Introduction to the financial management of healthcare organizations

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AUPHA/HAP Editorial Board for Undergraduate Studies

Brian Hensel, PhD, Chairman University of Missouri

Theresa Barry, PhD Arcadia University

Karen Dielmann, EdD Pennsylvania College of Health Sciences

Cathleen O. Erwin, PhD Auburn University

Thomas Gariepy, PhD Stonehill College

Jennifer B. Groebner, EdD Governors State University

Michael H. Kennedy, PhD, FACHE University of Texas Health Science Center at Tyler

David A. Rosenthal, PhD Baptist College of Health Sciences

MaryMargaret Sharp-Pucci, PhD Loyola University Chicago

Aaron C. Spaulding, PhD Mayo Clinic

Philip Wessel University of Central Florida

Health Administration Press, Chicago, Illinois

Association of University Programs in Health Administration, Washington, DC

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Health Administration Press, Chicago, Illinois

Association of University Programs in Health Administration, Washington, DC

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The statements and opinions contained in this book are strictly those of the author and do not represent the official positions of the American College of Healthcare Executives, the Foundation of the American College of Healthcare Executives, or the Association of University Programs in Health Administration.

Copyright © 2018 by the Foundation of the American College of Healthcare Executives. Printed in the United States of America. All rights reserved. This book or parts thereof may not be reproduced in any form without written permission of the publisher.

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Library of Congress Cataloging-in-Publication Data

Names: Nowicki, Michael, 1952– author. Title: Introduction to the financial management of healthcare organizations / Michael Nowicki. Description: Seventh edition. | Chicago, Illinois : HAP/AUPHA, Health Administration Press ; Washington, DC : Association of University Programs in Health Administration, [2018] | Includes bibliographical references and index. Identifiers: LCCN 2017014442 (print) | LCCN 2017011815 (ebook) | ISBN 9781567939057 (ebook) | ISBN 9781567939064 (xml) | ISBN 9781567939071 (epub) | ISBN 9781567939088 (mobi) | ISBN 9781567939040 (print : alk. paper) Subjects: LCSH: Hospitals—Business management. | Hospitals—Finance. | Health facilities—Business management. | Health facilities—Finance. Classification: LCC RA971.3 (print) | LCC RA971.3 .N69 2018 (ebook) | DDC 362.11068/1—dc23 LC record available at https://lccn.loc.gov/2017014442

The paper used in this publication meets the minimum requirements of American National Standard for Information Sciences—Permanence of Paper for Printed Library Materials, ANSI Z39.48-1984. ∞ ™

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I dedicate this book to my parents who, by their actions more than their words, instilled in me the value of lifelong learning. From my mother, I learned that effort is a reward in itself. From my father, I learned that correct answers count, always.

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v i i

BRIEF CONTENTS

Preface ....................................................................................................................xvii

Acknowledgments ..............................................................................................xviii

Part I: Financial Management

Chapter 1 Financial Management in Context ......................................................... 3

Chapter 2 Organization of Financial Management ............................................... 31

Chapter 3 Financial Analysis and Management Reporting .................................... 49

Chapter 4 Tax Status of Healthcare Organizations ................................................ 75

Part II: Operating Revenue

Chapter 5 Third-Party Payment ............................................................................ 93

Chapter 6 Medicare ............................................................................................ 120

Chapter 7 Medicaid ............................................................................................ 150

Chapter 8 Cost Accounting ................................................................................ 157

Chapter 9 Reimbursement .................................................................................. 198

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v i i i B r i e f C o n t e n t s

Part III: Working Capital

Chapter 10 Managing Working Capital ................................................................ 229

Chapter 11 Managing Revenue Cycle ................................................................... 252

Chapter 12 Managing Materials ............................................................................ 269

Part IV: Resource Allocation

Chapter 13 Strategic and Operational Planning .................................................... 295

Chapter 14 Budgeting ........................................................................................... 312

Chapter 15 Capital Budgeting .............................................................................. 335

Part V: Healthcare Reform: Past, Present, and Future

Chapter 16 Healthcare Reform Trends ................................................................. 365

Appendix: Answers to Self-Quizzes ............................................................... 389

Case Study: Hays County Integrated Delivery System ............................. 395

List of Abbreviations .......................................................................................... 409

Glossary ................................................................................................................. 415

References ............................................................................................................. 433

Index ....................................................................................................................... 459

About the Author ................................................................................................ 483

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i x

DETAILED CONTENTS

Preface ....................................................................................................................xvii

Acknowledgments ..............................................................................................xviii

Part I: Financial Management

Chapter 1 Financial Management in Context ......................................................... 3

Learning Objectives ................................................................................ 3 Introduction ........................................................................................... 4 Purpose of Healthcare Financial Management ........................................ 5 Major Objectives of Healthcare Financial Management ......................... 8 Quality Assessment and Healthcare Financial Management ................. 10 Effects of Quality on Profitability ......................................................... 13 Organizational Ethics and Healthcare Financial Management .............. 13 Value of Healthcare Financial Management ......................................... 15 Effect of Financial Management on the Changing

