Market-Based demand forecasting promotes informed strategic financial planning - Statistical Data Included

Healthcare Financial Management, Nov, 2001 by Alfred J. Beech

Exhibit 5 shows how this method was used by the case-study hospital to develop a baseline scenario describing future demand for outpatient surgery. Both the proxy utilization rate and the indexed market share are held constant, so case volumes are determined by population changes.

FINANCIAL RESULTS

Exhibit 6 on page 54 shows a set of profitability, liquidity capital-structure, and operating measures that were used as critical indicators by management. These measures indicate mixed financial results with the case-study hospital's four scenarios of future demand. The baseline scenario shows improvements in most liquidity and capital-structure measures, while the utilization-rate-decrease scenario shows the poorest results.

The hospital's management was concerned that all four scenarios show continued declines in profitability as measured by operating margin and economic value-added. (i) Because expense per adjusted patient day is increasing at a faster rate than net revenue per adjusted day (not shown in Exhibit 6), the results suggest that further expense management should be considered (ie, management has more control over expenses than payments).

The hospital's cash position improves in all scenarios and debt capacity increases slightly in the baseline scenario (and more so in the market-share-increase scenario). This result, which seems to contradict the operating results, may be attributable in part to slow replacement of fixed assets. The hospital's capital expenditures are lower than depreciation expense, and average age of plant is increasing, which implies that fixed assets are being replaced too slowly. In addition, debt-service coverage is being maintained by earnings on board-designated funds, which are accumulating because the funds are not being used for new and replacement capital. An increase in forecasted debt capacity is desirable, but the assumptions that produce this result must be examined carefully.

Net present value (NPV) drops by more than $10 million, or 20 percent, from the baseline to the utilization rate-decrease and market-share-decrease scenarios, and increases by $6 million in the market-share-increase scenario. (i) The risk of a 20 percent decline in an organization's market value is significant and suggests that management direct its attention to ensuring that the result does not occur.

Although the utilization-rate-decrease and market-share-decrease scenarios have similar results, these results have very different implications, thus underscoring the value of a market-based approach. Utilization-rate declines generally are considered to be beyond management's control, but management can respond to a loss of market share with well-placed strategic initiatives.

POSSIBLE MANAGEMENT RESPONSES

The baseline scenario is management's best estimate of future financial results. The hospital also considered two possible strategic responses to use if the utilization-rate-decrease scenario materialized, because that scenario posed the greatest potential financial risk. Both responses involved quantifying ways to reach the 2004 baseline operating margin (ie, 4.25 percent versus 2 percent).