quality

1. Financial Management of
Healthcare Organizations
By / Mahmoud Shaqria
‫شقريه‬ ‫محمد‬ ‫محمود‬
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Quality
Management

2. Working Capital Management
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3. Learning Objectives
After completing this lecture, you will be able to:
Define working capital.
Understand working capital management strategies.
Construct a cash budget.
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4. Working Capital:
*Current assets and Current liabilities
*Although non-current assets provide the capability to provide services, it is the combination of
current assets and current liabilities that turns that capability into service. For example, an X-ray
machine is useless without an adequate supply of film on hand or cash to pay the radiation
technologists. This lecture begins with a discussion of working capital and then focuses on the
management of two primary components of working capital in the health care industry: cash and
accounts receivable.
*The term “working capital” refers to both current assets and current liabilities. A related term, “net
working capital,” refers to the difference between current assets and current liabilities. That is: Net
Working Capital = Current Assets - Current Liabilities
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5. The Working Capital Cycle
*In the day-to-day operations of an organization, an ongoing series of cash inflows and
outflows pays for day-to-day expenses (such as supplies and salaries). The organization must
have sufficient funds available to pay for these items on a timely basis. This is particularly
problematic in health care, where it is not unusual for payments to be received more than two
months after the patient or third party has been billed for the provided services.
*Ideally, a health care organization would earn and receive sufficient funds from providing
services to enable it to meet its current obligations with available cash. To do this requires
managing the four phases of the working capital cycle obtaining cash; turning cash into
resources, such as supplies and labor, and paying bills; using these resources to provide
services; and billing patients for the services, and collecting revenues so that the cycle can be
continued.
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6. Working Capital Managing:
_With regard to cash, managing the working capital cycle
involves:
*not only ensuring that total cash inflows cover cash
outflows, but also managing the timing of these flows.
*To the extent that payments are due before cash is
available, the organization will have to obtain cash from
sources other than existing revenues, such as from
investments or through short-term borrowing.
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7. Working Capital strategy :
 To illustrate, suppose an organization starts the month of September with no working capital. During the
month, it delivers EGP20,000 worth of services, but must pay EGP9,000 in staff salaries every 15 days and
EGP2,000 for supplies every 30 days. (See TABLE 6/1)
 Situation 1 assumes that the full amount owed is collected during the month, but isn’t received until the end
of the month. Situation 2 assumes that the organization also collects the full amount owed, but in two equal
payments of EGP10,000 each – the first payment arriving after 15 days, and the second payment, after 30
days.
 In both cases, cash inflows (EGP20,000) equal cash outflows (EGP20,000). However, whereas in Situation
2 there is always sufficient cash on hand to meet the payments when due, in Situation 1 the organization
would not be able to meet its first EGP9,000 payroll on Day 15. To meet this obligation, it either must take
cash out of existing reserves or borrow. However, even in Situation 2, there is little margin for error. The
amount of working capital that an organization determines it must keep available as a cushion against
unforeseen expenses is called its working capital strategy.mahmoud shaqria 7

8. TABLE 6/1
Illustration of the Effects of Timing on Working Capital Needs
Situation #1 Situation #2
account Cash inflows Cash
outflows
Balance account Cash inflows Cash
outflows
Balance
Day 1 EGP0 EGP0
Day 15 revenues EGP10,000
salaries EGP9,000 EGP9,000 EGP9,000 EGP1,000
Day 30 revenues EGP20,000 EGP10,000
salaries EGP9,000 EGP9,000
supplies EGP2,000 EGP0 EGP2,000 EGP0
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9. Working Capital Management
Strategies
Working capital management strategy has two
components: asset mix and financing mix.
*Asset mix is the amount of working capital an
organization *keeps on hand relative to its potential
working capital obligations.
*Financing mix refers to how an organization chooses to
finance its working capital needs. mahmoud shaqria 9

10. Asset Mix Strategy:
*A health care provider’s asset mix strategy falls
on a continuum between an aggressive strategy
and a conservative strategy (see TABLE 6/2).
*Using the aggressive approach, the health care
organization attempts to maximize its returns by
investing its funds in potentially higher-earning
non-liquid assets such as buildings and
equipment; yet it does so at the risk of lower
liquidity with increased chances of inventory
stock-outs, dissatisfied customers from the
stringent collections policies to earn revenues
more quickly, and lack of cash to pay employees
and suppliers.
*Conversely, using a conservative approach,
a health care organization seeks to minimize
its risk of not having sufficient funds readily
available by having higher liquidity. However, it
does so at the cost of receiving lower returns,
since short-term investments typically earn a
lower return than do long term investments. mahmoud shaqria 10
TABLE 6/2 Working Capital Management Strategies
Aggressive Strategy Conservative
Strategy
Goal Maximize Returns Minimize Risk
Liquidity Low High
Risk High Low
Return High Low

11. Financing Mix Strategy
*Financing mix refers to how the organization chooses to finance its working capital needs. Temporary
working capital needs result from short-term fluctuations, whereas permanent working capital needs
arise from more ongoing factors, such as a permanent increase in patient volume. Borrowing short-
term at lower interest costs for short-term needs under normal conditions leads to a higher profit,
because working capital is otherwise being invested optimally (everything else being equal), but this
places the facility at risk because of possible higher debt payments if the need to borrow arises. If the
organization has long-term working capital financing needs, it is better off financing those needs with
long-term financing under normal conditions. Facilities borrowing long-term at higher interest costs to
support ongoing working capital needs face lower earnings, but reduce their risk with lower debt
payments.
TABLE 6/3 compares the key characteristics of short-term and long-term borrowing. Overall, an
aggressive working capital strategy involves maintaining a relatively low amount of working capital on
hand and financing working capital shortfalls with short-term debt. Though this results in a greater
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12. TABLE 6/3
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TABLE 6/3 Comparison of Key Characteristics of Short and Long-term Borrowing under Normal
Conditions
Short Term Long Term
Interest Rate1 Lower Higher
Interest Cost Lower Higher
Profit Higher Lower
Volatility Risks Variable Fixed

