DEPARTMENT OF HEALTH

[WCDOH]

25 SEPTEMBER 2012

IMPROVING FINANCIAL EFFICIENCIES, SERVICE DELIVERY AND PATIENT-CENTRICITY BY

CONSIDERING ALTERNATIVE FINANCE STRATEGIES, CAPITAL STRUCTURE POLICY, GREEN

PROCUREMENT POLICY AND TRIPLE-BOTTOM LINE PARTNERSHIPS

AN ANALYSIS OF THE RISKS AND REWARDS OF INNOVATING TO STRETCH THE HEALTH RAND

PREPARED BY:

AMANDA BRINKMANN

ADVISER TO THE MINISTER OF HEALTH: WESTERN CAPE GOVERNMENT

HEAD OF STRATEGIC PARTNERSHIPS: WESTERN CAPE GOVERNMENT

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TABLE OF CONTENT

1. Executive Summary

1.1 Agreement, Implications and Considerations

1.2 Decisions Required

1.3 Acknowledgements

2. Problem Statement

3. Objectives

4. Methodology and Approach

5. Existing Financial Strategy, Procurement Policy and Operational Realities: WCDOH

6. Finance Strategy and Procurement Policy Alternatives and Opportunities: Discussion

6.1 Zero-based and Activity-based Budgeting

6.2 Finance Decisions and Optimal Capital Structure

6.2.1 Gearing or Leverage

6.2.2 Financial Instruments

6.2.3 Establishing the full value of assets

6.3 Upfront purchase of Maintenance Contracts

6.4 Green Procurement

7. Operating Lease

7.1 General Advantages of an Operating Lease

7.2 Key Benefits of Operating Leasing to WCDOH

7.2.1 Financial Evaluation and Benefits of Operating Leasing

7.2.2 Proposed Structure of Operating Leasing Agreements

7.2.3 Cost Reductions, Benefits, Savings: Accruing to WCDOH

8. Conclusions

9. Recommendations

10. References

11. Glossary of Terms and Annexures

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1. EXECUTIVE SUMMARY

This document summarises the potential risks and rewards to the WCDOH, of procuring high-

value assets by using operating leases instead of by way of once-off cash procurement as is

currently standard policy. Alternative finance strategies and procurement policy is proposed

for consideration, including the incorporation of Green Procurement policy. Operating leasing

is situated within the context of the range of provincial objectives and includes considerations

of Extended Producer Responsibility, Life-cycle costing and usage analysis and eventual

disposal management.

The report furthermore deals with Corporate Social Investment [CSI], Triple Bottom Line

strategic partnerships as an extension to this procurement option and the potential added

value that could accrue to the WCDOH, its employees and patients, over time.

1.1 Agreements, implications and considerations

1.1.1 An asset/equipment backlog exists generally within the WCDOH, but specifically at the

three [3] Tertiary, Central Hospitals: Groote Schuur Hospital, Tygerberg Hospital and

Red Cross Hospital.

1.1.2 Some, or all, of the facilities managed by the WCDOH have a shortage of equipment

and/or ageing or obsolete equipment that need to be upgraded or replaced.

1.1.3 There are real costs, financial and non-financial, associated with the lack of necessary

equipment in certain facilities.

1.1.4 The budget allocated by Treasury to the WCDOH is currently not sufficient to meet

the annual equipment demands of all facilities, and by inference, insufficient to reduce

and/or eliminate the existing backlog. [ Annexure C. Botha, T. 26 March 2012]

1.1.5 Strategic Partnerships, efficiency, innovation, stretching the healthcare rand and

patient-centricity are all at the very heart of achieving the objectives of the WCDOH.

[ Annexure C. Botha, T. 26 March 2012]

1.1.6 The WCDOH only wishes to consider operating leases and NOT finance leases.

1.1.7 Possible assets which could be leased, if this route were followed, would be limited to:

a) High-value, high redundancy, high maintenance, high technology assets, required

at the three Central [Tertiary, Educational] Hospitals and other facilities

b) Transversal IT systems of hardware and or networks or systems which would

support the WCDOH Information Management data capabilities.

1.1.8 The process must adhere to all of the relevant regulatory frameworks and the

WCDOH‟s existing procurement process must be enhanced.

1.1.9 The “Essential Equipment List” for Central, Regional and District Hospitals and clinics

is also considered, as well as the transversal IT requirements. This would imply that

such asset planning should extend beyond the Medium Term Expenditure Framework

[MTEF].[ www-personal.umich.edu]

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1.2 DECISIONS REQUIRED

1.2.1 Principle agreement to pursue alternative finance strategy, procurement policy and

operating leasing along with triple bottom line partnerships within WCDOH.

1.2.2 Principle agreement to allow for individualized projects and case studies to be

conducted, under empirical conditions and within regulatory and policy frameworks,

so as to evaluate the qualitative, quantitative, tangible as well as intangible benefits of

operating leasing and alternative finance and procurement strategy over time.

1.3 ACKNOWLEDGEMENTS

This document is the culmination of a year-long investigative process that has involved

interrogation of data, research, interviews, robust debates, lobbying and hard work, dedication

and passion from a great many people. In no specific order, I wish to acknowledge the following

people:

Minister of Health, Mr Theuns Botha and Head of Department: WCDOH, Prof Househam,

for having the vision and foresight to provide the mandate for the exploratory process.

Mr Mike Loverock: Independent Financial Analyst – for assisting with the creation of the

financial models and scenarios.

Mr Isaac Smith: Head of Procurement: WCDOH – for bringing his experience, knowledge,

skills and wisdom to bear whenever required.

Messrs Van Niekerk, Jooste and Manning: Financial Management team: WCDOH – for their

openness to engage with new, innovative and different ideas and concepts.

Manufacturers and suppliers of medical and other high technology equipment – for their

inputs regarding mechanisms that would add value to the procurement and life-cycle of

assets.

Various officials, managers, role players and staff within Level 2 and 3 health facilities as

well as senior officials and management within WCDOH Head Office, too many to mention

by name - for their input in terms of desirability, feasibility and viability.

The intent remains for this to be a living document as we move towards becoming the Learning

Organisation [Liao, S. H., Chang, W. J., Wu, C. C., & Katrichis, J. M. 2011]. The hope is to arrive at

a policy solution which would deliver against the range of objectives of the WCDOH, whilst

mitigating any potential future financial and environmental risks. The report and recommendations

if adopted in its entirety will lead to the more effective use of capital, reduction in costs and

increases in available budget or free cash flow to WCDOH.

AMANDA BRINKMANN

Special Adviser to the Minister of Health & Leader of Government Business HOD: Strategic Partnerships: Western Cape Government

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2. PROBLEM STATEMENT

2.1 An asset/equipment backlog exists generally within the WCDOH, but specifically at the

three Tertiary, Central Hospitals.

2.2 Some, or all, of the facilities managed by the WCDOH have a shortage of equipment

and/or ageing or obsolete equipment that need to be upgraded or replaced.

2.3 There is particular need, as evidenced by the attached proposal titled: Strengthening

of the Surgical Platform: Western Cape Department of Health. [Brinkmann, A.

November 2011] for surgical theatres, suites and training facilities to be upgraded.

2.4 There are real costs, financial and non-financial, associated with the lack of necessary

equipment or the presence of ageing, inefficient, sub-optimal equipment in certain

facilities.

2.5 The budget allocated by Treasury to the WCDOH is currently not sufficient to meet the

annual equipment demands from all facilities, and by inference, insufficient to reduce

and/or eliminate the existing backlog. [ Annexure C. Botha, T. 26 March 2012]

2.6 National Treasury has issued a notice indicating a tightening of the budgetary

envelope. The estimated time horizon is anticipated to be three to five years. [National

Treasury Department: South Africa. August 2012]

2.7 Notwithstanding the above, negative impact on service delivery is not an option as is

evidenced by the Strategic Objective Four of the WCDOH as set out within the Annual

Performance Plan 2012/13[Annexure D: Western Cape Department of Health. March

2012] as well as with the spirit, content and objectives of Vision 2020 [Annexure B:

WCDOH. November 2011]. This is reiterated within the content of the WCDOH Budget

Speech 2012. [Annexure C. Botha, T. 26 March 2012]

2.8 There is an acute shortage of doctors and nurses in South Africa and Minister Aaron

Motsoaledi, National Minster of Health, has committed to the training of additional

clinical staff and the upgrade of facilities [Child, K. 11 Oct 2011].

