Introduction
Capital budgeting practices are very useful in both profit-making and non-profit making organizations. This is because all organizations are faced with financial constraints at one point in their operations. The capital analysis, therefore, helps in determining the ways in which to improve on its financial stability. Health care organizations also face the same problems and therefore need the methods of capital budgeting to survive. They also require extra sources of funds to maintain their performance (Kramer, & Ellertsen, 2009)
Capital budgeting
Capital budgeting is a process used by the managers of a business or of any organization to determine whether projects which require large sums of money to set up are worth pursuing. These are projects such as the building of new plants or long-term investments. The decision is reached when the projected cash input and the output are calculated so as to know whether the returns from the project will meet the target. Capital budgeting also helps the company to know which projects when undertaken will yield the most returns for the organization (Kleinmuntz, & Kleinmuntz, 1999). The most used methods of capital budgeting are net present value (NPV), discounted cash flow (DCF), and the payback period. The health care sector faces extraordinary financial strain due to the rising costs of offering its services. A lot of competition and reimbursement limitations are being experienced. In order to maintain their performance, the health care organizations must take measures such as controlling the costs and also on long term allocation of resources (Healthcare Financial Management, 2008). They must start some facilities or investment in new technologies as a response to these challenges. Capital investment methods are also significant to the health care organizations so as to give to the ways of maintaining their levels of performance in the competitive environment.
Break-even analysis, profitability, and payback process
Break-even analysis is the process by which the management accountants of organizations based on the variable and the fixed costs. Break-even point is the point at which a project’s cost of setting up equals the returns from the project. It reaches the point where the returns from the projects have covered the expenses incurred in setting up the project (Business Owners Toolkit, 2007).
Profitability is the ability of a business to make returns. It is expressed as profit margin which is the net profit after deduction of taxes divided by the sales for one year. The payback period is the time taken to break even on an investment. This is the time that the worth of a business can be determined since it is when its profitability is felt (Finance Scholar, 2008).
For proposal 1
Initial investment/outlay $15,000
Variable costs mp; $40/patient, with 500 patients per year, a total cost of $20,000.
Fixed costs $75,000/year
The total costs are $110,000.
Price charged per visit $120/patient fixed for three years
# of patients projected in 1st year 500
Increase in # of patients 500/year for fours years
In the first year, 120 * 500 patients, a total of 60,000 per year.
In the second year, 120 * 1000 patients, a total of 120,000.
The break-even point of proposal #1 is in the second year. It is the point where the returns will have covered the costs (Miller, and Ryan, 1995).
For proposal 2
Initial investment/outlay $50,000
Variable costs $500/patient for 1000 patients
Fixed costs $50,000/month
Total costs, $150,000.
Price charged per visit $950/patient fixed for three years
# of patients projected in 1st year 1,000
Increase in # of patients 500/year for fours years
During the first year, $950 * 1000, equal to $950,000.
The break-even point of the project will be in the first year since it will have covered all the expenses in this first year. Anticipated cash flow for proposal #1 [Y1:-35,000] [Y2:5,000] [Y3:45,000] [Y4:85,000]. The payback point for this proposal will be at the fifth year since it will have recovered all the expenses incurred in laying up the project.
Anticipated cash flow for proposal 2, [Y1:-150,000] [Y2:75,000] [Y3:300,000] [Y4:525,000]. The payback point for this proposal is in the third year since it will have recovered all the expenses in initiating the plan. It is at this point that the profitability of the plan will be felt.
Proposal #1 will be the most profitable in the long run since it is an organization’s own project not like the other one which requires lease terms.
Conclusion
Analysis of the anticipated profitability of any project is very essential in deciding the form of investment to engage in. this however requires those who have proper knowledge in accounting since the decision is a long term one.
References
Business Owners Toolkit (2007). Payback period Analysis. Web.
Finance Scholar (2008). Example and explanation of payback rule in recovering initial investment costs. Web.
Kleinmuntz, C. E. and Kleinmuntz, D. N. (1999). A strategic approach allocating capital in healthcare organizations. Healthcare Financial Management, 53 (4), 52-57.
Kramer, A. K.& Ellertsen, R. J. (2002). Using PCs for effective case-mix based budgeting. Healthcare Financial Management, 47 (6), 52-55.
Miller, T. R. & Ryan, J. B. (1995). Analyzing cost variance in capitated contracts. Healthcare Financial Management, 49 (2), 22-23.
Using an affordability analysis to budget capital expenditures. Healthcare Financial Management, 50 (6), 70-75.