Sample Finance Essay on Return on Investment for Health Information Systems

Return on Investment for Health Information Systems

Abstract

 A health facility making an investment in a new program, conducting quality improvement intervention or introducing new technology needs to find out the kind of financial returns it will obtain from the specific investment. Return on investment (ROI) analysis is a model that can be used to calculate the net financial gains or losses while at the same time taking into account the cost of investment, benefits obtained from additional revenues and costs that have reduced. These are then incorporated in the ROI formula as follows (ROI = {(investments gains -cost of investment)/Cost of investment}* 100 to find out the percentage return. The model has successfully been applied in other major companies where it has been used for economic and financial management purposes. In health care the model application is a bit complicated unlike in the other fields of business because there are additional issues considered when calculating returns and costs. This specifically refers to the fact that there should be a separation of costs and benefits to both soft and hard components where the hard component can be quantified easily in financial terms but the soft component cannot be easily quantifiable. However, the soft component has adopted certain metrics that assist in quantifying the soft returns and costs into tangible cash flows. Before making an investment, capital costs are a key component that is calculated and justified before the project implementation commences. ROI is not the final evaluation tool that can be used to evaluate the success of a project but a post implementation audit is also essential to be undertaken after implementation of all projects.

Return on Investment for Health Information Systems

Introduction

            Return on Investment (ROI) model has been in application in the fields of economics and financial management since its creation in twentieth century. It is a type of model that is used to evaluate and measure performance of various companies’ financial performance as well as the projects invested in. In health care, ROI can also be applied in evaluating investment projects and especially the clinical information systems. In this case, overall costs of investing in the project are calculated, the gains of the investment and the costs associated with the investment and then the ROI formula is used to determine the returns on investment in percentage. This is then compared to the projected return to find out whether the project was important. The gains and costs of the projects put into consideration the soft and hard components. The cost of the project is the capital that is justified before a project commences. Finally, implemented projects are further evaluated through post implementation audit. ROI is significant in measuring and evaluating projects in which hospitals have invested in to make sure they meet their objectives and add value to their health care operations.

Review of Historical Roots Returns On Investment (ROI)

The model was for the first time applied in DuPont Gun Powder Company that is located in Wilmington Delaware. Donaldson Brown created ROI in the beginning of twentieth century. He joined DuPont in 1909 as a salesperson that was to sell explosives and not to handle financial issues or deal with any mathematics formula company. The model was applied first when Donaldson was requested by the company’s executive to submit a report of which he applied return on Investment formula back in the year 1912. The company’s treasurer noticed the desire and acumen that Donaldson had in the field of finance and recommended him to develop uniform accounting procedures and other financial standards which were to be applied by, division managers of DuPont Company when evaluating performance. Additionally, the treasure also encouraged him to prepare statistical formulas to measure the entire performance of the company (Otley, & Emmanuel 2013).

The creation and successful results obtained from using Return on Investment Model was a great achievement for DuPont Company since the company used to invest in almost any venture. For instance the company used to make gunpowder, which was the main objective of incorporation and used capital from France, made different chemicals like Lacquers, cellulose and other components. In the year 1912, the company wanted to expand its market and benefit for advantages of the market of scale though diversification. The creation of wider customer base was through venturing in new products in Automobile Industry. This was before Donaldson joined the treasurer and finally becoming the member of executive’s staffs in General Motors Company (Otley & Emmanuel, 2013).

DuPont Gunpowder Company invested more than $ 25 in year 1920 to make General Motors Company grow which it is currently among the world’s largest Automobile companies.  When Donaldson took over the treasurer’s office, he brought about application of statistics and economics formula one of them being ROI which enabled the company make high returns and managed to acquire controlling interests in the weakening General Motors Company. During this time, the Brown was appointed as a vice president of finance in GM Company where he revived and recovered it in terms of financial positioning. In year 1923, Brown developed a model and brought forth technical aspects that allowed DuPont retain its controlling interest in General Motors Investment. In year 1924, Donaldson was appointed as a member of executive team at GM investment and in collaboration with the Company’s president he improved cost accounting skills and techniques that he had developed at DuPont of ROI. This principle of Return on Investment was hence forth widely applied in America and diffused worldwide in its application in field of finance and economics. Since then the ROI model has been applied in economics, financial management fields making investment decisions and determining the viability of a project in terms of riskiness and returns (Otley & Emmanuel 2013).

