Chapter 1
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Financial Information and the Decision-Making Process
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Learning
Objectives
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After studying this chapter, you should be able to do the following:
1. Describe the importance of financial information in healthcare organizations.
2. Discuss the uses of financial information.
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© Jones & Bartlett Learning, LLC
3. List the users of financial information.
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NOT the
FOR
SALEfunctions
OR DISTRIBUTION
4. Describe
financial
within an organization.
5. Discuss the common ownership forms of healthcare organizations, along with their
advantages and disadvantages.
Real-World Scenario
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In 1946 a small band of hospital accountants formed the American Association of Hospital
Accountants (AAHA). They were interested in sharing information and experiences in their
industry, which was beginning to show signs of growth. A small educational journal, first published in 1947, attempted to disseminate information of interest to their members. Ten years
later, in 1956,
the AAHA’s membership©had
grown&toBartlett
over 2,600
members. The
© Jones & Bartlett Learning,
LLC
Jones
Learning,
LLCreal growth,
however,
was
still
to
come
with
the
advent
of
Medicare
financing
in
1965.
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With the dramatic growth of hospital revenues came an escalation in both the number and
functions delegated to the hospital accountant. Hospital finance had become much more than
just billing patients and paying invoices. Hospitals were becoming big businesses with complex
and varied
financial
had to arrange
programs,
which Learning, LLC
© Jones
& functions.
Bartlett They
Learning,
LLC funding of major capital
© Jones
& Bartlett
could no
longer
be
supported
through
charitable
campaigns.
Cost
accounting
and
manageNOT FOR SALE OR DISTRIBUTION
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ment control were important functions to the continued financial viability of their firms. Hospital
accountants soon evolved into hospital financial managers, and so the AAHA changed its
name in 1968 to the Hospital Financial Management Association (HFMA).
hospital industry
continued
and
Third-party
insur-LLC
© JonesThe
& Bartlett
Learning,
LLCto boom through the late
© 1960s
Jones
&1970s.
Bartlett
Learning,
ance
became
the
norm
for
most
of
the
American
population.
Patients
either
received
it
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through governmental programs such as Medicare and Medicaid or obtained it as part of the
fringe benefit program at their place of employment. Hospitals were clearly no longer quite as
charitable as they once were. There was money, and plenty of it, to finance the growth required through increased demand and the new evolving medical technology. By 1980 HFMA
was a largeLLC
association with 19,000 members.
Primary
offices Learning,
were locatedLLC
in Chicago, but
Learning,
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& Bartlett
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1
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2 Chapter 1 Financial Information and the Decision-Making Process
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an important office was opened in Washington, DC, to provide critical input to both the execuNOT FOR SALE OR DISTRIBUTION
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tive and legislative branches of government. On many issues that affected either government
payment or capital financing, HFMA became the credible voice that policymakers sought.
The industry adapted and evolved even more in the 1980s as fiscal pressure hit the federal
government. Hospital
payments
were Learning,
increasing soLLC
fast that new systems were
sought to
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& Bartlett
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& Bartlett Learning, LLC
curtail the growth
rate.
Prospective
payment
systems
were
introduced
in
1983,
and
NOTalternaFOR SALE OR DISTRIBUTION
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tive payment systems were developed that provided incentives for treating patients in an
ambulatory setting. Growth in the hospital industry was still rapid, but other sectors of health
care began to experience colossal growth rates, such as ambulatory surgery centers. More
and more, health care was being transferred to the outpatient setting. The hospital industry
no longer
the only
large corporate
recognize
this trend,Learning,
the
©was
Jones
& Bartlett
Learning,
LLC player in health care.©ToJones
& Bartlett
LLC
HFMA
changed
its
name
in
1982
to
the
Healthcare
Financial
Management
Association
to
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reflect the more diverse elements of the industry and to better meet the needs of members
in other sectors.
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In 2010
HFMA
had over 35,000 members in a wide
NOT FOR
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OR DISTRIBUTION
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healthcare
expansion is a trend visiNOTThe
FOR
SALEindustry’s
OR DISTRIBUTION
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variety of healthcare organizations. The daily activities
ble even to individuals outside the healthcare system.
of their members still involve basic accounting issues—
The hospital industry, the major component of the
patient bills must still be created and collected, and payhealthcare industry, consumes about 5% of the gross
roll still needs to be met—but strategic decision making
domestic product; other types of healthcare systems,
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© Jones & Bartlett Learning, LLC
is much more critical in today’s environment. It would
although smaller than the hospital industry, are exNOT1−1
FOR
OR DISTRIBUTION
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OR DISTRIBUTION
be impossible to imagine NOT
any organization
planning
its
panding at even faster rates. Table
listsSALE
the types
future without financial projections and input. Many
of major healthcare institutions and indexes their relahealthcare organizations may still be charitable from
tive size.
a taxation perspective, but they are too large to depend
on charitable
giving&toBartlett
finance their
businessLLC
future.
© Jones
Learning,
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Learning Objective 1
FinancialNOT
managers
of
healthcare
firms
are
involved
in
a
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wide array of critical and complex decisions that will
Describe the importance of financial inforultimately determine the destiny of their firms.
mation in healthcare organizations.
This book is intended to improve decision makers’
understanding and use of financial information in the
© Jones
& Bartlett
Learning,
healthcare
industry.
