Home Ee 8. Assignment Exercises 17-1, 17-2, and 17-3 on pages 498 through 500
Assignment Exercises 18-1, 18-2, and 18-3 on pages 500 through 501
Practice Exercise 17–1
Exhibit 17–2 presents the Variance Analysis for hospital rehab services for the third quarter. For our practice exercise we will duplicate this report for the fourth quarter. We are able to reformat the information in Exhibit 17–2 into a worksheet as follows. The fourth quarter assumptions appear below the worksheet.
|Overhead Cost||divided by||# Therapy Minutes (Activity Level)||equals||Cost per Therapy Minute|
|Actual||(1) $950,000||(3) 350,000||(5) $2.71|
|Budgeted||(2) $930,000||(4) 310,000||(6) $3.00|
Exhibit 17–2 Variance Analysis for Hospital Rehab Services
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
The flexible budget calculation ($990,000) is based on actual quantity. When the $990,000 is compared with the actual cost of $920,000 for this activity center, a favorable price variance of $70,000 is realized. When the $990,000 is compared with the budgeted cost of $937,500 for this activity center, an unfavorable quantity variance of ($52,500) is realized. Exhibit 17–2 also illustrates the computation of a net proof total amounting to $17,500.
Example 2: Static Budget Variance Analysis for an Open Imaging Center
An example of static budget variance analysis for an open imaging center is given in Table 17–1 . As shown, the static budget’s number of procedures performed totaled 1,000, while the actual number totaled 1,100. The revenue per procedure is $400 for both budget and actual. The net revenue variance is favorable in the amount of $40,000 ($440,000 less $400,000).
The salaries and employee benefits expense line item exceeded budget by an unfavorable balance of $20,000. Likewise, the supplies expense line item exceeded budget by an unfavorable balance of $15,000. The remaining expenses did not vary; thus the total expense variance is an unfavorable $35,000. The operating income variance equals a favorable $5,000 (the net difference between $40,000 favorable and $35,000 unfavorable).
Table 17–1 Static Budget Variance Analysis for an Open Imaging Center
|Actual Amounts Incurred
||Static Budget Totals
||Static Budget Variance
|# Procedures Performed||1,100||1,000||—|
|Net Revenue ($400/procedure)||$440,000||$400,000||$40,000 F|
|Salaries & Employee Benefits||$170,000||$150,000||$20,000 U|
|Total Expenses||$375,000||$340,000||$35,000 U|
|Operating Income||$65,000||$60,000||$5,000 F|
Key: “F” = “Favorable” variance, while “U” = “Unfavorable” variance.
Note: Dollar amounts shown for illustration only.
Example 3: Flexible Budget Variance Analysis for an Infusion Center Within a Physician Practice
An example of flexible budget variance using different terminology is given for an infusion center within a physician practice in Table 17–2 . Assumptions for revenue, variable 206207expense, and fixed expense are set out below the table itself. An explanation of the computations in Table 17–2 follows.
Table 17–2 Flexible Budget Variance Analysis for Infusion Center Within a Physician Practice
As to Line 1, Number of Procedures:
Line 1 presents the number of planned procedures (80) and the number of actual procedures (96). Thus the procedures sales volume difference is 16 (96 less 80), and is favorable.
As to Line 2, Net Revenue:
· 1. Eighty planned budget procedures at $2,250 revenue apiece totals line 2 column E $180,000, while 96 actual procedures at $2,250 apiece totals line 2 column C $216,000.
· 2. The sales volume difference in column D totals $36,000 ($216,000 less $180,000).
· 3. To prove this figure, multiply the excess 16 procedures at the top of column D times $2,250 apiece equals the $36,000.
· 1. Set up a worksheet for the fourth quarter like that shown in Exhibit 17–2 for the third quarter.
· 2. Insert the Fourth Quarter Input Data (per assumptions given above) on the worksheet.
· 3. Complete the “Actual Cost,” “Flexible Budget,” and “Budgeted Cost” sections at the top of the worksheet.
· 4. Compute the Price Variance and the Quantity Variance in the middle of the worksheet.
· 5. Indicate whether the Price and the Quantity Variances are favorable or unfavorable for the fourth quarter.
Can you compute how the $950,000 actual overhead costs and the $930,000 budgeted overhead costs were calculated?
