Which of the following is an underlying assumption of the costminus−volumeminus−profit graph?

HealtH Care FinanCe

Fourth Edition

Judith J. BakEr, Phd, CPa and

r. W. BakEr, Jd dallas, texas

Basic Tools For Nonfinancial Managers

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Library of Congress Cataloging-in-Publication Data Baker, Judith J., author. Health care finance : basic tools for nonfinancial managers / Judith J. Baker and R.W. Baker.—Fourth edition. p. ; cm. Includes bibliographical references and index. ISBN 978-1-4496-8727-4 (pbk.)—ISBN 1-4496-8727-X (pbk.) I. Baker, R. W., author. II. Title. [DNLM: 1. Financial Management—United States. 2. Health Facilities—economics—United States. 3. Health Facility Administration—United States. W 80] RA971.3 362.1068'1—dc23 2013010480

6048 Printed in the United States of America 17 16 15 14 13 10 9 8 7 6 5 4 3 2 1

iii

New to This Edition......................................................................................................xvii

Preface ......................................................................................................................... xix

Acknowledgments ........................................................................................................ xxi

About the Authors ...................................................................................................... xxiii

About the Contributor ..................................................................................................xxv

PArT I—HEALTHCArE FINANCE OvErvIEw............................................................ 1

Chapter 1 Introduction to Healthcare Finance ........................................................ 3 The History ....................................................................................................3 The Concept ..................................................................................................4 How Does Finance Work in the Healthcare Business? ................................ 4 Viewpoints ......................................................................................................4 Why Manage? .................................................................................................5 The Elements of Financial Management ..................................................... 5 The Organization’s Structure .......................................................................6 Two Types of Accounting .............................................................................. 7 Information Checkpoint ...............................................................................9 Key Terms .......................................................................................................9 Discussion Questions ...................................................................................10 Notes .............................................................................................................10

Chapter 2 Four Things the Healthcare Manager Needs to Know About Financial Management Systems .........................................................................11

What Does the Manager Need to Know? .................................................... 11 How the System Works in Health Care ....................................................... 11 The Information Flow .................................................................................12 Basic System Elements .................................................................................14 The Annual Management Cycle .................................................................19 Communicating Financial Information to Others .................................... 20 Information Checkpoint .............................................................................20 Key Terms .....................................................................................................21 Discussion Questions ...................................................................................21 Notes .............................................................................................................21

Table of Contents

iv Table of Contents

PArT II—rECOrD FINANCIAL OPErATIONS ..........................................................23

Chapter 3 Assets, Liabilities, and Net worth ...........................................................25 Overview .......................................................................................................25 What Are Examples of Assets? .....................................................................26 What Are Examples of Liabilities? .............................................................. 27 What Are the Different Forms of Net Worth? ............................................ 27 Information Checkpoint .............................................................................28 Key Terms .....................................................................................................28 Discussion Questions ...................................................................................28

Chapter 4 revenues (Inflow) .................................................................................31 Overview .......................................................................................................31 Receiving Revenue for Services................................................................... 31 Sources of Healthcare Revenue ..................................................................33 Grouping Revenue for Planning and Control ........................................... 36 Information Checkpoint .............................................................................39 Key Terms .....................................................................................................40 Discussion Questions ...................................................................................40 Notes .............................................................................................................40

Chapter 5 Expenses (Outflow) ...............................................................................43 Overview .......................................................................................................43 Disbursements for Services .........................................................................44 Grouping Expenses for Planning and Control .......................................... 44 Cost Reports as Influencers of Expense Formats .......................................48 Information Checkpoint .............................................................................50 Key Terms .....................................................................................................50 Discussion Questions ...................................................................................50 Notes .............................................................................................................51

Chapter 6 Cost Classifications ................................................................................53 Distinction Between Direct and Indirect Costs .......................................... 53 Examples of Direct Cost and Indirect Cost ................................................ 54 Responsibility Centers ................................................................................. 56 Distinction Between Product and Period Costs ......................................... 58 Information Checkpoint .............................................................................59 Key Terms .....................................................................................................59 Discussion Questions ...................................................................................60 Notes .............................................................................................................60

PArT III— TOOLS TO ANALyzE AND UNDErSTAND FINANCIAL OPErATIONS .........................................................................61

Chapter 7 Cost Behavior and Break-Even Analysis ..................................................63 Distinctions Among Fixed, Variable, and Semivariable Costs ................... 63 Examples of Variable and Fixed Costs ........................................................ 66

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Analyzing Mixed Costs .................................................................................69 Contribution Margin, Cost-Volume-Profit, and Profit-Volume Ratios ...... 72 Information Checkpoint .............................................................................78 Key Terms .....................................................................................................78 Discussion Questions ...................................................................................78 Notes .............................................................................................................78

