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_LecturePacket4.pptxHealthcare Financial Management Lecture Packet # 4 2022
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Outline
Basic Concepts of Financial Accounting
Outlined by Generally Accepted Accounting Principles (GAAP)
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Financial Statements
Income Statement: (Revenues -Expenses).
Net Patient Service Revenue
Other Revenue
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Salaries & Benefits
Supplies
Insurance
Lease
Depreciation
Provision of Bad Debts
Interest
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Basic Concepts of Financial Accounting
Outlined by Generally Accepted Accounting Principles (GAAP)
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Basic Concepts of Financial Accounting
Going Concern:
It is assumed that the accounting entity will operate as a going concern.
The company will have an indefinite life. As a result, assets are valued differently.
e.g. For example, the land, building, and equipment of a hospital may have a value of $50 million when used for patient services.
However, if these services are sold to an outside party (for other purposes), the value of these assets may only be $20 million.
As a result of the Going Concern assumption, assets are viewed over a longer time frame and they are valued higher.
Thus, they are not true market measurements. _____________________________________________________________
The going concern assumption, coupled with the fact that financial statements must be prepared for relatively short periods means that financial accounting data is not exact.
Financial Statements are a systematic way to deal with complex measurements. However, the measure is not perfect. NO MEASURE IS PERFECT.
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Basic Concepts of Financial Accounting
Accounting Period:
An accounting period is the amount of time over which an organization’s managers or outside parities want to evaluate operational results.
The accounting period could be over months, a year, or a fiscal year.
It does not have to coincide with the calendar year.
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Objectivity:
The information reported in financial statements must be based on objective verifiable supporting data and not subjective data.
Financial statements should be based on supporting documentation, such as invoices and contracts.
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Reliability:
Financial statements should be reasonably free of error/bias.
It is assumed that the information fairly represents the economic events which have affected the company.
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Basic Concepts of Financial Accounting
Relevance:
Financial statements must be relevant to their users.
This is always a balancing act.
The information must be able to aid in decision making.
However, there can’t be so much information that the users get bogged down.
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Full Disclosure:
Financial Statements must contain a complete picture of the economic events of a business.
Anything less is viewed as misleading by omission.
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Conservatism:
The conservatism concept calls for choosing the approach that is least likely to overstate the financial condition of the business.
Goal of Conservatism: overstate expenses, understate revenues.
Think of your own personal/family budget.
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Basic Concepts of Financial Accounting
Consistency:
When a company’s financial statements are compared over extend periods of time (e.g. 10 years of annual statements). The users must feel confident when they are comparing the results over time.
If there is a change in accounting methods, it is required that an explanation of the change be disclosed in the footnotes.
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Comparability:
When users look at quarterly and financial statements of businesses in the same industry, the users must feel confident that the data are comparable.
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Accounting Methods:
Cash accounting, accrual accounting methods.
Accrual accounting methods is the only method that is audited by GAAP.
As a result, its use dominates financial statements.
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Basic Concepts of Financial Accounting
Accounting Methods (continued)
Cash Accounting:
With cash basis accounting, economic events are recognized when the financial transaction occurs.
The cash transaction dictates the action/ reporting.
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e.g. The clink provides services to a patient in December 2018. At that time the clinic bills the insurer $700. However, the clinic did not receive a payment from the insurer until February 2019.
Under cash accounting, the $700 dollar obligation on the part of the insurer will not appear on the clinic’s 2018 financial statements.
Instead, it will appear when the cash was received in February 2019.
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Basic Concepts of Financial Accounting
Accounting Methods (continued):
Cash Accounting:
The core argument in favor of favor of cash accounting is that the most important event is to record the receipt of cash, not the provision of services.
The recording of expenses (or expenditures) follow the same pattern.
Expenses would not be recorded until they were actually paid out.
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Cash Accounting Advantages:
Easy to use
Closely aligned with the accounting needed for tax purposes.
