All major business organizations dealing with economic conditions of uncertainty, opportunity costs, and scarce or depreciating resources have to develop capital budgets. The three major steps to developing a capital budget are: conducting a decision analysis to establish a base for knowledge building, establishing option pricing to secure an accurately assessed market position, and creating discounted cash flow (DCF) for making appropriate investment decisions for the organization.
No organization can manage capital projects by simply looking at the numbers of discounted cash flows. A financial analyst for any organization must look at the entire decision and assess all relevant variables and outcomes within an analytical hierarchy. Decision-making regarding capital budgeting is increasingly complex today because of uncertainty, particularly in the health care environment where safety assessments of pharmaceuticals, health care insurance allotments, and other factors may affect the future of the organization. All capital projects will involve numerous variables and possible outcomes-but health care perhaps more than most. (Evans, pp.1-2)
In the second phase of capital budgeting, financial management, or consideration of options within capital budgeting is called contingent claims analysis or option pricing. Timing (when to enter certain ventures), abandonment (what past ventures to discontinue) and growth (what ventures to expand upon) are all critical-one must ask such questions as, what aspects of health care in the organization are revenue-producing and/or necessary to the community, what areas are more necessary at certain times of year, and what can be discontinued? (Evans, p.3)
Discounting refers to taking a future amount and finding its value today. Future values differ from present values because of the time value of money. Financial management recognizes the time value of money because of inflation, uncertainty, and opportunity for investment. Thus, the more uncertain the economic environment or industry, the more necessary such revenue analysis becomes-and hence, once again, the necessity of such capital analysis for health care.