Capital Expenditure Budget

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If you were assigned to prepare a capital expenditure budget request to add a retail pharmacy in the hospital, which two individuals from your department(s) would you want to have on your team to help you? How would you utilize them to help you? Justify your response and include a minimum of one scholarly reference to support your answer.

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Planning and Budgeting 7 . mtcurado/iStock/Thinkstock Learning Outcomes By the end of this chapter, you will be able to: • Explain the importance of planning and budgeting • Describe the planning process • Describe decisions made in the budgeting process • Develop volume forecasts, revenue forecasts, expense forecasts, and preliminary budgets • Prepare a capital budget • Conduct a budget variance analysis smi81240_07_c07_167-194.indd 167 3/7/14 9:45 AM Section 7.1 Importance of Planning and Budgeting Introduction Bixby Hospital is a short-term acute care hospital that is part of a larger network of hospitals. They have 120 beds, 531 full-time equivalent employees providing more than 23,000 inpatient days of care, and more than 69,000 outpatient visits per year. Despite substantial decreases in patient volume since 2008, a favorable and generous payer mix and aggressively managed cost reductions have permitted Bixby to be highly profitable each of the past five years. This is a good position for management. It is also a challenge for management to sustain or improve upon prior years’ results. As they plan for 2013 and beyond, the board of directors has challenged management to earn an 8% operating margin and to avoid staff layoffs like the one that happened in 2010. Planning and budgeting don’t just happen in an organization. Planning and budgeting require a process that is designed to meet the organization’s needs and its capabilities for having persons spend time on the process. A budget for a healthcare organization typically involves preparing forecasts of the service that will be provided, how services will be paid, and how expenses are incurred. These forecasts are followed by forecasts for the numbers of services that will be provided and corresponding forecasts of the amounts of revenues and expenses incurred. To both assess financial performance and refine the budget process, analyses of the differences between budgeted and actual amounts are a final step in the budget process. 7.1 Importance of Planning and Budgeting Planning and budgeting are among the most important forward-looking activities for managers of healthcare organizations. A common expression among managers is to “plan the work and work the plan.” Planning the work involves making a careful assessment of current operations and making adjustments that will permit the organization to achieve future goals. For healthcare organizations, planning means establishing which services will be offered, projecting how many patients are likely to require these services, and developing guidelines on the number of employees and other resources necessary to provide these services in an effective and efficient manner. Working the plan involves adhering to the guidelines established in the budget and making changes only when the projections included in the budget process are found to need revision. Of course, no projections are perfect. Revisions are almost always required. Budgeting is the action of placing dollar values on the items in an organization’s operational plan. Placing dollar values on the number of patients receiving services involves use of the information developed for charges and payments, as discussed in Chapter 5. Preliminary inpatient and outpatient payment amounts for Medicare are posted in the Federal Register three to six months before the start of the government’s fiscal year on October 1, though final amounts are posted only a few weeks in advance. For physician services, preliminary payment amounts for Medicare are also posted in advance of the start of the calendar year, and last minute changes are common, leaving only a few days’ warning of annual adjustments in payment amounts. 168 smi81240_07_c07_167-194.indd 168 3/7/14 9:45 AM Section 7.1 Importance of Planning and Budgeting For private sector revenues, good budgeting goes hand in hand with insurance company and managed care plan negotiations. For many payers, the negotiation process occurs three months or more before the start of the contract year, permitting time to evaluate the management implications of changes in payments and the procedures required to receive appropriate payments. For some healthcare organizations, payment reductions may require curtailing the availability of services or redrawing guidelines to provide services more efficiently. Payment increases and payments for new services may require planning for how the services are to be provided to more patients. Note that three different years have been mentioned: calendar year, fiscal year, and contract year. The calendar From the Front Lines year is January 1 through December 31. The fiscal year of “No arguments are needed these days to an organization can be any 12-month period. It is com- convince business of the advantages of mon to select a fiscal year starting on January 1, March 1, the budget and its application to business June 1, or October 1, with January 1 being the most common. Contract years with insurance companies can also problems. A budget is a common sense be any 12-month period. Medicare uses the federal gov- forecast or an advance statement of operernment fiscal year of October 1 for hospital payments ations for a specified period of time.” and January 1 for physician payments. Contract years Source: Manager, Hinsdale Hospital (Rice, 1926). with private sector insurance companies typically start January 1. For healthcare organizations, the selection of a fiscal year that corresponds to major contract years will make interpretation and analysis of financial results easier but make for very busy periods of time for finance professionals. Placing dollar values on costs associated with treating a given number of patients receiving services involves use of the information developed for fixed and variable costs, as discussed in Chapter 6. Even though the two processes are generally kept separate, the development of practice guidelines and changes in service delivery are closely related to the budget process. Once an organization has adopted a practice guideline, it has also implicitly adopted use of the personnel and other resources required to implement and follow the guideline. Developing practice guidelines without recognizing the cost implications may be wasted time and effort. This chapter will present a planning process of delivery of healthcare services. Organizations must make a number of decisions, implicitly or explicitly, about the planning process, a few of which are highlighted in the following section. Planning contains budgeting, which has a forecasting component for the number of services, revenues, and expenses, and a mechanical component of placing forecasted dollar values on forecasted services. One of the products of a budget process is a projected income statement for the coming year. The finance term for a projected income statement is a pro forma income statement (alternatively termed a pro forma profit and loss statement or a pro forma statement of operations). In addition to the pro forma income statement, budgets also include cash budgets. A cash budget is a document that provides a projection of the timing of cash receipts and cash expenditures. The goal of a cash budget is to have a clear plan for borrowing and other actions to be taken in the event of cash shortfalls, below some level greater than zero days’ cash on hand. Another goal of a cash budget is to have a clear plan for investing and other actions to be taken in the event of cash excesses, above some level. 169 smi81240_07_c07_167-194.indd 169 3/7/14 9:45 AM Section 7.2 The Planning Process Budgeting also has communication and enforcement actions during the budget year, and evaluation actions after the budget period is over. A good budget is widely disseminated, involving managers for developing projections and permitting staff throughout the organization to understand the plans for service delivery, the financial implications of the organization’s plan, and the constraints placed on actions in order to accomplish the plan’s objectives. Budgets are often tied to management actions, such as in the area of human resources. The budget may permit the posting of open positions for new employees, or not permit additional persons to be hired. For many organizations, the managerial reach of budget administration makes some components of it not just forecasts, but a clear plan of what will happen in the organization. Total budgets are comprised of two components, the operating budget concerning the income statement and the capital budget concerning the balance sheet. The final step in the budget process is the evaluation of results. The finance term for analyses of budgeted and actual values is variance analysis. A variance analysis seeks to provide mathematical explanations regarding why actual results were above or below budgeted amounts. A good variance analysis is followed by verbal or written explanations to accompany the numbers, as well as enforcement actions by management. The results of the past year may have implications for salary changes and promotions of managers, as well as for the budgets established for future years. For Review: 1. What are planning and budgeting and why are they important in healthcare organizations? Planning means establishing which services will be offered, projecting how many patients are likely to require these services, and developing guidelines on the number of employees and other resources necessary to provide these services in an effective and efficient manner. Budgeting is the action of placing dollar values on the items in an organization’s operational plan. Planning and budgeting are important in that they require decision making on the part of managers and statements of goals. Plans and budgets permit clear communication about goals and a means for enforcing decisions. 7.2 The Planning Process The planning process for a healthcare organization starts with strategy. A strategy is a plan of action to achieve a specific aim. For many healthcare organizations, the aim is to achieve the mission statement. Recall the mission statement of Jersey Shore Hospital from Chapter 1: The mission is to provide “quality health services with an efficient balance of outpatient care, acute and sub-acute inpatient care, primary care and outreach services.” This is a noble and broad mission that requires additional work to transform it into specific aims. Senior management and the board of directors are charged with transforming the mission statement into specific aims that can be measured, monitored, and achieved. 170 smi81240_07_c07_167-194.indd 170 3/7/14 9:45 AM Section 7.2 The Planning Process Striving to provide “quality healthcare services” requires a definition of quality and a strategy to achieve results. For hospitals, Hospital Compare (http://www.medicare.gov/hospitalcompare/) was created by the Centers for Medicare & Medicaid Services and the Hospital Quality Alliance, a public-private collaboration established to promote reporting on the quality of care. Selected quality measures from Hospital Compare are presented in Exhibit 7.1 for Bixby Hospital. For most of the selected measures, Bixby is providing services in a manner resulting in scores that are better than the national average. The strategy for achieving good quality measures involves (1) policies for assuring quality, (2) training on quality initiatives, (3) leadership on quality initiatives, (4) measurement and reporting of quality outcomes, and (5) appropriate staffing for the number and medical needs of patients. The planning process and strategy are connected because the five components of the quality strategy require staff support and other resources. The plan must be specific about the inputs (staff and other resources) and output (quality measures) if it is to achieve its aims. Exhibit 7.1 Selected quality measures, Bixby Hospital, 2012 Quality Measure Timely emergency department care Average time patients spent in the emergency department before they were seen by a healthcare professional Average time patients who came to the emergency department with broken bones had to wait before receiving pain medication Timely surgical care Prophylactic antibiotic received within 1 hour prior to surgical incision Effective surgical care Patients having surgery who were actively warmed in the operating room or whose body temperature was near normal by the end of surgery Hospital acquired conditions Falls and trauma (rate per 1,000) Vascular catheter-associated infection (rate per 1,000) Serious complications and deaths Death from serious treatable complications after surgery Accidental cuts and tears from medical treatment Hospital Score National Average 14 minutes 28 minutes 32 minutes 60 minutes 100% 98% 100% 100% 0.00% 2.68% 11.34% 2.05% 0.580 0.000 Source: Author’s calculations based on Hospital Compare data (http://www.medicare.gov/hospitalcompare/). 