Standing Committee of AG31 October 2007, Cape Town

Budget 2008/09

Executive summary

Acting CFO: S Boyd

Page 2

Content

1. Purpose

2. Income statements and balance sheets 2007 to 2011

3. Audit income

4. Overheads

5. Capital expenditure

6. Funding

7. Way forward

Page 3

1. Purpose

• This is an executive summary presentation of the budget component of the AG strategic plan and budget for 2008/09.

• To obtain SCoAG support for the AG budget for 2008/09.

• As highlighted in the AG Strategic Plan and Budget 2009-11 the on-going funding challenge requires completion of research and analysis into an appropriate way forward for the AG and the government.

• To obtain SCoAG support through appropriate resolutions for specific issues and risks including arrear debtors, tariff increases and on-going funding.

• To understand any SCoAG concerns or requirements and action appropriately within the AG.

Page 4

2. Income statements and balance sheets 2007 to 2011 (1 of 2)INCOME STATEMENTS

Actual Forecast Budget Budget Budget31 March 2007 31 March 2008 31 March 2009 31 March 2010 31 March 2011

Rm Rm Rm Rm Rm

AUDIT INCOME 893.7 1,072.4 1,292.6 1,464.4 1,606.8 Own hours 559.6 657.9 857.1 1,012.4 1,151.2 S&T recoverable 34.2 53.8 67.2 72.6 77.7 Contract work 299.9 360.6 368.3 379.4 378.0

DIRECT AUDIT EXPENDITURE 657.2 782.2 899.6 992.2 1,061.4 Personnel 323.2 367.7 463.8 540.2 605.7 S&T recoverable 32.8 53.8 67.6 72.6 77.7 Contract work 301.2 360.6 368.3 379.4 378.0 CW % of audit income excl S&T 35% 35% 30% 27% 25%

Gross income 236.6 290.2 393.0 472.1 545.4 Own hrs gross profit 236 290 393 472 545

Gross margin % of audit income 26% 27% 30% 32% 34%

Other income 13.4 12.9 9.3 10.0 10.1

Gross profit plus other income 250.0 303.0 402.3 482.2 555.6

Overhead expenses 231.1 297.3 364.9 428.1 501.0

Overhead as % of audit income 26% 28% 28% 29% 31%

Depreciation 20.7 22.2 29.0 32.7 39.2

Net surplus / (deficit) (1.8) (16.5) 8.4 21.3 15.3

Net surplus as % of audit income 0% -2% 1% 1% 1%

• FC 07/08: Skills shortage continues to hamper financial results for 2007/08. Write-offs provision of R2m & doubtful debts provision increased by R8 m. Cost reduction actions of R15m in place.

• B 08/09:Major focus on recruitment and setup of new audit business units to achieve 2008/09.

• B 08/09: Overheads normalising below 30% in 2009 . Pre-liminary results from benchmarking shows within middle of the range.

• B 08/09: 1% surplus (vs 3%) due to mainly BE, SM and general 4% per annum cap.

• B 10-11: On-going focus to reduce contract work towards 20% in 2010 and 2011

Page 5

2. Income statements and balance sheets 2007 to 2011 (2 of 2)BALANCE SHEETS

• Balance sheet growth driven by audit income and staff growth as well as inherent business model. Special Audit Services Fund increase request assessed however overall funding requires resolution first.

Actual Forecast Budget Budget Budget31 March 2007 31 March 2008 31 March 2009 31 March 2010 31 March 2011

Rm Rm Rm Rm RmCapital employedCapital 133.3 116.8 125.1 146.4 161.8

- Reserves 129.8 128.0 111.5 119.8 141.2 - Special Audit Services Fund 5.3 5.3 5.3 5.3 5.3 - Net income for the year -1.8 -16.5 8.4 21.3 15.3

Long-term liabilities 75.5 81.8 88.1 99.4 111.0

Interest bearing borrowings 13.9 12.0 7.9 8.0 7.6 Medical Aid Liability 61.6 69.9 80.2 91.4 103.4

