Start by reading and following these instructions: 1. Quickly skim the questions or assignment below and the assignment rubric to help you focus.
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FINANCIAL CONDITION ANALYSIS 17 Learning Objectives After studying this chapter, readers will be able to Explain the purposes of financial statement and operating indicator analyses.
Describe the primary techniques used in financial statement and operating indicator analyses.
Conduct basic financial statement and operating indicator analyses to assess the financial condition of a business.
Describe the problems associated with financial statement and operating indicator analyses.
Describe how key performance indicators (KPIs) and dashboards can be used to monitor financial condition.
Introduction One of the most important characteristics of a healthcare organization is its financial condition: Does the business have the financial capacity to perform its mission? Many judgments about financial condition are made on the basis of financial statement analysis, which focuses on the data contained in a business s financial statements. Financial statement analysis is applied to historical data, which reflect the results of past managerial decisions, and to forecasted data, which constitute the road map for the business s future. Thus, managers use financial statement analysis both to assess current condition and to plan for the future.
Although financial statement analysis provides a great deal of important information regarding financial condition, it fails to provide much insight into the operational causes of that condition. Thus, financial statement analysis is often supplemented by operating indicator analysis, which uses operating data not usually found in an organization s financial statements such as occupancy, patient mix, length of stay, and productivity measures to help identify factors that contributed to the assessed financial condition. Through operating indicator analysis, managers are better able to identify and implement strategies that ensure a sound financial condition in the future.
Financial statement analysis The process of using data contained in financial statements to make judgments about a business s financial condition.
Operating indicator analysis The process of using operating indicators to help explain a business s financial condition.
Financial condition analysis involves a number of techniques that extract information contained in a business s financial statements and elsewhere and combine it in a form that facilitates making judgments about the organization s financial condition and operations. Often the end result is a list of organizational strengths and weaknesses. In this chapter, several analytical techniques used in financial condition analyses, some related topics, and the problems inherent in such analyses are discussed. Along the way, you will discover that financial condition analysis generates a great deal of data. A significant problem in assessing financial condition is separating the important from the unimportant and presenting the results in a simple, easy-to-understand, easy-to-monitor format. Thus, we close the chapter with some ideas about data presentation.
In addition to the chapter content, the Chapter 17 Supplement discusses four topics: market value ratios, common size analysis, percentage change analysis, and economic value added (EVA).
Financial Statement Analysis As you learned in chapters 3 and 4, generally accepted accounting standards require businesses to prepare four financial statements: (1) the income statement, (2) the statement of changes in equity, (3) the balance sheet, and (4) the statement of cash flows. Taken together, these statements give an accounting picture of an organization s operations and financial position. Because financial statement data are well organized and easily understood, such statements provide a logical starting place for analyzing an organization s financial condition.
In much of this chapter, Riverside Memorial Hospital, a 450-bed not- for-profit facility, is used to illustrate financial condition analysis. Although a hospital is being used to illustrate the techniques, they can be applied to any health services setting. Simplified versions of Riverside s three primary financial statements are contained in exhibits 17.1, 17.2, and 17.3. Riverside s income statements and balance sheets (exhibits 17.2 and 17.3) will be examined in later sections when we discuss ratio analysis and other tools that are used to help interpret the data. For now, our focus is on the statement of cash flows, which can be interpreted without the aid of additional data or tools.
The statement of cash flows (Exhibit 17.1), first described in Chapter 4, provides such information as whether the firm s core operations are profitable, how much capital the firm raised and how this capital was used, and what impact operating and financing decisions had on the firm s cash position.
The top part shows cash generated by and used in operations during 2015. For Riverside, operations provided $9,098,000 in net cash flow. The income statement reported $6,474,000 in operating income and $4,130,000 in depreciation, for $10,604,000 in operating cash flow. But as part of its operations, Riverside invested $1,297,000 in current assets (receivables and inventories) and reduced its spontaneous liabilities (payables and accruals) balance by $209,000. The end result, net cash flow from operations, is $10,604,000 . $1,297,000 . $209,000 = $9,098,000.
The next section of the statement of cash flows focuses on investments in fixed assets and securities. Riverside spent $4,293,000 on capital expenditures in 2015. Is that a large or small amount? The top part of the statement of cash flows reports a depreciation expense for 2015 of $4,130,000, so the hospital spent only slightly more than its depreciation expense on new fixed assets. Thus, it is likely that the capital expenditures were more to replace worn-out and obsolete assets than to add a significant amount of new property and equipment.
In addition to fixed-asset investments, Riverside invested $2,000,000 in short-term securities, for a total cash outflow from investing of $6,293,000.
Riverside s financing activities, as shown in the third section, highlight the fact that the hospital received $2,098,000 in nonoperating income (unrestricted contributions and investment income) and used $2,150,000 + $3,262,000 + $323,000 = $5,735,000 in cash to pay off previously incurred long-term debt, short-term debt, and capital lease obligations.
Cash flows from operating activities:
Operating income Adjustments:
Depreciation Increase in accounts receivable Increase in inventories Decrease in accounts payable Increase in accrued expenses Net cash flow from operations Cash flows from investing activities:
Investment in property and equipment Investment in short-term securities Net cash flow from investing Cash flows from financing activities:
Nonoperating income Repayment of long-term debt Repayment of notes payable Capital lease principal repayment Net cash flow from financing Net increase (decrease) in cash and equivalents Beginning cash and equivalents Ending cash and equivalents $ 6,474 4,130 (1,102) (195) (438) 229 $ 9,098 ($ 4,293) ( 2,000) ($ 6,293) $ 2,098 (2,150) (3,262) (323) ($ 3,637) ($ 832) 3,095 $ 2,263 EXHIBIT 17.1 Riverside Memorial Hospital:
Statement of Cash Flows, Year Ended December 31, 2015 (in thousands) When the three major sections are totaled, Riverside had a $9,098,000 . $6,293,000 . $3,637,000 = $832,000 net decrease in cash (i.e., net cash outflow) during 2015. The bottom of Exhibit 17.1 reconciles the 2015 net cash flow with the ending cash balance shown on the balance sheet. Riverside began 2015 with $3,095,000; experienced a cash outflow of $832,000 during the year; and ended the year with $3,095,000 . $832,000 = $2,263,000 in its cash and equivalents account, as verified by the value reported on the balance sheet (Exhibit 17.3).
Riverside s statement of cash flows shows nothing unusual or alarming.
It does show that the hospital s operations were inherently profitable, at least in 2015. Had the statement showed an operating cash drain, Riverside s managers would have had something to worry about; if it continued, such a drain could bleed the hospital to death. The statement of cash flows also provides easily interpreted information about Riverside s financing and fixed- asset investing activities for the year. For example, Riverside s cash flow from operations was used primarily to purchase replacement fixed assets, to invest in short-term securities, and to pay off notes payable and long-term debt.
Again, such uses of operating cash flow do not raise any red flags regarding the hospital s financial actions.
Managers and investors must pay close attention to the statement of cash flows. Financial condition is driven by cash flows, and the statement gives a good picture of the annual cash flows generated by the organization. An examination of Exhibit 17.1 (or better yet, a series of such exhibits going back the last five years and projected five years into the future) would give Riverside s managers and creditors an idea of whether or not the hospital s operations are self-sustaining that is, whether the business generates the cash flows necessary to pay its bills, including those associated with the capital employed.
Although the statement of cash flows is filled with valuable information, the bottom line tells little about the business s financial condition because operating losses can be covered by financing transactions such as borrowing or selling new common stock (if investor owned), at least in the short run.
SELF-TEST QUESTIONS 1. What are the four required financial statements?
2. What type of financial performance information is provided in the statement of cash flows?
3. What is the difference between net income and cash flow, and which is more meaningful to a business s financial condition?
4. Does the fact that a business s cash position has improved provide much insight into the year s financial results?
Financial Ratio Analysis The next step in most financial condition analyses is to examine the business s other financial statements. We analyzed Riverside s statement of cash flows first because this statement is formatted in a way that facilitates interpretation without further data manipulation. Now we examine the income statement and balance sheet. Although these statements contain a wealth of financial information, it is difficult to make meaningful judgments about financial condition by merely examining the statements raw data. To illustrate, one medical group practice may have $5,248,760 in long-term debt and interest charges of $419,900, while another may have $52,647,980 in debt and interest charges of $3,948,600. The true burden of these debts, and each practice s ability to pay the interest and principal due on them, cannot be easily assessed without additional data analyses, such as those provided by ratio analysis.
Ratio analysis combines data to create single numbers that have easily interpreted significance (for our purposes, numbers that measure various aspects of financial condition). Financial ratio analysis is ratio analysis applied to the data contained in a business s financial statements (income statement and balance sheet). In the case of the debt and interest payments described above, ratios could be constructed that relate each practice s debt to its assets and the interest it pays to the income it has available for payment.
Unfortunately, an almost unlimited number of financial ratios can be constructed, and the choice of ratios depends in large part on the nature of the business being analyzed, the purpose of the analysis, and the availability of comparative data. Generally, ratios are grouped into categories to make them easier to interpret. In the paragraphs that follow, the data presented in exhibits 17.2 and 17.3 are used to calculate an illustrative sampling of 2015 financial ratios for Riverside Memorial Hospital, which are then compared with hospital industry average ratios.
Industry average ratios are available from many sources. For example, Optum360 publishes an annual almanac that provides hospital industry data on 76 financial and operating indicator ratios. The ratios are reported in several groupings, such as by hospital size and geographic location. (For information about the 2016 edition, visit www.optumcoding.com/Product/43409/.) The industry average ratios presented in this chapter are for illustrative use only and hence should not be used for making real-world comparisons.
Note that in a real analysis, many more ratios would be calculated and analyzed. Also, although a hospital is used to illustrate ratio analysis, the specific ratios used in any analysis depend on the type of healthcare provider. Some ratios are more meaningful for hospitals, some for managed care organizations, some for medical practices, and so on.
Ratio analysis The process of creating and analyzing ratios from financial statement and other data to help assess a business s financial condition.