0.527 0.372 Analyze This Are the hospital scores for Bixby adequate? Are there any areas in which Bixby needs to improve? Please explain your reasoning. 171 smi81240_07_c07_167-194.indd 171 3/7/14 9:45 AM Section 7.2 The Planning Process Going back to our mission statement, providing an efficient balance of “outpatient care, acute and sub-acute inpatient care, primary care and outreach services” requires a measure for each service and a strategy to achieve results. Selected operating statistics for Bixby Hospital are presented in Exhibit 7.2. The number of nonemergency outpatient visits and emergency room visits are common measures for use of outpatient services. Counting the number of outpatient surgeries provides more specification to the use of outpatient services. Similarly, inpatient total discharges (the number of patients using inpatient services) and inpatient days are common measures for use of inpatient services. Counts of the numbers of inpatient surgeries and births provide more specification to the use of inpatient services. Further, the case-mix index is a measure of the severity of the conditions for which patients are being treated. A healthcare organization may implement its mission by specifying the availability of services that treat specific conditions or a combination of conditions. The strategy for providing outpatient and inpatient services involves (1) making hospital support for the services available, (2) having relationships with residents in the community who elect to use the hospital’s services, (3) having relationships with physicians in the community who refer patients to the hospital outpatient services and/or have privileges to admit patients to the hospital’s inpatient services, (4) measuring and reporting patient services, and (5) having appropriate staffing for the number and medical needs of patients. The connection to the planning process is that each of the five components of the patient services strategy requires staff support and other resources. The plan must be specific about the inputs (staff and other resources) and output (number of episodes of patient care) if it is to achieve its aims. Exhibit 7.2 Selected operating statistics, Bixby Hospital, 2012 Operating Statistics Outpatient Outpatient visits Emergency room visits Outpatient surgeries Inpatient Total discharges Inpatient days Inpatient surgeries Births Inpatient revenues (%) Case mix index Average length of stay Staffing Full-time equivalent positions FTE 4Inpatient daily census FTE 4 Total daily census Source: Author’s calculations. 2008 2009 2010 2011 2012 64,600 19,500 13,449 65,100 20,400 12,305 66,300 21,600 10,245 67,400 22,700 11,115 69,200 23,100 11,700 625 6.10 3.21 615 6.91 3.37 537 7.21 3.14 535 7.85 3.21 531 8.22 3.20 6,921 37,373 2,245 2,067 48.1% 1.3443 5.40 6,248 32,490 2,078 2,003 46.9% 1.3085 5.20 5,666 27,197 1,889 1,945 45.1% 1.2642 4.80 4,875 24,863 1,615 1,842 41.4% 1.3829 5.10 4,963 23,591 1,700 1,912 41.2% 1.3428 4.75 172 smi81240_07_c07_167-194.indd 172 3/7/14 9:45 AM Section 7.2 The Planning Process Analyze This Providing outreach services is a part of the mission of Bixby Hospital. Counts of outreach services are not routinely collected. How can Bixby measure fulfillment of its mission to provide outreach services? With a strategy in hand and specific aims for the quality, types of services, and quantity of services to be provided, the planning process continues on to forecast the quantity of services that might be provided in the future and the staff and other resources required for this quantity of services. The application of dollar amounts to the forecasts is the budgeting process. Once a budget has been adopted, the organization moves toward implementing plans, as displayed in Figure 7.1, the planning, managing, and controlling cycle. It is important to have plans established before the start of the accounting period. Once a plan is created, the organization can implement it, knowing that it is being provided with the expected set of services and managing operations to assure compliance to the plan. Organizations that do not have plans available and communicated prior to the start of an accounting period cannot readily expect results that follow the plan. Without a map, it is difficult to know which way to travel. Figure 7.1: The planning, managing, and controlling cycle Planning Revise Plans Implement Plans During the accounting period, Controlling Managing finance and information systems are developed to collect Collect Data data on services being provided to patients, revenues associated with these services, and expenses associated with the staff employed and other resources used to deliver services and manage the organization. The data collected by the healthcare organization links the planning, managing, and controlling cycle. It is the job of general managers to establish practices for collecting the data that are not routinely captured in financial accounting, such as patient satisfaction measures and quality measures. As noted in Chapter 2, it is the job of financial accountants to accurately capture relevant financial information, assure its accuracy, and report results. It is the job of general managers, and perhaps personnel in the finance office, to monitor revenues and expenses and to intervene if results are not following plans. The policies and procedures for intervention are part of the control function. 173 smi81240_07_c07_167-194.indd 173 3/7/14 9:45 AM Section 7.3 Decisions in the Budgeting Process Based upon analysis of the data being collected and the interventions by managers, the plans may require revisions. For some healthcare organizations, revisions may occur during the year. For other healthcare organizations, plans remain in place for the entire year and analyses only influence future plans. For all organizations, the planning process is continuous, with one plan leading into the next. Analyze This Bixby Hospital has been working on making its birthing center more attractive. If during the middle of 2013 a local, competing hospital implemented a plan that made its own birthing center even more convenient and attractive, should Bixby alter its budget forecast for births during the year? For Review: 1. How are planning, managing, and controlling linked in healthcare organizations? Can financial accounting manage the planning process alone? Data on financial accounting and data on patient satisfaction and quality link planning, managing, and controlling. Data on patient satisfaction, quality, and perhaps other measures included in plans come from outside financial accounting, meaning that financial accounting cannot manage the planning process alone. 7.3 Decisions in the Budgeting Process The budgeting process for an organization is, simply, the application of dollar values to the planning process. Of course, nothing is ever as simple as it may at first appear. Before considering the mechanics of the budgeting process (the forecasting of plans and the application of dollar amounts to the plans), a series of structure and management decisions about the budgeting process are described. The structure and management of the budgeting process varies widely among healthcare organizations. Some organizations have very rigid processes. Other organizations have very loose processes. There isn’t one correct budget process for all organizations. The budget process should be designed to fit the needs of the organization and be consistent with the other managerial processes employed. The following process elements serve to highlight decisions that must be made by managers, not to prescribe decisions. Budget Input There are many persons who might contribute to the budget process. Managers must decide who has input into the process and how the cycle of input proceeds, from initial specification of aims to final approval of the budget. At one extreme, budgets can be completely top-down. That is to say, the board of directors or senior management may decide upon the strategic plan and budget and simply pass it down to line managers to implement without any opportunity for discussion. Organizations that are in financially difficult circumstances will, at times, impose strict controls on the budget and use a very top-down process to affect quick change. At the other extreme, budgets can be completely bottom-up. That is to say, line managers can prepare projections of services to be provided and indicate the staffing and other resources 174 smi81240_07_c07_167-194.indd 174 3/7/14 9:45 AM Section 7.3 Decisions in the Budgeting Process desired for providing these services. The budget for the organization as a whole may simply be the sum of all line managers’ projections. Most healthcare organizations do not face circumstances that require a completely top-down process nor have they fostered the development of budgeting skills at the department level or have the financial flexibility to permit a completely bottom-up process. Instead, organizations that are not facing serious financial difficulties will employ a mixed input process. In a mixed input process, the board may set general targets, senior management may translate these into more specific targets, departments may prepare budgets that they envision being consistent with targets, senior management may review and adjust the departmental budgets to align with the general targets, and the board may approve the final budget. There may be more or fewer iterations of a budget proposal between department managers and senior management, depending on the established process and any disagreements on appropriate amounts. In a mixed input process, a number of persons might be involved in budgeting. The board of directors of the healthcare organization has important roles in the budget process. Most budget From the Front Lines processes start with input from the board on overall At our organization, managers and physiaims for the organization. Some of the aims are derived cians originate budget requests, which from the mission statement and specified in the operational planning process. Other aims may be unique are then evaluated. “It’s a wish list that to budgeting. For example, the board of directors at bubbles up.” Bixby Hospital has challenged management to earn an Source: Hospital CFO (Smith, Wheeler, Rivenson, & Reiter, 2000a). 8% operating margin and to avoid staff layoffs. Without conducting a serious analysis into what the board may have meant by “challenging” management to earn an 8% operating margin, a reasonable response by management would be to present a budget that includes an expected operating margin of 8% or more or to prepare an explanation for why an 8% operating margin is not feasible in the next year. Boards of directors vary dramatically in terms of how prescriptive they are to senior management about financial results. Beyond the board of directors, many other persons might have a role in the budgeting process. Total quality management and similar initiatives highlight the importance of empowering line managers and listening to customers about services desired and satisfaction with services delivered. In fact, most organizations will have mechanisms for considering the input of customers in their service offerings. Along these same lines, the input of physicians for the budgeting of services may be critical. Physicians are the vehicle for patient referrals and the provision of services. Their insight into the medical needs of patients in the community and their preferences about the level of staffing and availability of resources for the provision of services is critical to effective budgeting. Physicians are involved in volume of services forecasts and the budgeting of major purchases. A challenge for management is that having more people involved in the budget process typically implies a more time-consuming process and requires more formal mechanisms for presenting and evaluating budget requests. A benefit to having more people involved is an increase in information as it permits management to learn of information on new services that might be forthcoming, and patients’ and physicians’ attitudes about these services. Involvement might also increase the likelihood that managers and staff will be aware of the budget and accept limitations. 