Current liabilities 157.2 136.6 157.6 179.8 200.7

Trade and other payables 124.2 100.2 116.3 136.1 150.8 Leave liability 22.5 26.2 31.6 37.9 44.9 Current portion of long-term loan 10.5 10.1 9.6 5.8 5.0

365.9 335.1 370.8 425.6 473.5

Employment of capitalFixed assets 49.4 56.3 74.8 104.0 130.5

Cash investment 94.4 98.2 120.7 143.7 167.8

Current assets 222.1 180.7 175.3 178.0 175.2

Trade and other debtors 177.9 196.4 193.4 194.6 181.7 Bank and cash 44.2 -15.7 -18.1 -16.6 -6.5

365.9 335.1 370.8 425.6 473.5

Page 6

3. Audit income (1 of 3)

OWN INCOME 2008/09 VS 2007/08

• Audit income grows 28% versus PY. In terms of Own Hours Income 55% of this increase is due to increased hours and the 45% is due to salary increases of 7% and a general tariff increase of 4%. The increased hours is covered in more detail on the next slide.

• In terms of Contract Work the increase is due to increased AG vacancy rate assumption, increase in hours as a result of similair drivers to own hours, increased pre-issuance activities and use of more senior staff than in prior years. CW tariff negotiations in progress.

Budget Budget30 March 2008 31 March 2009 Movement

Rm Rm RmOwn Hours

Available hours 3,236,499 3,628,800 392,301 12%Recoveability 70.50% 70.29% -0.21% 0%Recoverable hours 2,281,802 2,550,771 268,969 12%Average tariff 307 336 29 9%

Value (R'm) 701 857 156 22%

Contract WorkRecoverable hours 677,956 896,113 218,157 32%Average tariff 370 411 41 11%

Value (R'm) 251 368 118 47%

S&T recoverableValue (R'm) 62 67 5 8%

1,013 1,293 279 28%

Page 7

3. Audit income (2 of 3)

AUDIT HOURS

• Overall main drivers for increased audit hours is driven by expanded existing audit coverage (risks and scope), new audits and performance auditing. The additional 2 working days, reduced span of control, additional audit business units and recruitment focus will provide the capacity.

• Stabilisation of increases due to expanded existing audit coverage not expected until both parties management at CMM level 4.

• Efficiency capability being established. Will include focus on efficiency improvements for 2010 and 2011.

Hours % Rand '000A: Regularity audits Existing audits

Return of work from private firms 37,955 39% 22,128Under budgeting in prior year 25,333 26% 14,769Other 34,631 35% 20,260

97,919 57,157Catch-up work

Due to late submission of financial statements -1,650 89% -962Other -198 11% -117

-1,848 -1,079New audits

SASSA 21,402 47% 12,477SA Rail Commuter Corporation 7,164 16% 4,177Tribal and Trust Fund - North West 3,846 8% 2,242Other 13,220 29% 7,741

45,632 26,636Increase in scope

Auditee requests for additional work 72,955 59% 42,533Increases in risk 30,151 24% 17,578Increased reporting requirements 11,869 10% 5,368Value for money audits 5,584 4% 3,255Other 3,695 3% 3,795

124,254 72,530B: Specialised audits 3,012 1,131

Total 268,969 156,375

*

Page 8

3. Audit income (3 of 3)

AUDIT RATES

• Movement in tariff intervals due to 7% salary increases, planned recruitment at market levels (i.e. high end of tables) and promotions. Overhead factor in the tariff formula at 207% materially consistent with prior year at 206%.