This is the reason why many sole proprietorships use cash accounting methods.
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Basic Concepts of Financial Accounting
Accounting Methods (continued):
Accrual Accounting:
The economic event creates the financial transaction and provides the basis for the accounting entry.
This economic event takes precedence over cash transaction itself.
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Revenue earned does not necessarily correspond to the receipt of cash.
When the revenue is recorded (i.e. services performed) in one accounting period and the payment does not occur until the next period, the revenue reported has not yet been collected and hence no cash has been received.
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Basic Concepts of Financial Accounting
Accounting Methods (continued):
e.g. A clinic provided services in 2018 and did not receive payment until 2019. The accounting year ended on 12/31/2018. The clinics books were closed after the revenue was recorded , but before the cash was received.
Thus, the clinic reported $700 of revenue on the 2018 financial statements even though no cash was collected.
With accrual accounting, the amount of money not collected is still listed in the financial statements.
Thus, not all of the revenues represent cash receipts.
This speaks to the importance of Revenue Cycle Management (turning revenue from services provided into cash).
We will revisit this concept later.
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Basic Concepts of Financial Accounting
Revenue Recognition Principle:
Requires that all revenues be recognized in period where they are realized and earned.
The period where services have been provided.
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Matching Principle:
Requires that an organization expenses be matched to the revenues to which they are related.
The implementation of matching principle creates many problems.
One such problem occurs with long lived assets such as property, buildings and equipment (PP&E).
E.g. assets such as a hospital ward can provide revenue for many years. The matching principle dictates that that its costs (e.g. deprecation costs) should be spread over those same years.
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Financial Statements
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Income Statement.
A financial statement which identifies which identifies how revenue is transformed into net income (Revenues -Expenses).
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Balance Sheet.
Identifies the company’s financial position. Also called the statement of financial position.
The balance sheet identifies what resources the company has and what it owns.
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Statement of Cash Flows.
Provides information on the company’s cash receipts and disbursements.
Cash received from operating, financing, and investing activities.
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Income Statement
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Income Statement
Income Statement:
Revenues - Expenses = Net Income.
The income statement summarizes the operations.
i.e. activities of an organization with a focus on its revenues, expenses, and profitability (net income).
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The income statement is also known as the statement of operations and statement of activities.
The income statement answers the most frequent question asked about business.
“Is the business making money.”
Income statement is sometimes viewed as the company’s most important measure.
We will talk about later.
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| 2019 | 2018 | |
| Revenues : | ||
| Net Patient Service Revenue | $169,013.00 | $140,896.00 |
| Other Revenue | $7,079.00 | $5,704.00 |
| Total Revenues | $176,092.00 | $146,600.00 |
| Expenses: | ||
| Salaries and Benefits | $126,223.00 | $102,334.00 |
| Supplies | $20,568.00 | $18,673.00 |
| Insurance | $4,518.00 | $3,710.00 |
| Lease | $3,189.00 | $2,603.00 |
| Depreciation | $6,405.00 | $5,798.00 |
| Provision of Bad debts | $2,000.00 | $1,800.00 |
| Interest | $5,329.00 | $3,476.00 |
| Total Expenses | $168,232.00 | $138,394.00 |
| Net Income | $7,860.00 | $8,206.00 |
Income statement ended 12/31/2018 and in 12/31/2019. Income is in thousands of dollars.
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Income Statement
Net Patient Service Revenue
Other Revenue
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| 2019 | 2018 | |
| Revenues : | ||
| Net Patient Service Revenue | $169,013.00 | $140,896.00 |
| Other Revenue | $7,079.00 | $5,704.00 |
| Total Revenues | $176,092.00 | $146,600.00 |
Income Statement
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Income Statement
Revenue:
Revenue is the income an organization receives.
The positive product of an asset.
Revenue is comprised mainly of an organizations operating activities.
This may include sales of products (sales), rendering of services, and earning from interest, dividends, and lease income.
