MHC6305 WEEK 2 DISCUSSION AND PROJECT INSTRUCTIONS

MHC6305 WEEK 2 LECTURE Page | 1

Recognizing Income

Accrual refers to when an income is recognized. There are two methods of recognizing income. The first is cash, in which income is only recognized when the organization actually receives money. The other method is to recognize income when a service is performed, creating an obligation on another person to pay, thus creating an accounts receivable. The organization does not yet have the money, but it has accrued an obligation on the part of another to pay at a future date. In healthcare, an obligation to pay is created when a patient is treated, but the money is received when the patient, or more often a third party, actually pays the bill. The second method is fraught with some perils in that the person may never pay, creating a write-off. It is quite common for a healthcare organization (HCO) to use the second method of accrual and have a very large accounts receivable. Some of that is mandated by the use of third-party payers, such as Medicare or Blue Cross, who pay when bills are submitted if all other terms are met. GAAP is a common set of accounting standards and procedures that companies use to compile the financial statements such as valid balance sheet, income statement, and cash flow statement. A major purpose of using the standards is to be able to compare different organizations, that is, to compare apples with apples rather than apples with oranges. Without common standards, it is not possible to know for sure where an organization stands financially vis-a-vis others in the industry. You are not expected to know GAAP standards, but you should be aware of their intent and purpose.

 In this lecture you have learned about the statements designed to provide pertinent financial information about an organization to its managers and to the public at large. Two significant sources of differences between gross and net revenue are charity care and bad debt. They have the same financial but different social effects. Charity care, although expensive, is a positive in that the organization has taken care of a person in need without expectation of payment and accrues goodwill for this service. Bad debt, on the other hand, occurs when an organization expects but does not receive payment for a service. These clients are often turned over to a collection agency, which might be seen to be a negative social event. While both charity care and bad debt are normal in the course of business, remember that there is a social value involved, especially for nonprofit businesses that can take advantage of social gains.

Income Statement

As in any business, three types of reports—the income statement, the balance sheet, and the cash flow—help evaluate an HCO's financial status. The income statement is a financial statement that provides information about revenues and expenses over a period of time. Revenues represent both cash received and payer obligations under accrual accounting. Expenses represent the resource expenditures to produce the revenue. The difference between revenues and expenses is a measure of the profit or loss of the period in question. Thus, an income statement provides information about the organization's operations and profitability. This is a key point: The income statement is important because it shows the profitability of a company during a specified time interval. Reporting this information promotes transparency. Financial transparency is when any individual from outside the firm is able to read and follow the financial statements of a company. If any of the financial statements are not transparent, then an investor may be unsure about whether a company is really profitable or if it is hiding potential risks.

An income statement provides information about the organization's operations and profitability. No business can be transparent without providing an accurate income statement.

Balance Sheet and Cash Flow Report

As in any business, three types of reports—the income statement, the balance sheet, and the cash flow—help evaluate an HCO's financial status. A balance sheet contains information about the assets and the liabilities of a business. It is from this information that we can discover the owners' equity or ownership value of the business. The balance sheet is a snapshot of a business's position at a given point in time, and it follows the formula, Assets = Liabilities + Equity. The right side of the balance sheet gives the business's mix of debt and equity financing, which is called the business' capital structure. Capital structure is a key financing decision discussed later in the course, and the balance sheet is critical to understanding that topic. The cash flow report shows whether the organization has the cash to cover its expenses or will need to tap a line of credit. That is, the total amount of money moving (or flowing) into and out of a business. Cash flow liquidity reflects how quickly a company can repay outstanding debt using generated cash funds.

 You now have been introduced to the cash flow of an organization. Review the following material to gain more insight to each of these topics before you begin you assignments.

 Resources:

The Balance sheet download pdf document

OfficeToDo. (2014). Calculating dept ratio in Excel [Video]. Available from https://www.youtube.com/watch?v=qDeTl6hos08 

eHow. (2009). Business calculations & accounting: Calculating working capital [Video]. Available from https://www.youtube.com/watch?v=YHjlySvGiNY