Budgeting and Cost Control in Healthcare

Budgeting and Cost Control Health Care

Budgeting and Cost Control in Health Care:

What is Present Value Analysis and how is it useful in determining the most cost effective choice among purchase-lease alternatives?

Strictly from the point-of-view of a businessperson, the net present value method, or NPV, of evaluating a potentially major project allows the businessman or woman to consider the time value of money. The time value of money is the value of money of a particular endeavor, in today's dollars. Thus, the calculation of NPV or net present value, gives the present value of the future cash flow, allowing a comparison of the amount of a project's yield or profit, with the amount of money needed to implement the potential project. "If the NPV is greater than the cost, the project will be profitable...NPV analysis is generally used to evaluate the project's cash flows, rather than the income from the project." (Business Owner's toolkit, 2004). A profit may be high, but is of little value if met with even higher costs, in other words.

The income from a potential project can also be shown on an income statement. Income statements, unlike present value analysis, however, do not take into consideration factors such as depreciation, which is not an out-of-pocket expense. "For instance, if revenue of $10,000 is reduced to $7,000 of income because of a $3,000." (Business Owner's toolkit, 2004). This is one of the main reasons why NPV is useful in calculating lease and purchase alternatives. If one purchases a particular item or property, one is financially responsible for what happens to that product in the future and must take into account the depreciation of the property or equipment that occurs.

For instance, if a hospital were to purchase several defibrillators, the hospital would have to take into consideration the long-term damage done to the defibrillators, if they were frequently used by the hospital. The accountant would have to consider the likely use of the equipment, if such equipment was frequently used by the staff, and if it had a high rate of replacement by the staff because of depreciation due to use. It would also consider if defibrillators were subject to frequent technological innovations, and had to be replaced if they frequently became outmoded or outdated.

Leasing equipment or property means that one does not have to take into consideration the long-term depreciation of the equipment or of the leased property. Because one is leasing the property or equipment in question, one is not responsible for the regular use and abuse that causes depreciation in its value, nor for the equipment's maintenance, nor any minimal expected damage done to the equipment, as a result of the lease, as the equipment or property depreciates according to the market value and becomes out of date. Once the equipment becomes out of date, one can simply lease more technologically forward equipment.

The disadvantage to leasing, however, is that an individual entity is always paying for the use of the equipment and thus adding to the organization's operating costs, rather than having them built into the budget of the organization in a consistent fashion. The best way to determine if an organization should lease a particular property or means of equipment is to calculate the NVP and then the income statement, and to determine if depreciation will be a significant and costly factor for the organization, if the equipment or property is purchased, or if leasing would prove more costly.