Finance Essay - Financial Management
Financial Management is a very important aspect of ensuring quality healthcare. As such, diligence in this aspect is required just as much as the diligence of the health practitioners and medications among other requirements. In this paper, various aspects of financial management are examined. First, the paper evaluates the need for having sufficient working capital where several reasons are outlined. Second, the paper goes further to examine the approaches that can be used to start up a pharmacy in the community hospital. Several concepts are evaluated in relation to financing the project. Also, the paper discusses two methods, net present value and internal rate of return that can be used to evaluate the profitability of the project and the action to be taken when they give conflicting outcomes. The paper goes ahead to make a cash flow projection for the projected guided by the stated assumptions. Finally, the paper evaluates the effect on the firm cash flow that would be caused by changes in policy at various governmental levels.
Importance and Need of working capital
Working capital is the nerve centre and the life blood of any business regardless of the size of the firm or the number of years that the firm has been in operations. As such, this element of a business facilitates the smooth running of the business. Therefore, this makes it practically impossible to run a business efficiently without sufficient working capital. The main advantages are outlined below.
Strengthen the Firm Solvency
Woking capital is a perfect measure of the firm’s ability to make prompt payment as and when they fall due. As such, the firm will have the capability of meeting its external obligation especially when the short term financial obligation concerned such as payments of raw materials, remuneration of employees, meeting the overheads costs without any delay (Shim & Siegel, 2008). As such, sufficiency in working capital means that the firm has the required solvency to keep running without any unnecessary interruptions.
Ability to meet the firm obligation promptly is a necessity if the business is to develop any credibility among suppliers and other parties that may extend credit to the firm. As a result, it creates goodwill to the firm since these stakeholders view the firm positively thus the firm enjoys creditors goodwill.
Ease of obtaining Credits
Financial institutions prefer extending credits to firm that have the ability to meet their obligation timely. The main reason why the financial institution will take this position is because they view such firm as low risks firm thus they stand lower chance that they will lose their money that they extend as credit. Also, due to low risks, such firm can use this credibility to negotiate for favourable terms with the financial institutions thus reducing its financing costs. The relationship between favourable treatment by financial institution and working capital is the credibility that arises from increased solvency and enhanced goodwill that enhance the ability to meet its financial obligation.
Regular and Reliable Supplies
A business cannot operate without the necessary stocks. Be it raw materials or goods that are bought for resale, a firm needs to have the necessary inventory in order to do business if the firm is involved is goods selling. As result, this brings in the role of suppliers. Just like financial institution will prefer to deal with a firm that is a low risks firm, supplier will also prefer a similar firm. As such, a supplier will evaluate the ability of the firm to pay for the goods supplied on time. In such a case, the firm is assured that it will attract highly capable suppliers thus ensuring it has a steady line of supply. Also, it is possible to enjoy preferential treatment due to the firm ability to meet its suppliers satisfied.
Ability to Face Crisis
Crises, either expected or random, require sufficient and strategic solution. In order to solve a crisis, especially monitory, immediate financing is required. Therefore, the firm needs to have sufficient funds to address such occurrences in order to minimise costs that are caused by crises such as stock outs. Consequently, this means that such costs can be avoidable in the event that a firm maintains sufficient working capital.
Financing Start Up
Working capital is a value that considers current assets and current liabilities. The difference between current assets and current liabilities is the working capital value. The value, once added to the fixed assets, the figure equals the value of the long term financing (Stolze, 2007). Currently, the firm is not operational yet. As such, there are no current or noncurrent assets. Therefore, the financing value will be the needed capital to finance both current and noncurrent assets. As such, evaluating the issue of acquisition of assets, renovations, disposable supplier and operational costs, they narrows down to the financing process. As such, they will be fully covered when the start-up finance is availed by the hospital.
First, credit line is one of the issues that will be used to finance supplies (Pandey, 2006). It is normal for business enterprises to use this line of credit to acquire supplies. As such, the firm will agree with the suppliers, using the hospital reputation, to arrange for suppliers to supply the drugs on credit at the agreed payment duration.
