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MHC6305 Financial Management of Healthcare Organizations
Cash Budgeting Case Study
Beaver Creek Clinic
Beaver Creek is an upscale winter resort located a short distance from Vail, Colorado. Beaver Creek Clinic is a small walk-in clinic located adjacent to the primary ski area. The clinic specializes in the treatment of injuries sustained while skiing. It is owned and operated by two physicians: James Peterson, an orthopedist, and Amanda Cook, an internist. The clinic has an outside accountant who takes care of payroll matters, but Dr. Cook does all the other financial work for the clinic. However, to help in that task, the clinic recently hired a part-time MBA student, Doug Washington.
On a Wednesday afternoon in October
2006
, Dr. Cook called Doug into her office to tell him that she had just received a phone call from the head of commercial lending at the First Bank of Denver, the clinic’s primary lender. Because of a forecasted reduction in bank deposits, and hence funds available to make commercial loans, First Bank has asked each of its commercial loan customers for an estimate of its borrowing requirements for the first half of
2007
.
Dr. Cook had a previously scheduled meeting at First Bank the following Monday to discuss cash management services, so she asked Doug to come up with an estimate of the clinic’s line of credit requirements to submit at the meeting. A line of credit is a short-term loan agreement by which a bank agrees to lend a business some specified maximum amount. The business can borrow (“draw down”) against the credit line at any time it is in force, which is usually no longer than one year. When a line expires, it will have to be renegotiated if it is still needed. The amount borrowed on the line, or some lesser amount, can be repaid at any time, but the full amount borrowed must be repaid at expiration. Typically, interest is charged daily on the amount drawn down, and a commitment fee is required upfront to secure the line. In general, lines of credit are used by businesses to meet temporary (usually seasonal) cash needs, as opposed to being used for permanent financing.
Dr. Cook was going on vacation, a trip that had already been delayed several times, and she would not be back until just before her meeting at the bank. Therefore, she asked Doug to prepare a cash budget while she was away. No one had taken the time to prepare a cash budget recently, although a spreadsheet model that had been constructed a few years ago was available for use. From information previously developed, Doug knew that no seasonal financing would be needed from First Bank before
January
, so he decided to restrict his budget to the period from January through
June
2007. As a first step, he looked through the clinic’s financial records to get the data needed to develop the billings forecast contained in Table 1.
Patient volume at the clinic is highly seasonal because the vast majority of the business occurs during the ski season, which generally runs from
December
through
March
. In fact, at one time Drs. Peterson and Cook thought about closing the clinic during the slow months. They didn’t, for two reasons: One, it would be very difficult to operate efficiently for only a portion of the year. Two, the area has started to attract a sizable number of summer visitors, which has made summer operations more financially attractive.
Again, on the basis of previous experience, Doug was able to convert billings for medical services into actual cash collections. On average, about 20 percent of the clinic’s patients pay immediately for services rendered. Third-party payers pay the remaining claims, with 20 percent of the payments made within 30 days and the 60 percent remainder paid within 60 days. For monthly budgeting purposes, patient payments (20 percent) are assumed to be collected in the month of billing, 20 percent are assumed to be collected in the month following the billing month, and 60 percent are assumed to be collected two months after the month of billing.
Variable medical costs at the clinic are assumed to consist entirely of medical and administrative supplies. These supplies, estimated to cost 15 percent of billings, are purchased two months before expected usage. On average, the clinic pays about half of its suppliers in the month of purchase (two months before use) and the other half in the following month (one month before use).
Clinical labor costs (for physicians and nurses) are the primary expense of the clinic. During the high season (December through March), these costs run to
$
150,000
a month, but some of the nursing staff work only seasonally, so clinical labor costs drop to $120,000 a month in the remaining months.
The clinic pays fixed general and administrative expenses, including clerical labor, of approximately $30,000 a month, while lease obligations amount to $12,000 per month. These expenditures are expected to continue at the same level throughout the forecast period. The clinic’s miscellaneous expenses are estimated to be $10,000 monthly.
The clinic has a semiannual, five-year, 10 percent, $500,000 term loan outstanding with First Bank that has amortization payments of $64,752, which are due on March 15 and September 15. Also, the clinic is planning to replace an old x-ray machine (which has no salvage value) in
February
with a new one costing $125,000. The clinic is a partnership, so, for tax purposes, any profits (or losses) are prorated to the two physician partners, who must pay individual taxes on this income. Thus, no tax payments are built into the cash budget.