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Net Patient Service Revenue:
Revenue solely from patient services.
“Net” signifies that amount shown is less than the clinics gross charges for the services that it provides.
The discount is incorporated before the revenue is recorded on the net patient service revenue line.
Patient service revenue category is the amount shown when discounts are already in place.
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| 2019 | 2018 | |
| Revenues : | ||
| Net Patient Service Revenue | $169,013.00 | $140,896.00 |
| Other Revenue | $7,079.00 | $5,704.00 |
| Total Revenues | $176,092.00 | $146,600.00 |
Income Statement
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Income Statement
Other Revenue:
The clinic reported “Other Revenue” in the amount of $7,079.
Other revenue can be interest earned from securities, unrestricted charitable contributions, food service, parking fees, gift shops, etc.
Issues with Other Sources Of Revenue:
Over reliance on such streams could lead to operational inefficiencies.
This occurs because of an over focus on items that are not in the main line of business.
Having other sources of revenues could place an organizations not-for profit status in jeopardy.
Recommended that hospitals create a for-profit subsidiary and pay taxes on revenues for items which are not part of its core business.
Please see supplemental reading titled: Can Net Income from Non-Patient-Care Activities Continue to Save Hospitals?
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Income Statement
Salaries & Benefits
Supplies
Insurance
Lease
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| Expenses: | 2019 | 2018 |
| Salaries and Benefits | $126,223 | $102,334 |
| Supplies | $20,568 | $18,673 |
| Insurance | $4,518 | $3,710 |
| Lease | $3,189 | $2,603 |
| Depreciation | $6,405 | $5,798 |
| Provision of Bad debts | $2,000 | $1,800 |
| Interest | $5,329 | $3,476 |
| Total Expenses | $168,232 | $138,394 |
| Net Income | $7,860 | $8,206 |
Income Statement
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Income Statement
Expenses:
Expenses are the negative product of an asset.
To produce revenues, organizations must incur costs, or expenses.
Salaries:
In health care organizations, salaries usually represent the largest expense category.
Please see supplemental readings titled :
Hospital-Owned Medical Practices: Gaining the Benefits without the Losses
Something Old Is New Again: Structuring Physician Practice Acquisitions
The Management of Healthcare Expenses in Hospitals and Health Systems
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Income Statement
Supplies:
Cost of supplies used in providing services (primarily medical supplies).
The clinic does not order and pay for supplies when a particular patient requires them.
Instead, the clinic may order before hand and keep an inventory.
Thus, the report does not reflect the actual cash spent by organization on patient care supplies.
We will revisit this concept later.
Insurance Expense:
The cost of commercial insurance to protect against unexpected emergencies.
Lease:
The clinic leased some of its equipment and the total amount of lease payments $3,189.00 (for that accounting period) is reported as an expense.
Buy-versus-lease decisions and EMR implementation.
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Income Statement
Depreciation
Provision of Bad Debts
Interest
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| Expenses: | 2019 | 2018 |
| Salaries and Benefits | $126,223 | $102,334 |
| Supplies | $20,568 | $18,673 |
| Insurance | $4,518 | $3,710 |
| Lease | $3,189 | $2,603 |
| Depreciation | $6,405 | $5,798 |
| Provision of Bad debts | $2,000 | $1,800 |
| Interest | $5,329 | $3,476 |
| Total Expenses | $168,232 | $138,394 |
| Net Income x | $7,860 | $8,206 |
Income Statement
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Income Statement
Depreciation:
Depreciation is a measure of how much tangible asset (i.e. building & equipment) has been used up during an accounting period.
For example, if a hospital buys new examination room equipment for $10,000 and expects the equipment to last ten years, the account might record $1,000 depreciation each year.
This is based on the assumption that one-tenth of the equipment is used up each year.
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The hospital will not report their purchase price as an expense on an income statement.
The one time purchase price is not recorded.
Instead, the purchase price is listed on other parts of the financial statement.