3. OBJECTIVES

Through innovation in financial, procurement and strategic partnership strategies and policies,

within severe budgetary constraints, ensure improved delivery of the various strategic objectives

and service delivery outcomes of WCDOH as well as those of the Western Cape Government

[WCG] as a whole, without compromising either the present or future delivery of such services.

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4. METHODOLOGY AND APPROACH

4.1 The existing capital structure [Flynn, D.2009. Chapter 13-3] and capital budgeting

structure [Flynn, D. 2009. Chapter 14-3] of WCDOH was interrogated and evaluated in

respect of efficiency and effectiveness.

4.2 The Five Principles of Financial Viability [Flynn, D. EDP 2012. Slide 26] were borne in

mind, adjusted for governmental circumstances.

4.3 The existing „Essential Equipment List‟ was assessed against what is required in reality

and adapted accordingly.

4.4 The benefits of new assets as well as replacement assets have been sufficiently

quantified for comparison against the opportunity cost of incurring finance costs.

4.5 Various pieces of legislation, policies, regulations, practice notes, strategies and plans,

as referenced within and annexed to this report were interrogated and reviewed.

5. EXISTING FINANCIAL STRATEGY, PROCUREMENT POLICY and OPERATIONAL

REALITIES: WCDOH

In summary, WCDOH currently employs the following financial strategies and policies:

5.1 Historic, Incremental Budgeting or Capped Budgeting

5.2 Working Capital Structure allows for the purchase of fixed assets mainly via outright

cash purchase

5.3 Valuation and Value are not quantified on the principles of risk and return in finance

5.4 Useful life of assets and operational maintenance are not adequately planned and

budgeted for

5.5 Budget priorities are not necessarily reflective of changing service delivery needs and

requirements

6. FINANCE STRATEGY AND PROCUREMENT POLICY ALTERNATIVES and

OPPORTUNIES: DISCUSSION

6.1 ZERO-BASED & ACTIVITY BASED BUDGETING

A hybridized version of a zero-based and activity based budgeting approach would allow for the

budget to be built around what is needed to deliver on the objectives of WCDOH.

6.2 FINANCE DECISIONS AND OPTIMAL CAPITAL STRUCTURES

6.2.1 Gearing or Leverage

An optimal capital structure strikes a delicate balance between cash funding and funding from

debt. An element of gearing or leverage, at a moderate level, could have the ability of bringing

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future procurement into the present. Long-term assets should ideally be procured via long-term

finance. Benefits and use are realized over time. [Flynn, D. 2009]

6.2.2 Financial instruments

Operational Leasing could fast-track the procurement of high technology, high maintenance, high

redundancy and high value equipment. Innovative contractual agreements between WCDOH,

Lessors and suppliers of assets could provide considerable added value.

6.2.3 Establishing the full value of assets

New techniques to establish the value of assets should be agreed based on the principles of risk

and return in finance.

6.3 UPFRONT PURCHASE OF MAINTENANCE CONTRACTS

WCDOH could purchase maintenance contracts up-front. This could lead to savings of up to 25%.

[Lipsitz, N. 6 October 2011]

6.4 GREEN PROCUREMENT

The White Paper on Greening the Procurement of Goods and Services within the Western Cape

Government [The Department of Environmental Affairs and Development Planning: Western Cape

Government. 21 June 2011] provides as follows:

6.4.1 Life-cycle analysis, costing, planning, sustainability and resource efficiency so as to

prolong the useful life of assets and re-use as long as possible.

7. OPERATING LEASE

In general, leasing is based on the concept that for the purpose of production / service delivery,

the determining factor is not the ownership of the assets to be acquired, but rather their

availability for use. [National Treasury.1 April 2000]

7.1 GENERAL ADVANTAGES OF AN OPERATING LEASE

7.1.1 Creating free cash flows within a budgetary constrained environment

7.1.2 Spreading the Cost by initially paying for use, thereby matching the costs of an asset

against the asset‟s future economic service potential

7.1.3 Complete Finance

7.1.4 Flexibility to add to or upgrade the asset base when required

7.1.5 Vendor Independence

7.1.6 Acceleration of service delivery projects via gearing

7.1.7 Transparency in contracting which improves governance

[www.fao.org. Accessed August 2012]

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7.2 KEY BENEFITS OF OPERATING LEASING TO WCDOH

7.2.1 FINANCIAL EVALUATION and BENEFITS OF OPERATING LEASING

Annexure F: TABLE ONE: OPERATING LEASING BENCHMARK SCENARIO MODEL REFERS

The financial model was built on the following assumptions:

WCDOH CAPEX budget for equipment is set at R200 million per annum.

Budget growth: 5% per fiscal, which effectively neutralises inflation.

Of the R200 million 2011/2012 budget, 50% [R100 million] is allocated to the procurement

of high value assets.

WCDOH determines to acquire equipment to the value of R75 million via operating leasing

and the balance of R25 million via outright cash purchase.

The equipment identified as appropriate for rental has an estimated minimum useful life

of seven years. To ensure the highest level of healthcare delivery, such equipment will

be replaced at the end of year five, but will continue in use at a separate / tier

two facility for its remaining economic life.

All rates used in the cash flow evaluation are at market rates as at April 2011.

Western Cape - Department of Health

Capital Expenditure Budget 2011 – 2016

Annual increase 5% 2011/2012 1. Allocation for low-value equipment and other assets 100 000 000 2. Allocation for big-ticket assets * 100 000 000

Budgeted Expenditure

200 000 000

Cash Flows

Annual Budget 2011/2012

100 000 000

Cumulative

0

Rental Cash Flows 2011/2012

(17 601 918)

Cumulative

0

Cash Differential Current Year 82 398 082

Cumulative 0

Less: (assets not rented) Current Year (25 000 000)

Available Cash: Current Year

57 398 082

Cumulative

82 398 082

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The table and its summary above are interpreted as follows:

7.2.1.1 From the rental cash flow in 2011/2012 costs of only R17.6 million is incurred.

7.2.1.2 This creates a potential for gearing, at an applied factor of 4.5 (75 million / 17.6

million.

7.2.1.3 This form of acceleration may be imprudent on an annual basis, because of the

cumulative effect of rental payments on succeeding years‟ budgets.

7.2.1.4 Acceleration in the 2011/2012 and again in the 2014/2015 budget years have been

assumed, with the cash flow effects thereof running through until the 2018/2019

budget year.

7.2.1.5 Consistent with the analysis for the 2011/2012 year, a surplus cash position of

approximately R50 million is reflected for the 2014/2015 year, which in turn

creates the ability for WCDOH to once more accelerate the procurement of

equipment.

7.2.1.6 A financing strategy of this nature could be regarded as a moderate approach to

asset procurement, within which there are countless permutations.

7.2.1.7 A vital component in the strategic decision-making process in general, but

specifically in this regard, is the potential cost savings that accrue to the WCDOH.

7.2.2 PROPOSED STRUCTURE OF OPERATING LEASING AGREEMENTS

The Lessor [who is vendor-independent] will purchase the assets from the supplier/s

selected by WCDOH at the best possible price, and

The Lessor will negotiate a discounted up-front maintenance/service contract,

The Lessor will include Extended Producer Responsibility into the contract,

The Lessor and Vendor agree to redeploy assets into lower-tier health facilities at their

cost, which costs shall include transport, installation, full maintenance and training of

clinical staff, where relevant

The Lessor will lease such assets to WCDOH at a fixed rate and over an agreed term, and

The Lessor, through a separate corporate social investment agreement with The Health

Foundation, donates leased assets to the WCDOH, at the end of the agreed lease period.

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7.2.3 COST REDUCTIONS, BENEFITS, SAVINGS: ACCRUING TO WCDOH

From a purely [and very limited] financial perspective, I would suggest that the acid test here is to

obtain comfort that the cost savings and benefits that accrue, at least exceed the costs of finance.

