The Importance of Management Understanding of Capital
Budgeting
The
importance of management understanding of capital budgeting is
essential in the health care
industry. Unlike other industries health
care firms have greater needs in management investment. For this reason this paper will be based on
the comprehension of capital budgets and the formulation in testing the
sensitivity of forecasts regarding alternative scenarios (Cleverley, Song,
& Cleverley, 2011, p 490).
Cash
management is very important in the health care industry, more so than in other
industries. Financial executives believe
that in cash management that reducing accounts receivables or the collection
cycle shortened will result in better control, but in reality cash management
should focus on the acceleration of receivables and also the complete cash
conversion cycle as shown below.
Cash Conversion Cycle
Regarding the cash aspect or
working capital of the cash conversion cycle it is important to understand what
it is used for, such as:
·
Current assets
o
Cash and investments
o
Accounts receivables
o
Inventories
o
Other current assets
·
Current liabilities
o
Accounts payable
o
Accrued salaries and wages
o
Accrued expenses
o
Notes payable
o
Current position of long-term debt
After determining the working capital
the cash budget focuses one the purchasing of resources, the production/sale of
service, billing, and collection all of which are part of the cash conversion
cycle. The purchasing of resources includes
the purchase of supplies and labor. The production
and sales of service require no inventory and include the length of stay and
final release of patient, which can be viewed as the final point of sale
(Cleverley, Song, & Cleverley, 2011, pp. 491-492). Billing on the other hand shows the interval
between release of patient and the generation of a bill (Cleverley, Song, &
Cleverley, 2011, p 492). Collection
refers to the generation of the bill to the actual collection of monies by
either the patient or the patient’s third-party payer. Understanding and managing the cash
conversion cycle is critical to minimizing what is required of the investment
of working capital. It is also necessary to develop a sound cash budget, which
includes outflows and inflows of projections during the planning process.
The
importance of management to comprehend the formulation in testing the
sensitivity of forecasts may be the most important in cash budgeting. Cash budgeting of revenue forecast in healthcare
include too functions: volumes by product line and expected prices by
payer. These include two categories of
methods used to develop estimates of volume: subjective forecasts and
statistical forecasts (Cleverley, Song, & Cleverley, 2011, p 492). Subjective forecasts depend on the
understanding and knowledge of the forecaster in the reliability and estimation
of product line volumes. Subjective
forecasting is the most reliable method of forecasting when future volumes
deviate from historical patterns. A
scenario of subjective forecasting may be when medical staff members are
surveyed regarding the staffs expected utilization for the next year
(Cleverley, Song, & Cleverley, 2011, p 509). Statistical forecasts is basically infers
the future can be predicted using a mathematical extrapolation of the past
(Cleverley, Song, & Cleverley, 2011, p 509). This process can be misleading if there is a
change in the forecast. These two
methods are the most critical to the revenue budgetary process as shown below.
Integration of the Budgetary
Process
ê
Cash
Budget
ê
Budgeted
Financial Statement
ê
Revenue
and Expenses
As
stated throughout, cash budgets are forecasts and as with anything there is no
guarantee that the results of these forecast will be achieved. This is why it is so important that management
test the sensitivity of forecasts regarding alternative scenarios, such as
slowdown in collection or declines in revenue. If a slowdown in collection or
decline in revenue can affect cash flow resulting in an immediate revision of
the cash budget. For instance, if
payment of a patient’s bill is delay for 60 days by Medicaid must be revised to
reflect a new pattern of payment (Cleverley, Song, & Cleverley, 2011, p
510).
In conclusion, the importance for
management to comprehend capital budgets and formulation in testing the
sensitivity of the forecast regarding alternative scenarios, such as slowdown
in collections and declines in revenues are critical in the understanding of
capital budgeting.