EXHIBIT 17.2 Riverside Memorial Hospital:
Statements of Operations (Income Statements), Years Ended December 31, 2015 and 2014 (in thousands) 2015 2014 Revenues:
Patient service revenue Less: Provision for bad debts Net patient service revenue Premium revenue Other revenue Net operating revenues Expenses:
Nursing services Dietary services General services Administrative services Employee health and welfare Malpractice insurance Depreciation Interest expense Total expenses Operating income Nonoperating income Net income $ 106,502 $ 95,398 3,328 3,469 $ 103,174 $ 91,929 5,232 4,622 3,644 6,014 $ 112,050 $102,565 $ 58,285 $ 56,752 5,424 4,718 13,198 11,655 11,427 11,585 10,250 10,705 1,320 1,204 4,130 4,025 1,542 1,521 $ 105,576 $ 102,165 $ 6,474 $ 400 2,098 1,995 $ 8,572 $ 2,395 Profitability ratios A group of ratios that measure different dimensions of a business s profitability.
Profitability Ratios Profitability is the net result of a large number of managerial policies and decisions, so profitability ratios provide one measure of the aggregate financial performance of a business.
Total Margin The total margin, often called the total profit margin or just profit margin, is net income divided by all revenues, including both operating revenues and nonoperating income:
Netincome $8,572 Totalmargin= = =0.075=7.5%.
Totalrevenues $114,148 Industry average= 5.0%.
Note that total revenues are defined as net operating revenues plus nonoperating income, so Total revenues = $112,050 + $2,098 = $114,148.
Riverside s total margin of 7.5 percent shows that the hospital makes 7.5 cents on each dollar of revenue. The total margin measures the ability of the EXHIBIT 17.3 2015 2014 Riverside Cash and equivalents Short-term investments Net patient accounts receivable Inventories Total current assets Gross property and equipment Accumulated depreciation Net property and equipment Total assets Accounts payable Accrued expenses Notes payable Total current liabilities Long-term debt Capital lease obligations Total long-term liabilities Net assets (equity) Total liabilities and net assets $ 2,263 4,000 21,840 3,177 $ 31,280 $ 145,158 25,160 $ 119,998 $ 151,278 $ 4,707 5,650 2,975 $ 13,332 $ 28,750 1,832 $ 30,582 $ 107,364 $ 151,278 $ 3,095 2,000 20,738 2,982 $ 28,815 $140,865 21,030 $ 119,835 $148,650 $ 5,145 5,421 6,237 $ 16,803 $ 30,900 2,155 $ 33,055 $ 98,792 $148,650 Memorial Hospital:
Balance Sheets, December 31, 2015 and 2014 (in thousands) organization to generate revenues from all sources and to control expenses.
With all else the same, the higher the total margin, the lower the expenses relative to revenues. Riverside s total margin is well above the industry average of 5.0 percent, indicating good expense control. How good? The industry data source also reports quartiles; for total margin, the upper quartile was 8.4 percent, meaning that 25 percent of hospitals had total margins higher than 8.4 percent. Although Riverside s total margin was better than average, it was not as good as the top 25 percent of hospitals.
Although industry average figures are discussed in detail later in the chapter, it should be noted here that the industry average is not a magic number that all businesses should strive to achieve. Some well-managed businesses will be above the average, while other good firms will be below it. However, if a business s ratios are far removed from the average for the industry, its managers should be concerned about why this difference occurs. Note also that according to standard practice, we are calling the comparative data averages, but in reality they are median values. Median values are better for comparisons because they are not biased by extremely high or low values in the industry data set.
Riverside s relatively high total margin could mean that the hospital s charges are relatively high, its costs are relatively low, it has relatively high nonoperating revenue, or a combination of these factors is at play. A thorough operating indicator analysis would help pinpoint the cause, or causes, of Riverside s high total margin.
Operating Margin Another useful margin ratio is the operating margin, which is defined as operating income divided by patient-related (operating) revenues:
Operatingincome $6,474 Operatingmargin= = =0.058=5.8%.
Netoperating revenues $112,050 Industryaverage= 3.5%.
The advantage of operating margin is that it focuses on core business activities and hence removes the influence of financial gains and losses, which are unrelated to operations and often are transitory. Riverside s total margin was 7.5 percent, while its operating margin was only 5.8 percent, compared to the industry average of 3.5 percent. Removing nonoperating income (primarily unrestricted contributions and investment returns) lowers profitability, but Riverside s core operations are more profitable than the industry average, which is good news. Note, though, that the format of many healthcare organizations financial statements makes this ratio difficult to determine without additional information. Furthermore, the definition of operating margin varies depending on data availability.
Return on Assets The ratio of net income to total assets measures the return on total assets, often just called return on assets (ROA):
Netincome $8,572 Return on assets = == 0.057 = 5.7%.
Totalassets $151,278 Industryaverage4.8%.
= Riverside s 5.7 percent ROA, which means that each dollar of assets generated 5.7 cents in profit, is well above the 4.8 percent average for the hospital industry. ROA tells managers how productively, in a financial sense, a business is using its assets. The higher the ROA, the greater the net income for each dollar invested in assets and hence the more productive the assets.
ROA measures both a business s ability to control expenses, as expressed by the total margin, and its ability to use its assets to generate revenue.
Return on Equity The ratio of net income to total equity (net assets) measures the return on equity (ROE):
Netincome $8,572 Return on equity = == 0.080 = 8.0%.
Totalequity $107,364 Industryaverage8.4%.
= Riverside s 8.0 percent ROE is slightly below the 8.4 percent industry average. The hospital was able to generate 8.0 cents of income for each dollar of equity investment, while the average hospital produced 8.4 cents. ROE is especially meaningful for investor-owned businesses because owners are concerned with how well the business s managers are using owner-supplied capital, and ROE answers this question. For not-for-profit businesses such as Riverside, ROE tells its board of trustees and managers how well, in financial terms, its community-supplied capital is being used.
Riverside s 2015 margin measures and ROA were above the industry averages, yet the hospital s ROE is below the average. As we explain later in the section on Du Pont analysis, this seeming inconsistency is a result of the hospital s low use of debt financing.
Liquidity Ratios One of the first concerns of most managers, and the major concern of a firm s creditors, is the business s liquidity. Will the business be able to meet its cash obligations as they come due? Liquidity ratios are designed to answer that question. Riverside has debts totaling more than $13 million (i.e., its current liabilities) that must be paid off within the coming year. Will the hospital be able to make these payments? A full liquidity analysis requires the use of a cash budget, which we discussed in Chapter 16. However, by relating the amount of cash and other current assets to current obligations, ratio analysis provides a quick, easy-to-use, rough measure of liquidity.
Current Ratio The current ratio is calculated by dividing current assets by current liabilities:
Current assets $31,280 Current ratio = == 2.3, or 2.3times.
Current liabilities $13,332 = Industryaverage2.0.
The current ratio tells managers that the immediate liquidation of Riverside s current assets at book value would provide $2.30 of cash for every Liquidity ratios Ratios that measure the ability of a business to meet its cash obligations as they come due.
$1 of current liabilities. If a business is getting into financial difficulty, it will begin paying its accounts payable more slowly, building up short-term bank loans (notes payable), and so on. If these current liabilities rise faster than current assets, the current ratio will fall, and this could spell trouble. Because the current ratio is an indicator of the extent to which short-term claim obligations are covered by assets that are expected to be converted to cash in the near term, it is a commonly used measure of liquidity.
Riverside s current ratio is slightly above the average for the hospital industry. Because current assets should be converted to cash in the near future, it is highly probable that these assets could be liquidated at close to their stated values. With a current ratio of 2.3, the hospital could liquidate current assets at only 43 percent of book value and still pay off current creditors in full. (To determine the minimum proportion of current assets that must be converted to cash to meet current obligations, divide the number 1 by the current ratio. For Bayside, 1 2.3 = 0.43, or 43 percent. This proportion is confirmed by noting that 0.43 . $31,280,000 = $13,332,000, the amount of current liabilities.) Days Cash on Hand The current ratio measures liquidity on the basis of balance sheet accounts and hence is a static measure of liquidity. However, the true measure of a business s liquidity is whether it can meet its payments as they come due, so liquidity is more related to cash inflows and outflows than it is to assets and liabilities. The days-cash-on-hand ratio moves closer to those factors that truly determine liquidity:
Cash andequivalents+ Short-term investments Days cashonhand = (Expenses Depreciation) /365 $2,263+ $4,000 $6,263 = == 22.5days.
($105,576 $4,130) /365 $277.93 Industryaverage = 30.6 days.
The denominator of the equation estimates average daily cash expenses by stripping out noncash expenses (depreciation) from reported total expenses and then dividing by 365, the number of days in a year. The numerator is the cash and securities that are available to make those cash payments. Because Riverside s days cash on hand is lower than the industry average, its liquidity position as measured by days cash on hand is worse than that of the average hospital.
For Riverside, the two measures of liquidity, current ratio and days cash on hand, give conflicting results. Perhaps the average hospital has a greater proportion of cash and equivalents and short-term investments in its current assets mix than does Riverside. More analysis would be required to make a supportable judgment concerning Riverside s liquidity position. Remember, though, that the cash budget, which we discussed in Chapter 16, is the primary tool used by managers to ensure liquidity.
Debt Management (Capital Structure) Ratios The extent to which an organization uses debt financing, or financial leverage, is an important measure of financial performance for several reasons. First, by raising funds through debt, owners of for-profit businesses can maintain control with a limited investment. For not-for-profit organizations, debt financing allows more services to be provided than if the organization were solely financed with contributions and earnings. Next, creditors look to equity capital to provide a margin of safety; if the owners (or community) have provided only a small proportion of total financing, the risks of the enterprise are borne mainly by its creditors. Finally, if a business earns more on investments financed with borrowed funds than it pays in percentage interest, its ROE is increased.
Debt management ratios fall into two categories:
1. Capitalization ratios. These ratios use balance sheet data to determine the extent to which borrowed funds have been used to finance assets.
2. Coverage ratios. Here, income statement data are used to determine the extent to which fixed financial charges are covered by reported profits.
The two sets of ratios are complementary, so most financial statement analyses examine both types.
Capitalization Ratio 1: Total Debt to Total Assets (Debt Ratio) The ratio of total debt to total assets (total liabilities and equity), called the debt ratio, measures the percentage of total capital provided by creditors:
Totaldebt $43,914 Debt ratio = == 0.290,or 29.0%.
Totalassets $151,278 Industryaverage = 42.3%.
For this ratio, debt typically is defined as all debt, including current liabilities. In essence, debt is defined here as everything on the capital side of the balance sheet except equity. However, as illustrated by the next ratio discussed, capitalization ratios have several variations, many of which use different definitions of what constitutes debt.
