Accounting PUBH 3652 Exam 1

Profitability Ratios

Operating Margin & Total Margin

Operating Margin Formula

Operating Income/Operating Revenue x 100

Total Margin Formula

Excess of Revenues/Total Revenue x 100

Liquidity Ratios

Current Ratio, Days Cash on Hand

Current Ratio Formula

Current Assets / Current Liabilities

Days Cash on Hand Formula

Available Cash and Cash Equivalents / Operating Expenses - Depreciation

3 multiple choice options

Debt to Cash

Total Debt / Cash and Cash Equivalents

Debt Management Ratios

Debt to Capitalization Ratio & Debt Ratio

Debt to Capitalization Ratio Formula

Long-term Debt / Long Term Debt + Net Assets x 100

Debt Ratio Formula

Total Liabilities/Total Assets x 100

Maximum Annual Debt Service Coverage Formula

Income Available for Debt Service (aka excess rev) / Maximum Annual Debt Service

Asset Management Ratio Formula

Days in AR = Net Accounts Receivable /Net Patient Service Revenue x 365

Capital Spending Ratio

Cash Flow from Operations / Capital Expenditures

The clinic provides additional patient services before year-end and recognizes the related revenue. Payment will be collected next year, and the services require no additional expenses. Would it increase, decrease, or have no effect on the current year's excess revenues over expenses (net income)?

Increase

-The clinic earned revenue by providing patient services this year. Even though payment comes next year, the revenue increases this year's net income.

The clinic collects an outstanding patient balance for services provided and recognized as revenue last year. Would it increase, decrease, or have no effect on the current year's excess revenues over expenses (net income)?

No Effect

-The revenue was already recognized last year. Collecting the money now increases cash and decreases accounts receivable, but does not create new revenue.

Employees earn overtime pay in December that the clinic will pay in January. Would it increase, decrease, or have no effect on the current year's excess revenues over expenses (net income)?

Decrease

-Employees earned overtime pay in December, so the expense belongs to this year even though the clinic pays it in January. The expense decreases this year's net income.

The clinic receives cash from a new bank loan immediately before year-end. No interest expense has yet been incurred. Would it increase, decrease, or have no effect on the current year's excess revenues over expenses (net income)?

No Effect

-Receiving a bank loan increases cash but also increases liabilities (debt). A loan is not revenue, so net income does not change.

The clinic earns additional interest income on its unrestricted investments. It reports this income as nonoperating income. Would it increase, decrease, or have no effect on the current year's excess revenues over expenses (net income)?

Increase

-The clinic earned interest income this year. Even though it is nonoperating income, it still increases total net income.

The clinic uses medical supplies purchased and paid for last year. The supplies were recorded as inventory until used. Would it increase, decrease, or have no effect on the current year's excess revenues over expenses (net income)?

Decrease

-When the clinic uses the medical supplies, it recognizes an expense this year. The supplies were recorded as inventory before they were used, so the expense decreases this year's net income.

Which of the following statements is FALSE?

Under the indirect method, adding depreciation back to net income reflects cash received as a result of depreciating the hospital's equipment.

3 multiple choice options

During an orientation program, a new hospital administrator asks why healthcare finance is studied separately from finance in other industries. After all, healthcare organizations must acquire resources, pay employees, invest in facilities, and remain financially viable just like other businesses. Which response best explains why healthcare finance requires specialized attention?

Healthcare relies heavily on third-party payment and includes a large number of not-for-profit organizations.

A regional health system is acquiring primary care practices, expanding its outpatient network, investing heavily in data analytics, and creating care management programs for patients with chronic conditions. At the same time, management is developing new workforce models because of shortages in several clinical specialties. Which explanation best connects these initiatives to broader healthcare industry trends?

Health systems are pursuing greater clinical integration and consolidation to manage population health, coordinate care, address social determinants of health, use data more effectively, and respond to staffing constraint

A community hospital is organized as a not-for-profit corporation. During a public meeting, a community member argues that the hospital should reduce its prices until it earns no annual profit because a not-for-profit organization should not accumulate earnings. Which response is most accurate?

The hospital may earn profits to replace facilities, invest in services, repay debt, and support its mission, but it cannot distribute those profits to owners.

A regional hospital is considering acquiring physician practices, an ambulatory surgery center, a home health agency, and a rehabilitation facility. Management believes that placing these services within one organization could improve care coordination and allow the system to manage patients across the continuum of care. Which statement best describes the potential value of this strategy?