Face of Healthcare ........................................................................ 16 Chapter Key Points .............................................................................. 16 Discussion Questions ........................................................................... 17 Appendix 1.1: Financial Accounting Outline ....................................... 18

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x D e t a i l e d C o n t e n t s

Appendix 1.2: Economics Outline ....................................................... 22 Appendix 1.3: Statistics Outline ........................................................... 28

Chapter 2 Organization of Financial Management ............................................... 31

Learning Objectives .............................................................................. 31 Introduction ......................................................................................... 32 Governing Body ................................................................................... 33 Organizations Designed to Integrate Care ............................................ 46 Chapter Key Points .............................................................................. 47 Discussion Questions ........................................................................... 47

Chapter 3 Financial Analysis and Management Reporting .................................... 49

Learning Objectives .............................................................................. 49 Introduction ......................................................................................... 50 Steps in Financial Analysis .................................................................... 50 Operating Indicators ............................................................................ 66 Financial Analysis and Annual Reports ................................................. 67 Chapter Key Points .............................................................................. 68 Discussion Questions ........................................................................... 68 Notes ................................................................................................... 69 Practice Problems and Self-Quizzes ...................................................... 70

Chapter 4 Tax Status of Healthcare Organizations ................................................ 75

Learning Objectives .............................................................................. 75 Introduction ......................................................................................... 76 Rationale for Tax-Exempt Status .......................................................... 76 Community Benefit and Tax-Exempt Status ........................................ 78 Judicial Challenges to Tax-Exempt Status ............................................ 80 IRS Challenges to Tax-Exempt Status .................................................. 82 Legislative Challenges to Tax-Exempt Status ........................................ 84 Chapter Key Points .............................................................................. 87 Discussion Questions ........................................................................... 87 Notes ................................................................................................... 88

Recommended Readings—Part I ......................................................................... 89

Part II: Operating Revenue

Chapter 5 Third-Party Payment ............................................................................ 93

Learning Objectives .............................................................................. 93 Introduction ......................................................................................... 94

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History of Third-Party Payment ........................................................... 94 Managed Care Organizations ............................................................... 97 HMOs ................................................................................................. 99 Post–Managed Care ........................................................................... 100 State Healthcare Reform .................................................................... 102 National Healthcare Reform .............................................................. 103 Methods of Payment .......................................................................... 104 Bad Debt and Charity Care ................................................................ 107 Cost Shifting ...................................................................................... 108 Problem 5.1: Cost-Shifting/Cost-Cutting Problem ............................ 111 Chapter Key Points ............................................................................ 114 Discussion Questions ......................................................................... 114 Practice Problems and Self-Quizzes .................................................... 115

Chapter 6 Medicare ............................................................................................ 120

Learning Objectives ............................................................................ 120 Introduction ....................................................................................... 121 Eligibility ........................................................................................... 121 Benefits .............................................................................................. 122 Financing ........................................................................................... 123 Reimbursement to Providers .............................................................. 125 Expenditures ...................................................................................... 128 Health Insurance Portability and Accountability Act of 1996 ............. 136 Affordable Care Act of 2010 ............................................................... 138 Fraud and Abuse ................................................................................ 139 Chapter Key Points ............................................................................ 144 Discussion Questions ......................................................................... 144 Notes ................................................................................................. 145 Appendix 6.1: Federal Safe Harbors ................................................... 147

Chapter 7 Medicaid ............................................................................................ 150

Learning Objectives ............................................................................ 150 Introduction ....................................................................................... 151 Benefits .............................................................................................. 151 Financing ........................................................................................... 152 Expenditures ...................................................................................... 153 Expansion .......................................................................................... 153 Fraud and Abuse ................................................................................ 155 Chapter Key Points ............................................................................ 156 Discussion Questions ......................................................................... 156 Note .................................................................................................. 156

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Chapter 8 Cost Accounting ................................................................................ 157

Learning Objectives ............................................................................ 157 Introduction ....................................................................................... 158 Methods of Classifying Costs ............................................................. 158 Methods of Allocating Costs .............................................................. 161 Methods of Assembling Costs ............................................................ 164 Problem 8.1: Differential Cost Analysis .............................................. 166 Methods of Determining Product Costs ............................................. 167 Problem 8.2: Job-Order Costing ........................................................ 169 Problem 8.3: Activity-Based Costing .................................................. 171 Relationship of Costs to Volume and Revenue ................................... 175 Problem 8.4: Breakeven Analysis ........................................................ 177 Problem 8.5: Breakeven Analysis for Capitated Revenue .................... 178 Chapter Key Points ............................................................................ 179 Discussion Questions ......................................................................... 179 Practice Problems and Self-Quizzes .................................................... 180

Chapter 9 Reimbursement .................................................................................. 198