Creditors prefer low debt ratios because the lower the ratio, the greater the cushion against creditors losses in the event of bankruptcy and liquidation.
Conversely, owners of for-profit firms may seek high leverage either to Debt management ratios A group of ratios that measure the extent of a business s financial leverage (capital structure).
leverage up returns or because selling new stock would mean giving up some degree of control. In not-for-profit organizations, managers may seek high leverage to offer more services.
Riverside s debt ratio is 29.0 percent. This means that its creditors have supplied somewhat less than one-third of the business s total financing. Put another way, each dollar of assets was financed with 29 cents of debt, and consequently, 71 cents of equity. (The equity ratio is defined as 1 . Debt ratio, so Riverside s equity ratio is 71 percent.) Because the average debt ratio for the hospital industry is more than 40 percent, Riverside uses significantly less debt than the average hospital. The low debt ratio indicates that the hospital would find it relatively easy to borrow additional funds, presumably at favorable rates.
Note that the debt-to-equity ratio, defined as Total debt Total equity, is a close relative of the debt ratio. These ratios are transformations of one another and provide the same information but with a different twist. Both the debt ratio and debt-to-equity ratio increase as a business uses a greater proportion of debt financing, but the debt ratio rises linearly and approaches a limit of 100 percent, while the debt-to-equity ratio rises at a faster rate and approaches infinity. Lenders, in particular, prefer to use the debt-to-equity ratio rather than the debt ratio because it tells them how much capital creditors have provided to the organization per dollar of equity capital. The higher this ratio, the riskier the creditors position. Other analysts tend to prefer the debt ratio because it makes it easier to visualize the liabilities and equity mix on the balance sheet.
Capitalization Ratio 2: Debt-to-Capitalization Ratio The debt-to-capitalization ratio, which is long-term debt divided by long-term capital (long-term debt plus equity), focuses on the proportion of debt used in a business s permanent (long-term) capital structure. This ratio is also called the long-term-debt-to-capitalization ratio or just capitalization ratio. (Note that we have included capital lease obligations in our definition of long-term debt because such obligations are similar in nature to long-term debt.) Long-term debt Debt-to-capitalization ratio = Long-term debt + Equity $30,582 == 0.222, or 22.2%.
$30,582 + $107,364 Industry average = 34.6%.
Many analysts believe that the debt-to-capitalization ratio best reflects the capital structure of a business. This belief is based on the fact that most businesses use as much spontaneous free credit (current liabilities less short-term bank loans) as they can get. Furthermore, short-term interest-bearing debt typically is used only to fund temporary current asset needs. Thus, the true capital structure of a business the one that reflects its target structure is best reflected by a ratio that focuses on permanent (long-term) financing.
Riverside s debt-to-capitalization ratio is 22.2 percent, compared to the industry average of 34.6 percent. This low use of debt financing in Riverside s permanent capital mix confirms the conclusion made earlier that the hospital has unused debt capacity.
Coverage Ratio 1: Times Interest Earned Ratio The times interest earned (TIE) ratio is 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. For a not-for-profit organization, which does not pay taxes, EBIT = Net income + Interest expense, whereas for a for-profit business, EBIT = Net income + Interest expense + Taxes. Riverside s TIE ratio is 6.6:
EBIT $8,572 + $1,542 $10,114 TIEratio == == 6.6.
Interest expense $1,542 $1,542 = Industryaverage4.0.
The TIE ratio measures the number of dollars of accounting income (as opposed to cash flow) available to pay each dollar of interest expense. In essence, it is an indicator of the extent to which income can decline before it is less than annual interest costs. Failure to pay interest can bring legal action by the firm s creditors, possibly resulting in bankruptcy.
Riverside s interest is covered 6.6 times, so it has $6.60 of accounting income to pay each dollar of interest expense. Because the industry average TIE ratio is four times, the hospital is covering its interest charges by a relatively high margin of safety. Thus, the TIE ratio reinforces the previous conclusions based on the debt and debt-to-capitalization ratios namely, that the hospital could easily expand its use of debt financing.
Coverage ratios are often better measures of a firm s debt utilization than capitalization ratios because coverage ratios discriminate between low-interest rate debt and high-interest rate debt. For example, a medical group practice might have $10 million of 4 percent debt on its balance sheet, while another might have $10 million of 8 percent debt. If both practices have the same income and assets, both would have the same debt ratio. However, the group that pays 4 percent interest would have lower interest charges and hence would be in better financial condition than the group that pays 8 percent. This difference in financial condition is captured by the TIE ratio.
Coverage Ratio 2: Cash Flow Coverage Ratio Although the TIE ratio is easy to calculate, it has three major deficiencies.
First, leasing is a common form of financing, and the TIE ratio ignores lease Asset management ratios Financial statement analysis ratios that measure how effectively a firm is managing its assets.
payments, which, like debt payments, are contractual obligations. Second, many debt contracts require that principal payments be made over the life of the loan, rather than only at maturity. Thus, most organizations must meet fixed financial charges associated with debt financing besides interest payments.
Finally, the TIE ratio ignores the fact that accounting income, whether measured by EBIT or net income, does not reflect the actual cash flow available to meet a business s fixed payments. These deficiencies are corrected in the cash flow coverage (CFC) ratio, which shows the amount by which cash flow covers fixed financial requirements. Here is Riverside s 2015 CFC ratio assuming the hospital had $1,368,000 of lease payments and $2,000,000 of required debt principal repayments:
EBITLease+ payments + Depreciation expense CFCratio = ++ Debt principal/ (1 .T Interest expenseLease payments ) $10,114 + $1,368 + $4,130 $15,612 = == 3.2.
$1,542$1,368++ $2,000/(10) .
$4,910 = Industryaverage2.3.
Like its TIE ratio, Riverside s CFC ratio exceeds the industry standard, indicating that Riverside is better at covering total fixed payments with cash flow than is the average hospital. This fact should be reassuring both to creditors and to management as it reinforces the view that Riverside has untapped debt capacity.
You may be wondering why there is a (1 . T) term applied to the debt principal. The reason is that investor-owned firms must make principal repayments with after-tax dollars and hence must earn more pretax dollars to both pay taxes and make the principal repayment. The grossed-up amount, which results from dividing by 1 . T, gives the amount of pretax dollars that are needed to cover the required principal repayments. Thus, the calculation, which contains pretax dollars in the numerator, now has pretax dollars in the denominator and hence is consistent in format.
Asset Management (Activity) Ratios The next group of ratios, the asset management ratios, is designed to measure how effectively a business s assets are being utilized. These ratios help answer whether the amount of each type of asset reported on the balance sheet seems reasonable, too high, or too low in view of current (or projected) operating levels. Riverside and other hospitals must borrow or raise equity capital to acquire assets. If they have too many assets for the volume of services provided, their capital costs will be too high and their profits will be depressed. Conversely, if the level of assets is too low, volume may be lost or vital services not offered.
Fixed Asset Turnover Ratio The fixed asset turnover ratio, also called the fixed asset utilization ratio, measures the utilization of property and equipment, and it is the ratio of total (all) revenues to net fixed assets (property and equipment):
Totalrevenues $114,148 Fixedassetturnover = = =0.95.
Netfixed assets $119,998 Industryaverage= 2.2.
Note that total revenues include both operating and nonoperating revenues:
$112,050 + $2,098 = $114,148. Also, net fixed assets are listed on the balance sheet as net property and equipment.
Riverside s ratio of 0.95 indicates that each dollar of fixed assets generated 95 cents in total revenue. This value compares poorly with the industry average of 2.2 times, indicating that Riverside is not using its fixed assets as productively as is the average hospital. (The lower-quartile value for the industry is 1.1; thus, Riverside falls in the bottom 25 percent of all hospitals in its fixed-asset utilization.) Before condemning Riverside s management for poor performance, it should be pointed out that a major problem arises from the use of the fixed asset turnover ratio for comparative purposes. Recall that most asset values listed on the balance sheet reflect historical costs rather than current market values. Inflation and depreciation have caused the values of many assets that were purchased in the past to be seriously understated. Therefore, if an old hospital that had acquired much of its plant and equipment years ago is compared to a new hospital with the same physical capacity, the old hospital, because of a much lower book value of fixed assets, would report a much higher turnover ratio. This difference in fixed-asset turnover is more reflective of the inability of financial statements to deal with inflation than of any inefficiency on the part of the new hospital s managers.
Total Asset Turnover Ratio The total asset turnover ratio measures the turnover, or utilization, of all of a business s assets. It is calculated by dividing total (all) revenues by total assets:
Totalrevenues $114,148 Totalassetturnover = == 0.75.
Totalassets $151,278 = Industryaverage0.97.
Again, note that total revenues include both operating and nonoperating revenues.
Each dollar of total assets generated 75 cents in total revenues. Riverside s total asset ratio is below the industry average, but not as far below as its Comparative analysis The comparison of key financial and operational measures of one business with those of comparable businesses or industry averages.
Also called benchmarking.
fixed asset turnover ratio. Thus, relative to the industry, the hospital is using its current assets better than its fixed assets. Such judgments can be confirmed by examining Riverside s current asset turnover. In 2015, Riverside s current asset turnover ratio (Total revenues Total current assets) is 3.6, compared to the industry average of 3.4, so the hospital is slightly above average in its utilization of current assets.
Days in Patient Accounts Receivable Days in patient accounts receivable is used to measure effectiveness in managing receivables. This measure of financial performance, which is sometimes classified as a liquidity ratio rather than an asset management ratio, has many names, including average collection period (ACP) and days sales outstanding (DSO). It is computed by dividing net patient accounts receivable by average daily patient revenue to find the number of days that it takes an organization, on average, to collect its receivables. In theory, the denominator of this ratio should focus on revenues other than immediate cash payments, but this information generally is unavailable, so net patient services revenue is used.
Also, note that premium and other revenue has not been included in the calculation because such revenue typically is collected either before or at the time services are provided, and hence does not affect receivables.
Netpatient accountsreceivable Days in patient accountsreceivable = Netpatient servicerevenue / 365 $21,840 $21,840 = == 77.3days.
$103,174 / 365 $282.67 Industryaverage = 64.0days.
Riverside is not doing as well as the average hospital in collecting its receivables. The lower quartile value is 78.7 days, so a large number of hospitals are doing worse. Still, as was discussed in the revenue cycle section of Chapter 16, it is important that businesses collect their receivables as soon as possible. Clearly, Riverside s managers should strive to increase the hospital s performance in this key area.