We will revisit this concept later.
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Income Statement
Depreciation:
Some reasons for pursuing a deprecation strategy instead of reporting the full cost of the asset when purchased:
Improper to allocated a fixed asset to a single accounting period: The assets are used to produce revenues over a longer period of time (matching principle).
Severe Impact on Profitability: If the cost of the fixed asset were reported when they were acquired it would have severe impacts on the reported profitability (revenues –expenses) in the year which it was acquired.
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Income Statement
Depreciation (continued):
Salvage Value:
Salvage value is the amount (if any) expected to be received when the final depreciation occurs at the end of the asset's useful life.
The result is the asset's annual depreciation expense, which is the charge that is reflected in each year's income statement.
The term straight line stems from the fact that the depreciation expense is constant every year.
We will revisit depreciation later.
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Income Statement
Uncompensated Care
Bad Debt -v- Charity Care:
Charity Care:
It is known that the patient cannot pay before the service is rendered.
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Bad Debt:
Results from the failure to collect for services provided to patients and third party payers that do have the capacity to pay.
A description of the policies regarding discounts and charity care will often appear in the footnotes of the financial statements.
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Income Statement
Provision of Bad Debts:
Bad debts are revenues that were expected to be collected and then reported.
However, the revenues will never be realized (collected) and the clinic expects it will ultimately will become losses (bad debt).
Bad debt expense category is based on past experiences.
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The clinic expected that $169,013,000 - $2,000,000 = $167,013,000 will be collect for patient services provided in 2019.
Bad debt loss to Net Patient Service Revenue: $2,000,0000/ $169,013,000 = .012 or 1.2 %.
Managers should review the clinics collection policy to ensure that its collection efforts are effective, and accounts must reconcile actual bad debt losses (which will not be known for some time) with past estimates.
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Income Statement
Interest Expense:
Interest expense for debt capital supplied.
Not all of the interest expense reported has been paid because the clinic typically pays the interest semi-annually or monthly.
Hence, some of the interest which has accumulated on some loans will not be paid until the following year(accrual accounting standards).
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| 2019 | 2018 | |
| Revenues : | ||
| Net Patient Service Revenue | $169,013.00 | $140,896.00 |
| Other Revenue | $7,079.00 | $5,704.00 |
| Total Revenues | $176,092.00 | $146,600.00 |
| Expenses: | ||
| Salaries and Benefits | $126,223.00 | $102,334.00 |
| Supplies | $20,568.00 | $18,673.00 |
| Insurance | $4,518.00 | $3,710.00 |
| Lease | $3,189.00 | $2,603.00 |
| Depreciation | $6,405.00 | $5,798.00 |
| Provision of Bad debts | $2,000.00 | $1,800.00 |
| Interest | $5,329.00 | $3,476.00 |
| Total Expenses | $168,232.00 | $138,394.00 |
| Net Income | $7,860.00 | $8,206.00 |
Income statement ended 12/31/2018 and in 12/31/2019. Income is in thousands of dollars.
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Income Statement
Net Income:
Because of the location on the income statement it is known as the bottom line.
Viewed as the single most important category on the financial statement.
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For-Profit organizations: Call net income: profit earned, profit line.
Not-for profit organizations: Call net income: revenues over expenses, excess of revenues over expenses.
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Income Statement
Not-for-profit Organizations and Profit Motive:
Not-for- profit organizations must still make a profit.
“No Margin no Mission”
If the clinic is to offer new services in the future, it must earn a profit today to produce the funds it needs for new assets.
Because of inflation, the clinic could not replace its current fixed assets base as needed without the funds generated by its ability to make a profit.
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All of a not-for-profit organization’s net income must be reinvested into the business.
While, an investor owned firm may return a portion of its net income to owners in the form of dividend payments.
We will talk about later.
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National Trends in Uncompensated Care and Profitability
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Healthcare Financial Management Lecture Packet # 4 2022
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