Overview of ROI

Return on investment is a most commonly used method of evaluating the financial consequences of an individual investment hence determining their feasibility. The metric measures the benefit that an investors gain from investing their resources to a given project or an investment. ROI is determined by using the formula (ROI = {(investments gains -cost of investment)/Cost of investment}* 100. It measures the percentage of returns that an investor gains from investing in a project that generates positive net present values whereby high ROI is an indication of investment gains being favorable compared to the investments cost. ROI is used to determine earnings generated from an invested project in capital decisions.  ROI uses cash flows to determine the difference in magnitude between the timing investments gain compared to costs or cash out lay for a specific project. Return on Investment Model has been applied widely over the past decades to evaluate capital decisions pertaining to acquisition of assets, programs, projects, initiatives, in venture capitals, and in investment decisions in the financial investments for instance, on shares (Baker, Benrud & Powell, 2005)

ROI originated as a result of company investing in other companies or through decentralization to increase their customer base and hence profitability. The investments are meant to increase the cash inflows to the company from both divisions and autonomous branches. As a management tool, ROI has widely been used in many decentralized companies and units. Even if ROI has been criticized as having a number of limitations for instance, inability to apply the model in making correct evaluations, it is the best available system in making investment decisions and evaluating projects feasibility and hence making decisions on whether to accept or reject the project. ROI has to a great extent raised the performances of division managers in most of the decentralized companies by evaluating their performance at a division level before preparing a group report. The Model enables the company when determining how the divisions have used the funds allocated and properties to generate profits. The managers of divisions are also in a position to utilize assets under their control in an optimal and most desirable way hence improving returns on outlays. The ROI is also used in business to evaluate and make decisions on whether to undertake or reject a project through analyzing the rate of returns in a given period of time. ROI is also used in evaluating projects in a given portfolio and hence compare their attractiveness in terms of returns on cash outflows and the one with the best ROI would be undertaken (Baker, Benrud & Powell, 2005)

Hard and Soft analysis

In implementation of IT in the hospital, return on investment analysis is of great important in that it is used in building a business case. Calculation of return on investments for clinical systems takes in to accounts both hard and soft analysis of the benefits. The soft benefits of the clinical invested system could include improved patient’s safety and also the quality that results from minimized misinterpretations of handwritten documents. Hard benefit of investment could include decreased length of days stayed in a hospital and the number of cases resulting from adverse drugs administered to patients. ROI computation in clinical systems is a bit complex, in health IT, return on investment involves comparing investments cost and revenue gains taking in to considerations savings that results from evading errors when administering drugs and improved efficiencies as a results of proper communication channels. Hard benefits are easily measured in terms of revenue generated which is contrary to soft which are difficult to express in terms of numbers. Hard benefits may take longer duration to regain revenue from investments while soft could take short duration to realize returns. For instance in case of hard benefits which could involve investment in extra number of beds in a hospital may necessitate high cash outlay which will require longer duration to recoup revenue gains while soft benefits like enhanced patient safety would be realized within a short period of time (Crawford & Pollack, 2004).

Return on Investments is a model that is most efficient to measure the feasibility of a project taking into considerations all the cost of investment, duration and gains as a result of accepting a given project. Decision makers should evaluate a given number of portfolios to determine one with high ROI which should be undertaken since the company would recoup high revenue within a short duration. ROI is an important management too that should also be used when evaluating divisions performances to determine their profitability depending on the returns on assets and properties invested (Baker, Benrud & Powell, 2005).

Return on Investment of a Project’s Soft Returns

To calculate the return on investment of any particular clinical system must not only involve tangible benefits that are quantifiable but also those that are intangible. These benefits referred to as the soft returns include transformation of business, quality improvement, staff productivity, efficiency of operations, patient satisfaction and cost avoidance. It is challenging to quantify the revenues as well as operating expenses that are related to soft returns obtained from a clinical system investment since there are no cash flows involved. However, there are steps that can be used in justifying soft returns that include identification of an opportunity to improve success; creating a formula to calculate benefits and determine process costs as well as the net benefits.