175 smi81240_07_c07_167-194.indd 175 3/7/14 9:45 AM Section 7.3 Decisions in the Budgeting Process Altogether, decisions on input present a trade-off between planning and control. A more bottom-up and open process permits a more informed plan. A more top-down or closed process permits tighter control. Healthcare organizations must evaluate their current financial circumstances and other managerial processes employed to determine how much input to include in the budget process. Budget Timing Time is money. Whether or not Benjamin Franklin was the first person to use this phrase in uncertain, but its wisdom is without question. Budgets can be assembled quickly, at the risk of being uninformed and error ridden. Budgets can also be painstakingly prepared over several months and be fully informed and very expensive. Just as there is a budget trade-off between planning and control, there is a trade-off between time spent planning, time spent managing, and time spent controlling. Most healthcare managers would prefer to spend their time managing operations rather than planning or conducting analyses of results. However, the time spent planning and analyzing is important. How long should a budget process take from start to finish? The budget timeline for Bixby is presented in Exhibit 7.3. The operating budget includes elements on the income statement, namely the revenues and expenses of the organization. The operating budget process takes about four months. The capital budget includes elements on the balance sheet, with an emphasis on the fixed assets and how they are purchased with borrowed money or savings. The capital budgeting process takes about three months. In both cases, the actual process likely takes more time than is listed in Exhibit 7.3 as clinical service departments, finance, and senior managers may be working on new strategies and plans for projects throughout the year. Exhibit 7.3 The budget timeline, Bixby Hospital Date July 1 July 15 August 15 August 31 September 15 September 30 September 30 October 15 October 31 July 1 July 1 July 15 August 1 August 31 September 15 Budget Activity Operating Budget Department service projection meetings Finance proposes pricing and revenues Finance evaluation of department projections Department review of revenue and volume Board of directors budget targets (operating margin, other aims) Expense budget for fixed expenses (and capital expenses) Budget target for variable expenses Board of directors review/approval Distribution of budget to departments Capital Budget Funds available for capital presented to departments Distribute capital request forms Capital request forms due Senior management review and prioritize list Financial management drafts financial analysis for selected projects Board of directors capital committee reviews presentations and approves selected projects and allocates funds 176 smi81240_07_c07_167-194.indd 176 3/7/14 9:45 AM Section 7.3 Decisions in the Budgeting Process Using a mixed input model, the operating budget starts with department projections that move up to finance for review before making revisions and submitting results for approval. Internally, finance and senior management complete reviews before making a presentation to the board of directors. For the capital budget, a subcommittee of the board, the capital committee, receives the presentation for projects that have been given a high priority by finance and senior management. Given the high dollar amounts and the time required for careful review of presentations, the board delegates approval of capital projects to the committee. The complete budget, including the operating budget and the capital budget, are approved by the full board of directors before distribution. Analyze This Is Bixby’s budget process too long? How could it be done faster? Budget Increments Within the policy of budget timing, there are also policies of the increments of the budget and how revisions can be made. Budget increments are the time periods within the year when actual results and budgets are compared. Increments could be weekly, monthly, quarterly, or just once per year. Once again, the budget process offers a trade-off between planning and controlling. For organizations facing difficult financial challenges, very short-range budget increments may be required. Healthcare organizations with 10 days’ cash on hand might not have the luxury of waiting three months before reviewing results. For organizations with fewer challenges, longer time periods permit a more flexible management of activities. In practice, budget increments are often associated with the timing of meetings of the finance committee of the board of directors or a meeting of the full board. Finance and senior managers have the ability to review interim results without a fully prepared analysis of actual and budgeted results. At the latest, full analyses are presented annually. Healthcare organizations rarely present operating budgets that encompass multiple years due to uncertainty in revenues. With Medicare and state Medicaid programs having annual payment rate determination processes, only single-year budgets can be reliably prepared. Budget Revisions Revisions to budgets are made annually, at a minimum, during the routine budget process and potentially more frequently. Revisions that are made annually are often made incrementally, following a percentage adjustment for changes in revenues and expenses. As an alternative, organizations can use zero-based budgeting. A zero-based budgeting process requires the creation of new information on all of the values in the budget, rather than adopting prior values and assumptions about the revenues and expenses of the organization. Zero-based budgets can be helpful when substantial changes in the cost structure of an organization are required, as each item in the budget must be examined and justified (Cichocki, Kerr, Clare, & Koegel, 2012). At times when substantial changes in costs are not required, the time and effort to review all programs and all assumptions in a budget can be substantial. For most organizations, the time and effort of preparing a zero-based budget is 177 smi81240_07_c07_167-194.indd 177 3/7/14 9:45 AM Section 7.3 Decisions in the Budgeting Process not worthwhile every year, but it may be worthwhile every few years. This is another case of a trade-off between time spent planning and time spent managing and controlling the organization. Revisions may be made to a budget within the fiscal year if there is new information on volumes of services, revenues, or expenses that merit the change. Most healthcare organizations will conduct reforecasting of patient volumes but will not change the initial budget unless there is a dramatic change that affects a large part of the organization. The loss of an agreement with an insurance company covering a large percentage of patients or the loss of key medical staff might trigger a need to prepare a revised budget for approval. Minor changes in patient volume forecasts, revenues, or expenses do not require revised budgets. Instead, minor changes require analysis and explanation at the end of the year. Fixed or Flexible Budgets Again, the key factors in a budget are the forecasts of patient volumes, expenses associated with treatment of patients, and revenues associated with treatment of patients. While projections of patient volumes are an important activity for management, some organizations question whether projections of patient volumes are an important aspect of the budget. To hold managers accountable to volume projections, most healthcare organizations use fixed budgets. Fixed budgets establish dollar amounts for revenues, expenses, and net income that are expected to be earned during the budget period. An alternative to a fixed budget is a flexible budget. A flexible budget establishes revenue and expense amounts per volume of activity. The budget is then presented as a number of patients multiplied by revenues and expenses. For managers that cannot be held accountable to projections of patient volumes, flexible budgets provide a more accurate assessment of the dollars to which the manager can be held accountable. The manager of the hospital pharmacy cannot have a substantial impact on the numbers of drugs that are provided to patients, as that will be determined by the volume and severity of patients and the treatment patterns of physicians (Edwards, 2011). The manager of the hospital pharmacy can control the number of pharmacists and technicians employed relative to patient volume and the expenses for the management of the pharmacy. It might make more sense to provide the hospital pharmacy with a budget per patient rather than a fixed dollar amount for the year. The intuition behind flexible budgets is based on cost structures presented in Chapter 6. Costs may be generally categorized as fixed or variable. For fixed costs, fixed budgets make perfect sense. Even for organizations that use flexible budgeting, there are fixed components for clear fixed costs, like marketing expenses and capital expenditures. Do fixed budgets make sense for variable costs? Certainly using an understanding of fixed and variable costs is important in the mechanics of the budget development process. Whether fixed or flexible budgets make sense for an organization is less dependent upon the fixed or variable nature of costs and more dependent upon whether managers can be held accountable to forecasts of patient volume. Further, organizations need a sophisticated and well-maintained cost accounting system to support flexible budgeting. The advantages of flexible budgeting may not justify the cost of an expensive accounting system. 178 smi81240_07_c07_167-194.indd 178 3/7/14 9:45 AM Section 7.3 Decisions in the Budgeting Process Budget Tightness and Legitimacy The process of soliciting input on budgets and the review by finance and senior management may reveal a range of views on what are reasonable amounts for volume, expenses, and revenues. Reconciling the range of views into a consensus on the budget is ideal but difficult to achieve. Included in department managers’ sense of reasonable amounts are the uncertainties associated with the volume of patients and the resources that will be required to treat them appropriately. Budgets that adhere to closely managed treatment guidelines and strict expense limits are termed tight budgets. Budgets that permit more flexibility of expenses within a department are termed loose budgets. Every department manager can envision ways to improve patient outcomes and the patient experience by adding more staff and other resources. If department managers are evaluated upon adherence to a budget, patient outcomes, and patient experiences, they will seek looser expense budgets. Senior managers understand the interests of department managers in having loose expenses budgets, as well as the needs of the organization to make optimal use of resources. If every department manager were permitted a loose budget and actually spent to the limit of budgeted expenses, overall expenses may exceed net revenues. Rather than seeking consensus, organizations often seek legitimacy. Legitimacy of a budget is a process that has sufficient opportunities for input and amounts for patient volume, revenues, and expenses that permit managers at all levels to accept the use of the budget for purposes of individual performance evaluation. For department managers, controlling total expenses at or below the budget level may be a component of their annual performance evaluation. For senior managers, the adherence to the entire budget, as measured by net income, may be a component of their annual performance evaluation. From the Front Lines Senior managers at our organization have 20–30% of total compensation related to financial performance, mostly budget adherence. The budgets and financial performance are very important and are treated very seriously. Source: Hospital CFO (Smith et al., 2000a). For Review: 1. If you were the manager of a clinic that anticipated 16,000 encounters, would you want a fixed budget of 16 persons, for the entire year, or a flexible budget that involves having a budget for the number of staff in a clinic being set at one full-time position for every 1,000 patient encounters in a year? If the budget includes an accurate projection of the number of patient encounters, a fixed budget and a flexible budget yield the same number of positions, 16. With a fixed budget, you would be certain to have all 16 persons all year, and this may provide some stability in the roles of the workers. With a flexible budget, you would have the ability to hire more employees if actual patient encounters increased more than the budgeted level. You would also bear the responsibility to reduce the number of positions if there were fewer patient encounters. 