Principles of Capital Financing and Capital Charging in Health Care Organizations

FINANCIAL MANAGEMENT IN HEALTH CARE 1

Principlesof Capital Financing and Capital Charging in Health CareOrganizations

Principles of Capital Financing and Capital Charging in Health CareOrganizations

Financialmanagement in any industry involves carrying out routine financialoperations, for example, negotiation of contracts, cash for expensemaintenance, and availability of money for expenses. Financialmanagement at the executive level of any health care organizationprovides the stakeholders with vital information for future strategicplanning. The health care providers, for example, hospitals and otherphysician practices may opt to the expansion of tests and treatmentsthrough buying more medical equipment. In addition, financialmanagement helps with decision making and identifying the best way tohandle operations within the organization.

Financial Management in Health Care is currently an important area ofstudy for the health care professionals. A health professional, forexample, should be able to figure out costs incurred of handlingprovision or operations of other added services to approximateoperation costs or service (Finkler, 2010). Health care takes a partof not-for-profit accounts systems and not necessarily a business orinvestor-owned accounting. Health care financial management,therefore, is very different from other profit-orientedorganizations. The paper examines the objectives of financialmanagement in health care, principles of equitable and effectivecapital financing and capital charging in the health careorganizations. In addition, the paper will also reviews options forthe execution of these principles, while considering comparativemerits of few alternatives.

TheObjectives of Financial Management in Health Care Organizations

One of the mainobjectives of financial management in health care is meant togenerate financial income used to carry out and facilitate affordablehealth care services (Cleverley &amp Cameron, 2007). In the healthcare system, there are many ways to generate income. One of the waysincludes fees incurred from patient treatments from the servicesrendered. The fees collected are used to facilitate services and forbuying needed medicine and appropriate tools and instrument thathelps the facilities serve more patients. The funds collected arealso collected from of the well-wishers and government budget.

Regulations that concerns financial accounting and management in ahealth care facility must first abide by the financial managementhealth care. Some of the regulations are principles, rules, andconventions, which underlies standards accounting (Folland et al.,2007). For example, in a health care system, financial managementpresents no obligation, but to guarantee that they comply with thestandards by relatable organizations. Financial management in healthcare also helps with the control of costs within the health facility.It is done to ensure that the funds collected are well-apportioned tospecific departments or sectors in dire need (Folland et al., 2007).They also guarantee unnecessary expenditures are reduced.

Approachesto Capital Financing and Capital Charging

Privateinstitutions base most of their investment projections on commercialcriteria. These institutions raise their capital from equity sourcesor debt or even retain profits while they account for retention costsas opposed to selling them off including their assets, depreciationcosts over their lifetime assets.

Organizations thatoperate in the most competitive markets either succeed or fail basedon their ability to rip enough from their long-term investments topay off asset base, interests, and returns to the equity holdersbecause of the investment capital. Here, Courtney &amp Briggs (2004)noted that accounting standards are often enforced to ensure thatshareholders in and lenders to are informed about the cost of capitaluse in other investment. The cost of capital represent incentives toremain in business and continue earning profits, which guaranteestrength and direct stimulus to manage and invest in capital assetsefficiently. In many health care organizations, the weakness orabsence of a well-set incentives create the need to have explicitpolicies on capital investment and application of capital charging.

Of capitalfinancing and charging, the basic model of any organization has thefollowing set of characteristics:

  • Capital allocation both within and between the sectors, which is an outcome of individual decisions manifold. No governmental or central body plans it. The allocative efficiency is dependent on competitive markets for production of goods and services.

  • Financing is provided by retention of businesses` profits or private capital markets. The cost of capital is determined by the private capital markets for any program or investment program based on the risks involved and capital supply balance and demand that prevails at the time.

  • Capital charging represents both assets depreciation and returns payment on the same assets, which is done explicitly through dividends or interest from increased retention of profits.

However, health caremarkets are not like the normal commercial markets. In the UnitedStates, for example, which mostly rely on private operatingbusinesses in the competitive markets to purchase and offer healthcare, approximately half of the entire health care expenditure isfrom the public sector (Zelman et al., 2009).

Across the world, Penner (2013) observed that governments have longbeen involved in health care planning and financing. In manycountries, health care providers are also owned by the state.Therefore, governments are involved closely in the financing andallocation of capital investments in the healthcare sector. Manyapproaches to allocation and capital charging are used. In manyplaces, the results often leave considerable scope for efficiencyimprovement in the use and allocation of capital.

