Chapter 17: Capital Expenditure Budgets Capital Expenditure Budgets • Because capital expenditures generally acquire long lasting assets, capital expenditure budgets usually involve longterm financial issues. • Capital expenditure budgets are also sometimes known as “capital spending plans.” Versus Operating Budgets • Usually deal with short-term revenues and expenses that are necessary to operate the facility. Creating the Budget Capital expenditure budgets are often created in two parts: • Spending for assets already acquired • Spending for new capital assets Budget Construction and the Cash Flow Analysis Concept • A cash flow analysis illustrates how the project’s cash is expected to move over a period of time. • When constructing a capital expenditure budget, the cash flow analysis should be cumulative. Cash Flow Reporting Methods Cash flow reporting for this purpose typically uses one of four methods: • Payback Method • Accounting Rate of Return • Net Present Value • Internal Rate of Return (All four methods are described, including an example for each, in the Appendix to the chapter.) Budget Inputs • Capital Expenditure Budget Construction with Operating Budget Inputs • If the operating budget proposal would require additional capital equipment and/or space renovations, then capital expenditure budget inputs may have to be included to recognize the impact of these operations proposals. Figure 17-1 Capital Expenditures Budget Inputs. Budget Construction and Startup Cost Concept • On the other hand, if the capital expenditures budget proposal includes operational expenses, management often requires that startup costs also be considered. Funding Request Process • The process of funding capital expenditure requests (also known as proposals) varies case-by-case depending upon the particular organization. Capital Expenditure Proposals • Acquiring new equipment • Upgrading existing equipment • Replacing existing equipment with new equipment • Funding new programs • Funding expansion of existing programs • Acquiring capital assets for future use Rationing Available Capital • Only a limited amount of capital is usually available for capital expenditures, so rationing is necessary. • Three factors will probably be considered: – Necessity for the request – Cost of capital to the organization – Return that could be realized on alternative investments Evaluating Capital Expenditure Proposals • Because rationing is necessary, evaluating the proposals is a method of allocating the available capital. • Evaluating capital expenditure proposals may be either subjective or objective. • Objective evaluation is the most desirable. (See more details in the chapter.) Evaluating Capital Expenditure Proposals An objective evaluation may involve two steps: • Scoring all proposals received • Ranking the higher-scoring proposals Chapter 16: Operating Budgets Budget Types • An organization’s objectives define – specific activities – how they are assembled – levels of operation • While an organization’s performance standards – set out performance levels • A budget quantifies these activities into financial terms. Budget Process Objectives Objectives should provide: • Written expression, quantified, of policies and plans • Basis to evaluate financial performance according to policies and plans • Useful tool for cost control • Creation of cost awareness throughout the organization Budget Types There are basic differences between two budget types: • Operating budgets • Capital expenditure budgets Operating Budgets • Deal with actual short-term operating revenues and operating expenses • Generally cover the next year (a 12month period) Capital Expenditure Budgets • Deal with capital expenditures for the organization (not operating revenues or expenses) • May also cover the next year, but with a futuristic view; may cover a five- or even ten-year period Responsibility Centers • Cost Centers (manager responsible for controlling costs) • Profit Centers (manager responsible for both costs and revenue) Budget Viewpoints • Transactions outside the operating budget may include: – Grants received by the organization – Foundation transactions • So if transactions are “outside,” they would not be part of the operating budget. Budget Viewpoints • Grants received by the organization may have restricted funds that require separate accounting. • If so, the separate accounting requirement generally means their transactions will be outside the operating budget. Budget Viewpoints • Foundation transactions should require separate accounting because the foundation will be a legally separate organization • The separate accounting requirement should mean their transactions will be outside the operating