Assignment Exercise 17–1: Variance Analysis
Greenview Hospital operated at 120% of normal capacity in two of its departments during the year. It operated 120% times 20,000 normal capacity direct labor nursing hours in 498499routine services and it operated 120% times 20,000 normal capacity equipment hours in the laboratory. The lab allocates overhead by measuring minutes and hours the equipment is used; thus equipment hours.
For Routine Services Nursing:
· • 20,000 hours × 120% = 24,000 direct labor nursing hours.
· • Budgeted Overhead at 24,000 hours = $42,000 fixed plus $6,000 variable = $48,000 total.
· • Actual Overhead at 24,000 hours = $42,000 fixed plus $7,000 variable = $49,000 total.
· • Applied Overhead for 24,000 hours at $2.35 = $56,400.
· • 20,000 hours × 120% = 24,000 equipment hours.
· • Budgeted Overhead at 24,000 hours = $59,600 fixed plus $11,400 variable = $71,000 total.
· • Actual Overhead at 24,000 hours = $59,600 fixed plus $11,600 variable = $71,200 total.
· • Applied Overhead for 24,000 hours at $3.455 = $82,920.
· 1. Set up a worksheet for applied overhead costs and volume variance with a column for Routine Services Nursing and a second column for Laboratory.
· 2. Set up a worksheet for actual overhead costs and budget variance with a column for Routine Services Nursing and a second column for Laboratory.
· 3. Set up a worksheet for volume variance and budget variance totaling net variance with a column for Routine Services Nursing and a second column for Laboratory.
· 4. Insert input data from the Assumptions.
· 5. Complete computations for all three worksheets.
Review the “Sensitivity Analysis Overview” section and Figure 17–5 in Chapter 17.
Figure 17–5 Three-Level Revenue Forecast (Sensitivity Analysis).
For example, assume 100 units are sold at $50 each for a total of $5,000 revenue. Further, assume variable costs amount to $30 per unit. One hundred units have been sold, so variable costs amount to $3,000 209210(100 times $30/unit = $3,000). The contribution margin equals $2,000 ($5,000 revenue less $3,000 variable costs). (For a further discussion of the contribution margin, refer to the chapter about cost behavior and break-even analysis.) Now further assume that fixed costs in this example amount to $1,200. Therefore, the operating income will amount to $800 ($2,000 contribution margin less $1,200 equals $800). The format of a contribution margin income statement will appear as follows:
Assignment Exercise 17–2: Three-Level Revenue Forecast
Three eye-ear-nose-and-throat physicians decide to hire an experienced audiologist in order to add a new service line to their practice.*They ask the practice manager to prepare a three-level volume forecast as a first step in their decision-making.
Assumptions: for the base level (most likely) revenue forecast, assume $200 per procedure times 4 procedures per day times 5 days equals 20 procedures per week times 50 weeks per year equals 1,000 potential procedures per year.
For the best case revenue forecast, assume an increase in volume of one procedure per day average, for an annual increase of 250 procedures (5 days per week times 50 weeks equals 250). (The best case is if the practice gains a particular managed care contract.)
For the worst case revenue forecast, assume a decrease in volume of 2 procedures per day average, for an annual decrease of 500 procedures. (The worst case is if the practice loses a major payer.)
*Audiologists were designated as “eligible for physician and other prescriber incentives” as discussed elsewhere. Thus the new service line was a logical move.
Using the above assumptions, prepare a three-level forecast similar to the example in Figure 17–5 and document your calculations.
Practice Exercise 17–II
Closely study the chapter text concerning target operating income.
The necessary inputs for target operating income include the following:
Compute the required revenue to achieve the target operating income and compute a contribution income statement to prove the totals.
· • Desired (target) operating income amount = $20,000
· • Unit price for sales = $500
· • Variable cost per unit = $300
· • Total fixed cost = $10,000
Compute the required revenue to achieve the target operating income and compute a contribution income statement to prove the totals.
