Financial Justification for Imaging Equipment
Claiming a share of the capital budget for imaging equipment is not always hard, but it certainly can seem overwhelming. The financial-justification step of capital budgeting can be particularly daunting, but it will be less difficult if it is preceded by an understanding of pro forma development and the concepts that underlie it, including total cost of ownership. Before financial justification begins, planning for the capital budget starts with consideration of the organization’s needs for the coming three or more years (especially equipment replacement, service expansion, and strategic positioning for the future). A prioritized list of these needs is drawn up, and financial justification is undertaken for one item at a time, beginning at the top of the list. The Pro Forma Every item in a capital budget must be weighed against every other to determine which investments will make the most sense, both clinically and financially. For replacement equipment, costs are weighed against the current business that would be lost without the replacement; for expanded services, costs are weighed against the future business that would not be gained without the expansion. In either case, a good decision can only be based on solid predictions of expenses and revenues. The pro forma serves to organize those predictions, which are made for a period of three to five years using today’s best available data. Begin assembling the pro forma by gathering all applicable revenue and expense information, and record, as you go along, all assumptions on which this information is based. Revenue assumptions, for example, include not only how the proposed capital item will bring in money, but also how that revenue will be counted (typically, using CPT® codes). Be realistic in predicting how many referrals you can expect to obtain, procedures per day, payor mix, and future reimbursement changes. Use the average revenue per applicable CPT code (including supply and contrast codes), multiplied by the expected procedural volume, to determine projected revenue. Take special care in compiling all expected expenses for the pro forma, since overlooking a major expense can cause a serious loss of credibility. The basic categories into which expenses will fall are: • capital equipment; • other equipment; • space (including renovation); • infrastructure, such as IT, shielding, or extra cooling; • staff salaries and benefits; • supplies; • service and maintenance; • upgrades; • depreciation; and • other direct, fixed costs. A classic pro forma would not include the cost of capital (or would make the entire amount a first-year outlay), but it should be remembered that the financing method will affect return on investment. How capital is accounted for is a difficult point in constructing the pro forma because the person responsible for making the capital-financing decision is not usually the person responsible for achieving the predicted net return. Following your organization’s rules for accounting for capital, however, will allow consistency in evaluating returns. Pro Forma Examples Three examples will illustrate that various types of capital-budget items require different treatment in the pro forma (and throughout the financial-justification process). In example 1, we want to add a new 64-slice CT system to the hospital radiology department to perform cardiac procedures. Revenue will be predicted based on hospital CPT codes. Additional equipment needed for 64-slice CT procedures will include a dual-head contrast injector, patient monitors, a crash cart, and an automated inventory-managing cabinet for contrast media. Additional lead shielding will be an infrastructure expense for this project. The pro forma will also include first-year salaries and benefits for additional technologist, nurse, and physician time. In example 2, we want to start a new digital breast-imaging center (with global billing). Predictions of revenue will be based on global CPT codes, with the possible addition of some philanthropic contributions. In addition to the primary mammography equipment, the center will need a mammography-friendly PACS, surgical carts, handheld biopsy devices, and a vacuum-assisted biopsy system. Infrastructure expenses will include enhanced information-handling capacity for all modalities and workstations that are part of the center. In addition to first-year salaries and benefits for extra technologists, nurses, and physicians, the pro forma will include the same costs for schedulers, compliance/accreditation staff, and perhaps other personnel. In example 3, we want the radiology practice to begin covering an additional hospital. Revenue predictions will be based primarily on professional-fee CPT codes, but additional payments could be expected for specific services rendered by the radiologists (such as overnight final interpretations or committee work). The full list of necessary equipment will include workstations, IT infrastructure, and upgraded telecommunications lines. Costs for infrastructure enhancements (such as reading-room setup) should be the responsibility of the hospital, not the practice, but this must be negotiated in advance. First-year salaries and benefits will be added to the pro forma for a PACS administrator, for marketing staff, and for personnel who will make critical-results calls. Total Cost of Ownership For any capital asset, it is vital to understand the total cost of ownership, defined as the lifetime cost of acquiring, operating, maintaining, and disposing of that asset. Analysis of the total cost of ownership provides a cost basis for evaluating the economic return expected from the investment. It brings out the hidden, nonobvious costs of an asset and helps ensure that nonacquisition costs are not overlooked during financial justification. Evaluating the total cost of ownership also can provide a more realistic assessment of the financial effects of any variables associated with the asset. Outside radiology, for example, a car with a higher sticker price might have a longer warranty and better tires, or a house that costs more to build might require less energy for heating and cooling. Within radiology, competing equipment models will be associated with different optional features, upgrade capabilities, manufacturer’s incentives, and service agreements. Assessing total cost of ownership can clarify which of these variables are most worthwhile (in addition to the exercise’s broader function of yielding a more accurate long-term cost prediction for the asset). Other types of analysis are used in addition to total cost of ownership as part of financial justification, often due to the institution’s established preferences. Total cost of acquisition, for example, covers the beginning phase of the total cost of ownership, while whole-life cost covers everything that comes later. Total cost of acquisition is a managerial accounting concept that includes all the costs associated with buying goods, services, or assets. It includes not only the net purchase price, but any other costs required to bring the asset to complete usability. Construction costs undertaken in preparation for the acquisition and special site modifications such as cooling or shielding are examples of the expenses included here. Whole-life cost is a separate assessment of all costs expected outside the total cost of acquisition. This type of accounting emphasizes the operating and maintenance costs of an asset, and it can therefore facilitate comparison of capital-budget proposals that involve similar acquisition costs. After Justification Once the entire process of financial justification has been completed and a capital-equipment request has been approved, negotiation of the purchase contract and service contract will follow. This is not the end of capital budgeting, however, because solid asset management for the life of the equipment will be needed. The best practice is to review the pro forma for each approved capital-budget item after a year, applying actual figures for expenses and revenues. This allows you to see how sound your predictions were; it also lets you adjust your projections for the second through fifth years of the project. If necessary, this annual review can be repeated after the second year for even greater accuracy. In health care, the pot of money is clearly finite. Money for operations usually comes from the revenues of the present, but money for capital equipment often comes from the profits of some prior time period. Capital investments are expected to produce returns. Understanding total cost of ownership and preparing a sound pro forma can help you ensure that they do. Penny Olivi, MBA, FAHRA, CRA, RT(R), is senior administrator, diagnostic radiology, at the University of Maryland Medical Center (UMMC) in Baltimore and is a past president of AHRA: The Association for Medical Imaging Management. This article has been excerpted from How to Create a Pro Forma and Total Cost of Ownership, which she presented at the UMMC Radiology Leadership Conference in Baltimore on October 23, 2009.