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CHAPTER 7 Managing Financial Operations

Revenue cycle (billing and collections)

Receivables management

Cash and marketable securities management

Inventory (supply chain) management

Operational monitoring and control

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Financial Operations

Financial operations involves the day-to-day oversight of such tasks as billing and collections (revenue cycle), cash management, and inventory management.

The specifics are highly dependent on the type of provider (e.g., hospital versus medical practice versus nursing home).

Thus, the focus here is on fundamental concepts as opposed to details.

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The Revenue Cycle

The revenue cycle is defined as all activities associated with billing and collecting for services.

In general, revenue cycle management should ensure that

patients are properly categorized by payer,

correct and timely billing takes place, and

correct and timely payment is received.

The revenue cycle includes the activities listed on the next slide.

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The Revenue Cycle (cont.)

Before-service activities:

Insurance verification

Certification of managed-care patients

Patient financial counseling

At-service activities:

Insurance status verification

Service documentation/claims production

After-service activities:

Claims submission

Third-party follow-up (if needed)

Denials management

Payment receipt and posting

Monitoring and reporting:

Monitoring

Review and improvement

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The Revenue Cycle (cont.)

In revenue cycle management, each of the identified activities is closely monitored to ensure that

the correct amount of reimbursement is collected on each patient,

reimbursements are collected as quickly as possible, and

the costs associated with the revenue cycle are minimized consistently with rapid and correct collections.

Two important keys to good revenue cycle management are information technology and electronic claims processing.

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Receivables Management

If a service is provided for cash, the revenue is immediately received.

If the service is provided on credit, the revenue is not received until the receivable is collected.

Receivables management, which falls under the general umbrella of the revenue cycle, is extremely important to healthcare providers.

Why?

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Accumulation of Receivables

Suppose Valley Clinic contracts with an insurer whose patients use $2,000 in services daily and who pays in 40 days.

The clinic will accumulate receivables at a rate of $2,000 per day.

However, after 40 days, the receivables balance will stabilize at $80,000:

Receivables = Daily sales × Average collection period

= $2,000

× 40

= $80,000

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Cost of Carrying Receivables

Valley Clinic must pay its expenses (i.e., labor and supplies) before it receives its payment.

Suppose Valley Clinic uses bank financing that has an interest rate of 10 percent to pay its costs (finance its receivables).

The annual cost of carrying the receivables is $8,000:

$80,000 × 0.10 = $8,000.

What two factors influence the dollar cost of carrying receivables?

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Monitoring Receivables

It is important that healthcare managers continuously monitor the firm’s receivables to ensure that

payment is received promptly, and

the quality of receivables does not deteriorate.

Monitoring methods include

average collection period (ACP), often called days in patient accounts receivable, and

aging schedules.

Receivables are monitored both in the aggregate and by specific payer.

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Cash Management

The goal of cash management is to hold the minimum amount necessary to meet liquidity requirements. Why?

The primary cash management technique is float management:

Acceleration of receipts

Disbursement control

The cost of cash management initiatives must be balanced by corresponding benefits.

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Float Management

Float is the difference between the cash amount on the bank’s books and the amount on the firm’s checkbook.

Suppose Family Healthcare writes $2,000 in checks daily. It takes six days for them to be received and clear the banking system, so the bankbook is $12,000 more than the checkbook.

Family Healthcare receives $3,000 in checks daily. They are cleared in three days, so the checkbook is $9,000 more than the bankbook.

Thus, the float is $12,000 − $9,000 = $3,000.

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Acceleration of Receipts

Float is maximized by accelerating receipts and slowing disbursements.

Some techniques used to accelerate receipts:

Daily receipt of deposit checks

Lockboxes

Concentration banking

Automated clearinghouses

Federal Reserve wire system

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Disbursement Control

Disbursement control is the “flip side” of receipt acceleration.

Some techniques used to control disbursement:

Payables centralization

Master and zero-balance accounts

Controlled (remote) disbursement

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Short-Term Securities Management

Businesses hold short-term (marketable) securities for two primary reasons:

As an interest earning substitute for cash

As a temporary repository for cash being accumulated to meet a specific need

In reality, cash and short-term securities are managed simultaneously.

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Short-Term Securities (cont.)

In general, short-term securities are chosen on the basis of safety.

Protection of principal is primary.

Amount of return is secondary.

Securities used depend on

the expected holding period, and

the size of the business.

Some examples:

Short-term Treasury securities

Money market funds

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What marketable securities might be held by a business that:

(1) keeps $50,000 in reserve to meet

unexpected cash outlays?

(2) is accumulating $100,000 to make the

next quarterly income tax payment?

(3) is accumulating $1 million that, along

with new debt financing, will be used to

purchase an MRI system?

Discussion Items

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Inventory Management

Inventory management, also called supply chain management or materials management, is important to providers because medical supplies are critical to patient services.

Inventories consist of base stocks plus safety stocks.

