AMSWER TO 14 pages assignment APA STYLE about healthcare finance
FINANCE AND BUDGETING
Financial control of a hospital is of utmost importance in maintaining the institution’s solvency. The hospital will not survive unless there is adequate income to cover operating expenses and capital improvements. This survival requires that every senior administrator and every department director be highly skilled financial managers. What is unique about the department of pharmacy is the disproportionate cost of supplies (e.g., drugs) versus wages compared with other hospital departments. Typically, 90 percent of a pharmacy’s budget is for drugs, whereas less than 10 percent is for employee wages. The reverse is true for most other departments. The overall cost of medications and the proportion of the drug expenditures that are under the influence of each clinical pharmacist require that every hospital pharmacist understands the principles of financial management. A review of the usual financial administrative structure within a hospital, the budget process, and the difference between cost and charge may be helpful.
Financial management is a principal function of all administrators and managers. An important and fundamental part of financial control is budgeting. Each hospital department will have an annual budget, and a good department manager will be able to anticipate revenue and predict expenses for the coming year.
FINANCIAL MANAGEMENT
Managers are responsible for planning, organizing, and controlling resources so that the organizations in which they are employed meet their goals. Many contemporary pharmacists meet this definition of a manager. Large hospitals and managed-care organizations employ pharmacists as clinical coordinators and formulary managers. The essence of the manager’s job is making decisions. Many of these decisions have important financial implications.
Financial management focuses on making wise decisions about obtaining and using financial resources. These resources include both funds that the owners of an organization have invested in it and funds that the organization has borrowed. Pharmacist managers face many such decisions:
· How much inventory to carry,
· Which sources of supply to use,
· How to set prices,
· Which drugs to include on a formulary,
· Whether a new disease management service will be profitable,
· Whether the hospital should open a pharmacist-managed hypertension clinic. etc
Thus being familiar with the tools and techniques of financial management will help pharmacists make better decisions when faced with such questions.
Financial Management can be defined as the management of the finances of a business / organisation in order to achieve financial objectives.
Taking a commercial business as the most common organisational structure, the key objectives of financial management would be to:
· Create wealth for the business
· Generate cash, and
· Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested.
There are three key elements to the process of financial management:
(1) Financial Planning
Management need to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit.
In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions.
(2) Financial Control
Financial control is a critically important activity to help the business ensure that the business is meeting its objectives. Financial control addresses questions such as:
· Are assets being used efficiently?
· Are the businesses assets secure?
· Do management act in the best interest of shareholders and in accordance with business rules?
(3) Financial Decision-making
The key aspects of financial decision-making relate to investment, financing and dividends:
• Investments must be financed in some way – however there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers
• A key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further.
GOALS OF FINANCIAL MANAGEMENT
The principal goal of financial management is to increase the value of the organization. A major part of achieving this goal is making efficient use of financial resources. Pharmacies, for example, carry inventories of prescription and non-prescription drugs. They must invest cash, a scarce financial resource, to buy inventories. Pharmacies make the most efficient use of cash that is invested in inventories when they carry the smallest amount of inventory necessary to meet consumer demand. Carrying larger inventories is inefficient because it takes cash away from other, more productive uses.
Making the most efficient use of financial resources is more important than ever before in pharmacy practice. Pharmacies of all types face substantial competition and economic challenges. The community pharmacy market has become increasingly competitive. Ambulatory consumers can obtain their prescription medicines from a number of outlets including pharmacies in supermarkets, ambulatory care clinics, and physicians’ offices, as well as traditional chain and independent community pharmacies. All of these face financial pressures. In the new competitive environment, pharmacies must use financial resources efficiently if they are to survive and grow. Hospital pharmacies face similar financial pressures. As a result, hospitals and long-term care facilities must manage resources efficiently or face bankruptcy. The pressure that cost containment efforts have placed on these facilities is passed down to each department—including the pharmacy. To prosper in this environment, pharmacy managers must understand and be able to communicate the financial implications of decisions they make and programs they plan.
The Role of Financial Management
Today, financial management plays a much larger role in the overall management of a business. Now, the primary role of financial management is to plan for, acquire, and utilize funds (capital) to maximize the efficiency and value of the enterprise. Because of this role, financial management is known also as capital finance.
In general, the financial management function includes the following activities:
• Evaluation and planning. First and foremost, financial management involves evaluating the financial effectiveness of current operations and planning for the future.