7.2.3.1 Ability to purchase up to four times more equipment by gearing moderately in

specific budgetary period

7.2.3.2 Creating free cash flows within the specific period so as to assist with service

delivery within financially constrained circumstances

7.2.3.3 By having state-of-the-art equipment at teaching hospitals, the ability to attract,

train and retain the best possible clinical talent in the province and country

7.2.3.4 By upgrading the surgical platform alone, it is anticipated that vast savings in

respect of patient experience, recovery, reduction in bed days, post-operative

morbidity and mortality would be achieved

7.2.3.5 The value of bringing future delivery into the present via sound finance and

procurement policies

7.2.3.6 Over time, replace obsolete and ageing equipment with sustainable, energy-efficient

assets

7.2.3.7 Inclusion of Extended Producer Responsibility into contractual agreements ensures

that the useful life the asset is extended as far as possible and that the cost of

disposal is vested in the producer

7.2.3.8 By planning for the acquisition of assets over the MTEF, a five, seven and ten year

horizon can be constructed; planning for the redeployment of assets to lower-

tiered facilities could be included into such planning

7.2.3.9 The cost of relocation, installation and training of staff related to assets will be

borne by the producer

7.2.3.10 Lower-tiered facilities will, over time, be able to diagnose and treat patients in situ,

thereby improving prognosis and overall patient outcomes, potentially saving the

health system considerable costs attached the late detection and treatment of

certain conditions

7.2.3.11 Savings related to the reduction in the maintenance division and budget of the

WCDOH over time as well as savings related to the up-front procurement of

maintenance contract, acting to mitigate finance costs over the term

7.2.3.12 Savings in transport of patients via Health Net – fuel, driver, support staff salaries

and consumables used en route

7.2.3.13 Hospitalisation costs at the facility to which the patients would have been taken,

which may include more bed days than would otherwise have been necessary

7.2.3.14 Savings in loss of man days [ and the costs thereof] related to providing at

treatment at facilities that are remote from the patient‟s home

7.2.3.15 General improvement of the patient experience and a complete move towards the

stated goal of patient-centricity by equipping the health network with improved

capacity and diagnostic abilities closer to where the patient is

7.2.3.16 Demand management, Disposal Management, Extended Producer Responsibility,

Full-life cycle assessment, costing and planning and contractual innovations

would optimize capital expenditure and asset acquisition

7.2.3.17 Improved staff morale and motivation over time

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8. CONCLUSIONS

8.1 The existing planning, finance strategy and procurement policies within WCDOH are

not optimised to deliver against the changing service delivery needs of patients as well

as clinicians.

8.2 The very constrained budgetary environment necessitates looking at new and

innovative capital and finance structuring methodologies.

8.3 To achieve societal outcomes, there is a shift towards partnering via the sustainability

platform as is evidenced by the findings attached to the establishment of The Health

Foundation [ Ernst & Young. 9 February 2012. Annexure A] as well as the outcomes of

the UN Global Compact/Accenture CEO survey[Lacy, P; Cooper, T; Hayward, R;

Neuberger, L. June 2010].

8.4 Green procurement policy and principles provide significant additional opportunities to

save costs and improve efficiencies. [DEADP. 21 June 2011]

8.5 There is a compelling case to be made for the use of Operating Leasing and the

proposed contractual structure so as to accelerate service delivery and reduce the

existing equipment/asset backlog.

8.6 Such policy has the potential to benefit other departments within WCGOV. Department

of Education and the acquisition and renewal of ICT infrastructure spring to mind.

8.7 The proposed gearing factor of 4.5 could in essence accelerate asset procurement by

more than 100% every 3 years.

8.8 By implementing a prudent and moderate operating leasing procurement strategy,

significant long term savings and benefits could accrue to the WCDOH, its patients and

employees.

8.9 The proposed upgrade of the Surgical Platform in the province, with further reference

to the acquisition of equipment and training in Laparoscopy or Minimally Invasive

Surgeries [Heisler, J. January 2012.] could lead to significant cost-savings to the health

system as well as improved patient outcomes. This is evidenced by the outcomes of a

range of global studies.[Braga, M. et al. Dec 2005]; [Rodriguez, A et al. January

2011.];[Maslekar, S. et al.March 2007.]; [Roumm, AR. Pizzi, L et al. March 2009.];

[Goldsmith, H. Herman, L. January 2002.]

8.10 It goes without saying that any form of funding [bond, loan, finance lease, operating

lease] carries a financing cost. The WCDOH budget, which is allocated from Treasury,

of course does not carry such a cost, at least not to the WCDOH.

8.11 If the only analysis undertaken is to compare the allocated cash [per the WCDOH

budget] to any form of debt financing, and the end objective of the analysis is the

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quantum of assets that can be acquired over time, by definition cash will always

prevail, by virtue of the financing costs of debt.

8.12 Additional assets made possible through the use of alternate finance strategies, whilst

not generating income, could have a material impact on reducing costs.

8.13 Examples of these costs are dealt with in the main document, and should be identified

within the operating budget, and quantified. These could correctly be considered hard

cash savings that accrue to the WCDOH, and a tangible benefit.

8.14 A meaningful and correct analysis in comparing a cash purchase to an operating lease

solution is then to include a line in the budget in which these cost savings are

recorded.

8.15 Properly managed financing costs can be seen as the price that the WCDOH pays for

the ability to bring the procurement of essential medical equipment from future years

into the now. Coupled to this ability, is the concomitant reduction in associated

expenses.

8.16 We have to shy away from a purely rands and cents analysis when considering the

cost benefits of employing a moderate operating leasing strategy.

8.17 Whilst an operational lease is subject to compound interest over the lease period, this

cost should ideally be weighed up against the short-to mid-term benefits as described

within this report.

8.18 Although difficult, it would be useful to compare the full, actual cost of assets procured

by cash over the complete useful life of the asset.

8.19 Assets are generally „sweated‟ for as long as possible, but the cost of running an

operational maintenance unit is not factored in, accounted or budgeted for adequately.

[Gartner Group. 2003]. The complete cost of ownership of state assets is therefore

not known.

8.20 The proposed new standard for leases moves away from the current „risk and returns‟

basis to a „right of use‟ basis. This adjustment would make accounting for leases

more congruent with the Conceptual Framework for Financial Reporting 2010, as

drafted by the International Accounting Standard Board. [IASB.2010]

8.21 By continuing on a „ business-as-usual‟ path, the backlogs in equipment will not be

addressed and this would have material impact on the ability of WCDOH to achieve its

strategic objectives.

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9. RECOMMENDATIONS

Given the constrained budgetary environment, the range of strategic objectives as iterated by the

WCDOH as well as Western Cape Government in general and the need to innovate so as to stretch

the health rand, the following recommendations are made for consideration by the Committee:

9.1 Zero-based and activity based budgeting to establish the real needs as required to

deliver against the objectives of WCDOH, specifically as those deliverables would up

operational efficiences, save costs in the longer term, improve quality and access to

services and be focused entirely on patient-centricity.

9.2 Based on the latter activity, develop a phased, rolling 10-year asset procurement plan,

that would seek to address the most immediate priorities over time.

9.3 These priorities would, in the main, be related to high technology, high redundancy,

high maintenance and high value assets. This should include ICT and management

information infrastructure.

9.4 Explicit rules need to be established which define the potential assets which would be

considered.

9.5 Key priority requirements should be projectised.

9.6 Such projects and case studies would be decided based on the necessity of the

procurement of such equipment so that such procurement aligns with delivery of the

Strategic Objective Four [ 4] of the WCDOH as set out within the Annual Performance

Plan 2012/13[Annexure D:Western Cape Department of Health. March 2012] as well as

with the spirit, content and objectives of Vision 2020 [Annexure B: WCDOH. November

2011]. Such projects would furthermore be guided by the content, intent and spirit of

the WCDOH Budget Speech 2012. [ Annexure C. Botha, T. 26 March 2012]

9.7 Certain projects, such as for instance the upgrading of the Surgical Platform in the

province, could be managed by the Strategic Partnerships portfolio in collaboration

with The Health Foundation. This recommendation is based upon the fact that a

significant number of suppliers, manufacturers and donor partners have already

indicated their support for such a project. The balance of funds which are not

secured via such partnerships and donations could be financed by WCDOH.

9.8 Operating Leasing, used in a moderate and pragmatic manner should be adopted as

part of the WCDOH‟s finance and procurement policy and strategy.

