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P A R T

Healthcare Finance

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Introduction to Healthcare Finance 1

C H A P T E R

THE HISTORY

Financial management has a long and distinguished his- tory. Consider, for example, that Socrates wrote about the universal function of management in human en- deavors in 400 B.C. and that Plato developed the concept of specialization for efficiency in 350 B.C. Evidence of so- phisticated financial management exists for much earlier times: the Chinese produced a planning and control sys- tem in 1100 B.C., a minimum-wage system was developed by Hammurabi in 1800 B.C., and the Egyptians and Sumerians developed planning and record-keeping sys- tems in 4000 B.C.1

Many managers in early history discovered and redis- covered managerial principles while attempting to reach their goals. Because the idea of management thought as a discipline had not yet evolved, they formulated princi- ples of management because certain goals had to be ac- complished. As management thought became codified over time, however, the building of techniques for man- agement became more organized. Management as a dis- cipline for educational purposes began in the United States in 1881. In that year, Joseph Wharton created the Wharton School, offering college courses in business management at the University of Pennsylvania. It was the only such school until 1898, when the Universities of Chicago and California established their business schools. Thirteen years later, in 1911, 30 such schools were in operation in the United States.2

Over the long span of history, managers have all sought how to make organizations work more effectively. Financial management is a vital part of organizational

After completing this chapter, you should be able to

1. Discuss the three viewpoints of managers in organizations.

2. Identify the four elements of financial management.

3. Understand the differences between the two types of accounting.

4. Identify the types of organizations.

5. Understand the composition and purpose of an organization chart.

P r o g r e s s N o t e s

effectiveness. This book’s goal is to provide the keys to unlock the secrets of financial man- agement for nonfinancial managers.

THE CONCEPT

A Method of Getting Money in and out of the Business

One of our colleagues, a nurse, talks about the area of healthcare finance as “a method of getting money in and out of the business.” It is not a bad description. As we shall see, rev- enues represent inflow and expenses represent outflow. Thus, “getting money in” repre- sents the inflow (revenues), whereas “getting money out” (expenses) represents the outflow. The successful manager, through planning, organizing, controlling, and decision making, is able to adjust the inflow and outflow to achieve the most beneficial outcome for the organization.

HOW DOES FINANCE WORK IN THE HEALTHCARE BUSINESS?

The purpose of this book is to show how the various elements of finance fit together: in other words, how finance works in the healthcare business. The real key to understanding finance is understanding the various pieces and their relationship to each other. If you, the manager, truly see how the elements work, then they are yours. They become your tools to achieve management success.

The healthcare industry is a service industry. It is not in the business of manufacturing, say, widgets. Instead, its essential business is the delivery of healthcare services. It may have inventories of medical supplies and drugs, but those inventories are necessary to service de- livery, not to manufacturing functions. Because the business of health care is service, the explanations and illustrations within this book focus on the practice of financial manage- ment in the service industries.

VIEWPOINTS

The managers within a healthcare organization will generally have one of three views: (1) fi- nancial, (2) process, or (3) clinical. The way they manage will be influenced by which view they hold.

1. The financial view. These managers generally work with finance on a daily basis. The reporting function is part of their responsibility. They usually perform much of the strategic planning for the organization.

2. The process view. These managers generally work with the system of the organization. They may be responsible for data accumulation. They are often affiliated with the in- formation system hierarchy in the organization.

3. The clinical view. These managers generally are responsible for service delivery. They have direct interaction with the patients and are responsible for clinical outcomes of the organization.

4 CHAPTER 1 Introduction to Healthcare Finance

The Elements of Financial Management 5

Managers must, of necessity, interact with one another. Thus, managers holding differ- ent views will be required to work together. Their concerns will intersect to some degree, as illustrated by Figure 1-1. The nonfinancial manager who understands healthcare fi- nance will be able to interpret and negotiate successfully such interactions between and among viewpoints.

In summary, financial management is a discipline with a long and respected history. Healthcare service delivery is a business, and the concept of financial management assists in balancing the inflows and outflows that are a part of the business.

WHY MANAGE?

Business does not run itself. It requires a variety of management activities in order to oper- ate properly.

THE ELEMENTS OF FINANCIAL MANAGEMENT

There are four recognized elements of financial management: (1) planning, (2) control- ling, (3) organizing and directing, and (4) decision making. The four divisions are based on the purpose of each task. Some authorities stress only three elements (planning, con- trolling, and decision making) and consider organizing and directing as a part of the con- trolling element. This text recognizes organizing and directing as a separate element of financial management, primarily because such a large proportion of a manager’s time is taken up with performing these duties.

1. Planning. The financial manager identifies the steps that must be taken to accom- plish the organization’s objectives. Thus, the purpose is to identify objectives and then to identify the steps required for accomplishing these objectives.

2. Controlling. The financial manager makes sure that each area of the organization is following the plans that have been established. One way to do this is to study current reports and compare them with reports from earlier periods. This comparison often shows where the organization may need attention because that area is not effective. The reports that the manager uses for this purpose are often called feedback. The purpose of controlling is to ensure that plans are being followed.

3. Organizing and directing. When organizing, the financial manager decides how to use the resources of the organization to most effectively carry out the plans that have been established. When directing, the manager works on a day-to-day basis to keep the results of the organizing running efficiently. The purpose is to ensure effective re- source use and provide daily supervision.

Financial

Clinical

Process

Figure 1–1 3 Views of Mgmt within an Organization.

