Critical finance formulas for facility managers

Simple formulas can help facilities professionals make decisions and communicate with executives

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Proper and efficient operation of a health care facility is a complex process that requires periodic capital investment to maintain the infrastructure. This is such an important element of health care facilities and the patients they serve that it deserves a persuasive advocate who can obtain the necessary funding.

Facilities professionals can use a variety of financial formulas to help make decisions and communicate with chief financial officers (CFOs) or other hospital executives. 

Commonly used calculations

Facilities professionals should meet with the CFO and others involved in capital decisions to determine what type of financial calculations they prefer, and be aware that this may vary depending on the size and complexity of the project. For instance, if simple payback is used, facilities professionals should determine if a standard has been established for funding approval (e.g., payback in five years or less). Some commonly used calculations include:

Facility condition index. The facility condition index (FCI) is a way of showing the financial condition of a building. Facilities professionals can track the FCI of a building over time to monitor the condition of a single building, and can also use FCI to compare multiple buildings.

To calculate FCI, facilities professionals should first determine the cost to fix all deficiencies and include maintenance, repair and replacement costs. Then, they should calculate the current replacement value — the amount it would cost to replace the building with new construction. 

FCI is calculated using the following equation: Sum of deficiencies ($) / Current replacement value ($)

For instance, a building that has $3 million worth of deficiencies and would cost $25 million to replace has an FCI of 0.12. Likewise, a building that has $1 million worth of deficiencies and would cost $20 million to replace has an FCI of 0.05. One common reference used for FCI scores is good (0-.05), fair (.05-.10), poor (.10 -.30) and critical (> .30).

Facilities professionals can use FCI as a tool to support arguments for increased funding for maintenance or facility upgrades or, when the sum of deficiencies is significant compared with the replacement value, capital funding for a new building. FCI gives facilities professionals, CFOs and others context that can help to make decisions.

Life-cycle costing. Calculating the life-cycle cost can help facilities professionals to evaluate options for equipment or projects. The initial price of a piece of equipment or building is important, but the life-cycle cost gives a bigger picture of the costs that will be incurred over time by considering additional information. 

For example, one chiller may cost significantly less than another to purchase and install, but if the lower-cost option is less efficient, it may require greater energy costs over its useful life. The life-cycle costing calculation gives facilities professionals a more robust accounting of the costs of each option to help make better decisions.

To calculate life-cycle costs, the following formula is used: Capital cost + Maintenance cost_pw + Energy cost_pw + Replacement cost_pw – Salvage value_pw

The capital cost is the initial capital expense for the equipment or project, and is always considered as a single payment. 

The maintenance cost is the sum of all scheduled operation and maintenance costs over the useful life of the project. So, a chiller that requires $1,000 in maintenance each year and is expected to last 15 years would have a maintenance cost of $15,000.

The energy cost is the price of energy the equipment is expected to use over its lifetime, and the replacement cost is the sum of all the component replacements expected to be needed over the equipment’s lifetime. The salvage value is the net worth of the equipment or building in the final year of its life-cycle period. Finally, the subscript “pw” indicates that the numbers are calculated using present worth, or today’s dollars.

The CFO must understand the long-term cost of the project because, in many cases, more efficient equipment or equipment that requires lower maintenance cost over the life of the project will provide significant savings for the organization. That doesn’t mean that the facilities professional and CFO will always agree on the preferred option, however. If the life-cycle costs of two options are similar, a CFO may prefer to go with a lower original cost, while a facilities professional may prefer lower ongoing maintenance costs.

Simple payback method. When considering a new piece of equipment or project that will result in cost savings, it is helpful to understand the length of time it will take to recoup the money expended in an investment. 

The simple payback period formula calculates that: Investment / Periodic cash inflow

In this formula, the investment is the total cost to purchase and maintain the equipment. The periodic cash inflow represents the amount of savings per year that the equipment or project will produce. For example, if a project costs $90,000, but will save $35,000 per year, the simple payback period is about 2.5 years. This formula can provide a quick way to compare and prioritize projects. For example, a facilities professional may be considering two energy projects: a steam trap replacement project or one focused on more efficient light fixtures. By calculating the payback period of both projects, a comparison can be made. 

Several American Society for Healthcare Engineering members have reported success when starting energy-efficiency efforts by focusing initially on energy projects with shorter payback periods, and then using the savings generated to fund projects with longer payback periods.

Simple return on investment. Return on investment (ROI) is another tool used to consider the financial benefits of an investment. Facilities professionals should consider the example of an energy-conservation program that will cost $100,000 per year for five years, but will save $150,000 each year in energy expense (earnings from the investment). 

The ROI can be calculated as: Earnings - Initial investment / Initial investment

In this case, calculating the ROI is as follows (note that the cost and savings were both multiplied by five since the project spans five years):

ROI = $750,000 - $500,000 / $500,000

The formula shows earnings of 0.5, or 50 percent ROI. Simple ROI works well when a facilities professional has two options to consider and where the gains and costs of an investment are easily determined. All other things being equal, the project with the greater ROI is preferable.

Net present value. If someone offered to give $1,000 today or $1,000 in five years, it would be better to accept the money now because it could be invested and become more than $1,000 in five years. This illustrates the concept of the time value of money — money in hand today is worth more than money realized later.

Calculating net present value allows facilities professionals to take into account the time value of money, which may aid in decision-making. For example, a project costing $7,500 that is expected to return $2,000 a year for five years ($10,000 return total) has a simple payback period of 3.75 years. Using net present value, facilities professionals can determine what an investment of $7,500 would yield if invested. If a hospital can invest at a rate of 10 percent, the $7,500 would become $12,078 after five years — a better financial return than the project. Although investing in the project will save the hospital resources, a CFO also may want to compare the project against money earned by investing.

Savings vs. equivalent revenue. Facilities professionals should be aware of the operating margin of their organizations. The operating margin is a percentage calculated by dividing the income from operations by the total revenue. For example, if an organization had an operating margin of 4 percent, this would indicate that for every $100 received in revenue, $4 would be left after all operating expenses had been paid. Stated another way, a savings of $4 in operating expense would be equal to $100 in revenue. In this example, equivalent revenue is savings multiplied by 25 (100/4). 

Better decision-making

Understanding financial terms and presenting cost information in a format that is familiar to those making financial decisions will improve communication and result in better decision-making. 

[This article originally appeared in the Winter 2016 edition of Inside ASHE, ©American Society for Healthcare Engineering 2016 and is reprinted with permission.]

Tom Stewart, SASHE, CHFM, CHC, is senior consultant at MSL Healthcare Partners Inc.; and Deanna Martin is membership and communications director for the American Society for Healthcare Engineering. They can be reached at tstewart@mslhealthcare.com and dmartin@aha.org.