Principles

The principlesfocus on the health care systems, which do not rely on forces fromcommercial market to determine the allocation and extent of thecapital investments in the provision of health care. In such healthcare systems, the problem often remains to replicate the constraintsand incentives that stimulate commercial markets efficiency, toensure that:

  • Healthcare providers are given enough capital funds to invest in health care equipment and building.

  • Capital investment financing is obtained through cost-effective sources, whether it is from the government, private capital markets, or international lending organizations.

  • One they are procured, assets are efficiently used, while they are obtained, maintained, or replaced through efficient disposal.

To achieve all the above objectives, it will depend on allowing themanagers through strong incentives full account of the capital costs,as well as capital investment benefits. In most of the non-markethealth care systems, service providers may not have to incur fulleconomic costs resulting from capital investments (Penner, 2013). Tothem, capital is a free good, or rather a heavily subsidized one forthat matter.

Although to obtain permission from payers in the health care, forexample, local or national government and social insurance funds, forthe purchase of assets could be difficult. It is so, especially oncethe permission is granted, which commonly is accompanied by thenecessary capital funds grants (Baker &amp Baker, 2006). In thatcase, equipment and buildings purchased by the grants are considered&quotfree good&quot to the providers of health care, who does nothave to pay more. In the expenditure and income account, nodepreciation charges will be included. In addition, no amount ofinterest has to be returned or paid on the amount of capital earned.

Once assets are purchased, the health care organizations have to findfunds to pay the staff, maintain, and operate them. The health careprovider at that point may make decisions based on the ability tooperate its new health care facility only at half its full capacity.In extreme cases, some of the health care providers may decide not touse the assets, but mothball them (Cleverley &amp Cameron, 2007).All there is no accounting costs or cash to doing so, the opportunitycost is clear, which include the forgone value. The forgone value towhich the resources applied in creating those assets could have beenput. To bring this opportunity cost into the perspective of thehealth care managers and decision-makers is the main point of&quotcapital charges.&quot

Capital charges are made up of two main elements: the cost of capitaland depreciation.

The cost of capital: it is the opportunity cost choosing notto invest the funds else in the market. For every dollar used topurchase, health care assets could be used to invest elsewhere in theeconomy, which according to Gruen &amp Howarth (2005), would beexpected to gain positive return in gains. The forgone investmentreturn is measured by the cost of capital. While the cost of capitalis relatable to the riskiness of the actual investment, cost ofcapital relevance is based on the marginal return from theinvestments considered to be of the same degree of health careinvestment riskiness.

Depreciation: it is the extent to which assets are used u orconsumed in a fiscal year. It is calculated conventionally as the oneof the &quotn&quot of the initial value asset. For example, apersonal computer may depreciate over a span of five years, but ahealth care building is lasts between 25 and 100 years. It is knownas &quotstraight line depreciation&quot (Courtney &amp Briggs,2004). Funds accumulated in business depreciation reserves are oftensufficient to enable health care providers to hand their mandates.

If health care organizations have to add depreciation to be anexpense, while paying for the cost of capital, these organizationswill no longer have to capital investments as free goods. Unless thehealth care organizations enjoy the luxury of having unlimitedbudgets, the same incentives will be used efficiently on capital andnot to over-invest it (Courtney &amp Briggs, 2004). If, forinstance, health care managers wished to buy more medical equipmentand built more buildings, then they will have fewer amounts offinances to pay their staff, extra materials, and outside services.

The capital charging objectives are meant to:

  • Make health care managers pay attention to costs of capital to avoid treating them everything as free goods.

  • Give them incentives to invest efficiently to labor, mix of capital, maintain assets, and use them in ways that maximizes disposal value while minimizing disposal costs.

  • Allows costs comparison among health care organizations, and

  • Establish fair competition basis among health care providers, which will be impacted by depreciation, costs of capital, and public providers.

CapitalFinancing

Privatelyowned health care organizations earn their revenues from either orboth the private and public sector institutions, and also borrowneeded capital from both the sectors. When capital is borrowed fromprivately-owned organizations, the health care providers wouldaccount and pay for it like the commercial model explained above(McLean, 2003). Through the mix of both public and private funding,the privately owned health care organizations often have the de factocapital charging systems and commercial incentives installed for theuse of the capital efficiently. Here, the focus of capital chargingis on the public health care organizations that receive most of theirfunding socially or from the state, as opposed to the privateorganizations. According to Finkler (2010), when the public sectorhas assets in public health care providers, it is the public sectormanagers to give the incentive to acquire, use, and discard capitalassets effectively.