Average Age of Plant The average age of plant gives a rough measure of the average age in years of a business s fixed assets (net property and equipment):
Accumulateddepreciation $25,160 Averageage of plant = == 6.1years.
Depreciation expense $4,130 = Industry average9.1 years.
Riverside s physical assets are newer than those of the average hospital. Thus, the hospital is offering more up-to-date facilities than average, and it will probably have fewer capital expenditures in the near future. On the other hand, Riverside s net fixed asset valuation will be relatively high, which, as pointed out earlier, biases the hospital s fixed asset and total asset turnover ratios downward. This fact raises serious questions about the interpretation of the turnover ratios calculated previously.
Comparative and Trend Analyses When conducting financial ratio analysis, the value of a particular ratio, in the absence of other information, reveals almost nothing about a business s financial condition. For example, if it is known that a nursing home management company has a current ratio of 2.5, it is virtually impossible to say whether this is good or bad. Additional data are needed to help interpret the results of this ratio analysis.
In the discussion of Riverside s financial ratios, the focus was on comparative analysis that is, the hospital s ratios were compared with the average ratios for the industry. Another useful ratio analysis tool is trend analysis, in which the trend of a single ratio is analyzed over time. Trend analysis gives clues about whether a business s financial situation is improving, holding constant, or deteriorating.
It is easy to combine comparative and trend analyses in a single graph such as the one shown in Exhibit 17.4. Here, Riverside s ROE (the solid lines) and industry average ROE data (the dashed lines) are plotted for the past five years. The graph shows that the hospital s ROE was declining faster than the industry average from 2011 through 2014, but that it rose above the industry average in 2015. Other ratios can be analyzed in a similar manner.
1. What is the purpose of ratio analysis?
2. What are two ratios that measure profitability?
3. What are two ratios that measure liquidity?
4. What are two ratios that measure debt management?
5. What are two ratios that measure asset management?
6. How can comparative and trend analyses be used to help interpret a ratio?
For Your Consideration How Many Ratios Are Enough?
In our discussion of financial statement ratio analysis, we discussed 14 ratios that are commonly used to help interpret financial statement data. Although that may seem like a lot of ratios, our discussion just scratched the surface. For example, one of the most widely used sets of comparative data for hospitals, the Almanac of Hospital Financial and Operating Indicators, published annually by Optum360, provides data on more than 30 financial ratios.
Without too much additional work, you could probably compile a list of 50 financial ratios. Yet studies have shown that about 90 percent of the information contained in financial statements can be uncovered using 10 or so carefully selected ratios.
How many ratios do you think are enough?
Does it matter how the ratios are selected? Is there a cost to using more ratios than necessary? What is the disadvantage of generating too much data?
Trend analysis A ratio analysis technique that examines the value of a ratio over time to see if it is improving or deteriorating.
SELF-TEST QUESTIONS EXHIBIT 17.4 Riverside Memorial Hospital:
ROE Analysis, 2011 2015 Lower Quartile Median Upper Quartile 2011 2012 2013 2014 2015 Du Pont analysis A financial statement analysis tool that decomposes return on equity into three components:
profit margin, total asset turnover, and equity multiplier.
ROE (%) 15 10 5 Return on Equity (ROE) Industry Year Riverside Lower Quartile Median Upper Quartile 2011 12.5% 2.6% 8.6% 13.3% 2012 10.0 2.5 8.6 13.3 2013 6.7 2.8 7.2 12.0 2014 2.4 4.1 7.2 12.1 2015 8.0 3.8 7.4 12.3 Tying the Financial Ratios Together: Du Pont Analysis Financial ratio analysis provides a great deal of information about a business s financial condition, but it does not provide an overview, nor does it tie any of the ratios together. Du Pont analysis, so named because managers at the Du Pont Company developed it, provides an overview of a business s financial condition and helps managers and investors understand the relationships among several ratios.
The analysis decomposes return on equity, one of the most important measures of a business s profitability, into the product of three other ratios, each of which has an important economic interpretation. The result is the Du Pont equation:
Equity multiplier Netincome Netincome Totalrevenues Totalassets =..
Totalequity Totalrevenues Totalassets Totalequity Riverside s 2015 data are used to illustrate the Du Pont equation:
$8,572 $8,572 $114,148 $151,278 =..
$107,364 $114,148 $151,278 $107,364 8.0% = 7.5% .
1.4 = 5.6% .
In the Du Pont equation, the product of the first two terms on the right side is return on assets (ROA), so the equation can also be written as ROE = ROA . Equity multiplier. Riverside s 2015 total margin was 7.5 percent, so the hospital made 7.5 cents profit on each dollar of total revenue.
Furthermore, assets were turned over (or created revenues) 0.75 times during the year, so the hospital earned a return of 7.5% . 0.75 = 5.6% on its assets.
This value for ROA, when rounded, is the same as was calculated previously in our ratio analysis discussion.
If the hospital used only equity financing, its 5.6 percent ROA would equal its ROE. However, creditors supplied 29 percent of Riverside s capital, while the equity holders (the community) supplied the rest. Because the 5.6 percent ROA belongs exclusively to the suppliers of equity capital, which comprises only 71 percent of total capital, Riverside s ROE is higher than its 5.6 percent ROA. Specifically, ROA must be multiplied by the equity multiplier, which shows the amount of assets working for each dollar of equity capital, to obtain the ROE of 8.0 percent. This 8.0 percent ROE could be calculated directly: ROE = Net income Total equity = $8,572 $107,364 = 8.0%. However, the Du Pont equation shows how total margin, which measures expense control; total asset turnover, which measures asset utilization; and financial leverage, which measures debt utilization, interact to determine ROE.
Key Equation: Du Pont Analysis The Du Pont equation decomposes a business s return on equity (ROE) into the product of three other ratios:
ROE = Total margin . Total asset turnover . Equity multiplier.
The value of this equation stems from the fact that the total margin measures expense control, the total asset turnover measures asset utilization, and the equity multiplier measures debt utilization. Du Pont analysis is particularly useful when the equation can be compared with both benchmark equations and previous years results.
Riverside s managers use the Du Pont equation to suggest how to improve the hospital s financial condition. To influence the profit margin, Riverside must increase revenues and/or reduce costs. Thus, the hospital s marketing staff can study the effects of raising charges, or lowering them to increase volume; moving into new services or markets with higher margins; entering into new contracts with managed care plans; and so on. Furthermore, management accountants can study the expense items and, while working with department heads and clinical staff, can seek ways to reduce costs. More specific ideas regarding actions needed to improve financial condition will be gleaned from an operating indicator analysis, which is discussed in a later section.
Regarding total asset turnover, Riverside s analysts, while working with both clinical and marketing staffs, can investigate ways of reducing investments in various types of assets. Finally, the hospital s financial staff can analyze the effects of alternative financing strategies on the equity multiplier, seeking to hold down interest expenses and the risks of debt while still using debt to leverage up ROE.
The Du Pont equation provides a useful comparison between a business s performance as measured by ROE and the performance of an average hospital. For example, here is the comparative analysis for 2015:
Riverside: ROE = 7.5% . 0.75 . 1.4 = 5.6% . 1.4 = 8.0%.
Industry average: ROE = 5.0% . 0.97 . 1.7 = 4.8% . 1.7 = 8.4%.
The Du Pont analysis tells managers and creditors that Riverside has a significantly higher profit margin, and thus better control over expenses, than the average hospital has. However, the average hospital has a better total asset turnover, and thus Riverside is getting below-average utilization from its assets. In spite of the average hospital s advantage in asset utilization, Riverside s superior expense control outweighs its utilization disadvantage because its ROA of 5.6 percent is higher than the industry average ROA of 4.8 percent. Finally, the average hospital has offset Riverside s advantage in ROA by using more financial leverage, although Riverside s lower use of debt financing decreases its risk. The end result is that Riverside gets somewhat less return on its equity capital than the average hospital gets.
One potential problem with Du Pont and ratio analyses applied to not-for-profit organizations, especially hospitals, is that a large portion of their net income may come from nonoperating sources. If the nonoperating revenues are highly variable and unpredictable, as they often are, return on equity and the ratios as previously defined may be a poor measure of the hospital s inherent profitability. All applicable ratios, as well as the Du Pont analysis, could be recast to focus on operations by using operating revenue and operating income in lieu of total (all) revenues and net income.
1. Explain how the Du Pont equation combines several ratios to obtain an overview of a business s financial condition.
2. Why might a focus on operating revenue and operating income be preferable to a focus on total revenue and net income?
Other Analytical Techniques Besides ratio and Du Pont analyses, two additional financial statement analysis techniques are commonly used in financial condition analysis. In common size analysis, all income statement items are divided by total revenues and all balance sheet items are divided by total assets. Thus, a common size income statement shows each item as a percentage of total revenues, and a common size balance sheet shows each account as a percentage of total assets. The advantage of common size statements is that they facilitate comparisons of income statements and balance sheets over time and across companies because they remove the influence of the scale (size) of the business.
Another frequently used technique when analyzing financial statements is percentage change analysis. Here, the percentage changes in the balance sheet accounts and income statement items from year to year are calculated and compared. In this format, it is easy to see what accounts and items are growing faster or slower than others and thus to identify which are under control and which are out of control.
The conclusions reached in common size and percentage change analyses generally parallel those derived from ratio analysis. However, occasionally a serious deficiency is highlighted only by one of the three analytical techniques, while the other two techniques fail to bring the deficiency to light. Thus, a thorough financial statement analysis usually consists of a Du Pont analysis to provide an overview and then includes several different techniques such as ratio, common size, and percentage change analyses. For illustrations of common size and percentage change analyses, see the supplement to this chapter.
1. What advantage do common size statements have over regular statements when conducting a financial statement analysis?
2. What is percentage change analysis, and why is it useful?
3. Which analytical techniques should be used in a complete financial statement analysis?
SELF-TEST QUESTIONS Common size analysis A technique to analyze a business s financial statements that expresses income statement items and balance sheet accounts as percentages rather than in dollars.
Percentage change analysis A technique to analyze a business s financial statements that expresses the year-to-year changes in income statement items and balance accounts as percentages.
SELF-TEST QUESTIONS Operating indicator A ratio that focuses on operating data rather than financial data.
