Introduction
Businesses have limited investment resources, but there are always numerous options for allocating the available resources. The investor must follow specific steps (Laopodis, 2020). Successful business operation requires capital investment and proper capital budgeting. An organization must select an investment that yields the best return over a specific time frame. This essay examines the capital budgeting justification of a healthcare organization, from identifying capital investments to evaluating their financial performance as investments.
Capital Item Description
Although capital investments are meant to increase a company’s operational cash flow, they may occasionally need to be increased to meet the anticipated expenses. The financial risks and returns associated with the chosen capital item are the most crucial factors to consider when selecting a capital investment (Gore & Wells, 2022). Capital investment can take the form of either financial capital or physical assets.
The capital item that I selected for the healthcare organization is physical capital. Gross Fixed Capital Formation (GFCF) is used to measure physical capital and varies across different countries, reflecting their stages of development (Gore, 2022). Rapidly industrializing countries have higher GFCF as opposed to already industrialized countries.
Rationale of Selection
Investment in physical assets was selected as the capital item due to the following reasons;
Expected and Actual Return Rates
A business’s different economic states may affect the profitability of its investments. Suffolk Community Hospital made two physical investments in its ER and clinic walk-in. The rate of return for the expansion of the ER was recorded as -10% when the economic state was deplorable, while a rate of 30% was experienced when it was excellent (Gore & Wells, 2022). The above outcomes demonstrate that physical investment is a viable financial risk that can be undertaken.
Probability Distribution
When investing in a physical asset in a healthcare facility, the net cash flow depends on several key factors, including the charge per scan and the number of patients served per day. Those factors are also unknown and depend on other variables, such as patient characteristics, doctor adoption of the technology, regional market conditions, and labor and supply prices (Gore & Wells, 2022). This uncertainty creates a probability of returns, where the returns from investments can be higher than anticipated, as opposed to financial capital, where a single return is typically anticipated.
Cost-Benefit Analysis
The cost-benefit analysis measures the benefits of a decision minus the capital used to achieve the decision reached. A choice to invest might be wise if it benefits everyone. (De Rus, 2021). The capital investment should cater to patient safety; hence, the benefits achieved from the investment are intangible.
Most risks that occur to patients are in the emergency department. These risks are caused by unfavorable conditions such as an intensified workload and staff shortage in the ED. 1.5-3% of adverse events in patients occur in the ED, while between 6 and 8.5% of the adverse events that occur in the ED, 36-71% of them, can be avoided (Alshyyab, 2022). Improvements in the emergency room’s staffing and equipment quality can go a long way in reassuring patients that they will be properly cared for. Investing in physical assets is more feasible than financial investment in improving patient safety.
Capital Budget with Projected Financial Benefits
Positive Financial Benefits
Before a company makes any investment, capital budgeting must be done; managers may use capital budgeting to allocate limited resources to investments in a way that adds the most outstanding value. Management of resources is crucial to the sustainability process. (Alkaabi, 2019). Preventing costly breakdowns and ensuring the highest level of security are two of the most important reasons to keep capital equipment in tip-top shape (Ermasova Mikesell, 2019).
The use of robots and AI in surgery has significantly aided surgeons in providing more personalized healthcare to patients, while also reducing repetitive tasks (Agarwal, 2020). A personalized patient experience can reduce risks that compromise patient safety. By increasing patient safety, more patients will seek better healthcare, ultimately leading to increased revenue.
Capital Equipment Costs
Costs that affect a machine can be in the form of capital equipment, personnel, and supply costs. Concerns have been raised about how to effectively control the cost of equipment; this is how to balance the cost of investment with the rate of returns (Chen, 2022).Capital equipment cost consists of the total amount of money to purchase a physical asset, i.e., an asset with a lifespan of more than a year.Capital equipment costs include the total amount required for purchase, maintenance, shipment, installation, and any changes, attachments, and more.
Personnel Cost
Physical assets require technicians or supporting staff to manage and maintain the asset/equipment, thus increasing the investment cost. Growth in labor costs does not necessarily translate into reduced productivity since, if the employed turnover rate is consistent, growth in labor costs leads to increased operating rates. The impact of turnover on labor productivity is much less than that of personnel costs on apparent labor productivity. Although turnover negatively influences the gross operating rate, it has a beneficial impact on apparent labor productivity. (Stundziene, 2022). When the labor productivity of workers is high, more revenues and returns are acquired from the investment, even with the increased personnel cost.