It is not LLC
an advanced treatise in © Jones & Bartlett Learning, LLC
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OR
DISTRIBUTION
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SALE
OR
accounting or finance but an elementary discussion of NOTThe
rapid
growth
of DISTRIBUTION
healthcare facilities providing
how financial information in general and healthcare
direct medical services has substantially increased the
industry financial information in particular are internumbers of decision makers who need to be familiar
preted and used. It is written for individuals who are
with financial information. Effective decision making
not experienced healthcare
financial
executives.
Its
in their
interpretation
of Learning, LLC
© Jones & Bartlett Learning,
LLCjobs depends on an accurate
© Jones
& Bartlett
goal is to make the language
of healthcare
finance
financial information. Many healthcare
decision
makNOT FOR
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OR DISTRIBUTION
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DISTRIBUTION
readable and relevant for general decision makers in
ers involved directly in healthcare delivery—doctors,
the healthcare industry. Three interdependent factors
nurses, dietitians, pharmacists, radiation technologists,
have created the need for this book:
physical therapists, and inhalation therapists—are
medically or scientifically trained but lack education
1. Rapid expansion and evolution of the healthcare
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© Jones & Bartlett Learning, LLC
and experience in business and finance. Their specialindustry
NOT
FOR
SALE
OR
DISTRIBUTION
NOT
FORcases,
SALE
ized education,
in most
didOR
notDISTRIBUTION
include such
2. Healthcare decision makers’ general lack of
courses as accounting. However, advancement and
business and financial background
promotion within healthcare organizations (HCOs) in3. Financial and cost criteria’s increasing importance
creasingly entails assumption of administrative duties,
in healthcare decisions
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82999_ch01_FINAL.indd 2
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Information and Decision Making 3
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Table 1–1 Healthcare Expenditures 2003–2012
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(Projected)
2012 ∗
2007 ∗
2003 ∗
Annual Growth Rate,
2007–2012 (%)
Total health expenditures
2,930.7
2,241.2
1,734.9
5.5
© Jones & Bartlett Learning, LLC 18.0
© Jones
& Bartlett Learning, LLC
Percentage of gross domestic product
16.2
15.8
NOT
FOR SALE 5.5
OR DISTRIBUTION
NOT
FOR SALE OR DISTRIBUTION
Health services and
supplies
2746.1
2098.1
1621.1
Personal health care
2446.3
1878.3
1447.5
5.4
Hospital care
931.7
696.5
527.4
6.0
Physician and clinical
604.5
478.8
366.7
4.8
Dental
services
115.8
95.2
76.9
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© Jones & Bartlett Learning, 4.0
LLC
Home health
85.7
59.0
38.0
7.6
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FOR
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OR
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FOR
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OR
DISTRIBUTION
Other professional and personal health
180.7
128.2
99.4
7.1
Prescription drugs
288.8
227.5
174.2
4.9
Other medical products
71.3
61.8
54.5
2.9
Nursing home care
167.8
131.3
110.5
5.0
Expenses
for prepayment
121.9
6.5
© Jones & Bartlett
Learning,
LLC and administration © Jones213.4
& Bartlett155.7
Learning,
LLC
Government public health
86.4
64.1
57.3
6.1
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Research and construction
184.5
143.1
111.8
5.2
∗Values are US$ in billions, except for “Percentage of gross domestic product.”
Source: Centers for Medicare and Medicaid Services, Office of the Actuary.
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accurate portrayal. However, few individuals in the
requiring almost instant, knowledgeable reading of fihealthcare industry today would deny the importance of
nancial information. Communication with the organifinancial concerns, especially cost. Payment pressures
zation’s financial executives is not always helpful. As
from payers, as described in the scenario at the begina result, nonfinancial executives often end up ignoring
© Jones
& Bartlett Learning, LLC
Jones
& underscore
Bartlett Learning,
ning of©the
chapter,
the need for LLC
attention to
financial
information.
NOT
FOR SALE
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FOR
SALEtoOR
DISTRIBUTION
costs. NOT
Careful
attention
these
concerns requires
Governing
boards,OR
which
are significant users of
knowledgeable consumption of financial information by
financial information, are expanding in size in many
a variety of decision makers. It is not an overstatement
healthcare facilities, in some cases to accommodate
to say that inattention to financial criteria can lead to
demands for more consumer representation. This trend
excessive costs and eventually to insolvency.
can be healthy for both the community and the facili© Jones & Bartlett
Learning, LLC
© Jones &The
Bartlett
Learning, LLC
effectiveness of financial management in any
ties. However, many board members, even those with
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OR
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FOR
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business is the product
of many factors, such as envibackgrounds in business, are overwhelmed by finanronmental conditions, personnel capabilities, and
cial reports and statements. There are important disinformation quality. A major portion of the total finantinctions between the financial reports and statements
cial management task is the provision of accurate,
of business organizations, with which some board
of this Learning,
activity
members are familiar,
and those
of healthcare
facili- LLCtimely, and relevant information.
© Jones
& Bartlett
Learning,
© Jones Much
& Bartlett
LLC
is carried out through the
accounting
process.
adeties. Governing board
must OR
recognize
these
NOT
FOR SALE
ORAnDISTRIBUTION
NOTmembers
FOR SALE
DISTRIBUTION
quate understanding of the accounting process and the
differences if they are to carry out their governing misdata generated by it are thus critical to successful decisions satisfactorily.
sion making.