Operating Indicator Analysis Operating indicator analysis goes one step beyond financial statement analysis by examining operating variables with the goal of explaining a business s financial condition. Like the financial ratios, operating indicators are typically grouped into major categories to make interpretation easier. For hospitals, the most commonly used categories are profit indicators, price indicators, volume (utilization) indicators, length-of-stay indicators, intensity-of-service indicators, efficiency indicators, and unit cost indicators.
Because of the large number of operating indicators used in a typical analysis, the indicators cannot be discussed in detail here. However, to give you an appreciation for this type of analysis, we discuss seven commonly used hospital operating indicators one from each category. Note that most of the data needed to calculate operating indicators are not contained in the financial statements. More complete data are required for this type of analysis.
Profit per Discharge Profit per discharge, a profit indicator, provides a measure of the amount of profit on inpatient services earned per discharge. Note that this measure is raw in the sense that it is not adjusted for case mix, which we discuss later, or local wage conditions. Often, operating indicators are calculated in both raw and adjusted forms. In 2015, Riverside s managerial accounting system reported $87,740,000 of inpatient service revenue, $84,865,000 of inpatient costs, and 18,281 patient discharges. Thus, Riverside s profit per discharge was $157:
Inpatientprofit $87,740,000 $84,865,000 Profit perdischarge == Totaldischarges 18,281 $2,875,000 == $157.
18,281 Industry average = $73.
Compared to the industry average, Riverside s inpatient services are more than twice as profitable. It is not uncommon in today s tight reimbursement environment for hospitals to lose money (as measured by accounting profit) on inpatient services. In fact, with an industry average profit per discharge of only $73, half of the hospitals are making less than $73, which indicates that a significant percentage of hospitals are losing money on inpatient services. Most, however, make up the losses with profits from other services or from nonoperating income.
Net Price per Discharge Net price per discharge, which is one of many price indicators, measures the average inpatient revenue collected on each discharge. Based on the data presented in the discussion of the profit-per-discharge indicator, Riverside s net price per discharge for 2015 was $4,800:
Netinpatient revenue $87,740,000 Netprice perdischarge = == $4,800.
Totaldischarges 18,281 Industryaverage = $5,056.
Riverside collects less per discharge than the average hospital; however, we have already seen that Riverside makes a profit of $157 on each discharge, so its inpatient services cost structure must be proportionally even lower than the industry average. Riverside s ability to make a profit on each discharge could be attributed to a lower-than-average case mix, which measures the average intensity of services provided, or to an aggressive cost management program.
Occupancy Rate (Percentage) Occupancy rate, one of many volume indicators, measures the utilization of a hospital s licensed beds and hence fixed assets. Because overhead costs are incurred on all assets whether used or not, higher occupancy spreads fixed costs over more patients and hence increases per patient profitability. Based on 95,061 inpatient days in 2015, Riverside s occupancy rate was 57.9 percent:
Inpatientdays 95,061 Occupancyrate = == 57.9%.
(Numberof licensedbeds .
365) 450 .
365 Industryaverage = 45.4%.
Riverside has a higher occupancy rate than the average hospital and hence is using its inpatient fixed assets more productively. Note that this conclusion contradicts the financial statement analysis interpretation of the hospital s 2015 fixed-asset-turnover ratio. While that ratio is affected by inflation, accounting convention, and the amount of assets devoted to other functions, the occupancy rate is not. Hence, it is a superior measure of pure asset utilization, at least regarding inpatient utilization. On this basis, Riverside s managers appear to be doing a good job, relative to the industry, of using the hospital s inpatient fixed assets. This measure can also be applied to staffed beds. In Riverside s case, the two measures of capacity are the same, but some hospitals have fewer staffed beds than licensed beds.
Average Length of Stay Average length of stay (ALOS), or just length of stay (LOS), is the number of days an average inpatient is hospitalized with each admission. ALOS and an alternative version adjusted for case mix are the sole LOS indicators. Riverside s 2015 LOS was 5.2 days:
Inpatientdays 95,061 LOS = == 5.2days.
Totaldischarges 18,281 = Industryaverage4.7 days.
On average, Riverside keeps its patients in the hospital slightly longer than the average hospital does. In general, that longer stay is considered to have a negative impact on inpatient profitability because most hospitals have a reimbursement mix heavily weighted toward prospective (episodic) payment.
With payment fixed per discharge, lower LOS typically leads to lower costs and hence higher profitability.
All Patient Case-Mix Index The all patient case-mix index is one of several intensity-of-service indicators.
The concept of measuring case mix was first applied to Medicare patients; hence, many hospitals calculate both a Medicare case-mix index and an all patient case-mix index. Case mix is based on diagnosis; diagnoses requiring more complex treatments are assigned a higher value. The idea is to be able to differentiate (on average) between hospitals that provide relatively simple, and hence low-cost, services from those that provide highly complex and costly services. Case-mix values assigned to diagnoses are periodically recalibrated, with the intent of forcing the average hospital to have a case-mix index of 1.0.
In general, case mix is related to size because large hospitals typically offer a more complex set of services than small hospitals do. Furthermore, case-mix values tend to be high at teaching hospitals (greater than 1.5) because the most complex cases often are transferred to such hospitals.
Riverside s all patient case-mix index was 1.12 for 2015, which is slightly below the industry average of 1.15. Thus, the patients that Riverside admits to the hospital require about the same intensity of services that patients at the average hospital require, which tells us that inpatient revenues and costs are not influenced by having a patient mix that is either relatively simple to treat or relatively complex.
Inpatient FTEs per Occupied Bed The number of inpatient full-time equivalents (FTEs) per occupied bed is a measure of workforce productivity and hence is an efficiency indicator. The lower the number, the more productive the workforce. When the focus is on inpatient productivity, inpatient FTEs are used. The measure can also be adapted to outpatient productivity. Needless to say, there are many situations in a hospital setting in which it is difficult to allocate FTEs to the type of service provided. With an inpatient workforce of 1,251 FTEs, Riverside s inpatient FTEs per occupied bed was 4.8 in 2015:
InpatientFTEs InpatientFTEsper occupied bed = Averagedaily census 1,251 1,251 = == 4.8.
450 260.55 = Industryaverage5.6.
Note that the average daily census the number of patients hospitalized on an average day was calculated by multiplying Riverside s occupancy rate (57.9 percent = 0.579) by the number of licensed beds (450). With higher- than-average labor productivity, coupled with better fixed-asset utilization, it is no surprise that Riverside s inpatient services are more profitable than those of the average hospital.
Salary per FTE Salary per FTE, one of the unit cost indicators, provides a simple measure of the relative cost of the largest resource item used in the hospital industry labor.
With total salaries of $83,038,613 in 2015 and 2,681 total FTEs, Riverside s salary per FTE in 2015 was $30,973:
Totalsalaries $83,038,613 Salary perFTE == = $30,973.
TotalFTEs 2,681 Industryaverage = $32,987.
Now, we can see that Riverside s above-average profitability is enhanced by both worker productivity and control over wages and benefits.
In a full operating indicator analysis, many more indicators would be examined in an attempt to identify the operating strengths and weaknesses that underlie a business s financial condition. Although operating indicator analysis has been illustrated using the hospital industry, its concepts can be applied to any healthcare business, although the indicators would differ. Also, operating indicators are interpreted in the same way as financial ratios (i.e., by performing comparative and trend analyses).
SELF-TEST QUESTIONS For Your Consideration Inflation Accounting Inflation accounting (also called replacement cost accounting or current cost accounting) describes a range of accounting systems designed to correct problems arising from historical cost accounting under inflation. It was widely used in the nineteenth and early twentieth centuries but was mostly replaced by historical cost accounting in the 1930s after asset values were devastated by the Great Depression.
Historical cost accounting leads to two basic problems. First, many of the historical numbers appearing on financial statements are not economically relevant because prices have changed since they were incurred. Second, the numbers on financial statements represent dollars expended at different points of time. Thus, adding cash of $10,000 held on December 31, 2015, with a $10,000 cost of land acquired in 1965 makes little sense because inflation has caused the two amounts to represent significantly (continued) 1. What is the difference between financial and operating indicator analyses?
2. Why is operating indicator analysis important?
3. Describe several metrics commonly used in operating indicator analysis.
Limitations of Financial Ratio and Operating Indicator Analyses While financial ratio and operating indicator analyses can provide a great deal of useful information regarding a business s operations and financial condition, such analyses have limitations that necessitate care and judgment. In this section, some of the problem areas are highlighted.
To begin, many large healthcare businesses operate a number of different services in quite different lines of business, and in such cases it is difficult to develop meaningful comparative data. This problem tends to make financial statement and operating indicator analyses somewhat more useful for providers with single service lines than for large, multiservice companies.
Next, generalizing about whether a particular ratio or indicator is good or bad is often difficult. For example, a high current ratio may show a strong liquidity position, which is good, or an excessive amount of current assets, which is bad.
Similarly, a high asset turnover ratio may denote either a business that uses its assets efficiently or one that is undercapitalized and simply cannot afford to acquire enough assets. In addition, firms often have some ratios and indicators that look good and others that look bad, which make a firm s financial position, strong or weak, difficult to determine. For this reason, significant judgment is required when analyzing financial and operating performance.
Another problem is that different accounting practices can distort financial statement ratio comparisons. For example, (continued from previous page) firms can use different accounting conven different levels of purchasing power. Under inflations to value cost of goods sold and end-tion accounting, the $10,000 cash would be ing inventories. During inflationary periods added to the current market value of the land, say, $50,000, which equalizes the purchasing these differences can lead to ratio distor power of the two amounts.
tions. Other accounting practices, such as During the past 50 years, accounting stan those related to leases, can also create prob dards have encouraged companies to supplement lems in ratio interpretation.
historical cost-based financial statements with Finally, inflation effects can distort price level (inflation) adjusted statements, but balance sheets and income statements. few companies have done so. Additionally, in the 1970s, the Financial Accounting Standards Numerous reporting methods have been Board reviewed a draft proposal that would man- proposed to adjust accounting statements date price level adjusted statements. However, for inflation, but no consensus has been because of stringent opposition from companies, reached on how to do this or even on the the proposal was never adopted.
practical usefulness of the resulting data. What do you think? Would it be easy to esti- Nevertheless, accounting standards encour-mate the current values of balance sheet assets?
