Lowest Cost Alternative

Figure 19-1 Capital Decision-Making Participants

LEARNING OBJECTIVE 1

Explain who is involved in the capital investment decision process.

PARTICIPANTS IN THE ANALYTICAL PROCESS

The capital decision-making process in the health-care industry is complex for several reasons. First, a healthcare firm, whether nonprofit or investor owned, is likely to have more complex and less quantifiable objectives than firms in other industries. Provision of care to the indigent and community access to services as well as to quality standards are often critical objectives for healthcare firms in addition to profits. Second, the number of individuals involved in the process, either directly or indirectly, is likely to be greater in the healthcare industry than in most other industries.  Figure 19–1  illustrates the relationships of various parties involved in the capital decision-making process of a healthcare facility.

External Participants

Financing Sources

The option of obtaining funds externally for many new programs is an important variable in the capital decision-making process. A variety of individual organizations are involved in the credit-determination process, including investment bankers, bond-rating agencies, bankers, and feasibility consultants. Many of these entities and their roles are discussed in  Chapter 21 . At this juncture, it is important to recognize that, collectively, these entities may influence the amount of money that can be borrowed and the terms of the borrowing, and this can affect the nature and size of capital projects undertaken by a given healthcare facility.

Rate-Setting and Rate-Control Agencies

Some states control or limit the rates that hospitals and other healthcare firms can charge for services. The influence exerted by rate-setting or rate-control organizations on capital decision making is indirect but still extremely important. Control of rates can limit both short-term and long-term profitability. This control can reduce a healthcare firm’s ability to repay indebtedness and thus limit its access to the capital markets. More directly, rate-setting organizations can limit the amount of money available for financing capital projects by reducing the amount of profits that may be retained. One of the major effects of rate control is to significantly reduce the level of capital expenditures by healthcare firms.

Third-Party Payers

Like rate-setting and rate-control agencies, third-party payers can indirectly influence the capital decision- making process. Through their reimbursement provisions, third-party payers can affect both capital expenditure levels and sources of financing. For example, many people believe that third-party cost reimbursement provides a strong incentive for increased capital spending: In most situations such cost reimbursement provides for the reimbursement of depreciation and interest expense, which then may be used to repay financial requirements associated with any indebtedness. As a result, the risk associated with hospital-indebted indebtedness is reduced. In the past, third-party cost reimbursement favorably affected the availability of credit. Conversely, recent departures from cost reimbursement have had an adverse impact on credit availability.

Planning Agencies

In many states, state approval of capital expenditures is still required. Planning agencies review certificate-of-need applications, and their recommendations are then passed on to the state authority responsible for final approval or disapproval. An unfavorable decision by the state may be appealed in court.

Internal Participants

Board of Trustees

Ultimately, the board of trustees is responsible for the capital expenditure and capital financing program of the healthcare firm. However, in most situations the board delegates this authority to management and special board committees. The board’s major function should be to clearly establish defined goals and objectives. The statement of goals and objectives is a prerequisite to the programming phase of management control, which includes capital expenditure analysis. Without a clear statement of goals and objectives, capital expenditure programs cannot be adequately defined and analyzed.

Another role of the governing board should be to approve a preliminary 5-year capital expenditure program. This capital expenditure program should link back to the strategic financial plan discussed in  Chapter 13 . The list of capital expenditures should be generated by management and should reflect not just a “wish list” of capital expenditures that would be desirable to make, but should represent management’s best guess concerning what future capital expenditures will be essential to meet and maintain the organization’s mission.

Planning Committee

Many healthcare facility boards of trustees have established planning committees whose primary function is to define, analyze, and propose programs to help the organization attain its goals and objectives. These committees are specialized groups within the board of trustees that are directly involved in capital expenditure analysis.

Finance Committee

Some boards of trustees also have established finance committees that have authority in several key financial functional areas, including budgeting and capital financing. In the latter two areas, a finance committee may be involved with translating programs, perhaps identified by the planning committee, into financing requirements. These requirements may be operational or capital. The finance committee’s major responsibility is to ensure adequate financing to meet program requirements. Many of the finance committee’s budgetary functions are delegated to the controller; many of its capital financing functions are delegated to the treasurer.

Chief Executive Officer

The chief executive officer is responsible on a day-today basis for implementing approved capital expenditure programs and developing related financing plans.

The chief executive officer must develop an organizational system that responds to the requests of department managers and medical staff for capital expenditures. Much of the authority vested in the chief executive officer’s position is delegated by the board of trustees. The administration also may seek board approval for its own programs.

Department Managers

Department managers make most of the internal requests for capital expenditure approval. In many health-care facilities, formal systems for approving capital expenditures have been developed to receive, process, and answer departmental requests. The allocation of a limited capital budget to competing departmental areas is a difficult task for management. Careful definition of the criteria for capital decision making can help make this problem less political and more objective.

Medical Staff

Medical staff demands for capital expenditures are a problem unique to the healthcare industry. Medical staff members, in most situations, are not employees of the healthcare firm but rather use it to treat their private patients. Because of their ability to change a firm’s utilization dramatically and thus affect financial solvency, administrators listen to, and frequently honor, medical staff members’ wishes. Healthcare firms thus encounter strong pressure from individuals who have little financial interest in the organization and whose financial interest may, in fact, be contrary to that of the healthcare firm.

Controller

The controller facilitates approval of capital expenditures. The controller is usually responsible for developing capital expenditure request forms and for assisting department managers with preparing their capital expenditure proposals. The controller usually serves as an analyst, assisting the administrator with allocating the budget to competing departmental areas. In many small healthcare firms, the controller’s function may be merged with that of the treasurer.

Treasurer

The treasurer is responsible for obtaining funds for both short- and long-term programs. The treasurer may work with the finance committee to negotiate for funds necessary to implement approved programs.