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Q: How should a not-for-profit senior living community objectively segment the financials of charitable mission initiatives from the basic senior living business operations?

A: This is a three-step process.

1) Create an income statement and sheet that includes only your senior living business operation (revenue, operating expenses, profit, debt service, cash flow, etc.). If necessary, show any cash from the business operation that is needed to fund charitable initiatives as a separate financial burden below the operating profit and net cash flow line entries. The expected outcome is the execution of sound business practices while meeting industry benchmarks for financial performance.

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by Jim Moore

How can I develop a more sharpened financial focus on my campus which has multiple living arrangements?

Great question.  The Senior living business is becoming increasingly complex.  The continuum of products and services is growing.  There is a pressing need to optimize the financial viability of each individual product or level of care on your campus.

Consolidated financials provide the big picture/summary approach, but to determine the true financial sensitivity of your organization you must develop individual cost/profit centers within your continuum.  Simply combining three or four businesses within a community into one overall consolidated income statement of revenues and expenses is not the best practice for the future.  Just using consolidated financials can frequently mask unacceptable subpar performance of one cost center, while penalizing the overall operation.  Each individual major product and service offered should meet reasonable industry financial benchmarks of revenues, expenses including an overhead allocation, net operating income, profit margins and cash flow.

Each cost/profit center should have initial stand-alone income statements before being merged into your consolidated financial statements.  It’s true that you must provide a seamless consolidated continuum of products and services for your residents.  However, each key element of this continuum must first be segmented as a stand-alone cost and profit centers and then (and only then) combined to track the overall campus results on a consolidated basis.

The stand-alone cost/profit center is a concept whose time has arrived.  It is already being implemented by progressive sponsors and owner/operators.  The benefits include sharpened pricing, focused cost controls and potential overhead cost reduction.  Finally, the concept is fast becoming a key element of a state-of-the-art business practice.

Do you have a question or need help with the complexities of multiple cost centers? Contact MDS today to see how we can help.

As we approach the end of 2016 (sorry, but yes, it is coming at you like a speeding locomotive whether you admit or not!) we hope you are actively evaluating where you are in terms of your 2016 goals.  Are you on track to accomplish everything you set out to accomplish? If not, why not?  Did you set goals that you have since deemed unnecessary, do you need more time or do you need a different strategy? What new goals have developed?

One of the many areas you need to be evaluating is your aging physical plant and capital investment.  Capital investment/improvements on an ongoing basis are crucial to keeping your senior living community in a competitive condition. If you have a newer facility you may be in the planning/budgeting stages but if your community has some years on it, you should be making these improvements to stay viable.  Either way, capital investment is something you need to be thinking about no matter how old or young your community is.

Three Capital Investment Traps

In planning a capital investment strategy, many owners and sponsors frequently commit three tactical errors.  They:

1. Spend money on the wrong things
2. Lose sight of their overall strategic objectives
3. Pay too much for less-than-optimum value

Consider Two Important Time Frames

In developing a new senior living community or improving an existing one, capital expenditure decisions must consider two distinct time frames:

• Short-Run – The initial (one time) costs of the capital investment
• Long-Run – The ongoing (perpetual) operating costs of ownership

Cost of Ownership Considerations

To plan effectively, you must carefully weigh the short run capital cost expenditures (immediate capital costs, such as new heating, ventilation, and air conditioning systems) against the long run costs of ownership (ongoing operating costs such as maintenance, utilities, and insurance). Investing less in capital improvements in the short run can sometimes be very expensive over your total ownership period.  These cost considerations become very important if you plan to hold your property for more than five years.  Even if you plan to be a short term property owner, realize that your ultimate sale value can be adversely affected by your earlier “short run” capital investment mentality.  The buyer’s sophisticated due diligence efforts will likely detect flaws in your original capital investment planning.

These four simple steps should help you make important cost of ownership trade-off decisions:

1. When considering two alternative capital investments evaluate the payback period and calculate the impact on total community value. How many years of operation are required for the operational savings/benefits to result in financial break-even or recovery of each of your alternative initial cash investment options? This can be a simple arithmetic calculation (dividing the initial cost of the capital investment by the estimated annual financial benefit or savings) or a more sophisticated discounted cash flow analysis that takes into consideration the time-value of money invested.  Ideally, your payback period should be between three and five years.  From that point forward, there should be an ongoing positive incremental financial impact.
2. Estimate the total impact on community value. To determine the increased intrinsic value of your community, you should capitalize the incremental increase in your net operating income resulting from the capital investment¹.  The capitalization rate is the cash return (percentage) that reasonable buyers or investors would expect to realize on their cash investment. This would obviously be influenced by their perception of relative risk.  Appendix C briefly describes the capitalization rate concept.
3. Value engineer your capital investments. This means lowering or controlling capital costs without significantly detracting from the look, operational efficiency, or marketplace acceptance of your community.  The results of this effort should be largely invisible to the consumer marketplace.
4. Let the “flash value” concept influence capital investment. Flash value is a fairly obscure, but surprisingly simple, way of quantifying, and thereby maximizing, perceived value in the eyes of the consumer.  This concept is defined as follows:

Flash Value Index  =    What Consumer Thinks an Item Costs

                                                      Your Actual Cost

Through consumer testing (focus groups, etc.), you can identify a menu of design features and amenities that exhibit a positive “flash value index” of greater than two to one.  This means that the consumer thinks the item is worth at least twice as much as your actual cost.  You should incorporate a number of highly favorable flash value items into your community.  Typical high flash value items in senior housing include high-quality wood molding or millwork, walk-in closets, unusual (but attractive) public spaces, recessed solid-core living unit entry doors, incandescent or new LED lighting vs. traditional, older fluorescent lighting, wall coverings and artwork, interesting roof lines, and “breaks” in exterior elevations.  The list could go on, but the ideal outcome is for a senior prospect and their family to comment, “This place sure seems to offer a lot for the money!”

