‘Formulaic’ liquidity calculation risks future sector investment

The introduction of the new Aged Care Financial and Prudential Standards aims to enhance financial governance and sustainability for providers. However, the shift to a formulaic calculation for liquidity requirements may have unintended consequences, particularly in restricting investment and sector expansion.

Key points

• The new Financial and Prudential Standards will take effect from July 1, 2025, as part of the new Aged Care Act, replacing existing legislation
• The new Standards simplify the current framework by replacing four Standards (Liquidity, Governance, Records and Disclosure) with three updated, focused Standards – Financial and Prudential Management, Liquidity and Investment
• A minimum liquidity amount will be introduced with residential aged care service providers required to keep 35% of cash expenses + 10% of refundable deposit liabilities at all times

Complexity beyond formulaic simplicity

The incoming enforceable minimum liquidity amount, which is tailored to all residential aged care providers, has a standardised calculation that brings consistency and clarity, yet the aged care sector’s financial landscape is inherently complex. 

The new Standards propose a one-size-fits-all liquidity formula based on Quarterly Financial Reports (QFRs), shifting away from the current Annual Prudential Compliance Statement (APCS) methodology, where providers assess their unique financial circumstances.

The minimum liquidity amount is calculated as follows: 35% of cash expenses (all providers) + 10% of refundable deposit liabilities (only providers with refundable deposits). The Commission provides a more detailed breakdown of those calculations here. 

The enforceable minimum liquidity amount aims to manage two risks:

• That a residential provider cannot refund refundable deposits when they’re due, potentially due to several resident exits in the same month
• A residential provider isn’t able to manage periods of financial stress resulting from a shortfall in their expected cash inflows, or an unexpected increase in their cash outflows

This change could force providers into holding excess liquidity, limiting the funds available for capital development, refurbishment, and innovation. 

According to financial analysis by chartered accountancy firm StewartBrown in their submission responding to the Financial and Prudential Standards, the proposed methodology increases required liquidity from an average 24% of liquid assets to 58%. 

For larger providers – who are key to accommodation expansion – this requirement skyrockets from 25% to 77%, significantly constraining investment capacity. Their submission calls this an ‘extreme adjustment’ despite the positives surrounding it. 

“The implied benefit of this approach is that it will provide more clarity and consistency of calculation and enable the Quality Commission to monitor the liquidity of providers on a quarterly basis and engage with providers who do not meet the minimum level of liquidity to assess the circumstances and possible remedy,” the submission stated.

“StewartBrown agrees with the implied benefit in having a consistent methodology in calculating the minimum level of liquidity required based on operating cash flows and refundable loans. Consideration of other factors, including current capital developments, future liquidity requirements, related entity support, secured lines of credit and equity (net asset) strength of the provider need to also be considered in any risk management framework matrix.

“Whilst an attractive option for clarity, a “one size fits all” approach also will have inherent complexity… The Quality Commission proposed liquidity calculation settings is likely to increase cost of capital for providers, discourage the proposed and essential planned capex for new construction in both residential aged care and retirement living at a time when this investment in new builds and renewal of existing building stock is essential.”

Impact on investment and sector growth 

Aged care is in urgent need of expansion, with demand projected to reach 250,000 places by 2030 and 360,000 by 2040. 

However, financial modelling suggests that current liquidity reserves already exceed necessary thresholds due to years of cautious financial management. 

StewartBrown’s data shows that the current average minimum liquidity percentage as calculated by each provider represents 24% of liquid assets (cash and cash equivalents plus financial assets). As highlighted earlier, the proposed minimum liquidity percentage would represent 58% of liquid assets. For some larger providers it could be closer to 77%. 

Instead of stimulating sector growth, the new liquidity mandates could inadvertently lead to a prolonged ‘capital strike’, deterring providers from investing in new builds and essential refurbishments.

StewartBrown argues that the proposed settings are overly conservative, particularly given the sector’s unique financial environment where 76% of residential aged care revenue comes from government subsidies. 

Their alternative proposal suggests a more balanced liquidity formula:

• 25% of quarterly cash expenses (down from 35%)
• 5% of refundable accommodation deposits (down from 10%)
• 2% of independent living unit (ILU) liabilities (down from 10%)

Additionally, they propose that providers who do not meet the prescribed liquidity levels be allowed to submit an alternate liquidity management strategy, incorporating factors such as net asset strength, available credit lines, and forecasted capital expenditure.

This approach is better placed to reward providers as they have shown restraint by maintaining liquid assets at the expense of development, and that there is no need to quarantine cash at a greater level than required. 

“Reforms implemented based on the Aged Care Taskforce recommendations will mean that in the future a lower amount of RAD will be refunded compared to that collected (2% pa retention each year over 5 years) and financial viability of providers, including increased revenue streams, will be improved and the sector more financially sustainable,” the submission added.

“The fact that the sector lost a cumulative $5 billion over a period of 4 – 5 years and there was little or no call on the government to refund RADs is testament to the fact that the sector can withstand financial stress, and current arrangements may be assumed to therefore be adequate.

“StewartBrown considers that meeting the proposed calculated liquidity amount and then having to maintain the calculated liquid assets have entirely different consequences. To this extent, the proposed minimum liquidity amount, in our opinion, will significantly inhibit the use of excess liquidity for essential capital investment (including acquisition) purposes and investment in innovation and technology.”

A rigid, formula-driven liquidity model could lead to unintended stagnation, limiting the very investments needed to expand and improve aged care services. A more flexible approach, integrating financial realities and sector-specific risk mitigation strategies, is essential to ensure both financial prudence and sustainable growth.