Assignment Exercise 17–3: Target Operating Income
Acme Medical Supply Company desires a target operating income amount of $100,000, with assumption inputs as follows:
· • Desired (target) operating income amount = $100,000
· • Unit price for sales = $80
· • Variable cost per unit = $60
· • Total fixed cost = $60,000
Assignment Exercise 18–1: Estimate of Loss
You are the practice manager for a four-physician office. You arrive on Monday morning to find the entire office suite flooded from overhead sprinklers that malfunctioned over the weekend. Water stands ankle-deep everywhere. The computers are fried and the contents 500501of all the filing cabinets are soaked. Your own office, where most of the records were stored, has the worst damage.
The practice carries valuable papers insurance coverage for an amount up to $250,000. It is your responsibility to prepare an estimate of the financial loss so that a claim can be filed with the insurance company. How would you go about it? What would your summary of the losses look like?
Assignment Exercise 18–2: Estimate of Replacement Cost
The landlord carries contents insurance that should cover the damage to the furnishings, equipment, and to the computers, and the insurance company adjuster will come tomorrow to assess the furnishings and equipment damage. However, your boss is sure that the insurance settlement will not cover replacement costs. Consequently, you have been instructed to prepare an estimate of what has been lost and/or damaged plus an estimate of what the replacement cost might be. How would you go about it? What would your summary of these losses look like?
Assignment Exercise 18–3: Benchmarking
Review the chapter text about benchmarking.
· 1. Select an organization: either from the Case Studies in Chapters 27–28 or from one of the Mini-Case Studies in Chapters 29–31.
· 2. Prepare a list of measures that could be benchmarked for this organization. Comment on why these items are important for benchmarking purposes.
· 3. Find another example of benchmarking for a healthcare organization. The example can be an organization report or it can be taken from a published source such as a journal article.
CHAPTER 27 Case Study: Strategic Financial Planning in Long-Term Care Neil R. Dworkin, PhD
John Maxwell, CEO of Seabury Nursing Center, a not-for-profit long-term care organization located in suburban Connecticut, had just emerged from a board of directors meeting. He was contemplating the instructions he had received from the board’s executive committee to assess the financial feasibility of adding a home care program to the Center’s array of services.
Seabury’s current services consist of two levels of inpatient care, chronic care, and subacute units, and a senior citizens’ apartment complex financed in part by the Federal Department of Housing and Urban Development. In keeping with its mission, Seabury has a reputation of providing personalized, high-quality, and compassionate care across all levels of its continuum.
The CEO and his executive team agreed to meet the following week to plan the next steps.
FRAMEWORK OF THE BOARD’S MANDATE
At its last retreat, the board made clear that, reimbursement and payment systems notwithstanding, Seabury must establish realistic and achievable financial plans that are consistent with their strategic plans. Accordingly, three points relative to integrating strategic planning and financial planning should hold sway:
· 1. Both are the primary responsibility of the board
· 2. Strategic planning should precede financial planning
· 3. The board should play an active role in the financial planning process
Ultimately, every important investment decision involves three general principles:
· 1. Does it make sense financially?
· 2. Does it make sense operationally?
· 3. Does it make sense politically?
The board’s interest in a possible home initiative was guided by these stipulations, particularly as they relate to Seabury’s growth rate in assets and profitability objectives. As a result of the financial downturn, the organization is experiencing declining inpatient volumes, a deteriorating payer mix, and a higher cost of capital, all of which have the potential to weaken its liquidity position.
Taking the strategic service line path to a home care program would be less capital intensive and should appeal broadly to the significant baby boomer population residing in its service area, whose preference would undoubtedly be to be treated in their homes.
When John Maxwell convened his executive team the following week, he had already decided to present an overview of the home health industry as gleaned by Seabury’s Planning Department. He prefaced his comments by drawing on recent research by the federal Agency for Healthcare Research and Quality that detailed why home health care in the 21st century is different from that which has existed in the past. He cited four reasons:
· 1. We’re living longer and more of us want to “age in place” with dignity.
· 2. We have more chronic, complex conditions.
· 3. We’re leaving the hospital earlier and thus need more intensive care.
· 4. Sophisticated medical technology has moved into our homes. Devices that were used only in medical offices are now in our living rooms and bedrooms. For example, home caregivers regularly manage dialysis treatments, infuse strong medications via central lines, and use computer-based equipment to monitor the health of loved ones.1
The CEO presented a profile of national home care data as compiled by the National Association for Home Care and Hospice as follows:
· • Approximately 12 million people in the United States require some form of home health care.
