Essay on Health Care Financial Management

Essay on Health Care Financial Management

Introduction

Project valuation is an important skill in healthcare financial management that helps an organization to decide whether to accept or reject an investment decision based on the rate of return on a project, for for-profit companies, and the rate of return to community, for non-profit businesses. Project valuation allows healthcare organizations to take into account the time value of money, opportunity cost and the projected rate of return on their investments. Managers should generally try to maximize value and minimize risks as part of the capital investment decision. This essay will first discuss the overall function of valuation methods and capital budgeting, followed by an analysis of the benefits and drawbacks of each valuation method. For each valuation method, a scenario will be given where the chosen method is beneficial in decision making. The essay will end with an analysis of the effects of inflation and healthcare trends, and how these should be factored into capital budgeting decisions.

Overall function of capital budgeting and its valuation methods.

Capital budgeting allows healthcare financial management teams to decide whether to accept or reject an investment decision based on the rate of return on a project, and enables managers to take into account the time value of money, opportunity cost and the projected rate of return on their investments. This essay will discuss the payback method, accounting rate of return, net present value method and internal rate of return method as project evaluation methods, and then analyse the implications of inflation and healthcare trends on capital budgeting decisions.

Need an essay assistance?

Our professional writers are here to help you.

PLACE AN ORDER

Evaluation of valuation method 1 and suitability for different types of organizations and scenarios

1. Foremost, the payback method allows organisations to measure the amount of time required to payback a project’s initial capital outlay on the basis of incoming cumulative cash flows.

The payback is advantageous because it is easy to understand and calculate, and provides a clear indicator of a project’s risk and liquidity. On the other hand, payback methods ignore the time value of money (in other words, the opportunity cost incurred which should be discounted for), as well as all cash flows that occur after the payback period. This can, however, be rectified by using a discounted payback period model (Fronczek-Munter, 2013).

Furthermore, the payback method typically encourages front-loading of cash flows in order to shorten the investment recovery time, and is limited because it does not take into account the financial viability of a project beyond the achievement of the payback or total value at maturity. FInally, the payback method disregards cash flows that come in toward the end of a project’s life cycle, which might outweigh cash flows at the start (Fronczek-Munter, 2013).

Generally, the payback method is suitable for healthcare organisations which have liquidity issues, take a more short-term view of their investment returns, or are primarily concerned with the ability of the project to pay back the initial outlay in a relatively short period of time. This may apply for smaller private healthcare practices or clinics which are relatively more cash strapped.

For example, the payback method would be helpful for a small clinical practice with a limited amount of funds that can only undertake one major project at a time. Hence, the management may want to set their limit at one project to be paid back within 2 years, in order to ensure that the investments do not bankrupt the organization.

Evaluation of valuation method 2 and suitability for different types of organizations and scenarios

2. Secondly, the accounting rate of return is a project valuation method that compares the cash flow returns on a project to an accounting rate of return that is composed of the cost of capital, past company data, and the project risk level. The ARR divides the average annual income by the average investment of the project, and will take the investment as the initial investment if the investment was front-loaded. The accounting rate of return is advantageous because it allows for a comprehensive consideration of the cost of capital, organisation historical performance and project risk level. However, the accounting rate of return does not take into account the time value of money.

The accounting rate of return would be more relevant for larger stakeholders such as Veteran Affairs’s (VA) hospitals and for-profit hospitals which need to take into account their historical performance, cost of capital and project risk lev