MIDTERM STUDYGUIDE
Module 1:
Legal Forms of Businesses:
There are three major categories of business organization (legal forms of businesses):
◦ Proprietorship (sole proprietorship) - Business owned
by one individual.
◦ Partnership - Two or more persons associate to conduct a
business that is not incorporated.
◦ Corporation (HCA, Tenet) - A legal entity that is separate and distinct from its owners and managers.
Proprietorships and Partnerships:
Advantages:
Ease of formation.
Subject to few regulations.
No corporate income taxes.
Disadvantages:
Limited life.
Difficult to transfer ownership.
Unlimited liability.
Difficult to raise capital.
Corporations:
Advantages:
Unlimited life.
Easy transfer of ownership.
Limited liability.
Ease of raising capital.
Disadvantages:
Cost of formation and reporting.
Double (or triple) taxation for investor-owned corporations.
Forms of Ownership:
In most industries, the only form of ownership is the investor-owned (for-profit) business.
However, in the health services industry, a significant proportion of businesses, particularly hospitals, are organized as not-for-profit corporations.
For-Profit (Investor-Owned Corporations):
Investors become owners by purchasing shares of common stock.
Stockholders have:
Right of control.
Claim on residual earnings and residual liquidation proceeds.
Typically expect a return on their investment in the form of dividends and/or capital gains.
Investor-owned corporations must pay:
Property taxes.
Income taxes.
Sales taxes.
Not-for-Profit Corporations:
If a business meets a stringent set of requirements, it can qualify as a not-for-profit (nonprofit) corporation. Such firms also are called tax-exempt or 501(c)(3) or (c)(4) corporations.
The primary goal of not-for-profit corporations is given by a mission statement, often in terms of service to the community.
These corporations:
Generally have no shareholders.
Are exempt from property, income, and sales taxes.
Agency problem:
Governmental agencies do not receive revenues by selling services or by soliciting contributions. Rather, the revenues are derived from taxing the populations that benefit from the governmental services, so providing additional services typically uses resources without generating additional income.
Who pays for healthcare:
Patients:
Out-of-pocket
Third Parties:
Insurance, public or private
Private Third-Party Payers:
For the most part, provider revenues come from third-party payers rather than from patients.
Private insurers:
Blue Cross/Blue Shield.
Commercial insurers.
Self-insurers.
Public Insurers:
Medicare:
Provide medical benefits to individuals aged 65 or older.
Four major coverages:
Part A: Hospital.
Part B: Physician services.
Part C: Managed Care.
Part D: Prescription drugs.
Medigap / Medicare supplemental insurances.
Centers of Medicare and Medicaid Services (CMS).
When an individual buys Medigap coverage, Medicare will first pay its share of the Medicare-approved amount for covered costs, and then the Medigap policy pays its share.
Medicaid:
Federal / state joint program aimed at providing a medical safety-net for low income mothers and children.
Managed Care Plans:
Managed care plans strive to combine both the provision of healthcare services and the insurance function in a single organization.
There are many types of plans:
Health maintenance organizations (HMOs).
Preferred provider organizations (PPOs).
Point-of-service (POS) plans.
Generic Reimbursement Methodologies:
Regardless of payer, there are a limited number of payment methodologies.
These fall into two broad categories:
Fee-for-service (FFS) - Payment is tied to the amount of services provided:
Cost-based.
Charge based.
Prospective payment.
Capitation - Where payment is tied to the size of the covered population (number of enrollees).
Cost-Based Reimbursement:
Payer pays all allowable costs incurred in providing services.
Medicare used this method for all hospitals in its early years (1966–1982).
Used rarely today:
One example is Medicare payment to critical access hospitals (CAHs).
Charge-Based Reimbursement:
Payer pays billed (gross) charges for services rendered.
Historically, all third-party payers reimbursed providers on the basis of billed charges.
Some payers still use billed charges as the payment method.
This method often results in a negotiated discount from gross charges ranging from 20% to 50% (or more)
Chargemaster – Rate schedule
Chargemaster:
Chargemaster - Facilitates accurate and efficient payment for services rendered.
Usually contains:
• Department code
• Service codes
• Service descriptions
• Charge amount
• Relative value units (RVUs)
• Revenue codes (four-digit codes that indicate location or type of service provided to institutional patient).