· • More than 33,000 home healthcare providers exist today.
· • Almost two-thirds (63.8%) of home healthcare recipients are women.
· • More than two-thirds (69.1%) of home healthcare recipients are over age 65.
· • Conditions requiring home health care most frequently include diabetes, heart failure, chronic ulcer of the skin, osteoarthritis, and hypertension.
· • Medicare is the largest single payer of home care services. In 2009, Medicare spending was approximately 41% of the total home healthcare and hospice expenditure.2
According to the U.S. Census Bureau, he continued, in 2010 Connecticut’s population was 3,574,097 of which 14.4% were age 65 or older.3 A Visiting Nurse Association (VNA) analysis of revenue by payer source in the state indicated that 60% of revenue was derived from Medicare.4
The CEO went on to explain that the feasibility determination would be based on initially setting the home care program’s capacity at 50 clients because that was the minimum 388389required for Certificate-of-Need (CON) approval in Connecticut. He distributed a model developed by healthcare finance expert William O. Cleverly ( Figure 27–1 ), which presents the logic behind the integration of strategic and financial planning.
In essence, he said, financial planning is influenced by the definition of programs and services in consort with the mission and goals. The next step entails financial feasibility of the proposed homecare program. Among the components that should be considered in determining financial feasibility are the following:
· • The configuration and cost of staff
· • The prevailing Medicare and Medicaid reimbursement rates
Figure 27–1 Integration of Strategic and Financial Planning.
Reproduced from W.O. Cleverley, Essentials of Health Care Finance, 7th ed. (Sudbury, MA: Jones & Bartlett), 289.
· • A projection of visit frequency by provider category based on the most prevalent clinical conditions
· • The physical location of the program and its attendant costs (e.g., rent, new construction)
· • A projection of cash flows
Direct care staff associated with the home care program includes:
· • Medical Social Worker (MSW)
· • Physical Therapist (PT)
· • Home Health Aide (HHA)
· • Registered Nurse (RN)
· • Registered Dietitian (RD)
Maxwell indicated that it would be useful to create a scenario depicting a home health visit abstract incorporating prevailing Medicare and Medicaid reimbursement rates for a 70-year-old male with heart failure and no comorbidities in order to gain traction and project potential cash flow. As previously noted, heart failure is a condition frequently requiring home healthcare services. Productivity in the home is typically based on the average number of visits per day by provider category. The visit scenario is depicted in Table 27–1 .
Table 27–1 A Home Health Visit Scenario
|Services||Visit Frequency||Payer||Rate||Rate × 4.2 *||Medicare Cost||Medicaid Cost|
|Nursing (RN)||2x/month, every other week||Mc||$166.83||$700.69||$700.69|
|Medical Social Worker (MSW)||Visits wkly for 4 wks||MA||$119.51||$501.94||$501.94|
|Physical Therapist (PT)||3x wkly for 2 wks||Mc||$103.22||$433.52||$433.52|
|Home Health Aide (HHA)||Visits 4hrs MWF wkly for 60 days||Mc||$25.00||$1,260.00||$1,260.00|
|Registered Dietitian (RD)||3x wkly for 1 wk||MA||$103.16||$309.48|
Mc = Medicare
MA = Medicaid
* 4.2 = The state′s formula for the #wks/per month
Total monthly Medicaid budget = $826.95
Total monthly Medicare budget = $2,394.21
Figure 27–2 Seabury Nursing Center’s Home Healthcare-Related Organization Chart.
Once the board decides to move ahead with the home care program and it is approved by the state, implementation and ongoing operations becomes a management control issue (see the Cleverly model in Figure 27–1). The CEO refers to a proposed table of organization as illustrated in Figure 27–2 .
Given the paucity of other home care programs in its service area, Maxwell knows that Seabury is likely to be accorded a green light.
As he and his team reflect on this, the looming question will be where will the clients come from? He knows that likely referral sources will include Seabury’s subacute inpatient population and residents from its senior citizens’ apartment complex who are
“aging in place.” Other likely sources will be recently discharged patients from the region’s two community hospitals, both bereft of home care programs. A premium will be placed on effective case management, and direct marketing to the community will also be necessary.
1. U.S. Department of Health and Human Services, “Human Factors Challenges in Home Health Care,” Research Activities, no. 376 (December 2011).
