Financial Management
Lecture 1: Introduction & value-based healthcare
Financial management: planning, organising, directing and controlling the organisation’s financial
activities in an efficient and effective way such that the organisation’s objectives are met.
Financial management has consequences for the patient’s health service delivery process and for the
organisation’s operations and financial activities.
Customer perspective on value
We want to assess whether a product/service has value or not.
Perceived benefits: what do we gain by means of that product/service?
- Time spent with the physician
- Health gain
Perceived sacrifices: what do we need to give up in order to acquire that product/service?
- Co-payment
B > S it has value from a customer perspective (very high level).
In healthcare: the service is
inevitable, it is necessary at a
certain point. This changes the
assessment in a way that you
might accept more sacrifices in
comparison to the benefits. This
depends on what type of service
is required (e.g. minor, can it be
postponed, severity). You only
attach value to something that
gives you more than that it costs
you.
Organisational perspective on value
There are costs attached to providing a product/service. If the inflow (revenues) is not as high as the
costs, you don’t create any value from an organisational perspective.
,Value creation: connecting the two perspectives
Idea: organisation meeting its objectives by creating value for customers (patients). If customers
don’t perceive the services to generate any value, they are not going to buy it and there is no
revenue/cash inflow for the organisation. In order to provide a service or produce a product, there
are costs involved (e.g. material, labour).
Revenue: someone buys it. Operating costs: costs for making that product feasible (resources spent
directly on the service). If the revenue > operating costs positive operating margin (positive
contribution for that service/product). This is not the only element that matters. There is also an
initial investment that has been taking place (related to the assets used which can be reused for
another service) Invested capital.
Working capital: current assets (accounts receivable, inventories and cash), less current liabilities
(primarily accounts payable and short-term debt). Measures the organisation‘s net position in liquid
assets.
Fixed capital: portion of the total capital outlay that is invested in fixed assets (such as land, buildings,
vehicles, plant and equipment), that stay in the business almost permanently.
Return on invested capital (ROIC) gives an indication of the financial value creation.
Weighted average cost of capital (WACC) =
WC/(WC+FC) * interest rate WC + FC/(WC+FC) * interest rate FC
,EXAMPLE:
An organisation has generated a revenue of €10.000.000 over the year for producing one particular
product. In order to do so, material and supplies are necessary. We also need to pay our staff. The
operating costs are €9.750.000. We end up with a positive operating margin (profit) of €250.000. In
order to generate that revenue, we needed an initial investment. We needed equipment, facilities
etc. The invested capital was €5.000.000. This is split between short and long mortgages of
€2.000.000 and €3.000.000. ROIC = 5%. For every euro that I invest, 5% I obtain as an operating
margin.
We invested 5
Mio and
obtained a
ROIC of 5%.
What if we had to pay interest rates of:
- 7% for the 2 Mio. short-term liability (working capital (WC)) €140,000
- 4% for the 3 Mio. long-term liability (fixed capital (FC)) €120,000
In total we pay €260.000 over that year for making that initial investment.
Weighted average cost of capital (WACC): €260,000/5,000,000 5.2%.
This means that we are losing money. You pay more on interest in order to make that investment of
€5.000.000 compared to what you gain out of it. So even tough you have a positive operating margin,
you need to spend more money on your interest (€260.000 > €250.000). This is not sustainable for
the long run and you are not creating any value. The WACC should at least be as high as the ROIC.
Value based management
Koller (1994): many management approaches have failed… often the cause of failure was
performance targets that were unclear or not properly aligned with the ultimate goal of creating
value.
Value is created only when companies invest capital at returns that exceed the cost of that capital.
Value can be increased by focusing on the organisation’s value driver (on a very high level).
Financial value drivers in general (how to increase financial value):
- Reduce cost of capital: interest rates
o If the interest rates are lower, then financial value increases
- Reduce total invested capital: sell/pay off debts
- Increase revenues: sales price * volume
o The more inflow you have, the higher the value gets
o Sales price is set on a competitive market and is regulated
o Volume depends on market share/consumer choice (increase quantity, sell more)
- Reduce operating costs: unit costs * volume
o E.g. reduce material costs by going do a different supplier, use fewer staff
Substitutes, complements or mutually exclusive?
, Koller (1994): “Value is created only when companies invest capital at returns that exceed the cost of
that capital”
Porter (2008): “Value is defined as the health outcomes achieved per dollar spent”
Koller focuses on the financial aspect and Porter takes the health outcomes into account. This
depends on the definition they give to value. You have to look at the quality of health outcomes in
order to keep patients coming to your organization.
Takeaway:
- Organisations are financially sustainable if they invest capital at returns that are at least as
high as the cost of that capital
o At least when we look on the long term
o On the short term you can obviously have losses. If you are able to recover and
compensate later on or you have savings/earnings from previous years, it is not a
problem
- On a high level, we consider the following financial values drivers:
o Cost of capital:
Interest rates
Asset/liability structure
What type of loans do I have? E.g. mortgages (lower interest rates),
short team loans (higher interest rates)
o Revenues
Reimbursement systems matter
o Operating costs
Often “easier” to steer
Profound cost knowledge is essential
Lecture 1: Introduction & value-based healthcare
Financial management: planning, organising, directing and controlling the organisation’s financial
activities in an efficient and effective way such that the organisation’s objectives are met.