Chapter 8 Understanding Inventory and Depreciation Concepts ............................79 Overview: The Inventory Concept .............................................................. 79 Inventory and Cost of Goods Sold (“Goods” Such as Drugs) ...................80 Inventory Methods ......................................................................................81 Inventory Tracking ......................................................................................82 Calculating Inventory Turnover ..................................................................84 Overview: The Depreciation Concept ........................................................ 85 Book Value of a Fixed Asset and the Reserve for Depreciation ................ 85 Five Methods of Computing Book Depreciation ....................................... 87 Computing Tax Depreciation .....................................................................89 Information Checkpoint .............................................................................90 Key Terms .....................................................................................................90 Discussion Questions ...................................................................................90 Notes .............................................................................................................91 Appendix 8-A A Further Discussion of Accelerated and

Units of Service Depreciation Computations ........................................93 Accelerated Book Depreciation Methods ..............................................93

Chapter 9 Staffing: The Manager’s responsibility ................................................101 Staffing Requirements ...............................................................................101 FTEs for Annualizing Positions .................................................................101 Number of Employees Required to Fill a Position:

Another Way to Calculate FTEs ............................................................104 Tying Cost to Staffing .................................................................................106 Information Checkpoint ...........................................................................110 Key Terms ...................................................................................................110 Discussion Questions .................................................................................110 Note ............................................................................................................110

PArT Iv—rEPOrT AND MEASUrE FINANCIAL rESULTS .....................................111

Chapter 10 reporting as a Tool ..............................................................................113 Understanding the Major Reports ............................................................ 113 Balance Sheet .............................................................................................113 Statement of Revenue and Expense ......................................................... 114 Statement of Changes in Fund Balance/Net Worth ................................ 117 Statement of Cash Flows ............................................................................117 Subsidiary Reports .....................................................................................119

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Summary ....................................................................................................119 Information Checkpoint ...........................................................................120 Key Terms ...................................................................................................120 Discussion Questions .................................................................................120 Notes ...........................................................................................................120

Chapter 11 Financial and Operating ratios as Performance Measures ...................121 The Importance of Ratios .........................................................................121 Liquidity Ratios ..........................................................................................123 Solvency Ratios ...........................................................................................124 Profitability Ratios .....................................................................................126 Information Checkpoint ...........................................................................128 Key Terms ...................................................................................................128 Discussion Questions .................................................................................128

Chapter 12 The Time value of Money ....................................................................129 Purpose ......................................................................................................129 Unadjusted Rate of Return .......................................................................129 Present-Value Analysis ...............................................................................130 Internal Rate of Return .............................................................................131 Payback Period ...........................................................................................131 Evaluations .................................................................................................133 Resources ...................................................................................................133 Information Checkpoint ...........................................................................133 Key Terms ...................................................................................................133 Discussion Questions .................................................................................134 Note ............................................................................................................134 Appendix 12-A Present-Value Table: (The Present Value of $1.00) ..... 135 Appendix 12-B Compound Interest Table: Compound Interest

of $1.00 (The Future Amount of $1.00) ..............................................137 Appendix 12-C Present Value of an Annuity of $1.00 ........................... 139

PArT v—TOOLS TO rEvIEw AND MANAgE COMPArATIvE DATA .....................141

Chapter 13 Trend Analysis, Common Sizing, and Forecasted Data .........................143 Common Sizing .........................................................................................143 Trend Analysis ............................................................................................144 Analyzing Operating Data .........................................................................145 Importance of Forecasts ............................................................................147 Operating Revenue Forecasts ...................................................................148 Staffing Forecasts ......................................................................................150 Capacity Level Issues in Forecasting ......................................................... 153 Summary ....................................................................................................153

Table of Contents vii

Information Checkpoint ...........................................................................155 Key Terms ...................................................................................................155 Discussion Questions .................................................................................155 Notes ...........................................................................................................155

Chapter 14 Using Comparative Data ......................................................................157 Overview .....................................................................................................157 Comparability Requirements ....................................................................157 A Manager’s View of Comparative Data ................................................... 158 Uses of Comparative Data ......................................................................... 159 Making Data Comparable ......................................................................... 164 Constructing Charts to Show the Data .....................................................168 Information Checkpoint ...........................................................................169 Key Terms ...................................................................................................169 Discussion Questions .................................................................................169 Note ............................................................................................................169

