We all know that managing capital is a challenging and time-consuming process.
A strong capital management program entails myriad checks, balances, processes, and practices. It usually involves frequent measurements and validations of liquidity ratios, spend restrictions, and other compliance requirements included in the debt covenants, board restrictions, and generally accepted internal control procedures. Ensuring that all of these requirements are being consistently met is no simple task for executive management and the board.
Fortunately, many facilities already have a resource in place that can strongly assist in meeting these responsibilities: the internal audit group. In most organizations, it is likely that the internal audit team already reviews capital management controls, such as ensuring that capital expenditures are properly approved and recorded in the financial records and that daily cash management policies are followed. But this group can also play an important role in many additional procedures. Some of these procedures may already be the responsibility of others in the organization, but involving internal audit can help to ensure they are carried out as planned.
For example, internal auditors can help in:
- Verifying bond covenant compliance
- Testing capital expenditure approvals
- Reviewing compliance with capital budgeting policies
- Ensuring adherence to asset disposal policies
- Performing hindsight validation of budget/ project assumptions and projected ROIs
- Testing adherence to organizational investment policies
- Reviewing and assessing repair and maintenance programs
Verifying bond covenant compliance. Ensuring compliance with every bond covenant is a key responsibility of the finance department and includes verifying covenant provisions regarding liquidity ratios, cash balances, and many other terms included in debt agreements to protect the interests of the debt holders. However, having internal auditors test these activities and verify they are being performed accurately and as required adds additional assurance that the covenants are being met.
Testing capital expenditure approvals. Many debt issues have conditions and/or limitations on capital project spend during the life of the debt issue. Most organizations have adequate capital budgeting processes that define maximum spends, department allocations, and approval for specific purchases, but follow-up controls to ensure adherence to budget approvals are not always as strong. When capital dollars are scarce, it is important that departments follow their budgets and avoid making unapproved substitutions. Too often, departments are allocated funds to replace aging, obsolete, and/or unreliable equipment that is critical to the operations of the department, but decide to use the funds for other purchases. This practice increases the risk that the older equipment will fail and require ongoing expensive repairs, resulting in unplanned expenditures of additional capital. Internal audit reviews can be an effective control to help ensure that such allocated funding is used in the way it was intended.
Reviewing compliance with capital budgeting policies. Most department managers follow budget and purchase policies honestly and to the best of their abilities. However, there are always some who try to "game" the system by buying equipment in stages or in individual units to circumvent capitalization policies and the inherent controls of the capital budgeting process. Knowing that internal auditors routinely review all purchases and reports on findings is a natural deterrent to this type of behavior.
Ensuring asset disposal policies are followed. Management typically gives nominal attention to disposal of assets. This task is usually delegated to material management or plant operations, with little follow-up or monitoring. However, internal audit can play an important role in ensuring key questions related to such disposals are given due consideration. For example:
- Can the equipment be used in other areas of the organization?
- Can it be donated to a deserving charity?
- If residual value remains, will it be used as trade-in capital or sold at a proper price?
- Are hazardous waste regulations always followed, as appropriate?
- Is protected health information always completely removed, if applicable?
Performing hindsight validation of budget\project assumptions and projected ROIs. Most capital acquisitions and projects require vetting through a justification process that analyzes areas such as mission relevance, department needs, patient care requirements, quality impacts, priority reviews, and ROI analysis. These requirements escalate with increasing project cost. Organizations typically perform significant work on the front end forecasting costs and revenue streams, contribution margins, and cash flow demands. However, many do not perform hindsight reviews to determine whether the goals and financial objectives of an equipment purchase or project as outlined in the approved budget were actually met. Having these reviews performed as part of the internal audit plan can strengthen the capital management process by providing a feedback loop on forecasted versus actual results on specific and significant capital expenditures.
Testing adherence to organizational investment policies. Many institutions learned painful lessons concerning their investment policies and activities in recent years and have revised them to a more conservative nature. An internal audit can help ensure these policies are followed consistently.
Reviewing and assessing the repair and maintenance programs. A strong repair and maintenance program is much more than just "fixing things when they break." A good program includes planned routine maintenance, ensured compliance with regulatory requirements and manufacturers recommendations, review of upgrades that could add value to the equipment, cost-benefit analysis of in-house or outsourced maintenance, and due consideration of whether to buy maintenance service contracts or assume risks internally. Although plant operations and department directors are primarily responsible for such activities, internal auditors can provide an excellent second review to ensure actions are being taken and provide perspective as to whether decisions make good financial sense.
Healthcare organizations all too often view their internal audit group as a requirement imposed by external auditors or the board with a highly limited role in testing detail processes in the internal control systems. Yet many internal audit departments are staffed with seasoned finance professionals who may have been with the organization for many years and who may possess a deep knowledge of operations, the political environment, and other matters. They may be able to contribute at much higher levels than currently allowed. Moreover, for chart audits, these groups also often have clinical staff, such as RNs, who could add much higher value if used strategically.
As one who spent many years in a large progressive audit group, I can assure you that an internal audit team can add significant value in helping organizations properly manage their capital
Steve Womack, FHFMA, CPA, is a principal, Spectrum Health Partners LLC and a member of HFMA's Tennessee Chapter (firstname.lastname@example.org).
Publication Date: Tuesday, March 01, 2011