Learning Objectives ............................................................................ 198 Introduction ....................................................................................... 199 Historical Context .............................................................................. 199 Healthcare Pricing Comes Under Public Scrutiny .............................. 201 Methods of Setting Charges ............................................................... 204 Problem 9.1: RVU Method of Setting Charges .................................. 204 Problem 9.2: Hourly Rate Method of Setting Charges ....................... 206 Strategic Charge Setting ..................................................................... 206 Problem 9.3: Surcharge Method of Setting Charges ........................... 207 Methods of Reimbursement to Providers ........................................... 208 Reimbursement Under the ACA of 2010 ........................................... 209 Reimbursement Under the PAMA of 2014 ....................................... 210 Reimbursement Under MACRA of 2015 ........................................... 210 Chapter Key Points ............................................................................ 210 Discussion Questions ......................................................................... 211 Notes ................................................................................................. 211 Appendix 9.1: Cost-Shift Pricing ........................................................ 214 Practice Problems and Self-Quizzes .................................................... 215

Recommended Readings—Part II ..................................................................... 225

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Part III: Working Capital

Chapter 10 Managing Working Capital ................................................................ 229

Learning Objectives ............................................................................ 229 Introduction ....................................................................................... 230 Definition of Working Capital ............................................................ 230 Importance of Working Capital ......................................................... 231 Sources of Working Capital................................................................ 231 Financing Temporary Working Capital Needs ................................... 232 Problem 10.1: Interest on Short-Term Loans ..................................... 233 Problem 10.2: Effective Annual Interest Rates on Trade Credit .......... 234 Managing Cash Flow ......................................................................... 235 Cash Budget ....................................................................................... 236 Problem 10.3: Calculating the Future Value of an Investment ........... 237 Evaluating Working Capital and Cash Performance ........................... 239 Chapter Key Points ............................................................................ 241 Discussion Questions ......................................................................... 242 Notes ................................................................................................. 242 Practice Problems and Self-Quizzes .................................................... 243

Chapter 11 Managing Revenue Cycle ................................................................... 252

Learning Objectives ............................................................................ 252 Introduction ....................................................................................... 253 Distinguishing Revenue Cycle from Accounts Receivable ................... 253 Importance of Accounts Receivable .................................................... 255 Management of the Revenue Cycle .................................................... 256 From Accounts Receivable Management to Revenue Cycle

Management .............................................................................. 263 Financing Accounts Receivable........................................................... 264 Federal Laws Governing Accounts Receivable .................................... 264 Evaluating Revenue Cycle Performance .............................................. 266 Chapter Key Points ............................................................................ 267 Discussion Questions ......................................................................... 267 Notes ................................................................................................. 268

Chapter 12 Managing Materials ............................................................................ 269

Learning Objectives ............................................................................ 269 Introduction ....................................................................................... 270

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Definitions of Inventory Management and Materials Management ................................................................ 270

Importance of Materials Management ................................................ 270 Inventory Valuation ........................................................................... 271 Costs of Inventory .............................................................................. 272 Problem 12.1: Inventory Valuation .................................................... 273 Economic Order Quantity and Reorder Point .................................... 276 Problem 12.2: Economic Order Quantity Qe, Total Cost TC,

and Reorder Point ...................................................................... 277 Managing Inventory When Uncertain Demand Exists ....................... 278 Evaluating Inventory Performance ..................................................... 279 Problem 12.3: Reorder Point Under Conditions of Uncertainty ........ 280 Chapter Key Points ............................................................................ 280 Discussion Questions ......................................................................... 281 Note .................................................................................................. 281 Practice Problems and Self-Quizzes .................................................... 282

Recommended Readings—Part III .................................................................... 291

Part IV: Resource Allocation

Chapter 13 Strategic and Operational Planning .................................................... 295

Learning Objectives ............................................................................ 295 Introduction ....................................................................................... 296 Definition of Planning ........................................................................ 296 Prerequisites to Planning .................................................................... 296 Types of Planning .............................................................................. 296 Corporate Planning ............................................................................ 298 Strategic Planning .............................................................................. 299 The Planning Process .......................................................................... 299 Value of Strategic Planning ................................................................ 306 Operational Planning ......................................................................... 307 Evaluating Plan Performance .............................................................. 309 Chapter Key Points ............................................................................ 310 Discussion Questions ......................................................................... 311 Notes ................................................................................................. 311

Chapter 14 Budgeting ........................................................................................... 312

Learning Objectives ............................................................................ 312 Introduction ....................................................................................... 313

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Definition of Budgeting ...................................................................... 313 Prerequisites to Budgeting .................................................................. 313 Types of Budgets ................................................................................ 314 Steps in the Budgeting Stage .............................................................. 316 Problem 14.1: Linear Regression and Estimation ............................... 319 Evaluating Budget Performance ......................................................... 325 Exercise 14.1: Budgeting Exercise ....................................................... 326 Chapter Key Points ............................................................................ 330 Discussion Questions ......................................................................... 330 Notes ................................................................................................. 330 Practice Problems and Self-Quizzes .................................................... 332