Tariff increase

Movement in tariff

intervalsTotal

changeBUSINESS EXECUTIVES 4.0% 0.0% 4.0%SENIOR MANAGER 4.0% 0.6% 4.6%AUDIT MANAGER 4.0% 6.5% 10.5%AUDITOR 4.0% 2.8% 6.8%TRAINEE 4.0% 3.7% 7.7%

TOTAL 4.0% 5.5% 9.5%

Page 9

4. Overhead

• Increased overheads largely driven by increased audit activity (28% increase Y on Y) and strategic imperatives (e.g. stakeholder reporting, leadership development, audit technical support, improved financial controls and systems, performance incentives, improved technology maintenance and tools and improved capability maturity).

• SAICA research and analysis initiative pre-liminary results show international SAI overhead % of audit income between 25% and 35%. AG 28% slightly below median. SAI’s in benchmark are predominantly developed economies, with mature democracies and minimal investments in transformation.

• New costs in 2008/09 include the performance incentive provision of R9m and once-off costs of R5.3m, mostly for ICT initiatives, and R3.6m for Afrosai conference. Excluding these costs the year on year increase reduces to 16%.

• Increased focus on service quality and efficiencies planned for 2009. Benefits expected to materialise in 2010 and 2011. Efficiency objective will be to maintain capacity and produce more as the audit business grows.

• Detailed analysis provided in notes in Annexure 1 of budget and strategic plan.

R '000Budget 07/08

Budget 08/09 Variance to

Budget %OPERATING COST 299,870 364,920 65,051 22%Staff Remuneration - Support 98,600 120,161 21,561 22%Other Personnel expenditure 23,179 32,482 9,303 40%Contract Work - Irrecoverable 13,052 18,329 5,277 40%Accommodation 32,762 42,322 9,560 29%Liaison 13,569 19,999 6,430 47%Professional Assistance 48,416 53,055 4,639 10%Technological Services 25,480 28,914 3,434 13%Auxillary Services 9,271 13,163 3,892 42%Bad debt provision 848 848 100%Other 35,541 35,646 106 0%

Movement

Page 10

5. Capital expenditure

• R50.1 million planned for 2008/09 versus R39 million for 2007/08. Represents a 29% increase.

• Main drivers include:

• New Gauteng and Brooklyn II premises furniture requirements.

• General under investment in technology during past 3 years. R5m under spend in 2007/08. Technology refresh of out-dated country-wide regional servers.

• Refer to Annexure 1 and note 19 for further details.

Page 11

6. Funding (1 of 3)

FUNDING STATEMENTS 2007 - 2011

• Business going concern funding statement format purpose to motivate retention of actual surplus. Actual deficit 2006/07 and forecast deficit for 2007/08. The AG requires approximately R63 million cash (including capital and interest) in 2007/08 to meet operating expenditure, capital expenditure and reserve requirements.

• Statement does highlight funding deficit issue. Funding model requires re-examination.

Actual Forecast Budget Budget Budget31 March 2007 31 March 2008 31 March 2009 31 March 2010 31 March 2011

Rm Rm Rm Rm RmPart 1Reserves and Staff liabilitiesStaff Liabilities 84.0 96.1 111.8 129.3 148.3 - Post Retirement Medical Aid (PRMA) 61.6 69.9 80.2 91.4 103.4 - Leave Liability 22.5 26.2 31.6 37.9 44.9Office reserves 5.3 20.2 16.9 18.7 20.3 - Special Audit Services Fund 5.3 5.3 5.3 5.3 5.3 - Performance Bonus 0.0 14.9 11.7 13.5 15.0

89.3 116.2 128.8 148.0 168.6Part 2

Working capitalCurrent assets (excluding bank) 177.9 196.4 193.4 194.6 181.7Current liabilities (excluding leave liability) (124.2) (100.2) (116.3) (136.1) (150.8)Net working capital 53.7 96.2 77.1 58.5 30.9

Part 3Capital expenditureInterest bearing borrowing payments 11.9 14.8 17.2 15.8 12.3Fixed assets acquisitions 10.9 21.1 40.2 52.0 56.5Capital requirement of the Office 22.8 35.9 57.4 67.8 68.8

Part 4Prestigious events (INCOSAI) 5.0 5.0 5.0 10.0

Part 5Comparison to available cash reservesCash and cash equivalents 138.6 102.6 102.6 127.1 161.3Office funding requirements (1+2+3+4) 165.9 253.4 268.3 279.4 278.4Surplus/(Deficit) on funding of the Office (27.3) (150.8) (165.7) (152.3) (117.1)

Page 12

• Significant mismatch between timing of inflows and outflows create cash flow problem.