9.9 The proposed structure of the Operating Leasing agreement, as proposed within this

report should be adopted and all contracts negotiated on this basis so that the full

added value benefits to WCDOH and its patients are realised over time.

9.10 The benefits of new as well as replacement assets must be quantified in order to

assess this cost against the opportunity cost of incurring finance costs.

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9.11 Factors, including: Net Present Value calculation should include, amongst others: *

Value of the asset * Funds being paid * Maintenance costs * Administration costs*

Potential staffing costs * Disposal value/cost of asset used * Environmental costs*

Input materials and resources required to operate the asset * Capital cost of the

asset* Positive cash flows that the asset is expected to generate, net of financing costs

*Changes to working capital requirements

9.12 Other than cash flows as basis for the valuation technique, other factors, such as the

capacity to influence existing and future service delivery, capacity to influence future

cash flows, capacity to generate present and future benefits, rewards or savings,

timing of cash flows and impact of the investment on the business operations should

be taken into consideration. WCDOH must appropriately evaluate whether the

benefits of ownership of equipment or assets in the present, seem to be greater than

the wealth foregone, expressed as the price. We should establish whether the total

exchange price is in reality lower than the value or worth of the asset to WCDOH.

9.13 Accounting for leases must be congruent with the Conceptual Framework for Financial

Reporting 2010, as drafted by the International Accounting Standard Board [IASB] as

well as Finance Instruction G22/2009. [Jooste, J. 27 March 2009]

9.14 Finally, it is my assessment, based on all of the information gathered, assessed,

interrogated and discussed over the past year, subject to internal compliance issues

being satisfied, that an Operating Lease methodology as proposed within this report

can generate compelling and very real benefits to the WCDOH and should therefor

form part of the overal finance, procurement and funding strategy.

9.15 In general, the Finance, Investment and Capital structures of WCDOH should be

reviewed so as to be in more in keeping with the delivery of the strategic objectives of

the Western Cape Government, The Western Cape Department of Health and with the

changing service delivery and business landscapes.

The report and recommendations if adopted in its entirety will lead to the more effective use of

capital, reduction in costs and increases in available budget or free cash flow to WCDOH.

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10. REFERENCES: FINANCIAL STRATEGIES REPORT AND RECOMMENDATIONS

Botha, T. 26 March 2012. Western Cape Health Budget Speech 2012 by Mr Theuns Botha,

Minister of Health at Western Cape Provincial Legislature

Braga,M.et al. December 2005. Laparoscopic versus open colorectal surgery: cost-benefit analysis

in a single center randomized trial.

Campbell, R. H. 2012. http://financial-dictionary.thefreedictionary.com/Finance+Lease. Define:

Financial Lease. Accessed August 2012

Child, K. 11 Oct 2011. Health Minister promises more doctors and nurses. www.mg.co.za.

Accessed September 2012

Enterprise Financial Solutions. 2012. Definition of Operating Lease

Ernst & Young. 9 February 2012. The Health Foundation: The Journey Thus Far. Presentation

format.

Flood, R.1999. Rethinking the Fifth Discipline: Learning from the Unknowable.

Flynn, D. EDP 2012. Financial Strategies Presentation document.

Flynn, D. 2009. Understanding Finance & Accounting. Chapter 6. Pg 27. 6. Non-financial issues in

analysis; 6.1 The Balanced Scorecard

Gartner Group. 2003. Total Cost of Ownership model.

Goldsmith, H. Herman, L. January 2002. Endoluminal gastroplication. A new therapeutic

endoscopic procedure for gastro-esophageal reflux disease.

Heisler, J. January 2012. Definition of Laparoscopic Surgery. About.com Guide. Accessed August

2012

http://www.businessdictionary.com/definition/positive-cash-flow.html. Define: Positive Cash

Flows. Accessed September 2012

http://www.fao.org/docrep/W4343E/w4343e08.htm. Basic Finance for Marketers. Advantages of

Operating Leases. Accessed August 2012.

http://www.investopedia.com/terms/n/npv.asp. Define: Net Present Value [NPV]. Accessed

August 2012.

http://www.investopedia.com/terms/o/operatinglease.asp. Define: Operating Lease. Accessed

August 2012.

17 | P a g e

http://www-personal.umich.edu/~alandear/glossary/m.html#mtef2. Definition: Medium Term

Expenditure Framework [MTEF]. Accessed September 2012

International Accounting Standards Board [IASB]. 2010. The Conceptual Framework for Financial

Reporting. www.ifrs.org. Accessed August 2012

Jooste, J.M. March 2009. Finance Instruction G22/2009. Classification of Lease Agreements in the

Standard Chart of Accounts as well as the Reporting on Lease commitments at the end of each

financial year.

Lacy, P; Cooper, T; Hayward, R; Neuberger, L. June 2010. A New Era of Sustainability. UN

Global Compact Accenture CEO Survey study 2010. ; CEO reflections on progress to date,

challenges ahead and the impact of the journey toward a sustainable economy.

Liau, S.H.,Chang, W.J., Wu, C.C. & Katrichis, J.M. 2011. A survey of market orientation.

Lipsitz, N. 6 October 2011. CT Tender: Savings on upfront maintenance contracts: Siemens and

City of Cape Town

Maslekar, S. et al. March 2007. Cost analysis for trans-anal endoscopic micro-surgery for rectal

tumours

National Treasury Department: South Africa. August 2012. Medium Term Expenditure Framework

Guidelines. Preparation of Expenditure Estimates for the 2012 Medium Term Expenditure

Framework.

National Treasury: South Africa. Public Finance Management Act No. 1 of 1999 [PFMA]. Date of

commencement: 1 April 2000. Updated to Government Gazette 33059, 1 April 2010.

Public Finance Management Act No1. Of 1999 [PFMA]. Date of Commencement: 1 April 2000.

Gazette#25915. Public-Private Partnerships issued in terms of the Public Finance Management

Act. Treasury Regulation 16.

Rodriguez, A et al. January 2011. Providing endoscopy for underserved patients benefits public

health and resident education.

Roumm, AR. Pizzi, L et al. March 2009. Minimally invasive: minimally reimbursed? An examination

of six laparoscopic surgical procedures.

The Department of Environmental Affairs and Development Planning [DEADP]: Western Cape

Government. 21 June 2011. Draft White Paper on Greening the Procurement of Goods and

Services within the Western Cape Government. Provincial Gazette Extraordinary No. 6880

Vancock, H. 2007. "Dimensions of sustainability". Journal of Engineering for Sustainable

Development: Energy, Environment, and Health 2 (1): 47–57.

Western Cape Department of Health [WCDOH]. November 2011. 2020 –The Future of Health Care

in the Western Cape. A Draft Framework for Dialogue

18 | P a g e

Western Cape Government Department of Health. March 2012. Health Annual Performance Plan

2012/13. www. Westerncape.gov.za/health. Accessed March 2012.

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11. GLOSSARY OF TERMS and ANNEXURES

GLOSSARY OF TERMS

1. Non-financial issues in analysis

This methodology takes issues of interest and benefit to a variety of stakeholders into account,

which issues may not be directly viewed as being able to be measurable in financial terms. These

issues nonetheless add value and so to provide a complete analysis, should be considered as part

of emergence: the whole being larger than the sum of the parts. [Flynn, D. 2009]

This requires systemic evaluation rather than the quite one-dimensional practices that are often

used in analysis models and requires a leap from current conservative measurement metrics to

William Flood‟s integrated model of systems thinking, design and systemic evaluation. [Flood,

R.1999]

2. The Balanced Scorecard

The Balanced Scorecard focuses not only on the financial outcomes, but also on the operational,

marketing and developmental facets of a company/organisation. This tool links the objectives and

strategies of the organisation to measurable outcomes, but not only in financial terms. One of the

main challenges for financial management is to identify and agree on the strategies that would

achieve the overall goals and objectives of the organisation via a process of strategy mapping.

The further challenge is inherent in apportioning weighted values or quantum‟s to such non-

financial outcomes. [Flynn, D. 2009]

3. The Triple Bottom Line

People. Profit. Planet.