Chapter 15 Capital Budgeting .............................................................................. 335

Learning Objectives ............................................................................ 335 Introduction ....................................................................................... 336 Definition of Capital Expenditures ...................................................... 337 Types of Capital Expenditure Budgets................................................ 338 Steps in the Capital Budgeting Stage .................................................. 338 Problem 15.1: Payback Period ............................................................ 341 Problem 15.2: Calculating the Present Value...................................... 342 Problem 15.3: NPV/IRR Calculation ................................................. 344 Financing Capital Expenditures.......................................................... 345 Lease Versus Purchase Decisions ........................................................ 347 Evaluating Capital Budgeting Performance ........................................ 347 Exercise 15.1: Lease Versus Purchase Decision Exercise ...................... 348 Chapter Key Points ............................................................................ 349 Discussion Questions ......................................................................... 350 Notes ................................................................................................. 350 Practice Problems and Self-Quizzes .................................................... 352

Recommended Readings—Part IV .................................................................... 361

Part V: Healthcare Reform: Past, Present, and Future

Chapter 16 Healthcare Reform Trends ................................................................. 365

Learning Objectives ............................................................................ 365 National Healthcare Reform .............................................................. 366 State Reform ...................................................................................... 377 Free-Market Reform ........................................................................... 379 The Future of Healthcare ................................................................... 380

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Chapter Key Points ............................................................................ 384 Discussion Questions ......................................................................... 384 Notes ................................................................................................. 385

Recommended Readings—Part V ...................................................................... 386

Appendix: Answers to Self-Quizzes ............................................................... 389

Case Study: Hays County Integrated Delivery System ............................. 395

List of Abbreviations .......................................................................................... 409

Glossary ................................................................................................................. 415

References ............................................................................................................. 433

Index ....................................................................................................................... 459

About the Author ................................................................................................ 483

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x v i i

PREFACE

Introduction to the Financial Management of Healthcare Organizations is intended to be the primary textbook in introductory courses in healthcare financial management at both the undergraduate and graduate levels as well as a reference book for program graduates and other practicing healthcare managers. The purpose of this book is to introduce students and managers in positions other than finance to the fundamental concepts and skills nec- essary to succeed as managers in an increasingly competitive employment environment.

For instance, program graduates find employment in a variety of healthcare set- tings. Therefore, the focus of this book—as well as the title of the book—extends beyond the hospital. Program graduates consistently report a deficiency in quantitative skills; this book includes problems representing key concepts. Traditional-age students report a need to apply the quantitative skills introduced in financial management. To address both of these concerns, this book includes mini-case studies within chapters, practice problems at the ends of many chapters, and a comprehensive case study at the end of the book.

Introduction to the Financial Management of Healthcare Organizations is part of Health Administration Press’s Gateway to Healthcare Management series. The textbooks in this series are geared specifically to students who are new to healthcare management.

In this edition, Part I includes an overview of financial management; the organization of financial management, including updated information on job responsibilities and salaries; financial analysis and management reporting; and the tax status of healthcare organizations, including the most recent court cases differentiating for-profit and not-for-profit hospitals.

Part II includes information about third-party payers and payment methodologies; Medicare and Medicaid, including updated laws pertaining to these public programs as

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x v i i i P r e f a c e

well as federal government settlements with providers on fraud and abuse allegations; cost accounting and analysis; and reimbursement, including charge setting.

Part III covers the management and financing of working capital; the management of the revenue cycle, including the distinction between the revenue cycle and accounts receivable; and materials management.

Part IV focuses on resource allocation and includes strategic, strategic financial, and operational planning; budgeting; and capital budgeting.

Finally, Part V provides an analysis of trends that will affect healthcare organizations in the future, including healthcare cost projections and the need for entitlement reform. The Affordable Care Act (ACA) of 2010 and the Medicare Access and CHIPS Reauthori- zation Act (MACRA) of 2015 are discussed throughout the book but more prominently in Parts II and V.

Each part of the book includes its own recommended reading list. A running glos- sary of important terms accompanies each chapter and is compiled at the end of the book; a list of acronyms used in the text is also included at the end of the book. At the end of every chapter, important points and discussion questions encourage students to summarize what they are learning and put it into their own words. The chapters are modular to allow instructors to either delete specific chapters or assign the chapters in an order based on individual preference or classroom requirements.

I hope you find Introduction to the Financial Management of Healthcare Organizations relevant, current, and easy to understand.

Acknowledgments I would like to gratefully acknowledge those who assisted me in this seventh edition: my wife, Tracey, and our kids, Hannah and David, who have often sacrificed time with Dad so that I could write; my many students over the years, who have challenged me to find a better way to explain, teach, and evaluate the understanding of difficult concepts; Thamarai Selvi Sundararajan, my graduate assistant, who helped proofread the book and provided the valuable supplemental materials; Texas State University for continuing to support faculty research efforts; and Dick Clarke, president emeritus of HFMA, who in ways too numer- ous to mention has always supported my academic career. Finally, special thanks to those at Health Administration Press who have made this seventh edition what it is.

