Thoughts from Ken Kaufman

Revisiting the Importance of Financial Planning

3 minute
Medical collage

Between 1987 and the early 1990s, Kaufman Hall created a formal corporate financial planning process designed specifically for not-for-profit hospitals. We recognized at the time that many not-for-profit hospitals were getting larger and more complex and that what passed for financial planning at the time was no more than reimbursement planning or budgeting—neither of which had the theoretical capability of solving complicated financial planning questions.

We didn’t create this financial planning process out of thin air. Many of us at Kaufman Hall were graduates of the University of Chicago Graduate School of Business (“GSB”), now known as Booth. The essential principles of corporate finance had been developed and articulated at the GSB, most notably by James H. Lorie. Lorie, through corporate finance, had introduced a new series of methods of running large-scale corporations and organized that methodology around the investment principle, the financing principle, and the dividend principle. At Kaufman Hall, we took Lorie’s theory and principles and adapted those principles to the unique planning needs of the not-for-profit hospital sector. In that regard, we started to prepare financial plans for clients in the late 1980s, and in 2024, we continue to build financial plans for the hospital industry and the methodology and theory behind our proprietary planning process has not changed in any consequential way.

I was reminded of all of this when I read that Richard Gonzalez was retiring from AbbVie as President and Chief Executive Officer. Gonzalez was the founding CEO of AbbVie and the company has been spectacularly successful under his leadership. But what was more interesting than Gonzalez’s retirement was the appointment of his successor. The new CEO will be Robert Michael, who is currently the Chief Operating Officer at AbbVie. Notably, Michael began his career at AbbVie as Vice President of Financial Planning and Analysis. According to Crain’s, he established and led AbbVie’s first financial planning organization. It is significant that an executive who started out as a financial planner could eventually rise to become that organization’s CEO. The fact that this is possible is an indication of how important the financial planning process is within the corporate for-profit business world. But it is also a powerful reminder that corporate financial planning should be given the same priority within the not-for-profit hospital universe.

All of this is to say that sophisticated financial planning remains the backbone for the management of complex organizations of any type or stripe. In the 1980s and 1990s, I wrote extensively about the theory and practice of corporate financial planning, but it is always a good time for an updated tutorial. To do that, I went back and read sections of a book written in 1994 by myself and Mark Hall. The book was entitled The Financially Competitive Healthcare Organization. It outlined a whole series of corporate finance skills and methods, but with special attention to financial planning best practices. Some key excerpts, still astonishingly relevant today, are as follows:

  • Management understands and applies principles of corporate finance. Consider again the difficulty of financial decision-making in healthcare today, and the high cost of mistakes in an environment of such complexity and uncertainty. How do financially capable organizations cope? They begin by building upon the strongest of foundations: the principles of corporate finance.   

    The capable organization seeks order. Order in this case can be defined as the use of consistent techniques to analyze and evaluate complex business problems. The principles of corporate finance impose mathematical order over essentially chaotic decision-making. A net present value analysis, for example, distills all of an investment’s characteristics down to a simple dollar value, enabling the organization to evaluate the investment on its own merits or to properly compare it with other investment opportunities.   

    Remember: every decision an organization makes either adds to or reduces the value of the overall operation. The cumulative effect of these incremental decisions determines the organization’s future financial success. Application of the principles of corporate finance enables the organization to measure the impact of each decision.   

    Given a technically capable finance department, senior management can aggressively incorporate analyses into the decision-making process and the board can depend on the numbers to validate the organization’s key strategic moves.
  • Management has a sophisticated financial plan. The financial plan is the backbone of the financially capable healthcare organization. Not to be confused with the budget, which is the annual plan that allocates human and capital resources, the financial plan quantitatively evaluates the organization’s financial risk given alternative scenarios. The sophisticated financial plan identifies corrective actions that the organization can make in response to certain expected or unexpected changes.   

    In business, as in sports, the team that best executes its plan is usually the winner. A sophisticated financial planning process enables the capable healthcare organization to execute. Logical and informed financial decisions give an organization the competitive edge in a marketplace whose changing needs demand quick response. Internally, a good financial plan lends the overall strategic plan a sharper focus and stronger momentum by bridging the gap between strategies and actions.
  • Management consistently applies quantitative decision-support tools. The financially capable organization distrusts intuitive solutions to complex business problems. This does not mean that the capable organization is afraid to make intuitive decisions but that it prefers to give its decision-making team a sound analytical footing on which to work. The executive team is comfortable with a wide variety of decision-support tools and is able to routinely prepare detailed financial projections for the organization as a whole and for the specific problem at hand.   

    The financially capable organization also employs a highly integrated planning process that instantly can show the financial impacts of changes to the strategic plan. This real-time decision-support structure allows for immediate analysis, consistent and reliable feedback, and improved communication, all prerequisites for first-class financial decision-making in our turbulent healthcare environment.

The above thoughts were written in 1994 and obviously times change and circumstances change. But the essential questions which underpin your analytic process do not change. Those questions are as follows:

  1. What is the ambition of your organization as it relates to financial success, clinical growth, and improvement in reputation?
  2. Based on the answer to question number 1, what would be the total required resources to achieve said financial success, clinical growth, and improvement in reputation?
  3. Based on the five-year financial plan, is your organization on track to produce those resources as a combination of cash flow from operations, capital capacity, and possible philanthropy?
  4. If not, what is the total shortfall in financial and capital capacity and are there operating and financial strategies available to close that shortfall?

The concluding observation from the 1994 financial planning chapter has not changed at all:

"The point is that the application of intuition plus experience without the benefit of analysis is just guessing, but the use of quantitative techniques without the buffer of experience and judgment is a meaningless mathematical exercise. Sophisticated financial planning creates a necessary and consistent context for able decision-making, despite uncertain and complex circumstances, and permits the informed application of executive judgment."

Corporate finance is a theory and methodology that has stood the test of time. It is perhaps the single most effective long-term technique to manage technically complex organizations. If all of this appears entirely obvious to Richard Gonzalez and Robert Michael at AbbVie, it should appear obvious to America’s hospitals as well.

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