Essentials of healthcare finance 8th edition pdf free

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William O. Cleverley, PhD Chairman and Founder Cleverley & Associates

Worthington, Ohio

James O. Cleverley, MHA President

Cleverley & Associates Worthington, Ohio

ESSENTIALS OF

HEALTH CARE FINANCE

EIGHTH EDITION

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Library of Congress Cataloging-in-Publication Data Names: Cleverley, William O., author. | Cleverley, James O., author. Title: Essentials of health care finance / William O. Cleverley and James O. Cleverley. Description: Eighth edition. | Burlington, Massachusetts : Jones & Bartlett Learning, [2018] | Includes bibliographical references and index. Identifiers: LCCN 2016047263 | ISBN 9781284094633 Subjects: | MESH: Costs and Cost Analysis | Financial Management | Health Services—economics Classification: LCC RA971.3 | NLM W 74.1 | DDC 362.11068/1—dc23 LC record available at https://lccn.loc.gov/2016047263

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Contents Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi

Content of the Book . . . . . . . . . . . . . . . . . . . . . . . . . . . vii

About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . .viii

Contributor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix

Chapter 1 Financial Information and the Decision-Making Process . . . . . . 1

Information and Decision Making . . . . . . . . . . . . . . . . . . . 4

Uses and Users of Financial Information . . . . . . . . . . . . . 5

Financial Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Forms of Business Organization . . . . . . . . . . . . . . . . . . . . . 8

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

Chapter 2 Billing and Coding for Health Services . . . . . . . . . . . . . . . . . . . . . . . 11

Generating Healthcare Claims . . . . . . . . . . . . . . . . . . . . .12

Scheduling and Registration . . . . . . . . . . . . . . . . . . . . . . .14

Provide Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

Medical Documentation and HIM/Medical Records . . .15

Charge Entry and Charge Master . . . . . . . . . . . . . . . . . . .19

Billing and Claims Preparation . . . . . . . . . . . . . . . . . . . . .25

Claims Editing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26

Claim Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27

Appendix 2-A Sample UB-04 Form and Sample CMS-1500 Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

Chapter 3 Financial Environment of Healthcare Organizations . . . . . . . 31

Financial Viability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

Sources of Operating Revenue . . . . . . . . . . . . . . . . . . . . .34

Healthcare Payment Systems . . . . . . . . . . . . . . . . . . . . . .36

Medicare Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40

Medicare Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52

Chapter 4 Legal and Regulatory Environment . . . . . . . . . . . . . . . . . . 97

Part I . Knowledge of the Law and Regulations Is an Essential Part of Healthcare Financial Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .99

Part II . Primary Regulatory Issues Confronting Healthcare Organizations Today . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

Legal Audits and Investigations . . . . . . . . . . . . . . . . . . 126

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

Chapter 5 Measuring Community Benefit . . . . . . . . . . . . . . . . . . . . . . 131

Tax Exemption Status . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132

Community Benefit Areas . . . . . . . . . . . . . . . . . . . . . . . . 133

The Community Value Index® . . . . . . . . . . . . . . . . . . . . 135

Estimating Financial Benefits in Not-for-Profit Healthcare Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139

Estimating Financial Benefits Provided by Not-for-Profit Healthcare Firms . . . . . . . . . . . . . . 142

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144

Appendix 5-A Schedule H Form . . . . . . . . . . . . . . . . . . 147

Chapter 6 Revenue Determination . . . . . . . . 151 Payment Methods and Their Relationship

to Price Setting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152

Methods for Controlling Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153

Generic Principles of Pricing . . . . . . . . . . . . . . . . . . . . . 154

Price Setting for Healthcare Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

Justifying Healthcare Firm Prices . . . . . . . . . . . . . . . . . 158

Health Plan Contract Negotiation . . . . . . . . . . . . . . . . 163

Health Plan Payment Schedules . . . . . . . . . . . . . . . . . . 166

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168

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Chapter 12 Financial Analysis of Alternative Healthcare Firms . . . . . . . . . . . . . 285

Long-Term Care Facilities and Nursing Homes . . . . 286

Medical Groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294

Health Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 301

Chapter 13 Strategic Financial Planning . . . 307 Strategic Planning Process . . . . . . . . . . . . . . . . . . . . . . . 308

Developing the Financial Plan . . . . . . . . . . . . . . . . . . . 314

Integration of the Financial Plan with Management Control . . . . . . . . . . . . . . . . . . . . . . . . . . 327

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327

Chapter 14 Cost Concepts and Decision Making . . . . . . . . . . . . . . . . . . . . . 335

Concepts of Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 336

Cost Measurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343

Break-Even Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 354

Chapter 15 Product Costing . . . . . . . . . . . . . . 361 Healthcare Cost Accounting . . . . . . . . . . . . . . . . . . . . . 362