—Michael Nowicki

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x i x P r e f a c e

Instructor resources Thisbook’sinstructorresourcesincludeatestbankofmultiplechoicequestions; additionalshort-answerandfill-in-the-blankquestions;PowerPointslidesinboth

outlineandSocraticformats;andanswerguidesforthein-bookdiscussion questions,mini-cases,andend-of-bookcase.

Forthemostup-to-dateinformationaboutthisbookanditsinstructorresources, gotoache.org/HAPandbrowseforthebookbyitstitleorauthorname.

Thisbook’sinstructorresourcesareavailabletoinstructorswhoadoptthisbook foruseintheircourse.Foraccessinformation,pleasee-mailhapbooks@ache.org.

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PA RT I

FINANCIAL MANAGEMENT

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3

Learning Objectives

C H A P T E R 1

FINANCIAL MANAGEMENT IN CONTEXT

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

➤➤ Understand➤the➤purpose➤of➤healthcare➤organizations

➤➤ Relate➤the➤purpose➤of➤healthcare➤financial➤management➤to➤the➤purpose➤of➤the➤organization

➤➤ Understand➤the➤objectives➤of➤healthcare➤financial➤management

➤➤ Apply➤quality➤assessment➤to➤healthcare➤financial➤management

➤➤ Apply➤organizational➤ethics➤to➤healthcare➤financial➤management

➤➤ Examine➤the➤value➤of➤healthcare➤financial➤management➤to➤the➤management➤functions➤and➤

the➤changing➤face➤of➤healthcare

➤➤ Review➤background➤accounting,➤economics,➤and➤statistics➤information➤(appendixes➤1.1,➤1.2,➤

and➤1.3)

No matter where you are in the healthcare finance arena, there are opportunities

to move things forward, to act, to resist complacency, to refuse to allow yourself to

think that things won’t ever change. As finance professionals we all have strengths

that will serve our organizations well in these times of change.

Debora Kuchka-Craig, 2011 chair of the Healthcare

Financial Management Association

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I n t r o d u c t i o n ➤ t o ➤ t h e ➤ F i n a n c i a l ➤ M a n a g e m e n t ➤ o f ➤ H e a l t h c a r e ➤ O r g a n i z a t i o n s4

IntroductIon Successful organizations, whether for-profit, not-for-profit, or governmental, have two things in common: (1) a congruent and well-understood organizational purpose, and (2) a functional management team. The purpose of this introductory chapter is to describe financial management in healthcare organizations within the context of organizational purpose and a competent management team.

orgAnIzAtIonAl PurPose

Organizational purpose is often determined by the owner. While a community-owned, not-for-profit healthcare organization’s purpose is to provide healthcare services to the com- munity, a corporate-owned (via stockholders) for-profit healthcare organization’s purpose is to provide profit for the owner.

By necessity, most organizations have more than one organizational purpose. For instance, even though a not-for-profit healthcare organization’s purpose is to provide health- care services to the community, the organization must survive economically—meaning that it must generate sufficient revenue to offset expenses and allow for growth. A for-profit healthcare organization’s purpose is to provide profit for the owner; however, the organi- zation must meet its customers’ needs—meaning it must keep the physicians, patients, employers, and insurance companies satisfied.

Most healthcare organizations also have secondary purposes—for example, many government-owned healthcare organizations provide large-scale medical education programs.

To maintain congruence, the management team must communicate the organiza- tional purpose or purposes not only to the employees but also to owners, customers, and other important constituents. When multiple purposes are present, the management team must prioritize the purposes.

HeAltHcAre mAnAgement teAm

In its broadest context, the objective of healthcare management is to accomplish the organizational purposes. Doing so is not as simple as it sounds, especially if the health- care organization’s purposes are “to provide the community with the services it needs, at a clinically acceptable level of quality, at a publicly responsive level of amenity, at the least possible cost” (Berman, Kukla, and Weeks 1994, 5). Healthcare managers must identify, prioritize, and often resolve these sometimes contradictory purposes in a politi- cal environment that involves the organization’s governing board and medical staff; in a regulatory environment that involves licensing and accrediting agencies; and in an economic environment that involves increasing competition, resulting in demands for lower prices and higher quality.

Competent healthcare managers attempt to accomplish the organizational purposes by planning, organizing, staffing, directing, and controlling (called the management

management functions

The➤key➤functions➤of➤

a➤manager,➤including➤

planning,➤organizing,➤

staffing,➤directing,➤and➤

controlling.

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C h a p t e r ➤ 1 : ➤ F i n a n c i a l ➤ M a n a g e m e n t ➤ i n ➤ C o n t e x t 5

functions) and through communicating, coordinating, and decision making (called the management connective processes). For more information on the management functions and connective processes, see Dunn and Haimann’s Healthcare Management (Dunn 2016).

