HA6 Financial Management

Dr.M.Mariappan
Associate Professor
Centre for Hospital Management, SHSS
 Chapter-1

Introduction to Financial
Management
 Learning Objectives
• Role of Financial Management in Healthcare
• Functions of financial management
• Application of financial management in
hospitals
• Role of finance manager in a hospital
• The risk-return trade-off in financial
decision – making
• Brief overview of the legal and tax
environment of financial decision making
 The key questions
• What capital investments should you make? That
is, what kinds of real estate, machineries, and
equipment should you purchase?
• Where will you raise money to pay for the
proposed capital investments? That is, what will
be the mix of equity and debt in your financing
plan?
• How will you handle the day-to-day financial
activities like collecting your receivables and
paying your suppliers?
 Overview on Healthcare finance
• Healthcare finance is concerned with
resource allocated to create new produce
goods or services or improve or modify or
any other conversional process.
• It deals with creation of wealth through
raising the financial resources and effective
utilization of resources provided in the
business.
• Basically finance is fuel to functioning of
whole business activities of the
organisation.
5
 Why is Finance Important?
• Finance is the language of business.
• Financial performance is the lifeblood of a business and is
essential to have a healthy business.
• Financial performance is the scorecard utilized by banks,
hospitals, investors, and by their boards to evaluate and
compare the success of all businesses.
• Financial performance determines whether an
organization can borrow money, can sell bonds, and at
what interest rate.
 Why is Finance Important?

• Healthcare managers need to know how to read

financial statements to ‘consistently’ achieve a
positive bottom line.
• All firms (businesses), no matter how old or large,
are evaluated using the same ‘financial’ metrics.
• Financial metrics (or financial ratios) are computed
primarily from the balance sheet and the income
statement.
 Financial Mistakes Can be Costly!

• Difference between an Operating Lease and a Capital

Lease
• Operating leases: The lessor (owner) of the property
transfers only the right to use the property to the
lessee. At the end of the lease period, the lessee
returns the property to the lessor. Lease expense is
treated as an operating expense in the income
statement and the lease does not affect the balance
sheet.
 Purpose of Finance

• Record and report transactions that change the

value of the firm.
• Assist operations in setting and achieving cost and
revenue improvements.
• Guard assets against theft, waste or loss.
• Assist governance in short and long term planning.
• Arrange and secure funding to implement
strategic decisions.
Key Members of the Financial Staff

• CFO or Financial Controller

• Finance Director or Accounts Manager
• Internal Auditor
• Corporate Compliance Officer
 The Role of Financial Management in the
Health Services Industry

• The primary role of financial management is

to plan for, acquire, and utilize funds (capital)
to maximize the efficiency and value of the
enterprise.
• Evaluation and planning. First and foremost,
financial management involves evaluating
the financial effectiveness of current
operations and planning for the future.
 The Role of Financial Management in the
Health Services Industry

• Long-term investment decisions. Although

more important to senior management,
managers at all levels must be concerned with
the capital investment decision process. Such
decisions, which focus on the acquisition of
new facilities and equipment (fixed assets), are
the primary means by which businesses
implement strategic plans, and hence they
play a key role in a business’s financial future.
 The Role of Financial Management in the
Health Services Industry

• Financing decisions. All organizations must

raise funds to buy the assets necessary to
support operations. Such decisions involve
the choice between internal and external
funds, the use of debt versus equity capital,
and the use of long-term versus short-term
debt. Although senior managers typically
make financing decisions, these decisions
have ramifications for managers at all levels.
 The Role of Financial Management in the
Health Services Industry

• Working capital management. An

organization’s current, or short-term, assets,
such as cash, marketable securities, receivables,
and inventories, must be properly managed
both to ensure operational effectiveness and to
reduce costs. Generally, managers at all levels
are involved, to some extent, in short-term
asset management, which is often called
working capital management.
 The Role of Financial Management in the Health
Services Industry

• Contract management. In today’s healthcare

environment, health services organizations must
negotiate, sign, and monitor contracts with
managed care organizations and third-party
payers. The financial staff typically has primary
responsibility for these tasks, but managers at all
levels are involved in these activities and must
be aware of their effect on operating decisions.
The Role of Financial Management in the Health
Services Industry
• Financial risk management. Many financial
transactions that take place to support the
operations of a business can, themselves,
increase a business’s risk. Thus, an important
financial management activity is to control
financial risk.
 Financial Management (FM)

Primary decision
1. Accounting
Financial Decision Areas 2. Micro economics
1. Investment Decisions 3. Macro economics
Support
2. Working capital management
3. Sources and cost of funds
4. Determination of capital Other related disciplines
structure 1. Marketing
Support
5. Dividend policy 2. Production
6. Analysis of risk and returns 3. Quantitative methods

Resulting in Shareholders
wealth maximisation
 Evolution of FM
• It belongs to 20th century
• The evolution may be divided into three broad
phases. They are
– Traditional approach,
– Transitional approach and
– Modern approach
 Traditional approach
• Originally it was called corporation finance
• It was put in narrow sense of procurement of funds by
corporate enterprises
• It was contributing three major areas like
– The intuitional arrangement in the form of financial
Institutions (capital markets)
– Financial Instruments from which the funds raised from
capital markets
– The legal and accounting relationship between the firm
and its sources of funds.
 Transitional approach
• It began 1940 and up to 1950
• Greater emphasise to day to day management
of finance such funds analysis, planning and
control
 Modern approach
• Broader sense and provides a conceptual and
analytical frame work for financial analysis
• It covers acquisition of funds as well as
allocation
• The new approach is an analytical way of
viewing the financial problems of a firm.
 Modern approach contd…
• The main contents of this approach are
– What is the total volume of funds an
Enterprise should commit?
– What specific assets should an enterprise
acquire?
– How should the funds required be
financed?
 Modern approach contd…

Alternatively
• How large should an enterprise be, and how fast should
it grow?
• In what should be the composition of its liabilities?
Finally as today the
• Financial management is nothing but
– Investment decision
– Financing decision
– Dividend policy decision
 Investment Decisions
• Investment decision deals with an asset
• Asset concerns long term investment is capital
budgeting and short term investment working capital
management
• A. Capital Budgeting
– Limited resources (own or outside source)
– Even huge funds available ROI is an issue
– Lack of clarity with regard to ROI
 Investment Decisions
• Analysis of risk and uncertainty (investment whether yield positive
results or could be uncertain)
• Can be estimated in terms of sale which include volume or price
• Since risk is involved in this decision needs risk analysis
• Finally to meet certain norms such as hurdle rate, required rate,
minimum rate of return and so on. This are nothing but cost of
capital, it is another kind of exercise.
• In summary capital budgeting
– Total assets and their composition
– Business risk complexion of the firm
– The concept and measurement of cost of capital.
 Investment Decisions
• B. Working capital management
• It is issue between profitability and risk
• Too high current assets or too high current liabilities
adversely affect the profitability
• Thus, it is important to see
– An overview of WC management as whole
– Efficient management of individual current assets
such as cash receivables and inventory etc.
 Investment Decisions

Most important of the three

decisions.
 What is the optimal firm size?
 What specific assets should be
acquired?
 What assets (if any) should be
reduced or eliminated?
 Financing Decisions

• It is concerned with financing mix or capital

structure or leverage
• Capital structure refers to the proportion of
debt (fixed, interest source of financing)and
equity (variable, dividend/ securities /
sources of funds)
• Financing decision results in investment
 Financing Decisions

• There are two aspects of financing decision

• 1. The theory of capital structure which shows
of debt and the return to the shareholders.
– The use of debt implies a higher return to
shareholders as also the financial risk.
– Hence there is trade-off between debt and equity
leads to optimal capital structure.
 Financing Decisions
• 2. Financing decision is the determination of
an appropriate capital structures given the
facts of a particular case.
• Thus, the financing decision covers two inter-
related aspects
– Capital structure theory
– Capital structure decision
 Financing Decisions

Determine how the assets will be

financed

• What is the best type of financing?

• What is the best financing mix?
• How will the funds be physically acquired?
 Asset Management Decisions

• How do we manage existing assets efficiently?

• Financial Manager has varying degrees of
operating responsibility over assets.
• Greater emphasis on current asset
management than fixed asset management.
 Dividend policy decision

• Dividend is paid to shareholders as return

against their investment
• It is paid out of profit
• There are two alternative with regard to
dividend policy
• a. the profit can be distributed to the
shareholders
• b. the profit can be retained.
 Dividend policy decision
• Hence the major attention is that what
proportion of net profits should be paid out to
the share holders?
• It is depending on the preference shareholders
and investment opportunities with in the
organisation.
• The second major aspect of the dividend
decision is the factors determining dividend
policy of a firm in practice.
 Objectives of FM
• Decision making in regard to the size and composition
of assets and the level and structure of financing.
• To make sure that firms achieve profit maximisation
and wealth maximisation.
• To adopt appropriate decision criterion for the three
decisions involved in FM.
• The firm should achieve and on policies that should
be followed it certain goals are to be achieved.
 What is the Goal of
the Firm?

Maximization of
Shareholder Wealth!
Value creation occurs when we
maximize the share price for current
shareholders.
 Strengths of Shareholder Wealth
Maximization

• Takes account of: current and future profits and

EPS; the timing, duration, and risk of profits and
EPS; dividend policy; and all other relevant
factors.
• Thus, share price serves as a barometer for
business performance.
 Risk –Return Tradeoff
• Most of the financial decisions involve alternative
options
• Should decide what capacity of the organisation or
equipment
• Should decide on debt –equity ration (2:1 or 1:1)
• Policies on credit
• Inventory management – at what level and what
quantity
 Risk –Return Tradeoff

Decisions, Return, Risk, and Market Value

Capital Budgeting decisions

Return
Capital structure decisions

Market value of the

firm
Dividend decisions

Risk

Working capital decisions

 Risk –Return Tradeoff

• In general the expected answer is

– What is the expected return?
– What is the risk exposure?
– Given the risk return characteristics of the
decision, how would it influence value?
 Financial Environment
• Businesses interact continually with the
financial markets.
• Financial Markets are composed of all
institutions and procedures for bringing
buyers and sellers of financial instruments
together.
• The purpose of financial markets is to
efficiently allocate savings to ultimate users.
 Flow of Funds in
the Economy

INVESTMENT SECTOR

INTERMEDIARIES
FINANCIAL BROKERS

SECONDARY MARKET FINANCIAL

SAVINGS SECTOR
 Flow of Funds in
the Economy

INVESTMENT SECTOR
INVESTMENT
SECTOR

INTERMEDIARIES
FINANCIAL BROKERS Businesses

FINANCIAL
Government

SECONDARY MARKET Households

SAVINGS SECTOR
 Flow of Funds in
the Economy

INVESTMENT SECTOR
SAVINGS
SECTOR

INTERMEDIARIES
FINANCIAL BROKERS Households

FINANCIAL
Businesses

SECONDARY MARKET Government

SAVINGS SECTOR
 Flow of Funds in
the Economy

INVESTMENT SECTOR
FINANCIAL
BROKERS

INTERMEDIARIES
FINANCIAL BROKERS Investment Bankers

FINANCIAL
Mortgage Bankers

SECONDARY MARKET

SAVINGS SECTOR
 Flow of Funds in
the Economy

INVESTMENT SECTOR
FINANCIAL
INTERMEDIARIES

INTERMEDIARIES
FINANCIAL BROKERS Commercial Banks

FINANCIAL
Savings Institutions
Insurance Cos.
SECONDARY MARKET Pension Funds
Finance Companies
Mutual Funds
SAVINGS SECTOR
 Flow of Funds in
the Economy

INVESTMENT SECTOR
SECONDARY
MARKET

INTERMEDIARIES
FINANCIAL BROKERS Security

FINANCIAL
Exchanges

OTC
SECONDARY MARKET Market

SAVINGS SECTOR
 Allocation of Funds
 Funds will flow to economic units that are
willing to provide the greatest expected return
(holding risk constant).
• In a rational world, the highest expected returns
will be offered only by those economic units with
the most promising investment opportunities.
• Result: Savings tend to be allocated to the most
efficient uses.
 Emerging Role of the Finance Manager in
India

• The industrial licencing framework has been considerably relaxed

• MRTP has been removed
• FERA has been relaxed, further it has been converted into FCRA
• Freedom on pricing and equity issues
• Changes in the interest rates
• Devaluation of money
• Investors have become more demanding
• Emerging money market and opportunities
• Dependence on the capital market has increased
 Emerging Role of the Finance
Manager in India
• These changes have made more challenges to the
finance managers. The key challenges are
– Investment planning
– Financial structure
– Treasury operations
– Foreign exchange
– Investor communication
– Management control
 Conclusion

• Financial management provides framework for

the future analysis and decision making. Using
appropriate financial management tools of shall
make sure the organisation to understand the
risks, uncertainty and future problems, according
the appropriate decision can be made. However
future is uncertain and it can happen anything.