Join this webinar to see new enhancements to the Axiom Healthcare suite, including improved integration in the Enterprise Planning suite and additional costing methods in Axiom™ Enterprise Decision Support.
THE BASICS OF CAPITAL BUDGETING
Capital budgeting in healthcare is the process of evaluating and allocating funding to potential major projects, investments, building or infrastructure improvements, or the purchase of durable goods such as beds and equipment. A healthcare system might, for example, use capital budgeting to review a proposal for the construction of a new hospital wing or acquisition of an outside physician practice before approving or rejecting the project.
Capital budgeting involves reviewing the organization’s inbound and outbound cash flows to determine whether a project would meet specific quantitative and qualitative objectives.
Capital budgeting empowers organizations to allocate funding to projects that will add value to their operations or otherwise support organizational goals. To evaluate those projects, leaders use a variety of capital budgeting methods that determine if the project will be beneficial in the long term.
While capital budgeting is similar to a profit-and-loss analysis, the two processes differ. Capital budgets focus on cash flows stemming from the project, rather than profit, which accounts for revenues and expenses. Depreciation, for instance, is not included in a capital budgeting analysis because it is not a cash transaction. Capital budgeting also takes into account the future cash flows of an investment, converting them into what they are currently worth (i.e., present value)
Another way to create accurate project budgets is through capital budget and spend benchmarks from peer organizations. Using key metrics on capital budgets and spend from hospitals nationwide, healthcare benchmarks can measure the actual performance of each investment against its business plan and budget to provide objective measurements and enable comprehensive comparisons of potential capital spending strategies. .
One of the primary elements of a capital budget is the capital itself. Healthcare organizations’ definition of capital must capture all potential strategic investments. This definition should include all different types of investments that will be subject to the organization’s capital allocation process, such as:
In addition to initial capital costs, organizations must understand cash inflows and outflows as a result of the investment, including implementation costs and operating costs, as well as if and how the project will generate tangible inbound funding. To accurately calculate the value of future cash flows, organizations must also account for inflation.
Capital budgeting is important because it provides healthcare organizations with a framework for accountability and the ability to measure the risks and returns associated with a potential project. By measuring potential investment decisions, an organization can better predict the success and overall value of an investment — and over time, those projects have a significant impact on the organization’s performance.
Without a capital budgeting process, healthcare organizations can’t accurately predict which projects will generate a return, which makes it difficult to decide where to invest resources. With the thorough analysis included in the capital budgeting process, healthcare organizations can make data-driven decisions with confidence.
Using capital budgeting calculations and analysis, healthcare organizations can make informed decisions around potential investments, purchases, and projects. Examples of these decisions include:
Overall, capital budgeting helps healthcare organizations select profitable projects, identify sources of funding, and control capital expenditures.
CREATING A CAPITAL BUDGETING PROCESS
With increasingly varied capital investment needs, non-financial criteria have become more important for identifying an effective “portfolio” of investments. While a comprehensive capital budget should incorporate standard quantitative analytics, proposed projects must also be evaluated based on weighted qualitative criteria. Sample criteria might include the extent to which projects support the organization’s:
There are many reliable quantitative capital budgeting methods that healthcare organizations can employ to determine their ROI. We explore a few of the most common techniques below.
Payback Period
The payback period capital budgeting method calculates how long it would take a healthcare organization to generate the cash flows necessary to see a return on investment. Consider, for example, a piece of hospital equipment that costs $1,000 but generates a cash flow of $100 per year. This piece of investment has a payback period of 10 years. In other words, it will take the organization 10 years to recoup its initial investment.
Using a payback period analysis is useful to determine the length of time it will take an organization to recover its invested funds. However, it fails to account for any cash flow generated beyond that payback period. For example, the piece of equipment may have a payback period of 10 years but continue to create annual cash flow of $100 for an additional five years. This creates a greater total return on investment than the payback period analysis suggested.
This means you could compare two projects, determine that one has a much shorter payback period than the other — for example, two years compared to five years — and conclude that the two-year payback period project is a better investment. However, that the project with a payback period of five years has an ROI three times greater than the project with the two-year payback period. Leaders who don’t account for the total return on investment for each project overlook a critical piece of information that could impact decision-making.
Internal Rate of Return
The internal rate of return (IRR) is the expected return on a project. In other words, it is the discount rate that makes the net present value equal to zero. When the IRR is higher than the capital required to complete the project, the project is considered profitable and a sound investment. When the IRR is lower, the investment is not profitable and should, in most cases, be rejected.
