Business Advisor: Financial Planning for ASCs: A Rubik’s Cube

Get total alignment, resolve ambiguities before moving forward with a new build.

Rubik’s Cube is a three-dimensional color-matching puzzle based on algorithmic sequencing of nearly infinite potential solution sets: 43,252,003,274,489,856,000 of them to be specific, according to its manufacturer.

In this article, we’ll use this well-known parlor game as a metaphor for the endless number of economic factor interactions that affect the financial planning and performance of startup ambulatory surgical centers (ASCs) and, ultimately, their owners’ returns on investments. As with solving Rubik’s Cube, only one of the infinite potential solutions will be perfectly suited for your specific ASC project.

While our focus is on the financial planning for an ASC startup, the practical lessons we’ll share apply to financial planning at all stages of ASC operations, including strategic growth strategies.

Economics at work

The term “economics” is applied in its operational form — i.e., how various combinations of input costs, pricing and operating revenue generation opportunities interact as a function of managerial decision making to produce financial performance results over time.

It’s critical to understand that a financial plan is not solely an accounting function. Rather, at its core, it translates mission, vision, strategy and intuition into abstract thinking at a level sufficient to create a cogent and cohesive financial and business plan that is adequate to attract and commit participating professionals and bankers to invest and support.

Nine lessons learned

Much like the nine colorful squares on each of the six sides of Rubik’s Cube, we offer nine key lessons learned to frame our mini master class for ASC startup financial planning. While this list of the operational economics factors that interact with the planning process and application is incomplete, it is sufficient for those who are preparing to plunge into an ASC startup.

1. The economics of a mission vision. The importance of well-constructed mission and vision statements is often trivialized when assembling key components of economic and financial strategy for an ASC business development plan. On the contrary, these statements are essential cornerstones of success.

Clarity of mission establishes the purpose and reason for a business to exist. Vision sets the direction, path and roadmap to guide the plan’s development and execution.

A practical example from one case study is the vision statement “a multispecialty ASC providing participating medical groups the opportunities for physician control, clinical innovation and financial margin expansion,” with the mission as “surgical excellence-compassionate care.”

2. The economics of balanced and managed specialty case mix, related volumes and payor mix. The Rubik’s Cube metaphor is particularly apt here. The multivariate economics equation is how specialty case type, volumes, payor mix and reimbursement rate expectations translate to cash receipts.

Cash in-the-door is the lifeblood of freestanding ASCs, especially in the first two years of operation. Accounts receivable on the books do not serve to make payrolls or pay vendors and bankers.

3. The economics of clinical asset acquisition requirements and fixed asset turnover rate management. The initial investment requirement for fixed and movable assets is substantial before a bill for a single case goes out the door. For multispecialty ASCs, fixed clinical asset investments can range from $180 to $250 per square foot. These assets are typically leased or financed through vendor lease agreements or bank debt arrangements. Such arrangements generally are shorter-term in duration, creating negative pressure on the operating statement and balance sheet.

4. The economics of inventory stocking and management. Initial inventory stocking can easily run as high as $500,000 or more depending upon the specialty mix, including implantable hardware. The cash implications of the initial inventory stocking and projections on the monthly supplies and drugs run rate spend are often underestimated.

5. The economics of facilities design and engineering. The idea is to wrap smart facilities around smart strategy. The first lesson is not to start with facility design and engineering. Rather, these should derive from your strategic and financial plan, including how you can or can’t reserve space for future growth.

Floor planning and patient movement through the surgical process require careful upfront consideration. Planning for case type matters. For example, GI procedures and eye surgery cases run at comparatively higher daily volume rates with compressed room turnover time requirements, and recovery times are shorter than those of other case types. Consequently, these cases may call for placing procedure rooms closer to the front of the clinical services floor plan.

Keep in mind that tenant improvement costs — the cost of the build-out within the ASC facility shell — can run as high as $280 per square foot depending upon specialty requirements such as floor vibration control, lead shielding, special ceiling weight handling requirements, use of conventional or stainless steel wall construction, and low-voltage wiring requirement for specialized inter-staff communication and information technology systems.

6. The economics of the cash burn rate. The most significant financial risk to ASC startups is the initial cash-burn phase of business development. Operating expense incurrence begins during this phase, while the point at which earned operating revenues are collected is somewhere out in the future. Financial plans almost always underestimate the aggregate cash-burn rate and total before cash-in equals cash-out.

