Follow steps to justify buying capital equipment

I think one of the easiest parts of budget preparation is the forecasting of capital equipment needs for the coming year. Some of you may disagree, especially if your center is new or you have just recruited a new group of physicians. For the rest of us, however, this is a fairly uncomplicated process. You've made your list and submitted it by now, so I won't bore you with the mechanics of that process; however, for the fresh mind, new to the position, and a quick review for the rest of us, it goes something like this:

During the course of the year, your staff and physicians have approached you to replace this piece of equipment, buy that new widget, upgrade or add to existing systems, assist in the promotion of their practice by buying a new laser, etc. We all know the exercise. You have to evaluate and prioritize, weigh the added value vs. the cost, be cognizant of the political aspects of your final decision, and then sell the idea to your boss. And that is where the rub comes from.

It is relatively easy to budget capital equipment. From a realistic standpoint, no one gives us much of a hassle when we submit the list. Oh, for certain, people look at it and question it to some degree, but up to the point of actually ordering the equipment, the money hasn't been spent. Therefore, it is not an immediate issue to be dealt with that requires a great deal of protracted thought.

Now that you're ready to "take money out of the bank," however, everyone is crawling down your back to get justification for the purchase. That is what I want to review: how to justify the purchase.

One of our centers performs sophisticated retina surgery. The administrator submitted her capital budget, which I reviewed several months ago. Actually, "glanced at" would be a better way to describe the process. I made a mental note of the request and filed it away to query it in greater detail when and if it came up again.

Request wouldn't go away

Well, right after the ball dropped in Times Square, the request to purchase this equipment hit my desk. While I am not at all a procrastinator, I abhor paperwork! If something can't be accomplished on my computer or over the telephone, it probably shouldn't be done in the first place. So, when the request landed on my desk for my signature, I did what many of you won't admit to: I pushed it to a corner of my desk in the hopes that I wouldn't have to deal with it; that eventually the paper would convert to dust and be swept away.

Well, it didn't take too many days for a fax to come to me from the administrator, asking about the capital expense request. More paper. Naturally, I did what some of us do. I located the original request, stapled the fax follow-up to it, and placed it on another corner of my desk. (I do have a system at least!) While this system works for a while, eventually we come to the next step, which is, of course, the phone call from the administrator. The issue now has to be dealt with, because it is a phone call and not paper.

From my standpoint, new equipment must be productive. There should be a definable goal for its purchase that is quantifiable. For example, the retina equipment eventually should pay for itself. For this example the situation was as follows: The current light source wasn't adequate for the surgeon to visualize many aspects of the posterior chamber of the eye on many patients. As a result of that situation, all of the patients that could have their surgery at our facility were taken to the local hospital for their operation due to the fact that the hospital had a light-source that was newer than ours. Therefore, by purchasing this newer equipment, our surgeons would have the capability to increase their volume at the ASC.

The other piece of equipment necessary was a newer pair of vitreous scissors that would be used on these more difficult patients. The entire CAPR (capital asset purchase request) made logical sense.

The next step, after the rationale for the equipment was behind us, was to do a financial analysis of the equipment. The physicians said they could and would bring us an additional 100 cases per year if we had this newer equipment. The first thing we have to do is what? Of course, we divide 100 by two. Now we have a more realistic number of new cases this equipment will bring in. How do we make it realistic? You are so right, we divide it by two again. So now we probably can assume that we could pick up an additional 25 cases per year by purchasing this equipment.

Next is the reimbursement. What will we get paid for these new cases? We determined that about 30% of the new volume would be Medicare with a reimbursement of about $500 per case. Fifty percent were commercial at $1,120 per case, and 20% were managed care at about $550 per case. Rounding the actual cases down -- always round expenses up and revenue down -- simple math told us that we stood to have a net revenue of $3,500 on the Medicare cases, $13,440 on commercial accounts, and $2,750 on managed care patients. The total additional net revenue would be $19,690.

Now, the equipment in question was $13,000, so, this is really a no-brainer. Any time you can have new equipment pay for itself in less than a year, go for it. Another factor in this scenario is the fact that no new staff would be required.

What is the cost per case?

But, let's deal with the "cost per case" issue now on this equipment. As we determined, the cost on these cases far outweighs the purchase of the equipment. In other words, the cases that would be added cost too much to do at the center. That determination, plus the fact that they can go three hours or more with the patient under anesthesia, really prohibits them from being performed at this center.

Depreciate purchases over 5 years

So, while we agree that by being conservative, we would do OK with these purchases, they are not appropriate for us. If, however, we had decided to move ahead with this equipment, we wouldn't be paying for the purchases over one year. We would have depreciated it over five years. So the total hit to the bottom line for this new equipment would be $217 per month ($13,000/60 months).

Don't make the mistake I did for too long. That mistake was to take the quoted number of cases at face value, in this case 100. I guarantee that we will not do 100 of these cases this year. If we did, we'd be heroes! But if we say we're going to do that many and then fall short by 20 or 30 cases, we look like idiots. Better to understate and look good rather than overstate and look bad.

You can use the same mental process for any capital expense. Look at it realistically, and try to separate the financial from the political issues. There is no question that all of us have bought equipment that we know cannot be justified. That's OK. It happens sometimes. Just as the slogan says: "Do the math!" Don't just do the math on the purchase, but on the long-term effects just as well.

[Editor's note: To suggest ideas on the column or provide feedback, contact Earnhart at 5905 Tree Shadow Place, Suite 1200, Dallas, TX 75252. E-mail: prosurg@onramp.net.] *

Source: Promina Gwinnett Hospital System, Lawrenceville, GA.