Module 3 Budgeting/Forecasting. Micro Case Study: Strategic Planning in the Current Environment

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1 Module 3 Budgeting/Forecasting Micro Case Study: Strategic Planning in the Current Environment 18. You have been nominated to serve on your organization s strategic planning committee. You are informed that this type of planning is iterative and involves several phases. You view this as an exciting opportunity as you know the importance of such planning. What are the phases of strategic planning? What are the desired outcomes of the process? The strategic planning process includes: o Identifying the organization s current position including its mission, vision, and long term goals o Conducting an internal and external assessment and comparing the organization s condition against those findings Often called a SWOT analysis The strategic planning process includes: Identifying strategies Selecting alternatives Gaining acceptance of the preferred alternatives Preparing plans to carry out strategies Assigning responsibilities Implementing and monitoring results Once the planning begins you are specifically asked to lead the team that will conduct an environmental assessment. What are you asked to do? How do you proceed? What is the relation of the strategic planning and environmental analysis to budgeting? Environmental Assessment is an examination of what s happening both internally for the organization and externally in the community or region surrounding the organization. It may include an: Analysis of regulations at State and Federal levels and their impact on the organization. Appraisal of labor market issues including ability to recruit clinicians and physicians 1 P age

2 Environmental Assessment may include an: o Assessment of the economy, employment, and business factors within the community and/or region. o Evaluation of reimbursement mix and changes. o Comparison of the organization s performance to its peers and others in the region or comparable entities nationwide. o Analysis of the current, past, and potential future customers based on demographic data for the service area. o Understanding of what the competitors in the region or market may be considering or are doing. o Review of performance indicators: patient satisfaction, financial ratio analysis, volume and outcome reports, etc The budget incorporates the strategic and operating plans for the organization, both in terms of the revenues and expenses, as well as the statistical volumes and resources associated with the plan. o It also provides a framework for setting priorities, securing and allocating resources efficiently, and controlling costs The budget summarizes a set of expectations integrating the impact of environmental factors and management decisions. Micro Case Study: Budgeting Training for Managers 19. You are responsible for assisting managers in various departments to develop and manage their budgets. These colleagues are not as familiar with the budgeting process as you are. You want to provide some training in the budget process and so you schedule a budgeting orientation meeting to provide an overview of the budgeting process. Develop the outline of your presentation be sure to include the role of department/unit business plans in the budgeting process. Budgeting Basics the steps: Establish goals and objectives Determine the budget calendar Distribute budget instructions, input forms, and projected inflation rates Obtain historical data on costs and volumes by accounting periods Analyze internal and external forces that could affect historical patterns Project the volume of activities (patient visits, tests, surgeries) using all the above information a total budget will include statistics, operations defining expense and revenues, capital, and cash flows 2 P age

3 Project expenses and revenues Determine the other capital needs (equipment, debt service, and working capital) Establish revenue and rates schedule, net of reductions from revenue required to generate sufficient cash to cover the operating costs and capital needs Submit the budget if required to others for final approval Micro Case Study: Finance Staff Training 20. You have been asked by Human Resources to serve as an internal trainer for finance staff development activities. You are interested in this role and decide that as a first step you will enroll in the current in house finance training to understand the content presented. Across several weeks the following questions are presented. As diligent participant, you dive in and attempt to answer the questions: a. Identify and explain the different types of budgets: What are they? What are their different purposes? How are they related to one another? Three main types of control budgets used in the budgeting process: Operating Budget Capital Budget Cash Budget The operating budget places responsibility for meeting budget targets on departmental managers, where greater direct control of resources resides. Within the operating budget itself, there are three main types of budgets statistical, revenue, and expense budgets Capital Budget: The capital budget is an annual process to estimate the resources committed for new projects, equipment, and facilities. Generally a minimum of two components: maintenance capital and strategic capital. The cash budget is a product of the operating and capital budget. This budget predicts the cash flow and cash availability, and the income generated from operations and other sources of cash. 3 P age