• Long-term investment decisions. Although these decisions are more important to senior management, managers at all levels must be concerned with the capital investment decision process. Such decisions focus on the acquisition of new facilities and equipment (fixed assets) and are the primary means by which businesses implement strategic plans; hence, they play a key role in a business’s financial future.
• Financing decisions. All organizations must raise funds to buy the assets necessary to support operations. Such decisions involve the choice between the use of internal versus external funds, the use of debt versus equity capital, and the use of long-term versus short-term debt. Although senior managers typically make financing decisions, these choices have ramifications for managers at all levels.
• Working capital management. An organization’s current, or short-term, assets, such as cash, marketable securities, receivables, and inventories, must be properly managed to ensure operational effectiveness and reduce costs. Generally, managers at all levels are involved, to some extent, in short-term asset management, which is often called working capital management.
• Contract management. Health services organizations must negotiate, sign, and monitor contracts with managed care organizations and third party payers. The financial staff typically has primary responsibility for these tasks, but managers at all levels are involved in these activities and must be aware of their effect on operating decisions.
• Financial risk management. Many financial transactions that take place to support the operations of a business can increase a business’s risk. Thus, an important financial management activity is to control financial risk.
ACCOUNTING AND FINANCIAL MANAGEMENT
A proper understanding of the tools and techniques of financial management requires a basic working knowledge of accounting. Accounting is a specialized language used to communicate financial information. This information is communicated via financial statements. Accounting data, and the financial statements developed from them, are maintained because they aid decision making.
Financial statements facilitate decision making in three areas:
· Financial statements provide information to decision makers.
With this information, decision makers can better assess the financial implications of various decisions they must make. For example, bankers are decision makers. Before making loans, they will carefully evaluate the financial statements submitted by applicants to decide whether they can repay the loans. Managers are also decision makers. They use financial statements, for example, to make pricing decisions, to help decide whether to hire additional personnel, to decide whether to buy new equipment, and to decide which services to offer.
· Financial statements aid decision makers by reporting the results of past decisions.
The prudence of a banker’s past lending decisions will be reflected in his or her current financial statements. Likewise, a manager who makes poor service and pricing decisions will notice, on financial statements, a decrease in profits.
· Financial statements keep track of a range of financial items such as cash, debts, and assets.
Decision makers need this information to efficiently and effectively manage their organizations.
Financial statements provide decision makers with the following types of information:
1. Present financial status of the business. The balance sheet, or statement of financial position, indicates what a business owns and what it owes at one point in time.
2. Past profit performance of the business. The income statement, also called the profit and loss statement, indicates whether the business made a profit or suffered a loss over some period of time.
3. Where the business is getting its cash and how it is spending it. This is found on the statement of changes in financial position or the cash flow statement.
4. How the owners’ investment in the business has changed over some period of time. This information is found in the statement of capital or the statement of retained earnings.
FINANCIAL STATEMENTS ANALYSIS
Financial Statements Analysis (FSA) refers to the process of the critical examination of the financial information contained in the financial statements in order to understand and make decisions regarding the operations of the firm. The FSA is basically a study of the relationship among various financial facts and figures given in a set of financial statements. The basic financial statements i.e. the Balance Sheet and the Income Statement contain a whole lot of historical data. The complex figures as given in these financial statements are dissected/broken up into simple and valuable elements and significant relationships are established between the elements of the same statement or different financial statements. This process of dissection, establishing relationships and interpretation thereof to understand the working and financial position of a firm is called the FSA.
Thus, FSA is the process of establishing and identifying the financial weaknesses and strength of the firm. It is indicative of two aspects of a firm i.e. the profitability and the financial position and it is what is known as the objectives of the FSA.
Objectives of the FSA:
Broadly, the objective of the FSA is to understand the information contained in financial statements with a view to know the weaknesses and strength of the firm and to make a forecast about the future prospects of the firm and thereby enabling the financial analyst to take different decisions regarding the operations of the firm. The objectives of the FSA can be identified as:
· To assess the present profitability and operating efficiency of the firm as a whole as well as for its different departments and segments.
· To find out the relative importance of different components of the financial position of the firm.
· To identify the reasons for change inthe profitability/financial position of the firm, and
· To assess the short term as well asthe long term liquidity position of the firm.
Types of Financial Analysis
Financial analysis can be classified into different categories depending upon (1) the material used, and (2) the modus operandi of analysis.
