Assignment 1 summer

Chapter 1

Financial

Information and the

Decision-Making

Process

Learning Objectives

• Describe the importance of financial information in healthcare organizations.

• Discuss the uses of financial information.

• List the users of financial information.

• Describe the financial functions within an organization.

• Discuss the common ownership forms of healthcare organizations, along with their advantages and disadvantages.

Importance of Financial Information

• Cash flow management

• Investment decisions

• Long-term goals of organization

• Main goal: reduce risks and maximize

profits

Ambulatory Surgery Center

• Consider two actions: to build or not to

build an ASC

• Uncertainty of decision making

• Results matrix: 50% utilization enables

ASC to operate in the black

• Does not account for desirability of

outcomes

Importance of Financial

Information, cont.

Healthcare Industry: Trends

• Rapid growth of healthcare industry,

including hospitals, long-term care

facilities, home health, ambulatory

services, etc.

• Healthcare costs are increasing:

healthcare spending is 17% of the U.S.

GDP

• Increasing importance of financial and cost

information in decision making

Healthcare Industry

• Healthcare industry differs from other

business organizations:

 Dominance of not-for-profit hospitals

 Main source of revenue: reimbursement from

government and private insurers

 Contribution to social well-being

Centers for Medicare and Medicaid Services, Office of the Actuary

Uses of Financial Information

• Evaluating the financial condition of an

entity

• Evaluating stewardship within an entity

• Assessing the efficiency of operations

• Assessing the effectiveness of operations

• Determining the compliance of operation

with directives

Financial Condition

• Status of a firm’s assets, liabilities, and

equity positions described in financial

statements

• Equated with an organization’s viability

• Most common use of financial information

• Underlies most business decisions

• Includes assessment of short-term versus

long-term conditions

Stewardship

• Management’s responsibility to properly

utilize organization’s resources, including

people, property, and financial assets

• Historically most important

• Designed to prevent loss of assets through

employees’ malfeasance

Efficiency

• The ratio of outputs to inputs; the lowest

possible cost of production

• Becoming increasingly important given

increasing healthcare costs and lower

reimbursement

• Implies availability of standards or

benchmarks for comparison

Effectiveness

• Attainment of objectives through

production of outputs

• Difficult to measure as organizations do

not always state their objectives

quantitatively

• Gets less emphasis than efficiency => see

unnecessary services at an efficient price:

 Lower cost of surgeries at outpatient surgery

centers, but are these surgeries necessary?

Compliance

• Whether or not an organization’s

directives are followed

• Financial reporting is required to ensure

compliance

 Internal uses (e.g., budgets)

 External uses (e.g., lenders or credit rating

agencies)

Financial Management Functions

• Two main duties of financial managers: controllership and treasurership

• Controllers deal with internal finances:

 Direct preparation of financial statements and reports

 Direct preparation of budgets

 Analyze future earnings and expenses

 Develop internal control procedures

 Prepare reports for regulatory agencies

Financial Management Functions,

cont.

• Treasurers deal with external finances:

 Establish billing, credit, and collection policies

 Manage investments

 Secure financing Short-term (e.g., arrange line of credit, short-term

transfer funds)

Long-term (e.g., bond issuance)

 Maintain investor & credit rating relations

 Analyze mergers and acquisition opportunities

Figure 1–2 Financial Organization

Chart of a Typical Hospital

FIGURE 1-2 Financial Organization Chart of a Typical Hospital

Forms of Business Organizations

• Main forms of business organization in

health care:

 Not-for-profit (NFP) business-oriented

 Investor-owned (IO) entities

 Government health care

 Nongovernmental NFP

• Differ in ownership structure

NFP Business-Oriented Organizations

• Objective function: maximize shareholders’ value versus profit maximization

• Shareholders: community versus individuals

• Exempt from federal income tax and most state and local property taxes

• Required to provide “community benefit”

• Lower cost of equity capital than IO, but more limited access to capital

• At present, 80% of hospitals are NFP

Investor-Owned Healthcare Entities

• Shareholders: risk-based equity investors

• Objective function: profit maximization for

shareholders

• Able to access capital through debt and

equity

• Subject to “double taxation” (i.e., taxed at

both the corporate level and the individual

level [shareholders])

Investor-Owned Entities

Main types of IO entities:

 Publicly traded

 Privately held

 Professional corporations/associations

 Sole proprietorships

 Limited partnerships

 Limited liability companies

Publicly Traded Companies

• Buy and sell shares of the firm on the

open market

• Subject to reporting requirements and

regulation by the Securities and Exchange

Commission (SEC)

• Advantage: ability to raise equity capital

through the sale of company stocks

Privately Held Companies

• Shares are held by few investors and not

available to the general public

• Advantage: subject to far fewer reporting

requirements by SEC

• Until recently, Hospital Corporation of

America (HCA) was the largest privately

held hospital system

Professional Corporations

• Professional corporations/associations

(PC, PA) are formed by professionals with

the advantage of corporation

• Shareholders are free from personal

liability, but professionals are liable

• Widely used by physicians as it protects

them from the liabilities of each other

Sole Proprietorships

• Unincorporated businesses owned by a single individual (e.g., solo practitioner physicians)

• Advantages:

 Easy and inexpensive to set up

 No profit sharing

 No government regulations

 No special income taxes

• Disadvantages:

 Unlimited liability

 Limited access to capital

Limited Partnerships

• Unincorporated businesses with two or

more owners

• Advantages:

- Easy to form

- Subject to few government regulations

- Not subject to double taxation

• Disadvantages:

- Unlimited liability by at least one partner

- Difficult to dissolve

- Potential for conflict among partners

Limited Liability Companies

• LLCs/Limited liability partnerships (LLPs)

combine the characteristics of partnership

with the liability protection of corporation

• Liability of the general partner is limited

• Flexible to structure allocations of income

and losses as owners choose

• Required to follow tax allocation rules

Government Healthcare

Organizations • Public corporations owned by a state or local

government

• Sometimes have access to additional revenue

through taxes

• Not able to raise funds through equity investments

• Like NFPs, exempt from property and income taxes

• May face political pressure to return some of the

earnings to the community or reduce prices if

earnings are too large

NFP Non-Business-Oriented

Organizations • Perform voluntary services in communities

• Tax-exempt

• Rely primarily on public donations

• Financial statements and financial management are different from business- oriented firms

• Examples: American Red Cross, American Cancer Society