Ownership Forms of Healthcare Organizations

Chapter 1

Financial Information and the Decision-Making Process

Learning Objectives •  Describe the importance of financial

information in health care 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

health care 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 to

operate in the black •  Does not account for desirability of outcomes

Financial Information, cont.

Health Care Industry: Trends

•  Rapid growth of health care industry including hospitals, long-term care facilities, home health, ambulatory services, etc.

•  Health care costs are increasing: health care spending is 17% of the U.S. GDP

•  Increasing importance of financial and cost information in decision making

Health Care Industry

•  Health care 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 wellbeing

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 vs. 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 => unnecessary services at an efficient price:

q Lower cost of surgeries at outpatient surgery centers, but are these surgeries necessary?

Compliance

•  Whether or not organization’s directives are followed

•  Financial reporting is required to ensure compliance Ø  Internal uses, e.g. budgets Ø  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: Ø direct preparation of financial statements and

reports Ø direct preparation of budgets Ø analyze future earnings and expenses Ø develop internal control procedures Ø prepare reports for regulatory agencies

Financial Management Functions, cont

•  Treasurers – deal with external finances: Ø establish billing, credit, and collection policies Ø manage investments Ø secure financing

Ø short-term, e.g. arrange line of credit, short-term transfer funds

Ø long-term, e.g. bond issuance Ø maintain investor & credit rating relations Ø analyze mergers and acquisition opportunities

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 – Non-Governmental NFP

•  Differ in ownership structure

NFP Business-Oriented Organizations

•  Objective function – maximize shareholders’ value, vs. profit maximization

•  Shareholders - community vs. 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 •  Currently 80% of hospitals are NFP

Investor-Owned Health Care 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 the

corporate level and individual level (shareholders)

Investor-Owned Entities

Main types of IO entities: ü Publicly-traded ü Privately held ü Professional corporations/associations ü Sole proprietorships ü Partnerships ü 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 – far few reporting requirements by SEC

•  Until recently, Hospital Corporation of America (HCA) was the largest privately held hospital system

Professional Corporations

•  Professional corporation/association (PC, PA) – formed by professionals with the advantage of corporation

•  Shareholders are free from personal liability, but professionals are liable

•  Widely used by physicians as they are protected from liabilities of each another

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

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 -  Difficult to dissolve -  Potential for conflict among partners

Limited Liability Companies

•  LLC/Limited liability partnerships (LLP) – combine characteristics of partnership and 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 HC 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