PArT vI—CONSTrUCT AND EvALUATE BUDgETS ..............................................171

Chapter 15 Operating Budgets ...............................................................................173 Overview .....................................................................................................173 Budget Viewpoints .....................................................................................174 Budget Basics: A Review ............................................................................ 174 Building an Operating Budget: Preparation ............................................ 176 Building an Operating Budget: Construction .......................................... 177 Working with Static Budgets and Flexible Budgets .................................. 179 Budget Construction Summary ................................................................182 Budget Review ............................................................................................183 Information Checkpoint ...........................................................................184 Key Terms ...................................................................................................184 Discussion Questions .................................................................................184 Notes ...........................................................................................................185

Chapter 16 Capital Expenditure Budgets ...............................................................187 Overview .....................................................................................................187 Creating the Capital Expenditure Budget ...............................................187 Budget Construction Tools .......................................................................188 Funding Requests ......................................................................................190 Evaluating Capital Expenditure Proposals ...............................................192 Information Checkpoint ...........................................................................193 Key Terms ...................................................................................................194 Discussion Questions .................................................................................194 Note ............................................................................................................194

viii Table of Contents

Appendix 16-A A Further Discussion of Capital Budgeting Methods ...............................................................................195

Assumptions...........................................................................................195 Payback Method ....................................................................................195 Unadjusted Rate of Return (AKA Accountant’s Rate of Return) .......196 Net Present Value ..................................................................................197 Internal Rate of Return .........................................................................197

PArT vII— TOOLS TO PLAN, MONITOr, AND CONTrOL FINANCIAL STATUS ................................................................................199

Chapter 17 variance Analysis and Sensitivity Analysis .............................................201 Variance Analysis Overview ....................................................................... 201 Three Types of Flexible Budget Variance ................................................. 201 Two-Variance Analysis and Three-Variance Analysis Compared ............. 202 Three Examples of Variance Analysis ....................................................... 204 Summary ....................................................................................................208 Sensitivity Analysis Overview .....................................................................209 Sensitivity Analysis Tools ............................................................................209 Summary ....................................................................................................212 Information Checkpoint ...........................................................................213 Key Terms ...................................................................................................213 Discussion Questions .................................................................................213 Note ............................................................................................................213

Chapter 18 Estimates, Benchmarking, and Other Measurement Tools ...................215 Estimates Overview ....................................................................................215 Common Uses of Estimates .......................................................................215 Example: Estimating the Ending Pharmacy Inventory ............................ 216 Example: Estimated Economic Impact of a New Specialty

in a Physician Practice ...........................................................................217 Other Estimates .........................................................................................219 Importance of a Variety of Performance Measures ................................. 219 Adjusted Performance Measures over Time ............................................ 219 Benchmarking ...........................................................................................220 Economic Measures ...................................................................................221 Measurement Tools ...................................................................................221 Information Checkpoint ...........................................................................224 Key Terms ...................................................................................................224 Discussion Questions .................................................................................224 Note ............................................................................................................224

PArT vIII—FINANCIAL TErMS, COSTS, AND CHOICES .......................................225

Chapter 19 Understanding Investment Terms ........................................................227 Overview .....................................................................................................227

Table of Contents ix

Cash Equivalents ........................................................................................227 Governmental Guarantor: The FDIC ....................................................... 228 Long-Term Investments in Bonds .............................................................229 Investments in Stocks ................................................................................230 Privately Held Companies Versus Public Companies .............................. 231 Investment Indicators ................................................................................232 Information Checkpoint ...........................................................................232 Key Terms ...................................................................................................233 Discussion Questions .................................................................................233 Notes ...........................................................................................................233

Chapter 20 Business Loans and Financing Costs ....................................................235 Overview of Capital Structure ...................................................................235 Sources of Capital ......................................................................................235 The Costs of Financing ..............................................................................236 Management Considerations About Real Estate Financing .................... 238 Management Decisions About Business Loans ........................................ 238 Information Checkpoint ...........................................................................238 Key Terms ...................................................................................................238 Discussion Questions .................................................................................239 Appendix 20-A Sample Amortization Schedule .................................... 241

Chapter 21 Choices: Owning versus Leasing Equipment ........................................243 Purchasing Equipment ..............................................................................243 Leasing Equipment ...................................................................................243 Buy-or-Lease Management Decisions ....................................................... 244 Accounting Principles Regarding Leases .................................................249 Information Checkpoint ...........................................................................249 Key Terms ...................................................................................................249 Discussion Questions .................................................................................250 Note ............................................................................................................250