Relationship to Planning, Budgeting, and Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 364

The Costing Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 365

Two Required Systems for Healthcare Costing . . . . 368

Relative Value Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . 371

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373

Chapter 16 The Management Control Process . . . . . . . . . . . . . . . . . . . . . 377

Essential Elements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 378

The Budgeting Process . . . . . . . . . . . . . . . . . . . . . . . . . . 382

Zero-Base Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . 391

Benchmarking at the Departmental Level . . . . . . . . 392

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 393

Chapter 17 Cost Variance Analysis . . . . . . . . 401 Cost Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 402

Investigation of Variances . . . . . . . . . . . . . . . . . . . . . . . . 403

Variance Analysis Calculations . . . . . . . . . . . . . . . . . . . 406

Variance Analysis in Budgetary Settings . . . . . . . . . . 410

Chapter 7 Health Insurance and Managed Care . . . . . . . . . . . . . . . . 171

HMO and Managed-Care Development . . . . . . . . . . 172

Integrated Delivery Systems . . . . . . . . . . . . . . . . . . . . . 177

Paying Providers in a Managed-Care Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181

Setting Prices in Capitated Contracts . . . . . . . . . . . . . 183

Medicare and Medicaid Risk Contracts . . . . . . . . . . . 188

Legal and Regulatory Issues . . . . . . . . . . . . . . . . . . . . . . 189

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190

Chapter 8 General Principles of Accounting . . . . . . . . . . . . . . . . . . . 195

Financial Versus Managerial Accounting . . . . . . . . . 196

Principles of Accounting . . . . . . . . . . . . . . . . . . . . . . . . . 197

Accrual Versus Cash Accounting . . . . . . . . . . . . . . . . . 203

Fund Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206

Conventions of Accounting . . . . . . . . . . . . . . . . . . . . . . 207

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207

Chapter 9 Financial Statements . . . . . . . . . . 211 Organizational Structure . . . . . . . . . . . . . . . . . . . . . . . . . 212

Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213

Statement of Operations (Revenues and Expenses) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217

Statement of Changes in Net Assets . . . . . . . . . . . . . 219

Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . 220

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 220

Appendix 9-A Case Example Audited Financial Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . 225

Chapter 10 Accounting for Inflation . . . . . . . 243 Reporting Alternatives . . . . . . . . . . . . . . . . . . . . . . . . . . . 244

Uses of Financial Report Information . . . . . . . . . . . . . 246

Case Example: Williams Convalescent Center . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254

Chapter 11 Analyzing Financial Position . . . 259 Developing an Effective Financial Reporting

System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 260

Case Example: Harris Memorial Hospital . . . . . . . . . . 264

Summary: Harris Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280

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Chapter 21 Capital Formation . . . . . . . . . . . . 475 Equity Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 477

Long-Term Debt Financing . . . . . . . . . . . . . . . . . . . . . . 480

Alternative Debt Financing Sources . . . . . . . . . . . . . . 485

More Recent Developments . . . . . . . . . . . . . . . . . . . . . 490

Early Retirement of Debt . . . . . . . . . . . . . . . . . . . . . . . . . 493

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 495

Chapter 22 Working Capital and Cash Management . . . . . . . . . . . . . . . . 503

Cash and Investment Management Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505

Management of Working Capital . . . . . . . . . . . . . . . . . 507

Short-Term Bank Financing . . . . . . . . . . . . . . . . . . . . . . 513

Investment of Cash Surpluses . . . . . . . . . . . . . . . . . . . . 514

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515

Chapter 23 Developing the Cash Budget . . . . . . . . . . . . . . . . . . . . . 519

Determining Required Cash and Investment Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 520

Sources and Uses of Cash . . . . . . . . . . . . . . . . . . . . . . . . 522

Preparing the Cash Budget . . . . . . . . . . . . . . . . . . . . . . 523

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 526

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 529

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557

Variance Analysis in Managed-Care or Bundled Payment Settings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 413

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 417

Chapter 18 Financial Mathematics . . . . . . . . 425 Single-Sum Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . 426

Annuity Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 429

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434

Chapter 19 Capital Project Analysis . . . . . . . 439 Participants in the Analytical Process . . . . . . . . . . . . . 440

Classification of Capital Expenditures . . . . . . . . . . . . 443

The Capital Project Decision-Making Process . . . . . . . . . . . . . . . . . . . . . . 445

Justification of Capital Expenditures . . . . . . . . . . . . . . 447

Discounted Cash-Flow Methods . . . . . . . . . . . . . . . . . 448

Selection of the Discount Rate . . . . . . . . . . . . . . . . . . . 452

Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453

Chapter 20 Consolidations and Mergers . . . 457 Defining the Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 458