In her article, titled, Dimensions of Sustainability, published in the Journal of Engineering for

Sustainable Development, Energy, Environment and Health, Hasna Vancock [ Vancock, H. 2007]

speaks to the fact that sustainability is a process – this process deals with the development of all

aspects of human life that affects sustenance. This process involves constantly trying to balance

conflicting goals, objectives and interests and involves the simultaneous pursuit of economic

prosperity, environmental quality and social equity, known as the three dimensions or the Triple

bottom line. Triple Bottom Line Reporting is fast becoming mandatory for listed companies and

government.

4. Finance Lease

A agreement where the lessor receives lease payments to cover its ownership costs. The lessee is

responsible for maintenance, insurance and taxes. Some finance leases are conditional sales or

hire purchase agreements. [Campbell, R.H. 2012]

5. Operating Lease

A contract that allows for the use of an asset, but does not convey the rights of ownership of the

asset to the lessee. An operating lease is not capitilised; it is accounted for as rental expense in

what is known as „off balance sheet financing‟. For the lessor, the asset being leased is accounted

for as an asset and depreciated as such. Operating leases result in assets or liabilities not being

recorded on the lessee‟s balance sheet. This can improve the lessee‟s financial ratios.

[http://www.investopedia.com/terms/o/operatinglease.asp]

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6. Capital Structure

Capital is a scarce commodity. The objective of business management is to create value and add

value by the correct allocation of scarce resources. There are two primary ways in which capital

is used to return in an operating business. These are investments in fixed assets and in current

assets that are referred to as working capital items.

Financial Management has to align the capital structure of an organisation

[debt; equity; cash; liquidity] to achieve the objectives, strategies and desired outcomes of the

business most optimally. [Flynn, D. 2009. Chapter 13-3]

7. Capital Budgeting

In the case of government, capital budgeting is the process of evaluating projects that generate

improvements in service delivery outcomes and that align with the achievements of the Strategic

Objectives of a particular department and the provincial government as a whole. In its broadest

sense, the term is used for any expansion or replacement decision.

All of the principles of capital investing are pertinent to capital budgeting. The capital investment

decision must earn the required return on investment in order to add value or by adding value to

the activities of the organisation.

Capital budgeting decisions are generally considered to be more risky than working capital

decisions, because capital budgeting decisions carry long-term commitments of funds and are not

easily reversed if they prove to be unsuccessful. [Flynn, D. 2009. Chapter 14-3]

8. Net Present Value [ NPV]

This methodology compares the value of a rand today to the value of the same rand in the future,

taking inflation and returns into account. If the NPV of a prospective project is positive, it should

be accepted. Conversely, if NPV is negative, the project should probably be rejected because cash

flows may also be negative. [www.investopedia.com]

9. Positive cash flow

Creating a situation where cash inflows during a period are higher than the cash outflows during

the same period. Positive cash flow, in the case of government, does not mean profit. It is

achieved due to the careful management of cash inflows and expenditure.

[www.thebusinessdictionary.com] The Capital Structure [Flynn, D. 2009. Chapter 13-3] plays a

large role in determining an organisation‟s positive or free cash flows.

10. Working capital policies and management

Financial managers constantly grapple with decisions relating to risk and return in all aspects of

the business. Working capital is no exception. This decision is also a clear risk and return issue.

Managers must decide how much of the scarce resources of capital should be invested in inventory

and debtors and then determine the extent to which creditors will be used to finance further

investments. In government terms, a more conservative policy would aim to be less reliant on

short-term credit, financing a greater proportion of current assets through the use of longer-term

finance. [Flynn, D. 2009. Chapter 13-3]

Commentary: Within the context of the report presented, working capital policies are

recommended so as to free up much needed cash flows within the narrowing fiscal envelope,

21 | P a g e

whilst not compromising on the ability to procure much needed equipment required to improve

service delivery in the immediate future.

11. The Learning Organisation

In their abstract, A survey of market orientation research [Liao, S. H., Chang, W. J., Wu, C. C., &

Katrichis, J. M. 2011], we become aware that a Learning Organisation refers “to an organisation-

wide activity involved in creating and using knowledge to enhance competitiveness”.

12. Laparoscopic Surgery

Laparoscopic surgery, also known as minimally invasive surgery, is a technique that allows surgery

to be performed without the long traditional incision. By using multiple small incisions, each a few

centimeters long, the surgeon inserts instruments including a tiny camera. The camera allows the

surgeon to visualize the surgery. Incisions are made through the skin, muscle and other tissue,

making laparoscopic surgery safer as less tissue is cut [Heisler, J. January 2012.].

13. Extended Producer Responsibility

Extended Producer Responsibility is based on the „Polluter pays‟ principle and entails making

manufacturers responsible for the entire lifecycle of the products and packaging they produce.

This means companies that manufacture, import and/or sell products and packaging, are required

to be financially or physically responsible for such products after their useful life. They must either

take back spent products and manage them through reuse, recycling or in energy production or

delegate the responsibility to a third party which is paid by the producer for the spent-product

management. [DEADP.June 2011]

14. Life-Cycle Costing Analysis or Life-Cycle Cost Assessment

This is a procurement evaluation technique which determines the total cost of acquisition,

operation, maintaining and disposal of the items acquired; the lowest ownership cost during the

time the items is in use. [DEADP.June 2011]

15. Disposal Management

This refers to the decommissioning, clearance and removable of unserviceable, redundant and

obsolete assets. It considers obsolescence planning; maintaining a data base of redundant

material; inspecting material for potential reuse; determining a disposal strategy; and executing

the physical disposal process. [DEADP.June 2011]

16. Capped Budgeting

Budgeting is done by using historic or incremental budgeting, which has, in the main, the net

effect of not necessarily being able to keep pace with the constantly changing healthcare needs of

the citizens of the province or the changes required within the healthcare system as a whole.

Capped budgeting, by inference, remains unchanged, irrespective of the changing needs of the

organization and its clients.

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17. Zero-based Budgeting and Activity-Based Budgeting

Expenses are justified for each new period and starts from a zero base. Each function within the

organization is analysed for needs and costs and budgets are built around what is need for the up-

coming period, regardless of whether such budgets are higher or lower than the previous period.

This allows for strategic goals to be implemented into the budgeting process.

Activity-based budgeting means that all activities that incur costs in every functional area of the

organization are recorded, their relationships defined and analysed. Activities are tied to the

strategic objectives, after which the cost of the activities are used to create the budget. This also

provides opportunities to streamline costs and improve business processes and activities. [Flynn,

D. 2009]

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ANNEXURE A: ERNST & YOUNG. 9 FEBRUARY 2012. THE HEALTH FOUNDATION: THE

JOURNEY THUS FAR. SLIDE 23 EXTRACTED FROM PRESENTATION

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ANNEXURE B: 2020 – The Future of Health Care in the Western Cape. A Draft

Framework for Dialogue: Key excerpt of material relevance to the Report and

Recommendations

“It is important to reflect on the achievements to date, what worked (and what did not) and the lessons learned. While a formal external evaluation of the 2010 plan has not been undertaken, this document summarises the most important achievements and lessons learned. An important theme

throughout the document is what should be done differently. (Section A).” “What is the case for change? The compelling motivation for change includes changes in provincial

demography, socio-economic determinants of health and the burden of disease; advances in technology; and the global, national and provincial policy environment. Sustaining the current good practices, and improving others, is key to becoming a world class organisation. We

must focus on key priorities and the most cost-effective interventions within the limited resources available. (Section B)”

“The planning for 2020 takes cognisance of both national and provincial policy developments. Important policy frameworks include the “green paper” on the National Health Insurance, the national Human Resources for Health framework and the provincial strategic plan, with particular

emphasis on Strategic Objective 4 (Improving Wellness). (Section B).” “Prevention of disease and the promotion of wellness is the basis of health service development.

The upstream factors that contribute to the burden of disease will be addressed with the relevant stakeholders through a “whole of society” approach. This approach has been recently endorsed through the Cape Town Declaration on Wellness. The Department of Health will focus on

prevention and downstream promotion within the health service delivery platform. (Annexures A and B).” “The Department has drafted a broad strategic overview of a desired health care system in 2020.