An integrated system may improve care coordination, retain patients within the network, share information systems, and offer payers a more complete package of services.

A not-for-profit hospital and an investor-owned hospital are each evaluating whether to build a new outpatient facility. The not-for-profit hospital emphasizes community access, while the investor-owned hospital emphasizes shareholder value. Despite these differences, both organizations conduct detailed analyses of expected demand, costs, revenues, financing, and financial risk. Which conclusion is most appropriate?

Their ultimate organizational goals differ, but both must consider financial viability and the efficient use of resources.

A new insurer offers an optional health plan to individuals without requiring a broad enrollment group. People who expect significant medical expenses are especially likely to enroll, while many healthy individuals decide that the premiums are not worth the cost. Which insurance problem is most clearly illustrated?

Adverse selection, because individuals with greater expected healthcare needs are more likely to purchase coverage.

An employer changes its health plan so that employees pay almost nothing for office visits, diagnostic testing, or prescription drugs. Over the following year, utilization rises substantially, including an increase in services that appear to offer limited clinical benefit. Which concept best explains this result?

Moral hazard, because individuals may use more healthcare when they do not bear the full cost of the services.

A health system is comparing three payer contracts. Contract 1 reimburses the organization for allowable costs. Contract 2 pays a predetermined amount for each inpatient diagnosis. Contract 3 pays a fixed monthly amount for each covered member, regardless of how many services the members use. Under which contract would the provider generally assume the greatest financial risk?

Contract 3, because capitation transfers both cost and utilization risk to the provider.

A payer establishes a single payment for an entire joint replacement episode. The payment must cover the hospital stay, surgeon services, anesthesia, diagnostic testing, and certain post-acute rehabilitation services. The participating providers must determine how the payment will be divided. Which statement best describes the intended effect of this arrangement?

The providers have an incentive to coordinate care, control the total cost of the episode, and avoid unnecessary or duplicative services.

A hospital administrator is comparing Medicare reimbursement for an inpatient hospital stay with reimbursement for a physician's professional services. The administrator wants to understand how clinical information is translated into payment under the two systems. Which statement is most accurate?

Inpatient hospital cases are assigned to diagnosis-related groups, while physician services are generally coded by procedure and assigned relative value units.

You are the service line leader responsible for outpatient orthopedic surgeries. During the year, surgical volume increased by 4%, reimbursement per case remained relatively stable, and patient quality measures did not materially change. Which trend would provide the strongest evidence that your financial management efforts successfully controlled operating expenses?

Labor and medical supply expense per surgical case declined by 6% while volume and quality remained stable.

You are reviewing the annual income statement of a regional health system. Operating revenue increased from $800 million to $848 million, but operating income declined from $24 million to $9 million. Patient volumes and service mix remained relatively stable. Which conclusion is most appropriate?

The organization's operating performance deteriorated because operating expenses increased faster than operating revenue.

A not-for-profit hospital reports an operating loss of $12 million but an overall increase in net assets, or net income, of $9 million. The CEO tells the board that the hospital was profitable and therefore had a successful year. Which response would provide the best assessment of the hospital’s performance?

The hospital's core operations generated a loss, but approximately $21 million of nonoperating income more than offset that loss.

A multispecialty clinic provided healthcare services in December with gross charges of $400,000. Based on payer contracts and expected patient collections, management estimates that the clinic will collect $260,000. The cash is expected to be received in January. During December, the clinic also purchased and paid $100,000 for medical supplies, but only $30,000 of those supplies were used in providing patient care during the month.

Under accrual accounting, which amounts should the clinic report on its December income statement?

Net patient service revenue of $260,000 and supplies expense of $30,000.

-Under accrual accounting, revenue is recognized when services are provided, not when cash is collected, and expenses are recognized when resources are consumed, not necessarily when they are purchased. Therefore, the clinic recognizes $260,000 of expected patient service revenue and only the $30,000 of supplies actually used.

You are the revenue cycle director of a hospital that recorded $10 million of gross patient service charges during December. The hospital estimated contractual allowances and other deductions of $4 million and therefore reported net patient service revenue of $6 million. Subsequent information indicates that the deductions should have been $4.5 million.

Which statement best describes the effect of the original estimate?

Net patient service revenue and operating income were overstated by $500,000, and expected cash collections were also overstated.