In identification of the process that requires improvement, an organization should establish the different health care processes that require specific improvements through certain information technology projects to ensure quality services are offered. Some of the processes in health care that have been enhanced through investments in IT include clinical documentation and standardization process, competency testing process, unit dose medication, packing and dispensing process. In development of a formula to calculate the overall benefits, costs in the process and net benefits, there is a challenge of quantifying the soft benefits in financial terms like it is possible with hard benefits. However, there are certain metrics can be applied to measure the impact of the soft benefits and hence their value. Some of these metrics include number of served patients per a service provider’s unit of time; amount of costs in creating a new chart and amount of time spent by staff to locate charts for phone calls or lab results. Others are amount of prescription time spent per physician; rate of reduction in medical errors; level of increase in employee morale; number of new skilled and qualified staff that have joined the organization; magnitude of brand preference; level of professional ethics adopted. Also, the patient quality metrics for instance in diabetics patient  could be the percentage of patients with HA1c’s below seven and for patients in tobacco use it could be the percentage of patients that smoke tobacco receiving education to ensure they cease taking it.

All these metrics can be useful in coming up with the total value of the soft benefits obtained from a system’s investment. After clearly understanding the metrics, it would be possible to convert them into tangible factors. For instance the increase in employee morale which is intangible can be converted to tangible by considering that retention of employee as a result of increase in morale of employees. This saves the organization costs of recruiting and training new employees, the human resources department can then provide tangible figures based on previous year employees turnover like reduce turnover of employees by five percent and make savings of $ 6,000 in costs of new recruitments. To come up with the value of soft benefits the benefits can also be put in categorized groups that quantify them as high, medium and low impact benefits. Then efforts should be made to calculate the total value of each group to a value that is equal to tangible savings previously identified.

The soft cost determination relates to finding out the amount of cash that would be spent on litigations, avoidance of risks, compliance and regulations, quality patient care, improvements of processes. The net benefits include the net value the system has added to the organization in its support to provide quality and efficient services which is determined by taking the overall net increase in profitability arising from soft benefits and deducting the soft costs. The formula for calculating return on project investment would then appear as ROI = (Net soft benefits /Project soft costs) * 100

To support a capital acquisition that enhances the overall quality and effectiveness of services provided by an organization, it would require formulation of a legitimate argument that would logically show the need to acquire such a capital item. It requires calculating the tangible financial benefits and the intangible benefits that can be expected from the capital acquisition versus the costs incurred for acquiring and implementing the asset as well as the costs that would be saved due to the acquisition. It would also require other considerations such as; reviewing alternative capital items, including their cost and benefit data, review of the capital acquisition’s prior performance overall risks associated with it if available, cost should be legitimate and competitive and solvency possible.

It is essential that a project management office is established to help in monitoring the projects that an organization invests in. This is because a project has complexities in varying degrees such as installation of new software and hardware systems, web page upgrading or integration of the project technologies internally in the whole organization as well as with other external organizations. The office will assist in ensuring that the project will be able to meet the organizations strategic goals and make sure there is adequate and appropriate skill set in the organization’s IT staff to enable the success of the project. An example of a soft benefit as an improvement is the attraction of more skilled and qualified staff to an organization which contributes to improving the quality of services provided. The reduction of medical errors is another soft benefit which improves the profitability of the organization since it saves costs if legal suits. Therefore, although it is not easy to quantify the soft returns of an information technology project, it is possible to justify the returns by following a number of steps and using key metrics that assist in finding the value of intangible benefits and the return on investment.

Justification for Capital Expenditure

Capital expenditure for a new project for a health care facility is quite complicated compared to regular businesses. Both human capital and asset capital are important parameters when performing a capital cost analysis. Capital expenditure for the health care project will require an entirely new setup given it is a new expedition. Therefore, the capital structure will cover all costs ranging from acquiring machinery, lease of premises, acquisition of new staff, training of additional personnel, individual installations and purchasing of supplies for the new unit. The total capital outlay is $ 2B. The money should cover all the expenses to start and run the health care facility. The expected rate of return for the project will be $500M per annum.

Firstly, 10% of the total capital will be set aside to act as floating cash for any special requirements after the start up. Any emergency occurrence during and after the project will be cushioned by $0.2 billion. The other amount will be divided between asset capital expenditure and human capital expenditure. The assets will take up 80% of the remainder while the human capital takes up the remaining 20%.

The appropriation of the expenditure takes into consideration the aspects of both soft and hard components. As for health care, both the gentle and hard costs count. Setting aside for the human capital as a capital expenditure directly addresses the issue of soft costs aimed at improving the overall image of the health care facility. Hard costs consist of the payments designed to providing the services required for the operation of the hospital.

The key criterion is to do a project that maximizes the capital deployed. The division of costs in the health centre should be put in a way to ensure no wastage of financial resources. The machinery and other items to be purchased should be considered efficiently and effectively.

