Capital Budget Decisions at Central State Hospital

Background and mission of the Hospital

The mission of Central State Hospital System (CSHS) is to provide comprehensive, high-tech healthcare (all but about 5 percent of needs) and medical and nursing education for the citizens of Grandville, Garry County, and the two adjacent counties, at a cost consistent with their ability to pay. (The counties are all in a depressed area of the country due to poor economic times and lose of the manufacturing sector. While they are not impoverished, they are barely holding their own on jobs and population growth.

Here are some representative decisions faced by the board that illustrate the dilemmas created by time, risk, liquidity, unique assets, and unique community groups.

CSHS has an operating budget of $100,000,000 per year. It has a cash flow of $6,000,000 from depreciation plus profits, but last years operating profits was in the red. Last years operating profits were a negative $1,000,000. A rainy day fund of $10,000,000 generates $500,000 per year non-operating income. Interest or principal could be used to meet expenditures next year.

The following strategic projects are proposed to the board.

Purchase the Farmington School: The purchase cost is $2,000,000, plus annual fixed maintenance costs for building security of $100,000, indefinitely. The school and its lot complete the north block of your main property. If you don't buy, they will probably be bought by some small business. The CEO proposes using the building for childcare for 125 preschoolers, hospital workers, and others. Revenues will cover all direct costs of child care but not the maintenance costs because of competition and the low income of the mothers. Employee focus groups indicate the program will be popular and will aid recruitment, retention, and absenteeism. Marketing research using surveys suggest that the program can be marketed to other organizations; thus the risk of loss is small.

Expand the ENT, Plastic, Gynecology, and Orthopedics surgical programs: This is feasible only as a package because of renovations required in the surgery suite; the cost is $3,500,000. The combined programs will bring 150 complex cases that are now being referred to other cities (costing $3,000,000 per year in lost revenue) back to Grandville. It will also protect against market share losses. The programs currently serve 750 cases, at a cost of $8,000 per case. The $3,000,000 is based upon Medicare reimbursement rates.

Partner with a major supplier who will guarantee price, delivery, and product quality. The company offers a comprehensive supply management service. As users order items, the company adjusts inventory, produces cost reports, and delivers new supplies as their computer program indicates. CSHS will save $250,000 per year in materials management salaries, $50,000 per year in inventory carrying costs, and recover storage space that would cost $1,000,000 to construct today.

Develop a cost-reduction program. This program will reduce cost of care by 1 percent per year, over five years. The program will require extensive training and a fund to purchase cost-saving renovation and equipment as cross-functional teams develop patient focused care. A hiring freeze, early retirement incentives, retraining, and reduction of part-time and temporary personnel will minimize involuntary terminations. These elements require an investment of $500,000 per year. In the first year, the program will help operating personnel achieve their budget target of breakeven, but it should contribute $2,000,000 to the bottom line in subsequent years.

Spend $1,500,000 to expand primary care physician membership in Grandvilles Central State Health Systems, CSHSs PHO. This will establish a fund to start young primary care doctors in practice in selected shortage areas around Garry County. It is estimated that the fund will support up to 10 physicians. It is estimated after costs are removed from additional revenues, each year will net about $300,000 in mostly Medicaid revenues.

In addition to the aforementioned strategic opportunities, CSHS faces a list of programmatic requests each year totaling about $3,500,000. About two dozen of these will consume 80 percent of the money. The finance committee sets the limit as part of the budget guidelines; this year it will be $3,000,000. This means your budget for the strategic opportunities are limited. Your limit is detailed in the next paragraph. Each item gets a programmatic review, and is ranked by the budget committees within the organization.

The finance committees low programmatic recommendation is related to last year's approval of a $10,000,000 plan funded by public bonds for expanded outpatient services and doctors' offices at the main site. "If you are too careless, the bond rating may drop, costing you several hundred thousand dollars in interest penalties," the finance committees chair notes. He adds, "An additional factor is the $1,000,000 losses from operations last year. We aren't the federal government. We can't do this indefinitely." Assuming that next years budget is break even, there will be $3,000,000 available for the strategic projects listed above, plus whatever is used from the rainy day fund and its earning.

Written Assignment:

Rank in order from most desirable to least the five strategic projects.

Evaluatie the finance committee's recommendation for yourself, decide how far down your list you will vote to fund. You might only recommend one or all. If you decide to go over your budget of $3,000,000 see item e. The remaining projects will be deferred.

Summarize (in a sentence or two) your reasons for supporting the proposals you will vote to fund.

Summarize what you will say to the advocates of the projects you deferred.

If necessary, summarize what you will say to expand the finance committees expenditure recommendations.

WORD OF CAUTION! TO EVALUATE CAPITAL BUDGETING DECISIONS A MIX OF NUMBERS AND THEORIES WORK BEST. So consider the costs, revenues, opportunity cost rate, industry, city conditions, etc with all five strategic projects.