Seven guiding principles have been identified to guide the 2020 strategy (Section C): 1. Patient-centred quality of care 2. A move towards an outcomes-based approach 3. The retention of a Primary Health Care philosophy 4. Strengthening the District Health Services model 5. Equity 6. Affordability 7. Building Strategic Partnerships “

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ANNEXURE C: WESTERN CAPE HEALTH BUDGET SPEECH 2012 BY MR THEUNS BOTHA,

MINISTER OF HEALTH AT THE WESTERN CAPE PROVINCIAL LEGISLATURE

EXCERPTS OF MATERIAL RELEVANCE TO THE REPORT AND RECOMMENDATIONS

“Creating Wellness

The department is now engaged in planning for 2020 to determine the service requirements going forward to 2020 and beyond. It will enable human resources, infrastructure and other requirements to be identified that will shape the future services. At the heart of the vision

for 2020, there is a renewed commitment to a quality, caring and patient-centred health service and improved health outcomes where the care pathways will be designed to respond to patient needs.”

“The shift in focus from illness to one of promoting and seeking wellness that gained significant ground during 2011/2012 culminating with the Wellness Summit and the ensuing Cape Town

Declaration will be further strengthened in the coming year. In particular, I am committed to developing wellness centres that will increase the access in communities to health services and activities promoting a healthier lifestyle.”

“Public private partnerships

Partnership with a range of stakeholders have increased year-on-year during the term of this government. In the past two years, the province has been able to secure successful partnerships with the private sector that have led to significant contributions to our

healthcare system. These public-private partnerships leverage the talents of the private sector for the benefit of public sector patients. It is based on a win-win philosophy that improves the physical health of patients and the financial health of the economy.”

“Surgical skills training centre

Located at the Red Cross War Memorial Children's Hospital, this centre is a partnership with the Children's Hospital Trust and Karl Storz Endoscopy SA, the latter having donated R10 million in equipment and technical assistance. It is the only training centre on this continent for surgeons-in-training from across Africa.”

“Western Cape Health Foundation

Supporting our efforts increase departmental income to address the R800 million maintenance backlog, we have appointed Ernst and Young Consultants, which resulted in the establishment of the independent Western Cape Health Foundation.

The Foundation will take responsibility for the Commercial Rights project and independently spearhead new and innovative initiatives to generate resources for health. This is a

significant step in strengthening this key relationship between the department and the private sector.

I am encouraged that a number of prominent people, including Dr Paul Cluver, who will chair the board of directors of the Health Foundation, have been willing to give of their time and energy to promote better health in the Western Cape. Clearly an example of people who also feel that it is

better together! The Foundation will be publicly introduced in the coming months.

These examples certainly demonstrate that the Western Cape has succeeded in responding with

solutions which have proved to bring about better health outcomes. At the heart of our

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provincial system is a commitment to accountability, affordability and efficiency - all

necessary elements for high-quality health outcomes.”

“The focus areas of the department in the coming 2012/2013 financial year include:

1. Developing action plans to improve overall patient experience and quality of clinical

care.

2. The full commissioning of the Khayelitsha Hospital.

3. Commissioning of the Mitchell's Plain Hospital.

4. Finalising the 2020 strategy and plan for health services in the Western Cape.

5. Finalising the priority projects related to the Cape Town Declaration on Wellness including

the:

High Five area approach to reduce alcohol-related injuries.

Healthy lifestyle campaign to decrease the incidence of chronic disease.

Programme to reduce intimate partner violence.

6. Improving maternal and child health outcomes.

7. Achieving an unqualified audit for finance, human resources and pre-determined

objectives.”

“Challenges

The allocation to the department in 2012/2013, although increasing in nominal terms, is marginally less in real terms than the 2011/2012 Adjusted Budget. The gap between the need for health services and the available resources remains the challenge and increases

the need to increase efficiency, work smarter and reprioritise services within the existing baseline allocation.”

“Distribution of the budget The budget of the department is divided between the eight budget programmes with R12.722

billion or 87% of the vote being allocated to Programmes 2, 3, 4 and 5 which fund the direct operational costs of providing health services.

Compensation of employees accounts for R8.478 billion or 58% of the total budget. The

department has allocated approximately 31 % or R4.456 billion to the procurement of goods and services, which amounts to approximately 55% of the goods and services procured by the Western Cape Government. “

“Programme Three: Emergency Medical Services

Emergency Medical Services, which is responsible for the provision of emergency medical transport including inter-hospital transfers and planned patient transport, is allocated R701 million or 4.8% of the vote.

An amount of R15 million has been allocated provisionally for the Information Communication Technology system. This new computer-aided dispatch system, required to

replace the existing system, will provide both the communication centre solution and the vehicle-based solution. It is anticipated that the system, once implemented, will improve the efficiency of the ambulance dispatch process and will also provide real-time information. “

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“HealthNet is a transport service for our patients and the only-of-its-kind in the country. We

have a fleet of 78 HealthNet vehicles, adapted for ill patients, which transport approximately 4000 patients from rural areas across the province to central hospitals per month. The service employs 95 personnel and performs outpatient transfers between levels of care.

This transport infrastructure also transfers patients from primary healthcare facilities to regional and district hospitals. Although the service is often under unfair scrutiny, the new electronic

supply and demand system will certainly improve the booking system, and address the problems of misuse.”

“Programme Four: Provincial Hospital Services

This programme is responsible for the provision of general specialist and specialised hospital services that include tuberculosis, psychiatric, rehabilitation and dental training hospitals.

Central hospitals, which are large functional service delivery structures, are integral to a coherent health care delivery system at provincial level. These hospitals are the health facilities where a majority of health sciences trainees are trained to become health

professionals, and where much of the health professional service skills, health research and knowledge capital resides.

The Western Cape is the only province that over a number of years attempted to define and manage general and highly specialist services separately within the central hospitals. The funding of these services was distributed accordingly to separate budgetary programs however after

concluding that with the current information and management systems that this was not possible the department has reverted to funding the hospitals as functional entities. This reinforces the argument that to attempt to manage and fund these hospitals divorced from the health system

within which they function is not viable.”

“Programme Five: Central Hospital Services

The central hospitals, Groote Schuur Hospital, Tygerberg Hospital and Red Cross Children's Hospital, provide highly specialised healthcare services and a platform for research and

training of health workers by the universities. All three hospitals provide highly specialised services as national referral centres.

Central hospitals are allocated R4.212 billion or 28.8% of the vote in 2012/2013, which amounts to a nominal increase of R240.029 million or 6%.

The total National Tertiary Services Grant of R2.182 billion, R270 million of the Health Professions Training and Development Grant and R3 million of the National Health Insurance Grant constitute approximately 58% of the funding allocated to this programme. The balance of R1.757 billion

allocated to the programme is derived from the provincial equitable share, which clearly illustrates the extent of the underfunding of highly specialised services by the national conditional grants. Personnel costs are especially high in these hospitals constituting approximately 69% of the expenditure of this programme.

The central hospitals will manage approximately 140 395 patient admissions in 2 545 beds and 1 123 389 patient day equivalents at a cost of R3 244 per patient day equivalent.”

“The provincial equitable share funding has been allocated as follows:

R47 million for the purpose of maintaining current infrastructure.

R11 million for preventive maintenance.

R180 million for the purpose of maintenance and capital expenditure.

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R12 million for Red Cross War Memorial Children's Hospital.”

“Although the Western Cape does not support the National Health Insurance green paper

in its current format, it does not mean that the province will not participate in the NHI pilot projects.

As an alternative solution, Western Cape Government proposes Universal Healthcare, built on a primary healthcare basis, similar to the structures implemented in the Western Cape at present, where patients are referred to regional and specialised facilities according to their medical needs, and government providing the transport infrastructure. The rest is governance-based on

good business principles - financial discipline, efficiency, equality, modernisation, monitoring and evaluation.

The lesson we have learned in the Western Cape is that we can improve healthcare for everyone by strengthening the positive elements of the public sector and removing its deficiencies on a planned and sustained basis. “

“In the efforts to increase wellness by working together we can all be better together! If all those who work in the department work effectively and efficiently and make the best use

of the available funds to provide the best service, we can be better together!”

“Improving the health status and well-being of the people of the Western Cape can only be

achieved through partnerships, put differently by working better together we can all live a better life!

Thank you!”