M&A Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 459

Overview of Theories of M&A Activity . . . . . . . . . . . . 462

Factors Affecting M&A Activity . . . . . . . . . . . . . . . . . . . 463

Why Do Mergers Succeed or Fail? . . . . . . . . . . . . . . . . 463

Valuations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 464

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 470

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Preface This book represents the eighth edition of a book pub- lished originally in 1978, entitled Essentials of Hospital Finance. The text has evolved from a book containing seven chapters that dealt largely with understanding and interpreting hospital financial statements into a comprehensive financial text. The Eighth Edition has 23 chapters that cover most of the major areas of financial decision making that healthcare executives deal with on a daily basis.

This book has been widely used over the years for many reasons. No other textbook so fully melds the best of current financial theory with the tools needed in day-to-day practice by healthcare managers. The textbook also encompasses virtually the whole spec- trum of the healthcare industry, including hospi- tals, pharmaceutical companies, health maintenance organizations, home health agencies, skilled nursing facilities, surgical centers, physician practices, hospi- tal departments, and integrated healthcare systems.

Building on the strong foundation of the previ- ous editions, the Eighth Edition introduces a number of enhancements. We have continued the inclusion of learning objectives at the beginning of each chapter. The learning objectives orient students to the material in the chapter and highlight some particular concepts and skills they should acquire by studying the chapter. Following the learning objectives, each chapter has a real-world scenario, which places the material in the chapter into the context of how the concepts and tools are used in practice. As with previous editions, each chapter concludes with a summary, followed by a large number of problems with related solutions. We believe the application of finance theory to real-world financial

problems is the best way to accomplish learning. One of the primary enhancements of the Eighth Edition is the addition and updating of supporting data tables that provide tangible benchmarking information for stu- dents and practitioners in a larger number of areas. In summary, the chapters are designed to provide a frame- work for understanding healthcare financial issues as well as resources for implementing appropriate opera- tional strategies.

Before discussing the coverage of this book, it is important to understand the objective, which has not changed in more than 30 years. This text is intended to provide a relevant and readable resource for healthcare management students and executives. This is important to understand because Essentials of Health Care Finance is neither a traditional financial textbook nor a traditional management or financial accounting textbook. It attempts to blend the topics of both accounting and finance that have become part of the everyday life of most healthcare executives. This textbook does not provide as much coverage of cost of capital, capital structure, and capital budgeting top- ics as is present in most financial management text- books. Essentials of Health Care Finance likewise does not provide major coverage of management control and budgeting systems that are present in most cost accounting and management accounting textbooks. Instead, this text tries to cover those types of financial decisions with which healthcare executives are most likely to be involved and provides the necessary mate- rials to help them understand the conceptual basis and mechanics of financial analysis and decision making as they pertain to the healthcare industry sector.

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Content of the Book The general basis of financial decision making in any business is almost always built on understanding three critical elements. First, most financial decisions are based on the use of accounting information. It is difficult to make intelligent decisions without having at least a basic understanding of accounting infor- mation. The user does not need to be a CPA, but it is essential to have a little understanding of what accounting is and is not. Second, all business units operate within an industry. The healthcare industry is a huge, complex industry that in many areas is unlike any other industry. Unless the student has an appre- ciation for these critical differences, major mistakes can be made. Finally, both accounting and finance are, in many ways, subsets of economics. The principles of economics form the conceptual basis upon which many types of business decisions are made.

Chapter 1 provides an introduction to the role of information in decision making. Chapter 2, “Bill- ing and Coding for Health Services,” recognizes the increasing importance that billing and coding play in financial decision making. Chapter 3 provides detailed information about the economic environment of healthcare firms. Specific coverage of payment meth- ods for all types of providers, from hospitals to phy- sicians, is included. Much of Chapter 3 was rewritten for this edition because payment rules are constantly changing. This edition covers current Medicare pro- spective payment systems for outpatient, home health, and skilled nursing facilities. Chapter 4 provides cov- erage of the numerous legal and regulatory provisions that affect today’s healthcare manager.

Chapter 5, “Measuring Community Benefit,” pro- vides expanded coverage of a topic that has gained more attention with the recent passage of healthcare reform. Nonprofit healthcare providers increasingly are being asked to document the community ben- efits they provide to their communities. Chapter 6, “Revenue Determination,” devotes specific attention to pricing and managed-care contract negotiations. Extensive coverage of managed care, its definition, concepts, organizational structures, and its finan- cial implications is included in Chapter 7 and woven throughout the remainder of the text. Managed-care

contracting is covered extensively in this edition along with coverage of “bundled payments.”