1. On the Basis of Material Used:Under this category the financial analysis can be of two types: a) External Analysis; b) Internal Analysis
a. External Analysis: The outsiders to the business carry out this kind of analysis, which includes investors, credit agencies, government agencies and other creditors who have no access to the internal records of the company.
b. Internal Analysis: In contrary to the above this analysis is done by those who have access to the books of accounts and other information related to the business. The analysis is done depending upon the objective to be achieved through this analysis.
2. On the basis of Modus Operandi: In this case too, the financial analysis can be of two types: a) Horizontal Analysis; b) Vertical Analysis
a Horizontal Analysis: Under this financial statements for a number of years are reviewed and analyzed. The current year’s figures are compared with standard or base year.
b Vertical Analysis: Under this type of analysis a study is made of the quantitative relationship ofthe various items in financial statements on a particular date. For example, the ratios of different items of costs for a particular period may be calculated with the sales for that period. These types of financial analysis are useful in comparing the performance of several companies in the same group, or divisions or departments in the same company.
LIMITATIONS OF FINANCIAL MANAGEMENT
Financial management is a tool that managers can use to better assess the financial implications of decisions they face. Its use should be limited to deciding among potential courses of action that will help the pharmacy to reach its goals. In most cases, it should not be used to decide what those goals are, nor should most decisions be based solely on financial criteria. For example, a hospital pharmacy could decrease its expenses, and maintain its revenues, by switching from unit-dose to multiple-dose drug distribution and by cutting out all clinical and educational services. If the pharmacy’s decisions were based solely on financial criteria, a financial analysis might show the advisability of this course of action. But a hospital pharmacy has a higher and more basic mission than to operate as cheaply and profitably as possible. Its primary mission is to provide pharmaceutical services that improve patient care. Unit-dose distribution and clinical and educational services substantially improve patient care. Consequently, the decision of whether to offer them should not be made solely on the basis of financial criteria. On the other hand, given that a pharmacy has limited financial resources, the decision as to which particular clinical and educational services to offer would benefit from a financial analysis.
Financial statements do not contain all the information, or in many cases even the most important information, about the factors that affect the finances of a pharmacy. Such necessary data as the state of the national and local economy, the demand for the organization’s product or service, the extent and nature of the competition, and the health and loyalty of key employees are not found in financial statements. This is because financial statements deal only with those events and factors that can be readily expressed in monetary terms. In using and interpreting financial statements properly, managers must keep these limitations in mind.
BUDGETS AND BUDGETING
A budget is a financial plan for the future concerning the revenues and costs of a business. However, a budget is about much more than just financial numbers. Budgetary control is the process by which financial control is exercised within an organisation. Budgets for income/revenue and expenditure are prepared in advance and then compared with actual performance to establish any variances.
Managers are responsible for controllable costs within their budgets and are required to take remedial action if the adverse variances arise and they are considered excessive. There are many management uses for budgets. For example, budgets are used to:
· Control income and expenditure (the traditional use)
· Establish priorities and set targets in numerical terms
· Provide direction and co-ordination, so that business objectives can be turned into practical reality
· Assign responsibilities to budget holders (managers) and allocate resources
· Communicate targets from management to employees
· Motivate staff
· Improve efficiency
· Monitor performance
Whilst there are many uses of budgets, there are a set of guiding principles for good budgetary control in a business. In an effective budget system:
· Managerial responsibilities are clearly defined – in particular the responsibility to adhere to their budgets
· Individual budgets lay down a plan of action
· Performance is monitored against the budget
· Corrective action is taken if results differ significantly from the budget
· Departures from budgets are permitted only after approval from senior management
· Unaccounted for variances are investigated
Most hospital pharmacy budgets contain three major components:
· Salary and wage expense
· Drugs, supplies, and equipment expense
· Revenue.
Every hospital will have its own format of financial reporting and budgetary summary. (Table 1)
· Salary and wage expense.
This includes payroll expense for regularly scheduled hours and for salaried employees. The salary subsection also includes a budgeted amount for overtime, sick, vacation, and holiday pay. While most department budgets do not represent benefits (e.g., health insurance, disability insurance, etc.), the hospital’s overall budget will. Benefits generally are 20 to 30 percent of total salary and wage costs.
· Supplies and equipment expense.
