Case Study: Financial Transformation and Management of a Residential Block

Published on August 24, 2024

Client: Shareholders and Directors of a Residential Block Management Company

Background

In the UK, residents of apartment blocks often hold a leasehold and a share in the freehold. Upon the sale of the final apartment, the lease typically requires the formation of a residential block management company to oversee the block’s financial affairs. Directors, elected from the shareholders, become responsible for issuing service charges, managing annual maintenance expenditure, and maintaining a reserve fund for major works.

However, many leaseholder directors lack the financial expertise to implement transparent financial reporting and controls. Directors have legal obligations under the UK Companies Act to prepare accurate accounts and safeguard company assets. Block management responsibilities often include budgeting, reporting on service charges, and ensuring compliance with lease terms.

To cope with the complexities, directors frequently outsource block management to external agents. Unfortunately, this sector is thinly regulated, and service quality varies significantly. Financial opacity often emerges as a critical issue, exacerbated by conflicts of interest when block managers appoint their preferred accountants. These accountants, while ostensibly working for shareholders, may prioritise the interests of the block managers.

Shareholders have the legal right to manage the financial affairs of their own residentail block management company and are under no legal obligation to hire external block managers. There are serious conflicts of interest that shareholders should be aware of before hiring block managers. The main risk is block managers who often wuote low fees to win clients, then subsequently find reasons to raise the service charge not only to cover their fees but also to meet the cost of block management. Particularly contentious are costs to cover block insurance and mainenance as well as the power to issue section 20 notices for almost any reason at all,. forcing leaseholders to pay for expenses that they have little say over. The law does a poor job in protecting leaseholders against rogue block managers who can manufacture costs. In practice this means they issue bills over an above the annual service charge to meet the costs of planned major works. Problems arise when not all leaseholders pay these demands on time. This can mean block managers sit on funds for many years before getting around to actually spending the monies accumulated on the planned major works. It also means issuing additional bills to meet increased contractor quotes due to delays in executing major works projects in the first place. The law states that block managers should not unneccesarily delay major works, but in practice this does happen. Many larger estate agents will have their client monies accounts audited, as part of their obligations to have statutory audits. However many smaller operators do not. So in practice there is no oversight or trnaparency into these client money accounts. They simply appear as debtors on residential company statutory accounts when filed at companies house. In the case of Micro Accounts a short format favoured by many block managers, this provides little or no insight into the quality of the debtor, and client money. Due to the lack of disclosure requirements in micro company accounts shareholders cannot readily distinguish between service charge debtor balances and paid up service charge cash or client money balances which would have appeared as cash balances in the companies bank account before it was closed down. This often means shareholders have zero insight into the cash available to meet creditors as they fall due.

Case Study1 - The insolvent block manager

Our client was facing disaster when they discovered that their block manager was operating whilst insolvent. The block manager was facing closure but carried on collecting client money without notifying the shareholders of their situation. We were asked to look into their financial position and discoverd that they had been operating under a creditors wind up arrangement and in all likelyhood would not be in a position to pay for the planned forthcoming major works without asking for new monies. The block manager which faced serious financial issues was the fourth managing agent and had failed to provide transparent communication due to poor management of the blocks accounts. The accounts were incomplete and minimized into Micro Accounts—a format that lacked the crucial financial details the directors should have used to manage expenditure, cash flow and liquidity. Micro accounts provided no profit and loss report, no cash flow statement, and no disclosure notes. The Micro Accounts included a four line summarised balance sheet, which showed movement on reserves but no explanation or reconciliation of the movement in shareholders funds. Such opaque accounting undermined trust in the block manager due to a lack of financial transparency.

Shareholders, who have a legal right to full accounts, were left in the dark about the true financial state of their building. The block management company had closed the official residential management company bank account and opened a so-called client monies account. Unfortunately, this meant the directors, unwittingly, gave control of the funds to a rogue block manager and agent. As a result, the directors no longer had bank mandate powers to sign cheques or even access the cash being collected from shareholders paying service charges. Without transparency, the directors were left in the dark and unable to execute their statutory legal obligations to shareholders.

The service charges had been increasing seemingly out of control, more than doubling in four years. In addition, major works that were previously covered by the service charge were now being billed separately, which violated the lease mandate. This arrangement left no provision for future planned major works, which should have been included in the annual service charge.

To make matters worse, the major works billed through section 20 notices were never completed as scheduled. Instead, the managing agent sat on shareholders' money for up to three years, using the funds for spurious projects like unnecessary demolitions and scaffold erections, further eroding trust. Upon further investigation, Bigham Consulting discovered that the managing agent was insolvent and undergoing a creditors' winding-up arrangement, a fact that had been concealed from the directors.