• Current model does not adequately cater for:

working capital requirements

managing contract work

capital expenditure and reserves for known future liabilities.

• If the current model remains, the 8.3% vacancy rate is achieved and debtor patterns remain the same the AG will experience cash shortfall of some R89 million.

Value R '0000 15 30 45 60 75 Gross NPV

Audit Income 0 0 0 0 0 1,293,981 1,293,981 1,241,866 HighInterest 0 0 0 7,944 0 0 7,944 7,729 LowSalaries -651,184 0 0 0 0 0 -651,184 -651,184 Low

Contractors 0 0 0 0 -368,302 0 -368,302 -355,899 LowSundry creditors 0 0 0 -244,759 0 0 -244,759 -238,142 Low

Capital Expenditure 0 0 0 0 -50,141 0 -50,141 -48,452 LowReplenishment of

reserves -20,000 0 0 0 0 0 -20,000 -20,000 n/a-671,184 0 0 -236,815 -418,443 1,293,981 -32,462 -64,083

Less 2% of debtors who never pay. -25,880 -24,837 HighLess x% of debtors who pay more than 60 days. tbd tbd High

Annual discount rate 16.50% -58,341 -88,920

Days post Salary paymentRisk

6. Funding (2 of 3)

‘STAND-ALONE’ FUNDING MODEL FOR 2008/09

Page 13

6. Funding (3 of 3)

INITIAL PROPOSALS FOR CONSIDERATION

There appear to be a number of options available for consideration. Results, when finalised by the end of the year, of the SAICA/AG tariff and funding initiatives need to be taken into account. Possible options are:

• Allocate audit budget to relevant treasury. AG recovers audit fees from relevant treasury. AG paid proportionately in advance at start of ‘planning’ and ‘fieldwork’ stages. ‘Reporting’ (20 - 30%) paid within 30 days of final invoice. AG tariffs increased to fund Capex and Reserves, after interest received.

• Allocate Corporate Services, Reserves and Capex budget to AG. AG tariffs reduced to exclude Corporate Services. Increase tariffs for working capital funding costs, after interest received.

• NT quarterly cash advance for operating expenditure. Increase tariffs to fund Capex and Reserves, after interest received.

• Increase AG tariffs for working capital, capex and reserve funding.

• Allocate audit budget to AG. Auditees’ note value of ‘service without charge’ in financial statements.

Page 14

7. Way forward

Action Who Date

- SCoAG supports AG budget 2008/09- SCoAG feedback on funding options- SCoAG supports AG request for special 2007/08 cash funding.

SCoAG 31.10.2007

- Prepare request for 2007/08 cash advance submission to NT.

DAG 15.11.2007

- Complete tariff and funding research project. DAG 15.12.2007

- Prepare request for funding model change. - Obtain stakeholders (incl. Min Fin) input and support.- Obtain SCoAG final support/approval.

DAG

AG

AG

Jan 2008

Feb 2008

Mar 2008

- Manage 2007/08 financial risks including cash flow optimisation including CS recruitment, project and capex post-ponement.

DAG Nov – Mar 2008

- Manage 2008/09 financial risks including critical success factors of recruitment and new audit business start-up.

DAG Nov 07 – Mar 09

Page 15

Appendices

Page 16

Gross profit contribution by band of staff

•

• BE’s create a deficit.

• 39% of AG gross profit contributed by AMs.

