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Capital Costs

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purchases of land, buildings, and equipment

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CON legislation/social security amendments

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Certificate of need legislation 2 programs were enacted in 1974 in attempts to slow the growth in healthcare capital costs: National Health Planning and Resources Development Act, Social Security Amendments- both compelled hospitals to get permission from a governmental entity before major capital expenditures

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Social Security Amendments 1983

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Introduced Medicare Prospective payment designed to slow Medicare costs by reimbursing hospitals and other healthcare providers based on predetermined payments rather than reimbursing costs after the fact

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The Tax Reform Act 1986

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lowered the tax deductibility for charitable gifts and restricted or increased the cost of acquiring capital through tax-exempt bond markets.

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OBRA

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Omnibus Budget Reconciliation Act 1990 moved capital costs to prospective payment over a ten year implementation period. These acts slowed capital growth.

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Balanced Budget Act 1997

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stifling effect on the access to capital, as many hospitals were forced to use funds earmarked for capital projects to subsidize operations b/c of reduced reimbursement from Medicare.

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Capital Expenditures

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Defined by an org. in its capital expenditures policy, and as result, the definitions vary. Capital expenditures are purchases of land, buildings, and equipment used for operations, are not for resale, have a useful life of more than one year; cost $5000 or more; and are subject to depreciation, with the exception of land, which is not depreciated unless the use of the land harms the future use of the land

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Land

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including all costs associated with acquiring land and making it ready for use (the cost of the land itself cannot be depreciated unless the use of the land harms the future use of the land)

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Land Improvement

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including all costs associated with sidewalks, parking lots, driveways, and fencing

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Buildings

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including all costs associated with constructing or buying buildings

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Fixed equipment

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including all costs associated with equipment that is permanently attached to the building, such as the plumbing system, furnace, and air conditioners

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Major Movable Equipment

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that has a useful life of three years or more and has a unit cost of $5000 or more

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Major Repairs

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benefit future periods and/or extend the useful life of the building or equipment

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Budgets for Replacement Capital

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expenditures include requests to replace existing buildings and equipment that are made for a number of reasons: scheduled replacement at the end of the useful life or when fully depreciated improved productivity improved quality b/c it is required by regulation

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Budgets for New Capital Expenditure

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include requests to add buildings and equipment for a number of reasons Expanded services Improved safety conditions Reduced operating expenses improved patient care

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Step 18

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ID and Prioritize Requests 18th step in the corporate planning/ first step in the capital budgeting process is for the budget committee to ID and prioritize all capital requests. The budget committee prioritizes the list based on community need and compliance with the strategic plan as initial criteria

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Step 19

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Project Cash Flows 19th step in the planning process and the second step in the capital budgeting process is for the dept. managers to project, and the budget committee to confirm, cash flows for e/ capital expenditure request. In cases of replacement equipment, this is a relatively easy step in that revenues (Volumes X Charge per procedure), expenses (Volumes X Expense per procedure) and resulting cash flow (Revenues-Expenses) For new equipment or equipment that the org. has never had before, revenues and expenses may be difficult to project

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Step 20

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Perform Financial Analysis The 20th step in the planning process and the third step in the capital budgeting process is for the budget committee or the chief financial officer (CFO) to perform financial analyses on the requests

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Pay Back Period Analysis

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is the number of years necessary for cash flows to recover the original investments. Easy to calculate, least sophisticated. Does not take into account the effects of time on money

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Net Present Value

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commonly used financial analysis for capital expenditures that relies on discounting cash flows. where discounted payback period gives the manager an answer in years, NPV gives the manager an answer in dollars. NPV of 0 means that the capital expenditures is generating discounted cash flows just sufficient to repay the original investment. If the NPV is positive, the expenditure is generating discounted cash flows in excess of the amount necessary to repay the original investment. If the NPV is negative the expenditure is generating discounted cash flows insufficient to repay the original investment

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Internal Rate of Return

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IRR is the discount rate of a capital expenditure where the discounted cash flows equal the expenditures original investment, or the discount rate where the NPV is 0. Discounted payback period analysis gives the manager an answer in years, and NPV analysis gives the manager an answer in dollars. IRR analysis gives the manager an answer in a percentage.

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Step 21

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ID Nonfinancial Benefits The twenty first step in the planning process and the fourth step in the capital budgeting process is for the dept. manager requesting the capital expenditure to ID nonfinancial benefits for the request. Examples of nonfinancial benefits community need medical staff politics

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Step 22

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Evaluate Benefits and Make Decisions 22nd step and last step in the planning process and the 5th and final step in the capital budgeting process is for the budget committee to evaluate the financial and non-financial benefits for e/ request and make decisions. A budget committee can use a decision matrix- with weighted criteria similar. Implicit in the decision making process is an evaluation of the decision.

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Financing Capital Expenditures

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HCOs can use cash generated from philanthropy, funded depreciation, operating surpluses, and debt to finance capital expenditures. The org. should use funded depreciation to finance replacement equipment and philanthropy, operating, surpluses, or dept to finance new equipment.

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Tax Reform 1986

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limited the tax deduction individuals were able to take for donations; as a result, philanthropy to hcos declined.

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Medicare

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Medicare reduced the risk associated with debt financing by reimbursing 100% of interest on debt use for capital expenditures.

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Nixon

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encouraged debt financing by allowing local gov. to create taxing authorities that issued tax-exempt bonds. HCOs finance about 80 to 90% of their capital needs with debt

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AHA reported

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In 2010, the AHA reported the lasting effects on the healthcare industry: 44% reported reduced access to capital and 67%had not started approved capital projects or had put capital projects on hold. One of the most significant factors affecting an org's ability to access the capital markets is the org's creditworthiness. A ratio of ratings upgrades to downgrades is one of the industry's most important ratios for determining creditworthiness

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5 Common Factors driving Credit Rating

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effective management and governance improved and sustained operating performance strong and liquid investment portfolios and management of debt structure risks favorable market demographics and market share and favorable change in org. or legal structure

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Debt to Capitalization Ratio

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Long term debt/long term debt + NA Higher values imply a greater reliance on debt financing as a percentage and may imply a reduced ability to carry additional debt

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Capital Expense Ratio

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interest expense +depreciation expense/ total expense x 100 high fixed costs in proportion to variable costs are said to be highly leveraged

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Average Age of Plant

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accumulated depreciation/ depreciation expense higher values reflect an older plant and equipment and indirectly may imply a difficulty in competing with \"newer\" HCOs. lower values reflect a newer plant and equipment.

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Discount Ratio

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