7. The economics of strategic growth. Excess volume capacity is a valuable asset of ASCs, especially when facility expansion potential is limited or nonexistent. Strategic, incremental volume growth requires careful consideration of case economics expectations, weighted case volumes by type, weighted third-party reimbursement rates, supplies expense, anesthesia expense and pre- and postoperative staff expense. The goal is margin expansion on incremental strategic case-rate growth.

8. The economics of equity and debt management. The financing of ASC startups requires an affordable balance of equity and debt. The equity portion comes from prospective owners. The sources of debt may be private lenders or banks. Every dollar of debt pressures balance sheets and operating financial statements, and every dollar of equity pressures the balance sheets of the investors. There is no magic ratio of one to the other.

9. Total project capitalization case summary. What is the potential total capitalization requirement of a startup ASC, with “total capitalization” defined as all investments required to reach the point of a cash-flow breakeven? As one might expect, it depends.

Let’s look at a case study: a 23,000-square-foot physician-owned multispecialty (10 clinical specialties) ASC with four ORs and two procedure rooms, absent the cost of the shell (leased as a tenant in a large, freestanding, multispecialty clinical facility). The full capitalization of this ASC was:

• Total tenant improvements: $6.4 million
• Total fixed and movable clinical equipment: $5.75 million
• Total initial acquisition of instruments, drugs and supplies: $500,000
• Projected annualized operating revenues at 90% case volume capacity are $20.5 million, at a 19% net distributable margin, depending upon how asset capitalization is managed, i.e., the ratio of equity to debt financings.

Full alignment

Getting ASC governance, management and ownership on the same page with the startup ASC financial plan and the operating economic factors that matter, including the potential for capital calls and all that goes with them, is crucial to success.

When groups of clinicians get together to admire their potential to be ASC owners, visions of control, unfettered clinical innovation and healthy dividend checks dance in their heads. While all of that may be available, the startup ASC is the classic business risk venture. It requires understanding and consensus on specific basic tenets of the risk to be assumed. Here are the six tenets — like the six sides of Rubik’s Cube — that need the most consideration.

1. Case volume. When all is said and done, this matters most. Reaching key volume milestones according to scheduled projections is most important, so when partners project their case volumes and delivery timing, they need to deliver.

2. Medicare certification, required licensing and accreditation. Nothing happens without these. The process can be time-consuming, arduous and costly, but without full credentialing, the enterprise sits dead in the water and burns cash at high levels.

3. Contracts with third-party payors. This is the gateway to incoming cash. Typically, five or six payors, including the governmentals, account for the lion’s share of revenue flow. Third-party contracting strategy normally revolves around a multiple of Medicare reimbursement expectations.

These negotiations are a dance. Typically, the target ratio for commercial payors, as a function of Medicare, is 2.5x to 3.5x, and higher whenever possible. Leverage is essential. It comes from the brand value of the collective provider groups and the supply of providers in the marketplace.

The startup ASC is the classic business risk venture. It requires understanding and consensus on specific basic tenets of the risk to be assumed.

4. Cost focus among surgeons. Surgeons with little or no experience with ASC ownership typically don’t realize they must pay attention to costs per case, staffing and supplies. Many are the surgeons who finally admit out loud that, “In the hospital, I didn’t care about cost.”

Variation in surgeon practice style matters. Excessive variation can occur among surgeons of the same specialty in the areas of supply consumption, case staffing, procedure time and room turnover time. Peer review in these three areas is critical to the financial performance of the ASC, especially in the first two years of operation.

5. Physician-owner leadership. This matters in the financial plan and thereafter. Physician leaders need to grow comfortable leading by example and with real data, especially as presented in the form of variation analyses and predictive analytics. They should use phrases such as, “The following factors are the most predictive of clinical and market performance outcomes.” Such skill sets can be taught.

6. Total asset and operating capitalization requirements. All founding owners need to understand these, including the upfront cash outlay and bank debt implications. Total capitalization, including working capital demands, is a guess. Additional capital calls to each desired financial performance goal should not be viewed as a failed financial plan. More so, they are evidence of a failed provider support plan.

ASCs can satisfy a range of worthwhile dreams and ambitions for would-be physician owners, provided all stakeholders begin with this sobering dose of reality: ASC ownership is hard work! The financial plan is simply a roadmap. Success is in the execution. OSM