179 smi81240_07_c07_167-194.indd 179 3/7/14 9:45 AM Section 7.4 Mechanics of Budgeting 7.4 Mechanics of Budgeting Once the planning process has been defined and the decisions in the budgeting process have been made, the organization can undertake the mechanics of budgeting. The key mechanics of budgeting include forecasting patient volumes and operating statistics, forecasting revenues, and forecasting expenses. The end product of the mechanical aspects of placing numbers on volumes and dollar amounts on revenues and expenses is a pro forma income statement. There are many ways in which organizations can develop forecasts. As with the identification of fixed versus variable costs, having the knowledge and insights of an experienced manager is a great starting point. Persons who see the patient flow process, who communicate with physicians, who keep up with the activities of competitors, who keep up with insurance company policies, and who keep up with clinical advances in the field can offer accurate assessments of likely patient volumes, revenues, and expenses. Finding and retaining such people can be difficult. To supplement the insights of experienced managers, organizations can use trends in data from prior years to prepare forecasts. A host of advanced statistical techniques have been developed for forecasting (González-Rivera, 2012). When trend analysis or other statistical techniques are used for forecasting, having managerial review of results may be helpful for purposes of legitimacy. Volume Forecasts The starting point for planning and budgeting is the forecast of patient volumes. Treating patients is the reason that healthcare organizations exist, so it is only fitting that identification of the number of patients would be the starting point. Depending on the sophistication of the budgeting process, the level of detail on patient volumes might be minimal, for example, only counting total patient visits. Alternatively, it could be a highly detailed count of patient visits by type of service. Consider the list of emergency department visits at Bixby Hospital presented in Exhibit 7.4. Analyze This What number of patient visits might Bixby Hospital expect to provide in 2013? Exhibit 7.4 Bixby Hospital, emergency department visits, 2012 APC 0613 0614 0615 0616 Description Level 2 Type A emergency visits Level 3 Type A emergency visits Level 4 Type A emergency visits Level 5 Type A emergency visits Total Patient Visits 2,138 7,215 10,253 3,494 23,100 Source: Author’s calculations. Net Patient Revenue $404,809 $2,151,374 $4,897,349 $2,471,101 $9,924,633 180 smi81240_07_c07_167-194.indd 180 3/7/14 9:45 AM Section 7.4 Mechanics of Budgeting A naive forecast of the number of emergency department visits in 2013 would be 23,100 patient visits. This forecast would assume no change in the number of visits. Recalling Exhibit 7.2, the number of emergency department visits has not remained constant over time. In fact, the number of emergency department visits has increased each of the past four years. An alternative forecast might be to add the average increase over each of the past four years (900 emergency department visits) to the 2012 value. Yet another alternative would be to use the trend of increases over the past four years (1,210 emergency department visits). A view of an Excel spreadsheet calculation of these forecasts is presented in Exhibit 7.5. A forecast in the range of 24,000 to 24,310 emergency department visits would be more reasonable than 23,100 emergency department visits. Exhibit 7.5 Forecasts of emergency department visits, Bixby Hospital, 2013 1 2 3 4 5 6 7 8 A B C Emergency Department Visits Year 2008 2009 Visits 19,500 20,400 Change 900 D E 2010 21,600 1,200 2011 22,700 1,100 Source: Author’s calculations. F 2012 23,100 400 G H 2013 ? 24,000 =AVERAGE(B4:E4)+F3 24,310 =TREND(B3:F3,B2:F2,G2) The AVERAGE function in Excel calculates the simple mean of the values listed. In Exhibit 7.5, the AVERAGE of the 2009–2012 changes in emergency department visits can be calculated manually and added to the number of visits in 2012 to yield the forecast for 2013: Average change in visits 5 900 1 1,200 1 1,100 1 400 4 years Average change in visits 5 900 per year Forecast of 2013 visits 5 Visits in 2012 1 Average change in visits Forecast of 2013 visits 5 23,100 1 900 Forecast of 2013 visits 5 24,000 The TREND analysis tool finds the line that best fits the relationship between two sets of numbers. In this case, the TREND analysis tool finds the best relationship between emergency department visits and time, as measured in years. The Microsoft Excel support files present a good explanation of the use of the trend analysis tool: http://support.microsoft .com/kb/828801. From this example, it may be clear that forecasting patient volume is not a simple process or one that can be taken lightly. The forecasts of patient volume are the foundation upon 181 smi81240_07_c07_167-194.indd 181 3/7/14 9:45 AM Section 7.4 Mechanics of Budgeting which forecasting of net patient revenues and operating expenses is built. Initial forecasts of patient volume are carefully examined and often contested in discussions involving physicians, department managers, and senior management. Analyze This If you were the budget manager at Bixby Hospital, what number of emergency department patient visits would you want to use in the budget for 2013? If you only had data for 2011 and 2012, would your answer be different? Who might you ask to learn more about expected numbers of emergency department volumes? In Exhibit 7.6, forecasts for all of Bixby Hospital’s patient operating statistics for 2013 are presented. These forecasts were developed using the trend analysis tool in Excel. The only items not forecasted were average length of stay and ratios involving the number of full-time equivalent (FTE) positions. The average length of stay was calculated as the ratio of the number of inpatient days divided by the number of discharges. FTE positions are calculated by taking the total number of hours worked by all employees and dividing by the number of work hours in a year for a full-time employee (2,080). Since healthcare organizations often employ many part-time workers, standardizing by full-time equivalent provides a consistent count of the number of employees. Inpatient daily census was calculated as inpatient days divided by 365 days. Total daily census was calculated as inpatient days divided by 365 days, plus outpatient visits and emergency department visits multiplied by 40%. The calculation of total daily census includes the conversion of outpatient visits and emergency department visits to the equivalent of inpatient visits. The calculation involves multiplying visits by 40% since outpatient and emergency department visits are, on average, 40% as costly as an inpatient day. Again, this is not a simple process. Reasonable people could disagree upon the best method for forecasting the number of patient visits for 2013. Ideally, an organization not only would use statistical techniques, such as trend analysis, but would also seek out the view of experienced managers in each of the clinical service departments. 182 smi81240_07_c07_167-194.indd 182 3/7/14 9:45 AM Section 7.4 Mechanics of Budgeting Exhibit 7.6 Forecast of selected operating statistics, Bixby Hospital, 2013 Operating Statistics Outpatient Outpatient visits Emergency room visits Outpatient surgeries Inpatient Total discharges Inpatient days Inpatient surgeries Births Inpatient revenues Case mix index Average length of stay Staffing Full-time equivalent positions FTE 4 Inpatient daily census FTE 4 Total daily census Source: Author’s calculations. 2009 2010 2011 2012 2013 65,100 20,400 12,305 66,300 21,600 10,245 67,400 22,700 11,115 69,200 23,100 11,700 69,970 24,310 10,356 615 6.91 3.37 537 7.21 3.14 535 7.85 3.21 531 8.22 3.20 488 9.61 3.17 6,248 32,490 2,078 2,003 46.9% 1.3085 5.20 5,666 27,197 1,889 1,945 45.1% 1.2642 4.80 4,875 24,863 1,615 1,842 41.4% 1.3829 5.10 4,963 23,591 1,700 1,912 41.2% 1.3428 4.75 4,148 18,545 1,440 1,813 38.7% 1.3500 4.47 With volume forecasts established, the next two steps in the budget process are to forecast the revenues and expenses associated with treating these patients. Once an organization sees the full implications of the volume, revenues, and expense forecasts, namely net income, it is not uncommon to revisit the forecasts for patient volumes. It is important for managers of healthcare organizations to understand that patient volume is partly under their control. Certain aspects of patient volume are uncontrollable, as they relate to the overall health status of a population, the rate of accidents and illnesses that affect the population, the availability of insurance coverage, and other factors. What is under the control or influence of managers are the availability of services, the relationships with residents in the community who elect to use the organization’s services, the relationships with physicians in the community who refer patients to outpatient services or have privileges to provide inpatient services, and the image of quality and caring promoted by the healthcare organization. Also somewhat outside of the control of management are the actions taken by competing healthcare organizations that have similar missions. Part of the job of managers of healthcare organizations is to assure that patient volume forecasts are realized, to the extent that they are under their control. Analyze This Do any of the volume forecasts for Bixby Hospital appear to be unreasonable? Please explain your reasoning. 183 smi81240_07_c07_167-194.indd 183 3/7/14 9:45 AM Section 7.4 Mechanics of Budgeting Revenue Forecasts Revenue forecasts are the product of volume of services forecasts and revenue per service forecasts. Revenue per service forecasts are partially known to the extent that the organization has negotiated contracts with insurance companies and managed care organizations and provides services to Medicare and Medicaid enrollees. While the From the Front Lines exact payment rates may not be known far in advance The budget tells the story of our priorities. of the start of the fiscal year, indications of the likely As a safety net hospital, our budget is full payment rates are often provided some time in advance. of risk and educated guesses. This year, we are estimating that graduate medical education payments won’t decrease, that the State won’t cut Medicaid any further, and that our add-on payments won’t be cut too severely. We also estimate volumes (inpatient, outpatient, emergency, etc.) based on last year’s volumes, market analysis, and macro trends (such as decrease year-over-year in inpatient admissions). In other words, we attempt to bring in known facts and evidence but, ultimately, there are a lot of estimates. Source: Chief operating officer, county medical center. The 2013 revenue budget for Bixby Hospital is presented in Exhibit 7.7. Management expects a 2% increase in the number of Medicare and Medicaid patients and a 1% increase in the payment rates per patient, for an overall 3% increase in Medicare and Medicaid net patient revenues. Obviously, these values could change substantially depending on federal and state budget decisions. Management also expects a nearly 10% decrease in the number of patients covered by private health insurance. Negotiations with insurance companies and changes in the mix of services provided to privately insured patients have yielded a 9% increase in revenues per patient, which still leaves a 1% decrease in private health insurance net revenues. In total, net patient revenues in 2013 are projected to be nearly identical to net patient revenues in 2012. Exhibit 7.7 Revenue budget, Bixby Hospital, 2013 Actual 2012 $17,626,545 $11,817,508 $80,585,777 $110,029,830 Medicare revenue Medicaid revenue Private insurance and other revenue Net patient revenues Source: Author’s calculations. Budget 2013 18,155,341 12,172,033 79,779,919 $110,107,293 Expense Forecasts Expense forecasts are also the product of volume of services forecasts and expense per service forecasts. However, unlike revenue forecasts, which are entirely variable, expense forecasts must consider the fixed and variable nature of costs. As presented in Exhibit 7.8, each of the types of operating expenses can be generally designated as being fixed or variable. Depreciation expense, lease expense, and interest expense may be related to patient volume in the long run, as the organization adjusts physical capacity and borrowing associated with different levels of patient volume. In the short run, these are treated as fixed expenses. 