Assignment
Overview
The success of an organization has a lot to do with the execution of the strategic and financial planning established by the business. Strategic planning identifies a company's overall mission, goals, and key strategies to achieve objectives on a short- and long-term basis. Financial planning involves internal efforts of an organization to establish financial goals and objectives and to ensure that these metrics are achieved. There is a correlation between the two planning strategies. The goals and objectives established in strategic planning set in motion the revenue targets and staffing needs that are built into the financial planning.
Health care facilities rely on various budgets and financial planning techniques to manage short- and long-term objectives. Some of these budgets track the organization in total and others will filter down to various departments or divisions of the health care facility. Key executives are the employees who are interested in the organization-wide results, while supervisors and managers of departments are concerned with the specific areas of the business they are responsible for. In addition, the department budgets put direct accounting on managers to drive results, whether it is to generate revenue, manage expenses effectively, or both. In addition, managers are tasked with achieving financial objectives, but in a manner that delivers quality services to patients. In most cases, managing to the bottom line without regard to quality care will lead only to short-term success.
The most critical of all budgets is the operating budget. This is generated annually and combines the annual revenue budget and expenditure budget. The annual revenue budget is the detailed revenue projections based on the categories of services offered by the facility. The expenditure budget for the organization is the combination of approved operating budgets for the various areas, as well as the current year's approved capital replacements and improvements (facilities upgrades and maintenance). It also includes depreciation and amortization expenses not specific to any department but related to the entire facility. Thus, there are facets managed at the macro level with executives and other parts of it by managers and supervisors of specific departments.
Another vital budget is the cash budget, which is a basic projection of revenue, expenditures, and cash flow on a monthly basis. This is vital to coordinate cash needed to meet short-term obligations as well as having funds available to invest in capital assets. Also, a regular process that is important to manage financial performance is variance analysis. It involves the periodic review (monthly, quarterly, or annually) of actual expenditures against the approved budget to determine the difference in percentage and dollar amount. Variance analysis is essential for an organization to assess expected revenue results and spending activities to address any items that have a significant difference to a budgeted or forecasted projection.
The Statement of Cash Flows provides insight into how cash is spent (as an outflow) and generated (as an inflow). Effective cash management techniques help organizations achieve success. Thus, health care facilities create rigid policies for safeguarding and efficient use of cash regarding petty cash funds, cash receipts received for services, and cash disbursements paid to vendors. In addition, maximizing returns on investing idle cash is an opportunity for health care facilities with a solid understanding of time value of money concepts and basic investment principles.
One strategy that has become more critical in the health care setting is break-even analysis as facilities have been challenged to deliver higher quality services to patients in a more cost-effective manner. Break-even analysis helps organizations determine how to price products and services or determine the minimum quantity that must occur to have the product or service within the business.
Financial statements such as the income statement and balance sheet provide some insight into how a health care facility is performing. However, analyzing these statements with a deeper dive through several financial ratios provide a better understanding of how an organization is doing with regard its objectives and goals. There are three categories of ratios used in analyzing performance. They are liquidity, solvency, and profitability ratios. Liquidity ratios measure the facility's ability to cover short-term expenses due within a year with cash and cash related assets. Solvency ratios focus on the assets in hand to cover long-term debt obligations such as outstanding loans and bonds. Finally, profitability ratios are used to determine the overall profitability of a business based on assets and net equity (net worth) invested into the operations. Profitability ratios are extremely important for publicly traded organizations to maintain the confidence of investors that they will be successful on a short-term and long-term basis.
What you will cover
1. Financial Planning
a. Describe the relationship between strategic planning and financial planning.
1) Strategic planning-process of identifying a company's overall mission, goals, and key strategies to achieve objectives on a short- and long-term basis
2) Financial planning-the internal efforts of an organization to establish financial goals and objectives and ensure that these metrics are achieved
3) Strategic and financial planning require assessing the organization's external and internal environments. For health care organizations, the key factors to assess in the external environment include the health status of the local population, regulatory issues or requirements, changes in technology, and the overall state of the economy. As for internal items, the company focuses on staffing, products and services, financing or debt capacity, facilities, and core strengths of the organization.
4) The goals and objectives established in strategic planning set in motion the revenue targets and staffing needs that are built into the financial planning of the organization. Based on this, the company will create detailed operating budgets, staffing projections, cash and capital budgets that match the overall strategic goals and objectives.
5) The degree of participation in financial planning can vary widely from one organization to another. With an authoritarian approach, a few key leaders of the organization make the budgeting and financial planning decisions. This is also called a top down approach because the leaders communicate down to the rest of the organization what budgeted targets and goals have been established. However, more organizations choose to use the bottom up approach in which staff throughout the organization participate in the budgeting and financial planning process. This is based on the belief that managers, physicians, and staff that support respective departments and services have a better understanding of the operations to establish financial targets.
b. Prepare various types of budgets.
1) Creating the various budgets usually involves several approaches. The first approach is called the incremental-decremental approach. This technique involves assigning a slight increase or decrease to each revenue or expense item, program, or department based on factoring in strategic and financial objectives that have been established. Consideration is also given to changes in the economic climate or demands for particular health care products and services.