However, the usefulness of this measurement depends on the organization’s capital structure. The IRR doesn’t necessarily give a full picture of the value that a project will generate; instead, it provides a benchmark figure for what projects may be profitable or not based on the organization’s cost of capital.
Net Present Value
Net present value (NPV) calculates how profitable a project will be compared to alternative options. This analysis involves discounting a stream of future after-tax cash flows back to present value. This enables organizations to understand the full value of a potential investment, illuminating whether the project will be profitable or not.
Net present value can be positive — representing a profitable project — or negative — indicating the initial investment is greater than the ultimate return. Theoretically, an organization should pursue projects with a positive NPV and reject those with a negative NPV — although actual decision-making may require more complex analysis.
Profitability Index
Profitability index computes the cash return per dollar invested in a proposed project. To calculate profitability index, divide the investment’s present values of cash inflows by the investment’s present value of cash outflows. If the result is greater than one, the investment will be profitable and should be accepted; if it is less than one, it should be rejected.
Because it is a ratio of cash inflow to cash outflow, the profitability index is useful for comparing projects that may have different magnitudes of cash flows.
Each individual healthcare organization’s capital budgeting process may look a little different. However, the following four steps provide a solid capital budgeting foundation.
1. Establish Objectives
Organizations must first establish objectives and goals to frame the capital budgeting process. These goals should be specific, measurable, and have a defined completion timeline. These goals can help organizations stay on track and make capital allocation decisions that align with long-range strategic and financial operating plans.
2. Quantify Available Capital
With established goals and guiding principles, organizations can move on to quantifying available capital. This involves defining the organization’s net cash flow available for project spending during a designated time period. This is a dual-sided process that must account for sources of funds (e.g., net income, new financing proceeds, cash reserve spend-down, etc.) and uses of cash (e.g., principal payments, external transfers, funds set aside for contingencies, and more).
3. Adapt the Process for High-Dollar, Multi-Year Projects
In the healthcare industry, projects often span multiple years and can cost into the millions. These high-dollar, long-range projects may require a modified capital budgeting process. For instance, organizations may implement “way points” to make additional capital allocation decisions as the project progresses. This empowers leaders to make more accurate funding decisions at every phase from concept and pre-planning to completion.
4. Apply the Appropriate Level of Business Planning Analysis
The dollar amount of a proposed project should trigger the appropriate level of analysis and review. High-dollar, multi-year projects, therefore, would undergo more rigorous evaluation. Applying standard analytic processes for potential projects — involving review of both qualitative and quantitative measures — is key to successful capital evaluation and allocation. A structured analysis process helps healthcare leaders confidently assess and approve capital priorities.
5. Improve Accuracy of Project Impacts With Peer Benchmarks
When extracted directly from capital planning and tracking systems, benchmarks provide accurate and timely comparisons of capital dollars that have been committed, funded, and spent at peer organizations. Organizations can establish a financial context on which to base key project investment decisions and better understand the financial impacts of proposed capital projects.
Healthcare organizations can simplify the capital budgeting process with these best practices:
With Axiom™ Capital Planning and Tracking, healthcare leaders can easily make decisions to optimize strategic and financial performance. Capital Planning and Tracking drives consistency, objectivity, and visibility into the entire capital project selection and management process. The solution empowers healthcare organizations to objectively evaluate capital requests, prioritize requests through ranking and scoring methods, monitor project progress against the capital budget, and determine the right amount of investment in capital projects to support strategic growth and effective care delivery. Through integration with the Axiom Healthcare suite, Axiom Capital Planning and Tracking supports a comprehensive decision-making framework for a hospital’s financial planning and analysis. Syntellis also aggregates and anonymizes capital spend analytics monthly from more than 600 hospitals nationwide. These capital benchmarks provide a wider breadth than equipment pricing with the most objective and current view into the way hospitals budget and spend their capital dollars.
Axiom Capital Planning and Tracking is a proven solution that helps organizations:
With Axiom Capital Planning and Tracking, healthcare organizations can select the best projects based on capital constraints and business goals.
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The world is saturated with data. If properly leveraged, data can reveal answers to many important questions. It can drive improvements across numerous industries, yet much of the data available today goes untapped. A decision support system (DSS) or decision support tool is designed to pull relevant data from multiple internal and external sources, analyze the data, and translate the findings into meaningful information that helps stakeholders make better decisions.