A medical group reports positive operating income for the year, and its income statement shows that net patient service revenue increased by 8%. However, the group’s cash balance declined substantially. Further review shows that patient accounts receivable increased by 35%, while accounts payable and capital spending remained relatively stable.

Which explanation is most consistent with these facts?

The group recognized revenue when services were provided, but a significant portion of that revenue had not yet been collected in cash.

A not-for-profit hospital purchases a new MRI system for $3 million in cash on January 1. The equipment has an estimated useful life of ten years, no salvage value, and is depreciated using the straight-line method. Which statement is most accurateregarding the first year’s financial statements?

The hospital will report $300,000 of depreciation expense, even though the current-year cash outflow for the equipment was $3 million.

Two similarly sized hospitals each report net income of $13 million.

-Hospital A reports operating income of $15 million and a nonoperating loss of $2 million.

-Hospital B reports an operating loss of $5 million and nonoperating income of $18 million.

Which conclusion is most appropriate?

Hospital A demonstrated stronger performance from its core healthcare operations, while Hospital B depended on nonoperating income to produce positive net income.

You are preparing a financial presentation for the board of a healthcare organization. Net income doubled during the year, but nearly all of the increase came from unrealized and realized gains on the organization’s investment portfolio. Operating revenue and operating margin remained relatively unchanged.

Which presentation would provide the board with the most decision-useful explanation?

Explain that total profitability improved, but the improvement came primarily from nonoperating investment results rather than stronger core operations.

A not-for-profit healthcare organization reports net income, or an increase in net assets, of $8 million for the year. Assume there were no owner distributions, contributions, or other changes in net assets. Which statement best describes how this result affects the organization's other financial statements?

Net assets on the balance sheet should increase by $8 million, but cash does not necessarily increase by the same amount.

You are preparing an orientation for new service line leaders who regularly receive the health system’s financial statements. One leader asks what information can be obtained directly from the balance sheet. Which question is the balance sheet best designed to answer?

What assets, liabilities, and net assets did the organization report at the end of the year?

At December 31, a senior living organization reported $400,000 of salaries payable for work employees had already performed. The salary expense was properly recognized in December. In January, the organization paid the employees the full $400,000. What is the effect of the January payment?

Cash decreases by $400,000, and salaries payable decreases by $400,000.

A hospital has diagnostic equipment with a carrying value of $6 million. A new technology enters the market, and management determines that the existing equipment is now worth only $2 million. The hospital records a $4 million write-down, and no related debt is forgiven or reduced. Which effect should appear on the hospital's balance sheet?

Equipment decreases by $4 million, and net assets decrease by $4 million.

A physician group reports $5 million of net income for the year. However, cash flow from operating activities was only $1 million. During the year, patient accounts receivable increased by $7 million and accounts payable increased by $3 million. Which explanation is most consistent with these results?

A significant portion of reported revenue had not yet been collected, which reduced operating cash flow relative to net income.

A healthcare organization began and ended the year with approximately the same amount of cash. During the year, it borrowed $30 million and used the proceeds to fund operating losses and replace aging equipment. Which measure would be most useful in determining whether the organization’s ongoing operations are financially sustainable?

Cash flow from operating activities.

A donor contributes $2 million to a not-for-profit hospital and specifies that the funds may be used only to provide charity care. The hospital has received the cash but has not yet spent any of it. How should the contribution generally be reflected on the balance sheet?

As cash and an increase in net assets with donor restrictions.

At the beginning of the year, a health system reported gross property and equipment of $40 million and accumulated depreciation of $14 million. During the year, it recorded $3 million of depreciation expense and had no asset purchases, disposals, or write-downs. What amounts should it report at year-end?

Accumulated depreciation of $17 million and net property and equipment of $23 million.

A hospital borrows $10 million through a long-term loan and immediately uses the proceeds to purchase new imaging equipment for $10 million. Ignore depreciation and assume both transactions occur during the same reporting period. Which description of the combined effect is most accurate?

Equipment and long-term debt each increase by $10 million, while the statement of cash flows reports an investing outflow and a financing inflow.

A hospital’s cash balance decreased by $12 million during the year. A board member immediately concludes that the organization experienced serious financial deterioration. The statement of cash flows shows $18 million of positive operating cash flow, $35 million of capital expenditures, and $5 million of net financing inflows. Which interpretation is most appropriate?

The hospital's operations generated cash, but capital investment exceeded the cash generated from operations and financing activities.