PArT IX—STrATEgIC PLANNINg: A POwErFUL TOOL ......................................251

Chapter 22 Strategic Planning and the Healthcare Financial Manager ....................253 Major Components of the Strategic Plan: Overview ................................ 253 Introduction ...............................................................................................253 Six Major Components ..............................................................................253 Varied Approaches to Strategic Planning .................................................255 Examples of Mission, Vision, and Value Statements ................................ 256 Recognizing a Special Status or Focus Within the Statements ............... 256 Financial Emphasis Within the Statements ..............................................258 Relaying the Message .................................................................................259 The Strategic Planning Cycle and Its Process Flow .................................. 261 Process Flow for Creating Goals, Objectives, and Action Plans .............. 261

x Table of Contents

Process Flow for Creating Action Plans and Their Performance Measures .........................................................................263

The Planning Cycle over Time ..................................................................264 Managers’ Responsibilities .......................................................................265 Federal Governmental Agencies Must Prepare Strategic Plans ............. 266 Why Are Federal Planning Requirements Important to Us? ................... 266 Introduction: Requirements, Plans, and Performance ...........................266 An Example: The VA Office of Information Technology

IT Strategic Planning Cycle ..................................................................268 Introduction ...............................................................................................269 The VA Office of Information Technology IT Strategic

Planning Cycle: An Example ...............................................................269 The VA Planning Cycle’s Process Flow ..................................................... 269 Planning Cycle Definitions for This Example .......................................... 271 Management Responsibilities Within the Planning Cycle....................... 272 Tools for Strategic Planning: Situational Analysis and

Financial Projections .............................................................................274 Situational Analysis (SWOT) .....................................................................274 Financial Projections for Strategic Planning ............................................ 276 Case Study: Strategic Financial Planning in Long-Term Care ................. 277 Appendix 22-A: Sample SWOT Worksheets and Question Guides ......... 277 Information Checkpoint ...........................................................................278 Key Terms ...................................................................................................278 Discussion Questions .................................................................................278 Notes ...........................................................................................................278 Appendix 22-A Sample SWOT Worksheets and Question Guides ....... 281 Introduction ..........................................................................................281 Scoring Summary Sheet for EHR Adoption and

Implementation .................................................................................281 Three Internal Worksheets for Strengths and Weaknesses .................281 Internal Worksheet for EHR Information Technology (IT)

Staff .......................................................................................................282 Internal Worksheet for Other Staff Involved in EHR ..........................284 Internal Worksheet for Technology and Capital Funding .................. 286 External Worksheet for Opportunities and Threats ...........................288

Chapter 23 Putting It All Together: Creating a Business Plan That Is Strategic ...............................................................................291

Overview .....................................................................................................291 Elements of the Business Plan ...................................................................291 Preparing to Construct the Business Plan ................................................292 The Service or Equipment Description .................................................... 292 The Organization Segment .......................................................................292 The Marketing Segment ............................................................................ 293

Table of Contents xi

The Financial Analysis Segment ...............................................................293 The “Knowledgeable Reader” Approach to Your Business Plan ............. 296 The Executive Summary............................................................................ 296 Assembling the Business Plan ...................................................................296 Presenting the Business Plan ....................................................................297 Strategic Aspects of Your Business Plan .................................................... 297 Information Checkpoint ...........................................................................298 Key Terms ...................................................................................................298 Discussion Questions .................................................................................298

PArT X—TECHNOLOgy AS A FINANCIAL AND STrATEgIC TOOL ....................299

Chapter 24 Information Technology and EHr: Adoption requirements, Initiatives, and Management Decisions .....................301

Introduction ...............................................................................................301 The Beginning of Adoption Requirements: Electronic

Data Interchange and Paperless Processing ........................................301 Current Adoption Requirements That Force

Management Decisions .........................................................................302 Why Is EHR Adoption Required Through Legislative Initiatives? ......... 303 The HITECH Initiative: Medicare and Medicaid EHR

Incentive Programs Overview ...............................................................304 The EHR Incentive Programs: Introduction ............................................ 304 HITECH Deadlines and Payments ........................................................... 306 Program Eligibility .....................................................................................308 “Meaningful Use” Within the HITECH Program .................................... 309 Certified EHR Technology Defined .......................................................... 309 HITECH Medicare and Medicaid EHR Incentive Programs

and Related Management Decision Points ..........................................310 Further Choices Between Two HITECH Programs Are Required .......... 310 Consider Program Benefits and Costs ......................................................313 Making Strategic Management Decisions About Multiple

Initiative Choices Is Also Required ......................................................314 The Private Sector’s Management Also Contributes to

EHR System Advances ...........................................................................314 Conclusion: Management Decisions and Leadership ............................. 316 The Process of Innovation and Leadership Decisions ............................. 316 Changes in Leadership May Impact the Strategy and

Progress of Healthcare Information Management .............................318 The Future .................................................................................................319 Technology in Health Care Mini-Case Study............................................ 320 Appendix 24-A: The E-Prescribing (eRx) Incentive Program for