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ANNEXURE D: WESTERN CAPE GOVERNMENT HEALTH. ANNUAL PERFORMANCE PLAN.

2012/13. EXCERPT SUMMARISING STRATEGIC OBJECTIVE FOUR [4]

“The draft strategy for 2020 has two main thrusts, as described in the Strategic Objective: Improving Wellness (SO 4) that forms part of provincial strategic plan.

Firstly, at the heart of the vision of 2020 is a renewed commitment to a caring, quality, patient-centric health service. The district health service, supported by all levels and sections of the service is the key vehicle to deliver this quality health service. The PHC philosophy implies a

comprehensive health service across levels of care and the various sectors allowing for meaningful and active participation by communities.

The limited resource base compared to the need for health services demands a more focused approach to improve health outcomes in the most efficient and productive manner possible. The Department acknowledges that addressing these challenges requires

strong partnerships with a range of role players. Secondly, there is an important conceptual shift from managing the consequences of the burden

of disease to improving wellness. Central to this approach is an increased emphasis on prevention and promotion by addressing the upstream risk factors that impact on health and wellness in the whole of society. The endorsement at the Western Cape Health Summit held in November 2011 of

the Cape Town Declaration on Wellness by approximately 250 delegates from all sectors of society in the Western Cape was an important milestone in this regard. There are six focus areas that have been identified and work is underway to identify, plan and implement projects in these

areas.”

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ANNEXURE E: FINANCE INSTRUCTION G22/2009

CLASSIFICATION OF LEASE AGREEMENTS IN THE STANDARD CHART OF ACCOUNTS AS WELL AS THE REPORTING ON LEASE COMMITMENTS AT THE END OF EACH FINANCIAL YEAR 1. The contents of this Finance Instruction must be brought to the attention of all

officials concerned. 2. Finance Instruction G19/2009 dated 10 March 2009 is applicable to the 2008/2009

financial year only and is repealed as from 1 April 2009. However Finance Instruction G22/2009 must be read in conjunction with Finance

Instruction G19/2006 dated 13 April 2006. 3. PURPOSE 3.1 The purpose of this Finance Instruction is to provide guidance to all financial staff on

the economic classification of lease payments in the budget and in BAS using the new SCOA accounts and segments. In addition the circular clarifies the link between the economic classification and the disclosure requirements in the Annual Financial Statements and also introduces the differentiation between Operational and Financial Leases.

4. DEFINITION OF LEASE COMMITMENTS

4.1 Lease commitments represent amounts owing from the reporting date to the end

of the lease contract.

4.2 A lease is a contract that gives the lessee (the renter) the right to use an asset for

an agreed period of time in return for a payment or series of payments.

4.3 A finance lease is a lease that transfers substantially all risks and rewards incidental

to ownership of an asset. Title may or may not eventually be transferred

4.4 An operating lease is a lease other than a finance lease.

4.5 Economic life is the period over which an asset is expected to yield economic

benefits or service potential to one or more users.

4.6 Useful life is the estimated remaining period, from the beginning of the lease term,

without limitation by the lease term, over which the economic benefits or service

potential embodied in the asset are expected to be consumed by the entity

4.7 The definition of a lease includes contracts for the hire of an asset, which contain a

provision giving the option to acquire title upon the fulfillment of agreed conditions.

These contracts are sometimes known as hire purchase contracts.

4.8 It is common practice for contracts to be termed rental agreements. This therefore

does not mean that this is excluded from being a lease. One still needs to go

through the conditions of the contract to determine whether it is a finance lease or

an operating lease.

4.9 It is important to note that the payment of a lump sum amount (rather than regular

periodic payment such as monthly payments) does not preclude lease accounting

as such arrangements may still meet the definition of a lease.

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5. DETERMINATION OF A FINANCE LEASE VS. OPERATING LEASE

5.1 FINANCE LEASE

Lease that transfers substantially all the risks and rewards of ownership

5.2 OPERATING LEASE

Lease that does not transfer substantially all the risks and rewards of ownership

6. CLASSIFICATION OF LEASES

6.1 The classification of leases is based on the extent to which risks and rewards

incidental to ownership of a leased asset lie with the lessor or the lessee rather than

on which party has legal ownership over the asset.

6.2 Risks include the possibilities of losses from idle capacity, technological

obsolescence or changes in value due to changing economic conditions. Rewards

may be represented by the expectation of service potential or profitable operation

over the asset’s economic life and of gain from appreciation in value or realisation

of a residual value

6.3 Although the following are examples of situations, which would normally lead to a

lease being classified as a finance lease, a lease does not need to meet all these

criteria in order to be classified as a finance lease:

The lease transfers ownership of the asset to the lessee by the end of the lease

term;

The lessee has the option to purchase the asset at a price which is expected to

be sufficiently lower than the fair value at the date the option becomes

exercisable, so that at the inception of the lease it is reasonably certain that the

option will be exercised;

The lease term is for the major part of the economic life of the asset even if title

is not transferred;

At the inception of the lease the present value of the minimum lease payments

amounts to at least 90% of the fair value of the asset.

Lessor

Treat as a sale

Lessee

Treat as a purchase

Right to use the

asset

Lessor

Lessee

Asset

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The leased assets are of a specialised nature such that only the institution can

use the assets without modifications being made;

The lessor’s losses associated with cancellation of the lease by the lessee is

borne by the lessee; or

The leased assets cannot easily be replaced by another asset.

6.4 Transactions and other events are accounted for and presented in accordance

with their substance and financial reality and not merely with legal form. While the

legal form of a lease agreement is that the lessee may acquire no legal title to the

leased asset, in the case of finance lease the substance and financial reality are

that the lessee acquires the economic benefits or service potential of the use of the

leased asset for the obligation to pay for that right an amount approximating to the

fair value of the asset and the related finance charge.

6.5 Sometimes the terms of a lease is such that the lessee is substantially in the same

economic position as if the lessee had borrowed money to buy the asset (even

though legal title may not pass to the lessee). For example, this may be the case if

the lease payments effectively are paying for the whole asset or if the lease term is

such that the lessee can use the asset for the major part of its economic life.

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7. CLASSIFICATION OF A LEASE AGREEMENT

8. ACCOUNTING POLICY

8.1 Operating and finance lease commitments are expensed when the payments are

made.

Assets acquired in terms of finance lease agreements are disclosed in the

annexures and disclosure notes to the Financial Statements.

8.2 The classification of the lease (i.e. operating or finance lease) must be made at the

inception of the lease agreement and accounted for as follows:

Ownership transferred at end of lease? Yes

Bargain purchase option?

Lease term = major part of economic life?

Present value of minimum lease payment >

fair value of asset?

OPERATING LEASE

No

Yes

No

Yes

No

Yes

No

FINANCE LEASE

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Item Segment Asset Segment Project segment

Operating lease

OPERATING LEASE LEASES: PHOTOSTAT MACHINES

LEASES: FAX MACHINES

NO PROJECTS (STAND ALONE

ITEM) CUR

Finance lease

FINANCE LEASE

(Capital portion of

instalments)

LEASES: CELLPHONES

LEASES: TELEPHONE SWITCHES

LEASES: MEDICAL EQUIPMENT

LEASES: NON-MEDICAL EQUIPMENT

NO PROJECTS (STAND ALONE

ITEM) CAP

Interest on leases

INTEREST ON LEASES

(interest portion of

instalment

LEASES: CELLPHONES

LEASES: TELEPHONE SWITCHES

LEASES: MEDICAL EQUIPMENT

LEASES: NON-MEDICAL EQUIPMENT

NO PROJECTS (STAND ALONE

ITEM) CUR

8.3 Unfortunately the PFMA prohibits borrowing by National/Provincial Departments

and the Treasury Regulations makes it clear that finance leases are deemed to be

borrowings and are therefore not permitted.

8.4 Although departments are not permitted to enter into/have finance leases, all

finance leases that they do have should be disclosed as finance leases. It will

however mean that the department will not be complying with the Treasury

Regulations (TR 13). Finance leases may not (incorrectly) be disclosed as operating

leases even when the lease is condoned by National Treasury.