Band Std. HoursAve. Tariff

Head-count

Head-count % Income

Income % Direct salaries

GP Contribution

GP Cont.%

BUSINESS EXECUTIVES 1,012.5 957 19 1.1% 18,410,288 2.1% 19,641,025 -1,230,737 -0.3%SENIOR MANAGER 1,265.6 936 131 7.3% 155,158,031 18.1% 94,347,519 60,810,512 14.2%AUDIT MANAGER 1,417.5 673 324 18.1% 309,128,400 36.1% 141,877,229 167,251,171 39.2%AUDITOR 1,468.1 310 379 21.1% 172,266,851 20.1% 85,136,708 87,130,144 20.4%TRAINEE 1,437.8 150 939 52.4% 202,128,959 23.6% 89,152,136 112,976,823 26.5%

1792 857,092,529 430,154,616 426,937,913

Contribution by bandIncome analysis - Budget 08/09

Page 17

•

• BE and SM contribution per head diminishing every year as a result of the tariff cap.

• Current vacancy rate for AM is 20%.

Band 06/07 07/08 08/09

% Change

p.a.Variable

overheads

Fixed overhead

forfeitVacancy at 31 Aug

Budget 07/08 (5% vacancy)

Budget 07/08 (0%)

Total vacancie

sVacancy

%BUSINESS EXECUTIVES 101,883 83,019 -64,776 -81.8% 44,000 -20,776 0 17 17 0 0.0%SENIOR MANAGER 581,667 504,173 464,202 -10.1% 44,000 420,202 6 96 96 6 6.3%AUDIT MANAGER 398,135 439,128 516,207 14.8% 44,000 472,207 45 286 301 60 19.9%AUDITOR 194,001 222,492 229,895 9.3% 44,000 185,895 37 407 428 58 13.6%TRAINEE 92,177 106,184 120,316 15.3% 44,000 76,316 80 806 848 122 14.4%

Overall change 8.04% Note 1 168 1612 1691 247 14.6%

Current vacanciesContribution per headIncome analysis - Budget 08/09

Vac. Impact per head

Budget 2008/09 sensitivity analysisGross profit contribution by head and level of vacancies per band of staff

Page 18

• Failure to achieve the 8.3% budget vacancy rate assumption will significantly impact the bottom line.

• If the current vacancy rate of 14.6% remains in 2008/09 the surplus of R8.4 million will change to a deficit of R13.4m.

Band

Full establish

ment 08/09 4% 6% 8.3% 10% 12% 14% 16% 4% 6% 8.3% 10% 12% 14% 16%

BUSINESS EXECUTIVES 19 0 0 0 0 0 0 0 0 0 0 0 0 0 0SENIOR MANAGER 143 6 3 0 -2 -5 -8 -11 2,581,243 1,380,665 0 -1,020,492 -2,221,070 -3,421,648 -4,622,226 AUDIT MANAGER 353 15 8 0 -6 -13 -20 -27 7,174,256 3,837,393 0 -2,836,334 -6,173,197 -9,510,060 -12,846,923 AUDITOR 413 18 10 0 -7 -15 -24 -32 3,303,738 1,767,116 0 -1,306,129 -2,842,752 -4,379,374 -5,915,997 TRAINEE 1,024 44 24 0 -17 -38 -58 -79 3,360,322 1,797,382 0 -1,328,499 -2,891,440 -4,454,381 -6,017,321

Note 2 16,419,559 8,782,555 0 -6,491,454 -14,128,458 -21,765,462 -29,402,467 Budgeted surplus 8,359,378 8,359,378 8,359,378 8,359,378 8,359,378 8,359,378 8,359,378Achieved surplus 24,778,938 17,141,933 8,359,378 1,867,925 -5,769,080 -13,406,084 -21,043,089

Sensitivity: Headcount impact of vacancy rates Sensitivity: Contribution impact of vacancy rates

Income analysis - Budget 08/09

Budget 2008/09 sensitivity analysis

Sensitivity analysis of impact of vacancy rate assumption changes