The Challenge

Bigham Consulting was engaged to step in and address the following key challenges:

• Rebuild Transparency and Financial Control: Recover and reconstruct the financial records to provide complete transparency for shareholders, including a full set of accounts—profit and loss, balance sheet, cash flow, and disclosure notes.
• Develop a Comprehensive Financial Reporting System: Create a system for ongoing financial oversight, budgeting, and forecasting, while also producing statutory accounts for audit and statutory filings.
• Online Accessibility for Shareholders and Block Management: Facilitate a transition to a digital platform for shareholders and management, enhancing access to service charge statements and financial data.

Approach

1. Reconstruction of Full Financial Accounts

We started by recovering the financial data from the previous managing agent and rebuilding the ledgers. This included a complete reconciliation of the service charge accounts, creditors' ledger, and cash position. Our objective was to not only provide transparency but also create a financial reporting structure that would allow the directors to regain control.

The financial system we implemented produced full accounts, including:

• Profit and Loss Account: Offering a clear view of the block’s income and expenses.
• Balance Sheet: Summarizing the block’s financial position at a given point in time.
• Cash Flow Statement: Disclosing the movement of cash in and out of the block’s accounts.
• Disclosure Notes: Providing additional clarity and legal transparency on significant financial matters.

2. Financial Services Framework

We established a structured approach to the block’s financial management, dividing it into three main services:

• Budgeting (Start-of-Year Service): We designed a detailed annual budget model. Block budgets were prepared at the beginning of each financial year. Service charge billing was based on the budget, as directed by the shareholders' lease. The budget included a full income and expenditure account, a budgeted balance sheet, a cash flow statement, and detailed disclosure notes, all mapped to the management accounts for variance analysis and board-level reporting.
• Quarterly Management Accounts (Periodic Service): A system for quarterly management accounts was implemented. These reports included a full set of accounts, along with a six-year historical comparison for trend analysis. They provided ongoing visibility into the financial performance of the block, with regular updates on service charge collections, expenditures, and cash flows.
• Statutory Accounts (End-of-Year Service): At the end of each financial year, we prepared draft statutory accounts ready for audit and statutory filings, ensuring compliance with all legal and financial reporting requirements.

3. Implementation of a Digital Portal for Shareholders and Management

Online Management - Client Statements and Credit Control

To improve communication and accessibility, we designed and hosted a block website. This website included a shareholder portal, where members could log in to view their individual service charge statements and access important financial data. The portal employed anonymized data models with secure encrypted login systems using PHP server-side scripting for added security.

We also provided special administrator access to the new block manager, responsible for issuing service charge bills based on reconciled ledger data. Additionally, the portal allowed directors to respond to legal queries from solicitors during property sales by accessing up-to-date financial records.

Results and Impact

• Full Financial Transparency: Shareholders now had access to complete financial statements, including profit and loss accounts, balance sheets, and disclosure notes.
• Full Financial Transparency: Shareholders now had access to complete financial statements, including profit and loss accounts, balance sheets, and disclosure notes.
• Efficient Financial Reporting: The board pack provided a comprehensive view of the block’s financial performance, from budgeting to quarterly management accounts and statutory filings.
• Digital Access and Reporting: The web-based system allowed shareholders and the block manager to view and manage financial data in real-time.

Conclusion

Through diligent financial restructuring, transparent reporting, and digital transformation, Bigham Consulting successfully helped the residential block management company regain control of its finances. By shifting from Micro Accounts to full statutory accounts, implementing a robust financial reporting framework, and creating an accessible online platform, we restored trust among shareholders and established a sustainable system for the block’s financial management.

This case demonstrates how Bigham Consulting’s Fractional CFO services can provide critical financial leadership, especially during times of transition, from detailed budgeting and financial reporting to compliance with statutory requirements, while leveraging technology to improve transparency and efficiency.

When Interim Finance Leadership is Required

• Temporary senior staff shortage, such as the sudden departure of a CFO.
• Sudden loss of liquidity, requiring experienced leadership to navigate the turbulence and help your organization better manage cash flow.
• Raising capital or bank funding, and the need to prepare a detailed financial model suitable for presenting to bankers.

A Fractional CFO is more than just a cost-saving measure; they are a strategic partner who can help steer your business towards financial success. Whether you're a startup looking to establish a solid financial foundation, a growing company needing expert advice, or an established business facing new challenges, a Fractional CFO can provide the expertise and leadership you need, without the long-term commitment of a full-time executive.

If you're interested in learning more about how a Fractional CFO can benefit your business, contact Bigham Consulting today. Our experienced financial professionals are here to help you achieve your goals.