The increasing importance of financial and cost criteria in healthcare decision making is the third factor
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Information And Decision Making
creating a need for more knowledge of financial inforNOT
FOR
SALE
OR
DISTRIBUTION
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mation. For many years accountants and others involved
The major function of information in general and
with financial matters have been caricatured as individfinancial information in particular is to oil the deciuals with narrow vision, incapable of seeing the forest
sion-making process. Decision making is basically
for the trees. In many respects this may have been an
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4 Chapter 1 Financial Information and the Decision-Making Process
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SEQUENCING
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Information
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EXAMPLE
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Financial forecasts of a
proposed ASC
Develop or not develop
Decision making
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the ASC
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Implementation of decision
Results
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Learning, LLC
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ASC is developed
Significant financial losses occur
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Figure 1–1 Information in the Decision-Making Process
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LLC from a defined list
the selection
of aLearning,
course of action
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OR
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of possible
feasible
actions. In many cases the
© Periodic
Jones measurement
& Bartlett Learning,
of results in LLC
a feedback loop, as
NOT
FOR 1−1,
SALE
DISTRIBUTION
in Figure
is aOR
method
commonly used to make
actual course of action followed may be essentially
sure that decisions are actually implemented according
no action; decision makers may decide to make no
to plan.
change from their present policies. It should be recAs previously stated, results that are forecast are not
ognized, however, that both
action
and
inaction
repalways
factors, such
as fail- Learning, LLC
© Jones & Bartlett Learning, LLCguaranteed. Controllable
© Jones
& Bartlett
resent policy decisions.
ure to adhere to prescribed plans,
uncontrollable
NOTand
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Figure 1−1 shows how information is related to the
circumstances, such as a change in reimbursement,
decision-making process and gives an example to ilmay obstruct planned results.
lustrate the sequence. Generating information is the
Decision making is usually surrounded by uncerkey to decision making. The quality and effectiveness
tainty. No anticipated result of a decision is guaran© Jones
Bartlett
Learning,
LLCand
© Jones
& Bartlett
Learning,
LLC
of decision
making &depend
on accurate,
timely,
teed. Events may
occur that
have been
analyzed but
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OR DISTRIBUTION
NOT
FORmatrix
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OR DISTRIBUTION
relevant information.
difference
between data and
not anticipated.
A results
concisely
portrays the
information is more than semantic: Data become inforpossible results of various courses of action, given the
mation only when they are useful and appropriate to
occurrence of possible events. Table 1−2 provides a
the decision. Many financial data never become inforresults matrix for the sample ASC; it shows that apmation because they are not viewed as relevant or are
proximately 50% utilization will enable this unit to
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& Bartlett Learning, LLC
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unavailable in an intelligible form.
operate in the black and not drain resources from other
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For the illustrative purposes of the ambulatory surareas.
If forecasting
shows
that utilization below 50%
gery center (ASC) example in Figure 1−1, only two
is unlikely, decision makers may very well elect to
possible courses of action are assumed: to build or not
build.
to build an ASC. In most situations there may be a
A good information system should enable decision
continuum of alternative ©
courses
of action.
For exammakers
action that
have the Learning, LLC
Jones
& Bartlett
Learning,
LLCto choose those courses©ofJones
& Bartlett
ple, an ASC might vary byNOT
size or
facilities
included
in
highest expectation of favorable
results.
Based
on the
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the unit. In this case prior decision making seems to
results matrix of Table 1−2, a good information system
have reduced the feasible set of alternatives to a more
should specifically
manageable and limited number of analyses.
• List possible courses of action
Once a course of action has been selected in the
© Jones & Bartlett Learning, LLC
© that
Jones
& affect
Bartlett
Learning,
LLC
• List events
might
the expected
results
decision-making phase, it must be accomplished.
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OR
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FOR
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• Indicate the probability that those events will
Implementing a decision may be extremely complex.
occur
In the ASC example, carrying out the decision to build
• Estimate the results accurately, given an action–
the unit would require enormous management effort to
event combination (e.g., profit in Table 1−2)
ensure the projected results are actually obtained.
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82999_ch01_FINAL.indd 4
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Uses and Users of Financial Information 5
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Table 1–2 Results Matrix for the ASC
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Event
Alternative Actions
25% Utilization
Build unit
Loss
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Learning,
LLC
Do not build unit NOT FOR SALE OR DISTRIBUTION
0
50% Utilization
75% Utilization
$10,000 Profit
$200,000 Profit
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Learning, LLC
0
0 DISTRIBUTION
NOT FOR SALE OR
An information system alone does not evaluate the
stated goals at a consistent level of activity. Viability is
desirability
Decision
makers
must evaluate
a far more
restrictive
term thanLearning,
solvency; some
© Jones of
& results.
Bartlett
Learning,
LLC
© Jones
& Bartlett
LLCHCOs
results
in
terms
of
their
organizations’
preferences
or
may
be
solvent
but
not
viable.
For
example,
a hospital
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their own. For example, construction of an ASC may be
may have its level of funds restricted so that it must
expected to lose $200,000 a year, but it could provide
reduce its scope of activity but still remain solvent. A
a needed community service. Weighing these results
reduction in payment rates by a major payer may be the
and determining criteria are purely a decision maker’s
vehicle for this change in viability.