4 b. Identify and explain the methods for determining operating revenue. Determining the operating revenues is a critical starting point for any budget. The projection of any operating revenues directly affects net income, some capital expenditure estimates, and cash flow estimates Three approaches: Estimate of Demand Past Activity Estimate the Number of Procedures or Patient Visits c. Identify and explain the typical components of an expense budget in a healthcare provider organization? The expense budget accounts for the quantities and types of resources to be used to achieve the projected statistical volumes. Includes: o labor, o supplies, o books/subscriptions o dues o education and travel expenses o maintenance contracts, o telephones, and o other resources used in the department d. Identify and explain the techniques for 1) developing and 2) evaluating a capital budget. Capital Budgeting The capital budget is an annual process to estimate the resources committed for new projects, equipment, and facilities. 4 P age

5 Individual capital projects may span several years due to the time requirement to develop and implement the project. Capital projects may involve the start up or acquisition of a new practice, service, or facility. Expenditures are classified as capital based on expected benefits of two or more years and a minimum investment set by the organization. The capital budget control process should consider a careful evaluation of each project appropriate to the size and complexity of a project. The following six components of information may be used to evaluate a capital project: Alternatives Available Benefit Data Resources Available Prior Performance Cost Data Risk Projection For developing the capital budget, there are generally a minimum of two components: maintenance capital and strategic capital Three common capital budget evaluation techniques: Payback method Net present value method Return on investment (ROI) method e. Explain how an organization utilizing the following strategies to derive needed capital for financing. What are the benefits and risks o f each strategy? Long term debt Equity financing Joint ventures Capital lease financing Strategic capital involves the expansion of existing programs, the initiation of new programs and services, or both It is common for organizations to identify more potential uses for capital dollars than the cash projections can support. Funding the capital needs may exceed the cash available and require the organization to consider incurring debt o Debt is usually evidenced by instruments such as bonds, notes, and mortgages 5 P age

6 Line of Credit: Are a source of financing however they are typically used to meet operational needs rather than to meet capital equipment or facility needs. o Long term debt o Equity financing o Joint ventures o Capital lease financing Long term debt is most often obtained via a debt issue in the form of long term bonds, usually tax exempt finance offerings The following two types of equity financing are available: o Internal equity financing o External equity financing In response to the increasing cost of debt financing and the shrinking supply of available capital in recent years, hospitals and medical practices have begun to look for other sources of capital. o The one vehicle that is becoming increasingly popular as a source of outside capital is the joint venture A lease arrangement provides for the payment and ownership of a capital asset as a contractual obligation executed over time, rather than at the time of possession. The parties involved in a lease include the user of the equipment, the lender, and the leasing company. f. Identify and explain the components of a cash budget. How are these interrelated? The cash budget is a product of the operating and capital budget. o This budget predicts the cash flow and cash availability, and the income generated from operations and other sources of cash o Prepared after the revenue, expense, and capital budgets have been prepared. Cash budget components: o Total Cash Available. o Total Cash Disbursements. o Total Cash Needed. Interrelationship of Budgets o All three of these budgets are highly interrelated. o The operating plan impacts the capital budget, which in turn impacts the operating budgets. o The operating budgets determine cash availability that in turn influences the capital budget. 6 P age

7 o All three of the budgets should be prepared and validated before the annual budgets are adopted. g. Define and provide examples of the following cost behaviors: Variable Fixed Semi variable Semi fixed or stepped variable Variable cost. Variable costs vary, in total, more or less in direct proportion to volume. An example is the relationship between supply costs and outpatient visits or patient days. For most healthcare organizations, about half of supply costs will vary directly with volume Fixed cost pattern. These are costs that, in the short run, do not change with changes in volume. Examples include depreciation, long term lease expense, or amortization of any incurred financing costs. Semi variable cost pattern. These are costs that vary in direct relation to volume after a minimal level of activity has been reached. An example of semi variable cost behavior in healthcare organizations is the telephone expense, whereby a monthly access and service charge is paid initially, no matter what the volume is, and then each time a long distance or local phone call is made an additional charge is assessed. Semi variable costs exhibit the behavior of fixed costs with a variable cost component Semi fixed or stepped variable. These are costs changing with volume, but not in direct proportion to the volume; rather, they follow a stair step pattern. An example of this in a hospital setting would be salary cost in an acute staffing area. 7 P age