This nonsalary section of the budget usually is sufficiently detailed so that the manager can monitor it by category. The supplies and equipment budget may include expense categories such as drugs, office supplies, and maintenance contracts. Many pharmacy directors subdivide the drug expense category into therapeutic classes to better monitor new services or trends in therapy. For example, the economic impact of a newly marketed drug to treat pancreatic cancer is easier to track if the expense is shown in the antineoplastic category of the drug section of the expense budget.
· Revenue.
Revenue is sometimes used interchangeably with charges. Generally, a department’s charges must cover its expenses.However, in some hospitals, pharmacy department charges are used to subsidize non-revenue producing departments. This component of the budget differs widely among hospitals. Generally speaking, depending on the particular payers that a hospital has, the pharmacy may be a cost center or a revenue center or a mixture of both. The department manager must clearly understand the mechanism for establishing pharmacy charges, whether by a fee structure or a percent markup, so that revenue can be reported and compared with the various expense categories in the expense budget.
The system for establishing pharmacy charges must be fair, economically sound, and explainable to patients and third-party payers. Some hospitals use a simple percent markup on drug cost strategy. The charge for a drug is the product of the acquisition cost and the markup. Higher-cost drugs theoretically yield a higher return. The professional fee concept is based on the fact that a prescription medication is not an article of trade capable of being bought and sold by anyone and that the cost of dispensing, including the skill and knowledge involved, is not related to the cost of the ingredients used. A professional fee may be applied to doses dispensed or on a per-diem or per-patient basis. This approach has particular merit for nondistributive clinical services.
Hospitals may choose a combination of approaches, using a percent markup for drugs dispensed and a professional fee for services, such as drug information or patient education, which are not necessarily related to a specific drug product. Hospital overhead and other shared expenses usually are allocated systematically and are not necessarily allocated according to the way the overhead is actually used.
Budget variances and management by exception
A key word to understand when you are looking at budgets is “variance”. A variance arises when there is a difference between actual and budget figures. Variances can be either:
· Positive/favourable (better than expected) or
· Adverse/unfavourable ( worse than expected)
A favourable variance might mean that:
· Costs were lower than expected in the budget, or
· Revenue/profits were higher than expected
By contrast, an adverse variance might arise because:
· Costs were higher than expected
· Revenue/profits were lower than expected
Should variances be a matter of concern to management? After all, a budget is just an estimate of what is going to happen rather than reality. The answer is – it depends.
The significance of a variance will depend on factors such as:
• Whether it is positive or negative – adverse variances (negative) should be of more concern
• Was it foreseen?
• Was it foreseeable?
• How big was the variance - absolute size (in money terms) and relative size (in percentage terms)?
• The cause
• Whether it is a temporary problem or the result of a long term trend
“Management by exception” is the name given to the process of focusing on activities that require attention and ignoring those that appear to be running smoothly. Budget control and analysis of variances facilitates management by exception since it highlights areas of business performance which are not in line with expectations. Items of income or spending that show no or small variances require no action. Instead concentrate on items showing a large adverse variance.
Are all adverse variances bad news?
An adverse variance might result from something that is good that has happened in the business. For example, a budget statement might show higher production costs than budget (adverse variance). However, these may have occurred because sales are significantly higher than budget (favourable budget). It is the cause and significance of a variance that matters – not whether it is favourable or adverse.
Table 1: A hypothetical income and expense report compared with a budget for a 6-month period.
Limitations of budgets
Whilst budgets are widely used in business, you should appreciate that they have some important limitations. In particular:
· Budgets are only as good as the data being used to create them. Inaccurate or unreasonable assumptions can quickly make a budget unrealistic
· Budgets can lead to inflexibility in decision-making
· Budgets need to be changed as circumstances change
· Budgeting is a time consuming process – in large businesses, whole departments are sometimes dedicated to budget setting and control
· Budgets can result in short term decisions to keep within the budget rather than the right long term decision which exceeds the budget
· Managers can become too preoccupied with setting and reviewing budgets and forgetting to focus on the real issues of winning customers
Budgets can also create some behavioural challenges in a business
· Budgeting has behavioural implications for the motivation of employees
· Budgets are de-motivating if they are imposed rather than negotiated
· Setting unrealistic targets adds to de-motivation
· Budgets contribute to departmental rivalry - battles over budget allocation
· Spending up to budget: it can result in a “use it or lose it” mentality - spend up to the budget to preserve it for next year
· Budgetary slack occurs if targets are set too low
· A “name, blame and shame” culture can develop - but managers should be answerable only for variations that were under their control
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