© Jones & Bartlett
Learning,anLLC
© be
Jones &Assessment
Bartlett Learning,
LLCcondition of business
responsibilitynot
easy task, but one that can
of the financial
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OR with
DISTRIBUTION
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DISTRIBUTION
improved
accurate and relevant information. NOT FOR
enterprises
is essential
to our economy’s smooth and
efficient operation. Most business decisions in our
economy are directly or indirectly based on perceptions
Learning Objective 2
of financial condition. This includes the largely nonAlthough
usually
Discuss the©
uses
of financial
information.
Jones
& Bartlett
Learning, LLC profit healthcare industry.
© Jones
&attention
BartlettisLearning,
LLC
directed
at
organizations
as
whole
units,
assessment
of
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the financial condition of organizational divisions is
equally important. In the ASC example, information on
the future financial condition of the unit is valuable. If
Uses And Users Of Financial
continued losses from this operation are projected, im©Information
Jones & Bartlett Learning, LLC
© Jones
& Bartlett
Learning,
LLC in
pairment
of the financial
condition
of other divisions
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NOT FOR
SALE
the organization
could
be inOR
the DISTRIBUTION
offing.
As a subset of information in general, financial inAssessment of financial condition also includes conformation is important in the decision-making process.
sideration of short-run versus long-run effects. The relIn some areas of decision making, financial informaevant time frame may change, depending on the decision
tion is especially relevant. For our purposes, we idenunder consideration. For example, suppliers typically
© Jones & Bartlett
LLC information that may© be
Jones & Bartlett Learning, LLC
tify five Learning,
uses of financial
are interested only in an organization’s short-run finanNOT FOR SALE
OR DISTRIBUTION
NOT FOR
ORbecause
DISTRIBUTION
important
in decision making:
cialSALE
condition
that is the period in which they
must
expect
payment.
However,
investment bankers, as
1. Evaluating the financial condition of an entity
long-term
creditors,
are
interested
in the organization’s
2. Evaluating stewardship within an entity
financial
condition
over
a
much
longer
time period.
3. Assessing the efficiency of operations
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& Bartlett
Learning, LLC
© Jones & Bartlett Learning, LLC
4. Assessing the
effectiveness
of operations
Stewardship
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5. Determining the compliance of operation with
directives
Historically, evaluation of stewardship was the most
important use of accounting and financial information
Financial Condition
systems. These systems were originally designed to
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Jones
Bartlett
Learning,
LLC
prevent
loss of&assets
or resources
through
employNOT
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OR
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FOR
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OR
DISTRIBUTION
Evaluation of an entity’s financial condition is probees’ malfeasance. This use is still very important. In
ably the most common use of financial information.
fact, the relatively infrequent occurrence of employee
Usually, an organization’s financial condition is equated
fraud and embezzlement may be due in part to the dewith its viability or capacity to continue pursuing its
terrence of well-designed accounting systems.
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82999_ch01_FINAL.indd 5
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6 Chapter 1 Financial Information and the Decision-Making Process
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For example,
development
of outpatient surgical centers
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Efficiency
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may reduce costs per surgical procedure and thus create
an efficient means of delivery. However, the necessity
of those surgical procedures may still be questionable.
Efficiency in healthcare operations is becoming an
increasingly important objective for many decision
makers. Efficiency is simply the ratio of outputs to
Jones(good
& Bartlett
Learning,
LLC
© Jones & Bartlett Learning, LLC
inputs, not the quality of©outputs
or not good)
Compliance
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NOT
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but the lowest possible cost of production. Adequate
assessment of efficiency implies the availability of
Finally, financial information may be used to deterstandards against which actual costs may be compared.
mine whether compliance with directives has taken
In many HCOs, these standards may be formally introplace. The best example of an organization’s internal
duced into
the
budgetary
process.
Thus,
a
given
nursdirectives is its
budget, &
anBartlett
agreement
between two
© Jones & Bartlett Learning, LLC
© Jones
Learning,
LLC
ing unit may
have
an
efficiency
standard
of
4.3
nursing
management
levels
regarding
use
of
resources
for a
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hours per patient day of care delivered. This standard
defined time period. External parties may also impose
may then be used as a benchmark by which to evaluate
directives, many of them financial in nature, for the
the relative efficiency of the unit. If actual employment
organization’s adherence. For example, rate setting or
were 6.0 nursing hours per patient day, management
regulatory agencies may set limits on rates determined
© Jones
& Bartlett
Learning,
LLC patterns.
© within
Jonesan&organization.
Bartlett Learning,
LLC by the orwould
be likely to
reassess staffing
Financial reporting
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NOT
FOR SALE
ORtoDISTRIBUTION
ganization
is required
ensure compliance.
Effectiveness
Learning Objective 3
Assessment of the effectiveness of operations is concerned with the attainment
objectives
through Learning,
proList the users of financial©
information.
© of
Jones
& Bartlett
LLC
Jones & Bartlett Learning, LLC
duction of outputs, not the relationship of outputs to
NOT FOR SALE OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
cost. Measuring effectiveness is much more difficult
than measuring efficiency because most organizations’
Table 1−3 presents a matrix of users and uses of
objectives or goals are typically not stated quantitafinancial information in the healthcare industry. It
tively. Because measurement of effectiveness is diffi© Jones
& Bartlett
Learning,
LLC on
© Jones
Bartlett
Learning,
LLC
identifies areas
or uses &
that
may interest
particular
cult, there
is a tendency
to place
less emphasis
decision-making
groups.
does not
consider
relative
effectiveness
moreSALE
on efficiency.
