17 October 2013
Forecasting for the future of Aged Care
Australia’s ageing population is well documented, with sustained levels of low fertility and increased life expectancy reducing labour force participation and increasing demand for health and aged care services (ABS).
Consequently, Australia’s health system is facing a formidable set of future challenges, from growing demand for higher standards of care and increasing rates of chronic disease to high costs associated with rapid innovations in technology.
Increasingly, health and aged care providers are playing a broader, more critical role in coping with these factors, particularly through the renewal and expansion of existing facilities and services. In fact, amongst the most important drivers for the viability and long term sustainability of the health and aged care sector are expansion, the building of new facilities and the upgrading of older facilities, and the improvement in the financial performance of individual providers (as reflected in operating results and balance sheet strength).
Improvement starts with forecasting
Predicting demographic trends is based on the process of forecasting – compiling past and present data and applying specific variables using statistical tools to measure expected results. By anticipating future growth, governments and communities can prepare for the future. Just as this methodology can be applied to determine population growth and other demographic measures, businesses can also take this approach to inform and plan the future of their operations. By considering possible future outcomes, health and aged care providers can make smarter decisions about the present.
Financial forecasting, or more specifically three-way financial forecasting, is a process that aids management decision-making by anticipating balance sheets, income statements and cash flow statements. One-year forecasts are likely to be more accurate than five-year forecasts because more actual information is likely to be known. However, long-term forecasts are essential for planning future funding, capital and operational needs. These long-term forecasts are a vital management tool, providing they are revised and refined as actual information becomes known to improve the quality of the information generated.
Forecasting funding needs
Many health and aged care providers are heavily reliant on government funding for their operations. However, as the population grows and the base of tax payers declines, this funding is likely to constrain further and become more strongly aligned with the care and financial needs of consumers. Providers need to understand what future funding changes mean for their business models.
It is imperative that providers align income categories with related expenses to determine which areas are operating profitably and which require review. For example, it’s important to consider whether government subsidies received for residents are currently covering the costs of providing care to these residents (i.e. care staff employment costs and medical supplies), in addition to the ongoing running of the facility. If increases in employment costs and utilities are outstripping funding, there is a clear need for a provider to consider what changes need to be made in the face of funding constraints, and how far into the future their break position might be.
Given the opportunity to proactively map out their business for the next five years, based on well informed assumptions, providers should be able to demonstrate which areas of their business (accommodation, care or services) have declining profitability and require efficiency improvements, diversification, consolidation or additional funding. Conversely, providers that can demonstrate higher margins and more attractive returns on investment are more likely to attract additional sources of income or capital, potentially
easing the reliance on government funding and providing more independence with the use of funds.
The benefits of forecasting
Budgeting and forecasting models are essential for growth in any organisation, particularly in terms of attracting investors, as they establish and evaluate expectations of operations, capital requirements and planned projects. The benefits of developing and using a forecast model are numerous and include:
- Aligning financial projections with strategic plans;
- Providing insight based on current operations;
- Identifying potential business units/services with information and reporting gaps;
- Identifying the ability to fund long term capital regeneration requirements (i.e. upgrades to buildings to remain in operation);
- Identifying return on investment;
- Identifying full impact on balance sheet and cash flows;
- Incorporating additional budgeting processes to identify full organisational impacts;
- The ability to scenario the effects of new projects or services, changes in operating conditions or industry reforms;
- Demonstrating/evaluating the financial viability of planned construction or expansion;
- Providing a benchmark against which to measure future
- Identifying potential risks and cash shortfalls before they occur.
‘How-to’ guide for three-way forecasting
The concept of developing a three-way forecast model can be daunting, however, much like a map helps those planning a long road trip, a financial model assists management achieve goals and strategic objectives.
A practical approach to creating a three-way forecast would be:
- Review current yearly income and expenses budgets (or most recent profit and loss statement) and identify and understand key business drivers that most impact on profit and loss. In aged care for example, this includes resident levels (ACFI) and occupancy which drive income. It also includes staffing and other direct expenses. Average resident length of stay impacts accommodation (RAD / DAP) payment inflows and outflows and therefore should be part of this analysis as well;
- Determine what timeframes need to be built into the forecast. For example, to best map growth a dynamic, changing organisation may need to develop a forecast model showing quarterly positions over 3-5 years. Using the existing financial position as the basis of the forecast (the ‘business-as-usual’ approach), providers should start to model these business drivers over the period of the forecast;
- Identify other income streams and operating costs and estimated yearly inflation rates for these (for example, an enterprise bargaining agreement with care staff with an agreed increase in wages for the next three years at 3% p.a.);
- Determine the capital expenditure requirements for the organisation and how these will be funded (from operational cash flows or through financing); and
- Consider the cash flow impacts of other balance sheet items (for example, debt repayments, payment of income tax and dividends).
Once the business-as-usual forecast is created and business drivers pinpointed, providers can see which business units/services are consuming more or less of their capital. From this, management can make informed decisions to improve efficiencies and better allocate precious resources. Variables can also be built into the model that cater for a range of scenarios to consider the business under its best, base and worst operating, funding and growth conditions.
The only real limitation of a financial model is the information used to construct it. Inputting quality information is more likely to lead to quality outputs. Conversely, inputting inferior or inaccurate information will present unreliable information.
The way for the future
Population growth, an ageing population and expectations of improved standards of care indicate the cost of providing health care is expected to keep rising well into the future. Will Government funding support these additional costs of providing services? Do other sources of capital need consideration or attraction?
While the future can’t be predicted, steps can be made to better prepare for what it may bring. A three-way financial forecast will provide the necessary tools to make well-informed decisions about current and future direction for a health or aged care service.
Formulating strategies to deal with external factors and to support continued growth is made easier with a clearer picture of what the future may look like in one, three or even five years. As much as service delivery is part of everyday business, financial forecasting should support the pursuit of sustainability, so the aged care sector is best prepared and equipped to handle future demands.