Private Hospital Feasibility Study – 5 Observations in 5 Minutes

Private Hospital Feasibility Study

Undertaking a private hospital feasibility study can be a daunting task. Even a high-level checklist of issues to address can be several pages long.  And the scope of a full private hospital feasibility is very broad – as this checklist shows. Regardless of the scope of the project, the heart of any feasibility study has two chambers: the demand for services and the revenue and costs expected. The demand for services chamber pumps “financial blood” into the revenue and expense chamber. The result is a live, functioning service.


Estimating Demand for Services in a Private Hospital Feasibility Study

The good news is that there are sources of hospital utilization data that can be used to project demand for services. The bad news is that you still have to use them judiciously and understand the limitations inherent in the data.

Even with good historical data, there are environmental factors that you must consider.

  • Will there be competition from other hospital providers?
  • Are physicians and other providers willing to refer patients to a new hospital?
  • Do health plans and insurance companies want to contract with a new hospital.
  • How far will individual patients travel for services?

Population-based calculations (discharges and/or patient days per thousand) can be very useful for tracking historical hospital utilization and forecasting future utilization. When estimating demand this way, it’s important to know the general scope of services your hospital will be offering. For instance, a new hospital (or a hospital expansion project) in an area with a growing, working-age population would most likely include maternity services and even a neonatal ICU. Plan for services such as orthopedic surgery and cardiology in a retirement community. Exclude the number of discharges and patient days of services you are not including in the initial complement of services.

The key metrics to develop are discharges per thousand, patient days per thousand, and outpatient visits per thousand. Match these metrics with population estimates term, and you have an initial estimate of the specific demand for hospital services in the near future. But now comes the harder part.


How much of the Demand will your new Hospital capture?

This element of a private hospital feasibility study is more challenging.  You may have good information on one or more of the environmental variables mentioned above. For instance, you may know that physicians – or patients- are unhappy with the quality of care at the nearest competing hospital. A major health plan may be looking for a contract with another hospital in the same geographic area.

When you don’t have this type of intelligence to bring to bear, you can model the key metrics using three or four scenarios of market penetration. These scenarios would reflect various levels of utilization over time in the geographic area around your new hospital.

For instance, you might estimate that your new hospital could capture five percent of the market during the first year. You could further project market share growing over time. You could also use this technique to estimate a market share where your facility would break even and begin to make a profit.

Estimating Gross Revenue (Billed Charges)

One method of estimating the revenue and net revenue of a hospital is to look at those elements at similar hospitals in a similar environment.  Look at the results for hospitals of similar size and scope of services. Calculate the percentage of inpatient revenue and the percentage of outpatient revenue. Such ratios will probably range from 50/50% to 75% outpatient/25% inpatient.

Project inpatient gross revenue by dividing the annual inpatient gross revenue of one or more similar hospitals, by the number of discharges in the year. Using figures from several similar hospitals will probably produce a more reliable estimate than relying on statistics from just one other hospital.

Project outpatient gross revenue by dividing the annual outpatient gross revenue of one or more similar hospitals, by the number of outpatient visits in the year.

Estimating Net Revenue

Hospitals are just about the only business where the amounts you charge are usually not anywhere near the amounts you collect. Contractual allowances are different between those two amounts. Bad Debt is another factor that is part of the calculation to get from gross to net revenue. Estimate both of these factors based on the reports on comparable hospitals in the general area. Take into account contractual allowances to government payors like Medicare and Medicaid. They usually only pay a percentage of the amounts billed to them. Contractual allowances may range from 40% to as high as 70% for hospitals with very aggressive charge masters.


Estimating Operating Expenses in a Private Hospital Feasibility Study

Operating expenses can be summarized in several major categories.

Salaries, Wages, and Benefits (SWB)

This category usually accounts for up to 50% of expenses for most hospitals. Estimate them first by analyzing the distribution of gross revenue allocated to inpatient vs. outpatient services at comparable hospitals.

For instance, suppose the inpatient gross revenue is 25% of the total gross revenue in your comparable hospital(s). Allocate 25% of the total SWB costs to inpatient services, and compute the inpatient SWB per patient day by dividing the inpatient SWB by inpatient days.

Compute the outpatient SWB per visit by dividing 75% of the total SWB by the number of outpatient visits at your comparable hospital(s). You can now estimate the inpatient and outpatient SWB for your private hospital feasibility study.

Supplies, Professional Services, Purchased Services, and Other Expenses

Estimate each of these elements using similar benchmarking technique described above for salaries, wages, and benefits. Estimate supply costs based on a figure per discharge. Prorate professional services, purchased services, and other expenses using the benchmark expenses for patient days and outpatient visits.


Financing, Interest, Depreciation, and Taxes

Two of these elements are highly dependent on the need for borrowing, and the loan terms available for your project. For most new construction, hospitals obtain a construction period loan, followed by a “take-out” or long-term loan when construction is completed. This type of loan covers the cost of constructing buildings and is amortized over 30 years. You may need a second loan for equipment. Those loans are usually amortized over 15 years.

New buildings are typically depreciated over 30 years. The Internal Revenue Service issues schedules that govern the depreciation of major and minor equipment. Taxes are a very specialized area, and are subject to numerous terms and conditions specific to the circumstances.


Land, Construction, and Equipment Costs

These costs vary considerably based on the location and size and scope of the hospital. Costs per square foot can range from $400 to $700, so size really matters. Major and Minor Equipment and furnishings can total up to 50% of the construction costs. Land costs are highly dependent on the location. For instance, land near a freeway on-off ramp would be more expensive than a site farther away in a residential area.

A complete private hospital feasibility study goes far beyond the initial market assessment and financial feasibility study of the project. It includes:

  • pre-planning sessions with real estate brokers and bankers,
  • selection of architects, engineers, and contractors,
  • construction and equipment purchases,
  • operational planning for staffing and supplies, and
  • post-opening evaluation of operations.

Check out the resources available from The Fox Group for assistance when you are faced with starting such a project!

When you need proven expertise and performance

Jim Hook, MPH

Mr. James D. Hook has over 30 years of healthcare executive management and consulting experience in medical groups, hospitals, IPA’s, MSO’s, and other healthcare organizations.