With the exception of nursing home administrators, no licensure requirements are needed to be a practicing healthcare manager. However, facility-accrediting organizations such as The Joint Commission require healthcare managers to possess such education and experience as required by the position. Moreover, formal educational programs for healthcare management do exist at both the undergraduate and graduate levels. Undergraduate pro- grams can seek program review and approval from the Association of University Programs in Health Administration. Graduate programs can seek program review and accreditation from the Commission on Accreditation of Healthcare Management Education. Furthermore, healthcare managers can seek membership and certification in professional associations, including the American College of Healthcare Executives (ACHE), which has more than 48,000 members, more than 9,000 of whom are certified as Fellows of the American Col- lege of Healthcare Executives (FACHE) (ACHE 2016a).

PurPose of HeAltHcAre fInAncIAl mAnAgement The purpose of healthcare financial management is to provide accounting and finance information that helps healthcare managers accomplish the organization’s purposes. No licensure requirements are needed to be a practicing healthcare financial manager. Facility- accrediting organizations such as The Joint Commission rarely provide requirements for healthcare financial managers; they often hold the organization’s chief executive officer (CEO) responsible for financial management.

Formal educational programs for healthcare financial management are not com- mon and usually exist as postgraduate certificate programs. The chief financial officers of most large healthcare organizations possess a master’s degree in business administration, a bachelor’s degree in accounting, and a certificate in public accounting and have healthcare experience. For formal continuing education and certification in healthcare financial man- agement, healthcare financial managers can seek membership and certification in healthcare professional associations, including the Healthcare Financial Management Association (HFMA). HFMA has more than 40,000 affiliates, including 1,332 certified healthcare financial professionals (CHFPs) and 1,663 members certified as fellows of the Healthcare Financial Management Association (FHFMA) (HFMA 2016b).

AccountIng

Accounting is generally divided into two major areas: financial accounting and managerial accounting. The primary purpose of financial accounting is to provide accounting informa- tion, generally historical in nature, to external users, including owners, lenders, suppliers, the government, and insurers.

management

connective processes

Management➤functions➤

that➤connect➤elements➤

of➤the➤healthcare➤

organization,➤including➤

communicating,➤

coordinating,➤and➤

decision➤making.

The Joint Commission

The➤primary➤accrediting➤

body➤for➤healthcare➤

organizations.

Healthcare Financial

Management

Association (HFMA)

Association➤of➤

healthcare➤financial➤

managers;➤confers➤

four➤certifications:➤

certified➤revenue➤

cycle➤representative,➤

certified➤technical➤

specialist,➤certified➤

healthcare➤financial➤

professional,➤

and➤fellow➤of➤the➤

Healthcare➤Financial➤

Management➤

Association.

financial accounting

A➤type➤of➤accounting➤

that➤provides➤historical➤

accounting➤information➤

to➤external➤users.

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Accounting information prepared for external use must follow formats established by the American Institute of Certified Public Accountants (AICPA) and other, similar organizations and must follow generally accepted accounting principles used for stan- dardization. The 1996 AICPA Audit and Accounting Guide for Health Care Organizations (AICPA 1996) established four basic financial statements that hospitals should prepare for external users:

1. A consolidated balance sheet

2. A statement of operations

3. A statement of changes in equity

4. A statement of cash flows

The primary purpose of managerial accounting is to provide accounting informa- tion, generally current or prospective in nature, to internal users, including managers. Such accounting information supports the planning and control management functions. In this way, managerial accounting is the link between financial accounting and the manager. Managerial accounting, or accounting information prepared for internal use, requires no prescribed format and therefore varies greatly among organizations. Managerial accounting

managerial accounting

A➤type➤of➤accounting➤

that➤provides➤

accounting➤information,➤

generally➤current➤or➤

prospective➤in➤nature,➤

to➤internal➤users.

CRITICAL CONCEPTS Measurements

Healthcare➤financial➤managers➤monitor➤many➤measurements.➤Among➤the➤most➤common➤

are➤the➤following:

•➤ Admissions:➤The➤number➤of➤patients,➤excluding➤newborns,➤accepted➤for➤inpatient➤

service

•➤ Average daily census:➤The➤average➤number➤of➤inpatients,➤excluding➤newborns,➤

receiving➤care➤each➤day➤during➤the➤reporting➤period

•➤ Average length of stay (ALOS):➤Derived➤by➤dividing➤the➤number➤of➤inpatient➤days➤

by➤the➤number➤of➤admissions

•➤ Occupancy rate:➤The➤ratio➤of➤average➤daily➤census➤to➤the➤average➤number➤of➤

statistical➤(set➤up➤and➤staffed➤for➤use)➤beds

!

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topics such as budgeting and inventory control require knowledge of economics, statistics, and operations research.

