Question

As the manager of a healthcare facility, what steps could you take to assess and minimize the riskiness of expected cash flows in capital budgeting analysis?

Answer 1

The decision-making process is a multi-step process with all parties involved in the final decision. The capital budgeting process consists of five steps: Identify and evaluate potential opportunities, estimate operating and implementation costs, predict cash flow or benefit, assess risk, and implement the project (fool.com, n.d.). Each step involved in the capital budgeting process requires accurately capturing data of the healthcare organization. Essential data needed for a successful capital budget are financial blueprints for the hospital’s objectives, cash flow statements, capital expenditures, alternatives to purchasing, and factors that will affect the operating budget (Curing, n.d.). Capital budgeting works toward long-term success and without that data the company cannot accurately do so.

Large hospitals rely on this as the elaborate projects of expansion and renovation are long-term investments which are proven to be profitable by the data collected. More times than not, the hospital will utilize borrowing for these investments. If the hospital’s data shows that their operational and capital expenses are limited, the project is considered high risk. Debt financing plays into the borrowing process as a need. As the project is high risk, the banking institutions will find the company high risk as well regarding borrowing capital. Although credit spreads have narrowed in recent months, healthcare is perceived as riskier credit than other municipal debt. Credit spreads thus are wider for borrowers in health care than for other tax-exempt borrowers (Payne, 2015). Depending on whether or not the company utilizes an outside financer or internal, weighs heavily into the overall decision of the hospital’s capital budgeting.

Additional analysis should be done in the forecasting process to cover all bases to approve or deny a project. Estimates and data captured can always turn out to be unreliable in a healthcare system that changes by the minute. Sensitivity analysis is a component that should account for alternative scenarios. Sensitivity analysis helps a business estimate what will happen to the project if the assumptions and estimates turn out to be unreliable. Sensitivity analysis involves changing the assumptions or estimates in a calculation to see the impact on the project’s finances (Koening, n.d.). Monitoring the results of the analysis can direct the facility when determining if the plan is indeed risky and not profitable, or something that should be accepted.

As stated, anticipating and preparing for changes in an ever-changing climate such as the healthcare industry is essential. Healthcare continues to grow in addition to the spending on healthcare by the government and consumers. Due to those circumstances, there has been a slowdown in the collections and declines in revenue within the healthcare industry. The Affordable Care Act (ACA) worked on decreasing spending by providing all consumers with affordable health care options. One report stated that the United States is on track to spend $2.6 trillion less on health care between 2014 and 2019 (rwjf.org, 2016). On the same note, the changes the ACA implemented was to increase patient financial responsibility and also lower reimbursement rates.