budget. Identifiable Versus Allocated Budget Costs • Within a departmental budget, certain costs will be specifically identifiable while others will be allocated instead. Budget Basics Review Regarding Identifiable versus Allocated Budget Costs: • Mostly identifiable = Direct patient care and supporting patient care • Usually allocated = general and administrative expense and patient related expense • Maybe not included at all in a manager’s budget = financial related expense Fixed Versus Variable Costs • Variable cost rises or falls in proportion to a rise or fall in volume. (Examples of volume: number of procedures or number of patient days.) • Fixed cost does not change even though volume rises or falls within a wide range. Building an Operating Budget: Construction Phases • • • • • • • • Plan Gather information Prepare input Construct/submit draft version of budget Make required revisions to draft Present preliminary budget Make required revisions to preliminary Submit final budget Building an Operating Budget: Construction Elements • • • • • Format to be used Budget scope Available resources Levels of review Time frame Building an Operating Budget: Information Sources • For the Operating Expenditures Plan: – Operating Revenue Forecast – Staffing Plan or Forecast – Other Operating Expenses • For the Preliminary Operating Budget: – Capacity Level Checkpoints (See Figure 16-5.) Building an Operating Budget: Assumptions • A series of assumptions are made during construction; many key assumptions are within forecasts used for the budget construction process. • Sufficient information at the proper level of detail is essential. Building an Operating Budget: Assumptions: Questions to Ask • Are special projects going to use resources during the new budget period? • Are operations going to be placed under unusual or inconvenient circumstances during the new budget period? (Renovation is an example.) Building an Operating Budget: Computations • Supported by their assumptions • Capable of being replicated or reproduced by another qualified individual • Comparable (as discussed in the text) • Budget assumptions and computations are intertwined in the construction process. Static Budgets • Are essentially based on a single level of operations. That level of operations—or volume—is never adjusted during the budget period. (See example in Table 16-4.) • It doesn’t move—therefore it is “static.” Flexible Budgets • Are based on a level of operation that will change. In other words, the level of operations, or volume, is adjusted to show change during the budget period. (See example in Table 16-5.) • It is adjusted, or flexed—therefore it is “flexible.” Budget Review To review a budget, the manager needs to know • How the budget report format is constructed • How to annualize partial year expenses (More details are in the chapter.) Building Budgets • The budget process should begin with a review of the strategy and objectives. • Remember: Building a budget means making a series of assumptions. Building Budgets To build a budget, a manager must consider • The workload forecast (it must tie into the forecasted volume) • Whether budget projects will use resources during the budget period • Whether budget operations will be placed under unusual or inconvenient circumstances during the budget period (remodeling, for example) Budget: Example 16-A Step 1. Revenue Expenses Excess of Expenses over Revenue Step 2. Revenue Expenses Excess of Revenue over Expenses Step 3. Revenue Expenses Excess of Expenses over Revenue Actual $21,600,000 22,000,000 $ (400,000) Budgeted $24,000,000 22,400,000 $ 1,600,000 Actual Budgeted $21,600,000 22,000,000 $ (400,000) $24,000,000 22,400,000 $ 1,600,000 Static Budget Variance $(2,400,000) (400,000) $(2,000,000) Budget Practice Exercise 16-1 Step 1. Revenue – Inpatient Revenue – Outpatient Subtotal Expenses – Inpatient Expenses – Outpatient Subtotal Excess of Expenses over Revenue Step 3. Revenue – Inpatient Revenue – Outpatient Subtotal Expenses – Inpatient Expenses – Outpatient Subtotal Excess of Expenses over Revenue Actual $17,550,000 4,400,000 $21,950,000 $16,100,000 4,000,000 $20,000,000 $ 1,850,000 Step 2. Budgeted Revenue – Inpatient Revenue – Outpatient Subtotal Expenses – Inpatient Expenses – Outpatient Subtotal Excess of Expenses over Revenue Actual $17,550,000 4,400,000 $21,950,000 $16,100,000 4,000,000 $20,000,000 $ 1,850,000 Budgeted $19,500,000 4,000,000 $23,500,000 $18,000,000 3,800,000 $21,800,000 $ 1,700,000 $19,500,000 4,000,000 $23,500,000 $18,000,000 3,800,000 $21,800,000 $ 1,700,000 Static Budget Variance $(1,950,000) 400,000 $(1,550,000) $(1,900,000) 200,000 $(1,700,000) $ 150,000
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