Chapter 1 Financial Information and the Decision-Making Process

Learning Objectives Describe the importance of financial information in health care organizations Discuss the uses of financial information List the users of financial information Describe the financial functions within an organization Discuss the common ownership forms of health care organizations, along with their advantages and disadvantages

Importance of Financial Information Cash flow management Investment decisions Long-term goals of organization Main goal - reduce risks and maximize profits

Ambulatory Surgery Center Consider two actions – to build or not to build an ASC Uncertainty of decision making Results matrix – 50% utilization enables to operate in the black Does not account for desirability of outcomes

Financial Information, cont.

Health Care Industry: Trends Rapid growth of health care industry including hospitals, long-term care facilities, home health, ambulatory services, etc. Health care costs are increasing: health care spending is 17% of the U.S. GDP Increasing importance of financial and cost information in decision making

Health Care Industry Health care industry differs from other business organizations:  Dominance of not-for-profit hospitals  Main source of revenue - reimbursement from government and private insurers  Contribution to social wellbeing

Uses of Financial Information Evaluating the financial condition of an entity Evaluating stewardship within an entity Assessing the efficiency of operations Assessing the effectiveness of operations Determining the compliance of operation with directives

Financial Condition Status of a firm’s assets, liabilities and equity positions described in financial statements Equated with an organization’s viability Most common use of financial information Underlies most business decisions Includes assessment of short-term vs. long- term conditions

Stewardship Management’s responsibility to properly utilize organization’s resources, including people, property and financial assets Historically most important Designed to prevent loss of assets through employees’ malfeasance

Efficiency The ratio of outputs to inputs, the lowest possible cost of production Becoming increasingly important given increasing healthcare costs and lower reimbursement Implies availability of standards or benchmarks for comparison

Effectiveness Attainment of objectives through production of outputs Difficult to measure as organizations do not always state their objectives quantitatively Gets less emphasis than efficiency => unnecessary services at an efficient price:  Lower cost of surgeries at outpatient surgery centers, but are these surgeries necessary?

Compliance Whether or not organization’s directives are followed Financial reporting is required to ensure compliance  Internal uses, e.g. budgets  External uses, e.g. lenders or credit rating agencies

Financial Management Functions Two main duties of financial managers – controllership and treasurership Controllers – deal with internal finances:  direct preparation of financial statements and reports  direct preparation of budgets  analyze future earnings and expenses  develop internal control procedures  prepare reports for regulatory agencies

Financial Management Functions, cont Treasurers – deal with external finances:  establish billing, credit, and collection policies  manage investments  secure financing  short-term, e.g. arrange line of credit, short-term transfer funds  long-term, e.g. bond issuance  maintain investor & credit rating relations  analyze mergers and acquisition opportunities

Figure 1–2 Financial Organization Chart of a Typical Hospital

Forms of Business Organizations Main forms of business organization in health care: –Not-For-Profit (NFP) Business-Oriented –Investor-Owned (IO) Entities –Government Health Care –Non-Governmental NFP Differ in ownership structure

NFP Business-Oriented Organizations Objective function – maximize shareholders’ value, vs. profit maximization Shareholders - community vs. individuals Exempt from federal income tax and most state and local property taxes Required to provide “community benefit,” Lower cost of equity capital than IO, but more limited access to capital Currently 80% of hospitals are NFP

Investor-Owned Health Care Entities Shareholders – risk-based equity investors Objective function – profit maximization for shareholders Able to access capital through debt and equity Subject to “double taxation,” i.e. taxed at the corporate level and individual level (shareholders)

Investor-Owned Entities Main types of IO entities: Publicly-traded Privately held Professional corporations/associations Sole proprietorships Partnerships Limited liability companies

Publicly-Traded Companies Buy and sell shares of the firm on the open market Subject to reporting requirements and regulation by the Securities and Exchange Commission (SEC) Advantage – ability to raise equity capital through the sale of company stocks

Privately-Held Companies Shares are held by few investors and not available to the general public Advantage – far few reporting requirements by SEC Until recently, Hospital Corporation of America (HCA) was the largest privately held hospital system

Professional Corporations Professional corporation/association (PC, PA) – formed by professionals with the advantage of corporation Shareholders are free from personal liability, but professionals are liable Widely used by physicians as they are protected from liabilities of each another

Sole Proprietorships Unincorporated businesses owned by a single individual (e.g. solo practitioner physicians) Advantages: -easy and inexpensive to set up -no profit sharing -no government regulations -no special income taxes Disadvantages: -unlimited liability -limited access to capital

Partnerships Unincorporated businesses with two or more owners Advantages: - Easy to form -Subject to few government regulations -Not subject to double-taxation Disadvantages: -Unlimited liability -Difficult to dissolve -Potential for conflict among partners

Limited Liability Companies LLC/Limited liability partnerships (LLP) – combine characteristics of partnership and liability protection of corporation Liability of the general partner is limited Flexible to structure allocations of income and losses as owners choose Required to follow tax allocation rules

Government HC Organizations Public corporations, owned by a state or local government Sometimes have access to additional revenue through taxes Not able to raise funds through equity investments Like NFPs, exempt from property and income taxes May face political pressure to return some of the earnings to the community or reduce prices if earnings are too large

NFP Non-business-Oriented Organizations Perform voluntary services in communities Tax-exempt Rely primarily on public donations Financial statements and financial management are different from business- oriented firms Examples: American Red Cross, American Cancer Society