PENGELOLAAN KEUANGAN RUMAH SAKIT

How are hospitals financing the future? Core competencies in capital planning

Healthcare Financial Management,  July, 2004

Financing the Future is a yearlong project to help hospitals take advantage of growth opportunities. Led by HFMA is partnership with GE Healthcare Financial Services, the project provides information, insights, strategies, and tools designed to help hospitals finance their future. The findings of Financing the Future are based on research conducted by HFMA and PricewaterhouseCoopers. To access the first four Financing the Future reports, visit www.financingthefuture.org.
Research findings have shown that more than 8 out of 10 hospital CFOs recently surveyed fear they will have greater difficulty funding capital expenditures over the next 10 years. This striking finding reveals the imperative need for healthcare CFOs to plan strategically and to find innovative ways to access capital.
The previous Financing the Future reports have focused on the numbers behind capital access and planning. They have shown the tremendous need for capital, as well as the ways to fund capital projects. The have also demonstrated the lack of capital funding in recent years and the anxiety about future capital access.
Building on that research, Report 5 in the Financing the Future series, summarized here, focuses on the how-to of capital planning and access. Experts interviewed for the project identified three areas in which healthcare financial executives need particular expertise for effective capital access: strategic planning, managing the balance sheet, and hiring experts. This report presents best practices in each of those core competencies, as well as "case in point" illustrations.
COMPETENCY 1: STRATEGIC PLANNING
The importance of coordinating strategic planning with capital planning cannot be emphasized enough. But all too often in health care, those planning processes are conducted separately, with negative results. Strategic objectives that are not financially tested may fail or never come to fruition. Conversely, when capital expenditures are set without a strategic plan, an organization may not have the capital needed to pursue revenue-generating opportunities.
Step 1. Analyse your internal position. The first step in careful strategic planning is to analyze the hospital's internal position. Questions to answer include: who are your patients, what are the characteristics of your medical staff, and how is your organization performing operationally and financially? A variety of quantitative data, including demographic, utilization, physician resource, and competitor profiling data, will aid in your analysis.
But quantitative data alone will not give you the basis for an accurate conclusion; the perceptions of your stakeholders are equally important. Seeking their feedback through community surveys, focus groups, town hall meetings, and open board meetings provides an opportunity for your organization to identify these perceptions and define strategic alternatives before planning begins.
Internal assessment should also include determining your organization's liquidity, profitability, and capital structure. This assessment provides the information necessary to understand the steps you need to take to make your organization more attractive to capital markets.
Step 2. Assess the external market. The second step is to look at your organization's market position as it relates to several key drivers, including:

* Population growth

* Consumer expectations

* Payer demands

* Health of the local economy

* Number and type of local healthcare providers

* New clinical technologies offered (or not offered) in the local market

External assessment helps identify potential capital needs, particularly capacity and equipment.
Step 3. Identify and prioritize strategic opportunities. You need to determine how well your organization is positioned, both operationally and financially, to respond to the changing market. This stage of strategic planning requires the most systematic link to capital planning. A few of the questions to answer at this stage include:

* Does your organization have the infrastructure to handle the increasing population growth in your market area?

* Do you have enough capital to cover ongoing needs?

* What would be the response to a new facility in your primary service area?