This may result in
NOTand
FOR
OR DISTRIBUTION
NOT
FORItSALE
OR
DISTRIBUTION
importance.
the delivery of unnecessary services at an efficient cost.
Table 1–3 Users and Uses of Financial Information
© Jones
& Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
Financial Condition
© Jones & Bartlett Learning, LLC
NOT FORUsers
SALE OR DISTRIBUTION
Stewardship Uses Efficiency Effectiveness Compliance
External
Healthcare coalitions © Jones & Bartlett
X
Learning, LLC
Unions
X OR DISTRIBUTION
NOT FOR SALE
Rate-setting organizations
X
Creditors
X
Third-party payers
Suppliers
X
Public © Jones & Bartlett Learning,
X LLC
NOT FOR SALE OR DISTRIBUTION
Internal
Governing board
Top management
Departmental management
X
X
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
X
X
X
X
X
X
X
©XJones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
X
X
X
X
©XJones & Bartlett
Learning, LLC
X
NOT FOR SALE OR DISTRIBUTION
X
X
X
X
X
X
X
X
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC. NOT FOR SALE OR DISTRIBUTION.
82999_ch01_FINAL.indd 6
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Financial Organization 7
© Jones & Bartlett Learning, LLC
© Jones & Bartlett Learning, LLC
Not every use of financial information is important
to SALE
the understanding
of financial management. The
NOT FOR
OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
in every decision. For example, in approving a HCO’s
following describes functions in the two categories
rates, a governing board may be interested in only two
designated by Financial Executives International,
uses of financial information: (1) evaluation of finanalong with an example of the type of activities concial condition and (2) assessment of operational effiducted within each of these functions:
Jones
& Bartlett
© Jones & Bartlett Learning, LLC
ciency. Other uses©may
be irrelevant.
TheLearning,
board wantsLLC
1.
Controllership
NOT FOR SALE OR DISTRIBUTION
NOT
FOR
SALE
OR
DISTRIBUTION
to ensure that services are being provided efficiently
(a) Planning
for
control: Establish budgetary
and that the established rates are sufficient to guarantee
systems
(Chapters
13 and 16)
a stable or improved financial condition. As Table 1−3
(b) Reporting and interpreting: Prepare financial
illustrates, most healthcare decision-making groups use
statements (Chapter 9)
financial
information
to assess
financial
condition and
© Jones
& Bartlett
Learning,
LLC
© Jones & Bartlett Learning, LLC
(c) Evaluating and consulting: Conduct cost
efficiency.
NOT FOR SALE OR DISTRIBUTION
NOT FOR
SALE
analyses
(Chapter
14)OR DISTRIBUTION
(d) Administrating taxes: Calculating payroll
FINANCIAL ORGANIZATION
taxes owed
(e) Reporting to government: Submit Medicare
It is important to understand the management strucbills andLearning,
cost reports LLC
(Chapters 2 and 6)
© Jones & Bartlett
Learning,
LLC
©
Jones
&
Bartlett
ture of businesses in general and HCO in particular.
(f) Protecting
assets: Develop internal control
NOT FOR SALE
NOT FOR SALE
OR DISTRIBUTION
FigureOR
1−2DISTRIBUTION
outlines the financial management strucprocedures
ture of a typical hospital.
(g) Appraising economic health: Analyze
financial statements (Chapters 11 and 12)
Learning Objective 4
2. Treasurership
© Jones & Bartlett Learning, LLC
© Jones & Bartlett Learning, LLC
(a) Providing capital: Arrange for bond issuance
Describe the
financial
functions
within
an
NOT FOR SALE OR DISTRIBUTION (Chapter 21) NOT FOR SALE OR DISTRIBUTION
organization.
(b) Maintaining investor relations: Assist in
analysis of appropriate dividend payment policy
(for-profit firms) (Chapters 20 and 21)
International
has catego (c) Providing
short-term
financing:LLC
Arrange
©Financial
Jones &Executives
Bartlett Learning,
LLC
© Jones
& Bartlett
Learning,
rized
financial
management
functions
as
either
conlines
of
credit
(Chapters
22
and
23)
NOT FOR SALE OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
trollership or treasurership. Although few HCOs
(d) Providing banking and custody: Manage
have specifically identified treasurers and controlovernight and short-term funds transfers
lers at this time, the separation of duties is important
(Chapters 22 and 23)
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
Senior Vice-President
and Chief Financial
Officer
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
Director of Patient
Accounting
Controller
Director of Patient
Registration
© Jones & Bartlett Learning, LLC
Director SALE
of
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OR DISTRIBUTION
Director of
Financial Reporting
and Disbursements
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
Director of Corporate
Compliance and Risk
Management
Director of Material
Management
© Jones & Bartlett Learning, LLC
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Financial Analysis
Figure 1–2 Financial Organization Chart of a Typical Hospital
© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC. NOT FOR SALE OR DISTRIBUTION.
82999_ch01_FINAL.indd 7
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8 Chapter 1 Financial Information and the Decision-Making Process
© Jones & Bartlett Learning, LLC
(e) Overseeing credits and collections: Establish
NOT FOR
SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
it operates
throughOR
the healthcare
services it provides.
