In accounting simulation basically refers to creation of artificial mathematical models which may either be simple or complex (Clark & Reed, 2010).The models created are then used for review and analysis of both financing and investment decisions. There are three main important financial models or statements that indicate the operating efficiency of any business, these are; the balance sheet, the income statement or the cash flow statement and the profit and loss account (Lasher, 2010). They are used to indicate efficiency or stability of a business (Clark & Reed, 2010). A cash flow statement basically indicates the amount of cash in and out of a business at a particular time. A balance sheet, on the other hand, ascertains the financial position of any business at a particular period, usually at the end of the trading period, it comprises three main components, these are ;assets, capital and liabilities (Lasher, 2010). From a balance sheet we are able to calculate working capital, which is the excess of current assets over the current liabilities. With working capital a business is able to finance its day to day operating expenses and activities.
The health care accounting simulation information indicates that the organization under study is being faced by capital shortage. The organization is faced by a working capital shortfall of about $2,300,000. An immediate solution is required to save the organization from the operating inefficiencies. This is due to the fact that the expenses for this organization are much higher than its revenue. This can be solved through the options outlined below.
Cost Cutting Options
The healthcare organization needs to downsize and reduce the agency staff. By downsizing the organization will lay off staff in order to reduce the wage bill. To ensure that patient care is not compromised, the remaining staff will be retrained and equipped with current skills. In order to reduce the wages expenses, this organization needs to reduce the cost of contracted staff; this will reduce wage expenses by half since the cost of contracted labour is estimated to be more than half of that of hospital staff. Unnecessary positions need to be scrapped out following evaluation of these jobs.
Loan Option Selected
To maintain the operating cash flow and reduce the working capital shortfall, this organization needs access funds through borrowing. The financial information indicates that the health care organization has a shortfall of $2,300,000. To salvage this situation, the organization needs to undertake loan option 1 and borrow a long-term loan with a repayment period estimated to be of over 5 years. The interest for the loan is estimated to be at 10 percent per annum. This will see the health care organization loan repayment spread over 5 years with monthly installments of $625,000. Moreover, there is need for a repayment condition in the loan agreement emphasizing that the organization repays the loan after 6 months. This takes the advantage of cost cutting options and more capital to make profits that will sustain the repayment of the debt.
Outcome of Capital Shortage decision
The wage bill will significantly be reduced by laying-off staff and by reducing the contracted staff. This will reduce operating expenses. The borrowed funds will provide an immediate remedy to the working capital shortfall and also provide an extra $200,000 for any contingencies. However, this will affect the capital structure of the organization since it will have high leverage.
Funding Options for equipment Acquisition
Cost effective source of funding for equipment acquisition
This organization needs to consider to capital-leasing the medical equipment as opposed to leasing. This is important since with capital leasing the ownership rights of the equipment is transferred to the lessee after the end of the leasing period as opposed to leasing where the lessor retains the equipment after the end of the lease contract period.
Outcome for equipment acquisition decision
The outcome for this decision is that expenses will be reduced since there will be no operating lease, which is an expense that might lead to operating inefficiencies. Moreover, the health care organization will gain ownership of the equipment after the contract period.
Funding Options for Capital Expansion
Source of Funding for capital expansion
There are numerous sources of funds for capital expansion. Some of these are, selling a considerable amount of the company’s stake, reinvest profits and borrowing. This organization needs to borrow to expand its capital base. This is due to the fact that they do not have enough funds for reinvestment.
Outcome for source of funding for capital expansion
This means that by increasing leverage the organizations will weaken its capital structure by becoming more levered due to low proportion of debt as compared to equity.
Summary and Conclusions
From this simulation review, it is evident that without proper working capital management, an organization cannot be able to finance its operating activities, since expenses will exceed revenue (Lasher, 2010). Moreover, it is important for an organization to evaluate its decisions using financial statements as opposed to making observational decisions (Clark & Reed, 2010). It is important to note that financing decisions may result in win-lose situations, whereby one side may gain while the other might lose. A good example is borrowing to increase cash-flow which results to high leverage. The knowledge gained will in future be used to make capital budgeting decisions in appropriate business environments.
Clark, V., & Reed, M. (2010). Using Monte Carlo simulation for a capital budgeting project. Management Accounting Quarterly, 3, 3-5.
Lasher, W. (2010). Practical Financial Management. Boston, MA: MC-Graw Hill/Irwin.