Physicians and Other Eligible Prescribers: A Matured Initiative ........320 Information Checkpoint ...........................................................................320 Key Terms ...................................................................................................321

xii Table of Contents

Discussion Questions .................................................................................321 Notes ...........................................................................................................321 Appendix 24-A The E-Prescribing (eRx) Incentive Program

for Physicians and Other Eligible Prescribers: A Matured Initiative .................................................................................................325

Introduction ..........................................................................................325 eRx Program Overview .........................................................................325 Incentive Payments and Financial Penalties for E-Prescribers............ 326 eRx Program Implementation ..............................................................328 Appendix Notes .....................................................................................331

Chapter 25 Electronic Health records Framework: Incentives, Standards, Measures, and Meaningful Use ........................................................333

Why Explore How the HITECH EHR Initiative Works? .......................... 333 The Initiative: Background ......................................................................333 Why Explore? .............................................................................................333 What Is the Framework, or Structure, of the

HITECH EHR Initiative? ......................................................................334 Incentives and EHR ...................................................................................335 Standards and EHR ...................................................................................338 Meaningful Use and EHR .........................................................................339 How Do You Establish Meaningful Use? ................................................... 339 Meaningful Use Progresses in Stages ........................................................ 340 Timelines: Rolling Implementation in Stages ......................................... 341 Measures of Meaningful Use and EHR..................................................... 343 Introduction ...............................................................................................343 Meaningful Use Objectives: The Reason for Measures ........................... 343 Stage 2 Core and Menu Sets of Objectives ...............................................343 The Measures That Support the Objectives .............................................345 Stage 2 Measurement Methods .................................................................346 Three Types of Meaningful Use Measures ...............................................346 Percentage-Based Measures as Reporting Requirements ........................ 347 Percentage-Based Measures for Eligible Professionals ........................... 348 Stage 2 Denominators Available for EPs ................................................... 348 Definitions for the EP Denominators ....................................................... 348 Eligible Professional (EP) Stage 2 Reporting: An Example ................... 349 Percentage-Based Measures for Hospitals ...............................................351 Stage 2 Denominators Available for Hospitals ......................................... 351 Definitions for the Hospital Denominator ...............................................351 Hospital Stage 2 Reporting: An Example .................................................352 More About Standards and Their Impact ...............................................354 Summary ....................................................................................................355 Supplementary Materials: The Mechanics of Percentage

Computations ........................................................................................355

Table of Contents xiii

Information Checkpoint ...........................................................................355 Key Terms ...................................................................................................355 Discussion Questions .................................................................................355 Notes ...........................................................................................................356

Chapter 26 New Information Systems: ICD-10 Implementation and the Manager’s viewpoint ..................................................................359

ICD-10 E-Records Overview and Impact ..................................................359 Overview of the ICD-10 Coding System ....................................................359 ICD-10-CM and ICD-10-PCS Codes ...........................................................359 E-Record Standards and the ICD-10 Transition ....................................... 360 ICD-10 Benefits and Costs .........................................................................361 ICD-10 Implementation: Systems Affected and Technology Issues ........ 363 Systems and Applications Affected by the ICD-10 Change ...................... 363 Understand Technology Issues and Problems ........................................ 364 An Example: Comparison of Old and New Angioplasty Codes .............. 364 ICD-10 Implementation: Training and Lost Productivity Costs ............. 364 Who Gets Trained on ICD-10? ..................................................................365 Costs of Training .......................................................................................366 Costs of Lost Productivity .........................................................................368 ICD-10 Implementation: Situational Analysis .......................................... 368 Implementation Planning Recommendations ........................................ 368 Situational Analysis Recommendations ....................................................369 Commencing an Information Technology SWOT Matrix

for ICD-10 .............................................................................................371 Project Management from the Manager’s Viewpoint .............................. 373 The Manager’s Challenge ........................................................................ 373 Project Management by Phases .................................................................373 The Manager’s Role ..................................................................................378 Appendix 26-A: ICD-10 Conversion Costs for a

Midwestern Hospital .............................................................................378 Information Checkpoint ...........................................................................379 Key Terms ...................................................................................................379 Discussion Questions .................................................................................379 Notes ...........................................................................................................379 Appendix 26-A ICD-10 Conversion Costs for a Midwestern

Community Hospital .............................................................................383 Authors’ Note ........................................................................................383

PArT XI—CASE STUDIES ..........................................................................................385

Chapter 27 Case Study: Strategic Financial Planning in Long-Term Care ..........................................................................387

Background ................................................................................................387 Framework of the Board’s Mandate ......................................................... 387

xiv Table of Contents

Industry Profile ..........................................................................................388 Feasibility Determination .......................................................................... 388 Notes ...........................................................................................................391