8.5 Practice Note 5 of 2007/08 issued by the Office of the Accountant General seeks to

provide the following circumstances where departments may enter into finance

leases without additional approval required:

8.5.1 Finance leases where:

A Finance lease is more economical than an operating lease; and

The period of the finance lease does not exceed 60 months in respect of motor

vehicles and 36 months for equipment except with written approval by the

relevant Treasury; and

The finance lease was entered into in terms of RT3 of 2006 or a transversal

contract entered into by National Treasury

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8.5.2 Blanket approval for any irregular expenditure incurred as a result of RT3 of 2000

and RT3 of 2003 Transversal contracts entered with various suppliers for the supply,

delivery, installation, commissioning and maintenance of office equipment and

labour saving devices has been given

9. PROCEDURES TO BE FOLLOWED BY DIRECTORATES/DISTRICTS AND INSTITUTIONS WITH

REGARD TO THE CLASSIFICATION AND ACCOUNTING OF LEASES

9.1 MAINTENANCE OF SEPARATE LEASE REGISTERS FOR FINANCE AND OPERATING LEASES

AND THE CLASSIFICATION OF LEASES:

9.1.1. Directorates/Districts and Institutions must ensure that all leases concluded be

identified and classified.

9.1.2. The following serves as examples of Operating and Finance Leases determined

from lease agreements currently in place.

Finance Leases Operating Leases

Cell phone contracts where the

department holds the contract

Photostat machines

Telephone Switchboard Agreements Fax machines

Equipment Lease Agreements

These agreements are sometimes

known as hire purchase agreements

where it was clear from the outset

that the asset will remain with the

department for most of its economic

life and the only reason why it was

not outright purchased was because

it was deemed more economical

and affordable to pay the purchase

price over a fixed period.

Also in cases where assets are almost

permanently placed with

Departments with the written

arrangement that Departments will

buy dedicated consumables to be

used on the equipment. If there is a

fixed portion paid for the availability

of the equipment and even possibly

a fixed amount for consumables per

month, the fixed amount for the asset

will be the lease and that for the

consumables will be a normal

commitment while the variable

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amount for the consumables at a unit

price will be normal expenditure. If

there is no charge for the asset being

placed on the premises there is no

lease.

It must be noted that the terms of the agreement will dictate whether an Operating

or Finance Lease has been concluded. If in doubt kindly approach the SCM Unit

at Head Office for assistance.

9.1.3 Leases concluded must be entered into a Lease Register. Separate Lease registers

must be maintained for Operational and Finance Leases. Each Lease register must

contain the minimum requirements as per paragraph 6 of Treasury Circular 5/ 2006

dated 10 March 2006 distributed under cover of Finance Instruction G19/ 2006

dated 13 April 2006.

9.1.4 Information on leases concluded and copies of the Lease Agreements must be

forwarded to SCM: Section Contract Management, 4 Dorp Street, Cape Town on a

monthly basis. An indication must also be given of the classification of the lease for

audit purposes.

9.1.5 The Section: Contract Management will also maintain a Lease Register and will

ensure that the Register maintained at Head Office agrees with the Lease Register

maintained by the Directorate/District/Institution.

9.1.6 The rental of gas cylinders via National Contract RT 81 should not be considered

as leases as the rental is payable annually in advance. If any other gases or

containers are rented or leased on a basis where it is payable on a fixed monthly/

quarterly/ six-monthly basis, these arrangements should be measured against the

criteria for leases.

9.2 ACCOUNTING OF LEASES

9.2.1 Leases must be accounted according to the new SCOA effective from 1 April

2008.

9.2.1.1 All Operating Leases must be paid as follows:

Item Segment

Operating Leases

Asset Segment

Leases: Photostat Machines

Leases: Fax Machines

Project Segment

No projects (stand-alone) current

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9.2.1.2 All Finance Leases to be paid as follows:

Item Segment

Financial Leases

Asset Segment

Leases: Cellphones

Leases: Telephone Switches

Leases: Medical Equipment

Leases: Non-Medical Equipment

Project Segment

No projects (stand-alone) capital

9.2.1.3 All interest payments on finance leases must be paid as follows:

Item Segment

Interest Paid: Finance Leases

Asset Segment

Leases: Cellphones

Leases: Telephone Switches

Leases: Medical Equipment

Leases: Non-Medical Equipment

Project Segment

No projects (stand-alone) current

9.2.2 At the end of the financial year i.e. from 1 – 15 April of each year the Section:

Contract Management will obtain the relevant information on the Finance Lease

payments made. A Journal where the interest portion will be shifted from capital

to interest will be drawn by Head Office before 31 April of each year.

Your co-operation is appreciated.

MR JM JOOSTE

pp HEAD: HEALTH

DATE: 27 March 2009 Jooste/Fin InstructionG22/2009

Classification of lease agreements in the SCOA/March 2009

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Western Cape - Dept of Health

Capex Budget 2011 - 2016

Annual increase 5 %

2011/2012 2012/2013 2013/2014 2014/2015 2015/2016 2016/2017 2017/2018 2018/2019 2019/2020 2020/2021

0 0 0 0 0 0 0 0 0 0

1. Allocation for low-value equipment and other assets 100 000 000 105 000 000 110 250 000 115 762 500 121 550 625 127 628 156 134 009 564 140 710 042 147 745 544 155 132 822

2. Allocation for big-ticket assets * 100 000 000 105 000 000 110 250 000 115 762 500 121 550 625 127 628 156 134 009 564 140 710 042 147 745 544 155 132 822

Budgeted Expenditure 200 000 000 210 000 000 220 500 000 231 525 000 243 101 250 255 256 313 268 019 128 281 420 085 295 491 089 310 265 643

Possible # Possible # Possible # Possible # Possible # Possible #

of units of units of units of units of units of units

* 6 units at 5 000 000 = 30 000 000 6 0 0 7 0 0

3 10 000 000 = 30 000 000 3 0 0 2 0 0

1 15 000 000 = 15 000 000 1 0 0 2 0 0

75 000 000

75 000 000 0 0 85 000 000 0 0

2011/2012 2012/2013 2013/2014 2014/2015 2015/2016 2016/2017 2017/2018 2018/2019 2019/2020 2020/2021

Cash Flows

Annual Budget Per Year 100 000 000 105 000 000 110 250 000 115 762 500 121 550 625 127 628 156 134 009 564 140 710 042 147 745 544 155 132 822

Cumulative 100 000 000 205 000 000 315 250 000 431 012 500 552 563 125 680 191 281 814 200 845 954 910 888 1 102 656 432 1 257 789 254

Rental Cash Flows Per Year (17 601 918) (17 601 918) (17 601 918) (37 978 339) (37 978 339) (27 604 078) (27 604 078) (20 376 421) (8 366 917) (8 366 917)

Cumulative (17 601 918) (35 203 837) (52 805 755) (90 784 094) (128 762 433) (156 366 511) (183 970 590) (204 347 010) (212 713 927) (221 080 844)

Cash Differential Per Year 82 398 082 87 398 082 92 648 082 77 784 161 83 572 286 100 024 078 106 405 486 120 333 622 139 378 627 146 765 905

Cumulative 82 398 082 169 796 163 262 444 245 340 228 406 423 800 692 523 824 770 630 230 256 750 563 877 889 942 505 1 036 708 409

less: (assets not rented) (25 000 000) (26 250 000) (27 562 500) (28 940 625) (30 387 656) (31 907 039) (33 502 391) (35 177 511) (36 936 386) (38 783 205)

0.25

Available Cash: Per Year 57 398 082 61 148 082 65 085 582 48 843 536 53 184 630 68 117 039 72 903 095 85 156 111 102 442 241 107 982 699

Cumulative 57 398 082 118 546 163 183 631 745 232 475 281 285 659 910 353 776 949 426 680 044 511 836 155 614 278 397 722 261 096

Accelerated equipment purchases: 2011/2012

13

4 units at 5 000 000 = 20 000 000

P

2 units at 10 000 000 = 20 000 000

A

1 units at 15 000 000 = 15 000 000 55 000 000

GE

Accelerated equipment purchases: 2014/2015

5 units at 5 000 000 = 25 000 000

1 units at 10 000 000 = 10 000 000

1 units at 15 000 000 = 15 000 000 50 000 000

ANNEXURE F: TABLE 1: OPERATING LEASING BENCHMARK SCENARIO MODEL

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