Operational Budgeting Definition

[Miqueo Snyder]

Complexorganizations are tasked with utilizing limited resources to create goods and services; a healthcare organization is no exception. The resources that serve as inputs to a healthcare organization include clinical and administrative staff, medical supplies and equipment, and government and private health insurance. The goods and services that serve as outputs of a healthcare organization include patient care outcomes, patient satisfaction, and community and population health.

Therefore, whether it is the director of a national health system (e.g., National Health Services in the UK), the CEO of an academic hospital (e.g., the Mayo Clinic), or the manager of a local urgent care center, they must understand how to design, modify, and implement a business budget.[1] A budgeting system is typically composed of five components.[2] These are the following:

The capital budget is often a big-ticket item throughout the budgeting process; therefore, it warrants further discussion. As stated above, the capital budget in the healthcare setting includes technologies, equipment, and sometimes physical buildings and facilities, which could require the investment of millions of dollars in any of the categories. Two financial models that could help managers evaluate whether a capital project is worth investing in are the weighted average cost of capital (WACC) and the discounted cash flow (DCF) models.[3][4]

The WACC model is based on the concept of opportunity cost, computed by plugging in several variables to generate a percentage rate of return. These variables include the cost of capital before tax, the cost of equity, the cost of debt, the corporate tax rate, the value of equity shares, and the market value of debt.[3] After plugging in these variables, the WACC equation will produce a percentage (e.g., 12%) representing the threshold rate of return that a capital investment needs to demonstrate to be profitable. In other words, if a project is estimated to return 5%, the organization will most likely experience a loss on the investment.

The DCF model considers the time value of money by projecting the value of an investment over its lifespan. With this model, the yearly revenue from a project (cash flow) is projected, and each annual revenue projection is then discounted by the interest rate (i.e., the discounted cash flow). All the discounted values are added together to reflect the cumulative current value, and finally, the initial capital investment is subtracted from the cumulative current value. The resulting figure is the net present value (NPV), which could be positive (i.e., resulting in a profit), zero (i.e., resulting in net even), or negative (i.e., experiencing a loss).[4]

In "Budgeting for Results," Ross writes that instead of viewing budgeting merely as a tool to estimate revenues and expenses, organizations should utilize budgeting as a process to translate organizational values into operational roadmaps.[1]

Further, this process can be completed through joint efforts among senior leadership, mid-level management, and corporate finance departments. Ross discusses the five fundamental budgeting systems as listed below:

In value-based care, healthcare organizations are judged by the outcome of care divided by the cost of delivering the care. Medicare designed prospective payment rates based on diagnostic-related groups (DRGs) in the 1980s for hospital reimbursements. The DRG-based payment system is a version of value-based care in which the cost of care is directly tied to the diagnosis and the severity of the illness.[6]

As a result, TDABC has emerged as an all-encompassing yet relatively efficient cost-accounting method that examines the entire care delivery process. Kaplan and Porter developed the 7-step method of TDABC that examines the care delivery roadmap, incorporates direct and indirect costs, estimates time spent per activity, evaluates capacity cost rate, and ultimately generates the cost of the entire care process.[5][7]

For individual patients, a well-budgeted healthcare operation can positively impact their care experience, quality, and outcome. In wound care management, 15% of costs are from dressings and materials, 35% are from nursing care time, and 50% are from hospitalization.[8]

If a wound care clinic erroneously increases the budget for dressings and materials but reduces the budget for nursing staff, then this budgetary decision would directly reduce nursing wound care time, worsen wound healing, and ultimately increase hospitalization and associated costs.

Ross emphasizes that budgeting is an important management tool that enables a healthcare organization to translate its visions into actions.[1] Rather than viewing budgeting as a tedious cost-control mechanism, Ross argues that organizations should evaluate whether their budget reflects their long-term objectives at the executive level, whether the budget process successfully performs and functions at the management level, and whether the process honors the constraints and opportunities at the finance level. A well-budgeted healthcare organization enables buy-in from its employees at all levels.

If healthcare budgeting is considered complex for a single organization, one could imagine how interwoven and intricate the process can be for a local government or state. The State of Maryland, for example, has been operating under an all-payer global budget system since 2014, which has led to cost savings and demonstrated collaboration among stakeholders, including hospital leaders, state and federal regulators, and payers.[9]

At the national level, healthcare budgeting directly impacts access, delivery, staffing, and quality of care. In the United Kingdom, the National Health Service (NHS) is tasked with delivering care to the public. In 2021, the NHS announced that it would add 5.9bn ($8.1bn) to its annual budget to tackle the long waiting time for diagnostic studies and elective medical care.[10] Regardless of the level and scale of budgeting, the same principles mentioned above still apply.

Healthcare budgeting is an extensive interprofessional process in any healthcare organization. When performed well, healthcare budgeting invites interdisciplinary participation from clinical staff (e.g., physicians, advanced practitioners, nurses, and pharmacists), operational staff (e.g., clinical engineering, environmental services, and nutrition services), and administrative staff (e.g., executives and managers). Nurse managers play a vital leadership role in budgeting, as evidenced by Baker, Lindholm, and Searle, because they can combine clinical experiences with operational understanding to make sound budgetary decisions.[2][8]

Given the importance of budgeting to patient care, organizational success, and public health, it is ever more critical for healthcare professionals to understand the fundamental principles of budgeting.

Budgeting is a crucial aspect of financial planning for businesses, and acts as a guide for both short-term operations and long-term strategic goals, ultimately aiding in decision-making and resource allocation for fiscal health and growth. This type of financial planning primarily includes capital and operational budgeting.

Capital budgeting focuses on long-term investments and acquiring capital assets to shape the business's future, involving significant funds and multi-year implications. In contrast, operational budgeting addresses immediate financial activities, managing day-to-day cash flow, operating expenses, and short-term needs within a single fiscal year.

Capital budgeting refers to the methodical evaluation and prioritization of potential investments in long-term assets. These assets can range from acquiring new machinery and equipment to substantial technology upgrades or introducing new product lines.

The capital budget consists of capital expenditures, which are substantial funds used to acquire or upgrade physical assets such as property, buildings, or equipment. It also includes capital projects, which are long-term investment endeavors to augment a company's capabilities or efficiency, and capital assets, like investments in technology, infrastructure, and intellectual property.

Capital budgeting involves pinpointing potential investment opportunities and evaluating them using methodologies like net present value (NPV), internal rate of return (IRR), and payback period. This analysis considers factors such as anticipated cash flows, the time value of money, and expected rates of return.

Various factors, including the potential rate of return, the present value of anticipated cash flows, and the time value of money, influence decision-making in capital budgeting. Aligning these investments with the company's overarching strategic goals is equally important.

Operational budgeting is integral to the financial health of a business, providing the necessary framework for managing day-to-day financial activities. It ensures that a company can cover its immediate expenses while maintaining the flexibility to adapt to changing market conditions and business needs.

An operational budget is a detailed projection of a business' revenue and expenses over a specific period, usually a fiscal year. It encompasses all aspects of operating expenses, including costs related to production, sales, administration, and other day-to-day activities.

The operating budget typically includes operating costs such as salaries, utilities, and rent. It also covers expenses related to raw materials, inventory, and production costs. Additionally, it accounts for regular financial obligations like property taxes and other routine expenses.

Preparing an operating budget is often an annual process, aligning with the fiscal year. It involves forecasting revenue, estimating expenses, and setting financial targets for the year. This cycle is essential for tracking financial performance, adjusting strategies as needed, and ensuring the company remains on a sustainable financial path.

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