Chapter 28 Case Study: Metropolis Health System .................................................393 Background ................................................................................................393 MHS Case Study .........................................................................................396 Appendix 28-A Metropolis Health System’s Financial Statements and

Excerpts from Notes ..............................................................................405 Excerpts from Metropolis Health System Notes to Financial

Statements ............................................................................................411 Appendix 28-B Comparative Analysis Using Financial Ratios and

Benchmarking Helps Turn Around a Hospital in the Metropolis Health System .....................................................................417

PArT XII—MINI-CASE STUDIES ...............................................................................423

Chapter 29 Mini-Case Study 1: Proposal to Add a retail Pharmacy to a Hospital in the Metropolis Health System .................................425

Chapter 30 Mini-Case Study 2: The Economic Significance of resource Misallocation: Client Flow Through the women, Infants, and Children Public Health Program ..................................431

Confronting the Operational Problem .................................................... 431 The Environment ......................................................................................431 The Peak-Load Problem ............................................................................432 Method .......................................................................................................433 Results ........................................................................................................435

Chapter 31 Mini-Case Study 3: Technology in Health Care: Automating Admissions Processes ......................................................................437

Assess Admissions Process .........................................................................437 Areas to Automate .....................................................................................438 Fax and Document Management .............................................................438 Communication Is Important ...................................................................438 Referral Tracking and Approval................................................................ 439 Analyzing Referral Activity .......................................................................439 Hours Saved ...............................................................................................440

Appendix A Checklists ............................................................................................441

Appendix B web-Based and Software Learning Tools .............................................445 Homepage for Healthcare Finance .......................................................... 445 Software Tools ............................................................................................445 Other Web-Based Tools ............................................................................. 445

Table of Contents xv

glossary .......................................................................................................................447

Examples and Exercises, Supplemental Materials, and Solutions ..................................459

Examples and Exercises .......................................................................................459

Supplementary Materials: The Mechanics of Percentage Computations ...............510

Solutions to Practice Exercises .............................................................................511

Index ...........................................................................................................................525

xvii

THE FOUrTH EDITION

The Fourth Edition continues to provide practical information with examples taken from real life in the healthcare finance world. For example, we have added the following:

A new chapter about “Strategic Planning and the Healthcare Financial Manager.” This subject was suggested to us as a valuable addition to the book, and we took the suggestion. The chapter contains details about the plan- ning process; examples of mission, vision, and value statements; and a governmental strategic planning cycle example. A new appendix contains “Sample SWOT Worksheets and Question Guides.”

A new case study about “Strategic Financial Planning in Long-Term Care.” The case study was written for us by Dr. Neil Dworkin. Dr. Dworkin is Emeritus Associate Professor of Management at Western Connecticut State University, where he taught strategic management, finance, marketing, health policy, and health delivery systems.

Two new and updated chapters about information systems, electronic health records (EHR), and their finan- cial management. Substantial financial incentives and penalties are involved with the adoption or nonadoption of electronic health records. Multiple initiatives and staggered transition periods will affect facilities and eligible professionals over the next several years. These two chapters help managers understand what is at stake and how their roles fit within the transition.

A new chapter about “Electronic Health Records Framework: Incentives, Standards, Measures, and Mean- ingful Use.” This chapter explains how a major EHR incentive program in force today actually works. Many managers are thrown into working intensively with some aspect of these requirements. This chapter explains the program’s inner workings and provides examples.

New visuals, examples, multiple updates, and supplemental materials have been added throughout.

We have restructured the Metropolis Health System (MHS) case study information into a comprehensive suite of information. This section now includes the major case study followed by an appendix containing an MHS financial statement and excerpts from notes. A second appendix shows how an MHS hospital was turned around using comparative analysis. Then a mini-case study describes a proposal to add a retail pharmacy to an MHS hospital. The restructuring now provides an interactive suite of case study material.

New website links. The Fourth Edition website now provides website links for those who want to take a deeper look at some subjects. (The links can also be used as a springboard for additional assignments.)

In short, we have continued to work to reveal the basic tools of healthcare finance and make them usable.

New to This Edition

xix

Our world of work is divided into three parts: the healthcare consultant, the instructor, and the writer. Over the years, we have taught managers in seminars, academic settings, and corporate conference rooms. Most of the managers were mid career adults, working in all types of healthcare disciplines. We taught them and they taught us. One of the things they taught us was this: a nonfinancial manager pushed into dealing with the world of finance often feels a dislocation and a change of perspective, and that experience can be both difficult and exciting. We have listened to their questions and concerns as these managers grapple with this new world. This book is the result of their experiences, and ours.