Financial management has consequences for the patient’s health service delivery process and for the
organisation’s operations and financial activities.
Customer perspective on value
We want to assess whether a product/service has value or not.
Perceived benefits: what do we gain by means of that product/service?
- Time spent with the physician
- Health gain
Perceived sacrifices: what do we need to give up in order to acquire that product/service?
- Co-payment
B > S it has value from a customer perspective (very high level).
In healthcare: the service is
inevitable, it is necessary at a
certain point. This changes the
assessment in a way that you
might accept more sacrifices in
comparison to the benefits. This
depends on what type of service
is required (e.g. minor, can it be
postponed, severity). You only
attach value to something that
gives you more than that it costs
you.
Organisational perspective on value
There are costs attached to providing a product/service. If the inflow (revenues) is not as high as the
costs, you don’t create any value from an organisational perspective.
,Value creation: connecting the two perspectives
Idea: organisation meeting its objectives by creating value for customers (patients). If customers
don’t perceive the services to generate any value, they are not going to buy it and there is no
revenue/cash inflow for the organisation. In order to provide a service or produce a product, there
are costs involved (e.g. material, labour).
Revenue: someone buys it. Operating costs: costs for making that product feasible (resources spent
directly on the service). If the revenue > operating costs positive operating margin (positive
contribution for that service/product). This is not the only element that matters. There is also an
initial investment that has been taking place (related to the assets used which can be reused for
another service) Invested capital.
Working capital: current assets (accounts receivable, inventories and cash), less current liabilities
(primarily accounts payable and short-term debt). Measures the organisation‘s net position in liquid
assets.
Fixed capital: portion of the total capital outlay that is invested in fixed assets (such as land, buildings,
vehicles, plant and equipment), that stay in the business almost permanently.
Return on invested capital (ROIC) gives an indication of the financial value creation.
Weighted average cost of capital (WACC) =
WC/(WC+FC) * interest rate WC + FC/(WC+FC) * interest rate FC
,EXAMPLE:
An organisation has generated a revenue of €10.000.000 over the year for producing one particular
product. In order to do so, material and supplies are necessary. We also need to pay our staff. The
operating costs are €9.750.000. We end up with a positive operating margin (profit) of €250.000. In
order to generate that revenue, we needed an initial investment. We needed equipment, facilities
etc. The invested capital was €5.000.000. This is split between short and long mortgages of
€2.000.000 and €3.000.000. ROIC = 5%. For every euro that I invest, 5% I obtain as an operating
margin.
We invested 5
Mio and
obtained a
ROIC of 5%.
What if we had to pay interest rates of:
- 7% for the 2 Mio. short-term liability (working capital (WC)) €140,000
- 4% for the 3 Mio. long-term liability (fixed capital (FC)) €120,000
In total we pay €260.000 over that year for making that initial investment.
Weighted average cost of capital (WACC): €260,000/5,000,000 5.2%.
This means that we are losing money. You pay more on interest in order to make that investment of
€5.000.000 compared to what you gain out of it. So even tough you have a positive operating margin,
you need to spend more money on your interest (€260.000 > €250.000). This is not sustainable for
the long run and you are not creating any value. The WACC should at least be as high as the ROIC.
Value based management
Koller (1994): many management approaches have failed… often the cause of failure was
performance targets that were unclear or not properly aligned with the ultimate goal of creating
value.
Value is created only when companies invest capital at returns that exceed the cost of that capital.
Value can be increased by focusing on the organisation’s value driver (on a very high level).
Financial value drivers in general (how to increase financial value):
- Reduce cost of capital: interest rates
o If the interest rates are lower, then financial value increases
- Reduce total invested capital: sell/pay off debts
- Increase revenues: sales price * volume
o The more inflow you have, the higher the value gets
o Sales price is set on a competitive market and is regulated
o Volume depends on market share/consumer choice (increase quantity, sell more)
- Reduce operating costs: unit costs * volume
o E.g. reduce material costs by going do a different supplier, use fewer staff
Substitutes, complements or mutually exclusive?
, Koller (1994): “Value is created only when companies invest capital at returns that exceed the cost of
that capital”
Porter (2008): “Value is defined as the health outcomes achieved per dollar spent”
Koller focuses on the financial aspect and Porter takes the health outcomes into account. This
depends on the definition they give to value. You have to look at the quality of health outcomes in
order to keep patients coming to your organization.
Takeaway:
- Organisations are financially sustainable if they invest capital at returns that are at least as
high as the cost of that capital
o At least when we look on the long term
o On the short term you can obviously have losses. If you are able to recover and
compensate later on or you have savings/earnings from previous years, it is not a
problem
- On a high level, we consider the following financial values drivers:
o Cost of capital:
Interest rates
Asset/liability structure
What type of loans do I have? E.g. mortgages (lower interest rates),
short team loans (higher interest rates)
o Revenues
Reimbursement systems matter
o Operating costs
Often “easier” to steer
Profound cost knowledge is essential
