CONCEPT ONE notes
Managing the Capital Cycle
Xiao Liu 07/06/2007
Importance of the Principles of Corporate Finance
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Healthcare leaders must be well versed in finance, because of constrained
reimbursement and increasing competition, costs, regulation and complexity.
Financial decisions have major implications for an organization’s success and even
survival.
The Sarbanes-Oxley Act (SOX) of 2002 is extending to the not-for-profit world. SOX
are used voluntarily by many healthcare boards to ensure their compliance with
fiduciary responsibilities.
Recent survey of the not-for-profit industry indicates the high correlation between the
board education and board performance. Thus, a higher level of financial knowledge
in the boardroom is needed.
The Capital Management Cycle
Definition:
The circular path involved in managing the flow of capital.
Three essential components:
1.
2.
3.
A continuous, integrated, strategic financial planning process: effectively balances
an organization’s strategies with its financial capabilities;
A capital structure process
A capital allocation process: allows organization to prioritize capital spending
Control
Points
of
Healthcare
Financial
Management
 Cash: Creditworthiness is highly dependent on
liquidity and cash is a direct source of capital
 Profitability: Sufficient profitability ensures
appropriate liquidity and supports required mount
of debt capacity. Appropriate level of debt and
cash will determine long-term profitability
requirements
 Debt: Not too much, as everyone knows, but not
too little.
 Capital spending: appropriate amount of capital
spending relates to profitability, and the
appropriate mix of cash and debt. Reminder: how
an organization allocates its capital spending can
The Continuing Impact of Allegheny Health
Education and Research Foundation’s
(AHERF) Bankruptcy
 AHERF’d run up a deficit under the policy
of rapid expansion led by its president Sherif
S. Abdelhad claimed to be 1.3 billion. After
that,
 Access to capital tightened dramatically
 Terms for capital have also tightened, e.g.
restrictive covenants, greater debt security
 Access to bond insurance fell dramatically
in the late 1990s and early 2000s
 Creditors are demanding greater scrutiny of
hospital finances
 Increased liquidity in the form of cash is
demanded of the healthcare organization by
the capital market, e.g. the “days cash on
hand” ratio, the critical measure of liquidity
has steadily increased during the last decade
be more important than the absolute number of dollars spent.
Characteristics of Financially Troubled Organizations
Three basic “financial pathologies” are present in those financially troubled organizations:
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2.
3.
All forest—no trees
 Board wants the big picture but doesn’t want to be bothered with the day-to-day
details of financial management. They say “Details are what management does.”
All trees—no forest
 The most prevalent of the three pathologies
 The board lacks a clear understanding of the organization’s overall strategic
financial goals and objectives and concentrates only on the details of day-to-day
management.
Management of incremental financial events
 In this pathology, opportunities and problems are isolated from one another and
considered to be truly separate, unrelated issues.
Characteristics of Financially Successful Organizations
1.
Sound and financially literate leaders
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Commitment to corporate finance principles and a single financial perspective
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Senior leaders have the capacity to envision, engage and execute.
CEOs are financially literate, financially interested, and financially responsible.
Boards govern around explicit expectations and metrics and are guided by an
attitude that senior management will deliver expected results on a consistent
basis.
Corporate finance principles are in integral component of management’s
philosophy.
The principle that has proven most effective is as follows:
 Financial performance must be sufficient to meet the cash flow requirements
of the strategic plan and, at the same time, maintain or improve the financial
integrity of the organization within an appropriate credit and risk context.
The organizing principle is written down to ensure common understanding.
Commitment to financial learning
a)
A strong continuing education process is necessary
4.
A planning philosophy and process
5.
Disciplined execution of plans
6.
Active management of capital structure and respect for capital market
In a word, to go round and round successfully in the healthcare circle game, healthcare
leaders need to know more finance than ever before.
Terms:
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SOX: Sarbanes-Oxley Act (2002).
Capital Structure: the way a corporation finances itself through some combination of
equity, debt or hybrid securities.
Capital Allocation: The organization annually/biannually allocates capital dollars to
most properties.
Financial Planning: a financial plan can be a budget, a plan for spending and saving
future income