Financing PACS: Balancing Financial & Technical Needs

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Traditionally, the high cost of entry has been an obstacle on the path to obtaining a picture archiving & communications system (PACS). Finding financial resources for PACS implementation may be complicated, but the number of financing options has increased as the PACS market has matured. The key to obtaining the financing that's needed to acquire a state-of-the-art PACS is to understand which option will reap the biggest benefits for your facility given its particular financial situation.


OPTING FOR OWNERSHIP

An organization must treat equipment that it owns as a capital expense and include it as an asset on its balance sheet. If it takes on debt in order to own equipment, it also must include the debt as a liability on its balance sheet. Balance sheets are important because they're used by financial institutions to determine a facility's debt rating, which affects how much money it can borrow and at what interest rate. Debt rating is a critical factor used by its financial managers in determining whether to own or lease major equipment expenses like PACS. If a hospital decides it wants to own its PACS, there are two basic purchasing choices: cash purchase or capital financing.

Cash Purchase. If the facility has the cash resources, it can pay for equipment outright with cash. In the case of a multi-million dollar PACS, only the most cash-rich institutions are likely to have this kind of money on hand. Even though a large cash purchase ties up capital that might be spent elsewhere, a cash purchase provides immediate ownership with no debt.
 
When making a cash purchase of IT equipment, financial managers look at obsolescence rate. Software-intensive technologies like PACS are generally seen by CFOs as having little value due to their high obsolescence rate. "The CFO will be asking himself, 'do I want to own this asset?'" says Ken Ostrowski, director of operations for Fujifilm Medical Systems, Financial Services. "In most cases the answer is no, because in five years it's not worth anything."

Capital Financing. If an organization has a good credit rating, it can finance a PACS in a process that's similar to financing a house: the borrower obtains funds from a lender at an interest rate determined by its credit rating. Healthcare facilities can obtain both capital loans and capital leases. The primary difference between the two is when title passes to the borrower; the accounting is the same. Loans are structured so that ownership starts at the beginning of the financing period; leases normally pass title at the end of the financing period.

Capital financing is readily available from vendors and third-party lenders. But financing software-intensive systems isn't traditional and unknowledgeable lenders may balk at lending money for software-intensive purchases, says Mike Kennedy, senior vice president of strategic marketing for GE Healthcare Financial Services. "If you're going to loan money for equipment, you know if they stop paying that you can take it and sell it," he says. "Software is worthless to anyone but the party that's using it and [lenders] have to be comfortable with that."

Lenders like GE Healthcare Financial Services that focus on healthcare lending are more comfortable with software financing than other types of third-party lenders, Kennedy says.

PACS planners relying on capital expense dollars must prepare extensive return on investment (ROI) scenarios. Financial management will want assurance that they've invested in a vehicle whose ROI meets or exceeds that of other investment options.

In fact, says Rik Primo, division manager for image management at Siemens Medical Solutions USA, proving ROI is the biggest challenge in preparing for PACS purchases.  That's because financial management understands the hard savings associated with PACS, but savings associated with workflow efficiencies are harder to grasp. "For example, they can easily understand that by buying an MR and doing 30 procedures a day, it's going to generate revenue," Primo says. "With PACS, the dollars are much softer and it's more about improving operational efficiencies - which also causes savings - but isn't quantifiable."


A LOOK AT LEASING

On an organization's income statement, income generated by radiology and other departments is shown as revenue. Items such as salaries, equipment leases, and administration costs are shown as expenses.

Depending on an institution's financial situation, it may be more appealing to keep PACS expenses off the balance sheet by claiming the cost as an operating expense. Because film and developing costs are already treated as administration costs, some organizations view software-intensive PACS equipment as an expense that can be easily operationalized.

Off-balance sheet treatment is accomplished by leasing rather than buying the equipment. There are two primary options for leasing a PACS: an operating, or fair market value (FMV) lease; or a per-use lease, also known as the application service provider (ASP) or managed service model.

Operating or Fair Market Value Lease. With an operating lease, the lessee pays a monthly fee and at the end of the lease term has the option to buy the equipment for fair market value; renew or upgrade the lease; or return the equipment with no further obligation.

Like capital financing, operating leases can usually be obtained from vendors or third-party lenders. However, an operating lease must meet the strict standards of the Federal Accounting Standards Board (FASB). One of the FASB requirements is that the total lease payments must have a present value - which is less than 90 percent of the equipment's cost. This means that for the same term, an operating lease will always be at least 10 percent less expensive than a capital lease or loan, which finances the full price of the equipment.