The goal of inventory management is to meet operational needs at the lowest cost.

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Inventory Management (cont.)

Some inventory management techniques now being used by providers include

just-in-time systems,

stockless systems, and

consigned inventory systems.

In addition, some providers have contracts with suppliers that are priced on the basis of the amount of medical services provided or even capitated.

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Monitoring Operations

Healthcare managers must monitor operations to ensure that the business operates efficiently and meets performance goals.

For the most part, monitoring involves a set of metrics that measure aspects of financial and operational performance.

Here we will introduce just a few commonly used hospital metrics that focus on managing operations.

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Outpatient Revenue Percentage

Net outpatient revenue

Outpatient revenue percentage = × 100.

Total revenue

Measures the percentage of total (net) revenue realized from outpatient services. A high or low value is not necessarily bad; it just measures the reliance on outpatient services (as opposed to inpatient services and other patient sources) as a source of revenue. If outpatient services are more profitable than inpatient services, a higher value would mean greater overall profitability. Note that the ratio is multiplied by 100 to convert the decimal form to a percentage.

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Medicare Percentage (Inpatient)

Medicare discharges

Medicare percentage = × 100.

Total discharges

Measures the percentage of discharges realized from Medicare patients—in other words, the hospital’s reliance on Medicare patients. Because government payers generally are considered to be less generous than other payers, and because Medicare patients on average have longer stays than younger patients (and hence higher costs), a high Medicare percentage is considered a negative indicator. Also, high reliance on Medicare and other government-insured patients means that the hospital will be affected to a greater degree by political rather than economic decisions.

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Occupancy Rate

Average daily census

Occupancy rate = × 100 .

Number of beds

Measures inpatient volume as a percentage of the number of beds. The higher the occupancy rate, the better, unless it is so high that the hospital does not have the capacity to deal with emergency situations. To raise the occupancy rate, hospitals can (1) increase admissions, (2) increase length of stay (which makes no sense under many reimbursement schemes), or (3) decrease the number of beds. Note that number of beds can be measured either as licensed beds or staffed beds. Also note that this measure is sometimes called occupancy.

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Length of Stay (LOS)

Total annual patient days

Length of stay = .

Total discharges

Measures the average number of days an inpatient stays in the hospital. Because most reimbursement is independent of length of stay (LOS), the shorter the LOS, the lower the cost of treatment and hence the greater the profitability of inpatient services. Note that this measure is often called average length of stay (ALOS).

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Price per Discharge

Net inpatient revenue

Net price per discharge = .

Total discharges

Measures the amount of net revenue per discharge. Because allowances have been deducted, net price per discharge measures the actual amount of revenue (reimbursement) per discharge. This indicator is a measure of the market’s assessment of the value of the inpatient services as opposed to the hospital’s assessment.

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Cost per Discharge

Total inpatient operating expense

Cost per discharge = .

Total discharges

Measures the average cost of each inpatient stay. Regardless of the reimbursement methodology, lower service costs lead to higher profitability, all else the same. Note that this ratio can be adjusted for wage and case mix differentials by multiplying the denominator by the wage and all-patient case mix indexes.

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Profit per Discharge

Inpatient revenue  Inpatient operating expenses

Profit per discharge = .

Total discharges

Measures the amount of profit earned on each inpatient discharge. Low values (including negative values) can be traced to high inpatient costs, low inpatient reimbursement, or both. Obviously, a lack of inpatient profitability can spell financial trouble for hospitals. However, lack of inpatient profitability can be offset (in whole or partially) by outpatient care profits and/or non–patient care revenues, such as contributions and grants.

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FTEs per Occupied Bed

Inpatient FTEs

FTEs per occupied bed = .

Average daily census

Measures the productivity of labor devoted to inpatient services as a function of the number of patients. Because the provision of inpatient services is labor intensive, labor productivity has a large influence on inpatient costs. Of course, in addition to the number of patients, the intensity of services provided also affects the requirement for labor resources. Thus, this ratio often is adjusted for case mix differentials by multiplying the denominator by the all-patient case mix index.

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A raw metric number, such as an occupancy rate of 58.0%, is difficult to interpret.

Managers use

comparative analysis, such as comparing to the hospital industry average of 62.3%; and

trend analysis, such as noting that the last five years’ occupancy (oldest first) was 61.1%, 60.7%, 59.7%, 58.8%, and 58.0%.

Interpreting the Metrics (Ratios)

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Key Performance Indicators and Dashboards

Key performance indicators (KPIs) are a limited number of operational (and financial) metrics that measure performance critical to the success of an organization.

Dashboards are a way of presenting an organization’s KPIs (often as gauges) that allows managers to quickly interpret the indicators.

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Dashboard Example

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This concludes our discussion of Chapter 7 (Managing Financial Operations).

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

Do you have any questions? If so, please feel free to post it on the discussion board under Chapter 7.

Conclusion

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