Capital Budgeting

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This week’s Tip continues on the theme of financial management, this time with a focus on budgeting, specifically capital budgeting. A capital budget is a plan for the acquisition of capital assets, such as buildings and equipment. The capital budget will greatly inform other aspects of the master budget because the success or failure in securing capital makes an extraordinary impact on the business. For example, if a community pharmacy is able to acquire capital that would allow it to expand into an adjacent store that is going out of business in a ‘strip mall’, this will result in a change of floor plan for the pharmacy, the quantity and array of goods that it carries, the potential for new services that includes new hires, and potentially a considerable reshaping of the entire business operation. Capital budgeting would include the monies and other resources necessary, the potential sources of those monies, and contingencies if any component of that budget falls short or must be altered. Capital budgeting is often conducted in larger organizations by soliciting from heads of departments/divisions their capital needs, or requests for such.

Mukherjee et al reviewed the capital budgeting processes of healthcare organizations.1 They examined: efficiency of for-profit versus not-for-profit hospitals; capital budgeting practices of the healthcare industry vis-à-vis other industries; and the effects of mergers and acquisitions on budgeting decisions. The found evidence that: for-profit hospitals exhibit greater efficiency, acquisitions have contributed to more efficient capital budgeting practices, physicians in almost all aspects of capital budgeting play a dominant role and that this impedes efficient decision-making. They also observed that 26.8% of decision-makers (eg, Chief Financial Officers, or CFOs) review all capital proposals versus 42% of them who evaluate only 50% or fewer. About ½ of CFOs evaluation criteria before receiving requests, 71% of them classified proposals according to clinical service line or elements of the strategic plan, and 86% ensured that proposals followed company-established guidelines. Most CFOs and other decision-makers placed less emphasis on cash flow impact as compared with other industries outside of health care. In this segment, they are more interested in  internal rate of return (IRR), net present value (NPV), and profitability index (PI) measures.

The pharmacy manager in a larger organization will routinely submit requests for capital improvements and must make the case for doing so in accordance with organization mission and in efficient use of the proposed resources. The manager/owner of smaller operations will on the other hand evaluate alternatives they consider worthwhile, although they might also solicit input from employees and/or outside consultants. The acquisition of capital even for smaller and more well-established businesses is quite important if they are to remain competitive and make changes that will inevitably be required from time to time. Not-for-profits behave in somewhat of a different manner. While hospital CFOs allow physicians perhaps too much voice in capital decisions, pharmacy managers in a for-profit organization must likewise be careful not to have their judgment clouded by any particular group or source of information.

Additional information about Budgeting can be found inPharmacy Management: Essentials for All Practice Settings, 5e. If you or your institution subscribes to AccessPharmacy, use or create your MyAccess Profile to sign-in to Pharmacy Management: Essentials for All Practice Settings, 5e. If your institution does not provide access, ask your medical librarian about subscribing.

1Mukherjee T, Rahahleh NA, Lane W. The capital budgeting process for healthcare organizations: A review of surveys. J Healthcar Manag. 2016;61:58-76.

Go to the profile of Shane Desselle

Shane Desselle

Professor of Social and Behavioral Pharmacy, Touro University California

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Go to the profile of Shane Desselle
Shane Desselle 4 months ago

How do you do your own planning for big future outlays/expenditures?