health care finance week 6

Part VI: Construct and Evaluate Budgets

CHAPTER 16: CAPITAL EXPENDITURE

BUDGETS

Capital Expenditure Budgets

• Because capital expenditures generally acquire long lasting assets, capital expenditure budgets usually involve long-term financial issues.

• Capital expenditure budgets are also sometimes known as “capital spending plans”.

vs. Operating Budgets

• Usually deal with short-term revenues and expenses that are necessary to operate the facility.

Creating the Budget

• Capital expenditure budgets are often created in two parts:

• Spending for assets already acquired, and

• Spending for new capital assets.

Budget Construction and The Cash Flow Analysis Concept

• A cash flow analysis illustrates how the project’s cash is expected to move over a period of time.

• When constructing a capital expenditure budget, the cash flow analysis should be cumulative.

Table 16–1 lllustration of Cumulative Cash Flow

• Cash flow reporting for this purpose typically uses one of four methods:

• Payback Method

• Accounting Rate of Return

• Net Present Value

• Internal Rate of Return

• All four methods are described, including an example for each, in the Appendix to this chapter.

Cash Flow Reporting Methods

Budget Inputs

• Capital Expenditure Budget Construction with Operating Budget Inputs

• If the operating budget proposal would require additional capital equipment and/or space renovations, then capital expenditure budget inputs may have to be included to recognize the impact of these operations proposals.

Figure 16–1 Capital Expenditures Budget Inputs

Budget Construction and Startup Cost Concept

• On the other hand, if the capital expenditures budget proposal includes operational expenses, management often requires that startup costs also be considered.

Funding Request Process

• The process of funding capital expenditure requests (a.k.a. proposals) varies case-by-case depending upon the particular organization.

Capital Expenditure Proposals

• Acquiring new equipment

• Upgrading existing equipment

• Replacing existing equipment with new equipment

• Funding new programs

• Funding expansion of existing programs

• Acquiring capital assets for future use.

Rationing Available Capital

• Only a limited amount of capital is usually available for capital expenditures, so rationing is necessary.

• Three factors will probably be considered:

– Necessity for the request

– Cost of capital to the organization

– Return that could be realized on alternative investments

Evaluating Capital Expenditure Proposals

• Because rationing is necessary, evaluating the proposals is a method of allocating the available capital.

• Evaluating capital expenditure proposals may be either subjective or objective.

• Objective evaluation is the most desirable; see more details in the chapter.

Evaluating Capital Expenditure Proposals

• An objective evaluation may involve two steps:

• Scoring all proposals received; then

• Ranking the higher-scoring proposals.

Table 16-A–1 Payback Method Input

Table 16-A–2 Accounting Income Input

Table 16-A–3 Net Present Value Computations