6 CHAPTER 1 Introduction to Healthcare Finance

4. Decision making. The financial manager makes choices among available alternatives. Decision making actually occurs parallel to planning, organizing, and controlling. All types of decision making rely on information, and the primary tasks are analysis and evaluation. Thus, the purpose is to make informed choices.

THE ORGANIZATION’S STRUCTURE

The structure of an organization is an important factor in management.

Organization Types

Organizations fall into one of two basic types: profit oriented or nonprofit oriented. In the United States, these designations follow the taxable status of the organizations. The profit- oriented entities, also known as proprietary organizations, are responsible for paying in- come taxes. Proprietary subgroups include individuals, partnerships, and corporations. The nonprofit organizations do not pay income taxes.

There are two subgroups of nonprofit entities: voluntary and government. Voluntary nonprofits have sought tax-exempt status. In general, voluntary nonprofits are associated with churches, private schools, or foundations. Government nonprofits, on the other hand, do not pay taxes because they are government entities. Government nonprofits can be (1) federal, (2) state, (3) county, (4) city, (5) a combination of city and county, (6) a hos-

pital taxing district (with the power to raise revenues through taxes), or (7) a state uni- versity (perhaps with a teaching hospital affiliated with the university). The organiza- tion’s type may affect its structure. Exhibit 1-1 summarizes the subgroups of both pro- prietary and nonprofit organizations.

Organization Charts

In a small organization, top management will be able to see what is happening. Exten- sive measures and indicators are not neces- sary because management can view overall operations. But in a large organization, top management must use the management control system to understand what is going on. In other words, to view operations, man- agement must use measures and indicators because he or she cannot get a firsthand overall picture of the total organization.

As a rule of thumb, an informal manage- ment control system is acceptable only if the

Exhibit 1–1 Types of Organizations

Profit Oriented—Proprietary Individual Partnership Corporation Other

Nonprofit—Voluntary Church Associated Private School Associated Foundation Associated Other

Nonprofit—Government Federal State County City City-County Hospital District State University Other

manager can stay in close contact with all aspects of the operation. Otherwise, a formal sys- tem is required. In the context of health care, therefore, a one-physician practice (Figure 1-2) could use an informal method, but a hospital system (Figure 1-3) must use a formal method of management control.

The structure of the organization will affect its financial management. Organization charts are often used to illustrate the structure of the organization. Each box on an orga- nization chart represents a particular area of management responsibility. The lines between the boxes are lines of authority.

In the health system organization chart illustrated in Figure 1-3, the president/chief ex- ecutive officer oversees seven senior vice presidents. Each senior vice president has vice presidents reporting to him or her in each particular area of responsibility designated on the chart. These vice presidents, in turn, have an array of other managers reporting to them at varying levels of managerial responsibility.

The organization chart also shows the degree of decentralization within the organiza- tion. Decentralization indicates the delegating of authority for decision making. The chart thus illustrates the pattern of how managers are allowed—or required—to make key deci- sions within the particular organization.

The purpose of an organization chart, then, is to indicate how responsibility is assigned to managers and to indicate the formal lines of communication and reporting.

TWO TYPES OF ACCOUNTING

Financial

Financial accounting is generally for outside, or third party, use. Thus, financial accounting emphasizes external reporting. External reporting to third parties in health care includes, for example, government entities (Medicare, Medicaid, and other government programs) and health plan payers. In addition, proprietary organizations may have to report to stock- holders, taxing district hospitals have to report to taxpayers, and so on.

Two Types of Accounting 7

Reception Scheduling

Billing Accounting

Front Office

Physician’s Assistant

Registered Nurse

Clinical Services

Physician

Figure 1–2 Physicians Office Organization Chart. Source: Courtesy of Resource Group, Ltd., Dallas, Texas.

8 CHAPTER 1 Introduction to Healthcare Finance M

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Key Terms 9

Financial reporting for external purposes must be in accordance with generally accepted accounting principles. Financial reporting is usually concerned with transactions that have already occurred: that is, it is retrospective.

Managerial

Managerial accounting is generally for inside, or internal, use. Managerial accounting, as its title implies, is used by managers. The planning and control of operations and related performance measures are common day-by-day uses of managerial accounting. Likewise, the reporting of profitability of services and the pricing of services are other common on- going uses of managerial accounting. Strategic planning and other intermediate and long- term decision making represent an additional use of managerial accounting.3

Managerial accounting intended for internal use is not bound by generally accepted ac- counting principles. Managerial accounting deals with transactions that have already oc- curred, but it is also concerned with the future, in the form of projecting outcomes and preparing budgets. Thus, managerial accounting is prospective as well as retrospective.

INFORMATION CHECKPOINT

What Is Needed? Reports for management purposes. Where Is It Found? With your supervisor. How Is It Used? To manage better. What Is Needed? Organization chart. Where Is It Found? With your supervisor or in the administrative offices. How Is It Used? To better understand the structure and lines of authority in

your organization.

KEY TERMS

Controlling Decision Making Financial Accounting Managerial Accounting Nonprofit Organization (also see Voluntary Organization) Organization Chart Organizing Planning Proprietary Organization (also see Profit-Oriented Organization)

10 CHAPTER 1 Introduction to Healthcare Finance

DISCUSSION QUESTIONS

1. What element of financial management do you perform most often in your job? 2. Do you perform all four elements? If not, why not? 3. Of the organization types described in this chapter, what type is the one you work

for? 4. Have you ever seen your company’s organization chart? If so, how decentralized is

it? 5. If you receive reports in the course of your work, do you believe that they are pre-

pared for outside (third party) use or for internal (management) use? What leads you to believe this?