Supply Cost
The equipment supply cost includes the actual cost of materials, direct labor, and direct overhead. Hospitals store and distribute a wide range of commodities, and the difficulties of keeping and distributing these things across the hospital supply chain are critical to providing high-quality patient care (Moons, 2019).The overhead cost increases the cash outflow of the investment to cater to the extra expenses that come with the associated investment.
Financial Ratios
Return on Investment
Ratio analysis measures an organization’s liquidity, operational efficiency, and performance. Return on investment, an example of ratio analysis, is used to measure the financial performance of an investment. One way to express return on investment is through dollar terms, where one subtracts the amount invested from the amount of money to be acquired from the investment (Gore & Wells, 2022).
Two significant problems are faced by this method of measuring return on investment. First, to make a meaningful judgment about the return on investment, one needs to know the size of the investment and the timing of the return. The quantity and timeliness of an investment’s return are factors that a percentage rate of return can better capture.
Rate of return = Dollar returns ÷ amount invested.
Net Present Value
Net present value (NPV) is determined by discounting cash inflows and outflows. Net present value is the total value of cash flow in the period of investment reduced to present value through discounting (Ermasova & Mikesell, 2019). Thus, calculating the difference between cash inflows and outflows, i.e., calculating the cash flows for each fiscal year and then discounting them to produce the project’s net present value (Karajović, 2021). When the NPV>0, the investment is said to be profitable. Furthermore, when NPV=0, the investment is said to have marginal significance. Equally, when the NPV<0, the investment is considered unprofitable.
NPV = ∑ [B (t) – C (t)]/ (1+d) t
Where:
- NPV is the Net – Present Value
- B (t) – Cash inflow in year t (benefit)
- C (t) – Cash outflow in year t (cost)
- t – A year from investment
- d – Discount rate
Consider:
- Capital expenditure = $10,000
- The useful life of expenditure = 5 years
- Annual return from expenditure = $2,000
- Value of investment at the end of the analysis period = $1,000
- Discount rate = 5% and 10%
Using:
- NPV = ∑[B(t) – C(t)]/(1+d) t
- Net Present Value
- 5% Discount Rate = $1,010
- 10% Discount Rate = -$555
Cash Payback Period
The cash payback period refers to the time required by the cash flow generated by the investment to pay back the total investment amount. It is computed by comparing the entire investment to the cumulative yearly financial savings over several years (Imteaz, 2021). Net yearly savings are the annual financial savings minus the annual operating and maintenance expenses. In general, investment is more appealing the faster its payoff is.
NPV of Savings = n ∑ n=1 AS (1 + r) n
Where AS – is the net annual saving of the year.
r – Rate of return.
n – Number of years since investment.
Recommendations
Typically, people use leasing to acquire assets such as a house. Consequently, according to the US Census Bureau, 31.5% of the houses owned in the US are acquired through leasing (Alkaabi, 2019). A 12.3% CAGR increase was anticipated from 2020 to 2027 for the size of the global enterprise asset leasing market, which was assessed to be $820.27 billion in 2019 (Ermasova Mikesell, 2019).
Growing businesses can use the money saved by leasing capital equipment to meet other financial demands. Leasing accounts for over 25% of all new capital equipment purchased in the United States. According to societal trends, people will continue to choose leasing over ownership (Agarwal, 2020).
Therefore, leasing is a more viable approach than financing because it has low upfront cash costs. It reduces the chances of an organization having obsolete equipment. It also shifts equipment maintenance costs to the leasing business and offers an easier way to acquire equipment if the company’s credit rating improves.
Conclusion
A sufficient amount of money must be available to aid the organization’s operation to be effective. When a business purchases material goods to accomplish its long-term goals and objectives, it invests capital. Capital investment may take the form of either financial assets or tangible, physical assets.
According to research (Crouzet, 2019), the decline in investments in physical capital after 2000 may be primarily attributed to an increase in intangible capital. Despite the information above, it is clear that purchasing physical assets, such as buildings and machines, improves patient safety in any healthcare organization. Hence, this is achieved by enabling doctors to provide more individualized patient experiences through robots and artificial intelligence.
References
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