8 h. Identify and explain key productivity and evaluation criteria Productivity Measurement and Evaluation One of the objectives of the budgeting and reporting process is to identify areas where corrective action may be appropriate. Specifically, management must determine that resources are being used as efficiently as possible. Key evaluation Focus Sample Approaches: Labor is generally the single biggest expense component of a healthcare provider, and it is therefore critical to measure and evaluate productivity on an ongoing basis. Often, it is possible to compare a department s statistical profile with that of similar departments, with national or regional averages, or with standards developed using management (industrial) engineering techniques. o It is also possible to modify the standard, such as the traditional patient day, using any of the available patient acuity measurement systems to produce a hybrid weighted patient day. Although comparable data from other institutions may be impossible to obtain, weighted patient day volumes could be collected and compared internally over time to develop acuity and productivity trend data for use in staffing models and decision making Because of the significance of labor expense for most healthcare organizations, it is also common for management to implement a separate labor productivity monitoring process. Sample reporting mechanism o Each variable cost center will be assigned a primary workload statistic associated with an equivalent labor statistic. o The labor statistic assigned is usually based on industry benchmarks that have been derived from high performing organizations. o Each reporting period, the system reports "earned" labor hours, based on actual workload units incurred during the period, to actual labor hours. The reporting path is similar to responsibility reporting. o Department managers explain variances to divisional leaders who report up to senior management. o The effect is to encourage high efficiency standards throughout the organization. 8 P age

9 Micro Case Study: Monthly Financial Reporting 21. As a finance manager you are asked to assist different department managers with their departmental monthly financial reporting. The monthly reports are prepared for the organization s executives so that they in turn may report to the board. There are three departments you have been assigned to assist: radiology, house keeping and the new outpatient day surgery center. What is the monthly reporting process? What data needs to be gathered? How do you believe the reporting should be structured? Management reporting can be effectively utilized in a budget process via responsibility reports. o Responsibility reports include information on statistics and revenues and expenses for each cost center or division. o They should be sent to each department head and each supervising vice president for those areas that they directly supervise. The responsibility reporting process is pyramid shaped, in which each department head who supervises more than one department receives an actual financial assessment, a budget versus actual, and the variances associated with the budget for that period. o On a monthly basis, these department heads provide explanations for their variances and send them to the vice presidents who supervise their direct departments. o The vice presidents, in turn, review the explanations, and then send their cumulative explanations to the chief executive officer for final review. o Once the CEO has determined that the variances have been adequately explained, the significant variances can be presented to the board of directors. Micro Case Study: Ratios! 22. Financial managers utilize ratio analysis in the performance of their responsibilities. What are the uses of ratio analysis, i.e. exactly what do ratios tell you and allow you to do? Explain what the following ratio categories measure and provide an example of a ratio in each of the categories: Profitability ratios. Liquidity ratios. Activity ratios. 9 P age

10 Capital structure ratios. Ratio analysis: a good measure of the present state of an organization s financial health. The Uses of Ratio Analysis? o Summarization of financial data o Assessing short and long range financial plans o Assessing debt capacity o Monitoring debt covenant compliance o Pricing of services o Strategic analysis Profitability ratios generally deal with the income statement, revenues and expenses, and how those relate to the organization s financial health and include: o Return on total assets o Return on equity Liquidity ratios. Liquidity ratios identifies assets are available to meet your short term obligations, and includes o Current ratio o Quick ratio o Acid test ratio Activity ratios. Measures the relationship between revenue and assets and include: o Total asset turnover o Fixed asset turnover ratios o Current asset turnover r o Inventory turnover ratio Capital structure ratios. These ratios are becoming one of the most important types of analyses because more and more facilities are incurring more debt as they posture for the future. This group of ratios include o The equity financing ratio o The cash flow to total debt ratio 10 P age

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