WORKING CAPITAL AND

BUDGETING
C h a p t e r Seven

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 Working Capital
• 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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 The Working Capital Cycle
• 1) obtaining cash;
• 2) turning cash into resources, such as
supplies and labor, and paying bills;
• 3) using these resources to provide services;
and
• 4) billing patients for the services, and
collecting revenues so that the cycle can be
continued.

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 Working Capital Strategy

• The amount of working capital that an organization

determines it must keep available as a cushion to
protect against unforeseen expenditures.
• To illustrate, suppose an organization starts the
month of September with no working capital.
• During the month, it delivers $20,000 worth of
services, but must pay $9,000 in staff salaries every
15 days and $2,000 for supplies every 30 days.

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• 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 $10,000 each – the first
payment arriving after 15 days, and the
second payment, after 30 days.

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-ve +ve

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• In both cases, cash inflows ($20,000) equal cash
outflows ($20,000).
• 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 $9,000 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.
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 Cash Management
• There are three major reasons for a health
care provider to hold cash:

1.Daily operations.
2.Precautionary purposes.
3.Speculative purposes.

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1-Daily operations refers to holding cash so that
day-to-day bills may be paid.
2-Precautionary purposes refers to holding cash
to meet unexpected demands, such as
unexpected maintenance of a facility or piece of
equipment.
3-Speculative purposes refers to holding cash to
take advantage of unexpected opportunities.

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 Sources of Temporary Cash
The three primary sources of short-term funds
include:
1.Extension of credit from suppliers (i.e. trade
payables).
2.Bank loans
3. Billings, collections, and disbursement policies
that increase the speed with which money is
collected.

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 Trade Credit/Payables
• When a health care organization buys on
credit, it is in fact using the supplier’s money
to pay for the purchase up until the time it
pays the supplier the amount owed.
• These credit obligations are called trade
payables (often referred to as accounts
payable).

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• Thus, one of the most important areas to
address in cash management is that of either
accepting or rejecting discounts offered by
suppliers for early payment.

These discounts are often stated as

follows:
2/10 net 30

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 Example: Cost of Foregoing a Discount
• A vendor offers a discount of 2% if payment is made
within ten days. If the discount is not taken, full
payment is due in 30 days. What is the annual cost
of not accepting the 2% discount?
 Percentage Discount   365 
APR =   
 100 - %Discount  Credit Period - Discount Period 
 2   365 
=   
 100 - 2   30 - 10 
= 37.24%

APR = Annual percentage rate

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Problems on Trade Credit Discount
Q1. Compute the annual approximate interest cost
of not taking a discount using the following
scenarios. What conclusion can be drawn from
the calculations?
a. 1/10 net 20
b. 1/10 net 30
c. 1/10 net 40
d. 1/10 net 50
e. 1/10 net 60
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Q2. Compute the annual interest cost of not
taking a discount using the following
scenarios. What conclusion can be drawn from
the calculations?
a. 1/10 net 30
b. 2/10 net 30
c. 3/10 net 30
d. 4/10 net 30
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 Relation APR??
1. 1/10 net 40
2. 1/10 net 50

3. 3/10 net 30
4. 4/10 net 30

5.1/10 net 30
6. 1/20 net 30
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 BUDGET
The budget is one of the most important
documents of a health care organization and is
the central document of the planning/control
cycle.
It identifies the revenues and resources that are
needed for an organization to achieve its goals
and objectives and allows the organization to
monitor the actual revenues generated and its
use of resources against what was planned.
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 Types of Budgets
Most health care organizations develop four
interrelated budgets: Statistics budget, Operating
budget, Cash budget, and Capital budget.
1). The statistics budget identifies the amount of
services that will be provided, usually by payor
type.
2). The operating budget is a combination of two
budgets the revenue budget and the expense
budget.
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-The revenue budget is a forecast of the operating
revenues that will be earned during the budget period.
It consists of net patient revenues and non-patient
revenues.
-The expense budget lists all operating expenses that are
expected to be incurred during the budget period, both
fixed and variable.
3). The cash budget represents the organization’s cash
inflows and outflows. The bottom line of the cash budget
is the amount of cash available at the end of the period.
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-In addition to showing cash inflows and outflows, the
cash budget also details when it is necessary to
borrow when there are cash shortages, and when
excess funds can be invested.
4). The capital budget summarizes the purchases to
be made during the year.
-Capital budgets for outpatient facilities may be fairly
small; those from large systems with inpatient
facilities may contain millions of dollars’ worth of
items.
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 RESPONSIBILITY ACCOUNTING
• Responsibility accounting is accountable for all the management,
budgeting, and internal accounting of a company. The primary objective
of this accounting is to support all the planning, costing, and responsibility
center of a company. Decentralization play a vital role in Responsibility
accounting .
• Decentralization : Decentralization is the degree of dispersion of
responsibility within an organization.
• Advantages and Disadvantages of Decentralization:

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 Responsibility Center
• An organizational unit that has been formally
given the responsibility to carry out one or more
tasks and/or to achieve one or more outcomes.
• The four most common types of responsibility
centers in health care are:
1. Service centers,
2. Cost centers,
3. Profit centers, and
4. Investment centers
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1. Service Centers
• Organizational units that are primarily responsible for
ensuring that health care-related services are provided to a
population in a manner that meets the volume and quality
requirements of the organization. They have no direct
budgetary control.

2. Cost Centers
• Organizational units responsible for providing services and
controlling their costs.

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3. Profit Centers
• Although many profit centers are responsible for service-
related activities, all profit centers are responsible for
controlling their costs and earning revenues.

4. Investment Centers
• Investment centers are responsible for making a certain return on
investment.
• For example, where a profit center might be content with a
simple $100,000 profit, an investment center might find this
unacceptable if it does not provide the desired return on
investment.

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The Four Main Types of Responsibility Centers
and Their Main Areas of Responsibility

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The Basic Attributes of a Responsibility Center Are:
• Responsibility: Duties and obligations of a
responsibility center.

• Authority: Power to carry out a given

responsibility.

• Accountability: Sanctions, both positive and

negative, attached to carrying out responsibilities.
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