184 smi81240_07_c07_167-194.indd 184 3/7/14 9:45 AM Section 7.4 Mechanics of Budgeting Salary and fringe benefits expenses have both a fixed and a variable component. With minimum numbers of employees for any level of patient volume, there is a fixed component to salary expenses. Fringe benefits costs (health insurance, life insurance, pension contributions, Social Security, other payroll taxes, etc.) are related to the number of employees and therefore also have a fixed and a variable component. Most supplies expenses are variable, as more patient visits require more supplies. About half of the other operating expenses (approximately $10 million per year) are associated with building maintenance and other fixed expenses. Exhibit 7.8 Fixed and variable operating expenses, Bixby Hospital, 2013 Operating Expenses Salary and fringe benefits expense Depreciation expense Lease expense Interest expense Supplies and other operating expenses 2012 $61,730,186 $5,849,240 $1,674,723 $840,479 $31,300,668 Type of Expense Variable / fixed Fixed Fixed Fixed Variable / fixed One unique challenge to Bixby Hospital is how to interpret the board of directors’ challenge to avoid staff layoffs like the one that happened in 2010. As presented in Exhibit 7.2, the number of full-time equivalent positions at Bixby decreased from 615 to 537 in 2010. The number has remained fairly constant over the past three years. With the assumption that the board is quite concerned with maintaining the number of positions, the forecasted operating expense budget for Bixby Hospital is presented in Exhibit 7.9. Exhibit 7.9 Operating expense budget, Bixby Hospital, 2013 Operating Expenses Salary and fringe benefits expense Depreciation expense Lease expense Interest expense Supplies and other operating expenses Total operating expense Actual 2012 $61,730,186 5,849,240 1,674,723 840,479 31,300,668 $101,395,296 Budget 2013 $60,495,582 6,321,974 1,794,355 848,884 35,315,691 $104,776,486 Preliminary Budgets The next to last step in the mechanics of the budget process is to combine the revenue and expense budgets to yield budgeted operating income. Forecasts of miscellaneous nonpatient revenue and taxes (if applicable) are also prepared at the end of the budget process. The preliminary budget for Bixby Hospital is presented in Exhibit 7.10. Using the budgeting assumptions provided in the previous sections, forecasted operating income is over $5.3 million, a 4.8% operating margin. With miscellaneous nonpatient revenue of $3.9 million, and no taxes, net income is forecasted to be $1.7 million less than in 2012, with a total profit margin of 8.1% for the year. 185 smi81240_07_c07_167-194.indd 185 3/7/14 9:45 AM Section 7.4 Mechanics of Budgeting Exhibit 7.10 Preliminary budget, Bixby Hospital, 2013 Actual 2012 $110,029,830 $101,395,296 $8,634,534 $2,260,304 $10,894,838 Net patient revenues Total operating expense Operating income Miscellaneous nonpatient revenue Net income or (loss) Budget 2013 $110,107,294 $104,776,486 $5,330,808 $3,907,068 $9,237,876 The example presented in Exhibit 7.10 is termed a preliminary budget, as it may be the subject of much discussion and analysis before becoming the final budget. With the preliminary budget completed, the implications of the budgeting process can be assessed. In many organizations, an evaluation of financial performance, as discussed in Chapter 3, may be performed on the preliminary budget. Questions asked during the evaluation of the preliminary budget focus on profitability and operational measures: • • • • • • Is the operating margin sufficient and consistent with the long-range financial plan? Is the total margin sufficient and consistent with the long-range financial plan? Is the outpatient revenue percentage consistent with current trends and the longrange plan? Is the Medicare payment percentage consistent with current trends and the longrange plan? At the forecasted volume of inpatient services, what is the planned occupancy rate? What is the ratio of salaries to revenues? Is this consistent with other healthcare organizations? The evaluation of the preliminary budget may result in changes that are made before approval of the final budget. Once the final budget is approved, it is communicated as the financial plan for the upcoming year. Analyze This To realize the 8.1% operating margin, 43 fewer persons would be employed at Bixby Hospital. The board of directors challenged senior management to avoid layoffs. Should senior management plan for an 8.1% operating margin or plan to spend $3.6 million to employ 43 persons and not have layoffs? For Review: 1. A senior manager reviewed the expense budget and thought that it was too high. What aspects of the mechanics of the budgeting process would need to change to reduce the budget? The expense portion of a budget includes forecasts of fixed costs and forecasts of patient volumes multiplied by variable costs. Reducing expenses requires either reducing projected fixed costs or reducing projected variable costs. In a short period of time, it can be difficult to change fixed costs, such as leases. Salary expenses, supplies, and other operating expenses can be reduced by changing the treatment processes. 186 smi81240_07_c07_167-194.indd 186 3/7/14 9:45 AM Section 7.5 Capital Budget 7.5 Capital Budget The capital budget for a healthcare organization is the complete listing of the projects and expenditures approved in the current budget and the projects and expenditures approved in prior time periods for which the investment is ongoing. Large-scale construction projects can take three or more years to complete, requiring inclusion on capital budgets for each year. Further, given the timing of when projects can start and be completed, even short-term projects may extend beyond one budget year. For investor-owned healthcare organizations, and even not-for-profit healthcare organizations with access to capital markets for investment in new projects, a general decision rule would be to accept all projects with positive net present value. For a number of reasons, organizations create processes that place limits on capital budgets each year. Having limits on capital budgets is called capital rationing. Capital rationing may arise due to hard constraints imposed by credit markets. Organizations with limits on borrowing associated with debt covenants may be required to limit capital budgets. More frequently, organizations set internal budget allocations, which are called soft constraints. There are a number of ways in which organizations can establish internal budget allocations. One common method of establishing capital budgets is to start with the operating budget to project depreciation expense, which indicates the amount that could be spent without impacting the balance sheet. Further net income provides an amount that may be available for capital expenditures, to the extent that plans for the debt ratio do not otherwise limit available funds. Beyond the sum of depreciation expense and net income, organizations need to examine how much of investments (marketable securities, assets limited as to use) could be used for capital expenditures or how much more could be borrowed. The forecasted 2013 balance sheet for Bixby Hospital is presented in Exhibit 7.11, based on the depreciation expense and net income included in the income statement forecast. Without changing the use of debt, Bixby has forecasted additional fixed assets of $14 million, which is its capital budget for the year. Exhibit 7.11 Forecasted balance sheet, Bixby Hospital, 2013 Assets Current assets Fixed assets Accumulated depreciation Net fixed assets Assets limited as to use Total assets $37,000,000 $104,681,305 $27,000,000 $77,681,305 $76,353,016 $191,034,321 Liabilities and Net Assets Current liabilities Long-term liabilities Total liabilities Net assets Total liabilities and net assets smi81240_07_c07_167-194.indd 187 $9,000,000 $40,375,920 $49,375,920 187 $141,658,401 $191,034,321 3/7/14 9:45 AM Section 7.5 Capital Budget With a capital budget in hand, financial managers are asked to evaluate the financial aspects of capital budget requests to propose projects to approve and to allocate funds. With a varietybased positioning strategy, Bixby Hospital is attempting to focus its strategic capital expenditures on providing specific and unique services, with a focus on the quality and effectiveness of the service. The sleep lab project fits well within this strategy, more so than the waiting room project, which fits well with an access-based strategy. The fact that the net present value for the sleep lab project is positive, larger than alternative uses of the space, and a good strategic fit, makes it a project that can be approved. Strategic projects make up one portion of a capital budget. A typical capital budget will include routine maintenance, strategic projects, and carry forward of prior capital expenditure plans. For the 2013 capital budget, Bixby Hospital conducted an assessment of its facilities, equipment, and technology to determine the priorities for replacement, repair, and any new acquisitions. The assessment and prioritization process addressed patient safety, obsolescence, new technology, building safety, and code compliance requirements. Routine maintenance and equipment replacements create capital expenditure needs of approximately $6 million per year. With all of the uncertainty for 2013 and 2014, the strategic capital budget recommendation is being limited to $8 million in 2012. At the $8 million level, the budget is 120% of the prior year depreciation expense. The proposed 2013 capital budget is presented in Exhibit 7.12. Exhibit 7.12 Proposed capital budget, Bixby Hospital, 2013 Routine Capital Budget Facility projects Information technology projects Medical equipment Total routine $2,300,000 $1,200,000 $2,500,000 $6,000,000 Phase I strategic capital projects Primary care clinic Ambulatory care center projects Total phase I $1,400,000 $2,500,000 $3,900,000 Phase II capital projects Hospital renovations Ambulatory care center projects Physical therapy center Total phase II Total capital budget $2,000,000 $900,000 $1,200,000 $4,100,000 $14,000,000 188 smi81240_07_c07_167-194.indd 188 3/7/14 9:45 AM Section 7.6 Budget Performance Evaluation (Variance Analysis) The examination room project for the clinic is one of the types of projects that might be included in Bixby’s phase I (year one) ambulatory care center projects. Given the amount of time and effort required to assemble background information, prepare budget forecasts, and conduct decision making, capital budgeting is a substantial and time-consuming aspect of financial management. For Review: 1. Why don’t organizations adopt all projects that have estimated net present values greater than zero? Organizations limit their capital expenditures based upon their ability to borrow money, as well as internal limits on how many projects they want to attempt to complete within a given year. 7.6 Budget Performance Evaluation (Variance Analysis) At the end of a budget period, the final step in the process is to evaluate budget performance. Organizations routinely present end-of-period performance reports that display the income statement for the period and the budgeted amounts for the period. Reports highlight variance, that is, the difference between actual and budgeted amounts. The level of formality of the report and the discussion that accompanies performance reports vary among organizations. Organizations that have financial difficulties often have more formal reporting and require fuller discussions to accompany reports. For performance reports that display underperformance, as defined by lower revenues, higher expenses, or lower net income, corrective action plans may also be required. Corrective action plans are proposals by managers for changes in operations to achieve results that are more consistent with the budget. The budget performance report for the first quarter of 2012 at Bixby Hospital is presented in Exhibit 7.13. The first quarter budget at Bixby Hospital is 23% of the annual budget for patient visits, to be consistent with historical values. When an organization presents a first quarter budget of exactly 25% of the annual budget, it might indicate historical values for an industry that does not experience seasonal trends, or it might be an approximation that has no particular significance. At Bixby Hospital, first quarter net patient revenues were higher than budgeted for all payers, especially Medicaid, at 15% more than budgeted. Salaries and supply expenses were also higher than expected. Depreciation, lease expense, and interest expenses were precisely as expected, budgeted at 25% of annual amounts, since these values truly represent fixed costs for the year that are evenly divided by quarter. As a result of net patient revenues exceeding budget more than operating expenses, operating income exceeded its budgeted amount. Miscellaneous nonpatient revenue was below its budgeted amount, as was net income. 