NOT
FOR SALE
DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
billing, credit, and collection policies (Chapters
Not-for-profit HCOs must be run as a business, how2 and 22)
ever, to ensure their long-term financial viability. With
(f) Choosing investments: Analyze capital
an annual budget of more than $10 billion, Ascension
investment projects (Chapter 19)
Healthcare is an example of one of the largest not-for© Jones
& Bartlett
Learning,
LLC
© Jones & Bartlett Learning, LLC
(g) Providing insurance:
Managing
funds related
profit
HCOs.
NOT
FOR SALE
OR DISTRIBUTION
NOT
FOR
SALE
OR
DISTRIBUTION
to self-insurance program
Not-for-profit organizations
(described
in Sec.
501(c)(3) of the Internal Revenue Code) usually are
exempt from federal income taxes and property taxes.
Learning Objective 5
In return for this favorable tax treatment, not-for-profit
organizations ©
areJones
expected
to provide
community
Discuss
the common
ownership
forms LLC
of
© Jones
& Bartlett
Learning,
& Bartlett
Learning,
LLC
healthcare
organizations,
along
with
their
benefit,
which
often
comes
in
the
form
of
providing
NOT FOR SALE OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
advantages and disadvantages.
more uncompensated care (vis-à-vis for-profit firms),
setting lower prices, or offering services that, from a
financial perspective, might not be viable for for-profit
firms. In addition to patient revenue in excess of ex© Jones & Bartlett Learning, LLC
©penses,
Jonesnot-for-profits
& Bartlett Learning,
LLC be funded by
can additionally
Forms
Of OR
Business
Organization
NOT FOR
SALE
DISTRIBUTION
NOT
FOR SALE
OR DISTRIBUTION
tax-exempt
debt, grants,
donations, and investments by
other nonprofit firms.
More so than in most other industries, firms in the
The primary advantage of the not-for-profit form of
healthcare industry consist of a wide array of ownerorganization is its tax advantage. It also typically enship and organizational structures. In health care there
joys
a lower cost of equity capital
compared
with for- Learning, LLC
© Jones & Bartlett Learning,
LLC
© Jones
& Bartlett
are four main types of organizations (adapted from the
profit firms. The main disadvantage
of this
form OR
of DISTRIBUTION
NOT FOR
SALE
NOT FOR SALE OR DISTRIBUTION
American Institute of Certified Public Accountants
organization is that not-for-profits have more limited
Audit and Accounting Guide, Health Care Organizaaccess to capital. Nonprofits cannot raise capital in the
tions, 2009):
equity markets.
Although for-profit firms are becoming increasingly
• Not-for-profit, business-oriented organizations
© Jones & Bartlett Learning, LLC
© Jones
LLC
prevalent
in many
sectors &
of Bartlett
health care,Learning,
not-for-profits
• For-profit healthcare entities
NOT FOR SALE OR DISTRIBUTION
FOR sector.
SALEAbout
OR DISTRIBUTION
still dominate NOT
the hospital
80% of hospi• Investor owned
tals
are
not-for-profit.
In
the
future,
however, this
• Professional corporations/professional associasector may witness the growth of investor-owned orgations
nizations, mainly due to their easier access to capital
• Sole proprietorships
that will be necessary for adapting to the rapid changes
Limited partnerships
© Jones &• Bartlett
Learning, LLC
© Jones & Bartlett Learning, LLC
in the healthcare system.
• Limited liability partnerships/limited liability
companies
• Governmental HCOs
• Non-governmental, nonprofit HCOs
For-Profit Healthcare Entities
The main objective of most for-profit firms is to
These four main types©ofJones
firms differ
in
terms
of
earn
profits that are distributed©toJones
the investor-owners
& Bartlett Learning,
LLC
& Bartlett Learning, LLC
ownership structure. Additionally,
different
reof the firms or reinvested in theNOT
firm FOR
for theSALE
long-term
OR DISTRIBUTION
NOT FOR
SALEHCOs
OR DISTRIBUTION
quire slightly different sets of financial statements.
benefit of these owners. For-profit hospital management must strike a balance between their fiduciary
Not-for-Profit, Business-Oriented Organizations
responsibilities to the owners of the company with
their other mission of providing acceptable-quality
© Jones & Bartlett Learning, LLC
© Jones & Bartlett Learning, LLC
Not-for-profit HCOs are owned by the entire comhealthcare services to the community.
NOT
FOR
SALE
OR
DISTRIBUTION
NOThave
FOR
SALE
OR of
DISTRIBUTION
munity rather than by investor-owners. Unlike its forFor-profit firms
a wide
variety
organization
profit counterpart, the primary goal of a not-for-profit
and ownership structures. For-profit firms that buy and
(also referred to as a nonprofit) organization is not to
sell shares of their company stocks on the open market
maximize profits but to serve the community in which
are referred to as publicly traded companies. A major
© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
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82999_ch01_FINAL.indd 8
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Forms of Business Organization 9
© Jones & Bartlett Learning, LLC
© Jones & Bartlett Learning, LLC
sole
proprietor
total control, there are few governadvantage
of
being
publicly
traded
is
the
ability
to FOR
NOT
SALE
OR has
DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
ment regulations and no special income taxes, and they
raise equity capital through the sale of company stocks.
are easy and inexpensive to dissolve. Its two main disPublicly traded firms are subject to reporting requireadvantages are unlimited liability and limited access to
ments and regulation by the Securities and Exchange
capital.