Capitation:
Capitation is entirely different from FFS reimbursement:
Payment is not tied to utilization, but rather to the number of covered lives.
Payment to providers usually is made on a per member per month (PMPM) basis.
Used primarily by managed care plans.
Medicare Reimbursement Methods:
Are prices the same in Shreveport as New York?
NO!
Medicare payments will vary based on market conditions in the facilities geographic location.
Are the costs /risks for a hip replacement the same for a 90 year old and 30 year old?
NO!
There are often risk adjustment payments based on the patient’s condition and treatment.
Different methods are used for different providers:
Most use a method of classifying patients into groups based on clinical data.
Patient groups are weighted to reflect different use of resources with the weights frequently updated.
Hospital Acute Inpatient Services:
The Inpatient Prospective Payment System (IPPS) is used.
Each discharge is assigned to a Medicare severity diagnosis related group (MS–DRG).
MS-DRG is adjusted to account for:
◦ Patient’s condition and treatment.
◦ Market conditions in facility’s geographic location.
Outpatient Hospital Services:
The Outpatient Prospective Payment System (OPPS) is used.
Similar to IPPS (Inpatient Prospective Payment System).
Each discharge is assigned to an Ambulatory Payment Classification (APC).
Payment rates are calculated using a base dollar amount:
First adjusted for local input prices
Then multiplied by the relative weight for each APC
Physician Services:
The Physician Fee Schedule is used.
Each service has a relative value unit (RVU) assigned that reflects amount of:
◦ Physician work
◦ Practice expenses
◦ Liability insurance costs
Payment rates are calculated using an RVU value
Health Reform and Insurance:
Affordable Care Act (ACA):
◦ New insurance standards
◦ Individual mandate to have insurance
◦ Health insurance exchanges
◦ Medicaid expansion
Under the ACA, insurers are required to use community ratings Preexisting condition – no longer allowed under ACA:
In essence, health insurers are required to take all applicants, regardless of health condition, gender, occupation, or age.
Module 2:
Regulation and Standards of Financial Accounting:
The Securities and Exchange Commission (SEC) has the legal authority to regulate the form and content of financial statements.
However, the SEC relies on the following organizations for implementation:
⚫ Financial Accounting Standards Board (FASB).
⚫ Industry Committees of the American Institute of Certified Public Accountants (AICPA).
⚫ Principles and Practices Board of the Healthcare Financial Management Association (HFMA).
GAAP:
The conventions that have evolved from the pronouncements and rulings of the
implementing organizations constitute a set of guidelines for the preparation of financial accounting statements called Generally Accepted Accounting Principles (GAAP)
GAAP applies only to financial accounting statements (as opposed to statements constructed for internal use).
GAAP DOES NOT remain static over time since business practices change over time. That means GAAP will change over time also.
Principles of financial accounting:
Materiality - To keep statements manageable, only entries that are important to the
operational and financial status of the organization need be separately identified.
Accrual accounting - Recognizes an event when a cash obligation is created:
More complicated.
Provides a better picture of the true economic status of a business.
Is required by GAAP.
Matching principle - A cornerstone of accrual basis accounting, dictates that expenses should be recognized and recorded in the same accounting period as the revenues they helped generate.
Cash Versus Accrual Accounting:
Cash accounting - Recognizes an event when a cash transaction takes place.
Simple and easy.
Mimics tax statements.
Accrual accounting - Recognizes an event when a cash obligation is created.
More complicated.
Provides a better picture of the true economic status of a business.
Is required by GAAP.
Income statement components:
The most important question about a business’s financial status is whether or not it is making money.
The Income Statement - Provides information about a business’s operations and economic profitability.
The income statement is often called by other names:
⚫ Statement of operations
⚫ Statement of activities
⚫ Statement of revenues and expenses
The income statement reports the results of operations over some period of time, say, a year. It has three key elements:
Revenues, which under accrual accounting represent both cash received and payer obligations.
Expenses, which are the resource expenditures required to produce the revenues. Again, note that under accrual accounting both cash and noncash expenses are recognized.
Profit = Revenues − Expenses:
Operating profit (Operating income).
