MANAGING THE CAPITAL CYCLE

Managing the Capital Cycle

Managing the Capital Cycle

Introduction

To succeed in a market economy, both for-profit and not-for-profit healthcare organizations must understand the importance of managing the strategic capital cycle. All organizations should be positioned to deliver capital resources when and where they are needed to achieve strategic objectives and to expand and renew their capital capacity. Growth in capital capacity centers around the management of three components: design and implementation of the financial plan, design and implementation of an appropriate capital structure, and a deployment and reinvestment of capital back into the organization.

Capital Cycle of Health Care Organizations

Managing the capital cycle starts and ends with the financial plan - the backbone of a competitive organization. A sophisticated financial plan will help an organization locate the critical relationship between strategy and financial capability and permits it to make the best use of its available resources and respond thoughtfully to competitive problems. The financial plan is an organization's radar screen(Copeland Koller Murrin 2000 ).

A good financial plan places an organization within an area of financial equilibrium that balances financial capability with strategic objectives. Ideally, CEOs and CFOs should try to keep their organizations within this area of financial equilibrium. There are times, however, when an organization's strategic appetite will exceed its financial capability. This is a signal that some level of management intervention, which the plan should quantitatively define, is required.

The financial plan further allows executive management to articulate the key financial objectives for the organization. These objectives are specific, quantitative, and directly related to the predetermined level of strategic investment. Examples include(Donaldson 2000):

A process that matches capital expenditures to financial performance;

The creation of additional incremental debt capacity;

The identification of short- and long-term profitability goals;

The identification of a short- and long-term cash position; and

A comprehensive strategy to maintain the highest possible bond rating.

Finally, the financial plan answers seven questions that are essential to the management of the capital cycle:

What are the organization's strategic capital requirements?

How much cash should the organization have?

How much debt can the organization afford?

What short- and long-term profitability targets are necessary to resolve any shortfalls?

What level of operating change is required to meet the profitability targets?

Where will the capital be obtained in the short and long term?

What transactions ate required to obtain necessary capital?

The cash conversion cycle can be measured in days. In some respects, it is like a garden hose. In equilibrium, the amount of water flowing out of a gar-den hose every second is equal to the amount of water flowing into the hose every second. The longer the hose, however, the greater is the amount of water tied up in it at any given time. Similarly, in a steady state, the amount of cash entering the cash conversion cycle every day will be equal to the amount of cash recovered from patient accounts every day. The longer the cash conversion cycle (in days), however, the greater is the volume of resources tied up in the cycle(DeFerrari Palmer 2001). Assets tied up in the cash conversion cycle earn little or no return and therefore incur ...