2. National Association for Home Care and Hospice, Basic Statistics about Home Care (Updated 2010).
3. Department of Commerce, U.S. Census Bureau, 2010 Demographic Profile.
4. Visiting Nurse Association, VNA Healthcare Annual Report (Hartford, CT: Hartford Healthcare, 2012).
CHAPTER 28 Case Study:
Metropolis Health System
· 1. The Hospital System Metropolis Health System (MHS) offers comprehensive healthcare services. It is a midsize taxing district hospital. Although MHS has the power to raise revenues through taxes, it has not done so for the past seven years.
· 2. The Area MHS is located in the town of Metropolis, which has a population of 50,000. The town has a small college and a modest number of environmentally clean industries.
· 3. MHS Services MHS has taken significant steps to reduce hospital stays. It has developed a comprehensive array of services that are accessible, cost-effective, and responsive to the community’s needs. These services are wellness oriented in that they strive for prevention rather than treatment. As a result of these steps, inpatient visits have increased overall by only 1,000 per year since 2008, whereas outpatient/same-day surgery visits have had an increase of over 50,000 per year.A number of programmatic, service, and facility enhancements support this major transition in the community’s institutional health care. They are geared to provide the quality, convenience, affordability, and personal care that best suit the health needs of the people whom MHS serves.
· • Rehabilitation and Wellness Center—for outpatient physical therapy and return-to-work services, plus cardiac and pulmonary rehabilitation, to get people back to a normal way of living.
· • Home Health Services—bringing skilled care, therapy, and medical social services into the home; a comfortable and affordable alternative in longer-term care.
· • Same-Day Surgery (SDS)—eliminating the need for an overnight stay. Since 1998, same-day surgery procedures have doubled at MHS.
· • Skilled Nursing Facility—inpatient service to assist patients in returning more fully to an independent lifestyle.
· • Community Health and Wellness—community health outreach programs that provide educational seminars on a variety of health issues, a diabetes education center, support services for patients with cancer, health awareness events, and a women’s health resource center.
· • Occupational Health Services—helping to reduce workplace injury costs at over 100 area businesses through consultation on injury avoidance and work-specific rehabilitation services.
· • Recovery Services—offering mental health services, including substance abuse programs and support groups, along with individual and family counseling.
· 4. MHS’s Plant The central building for the hospital is in the center of a two-square-block area. A physicians’ office building is to the west. Two administrative offices, converted from former residences, are on one corner. The new ambulatory center, completed two years ago, has an L shape and sits on one corner of the western block. A laundry and maintenance building sits on the extreme back of the property. A four-story parking garage is located on the eastern back corner. An employee parking lot sits beside the laundry and maintenance building. Visitor parking lots fill the front eastern portion of the property. A helipad is on the extreme western edge of the property behind the physicians’ office building.
· 5. MHS Board of Trustees Eight local community leaders who bring diverse skills to the board govern MHS. The trustees generously volunteer their time to plan the strategic direction of MHS, thus ensuring the system’s ability to provide quality comprehensive health care to the community.
· 6. MHS Management A chief executive officer manages MHS. Seven senior vice presidents report to the CEO. MHS is organized into 23 major responsibility centers.
· 7. MHS Employees All 500 team members employed by MHS are integral to achieving the high standards for which the system strives. The quality improvement program, reviewed and reestablished in 2010, is aimed at meeting client needs sooner, better, and more cost-effectively. Participants in the program are from all areas of the system.
· 8. MHS Physicians The MHS medical staff is a key part of MHS’s ability to provide excellence in health care. Over 75 physicians cover more than 30 medical specialties. The high quality of their training and their commitment to the practice of medicine are great assets to the health of the community. The physicians are very much a part of MHS’s drive for continual improvement on the quality of healthcare services offered in the community. MHS brings in medical experts from around the country to provide training in new techniques, made 394395possible by MHS’s technologic advancements. MHS also ensures that physicians are offered seminars, symposiums, and continuing education programs that permit them to remain current with changes in the medical field. The medical staff’s quality improvement program has begun a care path initiative to track effective means for diagnosis, treatment, and follow-up. This initiative will help avoid unnecessary or duplicate use of expensive medications or technologies.