The clinic has to maintain a minimum cash balance of $50,000 at First Bank because of compensating balance requirements on its term loan. This amount, but no more, is expected to be on hand on January 1, 2007.
If a daily cash budget is required, some additional assumptions about volume and collections are required:
1. Beaver Creek Clinic operates seven days a week.
2. Patient volume is more or less constant throughout the month, so the daily billings forecast will be the billings forecast for that month divided by the number of days in the month.
3. Daily billings follow the 20 percent, 20 percent, 60 percent collection breakdown based on monthly billings.
4. Patient payments are assumed to occur on the day of billing, “early” payers are assumed to pay 30 days after billing, and “late” payers are assumed to pay 60 days after billing.
5. The lease payment is made on the 1st of the month.
6. Of the clinical labor costs and general and administrative expenses, 50 percent are paid on the 1st of the month and 50 percent are paid on the 15th of the month.
7. Supplies are delivered on the 1st of the month and paid for on the 5th of the month.
8. Miscellaneous expenses are incurred and paid evenly throughout each month.
9. Term loan payments are made on the 15th of the month in which they are due.
10. The compensating balance of $50,000 must be in the bank on each day.
|
Table 1: Beaver Creek Clinic: Billings Forecast |
||
|
Year |
Month |
Amount |
| 2006 |
November |
$150,000 |
| December |
250,000 |
|
| 2007 | January |
350,000 |
| February |
450,000 |
|
| March |
300,000 |
|
|
April |
150,000 | |
|
May |
100,000 |
|
| June |
175,000 |
|
|
July |
||
|
August |
200,000 |
In addition to the cash budget itself, Dr. Cook asked Doug to consider several additional issues:
1. Will the clinic need to request a line of credit for the period and, if so, how big should the line be?
2. Perhaps a monthly budget may not reveal the full extent of the borrowing requirements actually needed. To see if her concern is valid, Dr. Cook suggested that Doug construct a daily cash budget for the month of January as a test case.
3. The existing cash budget model does not provide for interest paid on line of credit borrowings or interest earned on cash surpluses. Dr. Cook suggested that the monthly cash budget be modified to include these items. Currently, the interest rate on First Bank line of credit draw downs is 8 percent compounded monthly (8%/12 = 0.667% per month), and First Bank pays 4 percent compounded monthly (4%/12 = 0.333% per month) on temporary investments of excess cash.
4. Although the target cash balance has been based on First Bank’s compensating balance requirement, the term loan will be paid off in September 2007. Dr. Cook asked how the clinic might go about setting its target cash balance when no compensating balance is required.
5. Dr. Cook is well aware that the cash budget is a forecast, so most of the cash flows shown are expected values rather than amounts known with certainty. If actual patient billings, and hence collections, were different from forecasted levels, then the forecasted surpluses and deficits would be incorrect. Dr. Cook is very interested to know how various changes in key assumptions would affect the forecasted surplus or deficit. For example, if billings fell below the forecasted level or if collections were stretched out, what effect would that have?
6. Finally, Dr. Cook believes that the surge in patient volume over the forecast period is bound to result in some cash surpluses, and she wants to know what the clinic should do with them.
Place yourself in Doug’s position and conduct a thorough analysis. Be prepared to discuss your analysis.
Page 3 of 6
Week 6, Assignment 1
© 2007 South University
>Cash Budgeting
0 South University
($):
0 0 as a % of billings
$0 0 $0 0.0% $0 0 0.0% $0 0 $0 0 0 $0 0 $0 Jan $0 0 Feb $0 0 Mar $0 $0 Apr $0 $0 May $0 0.0% $0 Jun $0 $0 $0 $0 $0 Data:
0.0% 0.0% 0.0% November December January February March April May June July August $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 0 0 0 0 0 0 0 0 0 0 0 0 0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 0 0 0 0 0 0 0 $0 $0 $0 $0 $0 $0 FOR MONTH
January February March April May June 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 January February March April May June $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 0 0 0 0 0 0 outstanding
$0 $0 $0 $0 $0 $0 2 6 7 Collections: $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 -day payors
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Supplies payments: Payments: 0 0 $0 $0 $0 0 $0 $0 $0 $0 $0 $0 20 Collections: 0 0 0 0 0 0 0 0 0 0 Supplies payments: II. CASH GAIN OR LOSS Payments: Term loan payment III. CASH SURPLUS OR LOAN REQUIREMENTS Surplus cash or total loans Day 12 13 14 15 16 17 18 19 20 21 30 I. COLLECTIONS AND PAYMENTS Collections $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 Lease expense Term loan payment &A2
Cash Budgeting Case Study
© 2
0
7
Beaver Creek Clinic
Enter appropriate input values in cells colored red.