Asset Expense

Asset capital expenditure accounts for at least 75% of the total investment. Specifically, this translates to around $1.44B to be used for all capital installations. The allocation of the expenditure will be:

  • Leasing of premise: $0.1B
  • Purchase of new machinery: $1B
  • Purchase of beds and other furniture: $0.2B
  • Purchase of initial health supplies: $0.044B
  • Purchase of other items: $0.1B

To reduce the costs, it is necessary to lease out the premises. Particularly, this will shield from the enormous costs of buying or building. The contract will cover five years to give the business a start-off confidence and to cater for any business slow-down. Substantial space will be leased to include all the activities to be undertaken by the health care. Leasing will also allow the medical facility getting space in the prime areas where it might be impossible to buy or build premises.

Healthcare machinery is usually quite expensive, especially if it is needed to apply the up-to-date machinery. A capital layout of at least $1B will help the medical center acquire the modern machinery they will require to for the project. The machinery to be employed includes X-ray scanners, freezers, ambulances, and sterilizers among many other types of tools useful for a hospital setting. They will be given an average annual depreciation rate over 20 year’s useful life.

Principally, $0.2 million has been set out for purchasing beds and other office furniture items. Beds are quite a significant feature in the health sector, and thus, proper procuring is critical. Furniture to be purchased will include benches for patients, chairs for the wards, chairs and tables for the offices and waiting couches. On the whole, these assets will be allowed an average depreciation of 10% per annum on a reducing basis criterion.

Purchasing of initial hospital supplies does not refer to capital expenditure items, but they are placed here on the concept that we are doing a new project. In preceding balance sheets, the supplies will not be part of the capital as it will be under operational expenditure. The initial supplies include gloves, syringes, medicines, sterilizing substances, spectacle frames and packaging materials among many others. Essentially, these items will not be depreciated for this setup. $0.044B has been set to cater for these supplies.

The other times to be purchased include those assets that will facilitate delivery of the health services. The assets will be long term in nature but not included in any of the above segments. The items include stretchers, computers, curtains, bed sheets, staff uniforms, and other accessories. Software for the new project will also form part of these costs and will be treated the same way. Further, the items will be depreciated at an average rate of 20% per month as they are highly depreciating.

Human Capital

Being a new project, Harris Memorial Hospital will need to put up an entirely new human resource organ and equip it adequately (Gollier, 2009). In particular, this involves a recruitment, training and appraisal of staff. All these costs will eat into the initial capital of the project and form part of the initial cost. Some considerable amount of $0.2B has been set for this function. Such an amount will be phenomenal in ensuring all staffs are trained thoroughly about what they ought to do and the expectations because of that. Proper packaging of the human capital will cover up for all the hard and soft elements on the ROI. Issues top do with customer care, reducing the huge effects of wrong administering of drugs, improved productivity and efficiency of operations will be greatly enhanced through proper staffing and motivation.

Asset Capital covers up for all the hard components of ROI while the Human Capital conclusively covers for the soft elements in health care settings.

NPV Calculation:

Initial investment: $2B

Discount rate: 5%

The hurdle rate will be held at $140M that is 7%

Year/item1st year2nd year3rd year5th year6th year
Net cash inflow$500M$500M$500M$500M$500M
Inflows for previous year$500M$436M$408M$381M
Inflow for current year$500M$436M$408M$381M$356M
Hurdle rate$140M$140M$140M$140M$140M

Returns for the whole investment will be at $500M * 10Year (Average useful life of the project)

The given calculation will give us around $5B that is favorable for the business to start operations.

The NPV will therefore be: $5B – $2B = $3B (total returns – cost of investment)

Dividing the NPV aggregate by the ten terms gives us $300M per year which is way higher that the $140M risk adjusted rate of return.

Factoring Risk in the Investment

The health sector is quite a risky investment. A change in doctors or technology can considerably affect business. In a nutshell, the discount rates increase as the years go by. The reason behind this is confined to the power factor in every computation (1 + Dn=1) which thus will take care of any risk that occurs to the business with time (Gollier, 2009). As the years progress, the NPV plummets thus offering a cushion for the risks.

Post Implementation Audit

Post implementation audit (PIA) on a new information technology system will be generally important in proving its value to the organization. It is specifically significant in evaluating the hard and soft returns obtained from the system, including the reliability of the system and how successful the process of its implementation has been. The audit will assist in finding out whether there were any miscalculations in both hard and soft costs of the projects or the hard and soft returns resulting to a ROI that is either above or below what had been projected based on those calculation. It will assist in determining the savings in terms of costs for a certain financial period such as yearly or monthly proving the worthwhile of the project. It will be possible to come up with recommendations on any improvements required for the new system and also provide lessons on how to go about any other projects in the future.