13. Cash Management
In general, the term cash refers not only to coin and currency, but also to cash equivalents such as
interest-bearing savings and checking accounts. There are three major reasons for a health care
provider to hold cash:
● Daily operations.
● Precautionary purposes.
● Speculative purposes.
Daily operations refers to holding cash so that day-to-day bills may be paid.
Precautionary purposes refers to holding cash to meet unexpected demands, such as unexpected
maintenance of a facility or piece of equipment.
Speculative purposes refers to holding cash to take advantage of unexpected opportunities, such as
a group practice’s buying a competing practice that has decided to sell.
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14. Forecasting Cash Surpluses and Deficits
– The Cash Budget
 In order to minimize costs and plan ahead to finance deficits and invest
excess cash, a health care organization needs to clearly identify the
timing of its cash inflows and outflows. The main vehicle to project cash
inflows and outflows is a cash budget.
 Depending on the decision at hand, it may show inflows on a daily,
weekly, monthly, quarterly, semi-annual, annual, or multi-year basis. For
instance, forecasts about weekly inflows and outflows are not needed for
long-range planning, but monthly planning may require forecasting on a
weekly or even daily basis. Much of the information about preparing the
cash budget comes from the operating and capital budgets. To illustrate
cash inflows and outflows, a monthly cash budget for January through
March, 2018 for Cairo Health Organization (CHO) is illustrated in
TABLE6/4. mahmoud shaqria 14

15. Cash Inflows
 Cash inflow estimates are generally
derived from patient revenues, other
operating revenues, proceeds from
borrowing and/or stock issuances (for
investor-owned organizations), and non-
operating contributions.
 To estimate cash receipts from patient
revenues for the month, CHO needs to
estimate the amount of revenues and
when they will be received in cash.
Assume CHO forecasts the following
revenues for 2019 based upon 2018
data:
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Actual Patient Revenues
2018
Expected Patient
Revenues 2019
October EGP400,000 January EGP500,000
0
November EGP500,000 February EGP600,000
December EGP300,000 March EGP700,000

16. Working Capital:
 From its historical records, CHO estimates that it will collect 50 percent of revenues
earned in the month of service, 40 percent the following month, and 10 percent two
months after service has been delivered. All other revenues, such as contributions,
appropriations, cash from sale of investments and used equipment, and interest
income, are expected to total EGP44,000, EGP55,000, and EGP52,000 in January,
February, and March, respectively. Based on this information, CHO can calculate
cash inflows.
 For instance, February’s cash inflows of EGP585,000 are composed of 50 percent
of February’s revenue (EGP600,000 × 0.50 = EGP300,000), 40 percent of January’s
revenue (EGP500,000 × 0.40 = EGP200,000), 10 percent of December’s revenue
(EGP300,000 × 0.10 = EGP30,000), plus the other revenues for February
(EGP55,000) given above.
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17. Example 6/1
For CHO given following prepare cash budget for
first quarter of 2019:
1. revenues
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Actual Patient Revenues
2018
Expected Patient
Revenues 2019
October EGP400,000 January EGP500,000
0
November EGP500,000 February EGP600,000
December EGP300,000 March EGP700,000

18. Example 6/1
2 Funds are received as follows: 50% within the month of service, 40% one month
after service, and 10% two
months after service.
3 “Other Revenues” includes interest earned and are forecasted to be EGP44,000 in
January, EGP55,000 in February,
and EGP52,000 in March.
4 Cash outflows are forecasted to be EGP350,000, EGP450,000, EGP600,000, and
EGP500,000 in January, February, March,
and April, respectively.
5 “Cash Outflows” are for the current month.
6 The ending cash balance for December was EGP50,000.
7 CHO desires a required cash balance of 40% of the following month’s forecasted
cash outflows.
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19. mahmoud shaqria 19
Working Capital:

20. Cash Outflows

Cash outflows are estimated at EGP350,000, EGP450,000,
EGP600,000, and EGP1,400,000 for January, February,
March, and Total, respectively. These outflows include such
operating items as salaries and benefits, supplies, interest,
capital expenditure outflows for equipment and land, and
debt payments.
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21. Ending Cash Balance
 By subtracting cash outflows from net cash inflows, CHO can derive its monthly net cash flow. To this
amount, it adds the beginning cash balance to calculate the cash available before borrowing or investing. For
instance, in January there were net cash inflows of EGP464,000 and cash outflows of EGP350,000 that
resulted in a EGP114,000 net cash inflow for the month (row J). When this is added to the EGP50,000
available at the beginning of the month (row K), CHO had EGP164,000 in cash before borrowing or investing
(row L).

Though this number represents how much cash is available at the end of the month as a result of the normal
cash flows during the month plus the beginning balance, many health care organizations are required to end
a month (actually, begin the next month) with a certain minimum balance, called a required cash balance. If
they are below this amount they must borrow money, and if they are above they invest the excess. In the
case of CHO, the required cash balance is 40 percent of the next month’s forecasted cash outflows (row M,
January and row I, February: EGP180,000/EGP450,000 = 0.40).
To illustrate this process, CHO had EGP164,000 in January’s cash before borrowing or investing (row L), but
the required cash balance is EGP180,000 (0.40 × EGP450,000, February’s cash outflows). Therefore, it must
borrow EGP16,000 to make up the difference (row P). This results in an ending cash balance of EGP180,000
(row Q). If there had been a surplus, as in February (row N), CHO would have invested the excess funds
(row O).
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22. Thank you…
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