· 9. MHS Foundation Metropolis Health Foundation is presently being created to serve as the philanthropic arm of MHS. It will operate in a separate corporation governed by a board of 12 community leaders and supported by a 15-member special events board. The mission of the foundation will be to secure financial and nonfinancial support for realizing the MHS vision of providing comprehensive health care for the community. Funds donated by individuals, businesses, foundations, and organizations will be designated for a variety of purposes at MHS, including the operation of specific departments, community outreach programs, continuing education for employees, endowment, equipment, and capital improvements.
· 10. MHS Volunteer Auxiliary There are 500 volunteers who provide over 60,000 hours of service to MHS each year. These men and women assist in virtually every part of the system’s operations. They also conduct community programs on behalf of MHS. The auxiliary funds its programs and makes financial contributions to MHS through money it raises on renting televisions and vending gifts and other items at the hospital. In the past, its donations to MHS have generally been designated for medical equipment purchases. The auxiliary has given $250,000 over the last five years.
· 11. Planning the Future for MHS The MHS has identified five areas of desired service and programmatic enhancement in its five-year strategic plan:
Top of Form
· I. Ambulatory Services
· II. Physical Medicine and Rehabilitative Services
· III. Cardiovascular Services
· IV. Oncology Services
· V. Community Health Services
MHS has set out to answer the most critical health needs that are specific to its community. Over the next five years, the MHS strategic plan will continue a tradition of quality, community-oriented health care to meet future demands.
· 12. Financing the Future MHS has established a corporate depreciation fund. The fund’s purpose is to ease the financial burden of replacing fixed assets. Presently, it has almost $2 million for needed equipment and renovations.
MHS CASE STUDY
· • Balance Sheet ( Exhibit 28–1 )
· • Statement of Revenue and Expense ( Exhibit 28–2 )
Exhibit 28–1 Balance Sheet
|Metropolis Health System Balance Sheet March 31, 2___|
|Cash and Cash Equivalents||$1,150,000|
|Assets Whose Use Is Limited||825,000|
|Patient Accounts Receivable||7,400,000|
|(Net of $1,300,000 Allowance for Bad Debts)|
|Total Current Assets||10,625,000|
|Assets Whose Use Is Limited|
|Corporate Funded Depreciation||1,950,000|
|Held by Trustee Under Bond Indenture Agreement||1,425,000|
|Total Assets Whose Use Is Limited||3,375,000|
|Less Current Portion||(825,000)|
|Net Assets Whose Use Is Limited||2,550,000|
|Property, Plant, and Equipment, Net||19,300,000|
|Liabilities and Fund Balance|
|Current Maturities of Long-Term Debt||$525,000|
|Accounts Payable and Accrued Expenses||4,900,000|
|Bond Interest Payable||300,000|
|Reimbursement Settlement Payable||100,000|
|Total Current Liabilities||5,825,000|
|Less Current Portion of Long-Term Debt||(525,000)|
|Net Long-Term Debt||5,475,000|
|Total Fund Balances||21,500,000|
|Total Liabilities and Fund Balances||$32,800,000|
Exhibit 28–2 Statement of Revenue and Expense
|Metropolis Health System Statement of Revenue and Expense for the Year Ended March 31, 2___|
|Net patient service revenue||$34,000,000|
|Total Operating Revenue||$35,100,000|
|Other professional services||13,100,000|
|Provision for doubtful accounts||1,500,000|
|Income from Operations||$1,700,000|
|Nonoperating Gains (Losses)|
|Unrestricted gifts and memorials||$20,000|
|Nonoperating Gains, Net||100,000|
|Revenue and Gains in Excess of Expenses and Losses||$1,800,000|
· • Statement of Cash Flows ( Exhibit 28–3 )
· • Statement of Changes in Fund Balance ( Exhibit 28–4 )
· • Schedule of Property, Plant, and Equipment ( Exhibit 28–5 )
· • Schedule of Patient Revenue ( Exhibit 28–6 )
· • Schedule of Operating Expenses ( Exhibit 28–7 )
CHAPTER 29 Mini-Case Study 1: Proposal to Add a Retail Pharmacy to a Hospital in the Metropolis Health System
Sample General Hospital belongs to the Metropolis Health System. The new chief financial officer (CFO) at Sample Hospital has been attempting to find new sources of badly needed revenue for the facility. Consequently, the CFO is preparing a proposal to add a retail pharmacy within the hospital itself. If the proposal is accepted, this would generate a new revenue stream. The CFO has prepared four exhibits, all of which appear at the end of this case study. Exhibit 29–1 , a three-year retail pharmacy profitability analysis, is the primary document. It is supported by Exhibit 29–2 , the retail pharmacy proposal assumptions. The profitability analysis is further supported by Exhibit 29–3 , a year 1 monthly income statement detail. Finally, Exhibit 29–4 presents the supporting year 1 monthly cash flow detail and assumptions.