To carry out the post implementation process audits successfully, there are steps to be followed and certain factors that are necessary. Firstly, the organization should ensure there is no resistance to the audit process by enhancing the involvement of all staff members in conducting and providing feedback on PIAs. All the necessary information is collected even before the PIA commences. This is done by having all documents pertaining to the project such as business projections report outlining expected costs, benefits and ROI; the timeline of the project comprising of key metrics, a list of technical items needed by the system; project milestones as well as security and financial controls incorporated in to the system.

The right people to be engaged in the audit team should be carefully selected and they ought to include IT and business staff members taking part in the implementing the project and organization’s internal audit department representatives. The proper timing of the audit should also be determined, this will involve finding out the time that the system will take before it generates some data or results and the time it will take for staff members to know how the system operates. The audit can hence be scheduled a few months after its implementation has been completed. The PIA should start by having a meeting with all the team members to identify the activities and requirements of the audit process.

The next step would be reviewing all the documentations that were initially collected before the PIA. The auditing team will then note their findings in the audit report concerning the status of records and documents reviewed. In case they are not well kept, they will record that the implementing team ought to keep proper records. The audit team will further carry out scheduled interviews and circulate satisfaction surveys to users of the system. These two will assists the team members to find out how successful the project was in meeting its set objectives and also help in collecting constructive feedback that will be used for continuous improvements. The controls in the systems such as the security and financial controls are also tested to find out their effectiveness in terms of serving their purpose such as; is there any authorization requested by the system before logging in; does everyone have the right to access everything within the system or are there specific rights to different staff members; also does the financial controls ensure all the right accounting procedures are followed to prevent fraud; is it possible to have an audit trail for all transactions in the system .

The other step is finding out whether the systems data is reliable to be used in carrying out further evaluations, this is done by; comparing the information in the system with any hard data available to find out whether they match; sampling of a number of transactions is done to ensure their processing is well done. The business staff members then conduct a financial review of the system to find out the payoff. This is done by subtracting the both hard and soft costs from the hard and soft benefits. The resulting payoffs are then compared with what is in the business case target to know whether the system has achieved its target.

A meeting is then convened by the audit team members to discuss the activities of the implementation as well as PIA process to identify what may have gone wrong in both and establish specific areas that need improvements. A report is then prepared and made accessible to all members of staff for instance through the organizations internal website. A copy of the report is also submitted to the senior management with a summary of the key findings so as to play their role in implementing any recommendations suggested. Valuable lessons learnt from the PIA of the project are also highlighted so that they can be applied in any future projects. 

The post implementation audit helps in continuous improvements of projects, evaluating the expected both hard as well as soft costs and their benefits to determine the success of the project and its implementation in achieving the projected ROI. The audit process should therefore be conducted as soon as the project is implemented with the assistance an audit team comprised of key staff and adequate documentation. The PIA process results to valuable lesson for both the current project being implemented as well as the future projects in the organization.

Conclusion

Hospitals ought to consider using ROI model to measure and evaluate returns on the projects they want to invest in. When applying this model the important things that have to be considered have been identified as soft and hard benefits derived in the investments undertaken. The hard benefits can be quantified in cash while the soft benefits cannot be easily quantified. Justifying capital expenditure for the projects is also significant and it incorporates a number of factors such as the human and asset capital and the percentage allocated to each; the soft and hard components and risk component due to uncertainties that may be surrounding the project. After its implementation it is important that a post implementation audit is conducted. There are steps that are followed to ensure the success of the exercise such that it adds value to the entire process of project implementation. This will be useful in measuring the actual results against the projected results ensuring that an evaluation has been done on whether the project has attained its objectives. The audit will also result to valuable lessons to be used in future projects.

References

Baker, H. K, Benrud, E. & Powell, N. (2005). Understanding Financial Management. Hoboken, New Jersey: Blackwell Publishing.

Crawford, L. & Pollack, J. (2004). Hard and soft projects: a framework for analysis. International Journal of Project Management, 22(8), 645-653.

Gollier, C. (2009). Expected net present value, expected net future value, and the Ramsey Rule. Munchen: Univ., Centre for Economic Studies.

Otley, D. & Emmanuel, K. M. C. (2013). Readings in accounting for management control. Berlin, Heidelberg: Springer.