Net profit (Net income)
Expenses - Represent the resources used to create revenues—they are the costs of doing business. Like revenues, under accrual accounting, expenses do not necessarily reflect cash outlays
Expenses may be categorizes by:
Natural classification, such as salaries, supplies, research, and so on.
Functional classification, such as inpatient services, outpatient services, and so on.
Depreciation - The amortization expense of buildings and equipment when listed on the income statement.
Net Income - The second measure of profitability, which is often referred to as the “bottom line,”.
Net income measures overall (total) economic profitability as defined by GAAP.
Differences in the accounting of discounts, charity care, and bad debt loses:
In reporting revenues, note the following:
Discounts and allowances are not reported.
Charity care is not reported.
Bad debt losses result from the failure to collect revenues from patients or third-party payers who do have the capacity to pay.
Charity care represents services that are provided to patients who do not have the capacity to pay. Typically, such patients are identified before the service is rendered.
A description of policies regarding discounts and charity care often appears in the notes to the financial statements.
Gross vs. net patient revenue:
Net patient service revenue - Reports the amount expected to be collected (after the provision for bad debts is deducted).
Gross revenue - It is the total amount of money a company earns from selling its goods or services before any deductions.
Income statement for not-for-profit entities:
Shows how a nonprofit’s revenues and expenses lead to a change in net assets (instead of profit).
Accounting Equation:
Accounting Equation: (Assets = Liabilities + Equity)
Note that the accounting identity is often expressed as follows:
Equity = Assets – Liabilities
Balance sheet components (Assets, Liabilities and Equity):
The balance sheet is organized with a left side and right side:
Left Side (Assets) | Right Side (Liabilities and Equity) |
|---|---|
Current Assets | Current Liabilities |
Long-term Assets | Long-term Liabilities |
Total Assets | Equity (Net Assets) |
Total Liabilities and Equity |
The time frame of a balance sheet:
Presents a business’s position at a given point in time.
Marketable securities vs. long-term investments:
Long-term investments - Reports the amount the organization has invested in various forms of long-term (maturities that exceed one year) securities.
Marketable securities - Represent cash that has been temporarily invested in highly liquid, low-risk securities such as bank savings accounts, money market mutual funds, US Treasury bills, or prime commercial paper having a maturity greater than 90 days but less than one year.
Gross vs. net fixed assets:
Gross Fixed Assets:
The total original cost of all long-term tangible assets a company owns.
Includes: buildings, land, machinery, equipment, vehicles, etc.
Before depreciation is subtracted.
Net Fixed Assets:
The book value of fixed assets after depreciation.
Real assets vs. financial assets:
Real Assets - A physical asset, such as a medical practice or a piece of diagnostic equipment, that has the potential to generate future cash inflows.
Financial Assets - A security, such as a stock or bond, that represents a claim on a business’s cash flows. Financial assets are purchased with the expectation of receiving future payments.
Contra-asset account:
Contra-asset account - An account that reduces the value of a related asset account on the balance sheet.
Ex. Accumulated depreciation - Represents the total dollars of depreciation that have been expensed on the income statement against the historical cost of the organization’s fixed assets.
Accounts payable vs. notes payable:
Accounts payable - Represents payment obligations that have been incurred as of the balance sheet date but that have not yet been paid. Represents amounts due to vendors for supplies purchases.
Notes Payable - Short-term debt obligations, typically bank loans:
⚫Maturities of less than one year.
⚫Often takes the form of a line of credit.
⚫Usually used to finance temporary (seasonal or cyclical) increases in current assets.
Accrued expenses:
Accrued expenses (accruals) - Payment obligations of the business, primarily:
⚫Salaries to employees
⚫Taxes to government authorities
⚫Interest payments to debt suppliers
Equity account in a for-profit firm vs. not-for-profit:
In not-for-profit corporations, the equity account is called net assets—it is the dollar value of assets net of liabilities.
Equity in a for-profit company represents the owners' or shareholders’ share of the company’s value. It’s what’s left over after the business pays all its liabilities.
Fund accounting (unrestricted, temporarily restricted, and permanently restricted):
Fund Accounting:
Unrestricted.
Temporarily restricted.
Permanently restricted.
Capital structure:
Capital Structure - The structure of the liabilities and equity side of the balance sheet (i.e., the proportions of debt and equity financing).