Second, in community based organisations, it is best to apply matching approach in financial management. As such, this means that the pharmacy should use the matching approach. In doing so, it would be beneficial for the firm to use long time credit to finance its long term equipment costs. The matching concept applies in this situation since the firm will use long time credit to finance this non-current asset. In relation to the short term financial needs, the firm should apply the short term sources of funds in meeting this needs.
Finally, renovation, disposable supplies, salaries and benefits and unprecedented costs will be met using the capital injected by the hospital. Currently, since the firm is responding to an urgent need, the firm is assumed not to have sufficient amount to finance the entire enterprise. However, the firm can afford to put in substantial amount to support the start up with the necessary working capital.
Measurement of Rate of Return of the Project
Net Present Value
Net present value is one of the most useful discounting methods that are used in project appraisal. As such, this method will be instrumental in understanding the return of the project. However, this method does not present the rate of return as a rate but as a net value that the firm will gain when it invested in the project (Carroll, 2007: Gapenski & Pink, 2011). The acceptance rule states that the project will be rejected when the net present value is negative while it should be accepted when the value is positive.
Internal Rate of Return
Internal rate of return is a discounting technique that considers time value for money. The method measures the rate of return that a firm will gain when the firm invests. The measure is expressed as a percentage. The method is an extension on the net present value. However, in relation to the acceptance rule, the return rate should be accepted if it is greater than the firm set rate (Brigham & Houston, 2012: Gapenski & Pink, 2011). In this case, it should be assumed the required rate of return to be 10%.
In some instances, the internal rate of return and net present value may differ in relation to accepting the project or not. As such, they may yield conflicting solution when evaluating a project. When such a situation occurs, one may consider other factors such as payback period and profitability index of the project. However, in terms of structure, Net Present Value should be preferred in many instances since it shows the exact value that a project adds to the firm. Also, due to the scale of the project, in case of a conflict, Net present value should be preferred.
Profitability Analysis (presented in Excel File)
The details on the projection are presented in the excel document attached. The simulation is based on the following assumption
The underlying fundamental assumption of net present value and internal rate of return apply
The prices of the drugs on sale will remain relatively stable
The profitability uses the costs of sales approach in structuring the projections
The discounting rate is assumed to be 10%
The hospital has a good reputation to facilitate loan acquisition from a financial institution
The expected internal rate of return is 10%
Effects due to Policy Change
The project main concern is adherence to the law. First, the project needs to ensure that the law is followed relating to dispensing of drugs especially prescription drugs. As such, the firm needs to ensure that the pharmacy follows keenly any change in the law that relates to drugs that can be sold without out a prescription and the one that cannot be sold without a prescription. However, this should not be limiting concern since the hospital has staffs that are highly conversant with the relevant law since it has been inexistence for a long time. As such, the staffs have sufficient understanding of the law. Also, changes in recommended drugs for certain treatment, adoption of a drug for a treatment by the authorities and banning of a drug will need to be monitored since it also has the ability to influence on the pharmacy sales.
Brigham, E., & Houston, J. (2012). Fundamentals of financial management (7th ed.). Mason, OH: South-Western CENGAGE Learning.
Carroll, N. (2007). Financial management for pharmacists: A decision-making approach (3rd ed.). Philadelphia: Wolters Kluwer/Lippincott Williams & Wilkins.
Gapenski, L., & Pink, G. (2011). Understanding healthcare financial management (6th ed.). Chicago: Health Administration Press ;.
Pandey, I. (2006). Financial management [with CD copy] (9th ed.). New Delhi: Vikas Publishing House.
Shim, J., & Siegel, J. (2008). Financial management (3rd ed.). Hauppauge, N.Y.: Barron's Educational Series.
Stolze, W. (2007). Start up financing: An entrepreneur's guide to financing a new or growing business. Franklin Lakes, NJ: Career Press.