Capital investmentfinance by the publicly owned health care organizations mayprincipally borrow from the private sector, the government, andinternational lending organizations, with or without guarantees fromthe government that the debt will be cleared. From the health careorganization perspective, effective capital finance source forparticular funds are often made available (Folland et al., 2007).Both the government and international organizations, in extremecircumstances, typically limits the amount of funds they are ready tolend at a particular period. When funds for lending are exhausted,the rates of interests thus become irrelevant.

From a nationaleconomy perspective, however, one effective way to access capital isnot based much on the particular that charges lower interest rates.From government borrowing, interest rates do not project the level ofrisk of the project. For example, if private capital markets are madeefficient, then one single line of economic argument is allowed.After that, whatever a particular finance investment charges interestrates is, and thus the costs of capital for that particularinvestment (Baker &amp Baker, 2006). When the government offers tofinancing the health care organizations, but with lower rates ofinterest, then it will have to subsidize loan sizes. The government,based on this argument, affords to give the subsidy because it cancoerce its taxpayers to service it.

The interest ratescharged by the private lenders to health care organization towards aspecific health care investment is dependent on the assurance made bythe government to these lenders that they will pay. If, for example,the government guarantees the private lender that all the chargesincurred will be covered, then there is no risk faced by the lenderin genuinely financing the health care organizations, and thus theinterest rates are made correspondingly low.

However, agovernment ready to make such an assurance to the private may as wellfinance the health care provider because, according to Cleverley &ampCameron (2007), it gains nothing and has no transfer risk because itdoes not include the private sector. It is also because it willprobably have to cover high transaction cost by doing so. From theedge of the spectrum, if at all the government fails to assure orguarantee the private lender therefore the interests` rates will behigher because more risks are transferred to the private lender.

For instance, ifcapital is made available from particular international lendingorganizations at much lower rates of interest than it is from theprivate capital markets or the government, and from a nationalperspective, this becomes the most effective source of funds. McLean(2003) observed that is there is any implication subsidy in the rateof interest charged by these international lending institutions thefunders will have to service it eventually.

  1. Capital Allocation

The allocating resources process to specific capital investmentprojects is often separated from the source of finances (Gruen &ampHowarth, 2005). In the public institutions, for example, a system isneeded to determine the amount of resources invested annually.Numerous mechanisms for the capital resources allocation aredetermined, which employs criteria to be used to set up investmentpriorities. Mechanism of allocation and planning can be used in thepublic health care organizations. The mechanism is also based onwhatever the sources of capital financing and specific capitalcharging, either used or not.

CapitalCharging

Capital chargingdemands that health care organizations regard as costs both thenormal rate of demand and assets depreciation used as assets thatcorresponding investments are expected to earn. The two capitalcharges elements could be expressed to either be dividend payments orinterests and separate depreciation costs or be woven into singlecharges (Gruen &amp Howarth, 2005). Whether separate depreciation orsingle rental and cost of capital elements are incurred, some of theoptions for specific types of capital charging are chosen to cover anumber of dimensions.

In health careorganizations, capital charging can be applied readily to all newlyacquired assets. This is because their prices are known the same wayloan terms to finance procurement are viewed. It is straightforwardwhen establishing balance sheet, and asset register are handledwithin the organization. Eastaugh (2004) observed that interest anddepreciation in such a situation are added in the expenditures. Theaddition is aimed at recovering the prices required for all thehealth care services rendered.

The interest generated would be the cash payments to the lenderswhether it is international lending institutions, government, or theprivate sector. According to Cleverley &amp Cameron (2007),depreciation will not be the cash charge however, it would be totalcost based on the expenditure and income account, which is to be paidinto the depreciation reserves.

Within thehealthcare organization`s financial structure, and where thegovernment is the sole lender, it is possible to have an alternativedepreciation mechanism. Instead of giving finances to the health careorganization, which in turn uses them to buy health care assets andpay its staff, the government itself could buy the assets needed forthe provider. The particular health care organization would still beable to generate interest through making payments to the government(Folland et al., 2007). It will have to enter a series ofdepreciation costs through its expenditure amounts and incomeaccounts. However, the government, rather than the health careprovider, will be held responsible for encouraging depreciationreserve over a period, whether notional or real.

CapitalCharging in Health Care: To include existing assets?

Over time, while the old assets are continually replaced by new ones,the health care provider proportion of existing asset is based on anincrease in paying capital charges (Penner, 2013). However, Baker &ampBaker (2006) caution that it could take a lot of time before allexisting assets are placed on the balance sheet, depreciates, andpaid out of revenues. This is because the assets, for example,buildings, can last for a very long time. In addition, as land isconsidered non-depreciative, the value of land as an asset will notbe accounted, unless the health care organization in questionrelocates and has to purchase a new land.