Many managerial accountants believe that cost accounting—the study of costs, including methods for classifying, allocating, and identifying costs—is either synonymous with or a subset of managerial accounting. Others argue that cost accounting includes all managerial accounting and also requires some financial accounting. Cost accounting and managerial accounting also include topics that could be considered finance.

fInAnce

Historically, the purpose of finance has been to borrow and invest the funds necessary for the organization to accomplish its purpose. Today, the purpose of finance is to analyze the information provided by managerial accounting to evaluate past decisions and make sound assessments regarding the future of the organization (Finkler 2003). Finance uses techniques such as ratio analysis and capital analysis and requires knowledge of financial and managerial accounting (see appendix 1.1), economics (see appendix 1.2), statistics (see appendix 1.3), and operations research. Exhibit 1.1 shows the relationship of finance to the aforementioned supporting disciplines.

cost accounting

The➤study➤of➤costs,➤

including➤methods➤of➤

classifying,➤allocating,➤

and➤identifying➤costs.

capital analysis

A➤process➤to➤determine➤

how➤much➤a➤capital➤

expenditure➤will➤cost➤

and➤what➤return➤it➤will➤

generate.

ratio analysis

Evaluation➤of➤an➤

organization’s➤

performance➤by➤

computing➤the➤

relationships➤of➤

important➤line➤items➤in➤

the➤financial➤statements.

exHIbIt 1.1 Financial Management Relationships

Other disciplines

Operations research

Economics Statistics

Cost accounting

Managerial accounting

Financial management

Finance Financial

accounting

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I n t r o d u c t i o n ➤ t o ➤ t h e ➤ F i n a n c i a l ➤ M a n a g e m e n t ➤ o f ➤ H e a l t h c a r e ➤ O r g a n i z a t i o n s8

mAjor objectIves of HeAltHcAre fInAncIAl mAnAgement In this section, we will examine six major objectives of healthcare financial management: (1) to generate income, (2) to respond to regulations, (3) to facilitate relationships with third-party payers, (4) to influence the method and amount of payment, (5) to monitor physicians, and (6) to protect tax status.

generAte Income

While the purpose of healthcare financial management is to provide accounting and finance information that assists healthcare management in accomplishing the organization’s objec- tives, all organizations have at least one objective in common: to survive and grow. Orga- nizations in other industries might refer to this objective as maximizing owners’ wealth; healthcare organizations typically refer to it as maintaining community services. In either event, the organization will be of little use if it cannot afford to continue to operate.

Therefore, the most important objective of healthcare financial management is to generate a reasonable net income (i.e., the difference between collected revenue and expenses) by investing in assets and putting the assets to work.

resPond to regulAtIons

Although financial management in healthcare organizations has similar objectives to that of organizations in other industries, different objectives also exist. The government regulates healthcare to a significant degree because healthcare organizations are in a position to take advantage of the sick and the elderly; regulation protects individuals who cannot protect themselves. Federal, state, and local governments pay more than 55 percent of all health insurance expenditures and therefore have a vested interest in ensuring that government money is well spent (Martin et al. 2016). Healthcare organizations must also be accredited or certified to qualify for reimbursement from many third-party payers and to qualify for loans from certain lenders. Therefore, the second objective of healthcare financial man- agement is to respond to the myriad of regulations in a timely and cost-effective manner.

fAcIlItAte relAtIonsHIPs wItH tHIrd-PArty PAyers

The third objective of healthcare financial management is to facilitate the organization’s relationship with each third-party payer, such as an insurance company, that will pay all or a portion of the bill. Private health insurance, Medicare, and Medicaid account for more than 82 percent of all personal health consumption expenditures (Martin et al. 2016). Financial management must be responsive to third-party payers and in many ways must treat third-party payers as customers because the third party pays the bill. At the same time,

net income

The➤difference➤between➤

collected➤revenues➤and➤

expenses;➤a➤reasonable➤

amount➤is➤considered➤

the➤most➤important➤

objective➤of➤healthcare➤

financial➤management.

third-party payer

An➤agent➤of➤the➤patient➤

(the➤first➤party)➤that➤

contracts➤with➤a➤

provider➤(the➤second➤

party)➤to➤pay➤all➤or➤a➤

portion➤of➤the➤bill➤to➤

the➤patient.

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financial management must be attentive to the patient because the patient has influence over the third-party payer and in some cases may be partially responsible for the bill.

Influence metHod And Amount of PAyment

The fourth objective of healthcare financial management is to influence the method and amount of payment chosen by third-party payers. Third-party payers are becoming increas- ingly aggressive in asking healthcare organizations for discounts if they provide large numbers of patients. In certain cases, healthcare organizations are discounting prices below costs to maintain market share.

Some third-party payers, such as Medicare, are asking healthcare organizations to assume part of the financial risk for the patient by agreeing to a prospective payment, or, in other words, agreeing in advance to a price for providing care to a patient. Healthcare organizations lose money if they provide care that costs more than the prospective payment.