Commission. For-profit firms may also be privately
© shares
Jonesof&theBartlett
© Jones &businesses
Bartlettwith
Learning,
LLC
two
held, meaning the
companyLearning,
are held byLLC Partnerships are unincorporated
NOT
FOR
SALE
OR
DISTRIBUTION
NOT
FOR
SALE
OR
DISTRIBUTION
or more owners. Group practices of physicians somerelatively few investors and are not available to the
times were set up with this form. There are now a wide
general public. Privately held companies also have far
variety of partnership forms. They are easy to form, are
fewer reporting requirements by the Securities and
subject to few government regulations, and are not subExchange Commission. Large for-profit firms are
ject to©double
taxation.
On the Learning,
down side, partnerships
typically
publicly
traded.Learning,
However, there
© Jones
& Bartlett
LLC are excepJones
& Bartlett
LLC
have
unlimited
liability,
are
difficult
to dissolve, and cretions.
For
example,
HCA,
Inc.
is
a
national
forNOT FOR SALE OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
ate potential for conflict among the partners.
profit healthcare services company headquartered in
In a limited partnership there is at least one general
Nashville, Tennessee. Before 2005 HCA was the largpartner who has unlimited liability for the partnership’s
est publicly traded hospital company. In 2005 HCA
debts and obligations. Limited partnerships offer limwas purchased by a private equity firm and converted
© Jones & Bartlett
Learning,
LLC
© Jonesited
& Bartlett
Learning,
LLC
liability to
the limited
partners along with tax
from a publicly
traded
to a privately held company.
NOT FOR SALE
NOT
SALE ORtreatment.
DISTRIBUTION
flow-through
The disadvantage to limited
HCA,OR
Inc.DISTRIBUTION
remains a privately held company and
is FOR
partnerships is that they require a general partner who
still the largest for-profit hospital company, with 163
remains fully liable for their debts and obligations.
hospitals and related businesses in 20 states. In its fisA limited liability company, also called a limited
cal year ending December 31, 2008, the company had
liability
partnership,©isJones
a business
entity that
comafter-tax income ©
of Jones
$673 million.
& Bartlett Learning, LLC
& Bartlett
Learning,
LLC
bines
the
tax
flow-through
treatment
characteristics
of
Both publicly NOT
tradedFOR
and privately
held
for-profit
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SALE OR DISTRIBUTION
a partnership (i.e., no double taxation) with the liabilfirms are often referred to as “investor-owned” firms.
ity protection of a corporation. In a limited liability
Investor-owned firms are owned by risk-based equity
company, the liability of the general partner is limited.
investors who expect the managers of the corporation
Limited liability companies are flexible in the sense
to maximize shareholder wealth. Most large for-profit
© Jones
& legal
Bartlett
LLCfirms have a
© Jones
& Bartlett
Learning,
LLC of inthat they
permit owners
to structure
allocations
firms
use this
form.Learning,
Investor-owned
NOT FOR
SALE
OR DISTRIBUTION
FORany
SALE
come NOT
and losses
way OR
they DISTRIBUTION
desire, as long as the
relative
advantage
in terms
of financing. In addition to
partnership tax allocation rules are followed.
debt, for-profit firms can raise funding through riskbased equity capital. They enjoy limited liability, but
Governmental Healthcare Organizations
their earnings are taxed at both the corporate level and
shareholder level (so-called double taxation). The
© Jones & Bartlett Learning, LLC
© Jones & Bartlett Learning, LLC
Governmental HCOs are public corporations, typicompany pays corporate income tax, and the shareNOT FOR SALE
OR
DISTRIBUTION
NOT
FOR
SALE
OR
cally
owned
byDISTRIBUTION
a state or local government. They are
holder pays both tax on dividends paid by the company
operated for the benefit of the communities they serve.
and gains made on the sale of the company’s stock
A variation on this type of ownership is the public
A professional corporation, also called a profesbenefit organization. Assets (and accumulated earnsional association, is a corporate form for professionals
benefit&corporation
belong
who wanted to have
the advantages
of incorporation.
© Jones
& Bartlett
Learning,ALLCings) of a nonprofit public
© Jones
Bartlett Learning,
LLC
to the public or to the charitable
beneficiaries
theDISTRIBUTION
trust
professional corporation
does SALE
not, however,
shield its
NOT FOR
SALE OR
NOT FOR
OR DISTRIBUTION
was organized to serve. In 1999, for example, the
owners from professional liability. Professional corpoNassau County Medical Center, a 1,500-bed healthcare
rations and professional associations have been widely
system on Long Island, New York, converted from
used by physicians and other healthcare professionals.
county ownership to a public benefit corporation. The
Sole proprietorships are unincorporated businesses
© Jones & Bartlett Learning, LLC
© Jones & Bartlett Learning, LLC
purpose of the conversion was to give Nassau County
owned by a single individual. They do not necessarily
NOT
FOR
SALE
OR
DISTRIBUTION
NOT
FORgreater
SALEautonomy
OR DISTRIBUTION
Medical
Center
in its governing
have to be small businesses. Solo practitioner physiboard and decision making, so that it could compete
cians often are sole proprietors. There are several admore effectively with the area’s large private hospitals
vantages to a sole proprietorship: They are easy and
and networks.
inexpensive to set up, there is no sharing of profits, the
© Jones & Bartlett Learning, LLC
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82999_ch01_FINAL.indd 9
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10 Chapter 1 Financial Information and the Decision-Making Process
© Jones & Bartlett Learning, LLC
In some cases governmental HCOs may have access
NOT FOR
SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
invaluable
services,OR
the DISTRIBUTION
financial statements and finanNOT
FOR SALE
to an additional revenue source through taxes—an opcial management of these organizations are somewhat
tion not available to other not-for-profit HCOs. Similar
different from that of business-oriented firms. Although
to other not-for-profits, government HCOs are not able
many of the topics covered in this book are applicable
to raise funds through equity investments and are exto these firms, these firms are not explicitly covered in
© Jones
Bartlett Learning,
© Jones & Bartlett Learning, LLC
empt from income taxes and
property&taxes.
thisLLC
book.