189 smi81240_07_c07_167-194.indd 189 3/7/14 9:45 AM Section 7.6 Budget Performance Evaluation (Variance Analysis) Exhibit 7.13 Budget performance report, Bixby Hospital, first quarter 2012 Medicare revenue Medicaid revenue Private insurance and other revenue Net patient revenues Operating expenses Salary and fringe benefits expense Depreciation expense Lease expense Interest expense Supplies, other operating expenses Total operating expense Operating income Miscellaneous nonpatient revenue Net income or (loss) Total patient visits First Quarter First Quarter Actual Budget $4,153,879 $4,054,105 $3,125,897 $2,718,027 $19,785,422 $18,534,729 $27,065,198 $25,306,861 $15,426,789 $1,462,310 $418,681 $210,120 $7,564,125 $25,082,025 $1,983,174 $350,000 $2,333,174 13,124 $14,197,943 $1,462,310 $418,681 $210,120 $7,199,154 $23,488,207 $1,818,654 $519,870 $2,338,524 12,939 Variance $99,774 $407,870 $1,250,693 $1,758,337 $1,228,846 $0 $0 $0 $364,971 $1,593,818 $164,520 ($169,870) ($5,350) 185 Percentage Variance 2.5% 15.0% 6.7% 6.9% 8.7% 0.0% 0.0% 0.0% 5.1% 6.8% 9.0% 232.7% 20.2% 1.4% With actual amounts differing from budgeted amounts, an explanation of variances may be required. For some organizations, informal explanations of variances may be required. For the first quarter of 2012 at Bixby Hospital, the higher than expected number of patient visits was associated with higher revenues and higher expenses, resulting in higher net income. The shortfall in miscellaneous nonpatient revenue led to an actual net income that was only 0.2% less than budgeted. For other organizations, more formal explanations of variances may be required. Which variances merit the time and attention required to provide more formal explanations? Variances greater than specified dollar amounts, such as $100,000, may require explanations. Variances greater than specified percentages, such as 5%, may require explanations. Or, variances of specified dollar amounts or percentages that persist for some time From the Front Lines periods, such as three quarters, may require explanaOne CFO required an explanation of cause tions. There is no common rule for when explanations and a plan of action for variance of $5,000 are required. This is a decision for management. or 5% of budget. Another CFO required explanation for monthly variances of 5% (cost per patient/unit, not related to volume) and for variances of 2% that persist for 3 or more months—to avoid “low flying” problems. Source: Smith et al. (2000a). Even without a common rule for when explanations are required, there is a common practice for developing more information for the explanation, which is called variance analysis. A variance analysis is a separation of total revenue or expense variances into component parts. The two main components of revenue are volume of services and revenues per service. Similarly, the two main components of expenses are volume of services 190 smi81240_07_c07_167-194.indd 190 3/7/14 9:45 AM Section 7.6 Budget Performance Evaluation (Variance Analysis) and expenses per service, only for variable costs. For fixed costs, there is no separation of a variance into component parts. For example, if the actual expense for marketing at Bixby Hospital were $100,000 higher than the budgeted amount, there would be no reason that the higher amount was associated with providing services to more patients. The equations for conducting variance analyses are straightforward. For revenue variances, the three components are Revenue variance 5 Actual revenue 2 Budgeted revenue Revenue volume variance 5 (Actual volume 2 Budgeted volume) 3 Budgeted revenue per service Revenue per service variance 5 (Actual revenue per service 2 Budgeted revenue per service) 3 Actual volume For Bixby Hospital in the first quarter of 2012, the revenue variance analysis is presented in Exhibit 7.14. The total revenue variance was $1,758,337, which is the amount to be explained by the analysis. The portion of the revenue variance explained by a higher than expected number of patient visits was $361,616. The portion of the revenue variance explained by a higher than expected revenue per patient visits was $1,396,721. For Bixby, volume explained 20% of the revenue variance, and revenues per patient explained 80% of the variance. The simple explanation of having more patients and therefore more revenues was only partially correct. The full story would not have been revealed without a variance analysis. Exhibit 7.14 Revenue variance analysis, Bixby Hospital, first quarter 2012 Revenue variance Revenue volume variance 5 5 Revenue per service 5 variance Actual revenue 2 Budgeted revenue $27,065,198 – $25,306,861 (Actual volume 2 Budgeted volume) 3 Budgeted revenue per service (13,124 2 12,939) 3 $1,955.86 185 3 $1,955.86 (Actual revenue per service 2 Budgeted revenue per service) 3 Actual volume ($2,062.27 2 $1,955.86) 3 13,124 $106.42 3 13,124 Variance $1,758,337 $361,834 $1,693,525 For expense variances, the three components are Expense variance 5 Actual expense 2 Budgeted expense Expense volume variance 5 (Actual volume 2 Budgeted volume) 3 Budgeted expense per service Expense per service variance 5 (Actual expense per service 2 Budgeted expense per service) 3 Actual volume 191 smi81240_07_c07_167-194.indd 191 3/7/14 9:45 AM Summary & Resources Analyze This For Bixby Hospital, prepare a variance analysis for operating expenses for the first quarter of 2012. Variance analysis provides a more complete explanation for differences between actual values and budgeted values than a simple examination of performance reports. The real explanations only begin to be explored when the components are separated. Still, variance analysis provides numerical results, not the underlying reasons. It is the start of the questioning process. For volume variances, why was the number of patient visits different than budgeted? Were there external causes? Were there different levels of illness and injury in the community? Were there internal causes? Was there a successful marketing campaign that resulted in a higher number of physician referrals? Variance analysis permits the questions to be asked in a more structured format, guiding managers to important financial answers. For Review: 1. What are the sources of differences between budgeted amount of revenues and expenses and actual amounts? Is it possible that volume variances could exist for a revenue budget and not an expense budget? In simple variance analyses, the only two sources of variances are volumes of patients and revenue per patient or expense per patient. Since the first part of the calculation of volume variances is the same for revenues and expenses (Actual volume 2 Budgeted volume), it is not possible that volume variances could exist for a revenue budget and not an expense budget. For a situation where actual volume is different from budgeted volume, the magnitude of the volume variances will differ by the extent to which budgeted revenue per service is different from budgeted expense per service. Summary & Resources Chapter Summary Budgeting is among the more important forward-looking requirements for managers. Budgets require a careful examination of the aims of an organization, its strategy for achieving those aims, and very specific measures that translate broad statements about services into specific counts and dollar values. The mission statement may serve as the guiding star for a healthcare organization, while the budget serves as the road map. Budgeting is part of the planning, managing, and controlling cycle used by organizations. At one level, planning involves making decisions about what services to offer and to whom they are sold. The end results of planning are forecasts of patient volume. Budgeting is the application of dollar amounts to the forecasts. Budgeting results in projected revenues associated with patient volume, projected expenses associated with patient volume (variable costs), and projected expenses associated with maintaining the organization (fixed costs). Once a budget has been adopted, the organization moves toward implementing plans and managing revenues and expenses. A budget cannot control revenues, but it can help to control 192 smi81240_07_c07_167-194.indd 192 3/7/14 9:45 AM Summary & Resources expenses. To the extent that the budget is linked with human resources and other areas of expense, it can serve as a tool that restricts unauthorized expenses. At the end of the budget period, the last step in the process is to evaluate the differences between the actual financial results and budgeted results. Using performance reports and, when warranted, variance analysis, managers can assess reasons for financial results and be prepared to revise plans and establish the next budget. Discussion Questions 1. A senior financial official has a preference for having a rigid budget process that involves only senior managers and the board of directors. The budget is completed within one month each year and presents quarterly projections of patient visits, revenues, and expenses. Budgets are not revised and are fixed for the year. The expense portion of the budget is based on the prior year’s actual expenses, with a 1% increase in expenses per patient visit. What are the pros and cons of such a budget process? 2. As presented in Exhibit 7.13, the actual salary and fringe benefits expense was 8.7% more than budgeted and the actual number of total patient visits was 1.4% more than budgeted. Without doing a variance analysis, can you estimate the proportion of the expense variance associated with volume and salary and fringe benefits expense per patient visit? If salary and fringe benefits expense are 6% higher than the budgeted amount for one three-month period, what actions should managers take? Exercises 1. The portion of Exhibit 7.6 that provides forecasts for the number of births is given below. What would you forecast as the number of births for 2014? Births 2009 2,003 2010 1,945 2011 1,842 2012 1,912 2013 1,813 2. A series of projections have been made for births in 2014. Net patient revenues associated with births are projected to increase from $12,446 to $12,757, fixed expenses are projected to increase from $14,000,000 to $15,500,000, and variable expenses are expected to increase from $650 to $700 per birth. What are the budgets for births for 2013 and 2014? 