Advantage Of A Discounted Cash Flow Method Of Analysis Capital Budgeting in the Healthcare Industry

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Capital Budgeting in the Healthcare Industry

Over the past few months, proposed healthcare reform has become a hot topic, and the healthcare industry has come under intense scrutiny for the administration’s efforts to reduce rising healthcare costs. As part of the rising cost of healthcare, more hospitals than ever are placed in a situation where capital budgeting becomes an essential tool; Not just for sustenance but mainly for survival. Absence of a capital budgeting strategy can spell potential disaster for hospitals as cost increases negatively impact the bottom line as revenue declines, and when funding is limited, a game plan for how funding should be is essential. Otherwise the hospital will find itself in a precarious situation.

Capital budgeting is the analysis of investment options in which cash flows are received or given over a period of time. Often, the best option is the one that generates the most cash flow over time. This issue may be disputed because other hospitals may place more emphasis on non-monetary outcomes. In such cases, the best option is one that comes as close as possible to an outcome that brings the hospital closer to its goals. Capital budgeting is a complex process as the selection process requires a lot of care and competing forces make it more challenging. Where there is competition, politics is more likely to be a factor, and politics often has disadvantages, especially when the voice of the minority is drowned out by the majority or loud voices.

To better understand how capital budgeting works in the healthcare industry, we’ll explore three different scenarios that occur every now and then in most hospitals across the country. For example, human resources may offer day care facilities for employees with children. Rationale: Staff turnover rate will be reduced and day care services offered will attract more nurses to the hospital. Turnover is costly to the hospital. Therefore, even if there is no increase in revenue from this project, the hospital will get the benefit of this project due to lower costs.

Another scenario is that the Imaging Services Department has proposed to purchase additional CT scanners to reduce bottlenecks and backlogs in the department. Is it too expensive to buy a scanner and therefore, if the current one is working, is another one needed? One can argue that the high demand of use creates stress among the staff, the wear and tear of the machines increases the maintenance costs, the overtime salaries of the technicians increase the overhead costs, and the hospital remains vulnerable if the current scanners are seized to function. These are all valid considerations. However, a surprise; Do the total benefits exceed the total costs?

A final scenario involves a group of doctors working for a hospital proposing to purchase a special machine that eliminates the need for hospitalization at home. The new machine has the benefit of reducing hospitalizations. By reducing patient hospitalizations, the hospital can be better positioned to reduce variable costs associated with facility utilization, and safety can be increased because fewer patients in the facility will greatly reduce the likelihood of hospital overcapacity. The only drawback is the large cost. The machine requires a large capital outlay upfront. So, as good as buying feels, other options feel just as good, if not better.

Faced with three alternatives, a financial manager in the health care industry must determine the opportunity cost of capital. The opportunity cost of capital operates on the basic law of finance that states that today’s dollar is not the same as tomorrow’s dollar. Therefore, while analyzing the three options, the time value of money should not be neglected as one may arrive at wrong conclusions if one does not consider the time value of money in the analysis. Future cash flows are discounted to their present value using a stated interest rate. Once the present value of all options is established, the option with the highest present value is considered the best option. This method of analysis is known as discounted cash flow method and from a personal point of view; This method should be widely used in the healthcare industry as it is guided by the important laws of finance mentioned above. I acknowledge the fact that every hospital is unique and predicting future cash flow is difficult in other instances. In this case, other methods should be considered. However, the discounted cash flow method, although sometimes imperfect, should be preferred first if everything is clear and all variables are known.

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