Statement of Cash Flows:
Statement of cash flows - Combines both income statement and balance sheet data to create an income statement–like report that focuses on cash flows.
Designed to answer three questions:
Where did the business get its cash?
What did it do with the cash it got?
How did its cash position change?
Like the income statement, it reports transactions over some time period.
The top part of the statement is divided into three sections:
Cash flows from operating activities.
Cash flows from investing activities.
Cash flows from financing activities
The bottom part reconciles the change in cash on the statement with the cash account on the balance sheet.
Net Working Capital:
Net working capital - A liquidity measure equal to current assets minus current liabilities. It measures the difference between total current assets and total current liabilities.
Depreciation calculation:
Depreciation calculation - How you spread the cost of a long-term asset (like equipment or buildings) over its useful life. It reflects wear and tear or loss of value over time.
Depreciation Expense = Cost of Asset−Salvage Value / Useful Life (years)
Module 3:
Financial ratios categories: profitability, liquidity, debt management, and asset
management:
Profitability Ratios:
Profitability Ratios - A group of ratios that measure different dimensions of a business’s profitability:
Total Margin - Net income divided by all revenues, including both operating revenues and nonoperating income.
Operating Margin - Operating income divided by patient related (operating) revenues.
Return on Assets - The ratio of net income to total assets measures the return on total assets.
Return on Equity - The ratio of net income to total equity (net assets).
Liquidity:
Liquidity Ratios - Ratios that measure the ability of a business to meet its cash obligations as they come due:
Current Ratio - Calculated by dividing current assets by current liabilities.
Days Cash on Hand - Measures liquidity on the basis of balance sheet accounts and hence is a static measure of liquidity.
Debt Management (Capital Structure) Ratios:
Debt management ratios - A group of ratios that measure
the extent of a business’s financial leverage (capital structure):
Capitalization ratios - These ratios use balance sheet data to determine the extent to which borrowed funds have been used to finance assets.
Total Debt to Total Assets (Debt Ratio) - Measures the percentage of total capital provided by creditors.
Debt-to-Capitalization Ratio - Focuses on the proportion of debt used in a business’s permanent (long-term) capital structure.
Coverage ratios - Here, income statement data are used to determine the extent to which fixed financial charges are covered by reported profits.
Times Interest Earned Ratio - Determined by dividing earnings before interest and taxes (EBIT) by interest charges. EBIT is used in the numerator because it represents the amount of accounting income that is available to pay interest expense.
Cash Flow Coverage Ratio - Shows the amount by which cash flow covers fixed financial requirements.
Asset Management Ratio:
Asset management ratios - Financial statement analysis ratios that measure how effectively a firm is managing its assets.
Fixed Asset Turnover - Measures the utilization of property and equipment, and it is the ratio of total (all) revenues to net fixed assets (property and equipment).
Days in Patient Accounts Receivable - Used to measure effectiveness in managing receivables.
Average Age of Plant - Gives a rough measure of the average age in years of a business’s fixed assets (net property and equipment).
Ratio analysis:
Ratio analysis - The process of creating and analyzing ratios from financial statement and other data to help assess a business’s financial condition.
Financial ratio analysis - Combines values from the financial statements to create single numbers that: Facilitate comparisons.
Conduct profit (cost-volume-profit) analysis:
Cost-volume-profit (CVP) analysis - Allows managers
to examine the effects of alternative assumptions regarding costs, volume, and prices.
When average cost per visit as volume increases the average cost per unit goes down. Primarily because we're able to spread the fixed costs over a larger volume of visits.
Contribution Margin:
Contribution Margin - The difference between per unit revenue and per
unit cost (variable cost rate) and hence the amount that each unit of
volume contributes to cover fixed costs and ultimately flows to profit.
Contribution Margin=Sales Revenue−Variable Costs
Contribution Margin Ratio= Sales Revenue/Contribution Margin×100
Determine break-even volume:
Breakeven Analysis - The volume needed for an organization (or service or program) to be financially self-sufficient.
Break-Even Volume (Units)= Fixed Costs/Contribution Margin per Unit
Calculate expected profits at specific patient volumes:
Profit=(Contribution Margin per Patient×Patient Volume)−Fixed Costs
Patient Volume= Fixed Costs/ Contribution Margin per Unit