The future state of healthcare delivery may be hard to predict, but a realistic assessment of your organization's current state and finances provides a solid foundation for setting the organization's future strategic direction.
Step 4. Allocate capital. Tightly linked to identifying strategic priorities is capital allocation. This is the process by which organizations assess and set priorities among capital requests. Setting capital priorities begins with the allocation of the five-year capital spending pool to a minimum of three different "buckets": routine projects (maintaining facilities), mandated projects (fulfilling regulatory requirements), and strategic projects (developing new facilities).
Each capital request is then evaluated according to several criteria and ranked within its funding pool. There are several ways to consider the prioritized list of projects. For example, the list can be reviewed as a group to determine whether funding should simply be allocated to the capital projects with the highest scores. Or high-ranked projects that involve significant capital costs may be replaceable with several lower ranked, less expensive projects. Also, a capital partner or philanthropic resource might be identified for some higher ranked projects, thereby freeing capital for other needs.
Step 5. Develop implementation plans and performance goals. Without an actionable plan with measurable goals, a strategic plan can't be effective--in fact, it may not even move to implementation. And if capital allocation isn't tied to strategic planning, organizations are inclined to allocate capita] based on history or a subjective and potentially politically motivated process. At this point, healthcare executives must develop tactical steps for implementation, assignments of accountability, and measurable goals.
Step 6. Re-evaluate the plan on an ongoing basis. Monitoring the success of your strategic plan must become an integral part of day-to-day operations. Has your organization been successful in implementing the objectives? Are there issues that are impeding progress? Are the objectives still optimal for the success of your organization?
Answering those questions can tell you whether additional resources are necessary or tight time frames should be modified, for example.
COMPETENCY 2: MANAGING THE BALANCE SHEET
Accessing capital depends largely on maintaining a balance between debt and assets--i.e., managing the balance sheet. Maintaining this balance helps ensure that your organization can assume new debt when necessary for capital projects and has sufficient cash for other capital projects. Balance sheet management is a key component of planning and is closely linked to strategic planning.
Step 1: Analyze your cash levels and debt capacity. Healthcare organizations need enough cash either to fund their capital projects or to qualify for credit. Three approaches are generally used to determine an organization's debt capacity:
* Cash flow approach (focused on the relationship between current profitability and maximum annual debt service)
* Debt-to-capitalization approach (focused on the relationship between debt and total capitalization)
* Cash-to-debt approach (focused on the relationship between liquidity and debt)
Step 2. Assess your capital needs. The previous section, on strategic planning, discussed ways to assess capital needs through internal and external analysis and capital allocation. Your organization's balance sheet can be managed effectively only in concert with a systematic assessment of the organization's strategic priorities and related capital needs.
Step 3: Match capital needs with capital sources. Because capital projects can be financed in many different ways and have different returns on investment, the organization must find financing vehicles that fit best with its financial profile, its strategic priorities, and the specific capital project. Matching capital sources to cap ital needs requires filtering through myriad issues.
Step 4: Consider alternative capital sources. Effective balance sheet management requires considering "alternative" sources of capital. Two of the most frequently used alternative financing options are leasing and monetization.
The need for leasing often stems from simply the need to put more cash on the balance sheet; in other instances, the decision is more strategic, such as the desire to free capital for other strategic initiatives.
Because many lessors, such as banks, leasing companies, and equipment vendors, may be interested in providing leasing, it's important to solicit quotes from a variety of lessors and to compare the cost of leasing with using cash or bond proceeds.
Monetization is another way of getting more cash on the balance sheet and reducing debt-to-capital ratios. Growing investor interest in medical real estate, increased real estate pricing, and historically low interest rates have combined to convince some hospitals to sell their medical office buildings.
"There are very few medical centers that have huge reserves of cash on hand," says Larry Goodman, MD, president and CEO of Bush University Medical Center in Chicago. "We are looking at monetizing several buildings on campus." It not only improves the system's cash on hand, but also "gets back to the core mission."
Step 5: Mitigate risks. To lessen the risk of rising interest rates, many CFOs have engaged in interest rate swaps and derivatives. As discussed in earlier Financing the Future reports, many bond transactions involve interest rate swaps, and some systems have engaged in swap or "swaptions" on existing debt. CFOs need to clearly understand the risks and rewards of these arrangements as well as how to treat them from an accounting standpoint.
Step 6: Monitor the balance sheet on an ongoing basis. Careful monitoring of the balance sheet allows you to routinely evaluate opportunities to lower the cost of capital and reduce risks; it will also help you assess whether your organization can handle increasing debt. Following are a few of the questions you should include in a regular review of your organization's balance sheet:
* Are there large discrepancies in balances between the prior year and the current year?
* Did total assets increase over the prior year?
* Did current assets increase, decrease, or stay about the same?
* Did current liabilities increase, decrease, or stay about the same?
* Did land, plant, and equipment increase or decrease significantly over the prior year?
* Did long-term debt increase or decrease significantly over the prior year?
COMPETENCY 3: HIRING CAPITAL ADVISERS
Although some capital access efforts, such as philanthropy, are routine, others are pursued only rarely. For that reason, many hospital CFOs lack the technical expertise, time, or qualifications to work through the capital access and debt issuance process.
"CFOs are generally behind the curve when it comes to accessing capital, especially in the debt market," according to Mark Harrison, CFO of Allina Hospitals and Clinics, Minneapolis.
On whom can hospital CFOs rely to help them through the important process of accessing capital on the debt markets? Most debt deals require three different experts or advisers:
* A financial adviser, to structure the deal and represent a hospital's interest
* A bond counsel, to develop the legal documentation
* An investment bank or underwriter to be the sales conduit between the hospital and the bond buyers
There are five general strategies for working with a variety of advisers.
Strategy 1: Pick good advisers. Look for advisers who have a strong track record with rating agencies.
Strategy 2: Decide whether to use a trusted adviser or enter the competitive proposal process. On one hand, a trusted adviser brings knowledge of your organization to the table that you would have to pay new advisers to learn. On the other hand, there are times when your priority should be objectivity; in those instances, it's best to use a competitive process.
Strategy 3: Keep it simple. Don't let your advisers structure an overly complex transaction. If it's too complex, it's not worth doing. Also, fees and commissions increase with complexity.
Strategy 4: Connect the dots. Make sure your in-house attorneys are involved in selecting external legal advisers and that they regularly communicate with you and each other. Similarly, the CFO needs to be involved in selecting a financial adviser and investment bank. Also, it's important that the advisers you choose are able to work as a team.
Strategy 5: Have strong finance committee members on the board. Make sure your board has real financial expertise. Board members who have their own business experience in the debt market also may provide additional unbiased insight. Sarbanes-Oxley requires that corporations disclose whether their audit committees include financial experts. Although not-for-profit hospitals aren't required to follow Sarbanes-Oxley, many are choosing to comply with this guideline.
Finding the right advisers to work with you is important because it enables you to keep your eye on operations while the experts focus on structuring your organization's capital access process.
LOOKING AHEAD
The previous Financing the Future reports have examined capital supply, capital spending, capital need, and capital access. The next report, to be released in September 2004, will draw on leading industry analysts and providers to answer key questions about the future healthcare environment, including:
* What is the most likely scenario for the U.S. healthcare system in the next decade?
* What should be the role of state and federal government in changing the system?
* What can an individual hospital or health system do to survive--and to thrive?