A not-for-profit clinic began the year with $80 million of net assets. During the year, it reported a $6 million increase in net assets, sometimes described as net income, and had no donor contributions, distributions, reclassifications, or other direct changes to net assets. Which statement is most accurate?

Ending net assets should equal $86 million, although cash may have increased or decreased by a different amount.

You are reviewing the annual results of a health system that reported $240 million of operating revenue and $229.2 million of operating expenses. The organization also earned $6 million of investment income during the year. Which calculation and interpretation of its operating margin is most accurate?

The operating margin is 4.5%, meaning the organization generated 4.5 cents of operating income from each dollar of operating revenue.

A community hospital reports $18 million in cash, $12 million in short-term investments, $182.5 million in total annual expenses, and $9.5 million in depreciation expense. Based on these amounts, approximately how many days cash on hand does the hospital have?

63.3 days

A medical group has $45 million of current assets and $30 million of current liabilities, resulting in a current ratio of 1.5. Management then uses $10 million of cash to pay $10 million of accounts payable. Assuming no other transactions occur, what will happen to the current ratio?

It will increase to 1.75.

A hospital reports $72 million of long-term debt and $108 million of net assets. A lender wants to determine the percentage of the hospital's permanent capital that is provided by long-term creditors. What is the hospital's debt-to-capitalization ratio?

40.0%

A regional health system reports $36 million in net patient accounts receivable and $240 million in annual net patient service revenue. The peer group average is 42 days in patient accounts receivable. Which calculation and interpretation is most accurate?

The health system has 54.8 days in receivables and appears to be collecting more slowly than its peers.

A not-for-profit hospital reports $300 million of operating revenue, $9 million of operating income, and $12 million of nonoperating income. Its total revenue, including nonoperating income, is $312 million. Which statement best describes the hospital's operating and total margins?

The operating margin is 3.0%, while the total margin is approximately 6.7% because nonoperating income materially improved total profitability.

A regional hospital reports total salary expense of $101.4 million and an average workforce of 1,300 full-time equivalents during the year. The peer group reports average salary expense of $74,500 per FTE. Which calculation and interpretation is most accurate?

Salary per FTE is $78,000, which is above the peer average and warrants further analysis of wage rates, overtime, employee mix, premium pay, and local labor market conditions.

A hospital’s current ratio improved from 1.4 to 1.7 over three years. Over the same period, the peer group average remained near 2.1. Management argues that the hospital no longer has a liquidity concern because its ratio has improved each year. Which conclusion is most appropriate?

The hospital's liquidity has improved over time, but it remains weaker than the peer group and should continue to be evaluated.

A hospital’s operating margin has declined for three consecutive years, while its days in patient accounts receivable and labor cost per adjusted discharge have both increased. The CFO wants management to understand not only what has happened financially, but also why it has happened. Which next step would be most useful?

Examine operating indicators such as patient volume, payer mix, denial rates, length of stay, staffing levels, productivity, and cost per unit of service.

Two hospitals provide nearly identical services, treat similar patient populations, and operate at similar volumes. Hospital New opened three years ago, while Hospital Old has operated in the same well-maintained facility for 25 years. Hospital Old reports a substantially higher fixed asset turnover ratio. Which interpretation is most appropriate?

Hospital Old may appear more efficient because its older assets have lower book values, making the comparison potentially misleading.

How does healthcare reimbursement work?

Fee-for-service = per service

DRG = per case

Capitation = fixed payment per patient over time.

Why does the healthcare industry face financial challenges?

High operating costs, delayed payments, insurance rules, and uncompensated care.

What does the income statement show?

Financial performance over time.

Revenues − expenses = net income or excess revenues over expenses.

What does the balance sheet show?

Financial position on one date: assets, liabilities, and net assets.

What is the accounting equation?

Assets = Liabilities + Net Assets

When are revenues and expenses recorded under accrual accounting?

Revenue when earned; expenses when incurred (not necessarily when cash moves).

Does receiving a loan or collecting last year's receivable increase net income?

No. A loan creates a liability; collecting an old receivable does not create new revenue.

What are ratio analysis and trend analysis?

Ratio analysis evaluates financial health using ratios; trend analysis compares results over time.

What is benchmarking and common-size analysis?

-Benchmarking compares with peers or targets

-Common-size analysis expresses amounts as percentages of a total

What do profitability, liquidity, and debt ratios measure?

Profitability = earnings

liquidity = ability to pay near-term bills

debt ratios = debt levels and repayment ability.