For this reason, many hospitals find operating leases attractive when they plan to replace equipment at the end of its planned economic life.

"A lot of PACS financial planning has to do with thinking forward about when to replace the assets," says Marty Zimmerman, president and CEO of LFC Capital. "Do you want to plan to upgrade the equipment, replace it at the end of its economic life, or simply run it until it quits?  If you do the latter, you're likely to be less competitive economically."

Operating leases provide the lessee with protection against obsolescence, since the equipment can be returned at the end of the lease term - before it's fully paid. They are appealing to organizations that want to minimize interest costs over the equipment's economic life. In addition, because the terms of the operating lease require the lease financer to have 10 percent equity in the equipment, the financing entity and the healthcare facility share the investment risk.

Per-Use Lease (ASP or Managed Service Model). A healthcare institution can outsource its PACS by using a vendor that will provide the equipment on a per-use basis, also called the application service provider (ASP) or managed service model. Historically, an ASP system is managed offsite by the vendor while managed service utilizes an onsite system, but in the current environment the terms are used interchangeably. Hospitals interested in a per-procedure lease have the option of an onsite or offsite PACS, depending on their space requirements and comfort level with an offsite system.

Like an operating lease, the lessee pays no up-front costs with the per-use model. Typically, the lessee signs a five-year contract with an agreement to pay a per-procedure fee. At the end of the lease, the hospital would have the option to renew the lease or have the equipment removed. Like operating leases, per-use leases eliminate the risk of technology obsolescence, provided that the contract is properly structured.

"A managed service model allows hospitals to convert analog modalities at whatever rate they need without paying for them until they do it," says Matt Long, vice president of marketing for Stentor Inc. "You're paying in real time and there's no risk of purchasing something that you're not going to be utilizing."

Using an ASP makes costs very easy to predict, says Long. "Everyone is worried about the bottom line, and if you can make the financing predictable, it's very attractive to the financing community," he adds.

When considering the per-procedure financing model, an organization's CFO may want comparisons of long term per-use vs. capital financing costs because per-use leasing has traditionally been more expensive over the long term than capital financing.


OTHER OPTIONS

There are a variety of other financing options. For example, non-profit hospitals can obtain a tax-exempt lease that allows them to access funds at a tax-exempt interest rate. In some communities, hospitals rely on public bond measures to finance large purchases. And some PACS can be financed by operationalizing part of the expense and capitalizing the rest. A reliable financing source can provide advice on all of the available options.


VENDOR OR LENDER?

Unless your organization is making a cash purchase, you'll have to decide whether to use third-party or vendor financing for your purchase.

Vendor financing is convenient, and most vendors have in-house financing divisions that can offer the same variety of options as third-party lenders. According to David Sacks, director of global finance for Agfa Financial Services, having a variety of financing options gives vendors a competitive advantage. "We are constantly developing new programs and options to lead with," he says. "We have the ability to provide flexibility and creative financing, which gives us a leg up."

Sacks says that Agfa's financing specialists start meeting with PACS planners at the beginning of the bidding process. "Financing shouldn't be an afterthought," he adds. "It should be part of the RFP process."

Fuji's Ostrowski says that vendor financing is easier to get than third-party financing because the vendors are more knowledgeable about the equipment that they sell and are eager to help the customer finance it. "The financial resources out there are drying up," he says. "A bank knows what to do with a house. They don't know what to do with advanced technology equipment, so they shy away."

But most healthcare institutions have existing relationships with third-party lenders, such as local banks or institutions that specialize in healthcare financing. Working with third-party lenders is appealing to hospitals because of the expertise that their advisers bring to the table. "We have people whose exclusive job is to understand financial needs," says Kennedy of GE Healthcare Financial. "PACS is very expensive and you'll be making substantial payments, so you want the loan to be serviced properly."

LFC Capital's Zimmerman agrees. "The analogy is, do you do your own investing or do you get an investment banker to do it for you? Third-party lenders do something that others can't do. If they're focused and knowledgeable, they'll save more than they cost," he adds.

Unlike Agfa's Sacks, Zimmerman recommends that healthcare facilities negotiate the PACS price before discussing financing. Bundling the financing, he says, can allow the vendor to make a program look cheaper than it really is. "It's best to look at financing separately," he advises. "Then you're getting an objective perspective."