What are the advantages and disadvantages of age, but do not require, businesses to dis inflation accounting? Should generally accepted close supplementary data to reflect the accounting principles be revised to require infla effects of general inflation. Inflation effects tion accounting?
tend to make ratio comparisons over time for a given business, and across businesses at any point in time, less reliable than would be the case in the absence of inflation.
SELF-TEST QUESTIONS 1. Briefly describe some of the problems encountered when performing financial statement and operating indicator analyses.
2. Explain how inflation effects created problems in the Riverside illustration.
Benchmarking Benchmarking The comparison Most techniques for evaluating financial condition require comparisons to make of performance metrics, such as meaningful judgments. In the previous examination of selected financial and financial ratios, operating indicator ratios, Riverside s ratios were compared to industry aver- of one business age ratios. However, like managers in most businesses, Riverside s managers against those of go one step further they compare their ratios not only with industry aver-similar businesses and industry ages but also with industry leaders and primary competitors. The technique averages. Also of comparing ratios against selected standards is called benchmarking, while called comparative the comparative ratios are called benchmarks. Riverside s managers benchmark analysis.
against industry averages; against National/GFB Healthcare and Pennant Healthcare, which are two leading for-profit hospital businesses; and against Woodbridge Memorial Hospital and St. Anthony s, which are its primary local competitors.
To illustrate the concept, consider how Riverside s analysts present total margin data to the firm s board of trustees:
2015 2014 National/GFB 9.8% National/GFB 9.6% Industry top quartile 8.4 Industry top quartile 8.0 St. Anthony s 8.0 St. Anthony s 7.9 Riverside 7.5 Pennant Healthcare 5.0 Industry median 5.0 Industry median 4.7 Pennant Healthcare 4.8 Riverside 2.3 Industry lower quartile 1.8 Industry lower quartile 2.1 Woodbridge Memorial 0.5 Woodbridge Memorial (1.3) Benchmarking permits Riverside s managers to easily see where the firm stands relative to its competition in any given year and over time. As the data show, Riverside was roughly in the middle of the pack in 2015 with respect to its primary competitors and two large investor-owned hospital chains, although its showing was better than the average hospital s. Its 2014 performance was significantly worse, so it improved substantially from 2014 to 2015. Although benchmarking is illustrated with one ratio, other ratios can be analyzed similarly.
Also, for presentation purposes, bar charts are often used with comparative data that are color coded for ease of recognition and interpretation.
All comparative analyses require comparative data. Such data are available from a number of sources, including commercial suppliers, federal and state governmental agencies, and various industry trade groups. Each of these data suppliers uses a somewhat different set of ratios designed to meet its own needs. Thus, the comparative data source selected dictates, in a very real sense, the ratios that will be used in the analysis. Also, there are minor and sometimes major differences in ratio definitions between data sources for example, one source may use a 365-day year, while another uses a 360-day year. Or one source might use operating values, as opposed to total values, when constructing ratios. It is very important to know the specific definitions used in the comparative data because definitional differences between the ratios being calculated and the comparative ratios can lead to erroneous interpretations and conclusions. Thus, the first task in any ratio analysis is to identify the comparative data set and the ratios to be used. The second task is to make sure the ratio definitions used in the analysis match those from the comparative data set.
1. What is benchmarking?
2. Why is it important to be familiar with the comparative data set?
Key Performance Indicators and Dashboards Financial statement data are usually created on an annual and quarterly basis, while operating indicator data are generated much more often, even daily.
Furthermore, financial condition analyses produced from this information may include literally hundreds of metrics (ratios and other measures). Although annual and quarterly financial condition analyses are always performed, managers need to monitor financial condition on a more regular basis so that problem areas can be identified and corrective action taken in a timely manner.
However, the type of financial condition analyses described in this chapter with, say, weekly data would overload managers, and as a result, important findings could be missed.
To help solve the data overload and timeliness problems, many healthcare businesses use key performance indicators (KPIs) and dashboards. KPIs are a limited number of financial and operating indicator metrics that measure performance critical to the success of an organization. In essence, they assess the current state of the business, measure progress toward organizational goals, and facilitate prompt managerial action to correct deficiencies.
The KPIs chosen by any business depend on the line of business and its mission, objectives, and goals. In addition, KPIs usually differ by timing.
For example, a hospital might have a daily KPI of number of net admissions (admissions minus discharges), while the corresponding quarterly and annual KPI might be occupancy rate. Clearly, the number of KPIs used must be kept to a minimum to allow managers to focus on the most important aspects of financial and operating performance.
Dashboards are a common way to present an organization s KPIs. The term stems from an automobile s dashboard, which presents key information (e.g., speed, engine temperature, oil pressure) about the car s performance.
Often, the KPIs are shown as gauges, which allow managers to quickly interpret the indicators. The basic idea here is to allow managers to monitor the business s most important financial and operating metrics on a regular basis (daily for some metrics) in a form that is easy to read and interpret.
1. What is a key performance indicator (KPI)? A dashboard?
2. How are KPIs and dashboards used in financial condition analysis?
SELF-TEST QUESTIONS Key performance indicator (KPI) A financial statement ratio or operating indicator that is considered by management to be critical to mission success.
Dashboard A format for presenting a business s key performance indicators that resembles the dashboard of an automobile.
SELF-TEST QUESTIONS Key Concepts The primary purpose of this chapter is to present the techniques used by managers and investors to assess an organization s financial condition. The main focus is on financial condition as reflected in a business s financial statements, although operating data are also introduced to explain a business s current financial status. The key concepts of this chapter are as follows:
Financial statement analysis, which is designed to identify a firm s financial condition, focuses on the firm s financial statements.
Operating indicator analysis, which uses data typically found outside of the financial statements, provides insights into why a firm is in a given financial condition.
Financial ratio analysis, which focuses on financial statement data, is designed to reveal the relative financial strengths and weaknesses of a company as compared to other companies in the same industry, and to show whether the business s financial condition has been improving or deteriorating over time.
The Du Pont equation indicates how the total margin, the total asset turnover ratio, and the use of debt interact to determine the rate of return on equity. It provides a good overview of a business s financial condition.
Liquidity ratios indicate the business s ability to meet its short-term obligations.
Asset management ratios measure how effectively managers are using the business s assets.
Debt management ratios reveal the extent to which the firm is financed with debt and the extent to which operating cash flows cover debt service and other fixed-charge requirements.
Profitability ratios show the combined effects of liquidity, asset management, and debt management on operating results.
Ratios are analyzed using comparative analysis, in which a firm s ratios are compared with industry averages or those of another firm, and trend analysis, in which a firm s ratios are examined over time.
In a common size analysis, a business s income statement and balance sheet are expressed in percentages. This facilitates comparisons between firms of different sizes and for a single firm over time.
In percentage change analysis, the differences in income statement items and balance sheet accounts from one year to the next are expressed in percentages. In this way, it is easy to identify those items and accounts that are growing appreciably faster or slower than average.
Benchmarking is the process of comparing the performance of a particular company with a group of benchmark companies, often industry leaders and primary competitors.
Financial condition analysis is hampered by some serious problems, including development of comparative data, interpretation of results, and inflation effects.
Key performance indicators (KPIs) are a limited number of metrics that focus on those measures that are most important to an organization s mission success. Often, KPIs are presented in a format that resembles a dashboard.
Financial condition analysis has its limitations, but if used with care and judgment, it can provide managers with a sound picture of an organization s financial condition as well as identify those operating factors that contributed to that condition.
Questions 17.1 a. What is the primary difference between financial statement analysis and operating indicator analysis?
b. Why are both types of analyses useful to health services managers and investors?
17.2 Should financial statement and operating indicator analyses be conducted only on historical data? Explain your answer.
17.3 One asset management ratio, the inventory turnover ratio, is defined as sales (i.e., revenues) divided by inventories. Why would this ratio be important for a medical device manufacturer or a hospital management company?
17.4 a. Assume that Kindred Healthcare and Sun Healthcare Group, two operators of nursing homes, have fiscal years that end at different times say, one in June and one in December. Would this fact cause any problems when comparing ratios between the two companies?
b. Assume that two companies that operate walk-in clinics both had the same December year-end, but one was based in Aspen, Colorado, a winter resort, while the other operated in Cape Cod, Massachusetts, a summer resort. Would their locations lead to problems in a comparative analysis?
17.5 a. How does inflation distort ratio analysis comparisons, both for one company over time and when different companies are compared?
b. Are only balance sheet accounts or both balance sheet accounts and income statement items affected by inflation?
17.6 a. What is the difference between trend analysis and comparative analysis?
b. Which is more important?
17.7 Assume that a large managed care company has a low return on equity (ROE). How could Du Pont analysis be used to identify possible actions to help boost ROE?
17.8 Regardless of the specific line of business, should all healthcare businesses use the same set of ratios when conducting a financial statement analysis? Explain your answer.
17.9 What are key performance indicators (KPIs)? What is a dashboard?
Problems 17.1 a. Modern Medical Devices has a current ratio of 0.5. Which of the following actions would improve (i.e., increase) this ratio?
Use cash to pay off current liabilities.
Collect some of the current accounts receivable.
Use cash to pay off some long-term debt.
Purchase additional inventory on credit (i.e., accounts payable).
Sell some of the existing inventory at cost.
b. Assume that the company has a current ratio of 1.2. Now which of the above actions would improve this ratio?
17.2 Southwest Physicians, a medical group practice, is just being formed. It will need $2 million of total assets to generate $3 million in revenues. Furthermore, the group expects to have a profit margin of 5 percent. The group is considering two financing alternatives.
First, it can use all-equity financing by requiring each physician to contribute his or her pro rata share. Alternatively, the practice can finance up to 50 percent of its assets with a bank loan. Assuming that the debt alternative has no impact on the expected profit margin, what is the difference between the expected ROE if the group finances with 50 percent debt versus the expected ROE if it finances entirely with equity capital?
17.3 Riverside Memorial s primary financial statements are presented in exhibits 17.1, 17.2, and 17.3.
a. Calculate Riverside s financial ratios for 2014. Assume that Riverside had $1,000,000 in lease payments and $1,400,000 in debt principal repayments in 2014. (Hint: Use the book discussion to identify the applicable ratios.) b. Interpret the ratios. Use both trend and comparative analyses.
For the comparative analysis, assume that the industry average data presented in the book are valid for both 2014 and 2015.