When the controller reviewed the exhibits, she asked how the working capital of $49,789 was derived. The CFO explained that it represents 3 months of departmental expense. He also explained that the cost of drugs purchased for the first 60 days was offset by these purchases’ accounts payable cycle, so the net effect was 0. In essence, the vendors were financing the drug purchases. Thus, the working capital reconciled as follows:
|Cost of drugs (2 months)||$303,400|
|Vendor financing (accounts payable)||($303,400)|
|Departmental expense (3 months)||$49,789|
|Total Working Capital Required||$49,789|
The controller also noticed on Exhibit 29–4 that the cost of renovations to the building is estimated at $80,000 and equipment purchases are estimated at $50,000 for a total capital expenditure of $130,000. The building renovations are depreciated on a straight-line basis over a useful life of 15 years, whereas the equipment purchases are depreciated on a straight-line basis over a useful life of 5 years. The required capital is proposed to be obtained from hospital sources, and no borrowing would be necessary. In addition, the total capital expenditure is projected to be retrieved through operating cash flows before the end of year 1.
Exhibit 29–1 Sample General Hospital 3-Year Retail Pharmacy Profitability Analysis
|Year 1||Year 2||Year 3|
|Cost of Goods Sold||2,047,950||2,088,909||2,151,576|
|Salaries and Wages||192,000||197,760||203,693|
|Materials and Supplies||12,000||14,400||17,280|
|Contract Services and Fees||14,400||17,280||20,736|
|Depreciation and Amortization||15,333||15,333||15,333|
|Provision for Bad Debts||25,876||26,922||28,284|
|Year 1||Year 2||Year 3|
|Cash at Beginning of Period||—||73,597||376,607|
|Net Cash Activities||73,597||303,010||360,884|
|Cash at Ending of Period||73,597||376,607||737,490|
|Year 1||Year 2||Year 3|
|Number of Prescriptions Sold||55,350||56,457||58,151|
Courtesy of Resource Group, Ltd., Dallas, Texas.
Exhibit 29–2 Sample General Hospital Retail Pharmacy Proposal Assumptions
|1.||Annual Prescription Estimates—Rate of Growth/Capture||Per Day||Annual|
|2.||Average Net Revenue per Prescription—Yearly Increases|
|Year 1||$ 46.75|
|Year 2||2.0%||$ 47.69|
|Year 3||2.0%||$ 48.64|
|3.||Bad Debt Percentage||1.0%|
|4.||Average Cost per Prescription—Yearly Increases|
|Year 1||$ 37.00|
|Year 2||3.0%||$ 38.11|
|Year 3||3.0%||$ 39.25|
|5.||Inflation Rates—Per Year|
|Salary and Wages||3.0%|
|Other Than Prescriptions||2.0%|
|Benefits as a % of Salaries||20.0%|
|6.||Initial Capital Requirements|
|Year 1||Year 2||Year 3|
|Net Income before Taxes||238,053||287,676||345,550|
|Year 1||Year 2||Year 3|
|Beginning Cash Balance||—||73,597||376,607|
|Net Cash Activity||73,597||303,010||360,884|
|Ending Cash Balance||73,597||376,607||737,490|
Courtesy of Resource Group, Ltd., Dallas, Texas.
Exhibit 29–3 Sample General Hospital Retail Pharmacy Proposal Year 1 Monthly Income Statement Detail
Exhibit 29–4 Sample General Hospital Retail Pharmacy Proposal Year 1 Monthly Cash Flow Detail and Assumptions
So how was the proposal received by the hospital’s board of trustees? They first asked for a small market study to test the amount of prescription sales projected within the proposal. When the market study results came back positive, the board approved the project, and renovations are about to commence.