September 2004

Beyond Facilities

Not all capital expenditures are for facility-related projects. Investments are often needed for other strategically important initiatives including clinical service development, information systems and other infrastructure improvements, and system development needs such as joint ventures and medical staff development.

Another potential use of capital funds is to strengthen the financial profile of the organization to improve its creditworthiness, reduce its cost of borrowing, or enhance its ability to weather a financial downturn. This approach could include increasing the number of days for cash on hand or paying down debt to improve debt service ratios.

Anticipating and preparing for strategic capital investments needed several years into the future is important.  Developing a capital needs lists for a planning horizon of at least five years is critical.  Many long-term capital needs can be identified during the strategic planning process and, ideally, by the development of a long-range master facility plan.

Setting Priorities

After identifying all the potential needs for capital, projects that are mandated (e.g., corrections to code violations) or otherwise not optional (e.g., replacement of a boiler) should be identified and funded. The remaining projects need to be evaluated using similar criteria so that projects with the greatest value to the organization are given the highest priority.

The criteria used to evaluate projects and initiatives during the capital prioritization process will fall into several categories, such as market, financial, and community impact. Criteria will vary from organization to organization and each criterion can be weighted differently to reflect its relative importance. For some organizations, financial criteria may be weighted more heavily, while others may choose to weigh market factors more.

Although some criteria are more subjective than others, it is important that the criteria are quantifiable, so that projects can be objectively compared to one another. An example of criteria and weights similar to those used by a large medical center in the Northeast is presented below.

Selecting Priorities

To evaluate a potential capital expenditure, points should be assigned to the project for each criterion. The points for all criteria are then added, including application of criterion weights if these are used, to determine the total score for the project. The scores of all projects under review are then ranked from highest to lowest to determine the relative value and priority ranking.

Organizations may choose to fund the highest priority projects in descending order until the capital spending pool is depleted. Some may decide to fund several smaller, lower priority projects that cost the same as one higher priority project, but result in a greater benefit to the hospital or system overall. Organizations also should consider strategies that increase the spending pool and expand the potential number of projects that can be funded, including equity funding by other parties and fundraising for selected projects as appropriate.

Realizing the Benefits

A capital prioritization analysis enabled a multihospital health care system in the Midwest to thoughtfully allocate funds to projects and initiatives that more effectively supported system and hospital goals. The process also led to an improved business planning foundation for all projects, as managers became familiar with the evaluative criteria. In some cases, a project that failed the first round of evaluations was reconsidered after closer attention to the business model led to a more creative approach and a better return on investment.

The process of developing criteria, weighting criteria, and forcing all capital projects to submit to an objective evaluation process is extremely valuable for all health care organizations. This comprehensive and systematic approach enables the organization to understand and be explicit about its values and to exercise discipline over a critical and scarce resource.

For more information on capital planning and prioritization, contact Tracy Johnson or Alan Zuckerman, or call 215-636-3500.