Chapters 8, 9, and 10 cover financial reporting for healthcare firms. Specific discussions of accounting jargon are included. Perhaps of more importance, the accounting terms are related to healthcare issues, such as self-insurance of professional liability.

Chapters 11, 12, and 13 cover financial analysis and financial planning. Chapter 11 has been thor- oughly revised to reflect the best analytical tools and techniques available for financial statement analysis. Chapter 12 provides specific coverage of healthcare firms other than hospitals. Comparative financial and operating benchmark values are included for hospi- tals, and benchmark values are included for hospitals, health maintenance organizations, nursing homes, and medical groups. These benchmark values are used later to evaluate the financial position of a number of different kinds of healthcare firms.

Chapters 14 through 16 cover cost finding, pric- ing, break-even analysis, and budgeting, and other managerial-care examples and concepts have been added in this edition. This edition also features more extensive coverage of relative value units. Chapter 17 includes material on the application of variance analy- sis techniques to both healthcare providers and payers.

Chapters 18 through 21 include coverage of capital budgeting, consolidations, valuation, and capital formation topics as they pertain to healthcare firms. Special attention is given to capital formation in both taxable and voluntary nonprofit situations. Chapter 20 covers the increasingly important topics of consolidations, mergers, and acquisitions. In that chapter we offer detailed coverage of several valuation techniques. Chapter 21 includes extensive coverage of sources of capital used by healthcare providers, especially tax-exempt revenue bonds. Chapters 22 and 23 cover the topics of working cap- ital management and cash budgeting.

Building from the practical educational approach of prior editions, we believe that the enhancements made to the text will provide students and practitioners with a greater understanding of financial application in the complex and changing healthcare industry.

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About the Authors William O. Cleverley, PhD, is the chairman and founder of Cleverley & Associates, which was started in January 2000. Before forming Cleverley & Associates, Dr. Cleverley was the president and founder of CHIPS (Center for Healthcare Industry Performance Studies). United Healthcare acquired the firm in March 1998, and Dr. Cleverley remained on staff as a part-time employee until December 1999. Dr. Cleverley is also professor emeritus at The Ohio State University where he taught courses in healthcare finance starting in 1973.

Dr. Cleverley was the original author of Essen- tials of Healthcare Finance in 1978. In addition, he has authored over 250 articles on healthcare financial issues in a wide variety of both academic and profes- sional journals.

James O. Cleverley, MHA, is the president of Cleverley & Associates, where he has worked since

September 2003. Mr. Cleverley consults with hospi- tal and healthcare organizations to identify financial and operating opportunities, as well as related strate- gies for performance improvement. Before joining the firm, he directed a statewide health services program for a medical association.

Mr. Cleverley has authored over 50 books and articles dealing with healthcare financial analysis and application, including the annual Community Value Index® hospital survey, the State of the Hospi- tal Industry, and Essentials of Health Care Finance. He is a two-time recipient of the Healthcare Financial Management Association’s Yerger/Seawell Best Article award.

Mr. Cleverley received his master of health admin- istration from The Ohio State University in 2004. He received his bachelor of science in business adminis- tration from The Ohio State University in 1999.

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Peter A . Pavarini, Esq . Squire, Sanders & Dempsey, LLP Columbus, Ohio

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Financial Information and the Decision-Making Process

LEARNING OBJECTIVES

After studying this chapter, you should be able to do the following:

1 . Describe the importance of financial information in healthcare organizations . 2 . Discuss the uses of financial information . 3 . List the users of financial information and their uses for it . 4 . Describe the financial functions within an organization . 5 . Discuss the common ownership forms of healthcare organizations, along with their advantages and

disadvantages .

REAL-WORLD SCENARIO

In 1946, a small band of hospital accountants formed the American Association of Hospital Accountants (AAHA). They were interested in sharing information and experiences in their industry, which was beginning to show signs of growth. First published in 1947, a small educational journal was created in an attempt to disseminate infor- mation of interest to their members. Ten years later, in 1956, the AAHA’s membership had grown to over 2,600 members. The real growth, however, was still to come with the advent of Medicare financing in 1965.

With the dramatic growth of hospital revenues came an escalation in both the number and functions delegated to the hospital accountant. Hospital finance had become much more than just billing patients and paying invoices. Hospitals were becoming big businesses with complex and varied financial functions. They had to arrange funding of major capital programs, which could no longer be supported through charitable campaigns. Cost accounting and management control were important functions for the continued financial viability of their firms. Hospital accountants soon evolved into hospital financial managers, and so in 1968 the AAHA changed its name to the Hospital Financial Management Association (HFMA).

The hospital industry continued to boom through the late 1960s and 1970s. Third-party insurance became the norm for most of the American population. Patients either received insurance through governmental programs