2) Operating budget-a budget that projects a net income or loss based on the budgeted revenue and operating expense amounts for an organization or department.
a) Revenue budget-the projected operating revenue expected to be earned during the budget period.
b) Expense budget-the projected operating expenses expected to be incurred during the budget period. These expenses include staffing costs, supplies, rent, and utilities, as well as depreciation expenses for assets invested in the operations.
3) Cash budget-a budget that provides details on the cash inflows and outflows for the budgeted period. The intent is to provide the amount of cash available to the organization at the end of the budgeted period.
4) Capital budget-establishes the major purchases of assets planned for a budgeted period. Capital budgets for hospitals and large providers can be substantial. The capital budget that is established is somewhat contingent on the overall cash available and the organization's ability to secure any additional financing needed to cover the purchases.
5) Pro Forma Financial Statements
a) Income statement-the projected income statement for a budgeted period based on the final operating, cash, and capital budgets.
b) Balance sheet-the projected balance sheet for a budgeted period based on the final operating, cash, and capital budgets.
c. Perform a break-even analysis.
1) Break-even analysis has become more critical in the health care arena as technology has a constant impact on the costs of delivering services. In addition, health care providers are under constant pressure to become more cost-efficient even as compliance and regulatory requirements continue to rise.
2) Break-even analysis helps health care providers make decisions with regard to how to price a product or service or determine the minimum quantity that must occur to deliver the service. The analysis can also help determine if a service should be provided at all or be outsourced to another organization to provide it.
3) The key premise of break-even analysis is to determine whether a product or service will generate sufficient revenues to cover its ongoing costs. This determination is based on the relationship between revenues, costs, and volume.
4) The basic formula for a break-even analysis is:
Price x Volume Sold = Fixed Costs + (Variable Cost per unit x Volume Sold)
The left side of the equation calculates the total revenue while the right side calculates the total costs. The break-even point is where the amounts equal each other. With a price increase, few units need to be sold to reach a certain break-even point. With a price decrease, more units would need to be sold to reach a certain break-even point. Volumes sold greater than the break-even point generate a profit while volumes below create a loss because the total costs outpace the revenue generated.
5) Fixed costs stay the same no matter what volume is sold, but variable costs increase per unit. However, lowering either type of costs can reduce the amount of the volume sold to reach a particular break-even point. However, the fixed costs are generally the more difficult cost component to reduce.
d. Calculate present value and future value of cash flows.
1) Time value of money is the concept of interest that a dollar available today is worth more than a dollar received in the future. Time value of money calculations include:
a) Rule of 72: an easy method to determine the number of years required for an investment to double in value at fixed annual rates of interest. This is done with having the number 72 divided by the annual interest rate.
b) Future Value of a Single Sum: involves calculating the future value of a single sum of cash invested today.
c) Present Value of a Single Sum: determining how much money needs to be invested today to meet a financial obligation in the future.
2) Explain major principles of investing funds.
a) Time value of money is based on the concept of interest-all financial markets exist on the premise that investors expect to receive more money back in the future than the amount that was originally invested.
b) Prudent investing requires understanding the markets and securities-the golden rule for investors is, "if you don't understand it, don't buy it." Hence, it is critical to understand the correlating risks that come with the expected returns on an investment.
c) Investors are rewarded for the risks they take-as the degree of risk goes up, investors expect and receive higher returns for the additional risks taken, all else equal.
e. Evaluate financial performance using financial ratios.
1) Businesses and credit analysts use ratios in the review of the financial operations of health care facilities. These ratios are important; however, they need to be used in the context of the review of the change of the ratio over time and the difference in the ratios between companies in the health care industry. A single ratio by itself has limited value. Changes in ratios from year-to-year and using information in the financial statements to determine the reason for change in the ratio can yield valuable information on the operations of the business.
2) Liquidity Ratios: used to show that the medical facility can meets its upcoming obligations with available resources (i.e., current assets in hand to cover current liabilities owed)
a) Current Ratio: Current Assets / Current Liabilities
b) Quick Ratio: (Cash + Short-Term Investments + Net Accounts Receivable) / Current Liabilities
c) Days Cash Available: (Cash and Short-Term Investments) / Daily Cash Operating Expenses
3) Solvency Ratios: used to show that the medical facility can meet its total obligations with available resources (i.e., total assets in hand to cover all liabilities and debts owed)
a) Debt-To-Net-Worth: Total Liabilities / Net Worth
b) Debt Service Coverage Ratio: (Net Income plus Interest, Depreciation and Amortization) / Maximum Annual Debt Service
4) Profitability Ratios: used to determine the overall profitability of a business based on assets and net worth invested
a) Operating Margin: Net Income / Total Revenue
b) Return on Equity: Net Income / Owner's Equity
DISCUSSION PROMPTS
1. What aspects of strategic planning and financial planning that overlap?
2. How does the cash flow projections help a company with its planning for future operations?
3. Understanding the importance of ratio analysis for industry benchmarks in addition to comparisons with competitors.
Attachment:- Ratio_Analysis.rar