INPUT DATA:
KEY OUTPUT:
Projected
Billings
Projected Cost Data:
Net
Cash Flow
20
6
Variable costs:
Jan
$0
November
Supplies
0.0%
Feb
December
% paid before use:
Mar
2007
2 months prior
Apr
January
1 month prior
May
February
Jun
March
Fixed Costs:
April
Monthly clinical labor costs:
Cum (Loan)
May 0
High season
or Surplus
June
Low season
July
August
Other monthly costs:
Gen/admin expense
Billings as a %
Lease payment
of forecast*
Misc expense
Cash Balance Data:
Semi-annual costs:
Loan amortization
Target balance
Beginning cash
One-time costs:
New equipment
Collections
% from patients
*This input is used to create scenarios in which
% coll in 1 month
actual collections are less than forecasted.
% coll in 2 months
MODEL-GENERATED DATA:
Monthly Cash Budget:
I. COLLECTIONS/PAYMENTS
Billings (expected)
Billings (actual)
Collections:
Month of sale
1 month after sale
2 months after sale
Total collections
Supplies purchases
Supplies payments:
2 mos prior to use
1 mo prior to use
Total supplies costs
II. CASH GAIN OR LOSS
Collections $0 $0 $0 $0 $0 $0
Payments:
Supplies $0 $0 $0 $0 $0 $0
Clinical labor
General/administrative expenses
Lease expense
Miscellaneous expenses
Term loan payment
New equipment 0
Total payments
Net cash gain (loss)
III. CASH SURPLUS OR LOAN REQUIREMENTS
Cash at start if no
borrowing is done
Cumulative cash
Target cash balance
Surplus cash or total loans
to maintain
target cash balance
Daily Cash Budget:
I. COLLECTIONS/PAYMENTS
Day 1
3
4
5
8
9
10
11
Billings $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Patient payments
30
60-day payors
Total collections $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
2 mos prior to use 0
1 mo prior to use 0
Total supplies costs $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
II. CASH GAIN OR LOSS
Collections $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Supplies $0
Clinical labor $0
General/admin expenses
Lease expense 0
Misc expenses
Term loan payment
Total payments $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Net cash gain (loss) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
III. CASH SURPLUS OR LOAN REQUIREMENTS
Cash at start if no
borrowing is done $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Cumulative cash $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Target cash balance 0 0 0 0 0 0 0 0 0 0 0
Surplus cash or total loans
outstanding to maintain
target cash balance $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Day 1 2 3 4 5 6 7 8 9 10 11
Daily Cash Budget – Continued:
Day 12
13
14
15
16
17
18
19
21
I. COLLECTIONS AND PAYMENTS
Billings $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Patient payments $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
30-day payors
60-day payors 0 0 0 0 0 0 0 0 0 0
Total collections $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
2 mos prior to use
1 mo prior to use
Total supplies costs $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Collections $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Supplies
Clinical labor $0
General/admin expenses 0
Lease expense
Misc expenses $0 $0 $0 0 $0 $0 $0 $0 $0 $0
Total payments $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Net cash gain (loss) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Cash at start if no
borrowing is done $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Cumulative cash $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Target cash balance 0 0 0 0 0 0 0 0 0 0
outstanding to maintain
target cash balance $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Daily Cash Budget – Continued:
Day 22
23
24
25
26
27
28
29
31
Billings $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Collections:
Patient payments $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
30-day payors 0 0 0 0 0 0 0 0 0 0
60-day payors 0 0 0 0 0 0 0 0 0 0
Total collections $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Supplies payments:
2 mos prior to use
1 mo prior to use
Total supplies costs $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 II. CASH GAIN OR LOSS 31
Payments:
Supplies Clinical labor
General/admin expenses
Misc expenses $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Total payments $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Net cash gain (loss) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
III. CASH SURPLUS OR LOAN REQUIREMENTS
Cash at start if no
borrowing is done $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Cumulative cash $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Target cash balance 0 0 0 0 0 0 0 0 0 0
Surplus cash or total loans
outstanding to maintain
target cash balance $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Day 22 23 24 25 26 27 28 29 30 31
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