NOT FOR SALE OR DISTRIBUTION
NOT
FOR
SALE
OR
DISTRIBUTION
Governmental HCOs can face political pressures if
their earnings become too great. Rather than reinvestSUMMARY
ing their surplus in productive assets, the hospital
might be pressured to return some of the surplus to the
The healthcare sector of our economy is growing
community,
to
reduce
prices,
or
to
initiate
programs
rapidly
both in
and &complexity.
Understanding
© Jones & Bartlett Learning, LLC
© size
Jones
Bartlett Learning,
LLC
that are not
financially
advisable.
the financial and
economic
implications
of decision
NOT FOR SALE OR DISTRIBUTION
NOT
FOR SALE
OR DISTRIBUTION
making has become one of the most critical areas enNonprofit, Non–Business-Oriented Organizations
countered by healthcare decision makers. Successful
decision making can lead to a viable operation capable
Non–business-oriented HCOs perform voluntary
of providing needed healthcare services. Unsuccessful
© Jones
& Bartlett
LLC
Jones making
& Bartlett
Learning, LLC
services
in their Learning,
communities;
accordingly, they are © decision
can and often does lead to financial
NOT FOR
OR DISTRIBUTION
FORThe
SALE
DISTRIBUTION
often SALE
called voluntary
health and welfare organiza- NOT
failure.
role OR
of financial
information in the
tions. They are tax exempt and rely primarily on pubdecision-making process cannot be overstated. It is
lic donations for their funds. Examples include the
incumbent on all healthcare decision makers to beAmerican Red Cross and the American Cancer
come accounting-literate in our financially changing
Society. Although these types
of organizations
provide
healthcare
© Jones
& Bartlett
Learning,
LLC environment.
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
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82999_ch01_FINAL.indd 10
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Summary 11
© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
ASSIGNMENTS
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1. Only in recent years have hospitals begun to develop meaningful systems of cost accounting. Why did they not begin such development sooner?
© Jones & Bartlett Learning, LLC
© Jones & Bartlett Learning, LLC
DISTRIBUTION
2. Your
hospital
hasSALE
been approached
by a major employer in your market
area
to negotiate
NOT
FOR
SALE OR
NOT
FOR
OR DISTRIBUTION
a preferred provider arrangement. The employer is seeking a 25% discount from your current charges. Describe a structure that you might use to summarize the financial implications of this decision. Describe the factors that are critical in this decision.
type of
financial information
should be routinely
to board
members?
© Jones3.&What
Bartlett
Learning,
LLC
© provided
Jones &
Bartlett
Learning, LLC
NOT FOR SALE OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
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82999_ch01_FINAL.indd 11
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12 Chapter 1 Financial Information and the Decision-Making Process
© Jones & Bartlett Learning, LLC
© Jones & Bartlett Learning, LLC
SOLUTIONS
AND
ANSWERS
NOT
FOR SALE OR DISTRIBUTION
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1. Before 1983 most hospitals were paid actual costs for delivering hospital services. With
the introduction of Medicare’s prospective payment system in 1983, hospitals now receive
prices based
diagnosis-related
thatLLC
are fixed in advance. Cost©control
and,
© on
Jones
& Bartlett groupings
Learning,
Jones
& Bartlett Learning, LLC
therefore, cost
accounting
are
critical
in
a
fixed-price
environment.
The
expansion
of
manNOT FOR SALE OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
aged care has further restricted revenue and fostered greater interest in costing.
2. This problem could be set up in a results matrix (see Table 1−2). The two actions to be
charted are to accept or to reject the preferred provider arrangement opportunity. Possible
events&center
on the
magnitudeLLC
of volume changes, for example,
to lose
1,000 patient
© Jones
Bartlett
Learning,
© Jones
& Bartlett
Learning, LLC
days
or
to
gain
500
patient
days.
A
key
concern
in
estimating
the
financial
impact
is DISTRIBUTION
the
NOT FOR SALE OR DISTRIBUTION
NOT FOR SALE
OR
hospital’s incremental revenue and incremental cost positions. In short, how large would
the revenue reduction and cost reduction be if significant volume were lost? Actuarial
gains or losses of business are functions of the hospital’s market position.
© Jones & Bartlett
Learning,
Jonesinformation
& Bartlettthat
Learning,
LLCes3. Board
membersLLC
do not need to see detailed©financial
relates to their
tablished
plans
to
ensure
that
the
plans
are
being
met.
If
significant
deviations
have
ocNOT FOR SALE OR DISTRIBUTION
NOT FOR SALE OR DISTRIBUTION
curred, more details may be necessary to take corrective action or to modify established
plans.
© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
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© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
NOT FOR SALE OR DISTRIBUTION
© Jones & Bartlett Learning, LLC
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