An effective decision support system structures data with flexible reporting and analysis tools that make the data more accessible and consumable. It helps leaders quantify the potential impacts of different decisions. Information gleaned from a decision support system can help entities determine strengths, weaknesses, and opportunities for improvement.
Sound decisions start with reliable data. The purpose of a decision support system is to use data to provide transparency and clarity into a certain topic so leaders can make streamlined, data-based decisions that align with individual or organizational goals. The system takes data from disparate sources and puts it in a usable format to help leaders better understand the many factors affecting performance — financial, operational, or otherwise — and how they interact to drive specific outcomes.
A decision support system is important because it creates a single source of truth and a central repository for aggregating data, compiling reports, and making reasoned, data-driven decisions. It provides transparency into both the data and the overall decision-making process, which is a necessity in an environment where organizational decisions, costs, and the quality of services or products face mounting scrutiny across many industries. Decision support systems also are important post-decision, because they enable entities to better view and track progress toward organizational goals over time.
Hospitals are complex, multi-faceted organizations with many levels of decision-makers, including managers, directors, executives, and more. At a fundamental level, some of the different types of decision-making in hospitals include:
Decision support in healthcare is a critical tool that helps healthcare leaders, clinicians, and other healthcare professionals sift through a large amount of data and analyze relevant data points to make important decisions. Hospital decision support is an information cornerstone in healthcare, helping to guide data-driven decisions across nearly all hospital and health system functions, including clinical, financial, and operational considerations.
With healthcare data available from an ever-wider range of internal and external sources, technology can provide solutions to data-gathering and aggregation challenges. Decision support systems help hospitals, health systems, and other healthcare providers harness their data to drive better decision-making amid changing market conditions. A decision support system in healthcare helps organizations quantify the impact of every decision they make across different departments by collating, calculating, and extrapolating data in a way that stakeholders can readily utilize.
Data is the lifeblood of every hospital and health system. A decision support system or “DSS system” is used in a hospital to facilitate timely and accurate data-driven decision-making, and to bring transparency and visibility to clinical, financial, and operational decisions. By leveraging data, healthcare decision support systems provide analytics that can help healthcare leaders determine the best ways to reduce rapidly rising healthcare costs, improve efficiencies, enhance patient safety, improve patient care, and achieve better patient outcomes.
Rising costs and the focus on value-based care continues to increase the demand for robust analytics to guide a broad spectrum of healthcare decisions. Decision support systems are critical, connecting organizational data with core planning solutions and external market data to give hospital leaders a comprehensive view of performance across cost, quality, and service line measures.
The primary types of decision support in healthcare are:
Healthcare financial decision support is focused on helping hospital executives, department managers, and other healthcare leaders determine how best to manage their organizations. Healthcare financial decision support software aggregates and analyzes data from a variety of sources so leaders can make informed, data-driven decisions on how to maximize efficiencies, reduce costs, optimize revenue, and position their organizations for growth. For example, a financial decision support system applies cost data to department operations to support budgeting, productivity, and performance monitoring. It also can provide data for assessing service-line profitability, performing health plan analyses, and quantifying the cost of quality.
Clinical decision support is a core component of ensuring high quality patient care at the bedside. A clinical decision support system provides data and analytics to help physicians, advanced practice nurses, and other caregivers more accurately diagnose patient conditions and identify the best treatments. Clinical decision support systems sort through large amounts of data from electronic health records (EHRs) and other sources to help clinicians as they provide patient care in real time. The goal of a clinical decision support system is to help avoid adverse events and enhance the quality, effectiveness, and efficiency of care. For example, it can help a physician link symptoms to a specific diagnosis, determine an appropriate medication dosage, and avoid harmful medication interactions.
Clinical analytics refers to a type of healthcare decision support that takes a more comprehensive view of care delivery within an organization, as opposed to clinical decision support which focuses on care decisions for individual patients. With clinical analytics, healthcare executives and clinical and finance leaders can compare their organization’s clinical data to peer organizations to gauge performance down to specific departments or service lines. It allows them to establish an accurate picture of costs and utilization at the encounter level, then perform meaningful analysis across various patient cohorts or clinical service lines. These insights are then used to make vital decisions such as how to reduce unwarranted and often costly variations in care, enhance care coordination, and track and improve workforce productivity.
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