ABC Health System Capital Project Scoring Criteria and Weights

Benefit Area      Criteria                   Sample Weights/Scoring

Strategic/        Fit with key strategic     0.5 point for each

Market            goals                      strategic goal met

                  Support of clinical        1 point if yes, 0 if no

                  priorities

                  Effect on market position  1 if market share gain,

                                             -1 if market share loss,

                                             0 if no change

                                             MAXIMUM SCORE: 5 WITH

                                             SIX GOALS

Financial/        Revenue potential          2 points for positive

Operational                                  revenue impact

                  Achievability of

                  operating savings          2 points if yes, 0 if no

                  Capacity to increase

                  productivity               2 points if yes, 0 if no

                  Return on investment       2 if >10%, 0 if 0-10%,

                                             -2 if <0%

                  Level of investment        0.5 for every $x million

                                             in costs

                                             MAXIMUM SCORE: 8 IF NO

                                             CAPITAL COST

Stakeholder/      Effect on quality of care  1 for improvement, 0 for

Community Impact                             no change

                  Effect on patient          -1, 0, or 1 depending on

                  satisfaction               level of improvement

                                             (negative to positive)

                  Level of medical staff     -1, 0, or 1 depending on

                  support                    level of support

                                             (negative to positive)

                  Increases employee

                  satisfaction               1, 0, or 1 depending on

                                             amount of change

                                             (negative to positive)

                                             MAXIMUM SCORE: 4

Source: Johnson, Tracy K., "The Capital Challenge:

Needs versus Resources," Healthcare Financial Management,

May 2003, pp. 62-68

CHECKLIST OF CRITERIA FOR EVALUATING APPROPRIATE CAPITAL SOURCES
Criteria Related to Capital Source

* Cost of capital

* Covenants

* Rate of return required

* Wishes of philanthropic donors

* All-in borrowing rate

* Costs of issuance of the debt

* Structure of the financing documents and underlying security requirements

* Maintenance and incurrence covenants

* Principal amortization

* Interest-rate risk

* Average useful life versus average maturity

* Disclosure requirements

* Prepayment penalties and unwind provisions

* Accounting treatment

Criteria Related to Capital Project

* Criticality of the project to the organization's core mission

* Expended life of technology or equipment

* Need to partner with physicians

Criteria Related to Organization

* Tax status or other tax implications

* Debt capacity

* When the money is needed

* Tax-status implications of the use of proceeds

* Credit position

* Control issues (how much control must your organization give up?)

* Potential for investment-grade rating

* Potential to obtain credit enhancement

COPYRIGHT 2004 Healthcare Financial Management Association
COPYRIGHT 2004 Gale Group

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