3. For 2012, the budget and actual values are presented in the following table. What were the sources of variances for revenues and expenses? Births Net patient revenue per birth Total net patient revenue Fixed expenses Variable expenses per birth Total variable expenses Net income smi81240_07_c07_167-194.indd 193 193 2012 Budget 1,842 $12,263 $22,588,446 $13,500,000 $650 $7,970,950 $1,117,496 2012 Actual 1,912 $12,142 $23,215,504 $13,500,000 $675 $8,195,850 $1,519,654 3/7/14 9:45 AM Summary & Resources Key Terms capital budget A document that provides a projection of elements on the balance sheet, with an emphasis on the fixed assets and how they are purchased through borrowing money or using savings. flexible budget A budget that establishes dollar amounts for revenues, expenses, and net income on a per unit of service basis. As volume of services varies, so does the total amount of the budget. capital rationing The application of internally or externally imposed limits on funds available for capital expenditures. Under capital rationing, not all profitable projects may be approved, meaning that only the most profitable projects can be accepted. operating budget A document that provides a projection of the elements on the income statement, namely the revenues and expenses of the organization. pro forma income statement A projected income statement (for the next period). cash budget A document that provides a projection of the timing of cash receipts and cash expenditures. strategy A statement of actions that are designed to achieve a specific aim. variance analysis A comparison of actual results and budgeted results with calculations of differences associated with volumes of services and revenues or expenses per unit of service. fixed budget A budget that establishes dollar amounts for revenues, expenses, and net income that are expected to be earned during the budget period, with a specific planned volume of services. zero-based budgeting A budgeting process that requires new information on all of the assumptions in the budget, rather than adopted prior assumptions. Suggested Websites • For analyses of the survey results on hospital services, see Hospital Compare: http://www.medicare.gov/hospitalcompare/ 194 smi81240_07_c07_167-194.indd 194 3/7/14 9:45 AM Capital Investment Decisions 10 .welcomia iStock/Thinkstock Learning Outcomes By the end of this chapter, you will be able to: • Understand the role of financial analysis for capital investments • Describe a capital investment process • Prepare cash flow estimates • Classify projects for investment analysis • Conduct cash flow analysis, using net present value, internal rate of return, and payback period decision rules smi81240_10_c10_245-268.indd 245 3/10/14 4:55 PM Section 10.1 Financial Analysis for Capital Investments Introduction Chamberlin Skilled Nursing, Inc. is concerned about its viability as a stand-alone skilled nursing facility. One plan that has been put forward is to acquire Soniat Skilled Nursing, Inc., a company with a similar mission and set of services, though in a different geographic market. The purchase of Soniat would be a substantial capital expenditure for Chamberlin. Soniat’s owners are agreeable to a plan of being acquired, if the price is right. Determining how much Chamberlin would be willing and able to pay for Soniat will require a careful capital expenditure analysis. Not all capital expenditure decisions are as large and difficult as purchase of an entire business. Many capital expenditure decisions are routine and involve the renovation or replacement of existing buildings and equipment. In any particular year, there may be many requirements for new or replacement equipment, and organizations must make decisions about which capital expenditures to make right now, and which to defer to future years. This chapter provides a financial framework for capital expenditure decision-making. 10.1 Financial Analysis for Capital Investments For the day-to-day activity of the organization, planning and budgeting focus on the operating budget, as described in Chapter 7. The operating budget should be consistent with both short-run and long-run aims of the organization and be guided by the strategic plan. It is important to have a good sense of what the aims of the organization are and how they translate into services that are offered to the community. In the short run, the plan includes expected volumes of services, expected revenues, and expected expenses. The end result of short-run planning is a pro forma income statement. Buildings, clinical space, and medical equipment are all necessary for providing healthcare services. For short-run planning, existing facilities are taken as fixed, which may place capacity limits on the volume or availability of programs or services. Further, in the short run, many clinical program offerings may also be fixed. Hiring of specialized clinical personnel and rearranging clinical space doesn’t happen overnight. In the long run, plans are open to changing the assets and programs of the organization. The end result of long-run planning is the pro forma balance sheet of the organization. The asset side of the balance sheet is planned through a process of capital investment decision making, or capital budgeting, as the acquisition of assets requires the use of equity capital or debt. Capital budgets indicate dollar amounts approved for the purchase, construction, or development of assets or programs. In aggregate, total expenditures for physical assets for healthcare organizations in the United States exceeded $103 billion in 2011. Expenditures for buildings for healthcare organizations were more than $45 billion in 2011, of which more than 80% came from private sources (as opposed to federal, state, or local governments). Expenditures for equipment in healthcare organizations were more than $58 billion in 2011, of which more than 70% came from private sources (Centers for Medicare & Medicaid Services, 2012). The total amounts of private spending for healthcare buildings and equipment over the last decade are presented in Figure 10.1. The recession and concerns over healthcare reform have slowed the increase in private capital spending that occurred in the years leading up to 2008. Still, $75 billion in expenditures is a lot of money. Each of these dollars spent on 246 smi81240_10_c10_245-268.indd 246 3/10/14 2:27 PM Section 10.1 Financial Analysis for Capital Investments buildings and equipment for healthcare organizations was the end result of a capital investment process. Figure 10.1: Private expenditures, healthcare buildings and equipment, 200222011 Equipment Buildings 100 90 Dollars (in Billions) 80 70 60 50 40 30 20 10 0 2002 2003 2004 2005 2006 2007 Year 2008 2009 2010 2011 Source: Centers for Medicare & Medicaid Services (2012). Medicare & Medicaid Statistical Supplement. Retrieved from http:// www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/MedicareMedicaidStatSupp/index.html Each item in a capital budget is a capital investment. The key idea behind capital investments, each being an asset or a program, is that there is an expectation of a cash outflow in the near term, and net income from the resulting activities facilitated in the long term. For some capital investments, like a renovation to expand a clinic, expenditures may happen quickly, and net income may be earned in the same year. For other capital investments, like the construction of a new outpatient building, expenditures may occur over several years, with several more years of creating programs that eventually result in positive net income. For some capital investments, there are only expenses without any net income, as is the case with new information systems. As noted in Chapter 8, corporate finance involves preparation of information for making decisions about asset acquisition and other long-term investment decisions. Therefore, the analysis of individual capital investments, the capital budget, and the planned balance sheet are important products of corporate finance. This chapter will present the finance contributions toward capital investment decisions and budgeting. It will present a framework for considering capital investments, focusing on cash flow analysis and decision rules for undertaking investments. The full capital expenditure budget will then be developed, with a focus on capital budgeting in not-for-profit organizations that may face financing constraints. 247 smi81240_10_c10_245-268.indd 247 3/10/14 2:27 PM Section 10.2 A Capital Investment Process For Review: 1. What is the focus on capital investment decision making? Capital investments are long-run decisions. The focus is on the acquisition of assets or programs that will involve expenses in the short run and, for many investments, net income in the long run. The financial statement of importance is the balance sheet. 10.2 A Capital Investment Process Just as organizations develop processes for operating budgets, processes are required for capital investments. A depiction of the process for capital investments is provided in Figure 10.2. All investments start with strategy. A strategy is a pattern of decisions that organizations make over time. The key to effective long-run strategy is that the pattern of decisions is consistent and positions an organization to be unique in the marketplace. Long-run strategy is highlighted in the next section. With a strategy in mind, the next step in capital investments is to identify assets and programs, collectively called projects, in which the organization might make long-term investments. For certain large-scale projects, such as the purchase of a company in the same general business, the idea for the capital expenditure may be a direct result of the strategic planning process. Chamberlin Skilled Nursing’s plan for the purchase of Soniat Skilled Nursing is a direct result of a strategic intent to grow and diversify its facility holdings. For other projects, the source may be a department’s need to replace aging or outdated equipment, or a clinical group’s interest in having more space or equipment, or offering a new service. Given the multitude of ways in which individuals, departments, and groups of departments might generate ideas for projects, organizations generally define a process for making decisions on the use of scarce resources for capital expenditures. Figure 10.2: Capital investment process Strategy Monitor Identify Decide Estimate 248 smi81240_10_c10_245-268.indd 248 3/10/14 2:27 PM Section 10.2 A Capital Investment Process Step 1: Identify A traditional capital investment process in healthcare organizations includes four steps: identify, estimate, decide, and monitor. The first step is to identify and classify projects for consideration. For larger healthcare organizations that have a large number of potential projects, this step may involve the submission of proposals. At Bixby Hospital, a capital request form is required for all potential capital expenditures. The cover page for the request form is presented as Exhibit 10.1. The form starts with the identification of the department making the request, and the name of the equipment being proposed for purchase or the title of the project being proposed for development. Preparation of a full proposal may generate substantial information for decision makers. For purposes of initial review and ultimate presentation of an approved project, a brief description is also required. Exhibit 10.1 Capital request form, cover page, Bixby Hospital, 2012 Department: Name of Equipment or Title of Project: Brief Description: (maximum 1 page if attached) Amount Requested Cost of Project/Equipment: Cost of Internal Installation Costs (current employees): Cost of Marketing (if new services): Total Amount Requested: Purchasing Review of Quotes for Price Comparison? Expected Useful Life (Years): Maintenance Annual Expense: Disposable Components Annual Expense: Justification New Purchase/Replacement: Disposition of Current Equipment: Trade-in/Parts/Sale: Purpose (Patient Care, Productivity, Financial, Other): Brief Description (maximum 1 page if attached): Capital Investment Decision Equipment/Project Approved in Capital Budget If YES, Total Amount Approved: If NO, Brief Reason: Approvals Administrator Biomedical Engineering Committee Infection Control Committee Marketing and Planning Source: Author. $ $ $ $ Date: $ $ $ $ Physical Plant Committee Supply Chain Committee Regulatory Affairs (certificate of need) Other 249 smi81240_10_c10_245-268.indd 249 3/10/14 2:27 PM Section 10.2 A Capital Investment Process An ideal description also classifies each project as being dependent upon the approval of other projects, independent of other projects, or mutually exclusive of other projects