The book is designed for use by a manager (or future manager) who does not have an educational back- ground in financial management. It has long been our philosophy that if you can truly understand how a thing works—whatever it is—then you own it. This book is created around that philosophy. In other words, we intend to make financial management transparent by showing how it works and how a manager can use it.

USINg THE BOOK

Users will find examples and exercises covering many types of healthcare settings and providers included. The case study of Metropolis Hospital System is woven throughout the book. Three mini-case studies are provided to give an even broader view of the subjects covered. “Progress Notes” set out learning objectives at the beginning of each chapter. An “Information Checkpoint” segment at the end of each chapter tells the user three things: information needed, where this information can be obtained, and how this information can be used. A “Key Terms” section follows the “Information Checkpoint.” Each of these features displays its own quick-reference icon.

Access to the website is shown in Appendix B, “Web-Based and Software Learning Tools.” For users who prefer a calculator, Appendix B provides guidance on where to obtain in formation on using a business analyst calculator. And for those users who choose neither a computer nor a calculator, instructions are set out so prob- lems can also be worked by hand, with paper and pencil.

Preface

xxi

This book originated during the course of our activity-based costing seminars for Irwin Professional Seminars, when class members kept inserting finance questions into the sessions. The original concept for the book was clarified when Cleo Boulter, then Associate Professor at the University of Texas at Houston Center on Aging, recruited us to teach intensive finance sessions to her midcareer students, an arrangement that continued over a period of years. The needs of these students and their reaction to the material provided the core of the book’s First Edition content.

The Fourth Edition has evolved with the help of numerous instructors and students who give us feedback; we listen. In particular we thank Dr. Neil Dworkin, Emeritus Associate Professor of Management at Western Connecticut State University, who has provided input and an excellent new case study. We wish to acknowledge the continuing support of Janet Feldman, PhD, RN, Vice President, Qualitas Associates, Downers Grove, Illi- nois, along with certain technical support provided by Colleene McMurphy, CPA, of McMurphy and Associates, Winnsboro, Texas.

The input from finance sessions we taught as Adjunct Faculty at Texas Womans’ University in Dallas also contributed to shaping the content of the Fourth Edition. Our continued gratitude goes to Craig Sheagren, Senior Vice President/CFO, McDonough District Hospital, Macomb, Illinois, and Nancy M. Borkowski, PhD, Profes- sor, Department. of Professional Management/Health Management, St. Thomas University, Miami, Florida, for their encouragement, information, suggestions, and assistance with the original concept of the book. We also thank John Brocketti, Chief Financial Officer, SUMA Health System, Akron, Ohio; Christine Pierce, Partner, The Resource Group, Cleveland, Ohio; and Dr. Frank Welsh, Cincinnati, Ohio, for their ongoing information and suggestions.

Many others also contributed suggestions, recommendations, and information to help shape and refine the initial concept. We continue to acknowledge these individuals, listed below, including their original affiliations:

Ian G. Worden, CPA, Regional Vice President of Finance/CFO, PeaceHealth, Eugene, Oregon Carol A. Robinson, Medical Records Director, Titus Regional Medical Center, Mt. Pleasant, Texas John Congelli, Vice President of Finance, Genesee Memorial Hospital, Batavia, New York Charles A. Keil, Cost Accountant, Genesee Memorial Hospital, Batavia, New York George O. Kimbro, CPA, CFO, Hunt Memorial Hospital District, Greenville, Texas Bob Gault, Laboratory Director, Hunt Memorial Hospital District, Greenville, Texas Ted J. Stuart, Jr., MD, MBA, Northwest Family Physicians, Glendale, Arizona Mark Potter, EMS Director, Hopkins County Memorial Hospital, Sulphur Springs, Texas

and Leonard H. Friedman, PhD, Assistant Professor, Coordinator, Health Care Administration Program, Oregon State University, Corvallis, Oregon Patricia Chiverton, EdD, RN, Dean, University of Rochester School of Nursing, Rochester, New York Donna M. Tortoretti, RNC, Chief Operating Officer, Community Nursing Center, University of Rochester School of Nursing, Rochester, New York Billie Ann Brotman, PhD, Professor of Finance, Department. of Economics and Finance, Kennesaw State University, Kennesaw, Georgia

Acknowledgments

xxiii

About the Authors

Judith J. Baker, PhD, CPA, is Executive Director of Resource Group, Ltd., a Dallas-based health care consulting firm. She earned her Bachelor of Science degree in Business Administration at the University of Missouri, Columbia and her Master of Liberal Studies with a concentration in Business Management at the University of Oklahoma, Norman. She earned her Master of Arts and Doctorate in Human and Organizational Systems, with a concentration in costing systems, at the Fielding Institute, Santa Barbara, California. She is an adjunct faculty member at the Case Western Reserve University Frances Payne Bolton School of Nursing.

