SECOND QUARTER:
Volume 4, Number 2
May – July 2009
Capital Formation Strategies for Hospitals
By: Calvin W. Weise; CPA, MBA, CMA
By: Dr. David Edward Marcinko; MBA, CMP™
By: Hope Rachel Hetico; RN, MHA, CPHQ, CMP™
Institute of Medical Business Advisors, Inc.
Introduction: Strategic Importance of Capital Investing
Some of the most important strategic decisions hospital executives make are related to capital expenditures. Almost every hospital has capital investment opportunities that are far in excess of their capital capacity. Capital investments are bets on the future. How these capital bets are placed has long-lasting implications. It is of utmost importance that hospitals bet right. And, the current financial crisis illustrates just how wrong they were in 2009.
Hospitals are capital intensive businesses. Hospital buildings are unique structures that require large amounts of capital to construct and maintain. Inside these buildings are pieces of expensive equipment that have fairly short lives. Technological innovations continually drive demand for new and more expensive equipment and facilities. The ability to continually generate capital is the lifeblood of hospitals. In order to compete and succeed, it’s imperative for hospitals to continually invest in large amounts of capital equipment and expensive facilities.
Capital investment is fueled by profit. In order to continually make the necessary capital investments, hospitals must be profitable. Hospitals unable to generate sufficient profit will fail to make important capital investments, weakening their ability to compete and survive.
Hospital managers bear important responsibility in choosing which capital investments to make. There are always more capital opportunities than capital capacity. In many cases, capital opportunities not taken by hospitals create openings for others with capital capacity to fill the vacuum. By not taking such opportunities, hospitals are weakened, and their operating risk increases.
Stewardship is a term that aptly describes the responsibility borne by hospital managers in making capital investments. The New Testament parable of the talents describes this kind of stewardship. In this story, a merchant entrusted three managers with money to invest. One manager was given five units, another two, and a third one. At the end of the investment period, the two managers given five units and two units reported a 100% return. The manager given one unit reported zero return — he was fired and his unit was given to the first manager.
This is stewardship — and hospital managers are stewards of their organizations’ assets. Too often, not-for-profit hospital managers hold an erroneous view of the returns expected of them. Like the third manager in the parable, they think zero return on equity is acceptable. They understand capital investment funded by debt needs to cover the interest on the debt, but they view capital investments funded by equity as having no cost associated with the equity. From an accounting perspective, they are right. From a stewardship perspective they are dead wrong — just like the third manager in the parable.
Here’s why: as stewards, they are responsible for managing the entrusted assets. They can either put these assets at risk themselves, or they can put those assets in the market and let other managers put them at risk. If they choose to put them at risk themselves, and then they have the mandate of creating as much value from putting them at risk as they would realize if they put them in the market for other managers to put at risk. They have the duty to realize returns that are equivalent to the returns they could realize in the market; otherwise, they should just put them in the market. They can either invest in hospital assets or work the assets themselves, or they can invest in financial market assets so others can work the assets. When they choose to invest in hospital assets, the required return is not zero. That’s the return they get fired for. The required return is equivalent to market returns.
Thus, when evaluating performance of hospital management teams, the minimum acceptable performance level is return on equity that is equivalent to the return that could be realized by investing the hospital assets in the market. And, when evaluating a capital investment opportunity, it is important to apply a capital charge equivalent to the hospital’s weighted cost of capital — a measure that imputes an appropriate cost to the equity portion of the capital along with the stated interest rate for the debt portion of the capital structure.
A. Strategic Considerations in Capital Formation
B. Analysis of Hospital CreditsGrowth
Market Position
Table 3: Market Share and Market Dominance: Hospital A dominates in one zip code
Table 4: Market Share and Market Dominance: Hospital A dominates in four zip codes
Table 5: Market Metrics in Randomly Selected California Hospitals
Market DefinitionsHospital Competitive Markets.
Hospital Types
Financial Ratio Analysis
Governance
C. Capital Formation Process
D. Capital Strategy
Case Model: The Valley Medical Center
Checklist 1: Credit Scoring
Hybrid Cost Analysis and Activity-Based Medical Cost Management
By: Dr. David Edward Marcinko; MBA, CMP™
By: Hope Rachel Hetico; RN, MHA, CPHQ, CMP™
Institute of Medical Business Advisors, Inc.
Introduction: Understanding Mix Cost Accounting and Modeling
Hospital and medical business costs may generally be divided into fixed, variable, and mixed (micro) overhead costs. However, the concept of mixed (micro) or hybrid costs has yet to be fully explored with its collateral modeling concept of activity based medical cost management. This chapter will explore these methods of costing for healthcare organizations using the following techniques and examples. A mixed (semi-variable) cost is one that contains both fixed and variable elements. For example, a CT scanner can be leased for $150,000 per year plus $100 per scan. In this case, the yearly lease is the fixed element while the per unit copy charge varies depending on use.
To further illustrate, assume that during a particular year the CT scan is used 1,000 times. The cost of the lease will then be $250,000; this cost is made up of the $150,000 in fixed cost plus $100,000 (1,000 x $100) in variable costs. Even if the leased CT scan is not used a single time during the year, the hospital will still have to pay the minimum $150,000 charge, but for each time the machine is used, the total cost of leasing it increases by only $100. Remember, this is a cost analysis and does not necessarily represent a revenue, charge, or profit analysis.
Healthcare organization business case development:
· focuses on “bottom line” results (savings vs. investment); · adjusts for future risks; and · identifies performance measures.
The idea is to get a handle on how much every task costs by factoring in the labor, technology and office space to complete it. In this way, the next time a discounted managed care contract is offered in 2009, or your medical clinic or hospital department is over-budget, you will know how to accept or reject the contract, or solve the variance problem. |
A. Hybrid Cost Analysis
B. Medical Activity-Based Cost Management
The Critical (Clinical) Path Method
Analyze Medical Service Activities
Gather Healthcare Costs
Trace Costs to Patient Healthcare Service Activities
Establish Output Measures
Analyze Medical Costs
Risk Adjusters
Medical Practice Cost Analysis
Table 1: Projected Utilization Costs
Table 2: Cost per CPT Procedure
Table 3: Patient Encounter Cost Drivers
Table 4: Activity-Based Cost Report
Medicare Physician Fee Schedule
ABCM/CPM in the Hospital Admission Setting
C. Conclusion
Case Model 1: The Federal Veteran’s Administration Healthcare System
Case Model 2: St. Peter’s Hospital Emergency Room
Checklist 1: Information and Variables Used to Influence Hybrid Costs
Checklist 2: Information Used for Critical Path Method Identification Activities
Checklist 3: Transactional Information Useful in Activity Based Medical Costing
Checklist 4: Information Used in a Healthcare Organization Cost Analysis
Checklist 5: Activity-Based Cost Management Processes