Chapter 3: Paying for Health Services

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Healthcare Business Basics

CHAPTER 2 Healthcare Business Basics

Concept of a business

Legal forms of business

For-profit versus not-for-profit ownership

Organizational goals

Financial goals

Taxes

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Concept of a Business

A business is an entity that

raises money in the capital markets,

invests these funds in assets (land, buildings, equipment, inventories, and so on),

uses these assets to create products or services, and

sells these products or services to sustain itself.

A pure charity is different. Why?

Concept of a Business

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Legal Forms of Business

There are four major categories of business organization (legal forms of business):

Proprietorship (sole proprietorship)

Partnership

Corporation

Hybrid forms

How much does the organizational form influence the practice of healthcare finance?

Legal Forms of Business

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Proprietorships and Partnerships

Advantages:

Ease of formation

Subject to few regulations

No corporate income taxes

Disadvantages:

Limited life

Difficult to transfer ownership

Unlimited liability

Difficult to raise capital

Proprietorships and Partnerships

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Corporation

Advantages:

Unlimited life

Easy transfer of ownership

Limited liability

Ease of raising capital

Disadvantages:

Cost of formation and reporting

Double (or triple) taxation for investor-owned corporations

Corporation

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Hybrid Gorms of Organization

Limited partnership (LP)

General partners have control

Limited partners are liable only for their initial contribution

Not commonly used by healthcare providers

Limited liability partnership (LLP)

Partners share general business liability

However, partners are liable only for their own malpractice actions

Hybrid Forms of Organization

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Hybrid Forms of Organization (cont.)

Limited liability company (LLC)

Members are taxed like partners

Liability like that of stockholders

Professional corporation (PC) or professional association (PA)

Owners have benefits of incorporation

However, they are still liable for malpractice

Often used by individual clinicians

Hybrid Forms of Organization (cont.)

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Alternative Forms of Ownership

In most industries, the only form of ownership is the investor-owned (for-profit) business.

However, in the health services industry, a significant proportion of businesses, particularly hospitals, are organized as not-for-profit corporations.

Alternative Forms of Ownership

How much does ownership influence the practice of healthcare finance?

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Investor-Owned (For-Profit) Corporations

Investors become owners by purchasing shares of common stock.

Primary market transactions

Initial public offerings (IPOs)

New common stock sales

Secondary market transactions

On exchanges

In the over-the-counter market

Stockholders have:

right of control, and

claim on residual earnings and residual liquidation proceeds.

Investor-Owned (For-Profit) Corporations

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Not-For-Profit Corporations

If a business meets certain requirements, it can qualify as a not-for-profit (nonprofit) corporation.

These corporations:

generally have no shareholders and, hence, do not have a single clientele to which managers are responsible;

receive various tax exemptions; and

can be thought of as being owned by “the community.”

Not-For-Profit Corporations

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Organizational Goals

The primary goal of for-profit corporations is shareholder wealth (stock price) maximization.

The primary goal of not-for-profit corporations is generally expressed in a mission statement, often in terms of service to the community.

What is the primary goal of proprietorships and partnerships?

Organizational Goals

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Stakeholders

All businesses have stakeholders, who are parties that have an interest (often financial) in the business.

Stakeholders include owners (if for profit), managers, employees, suppliers, patients, and even the community at large.

Not-for-profit managers must satisfy all stakeholders.

For-profit managers are primarily concerned with satisfying owners.

Stakeholders

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Discussion Items

What responsibilities do for-profit businesses have to stakeholders other than owners?

Should for-profit businesses behave ethically? If so, why?

Discussion Items

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Financial Goals

The primary financial goal of investor-owned corporations stems from their organizational goal: shareholder wealth (stock price) maximization.

The primary financial goal of not-for-profit corporations is to ensure the financial viability of the organization.

Does the difference in financial goals lead to different behavior?

Financial Goals

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Tax Laws

Some understanding of tax laws is necessary because taxes influence

financing decisions,

the operating cash flows available to an investor-owned business, and

the ability to raise contribution capital.

There are several types of taxes:

Federal, state, and local

Personal versus corporate

Ordinary income versus capital gains

Tax Laws

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Personal Taxes

Individuals pay federal (and perhaps state) taxes on salaries, interest, and other income at rates that can approach 50%. (Capital gains and dividends [in some years] are taxed at lower rates.)

Taxes reduce the amount of useable income. Consider a person paying 40% in taxes who receives $100 in interest:

Personal Taxes

After-tax amount = Before-tax amount × (1 − T)

= $100 × (1 − .40)

= $100 × .60 = $60

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Corporate Taxes

Investor-owned corporations pay federal and state taxes on corporate income at rates that can exceed 40%.

Not-for-profit corporations, for the most part, are not subject to taxation.

Not-for-profit corporations have two additional tax benefits:

Can issue tax-exempt (municipal) bonds

Can receive tax-exempt contributions

Corporate Taxes

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Taxable Versus Muni Bonds

Assume that a for-profit healthcare organization must offer a 10% interest rate on its new bonds.

Jane Green, an individual investor with a 28% tax rate, buys one $1,000 bond. What is the effective (after-tax) annual interest?

AT$ = (.10 × $1,000) × (1 − .28)

= $100 × .72 = $72

AT% = 10% × (1 − .28) = 10% × .72

= 7.2%

Taxable Versus Muni Bonds

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Discussion Items

Assume that a not-for-profit healthcare organization can issue similar-risk municipal bonds with an 8% interest rate. Should Jane buy the not-for-profit bond rather than the for-profit bond?

At what rate on the for-profit bond would Jane be indifferent between the two bonds?

AT% = BT% × (1 − T)

8% = BT% × (1 − .28) = BT% × .72

BT% = 8% ÷ .72 = 11.1%

Discussion

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Discussion Item

Not-for-profit businesses generally are exempt from local property taxes and state and federal income taxes. Should policymakers mandate that not-for-profit healthcare organizations provide indigent (charity care) services equal to the tax benefits received?

Discussion Item

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Conclusion

This concludes our discussion of Chapter 2 (Healthcare Business Basics).

Although not all concepts were discussed, you are responsible for all of the material in the text.

Do you have any questions?

Conclusion

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