Judith has over thirty years experience in health care and consults on numerous health care systems and costing problems. She has worked with health care systems, costing, and reimbursement throughout her career. As a CMS contractor she has assisted in validation of costs for new programs and for rate setting and consults on cost report design.

Judith has written over 40 articles, manuals, and books. She served as Consulting Editor for Aspen Publishers, Inc. Her books include Activity-Based Costing and Activity-Based Management for Health Care, Prospective Payment for Long-Term Care: An Annual Guide, and Prospective Payment for Home Health Agencies. She is editor emeritus of the quarterly Journal of Healthcare Finance.

r.w. Baker, JD, is Managing Partner of Resource Group, Ltd., a Dallas-based health care consulting firm. He has more than 30 years of experience in health care and has designed, directed, and administered numerous financial impact studies for health care providers. His recent studies have centered around facility-specific MDS data collection and analysis. He and his firm subcontracted to the HCFA/CMS Nursing Home Case Mix and Quality Demonstration for over nine years.

R.W. is the editor of continuing professional education seminar manuals and training manuals for facility personnel and for research staff members. He served as a Consulting Editor with Aspen Publishers, Inc. and is co-author of A Step-by-Step Guide to the Minimum Data Set (Aspen Publishers, Inc.).

xxv

About the Contributor

Neil R. Dworkin, PhD, is Emeritus Associate Professor of Management at Western Connecticut State University, where he was Coordinator of the Masters in Health Administration Program and where he taught Strategic Management, Finance, Marketing, Health Policy, and Health Delivery Systems. Dr. Dworkin is also a licensed nursing home administrator in Connecticut and New York.

P a r t

Healthcare Finance Overview

P a r t

I

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

C h a p t e r

Introduction to Healthcare Finance

the history

Financial management has a long and distinguished history. Consider, for example, that Socrates wrote about the universal function of management in human endeavors in 400 b.c. and that Plato developed the con- cept of specialization for efficiency in 350 b.c. Evidence of sophisticated financial management exists from much earlier times: the Chinese produced a planning and con- trol system 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 systems 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 prin- ciples of management because certain goals had to be accomplished. As management thought became codified over time, however, the building of techniques for man- agement became more organized. Management as a discipline 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 organi- zations.

5. Understand the composition and purpose of an organiza- tion chart.

3

C h a p t e r

1

effectiveness. This text’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, reve- nues represent inflow and expenses represent outflow. Thus, “getting money in” represents 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 text 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 delivery, 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) financial, (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 organiza- tion. They may be responsible for data accumulation. They are often affiliated with the information 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

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 nonfinan- cial manager who understands healthcare finance will be able to interpret and nego- tiate 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 operate properly.

the eleMents oF FinanCial ManaGeMent

There are four recognized elements of financial management: (1) planning, (2) controlling, (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, controlling, and decision making) and consider organizing and directing as a part of the controlling 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 resource use and provide daily supervision.

Figure 1–1 Three Views of Management Within an Organization.

Financial

Clinical

Process

The Elements of Financial Management 5

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 income 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 non- profits 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 (per- haps with a teaching hospital affiliated with the university). The organization’s type may affect its structure. exhibit 1–1 summarizes the subgroups of both proprietary and non- profit 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 man- agement control system is acceptable only

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

exhibit 1–1 Types of Organizations

6 Chapter 1 Introduction to Healthcare Finance

if the manager can stay in close contact with all aspects of the operation. Otherwise, a formal system 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 executive 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.

Figure 1–2 Physician’s Office Organization Chart. Courtesy of Resource Group, Ltd., Dallas, Texas.

Reception Scheduling

Billing Accounting

Front Office

Physician’s Assistant

Registered Nurse

Clinical Services

Physician

Two Types of Accounting 7

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8 Chapter 1 Introduction to Healthcare Finance

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 ongoing 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 accounting principles. Managerial accounting deals with transactions that have already occurred, 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)

Two Types of Accounting 9

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

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

notes

1. C. S. George, Jr., The History of Management Thought, 2nd ed. (Englewood Cliffs, NJ: Prentice Hall, 1972), 1–27.

2. Ibid., 87. 3. S. Williamson et al., Fundamentals of Strategic Planning for Healthcare Organizations

(New York: The Haworth Press, 1997).

10 Chapter 1 Introduction to Healthcare Finance

C h a p t e r

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

Four Things the Healthcare Manager

Needs to Know About Financial

Management Systems

What Does the Manager neeD to KnoW?

Financial management is both an art and a science. You, as a manager, need to perceive the structure and reason- ing that underlies management actions. To do so, you need to be able to answer the following four questions: