Hospital management: what medical directors need to know about investment and finance
Executive Education / 2 July 2020
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Professor Dr. Georg Schlichting ist Professor für Volkswirtschaft & Quantitative Methoden an der Hochschule Koblenz. Außerdem ist er Dozent und Autor. Seine Fachgebiete sind Volkswirtschaftslehre, Betriebswirtschaftslehre, Financial Planning/Consulting sowie Statistik.

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First, the theory: An investment represents a carefully calculated, (usually) long-term commitment of financial resources to specific assets with the aim of generating future returns that exceed the original outlay. Whenever an investment is made, there is a financial outflow. Thus investments are capital-spending transactions whereby free capital is transformed into committed capital. In the context of managing a hospital, clinic, hospital network or private hospital chain, investments may typically involve a new MRI facility, surgical robotics, a state-of-the-art HIS or a whole new hospital building. These investments tie up financial resources, rendering them unavailable for other purposes. For a hospital, the aim of such investments is to provide better medical care to more patients thanks to better information management, and by doing so, to generate additional revenues (financial inflows).

Consequences of investing for hospital managers

Investments are made to achieve predefined objectives or bring about specific changes at a hospital or clinic. To make a well-founded investment decision, all the changes which the investment is expected to trigger must be worked out and subjected to financial analysis. This involves weighing up all the various ways in which the funding could be used – because despite rumours to the contrary, money can only be spent once. Such an analysis is a vital prerequisite for any objective investment decision, not least because it makes the quantitative consequences measurable (using numbers) and sets them out in a schedule of incoming and outgoing payments – the investment cash flow. Then there are all the qualitative consequences which cannot be measured in numbers, such as the hospital’s enhanced prestige, greater financial autonomy or improved working conditions.

Investment costing and financial planning for medical practitioners in hospitals

Planned investments must be carefully costed! For medical directors to be capable of speaking and arguing in budget negotiations and discussions with their administrative colleagues, they must first be aware of and understand the principles of investment costing. When assessing an investment’s profitability, a distinction should be made between static and dynamic methods. Static methods consist of simple comparative calculations based on an average period which is assumed to be valid for the entire term of an investment. This approach is relatively simple and cost-effective, with a comparatively high level of practical relevance. In contrast, dynamic methods record every detail of cash flows over time. While they depict reality much more accurately, they also need much more mathematical input. A complete financial plan can resolve this dilemma. Like the methods described above, the point of a plan is to calculate the benefits of an investment. The major advantage of a plan is that the other methods’ shortcomings can be eliminated by formulating the plan in such a way as to include only the most relevant data, thus reducing complexity.

Bottom line

The various methods used to cost investments make it possible to evaluate investment decisions in quantitative terms. Dynamic methods are generally preferable to static methods because they use more information to calculate profitability and consequently present a more accurate picture of reality. However, a full financial plan is an even more appropriate means of forecasting an investment’s profitability.

But medical directors are doctors first, managers second. In a real-world hospital management context, they are unlikely to use the above-mentioned methods themselves. However, they are responsible for proposing investment decisions and being able to justify them not just on medical grounds, but also in terms of their financial impact.