17.4 Consider the following financial statements for BestCare HMO, a not-for-profit managed care plan:
BestCare HMO Statement of Operations and Change in Net Assets, Year Ended June 30, 2015 (in thousands) Revenue:
Premiums earned $26,682 Coinsurance 1,689 Interest and other income 242 Total revenues $28,613 Expenses:
Salaries and benefits $15,154 Medical supplies and drugs 7,507 Insurance 3,963 Provision for bad debts 19 Depreciation 367 Interest 385 Total expenses $27,395 Net income $ 1,218 Net assets, beginning of year $ 900 Net assets, end of year $ 2,118 BestCare HMO Balance Sheet, June 30, 2015 (in thousands) Assets:
Cash and cash equivalents $2,737 Net premiums receivable 821 Supplies 387 Total current assets $3,945 Net property and equipment $5,924 Total assets $9,869 (continued) (continued from previous page) Liabilities and Net Assets:
Accounts payable medical services $2,145 Accrued expenses 929 Notes payable 141 Current portion of long-term debt 241 Total current liabilities $3,456 Long-term debt $4,295 Total liabilities $7,751 Net assets (equity) $2,118 Total liabilities and net assets $9,869 a. Perform a Du Pont analysis on BestCare. Assume that the industry average ratios are as follows:
Total margin 3.8% Total asset turnover 2.1 Equity multiplier 3.2 Return on equity (ROE) 25.5% b. Calculate and interpret the following ratios for BestCare:
Industry Average Return on assets (ROA) 8.0% Current ratio 1.3 Days cash on hand 41 days Average collection period 7 days Debt ratio 69% Debt-to-equity ratio 2.2 Times interest earned (TIE) ratio 2.8 Fixed asset turnover ratio 5.2 17.5 Consider the following financial statements for Green Valley Nursing Home, Inc., a for-profit, long-term care facility:
Green Valley Nursing Home, Inc., Statement of Income and Retained Earnings, Year Ended December 31, 2015 Revenue:
Net patient service revenue $3,163,258 Other revenue 106,146 Total revenues $3,269,404 Expenses:
Salaries and benefits $1,515,438 Medical supplies and drugs 966,781 Insurance 296,357 Provision for bad debts 110,000 Depreciation 85,000 Interest 206,780 Total expenses $3,180,356 Operating income $ 89,048 Provision for income taxes 31,167 Net income $ 57,881 Retained earnings, beginning of year $ 199,961 Retained earnings, end of year $ 257,842 Green Valley Nursing Home, Inc., Balance Sheet, December 31, 2015 Assets Current Assets:
Cash $ 105,737 Marketable securities 200,000 Net patient accounts receivable 215,600 Supplies 87,655 Total current assets $ 608,992 Property and equipment $2,250,000 Less accumulated depreciation 356,000 Net property and equipment $1,894,000 Total assets $2,502,992 (continued) (continued from previous page) Liabilities and Shareholders Equity Current Liabilities:
Accounts payable $ 72,250 Accrued expenses 192,900 Notes payable 100,000 Current portion of long-term debt 80,000 Total current liabilities $ 445,150 Long-term debt $1,700,000 Shareholders Equity:
Common stock, $10 par value $ 100,000 Retained earnings 257,842 Total shareholders equity $ 357,842 Total liabilities and shareholders equity $2,502,992 a. Perform a Du Pont analysis on Green Valley. Assume that the industry average ratios are as follows:
Total margin 3.5% Total asset turnover 1.5 Equity multiplier 2.5 Return on equity (ROE) 13.1% b. Calculate and interpret the following ratios:
Industry Average Return on assets (ROA) 5.2% Current ratio 2.0 Days cash on hand 22 days Average collection period 19 days Debt ratio 71% Debt-to-equity ratio 2.5 Times interest earned (TIE) ratio 2.6 Fixed asset turnover ratio 1.4 c. Assume that there are 10,000 shares of Green Valley s stock outstanding and that some recently sold for $45 per share.
What is the firm s price/earnings ratio?
What is its market/book ratio?
(Hint: These ratios are discussed in the supplement to this chapter.) 17.6 Examine the industry average ratios given in problems 17.4 and 17.5. Explain why the ratios are different between the managed care and nursing home industries.
17.7 Recent financial statements for The Heart Hospital are provided below:
The Heart Hospital, Balance Sheet, September 30, 2015 (in thousands) Current assets:
Cash $14,202 Accounts receivable, net 5,918 Medical supplies inventory 1,211 Prepaid expenses and other current assets 1,429 Total current assets $22,760 Property, plant, and equipment, net $33,769 Other assets 901 Total assets $57,430 Current liabilities:
Accounts payable $ 1,910 Accrued compensation and benefits 2,543 Other accrued liabilities 1,843 Current portion of long-term debt 2,064 Total current liabilities $ 8,360 Long-term debt 21,640 Total liabilities $30,000 Owners equity $27,430 Total liabilities and owners equity $57,430 The Heart Hospital, Statement of Operations, Year Ended September 30, 2015 (in thousands) Patient service revenue net of discounts and allowances $66,962 Provision for bad debt ( 2,457) Net patient service revenue $64,505 Operating expenses:
Personnel expense $21,707 Medical supplies expense 15,047 Other operating expenses 9,721 Depreciation expense 2,625 Total operating expenses $49,100 Income from operations $15,405 Other income (expenses):
Interest expense ($ 1,322) Interest and other income, net 159 Total other income (expenses), net ($ 1,163) Net income $14,242 a. Perform a Du Pont analysis on The Heart Hospital. Assume that the industry average ratios are as follows:
Total margin 15.0% Total asset turnover 1.5 Equity multiplier 1.67 Return on equity (ROE) 37.6% b. Calculate and interpret the following ratios for The Heart Hospital:
Industry Average Return on assets (ROA) 22.5% Current ratio 2.0 Days cash on hand 85 days Average collection period 20 days Debt ratio 40% Debt-to-equity ratio 0.67 Times interest earned (TIE) ratio 5.0 Fixed asset turnover ratio 1.4 17.8 Refer to the financial statements for The Heart Hospital in Problem 17.7. Prepare a common size balance sheet (where each account is expressed as a percentage of total assets) and a common size income statement (where each account is expressed as a percentage of total revenues). What do the common size balance sheet and income statement reveal about The Heart Hospital?
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MARKET VALUE RATIOS, COMMON SIZE 17 ANALYSIS, PERCENTAGE CHANGE ANALYSIS, AND ECONOMIC VALUE ADDED Market Value Ratios In addition to the financial ratios discussed in the chapter, another group of financial ratios focuses on stockholder metrics. For investor-owned firms with publicly traded stock, ratios that relate the firm s stock price to its earnings and book value per share can be developed. Such market value ratios give managers an indication of what investors think of the firm s past performance and future prospects as indicated by stock price. If the firm s liquidity, asset management, debt management, and profitability ratios are all good, its stock price (and hence market value ratios) will be high.
Price/Earnings Ratio The price/earnings (P/E) ratio shows how much investors are willing to pay per dollar of reported profits. Suppose the stock of General Home Care, an investor-owned home health care company, sells for $28.50, while the firm had 2015 earnings per share (EPS) of $2.20. Then, its P/E ratio would be 13.0:
Priceper share $28.50 P/Eratio = == 13.0.
Earnings pershare $2.20 Industryaverage = 15.2.
P/E ratios are higher for firms with high growth prospects, other things held constant, but they are lower for riskier firms. General s P/E ratio is slightly below the average of other investor-owned home health care companies, which suggests that the company is regarded as being riskier than most, as having poorer growth prospects, or both.
Market/Book Ratio The ratio of a stock s market price to its book value of equity gives another indication of how investors regard the company. Companies with relatively high rates of return on equity generally sell at higher multiples of book value than those with low returns. General Home Care reported $80 million in total equity on its 2015 balance sheet, and the firm had 5 million shares outstanding, so its book value per share is $80 5 = $16.00. Dividing the price per share by the book value per share gives a market/book (M/B) ratio of 1.8:
Priceper share $28.50 M/Bratio = == 1.8.
Book valueper share $16.00 Chapter 17 Supplement =Industryaverage2.1.
Investors are willing to pay slightly less for each dollar of General s book value than for that of an average home health care company.
Common Size Analysis 1. What are two ratios that measure market value for publicly traded investor-owned businesses?
SELF-TEST QUESTION There are analytical techniques other than ratio analysis that are used to interpret financial statements. In common size analysis, all income statement items are divided by total revenues, and all balance sheet items are divided by total assets. Thus, a common size income statement shows each item as a percentage of revenues, and a common size balance sheet shows each account as a percentage of total assets. The significant advantage of common size statements is that they facilitate comparisons of income statements and balance sheets over time and across firms because they compensate for scale (size) differentials.
Exhibit S17.1 contains Riverside s common size income statement for 2015, along with the common size statement for the hospital industry.
An analysis of the common size statements shows few significant differences between Riverside and the industry. Perhaps the most important difference is that Riverside s operating income is well above average while its nonoperating income is well below average. Although having a higher income from core operations is good, Riverside s managers should examine its contributions and endowments to see if better management could result in higher nonoperating income. Additionally, a lower percentage of Riverside s revenue comes from capitated contracts and other patient-related sources than is true of the average hospital.
Exhibit S17.2 contains Riverside s common size balance sheet for 2015 along with industry average data. Three striking differences are revealed: (1) Riverside s current assets are significantly lower than the industry average, (2) its net property and equipment are significantly higher, and (3) it uses far less debt financing than the average hospital uses.
Chapter 17 Supplement: Market Value Ratios, Economic Value Added, and Other Analyses Riverside Industry Average Patient service revenue Less: Provision for bad debts Net patient service revenue Premium revenue Other revenue Total operating revenues Expenses:
Nursing services Dietary services General services Administrative services Employee health and welfare Malpractice insurance Depreciation Interest expense Total expenses Operating income Nonoperating income Net income 93.3% 2.9 90.4% 4.6 3.2 98.2 % 51.1% 4.8 11.6 10.0 9.0 1.2 3.6 1.4 92.5% 5.7% 1.8 7.5% 90.4% 3.o 87.4% 7.2 2.4 97.0% 50.7% 4.7 11.5 10.2 9.2 1.0 3.0 1.9 92.2% 4.8% 3.0 5.0% EXHIBIT S17.1 Riverside Memorial Hospital:
Common Size Income Statement for 2015 Chapter 17 Supplement Note: This table contains inconsistencies because values are rounded to the nearest tenth of a percent.