Call to Action

      Before you move on, remember you can get very creative with your capital investments by taking four basic steps:

1. Evaluate the investment payback period.
2. Estimate the total impact on existing operation and long-run community value.
3. Value engineer for cost investment savings.
4. Invest in flash value to enhance perceived value.

Finally, address the key question, “Is now the appropriate time to take action?”

In additional to authoring several books based on his years of experience in Senior Housing, Jim Moore has published countless articles for both mainstream and market specific publications.  Jim answers your questions in regards to strategy and operations every month in McKnights Senior Living

You Asked: Do I Need An Exit Strategy?

Many owner/operators say they don’t intend to sell; they plan to ride out the various business cycles and they’re not about to leave the senior living industry. But having a sound exit strategy doesn’t necessarily mean you’re actually planning to get out. It’s somewhat like thinking about our life expectancy. To stay healthy, should you do anything differently? In early 2016, you can use an exit strategy for several beneficial reasons.

Here is a simple strategy for estimating the approximate value of this exit strategy by determining today’s valuation, using a capitalization rate of 7%. Simply divide your actual annual net operating income (NOI) by 0.07. If your community has annual revenue of $3.6 million and expenses of $2.3 million representing an operating profit margin of 36%, then the NOI from this performance would be $1.3 million. Dividing that annual NOI figure by 0.07 reflects a preliminary value of approximately $18.6 million. Many who went through that simple exercise have changed their attitude about whether to consider an exit strategy.

Whether you actually decide to sell is an important decision. Whether you plan to fold your cards soon or hold them for a long time, having a sound exit strategy can only help.

To find out how Jim and the staff at MDS  can help you in regards to developing your exit strategy, contact us today.

There Is A Win-Win Strategic Solution

The potential impact of the emerging minimum wage increase on Senior living is currently unclear.  Right now it may be speculation, but it could become very real in the near future.  Now is the time to anticipate a future impact and develop an appropriate response.  The good news is that regardless of the minimum wage impact on Senior living, there are available practical responses that will have a favorable long run impact for astute owner-operators.

 The minimum wage issue is clearly an ethical dilemma and a real world business challenge.  Two conflicting issues are emerging; a legitimate moral and financial concern for lower paid, entry level employees versus a potentially serious fundamental business impact.

Many feel that modestly increasing the standard of living for lowly paid workers is the right thing to do.  But price and profit sensitive businesses with high concentrations of low-cost workers are concerned.   Industries like fast food would be dealing with several critical variables like higher prices, possibly a lower customer base, or lower profits.  Consideration is also being given to lowering cost by reducing entry level employee counts.  Simply stated, the fast-food industry and other businesses may have to reevaluate and adjust their business model.

There are also concerns that if the baseline minimum wage of $7.25 per hour (the current Federal standard), is increased by approximately $1.50 to at least $8.75 per hour, there could also be pressure to increase the hourly wages of other lower paid entry-level employees in an attempt to sustain the current offset from the increased minimum wage.  New York, California, Oregon, and Connecticut and Massachusetts have already set their minimum wage higher than $8.75 per hour.  Other states already either have an official minimum wage of at least $8.00 per hour or considering similar increases.

How Might This Affect the Senior Living Industry

There is a heavy concentration of entry level workers at a typical independent living or assisted living community.  Those entry level positions typically include housekeepers, laundry personnel, cooks, servers, and other dietary employees, as well as drivers, security personnel, some maintenance positions, and healthcare workers.

Let’s look at a typical 110 unit assisted living community with 55 Full Time Equivalent Employees (FTEs).  This staffing ratio of 0.5 FTEs per unit is a typical benchmark.  The types of lower wage earner workers mentioned earlier totals 43 FTEs.  Their current entry level wages range from $11.00 per hour (housekeeper, laundry and some health care support, security and maintenance workers) to $11.70 per hour for CNAs.

There could eventually be pressure by workers, labor unions and other interest groups to attempt to sustain the current offset between minimum wage levels and other entry level worker pay.  For example, if the minimum wage is increased by approximately $1.50 per hour, this offset, if also achieved by other workers, will have a significant financial impact on this assisted living community.

A financial sensitivity analysis of this issue revealed the following:

• Annual Payroll Increase of $149,800 or 10.2%
• Total Expense Increase of 4.5%
• Net Operating Profit Margin Decrease of 3.4% (from $1.5 million to $882,450 in net income)

At an 8.0% capitalization rate, the intrinsic value of this community would decrease by approximately $1.9 million.  Granted, the potential minimum wage increase impact on other entry level wages involves speculation at this time, but the change is very likely to occur.

There is a viable win-win solution to this potential financial dilemma.  The solution involves three basic initiatives:  1) Reducing overall operating expenses, 2) Enhancing revenues and 3) Realizing organic growth through increased occupancy and expanded services within the community.  This strategy can be a very significant win-win solution because it addresses both the potential minimum wage financial impact and also improves the community’s long run financial performance.