Some third-party payers are asking healthcare organizations to assume risk by agreeing to a capitated price (i.e., a price per head or subscriber) before the subscriber actually needs care. Capitated prices put healthcare organizations at risk for the cost of care, if needed.

monItor PHysIcIAns

The fifth objective of healthcare financial management is to monitor physicians and their potential financial liability to the organization. In 2015 (the most recent year for which data were available at time of publication), professional services including physicians, dentists, and other professionals accounted for 30.9 percent of all personal healthcare expenditures (Martin et al. 2017). However, physicians influence much of the healthcare spending that is not directly attributed to them. For example, physicians order the patient admission, the diagnostic testing and treatment for the patient, and the patient discharge. Healthcare financial management must ensure through the utilization review process that physician ordering patterns are consistent with what the patient needs. In addition, healthcare finan- cial management must ensure through the credentialing process and the risk management process that the healthcare organization using more healthcare has minimized its exposure to legal liability for a physician’s possible negligent actions.

Protect tAx stAtus

The sixth major objective of healthcare financial management is to protect the organiza- tion’s tax status. For-profit healthcare organizations seek ways to reduce their tax liability, and not-for-profit healthcare organizations try to protect their tax-exempt status. Protect- ing tax-exempt status has become more difficult as state and local governments seek new

prospective payment

A➤payment➤system➤in➤

which➤a➤healthcare➤

organization➤accepts➤a➤

fixed,➤predetermined➤

amount➤to➤treat➤a➤

patient,➤regardless➤

of➤the➤true➤ultimate➤

cost➤of➤that➤treatment.➤

Diagnosis-related➤

groups➤(DRGs)➤are➤one➤

type➤of➤prospective➤

payment;➤Medicare➤

pays➤hospitals➤a➤fixed➤

amount➤for➤an➤episode➤

of➤treatment➤based➤on➤

that➤treatment’s➤DRG.

capitated price

A➤healthcare➤payment➤

system➤in➤which➤an➤

organization➤accepts➤a➤

monthly➤payment➤from➤

a➤third-party➤payer➤for➤

each➤individual➤covered➤

by➤that➤payer’s➤plan,➤

regardless➤of➤whether➤

a➤given➤individual➤

is➤treated➤in➤a➤given➤

month.➤Also➤known➤as➤

capitation,➤it➤provides➤a➤

financial➤incentive➤to➤a➤

healthcare➤organization➤

to➤keep➤its➤population➤

from➤using➤more➤

healthcare➤services➤

than➤necessary➤because➤

the➤organization➤profits➤

only➤if➤the➤total➤cost➤of➤

treating➤the➤specified➤

population➤falls➤below➤

the➤total➤capitated➤price➤

provided➤by➤the➤third-

party➤payer.

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revenue sources, and tax-exempt status has come under judicial and public scrutiny (see chapter 4).

QuAlIty Assessment And HeAltHcAre fInAncIAl mAnAgement The healthcare industry has long had difficulty with defining quality:

Quality➤.➤.➤.➤you➤know➤what➤it➤is,➤yet➤you➤don’t➤ know➤what➤it➤is.➤But➤that’s➤self-contradictory.➤ But➤some➤things➤are➤better➤than➤others.➤That➤is,➤ they➤have➤more➤quality.➤But➤when➤you➤try➤to➤say➤ what➤that➤quality➤is,➤apart➤from➤the➤things➤that➤

have➤it,➤it➤all➤goes➤poof!➤There’s➤nothing➤to➤talk➤about.➤But➤if➤you➤can’t➤say➤what➤quality➤ is,➤then➤for➤all➤practical➤purposes,➤it➤doesn’t➤exist➤at➤all.➤But➤for➤all➤practical➤purposes➤it➤ does➤exist.➤What➤else➤are➤the➤grades➤based➤upon?➤Why➤else➤would➤people➤pay➤fortunes➤ for➤some➤things➤and➤throw➤others➤in➤the➤trash➤pile?➤Obviously,➤some➤things➤are➤better➤ than➤others➤.➤.➤.➤but➤what’s➤the➤‘betterness?’➤.➤.➤.➤So➤round➤and➤round➤you➤go,➤spinning➤ mental➤wheels➤and➤nowhere➤finding➤any➤place➤to➤get➤traction.➤(Pirsig➤1974,➤179)

Since the 1970s, healthcare organizations have responded to serious pressure to define quality. In the early 1970s, accrediting agencies and third-party payers applied this pressure. In the late 1970s and early 1980s, the consumer movement added pressure. In the late 1980s through the present, competition has added pressure. Economists predict that the pressure will continue as competition drives prices to their lowest—and relatively equal—point, and the market will force healthcare organizations that survive to compete on quality in addition to price. Healthcare organizations have responded to this pressure with two contrasting strategies: either a proactive strategy that attempts to adopt a com- prehensive view of quality or a reactive strategy that attempts to limit views of quality to views developed by others.

ProActIve strAtegy