under consideration. Dependent projects should clearly indicate the nature of the relationships with other projects and any timing issues. For example, the purchase of magnetic resonance imaging (MRI) equipment is dependent upon having an appropriate location in the building. The space for an MRI requires lead shielding for radio frequency, vibration resistance, appropriate electrical power, heating, ventilation, and air conditioning, and plumbing for an MRI cooling unit. If the purchase of the MRI and space renovation are separate projects for approval purposes, their connection as dependent projects must be clearly identified. And space renovation needs to occur first. Independent projects do not have identified relationships to other capital expenditures. Independence among projects doesn’t necessarily mean independence from other budget decisions. Purchase and installation of an MRI requires the hiring of technicians and perhaps other personnel, which may be dependent upon the operating budgeting process. An important note here is that after capital expenditures have been made, the resulting activity becomes part of the operations of the organization, and all financial results become part of the operating budget. For this reason, approval of capital budgets often occurs before the approval of operating budgets, permitting time for the financial implications of new projects to be included in the operating budget. Mutually exclusive projects are those that involve selection of one proposed project or another, or neither, not both. Proposals for the purchase of used MRI equipment and new MRI equipment, for an existing space, is a case of mutually exclusive projects. The organization may select between the two projects. Some instances of mutually exclusive projects may be less obvious. A proposed sleep lab and an additional MRI might each seek to use the same space in the building. Unless both proposals are quite specific in their identification of the space in the building to be used, it may be possible to approve both projects, purchase equipment, and then discover that both projects aren’t feasible because the space has been approved for two purposes. Step 2: Estimate The second step in the capital investment process is to estimate cash flows and the riskiness of the cash flows. Again, most capital investments involve the purchase of equipment or other assets and expenditures for project development early in the timeline. The cover sheet of the form includes amounts for the initial cost of the project, including amounts associated with the use of current Bixby employees to install the equipment or otherwise get the project started. The cost of current employees isn’t a new expenditure. The costs of current employees are included on the form to indicate the opportunity cost of other activities that those employees could be pursuing were it not for the new project. To satisfy good control procedures, healthcare organizations may have purchasing departments that coordinate all purchasing activities and obtain price quotes for all purchases above a stated threshold. For small organizations, multiple quotes may be requested for comparison purposes at a level of $1,000. For large organizations, thresholds may be $5,000, $10,000, or more. For the purchase of MRI equipment, it may be required that several quotes for prices be obtained for equipment within certain specifications (magnetic power and other issues). 250 smi81240_10_c10_245-268.indd 250 3/10/14 2:27 PM Section 10.2 A Capital Investment Process Development of estimates of cash flows on the revenue side involves coordination with marketing and planning personnel. Finance personnel can be expected to have good insights on the expenses associated with new equipment and programs. They can’t always be expected to have expertise in forecasting the volumes of services associated with new equipment and programs. This is the area of expertise of personnel in marketing and planning. The riskiness of the cash flows can be incorporated into analyses in two ways. First, organizations may prepare alternative forecasts of cash flows to understand the sensitivity of alternative assumptions about the functioning of a project on its cash flows. Second, the discount rate used to evaluate future cash flows may be adjusted to account for the riskiness of a project. These methods are discussed further in this chapter. Step 3: Decide The third step in the capital investment process is the decision. Organizations often have different criteria for decision making with new projects, as opposed to replacement projects. If the useful and technologically appropriate life span for an MRI is 10 years (perhaps with a life span of seven years in depreciation for financial accounting), an organization nearing the 10-year point may examine the costs of new equipment. If new equipment will merely replace existing equipment, there may be little uncertainty about other cash flows, and the decision may be made without much additional information. For new projects, justification for the project must be included. The ideal justification includes consideration of how the project enables the healthcare organization to fulfill its aims and technical information on the proposed expenditure. Among the goals of a healthcare organization are those related to patient care, which would be justification for new medical equipment or clinical program expenditures. Enabling new or better ways to treat patients is often a good justification for medical projects. Productivity improvement and purely financial reasons are also reasonable justifications for new projects. Information system upgrades that permit faster data entry or retrieval, which can reduce the time spent by clinical personnel, may be good projects to improve productivity. Accounts receivable system upgrades that accelerate payments may be justified purely on the basis of positive net cash flows. Healthcare organizations may also have criteria for project approval beyond improving patient care, productivity, and financial results. Other justifications for project acceptance may include improving patient satisfaction, improving provider satisfaction, and providers’ financial results, independent from the finances of the organization, and improving community goodwill. A key aspect of good financial management is to be clear about the criteria for project approval. Projects that are proposed on the basis of financial results, that are actually accepted to keep one particular provider satisfied, may result in many wasted hours of analysis during the monitoring phase as they fail to provide expected financial results. The final part of the decision-making step is the decision. Capital investment decisions are sometimes clearly yes or no, but they more often involve the use of a scoring system. Based upon an organization’s mission and strategy, the elements of a scoring system might include categories that represent the highest priorities: ensure patient/employee health and safety, 251 smi81240_10_c10_245-268.indd 251 3/10/14 2:27 PM Section 10.2 A Capital Investment Process improve quality (clinical outcomes, patient satisfaction), improve productivity, increase volume and market share, and ensure financial health (Lyons, Gumbus, & Bellhouse, 2003). Projects may be ranked by a scoring system and funded starting at the top of the list and going down until available funds are exhausted. If a project is approved, project timing, the dollar amount of the approval, and the specification of any additional constraints on the use of funds are included in the communication of the decision. If a project is denied, good management practice dictates that a brief reason be provided. In some cases, there may be financial constraints that led to a denial for the current capital budget and permit the project to be reconsidered for a future capital budget. The score for a project may have been good, but there were other projects with higher scores. In other cases, the project may not be viewed as a good fit with the organization’s strategy, or it may be determined that it does not provide an adequate financial return on investment. The score for a project may be sufficiently low and would never be funded. In these cases, the project is simply denied. Providing honest reasons for project denial may require tact. Suppose that a project for the renovation of a waiting area is proposed with the justification of improving satisfaction with a particular clinician. A denial of the project does not necessarily mean that the organization is not interested in the satisfaction of the provider. It may be that provider satisfaction is very important and that in the current year purchases of replacement medical equipment were a higher priority. Nobody likes to hear that something, or someone else, is a higher priority, so tact is important. Analyze This How would you explain to an important physician that a project to renovate the waiting room outside of her clinic was denied? What information would you share with the physician? Step 4: Monitor The decision is the end of the third step, and the start of the fourth step in the capital investment process. Before budgetary approval, approval by other aspects of management and perhaps outside parties may also be required. Department administrators, who may be held accountable for the achievement of project goals, must approve projects. Individual program managers may be permitted to propose projects, but not without the approval of the lead administrator. Once approved, monitoring and control of the budget falls under the control of the administrator. Similarly, a host of other managers may be required before approval. For example, if a project requires specialized supplies, the office of procurement or a supply chain committee may be asked if the plan for supplies can be provided as stated in the plan and whether the plan has any implications for current use of supplies. For projects that involve large purchases or construction that fall under the authority of statelevel certificate of need programs, there may be a series of official approvals that are also required. Certificate of need programs still operate in many states as a means to limit construction and purchases of equipment as a means of controlling the growth in healthcare costs (Cauchi, 2009). 252 smi81240_10_c10_245-268.indd 252 3/10/14 2:27 PM Section 10.2 A Capital Investment Process Postapproval reviews are a component of the capital budgeting process in many organizations and may be used as additional opportunities for decision making on the continuation of projects. They may also be used as analyses of the capital budgeting process itself. Based upon postapproval reviews, organizations may learn more about what should be included on the capital budget request form, so the right questions are asked early in the process. Organizations may also learn how to improve on cash flow estimation techniques. Too often, projects are approved with no follow-up to determine whether the capital budget process is working properly and leading toward a more effective healthcare organization. The finance contributions to the second and third steps are expanded upon in later sections. Estimating cash flows is perhaps the most important role for financial managers, and the most difficult. Decision making typically involves an assessment of financial results, even if they are not the primary justification for a project. Before these finance contributions are explained, an explanation of long-run strategy is presented. Long-Run Strategy The strategy of a healthcare organization is the plan by which it intends to achieve its aims. The te...
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Running head : PREPARING CAPITAL BUDGET EXPENDITURE

Preparing capital expenditure budget
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PREPARING CAPITAL BUDGET EXPENDITURE
Preparing capital expenditure budget
Preparation of capital expenditure budgets is one of the most critical tasks in
developing organizations. This is particularly so due to the huge finances involved and also
the high expectation in the roles or contribution of the expansions to the future performance of
the organization. Notably, capital expenditure budgets are the budgets prepared when an
organization wishes to acquire or upgrade its facilities or operations (Gapenski, & Gapenski,
20...


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