Executive Summary
Sample General Hospital has been experiencing financial difficulties and in response recently hired a new chief financial officer who is determined to increase the profitability of the hospital. In order to do this he has proposed that the hospital add a retail pharmacy onto the main hospital, allowing patients to purchase their prescriptions directly from the hospital.
In order to create a comprehensive proposal the CFO created an analysis of expenses and a forecast to predict the profitability of such an endeavor. He predicts that vendor’s would finance the working capital needed to purchase the initial prescription drugs to stock the pharmacy. Vendor’s fees would negate the first sixty days of capital expenditures and the only working capital the new endeavor would need is $49,798. When asked what the working capital entailed the CFO explained “it represents three months of departmental expense” (Baker 425). These expenses would include the day to day administrative costs associated with the running of the Pharmacy for the first sixty days.
The building to be used for the pharmacy is already standing which greatly lessens the startup time and costs associated with the new pharmacy. The analysts calculated the costs of renovation and equipment to be $80,000 and $50,000 respectively. The renovation expense will be depreciated out over the next fifteen years using the straight line depreciation method and the equipment expense would be depreciated using the same method but assuming a useful life of only 5 years.
The proposal predicts an operating profit margin of 9.2% in year one and this number steadily increases, reaching 12.2% by year three. This is a promising prediction considering many endeavors take several years to show positive net income. The required capital needed to renovate the pharmacy and begin its operations can be obtained from hospital resources without the use of debt to finance the endeavor, according to the written proposal.
The controller calculated that the average prescription cost at $47 and the cost to the hospital for each prescription is $37 making the profit per prescription $10. The controller assumes that 4,100 prescriptions will be filled by the pharmacy each month allowing for a gross profit margin of 21% consistently every month throughout the first year.
Net Cash flows are predicted to turn positive after the first nine months of operations. After the initial expenditures in month one the controller predicts that the pharmacy will have positive cash flows every month during the next year. In month ten the net cash flows turn positive and we can assume that this is the intended payback period for the initial renovation and equipment expenses.
Overall the proposal looks promising for the hospital. Patients are likely to purchase their prescriptions where they receive their care due to convenience and the predictions based upon the number of prescriptions the hospital writes per month show a gross profit margin consistently positive across the first twelve months of the pharmacy being operational.
The board of the hospital supports this proposal because it shows evidentiary support of the CFO’s claim that the pharmacy will have positive profit margins beginning in the first year. Revenue in the first year is estimated to total $238,053 which is impressive when compared to the first year deficit that often occurs in cases like this. The proposal shows that the capital expenditures needed for the initial startup will be paid off by the revenues of the pharmacy by the tenth month and after that time the pharmacy will remain profitable and it’s profit margin will increase consistently for the next two years.
These revenue predictions were created using historical data of the monthly number of prescriptions the hospital prescribes to determine an average. This number was multiplied by the average profit from each sale of a prescription ($10) in order to show a gross profit margin of 21% and revenues in the first month of $39,975. The amount of prescriptions that are purchased through the new pharmacy are assumed to remain stable for the first three months and then grow before remaining stable for two more months; beyond that point they assume continuous growth.
This proposal was also approved because the working capital needed to run the pharmacy will be provided, for the most part, by the vendors paying to have their drugs in the hospitals pharmacy. For a vendor having their drugs offered at a hospital rather than a retail pharmacy located further from the patients care is a lucrative opportunity. The amount of pharmacies in the United States will consistently increase with the need of the people, and as our population grows so does the number of individuals needing prescription medications. Over time new medications are created to treat new ailments and as a result this number will also increase.
The need for pharmacies is unlikely to decrease in the near future and this makes the investment by the hospital much less risky than it could be otherwise. However, there is a large amount of regulations that come with starting a pharmacy and the expense of employing qualified pharmacists and pharmacy technicians can be significant. A pharmacy must be licensed and all prescriptions must be secured at all times. Malpractice suits arising from patients receiving the wrong prescriptions or criminal cases filed due to missing prescriptions can cause the Hospital heavy losses. Hospitals are the object of a large quantity of malpractice suits each year and having a pharmacy under the name of the hospital opens them up to a great deal of risk in this regard.
In 2012 a man died from a Vicodin overdose that was blamed upon negligence on the part of Walgreens. According to an article on Guardianlv.com “the pharmacy continued to fill prescriptions through July 2012, when Oles died of an opiate overdose” (Balen) after his doctor personally called the pharmacy to tell them that the man was abusing the drugs and the prescription should no longer be filled. This resulted in his eventual overdose. The pharmacy settled the suit in 2014 for $80 million dollars. When starting a pharmacy the amount of regulations and the possibility of expensive suits must be taken into account.
According to statista.com, “In 2010, pharmacy and drug store sales amounted to approximately 222.81 billion U.S. dollars” (Statista.com). The pharmacy has the potential to help this hospital become more profitable and the predictions used in the proposal are promising. However it is important to consider the extensive licensing and regulations that must be adhered to when opening a pharmacy and that the revenue data provided is only a forecast. They will need to be subjected to various sensitivity analyses to determine the consequences of changes in certain systematic and industry specific factors.
Works cited
Baker, J. J. & Baker, R. W. (2014). Health care finance: Basic tools for nonfinancial managers, 4th edition. Mini Case Study 1: Proposal to add Retail to Pharmacy to a Hospital in the Metropolis Health System Page 425
"Acute Care Hospital Inpatient Prospective Payment System." N.p., n.d. Web. 15 Dec. 2014.
Balen, Beth. "Walgreens Sued for Negligence in Vicodin Overdose Death." Guardian Liberty Voice. N.p., n.d. Web. 14 Dec. 2014.
"Topic: Drug Store/Pharmacy Market in the U.S." Www.statista.com. N.p., n.d. Web. 14 Dec. 2014.