To apply capital charging on new assets only presents two potentialfailings. The first one includes performances of different healthcare providers that have the comparison of both the old and newassets. For instance, capital charging applied to new assets hasmodern equipment and building, will have an added cost advantage overthat one with less capital stock (Finkler, 2010). Compared with thesecond healthcare provider, for example, the first provider, forinstance, will require a few new investments than the second, andtherefore, will be required to pay a lot of capital charges.Therefore, the first health care provider, for example, will beviewed to have lower cost, for example, if it is using a lot ofresources to deliver quality health care to the second one.

Secondly, ifpublicly-owned health care providers, for instance, compete with theprivate providers, whether it is from the private or public sectorlenders, the private providers will be in a disadvantaged competitiveposition unless the public health care provider to cover enoughcapital charges in every asset involved. To apply capital charges onthe new assets alone will reduce the level of unfairnessprogressively, but will entirely be removed. It is recommendedtherefore that both the new and existing assets be applied. However,Zelman et al. (2009) noted that the only disadvantage that faces thisoption is the increase in the administrative costs for theimplementation of the capital charging system. It should also benoted that this administrative cost is relatively small compared tothe potentiality the use of capital will likely to have.

  1. Capital Charging: Asset Valuation

Given the impracticality and inappropriateness of the historical costvaluation, Courtney &amp Briggs (2004) noted that it is preferableto apply certain forms of current costs, for example,inflation-adjustment accounting for those publicly-owned health careorganizations. To determine the current values of long-term assetsand, in particular, the buildings and equipment used by thepublicly-owned health care organizations means it is not completelystraightforward.

The majority of the health care assets, for example, hospitals, arevery specialized with no apparent significance in the second-handmarket. An open market, for instance, is practically impossible whendetermining health care use. According to McLean (2003), the onlymarket value realistically obtained is the real price of the asset(building) if it is sold for residential or commercial use afterconversion. However, not often do the open market value when usedalternatively is not related to the actual value of the outputs,while is also likely to cost lives to building the hospital.Therefore, an open market value is relevant, especially withalternative use, which is only where the asset involved is not neededfor health care anymore, and as surplus can be offered to the highestbidder.

Fig 1: Valuation of a health care Asset

Conclusion

Finance forinvestment based on the physical capital of the health careprovisions may be made available from the international lendinginstitutions, government, or the public sector. However, whateverfinancial source there is, applying capital charging for allpublicly-owned health care organizations is a worthwhile andpractical measure. The measure would have potential benefits thatinclude making the managers well-aware of the costs of capital avoidtreating it as a free good. Other benefits include improvement ofefficiency with which the cost of capital is used, which ensures anappropriate mix of labor and capital in the delivery of qualityhealth care.

To establish thebasis of fair competition that exists between the public and privatesector health care providers, there exist a series of options thecapital financing and capital charging for the precise way it maytake. There is a balance between the pros and cons that exist betweenthe options recommending some approaches, which include: theapplication of capital charges, which exist between the assets andinvestments of health care organizations. Principles of capitalcharging and financing allow transitional period, which will beintroduced in the adjustment of the asset base of all health careproviders.

References

Baker, J. J., &amp Baker, R. W. (2006). Health care finance:Basic tools for nonfinancial managers. Sudbury, Mass: Jones andBartlett Publishers.

Cleverley, W. O., &amp Cameron, A. E. (2007). Essentials ofhealth care finance. Sudbury, Mass: Jones and BartlettPublishers.

Courtney, M. D., &amp Briggs, D. (2004). Health care financialmanagement. Sydney: Elsevier Mosby.

Eastaugh, S. R. (2004). Health care finance and economics.Sudbury, Mass: Jones and Bartlett Publishers.

Finkler, S. A. (2010). Financial management for public, health,and not-for-profit organizations. Upper Saddle River, NJ:Prentice Hall/Pearson.

Folland, S., Goodman, A. C., &amp Stano, M. (2007). The economicsof health and health care. Upper Saddle River, NJ: PearsonPrentice Hall.

Gruen, R., &amp Howarth, A. (2005). Financial management inhealth services. Maidenhead, England: Open University Press.

McLean, R. A. (2003). Financial management in health careorganizations. Clifton Park, NY: Delmar Learning.

Penner, S. J. (2013). Economics and financial management fornurses and nurse leaders. Sudbury, Mass: Jones and BartlettPublishers.

Zelman, W. N., McCue, M. J., &amp Glick, N. D. (2009). Financialmanagement of health care organizations: An introduction tofundamental tools, concepts, and applications. San Francisco:Jossey-Bass.