Riverside Industry Average Cash and equivalents Short-term investments Accounts receivable Inventories Total current assets Gross property and equipment Accumulated depreciation Net property and equipment Total assets Accounts payable Accrued expenses Notes payable Total current liabilities Long-term debt Capital lease obligations Total long-term liabilities Net assets (equity) Total liabilities and net assets 1.5% 2.6 14.4 2.1 20.6% 96.0% 16.6 79.4% 100.0% 3.1% 3.7 2.0 8.8% 19.0% 1.2 20.2% 71.0% 100.0% 3.7% 2.0 17.2 2.5 25.4% 90.1% 15.5 74.6% 100.0% 3.9% 4.1 3.2 13.3% 36.5% 0.9 37.4% 49.3% 100.0% EXHIBIT S17.2 Riverside Memorial Hospital:
Common Size Balance Sheet for 2015 Note: This table contains inconsistencies because values are rounded to the nearest tenth of a percent.
Chapter 17 Supplement Chapter 17 Supplement SELF-TEST QUESTIONS SELF-TEST QUESTIONS 1. How are common size statements created?
2. What advantage do common size statements have over regular statements when conducting a financial statement analysis?
Percentage Change Analysis Another technique frequently used when analyzing financial statements is percentage change analysis. In this analysis, the percentage changes in the individual items on the income statement and accounts on the balance sheet over some period are calculated and compared. In this format, it is easy to see which items are growing faster or slower than others and hence to see which of them are under control and which are out of control.
To illustrate percentage change analysis, consider Riverside s income statements shown in Exhibit S17.3, where the 2014 and 2015 items have been converted into percentage changes. Note that Riverside s net patient service revenue grew at a 12.2 percent rate, while at the same time, nursing services expenses grew by only 2.7 percent. Conversely, dietary services expenses grew at 15.0 percent. This information tells Riverside s managers that revenues associated with patients grew faster than nursing expenses (which is a positive trend for the hospital), but dietary services expenses grew faster than revenues (which is a negative trend). Other items on the income statement would be analyzed in a similar manner. Also, percentage change analysis could be applied to balance sheet accounts in the same way as our income statement illustration.
The conclusions reached in a percentage change analysis, as well as in a common size analysis, generally parallel those derived from ratio analysis. However, occasionally, a serious deficiency is highlighted only by one of the three analytical techniques, while the other two techniques fail to reveal the deficiency. Thus, a thorough financial statement analysis includes a Du Pont analysis to provide an overview and also includes ratio, common size, and percentage change analyses.
1. What is percentage change analysis?
2. Why is it useful?
3. Which analytical techniques should be used in a complete financial statement analysis?
Economic Value Added Up to this point, we have focused on using different techniques to evaluate the financial condition of a business. In many situations it is useful to have Chapter 17 Supplement: Market Value Ratios, Economic Value Added, and Other Analyses Percentage 2015 2014 Change Revenues:
Patient service revenue Less: Provision for bad debts Net patient service revenue Premium revenue Other revenue Total operating revenues Expenses:
Nursing services Dietary services General services Administrative services Employee health and welfare Malpractice insurance Depreciation Interest expense Total expenses Operating income Nonoperating income Net income $106,502 3,328 $ 103,147 5,232 3,644 $ 112,050 $ 58,285 5,424 13,198 11,427 10,250 1,320 4,130 1,542 $105,576 $ 6,474 2,098 $ 8,572 $ 95,398 3,469 $ 91,929 4,622 6,014 $102,565 $ 56,752 4,718 11,655 11,585 10,705 1,204 4,025 1,521 $ 102,165 $ 400 1,995 $ 2,395 11.6% 4.1 12.2% 13.2 39.4 9.2% 2.7% 15.0 13.2 1.4 4.2 9.6 2.6 1.4 3.3% 1,518.5% 5.2 258.0% EXHIBIT S17.3 Riverside Memorial Hospital:
Statements of Operations (Income Statements), Years Ended December 31, 2015 and 2014 (in thousands) with Percentage Changes Chapter 17 Supplement a single measure that provides information on both financial condition and managerial performance. That measure is economic value added (EVA), which focuses on managerial effectiveness in a given year. The basic formula for EVA is as follows:
EVA = NOPAT . (Total capital . Corporate cost of capital), where NOPAT is net operating profit after taxes.
In the EVA equation, NOPAT can be thought of as revenues minus all operating costs, including taxes (if applicable) but excluding interest expense.
It is actually calculated as follows:
EBIT . (1 . T), where EBIT is earnings before interest and taxes.
Total capital is the sum of the book values of investor-supplied (interest- bearing) debt and equity, while the corporate cost of capital is the business s cost of financing. In essence, EVA measures the dollar profit above the economic dollar cost of creating that profit. Because the calculation of EVA Chapter 17 Supplement Chapter 17 Supplement does not require market value data, it can be applied to both for-profit and not-for-profit businesses.
To illustrate the EVA concept, consider Riverside Memorial Hospital EVA performance in 2015. The hospital had $8,572,000 of net income and $1,542,000 in interest expense, for NOPAT of $10,114,000. Its investor- supplied capital was $2,975,000 in notes payable, $30,582,000 in long-term debt and capital lease obligations, and $107,364,000 in equity, for total capital of $140,921,000. Assuming a 7 percent corporate cost of capital, Riverside s 2015 EVA was $249,530:
EVA = $10,114,000 . ($140,921,000 . 0.07) = $10,114,000 . $9,864,470 = $249,530.
Riverside s EVA of $249,530 tells its managers that the hospital generated a positive economic income in 2015. In essence, it needed $140,921,000 in investor-supplied capital to generate $10,114,000 in operating profit. The $140,921,000 in capital required to support operations had an overall cost of 7 percent, so the dollar cost to obtain the capital was $9,864,470. Because operations earned more in profit than it cost to generate that profit, the hospital had positive economic income (EVA).
EVA is an estimate of a business s true economic profit for the year, and it differs substantially from accounting profitability measures such as net income. EVA represents the residual income that remains after all costs, including the opportunity cost of the employed equity capital, have been recognized.
Conversely, accounting profit is formulated without imposing a charge for equity capital. EVA depends on both operating efficiency and balance sheet management: Without operating efficiency, profits will be low; without efficient balance sheet management, there will be too many assets, and hence too much capital, which results in higher-than-necessary dollar capital costs.
For investor-owned businesses, there is a direct link between EVA and the value of the business the higher the EVA, the greater the value to owners.
For not-for-profit firms, equity capital is a scarce resource that must be managed well to ensure the financial viability of the organization, and hence its ability to continue to perform its stated mission. EVA lets managers know how well they are doing in managing this scarce resource because the higher the EVA in any year, the better the job managers are doing in using the organization s contributions and earnings to create value for the community.
Of course, EVA measures only economic value; any social value created by the equity capital is ignored and, therefore, must be subjectively considered.
EVA can be applied to divisions as well as to entire businesses, and the charge for capital should reflect the risk and capital structure of the business unit, whether it is the aggregate business or an operating division.
Chapter 17 Supplement: Market Value Ratios, Economic Value Added, and Other Analyses In practice, the calculation of EVA is much more complex than presented here because many accounting issues must be addressed properly when estimating a firm s NOPAT. Nevertheless, the brief discussion here illustrates that a business s true economic profitability depends on both income statement profitability and effective use of balance sheet assets. Specifically, EVA is improved by (1) increasing revenues and decreasing costs, and hence increasing NOPAT; (2) decreasing the amount of assets used to create NOPAT; and (3) decreasing the business s capital costs. Of course, all of this is easier said than done, and there are potential negative consequences associated with these actions. Still, the EVA model provides a good (but perhaps overly simple) road map to financial excellence.
SELF-TEST 1. What is economic value added (EVA), and how is it measured? QUESTIONS 2. Why is EVA a better measure of financial performance than are accounting measures such as earnings per share and return on equity?
3. What does EVA tell managers about how to achieve good financial performance?
Chapter 17 Supplement GLOSSARY Accountable care organization (ACO). A network of healthcare providers joined together for the purpose of increasing patient service quality and reducing costs.
Accounting. The field of finance that involves the measuring and recording of events, in dollar terms, that reflect an organization s operational and financial status. See Financial management.
Accounting breakeven. Accounting breakeven occurs when revenues are sufficient to cover all accounting costs; in other words, zero profitability. See Economic breakeven.
Accounting entity. The entity (business) for which a set of accounting statements applies.
Accounting period. The period (amount of time) covered by a set of financial statements often a year, but sometimes a quarter or another time period.
Accrual accounting. The recording of economic events in the periods in which the events occur, even if the associated cash receipts or payments happen in a different period.
Accrued expenses. A business liability that stems from the fact that some obligations, such as wages and taxes, are not paid immediately after the obligations are created.
Activity-based costing (ABC). The bottom-up approach to costing that identifies the activities required to provide a particular service, estimates the costs of those activities, and then aggregates those costs. Particularly useful when costing individual services.
Adverse selection. The problem faced by insurance companies because individuals who are more likely to have claims are also more likely to purchase insurance.
Aging schedule. A table that expresses a business s accounts receivable by how long each account has been outstanding.
Allocation rate. The numerical value used to allocate overhead costs; for example, $10 per square foot of occupied space for facilities costs.
American Institute of Certified Public Accountants (AICPA). The professional association of public (financial) accountants.
Amortized (installment) loan. A loan that is repaid in equal periodic amounts that include both principal and interest payments.
688 Glossary Annual report. A report issued annually by an organization to its stakeholders that contains descriptive information and historical financial statements.
Annuity. A series of payments of a fixed amount for a specified number of equal periods.
Annuity due. An annuity with payments occurring at the beginning of each period. See Ordinary (regular) annuity.
Asset. An item that either possesses or creates economic benefit for the organization.
Asset management ratios. Financial statement analysis ratios that measure how effectively a firm is managing its assets.
Automated Clearing House (ACH). An electronic communication network for transmitting data from one financial institution to another.
Average collection period (ACP). The average length of time it takes a business to collect its receivables. Also called days sales outstanding (DSO) and days in patient accounts receivable.
Balance sheet. A financial statement that lists a business s assets, liabilities, and equity (fund capital).
Benchmarking. The comparison of performance metrics, such as financial ratios, of one business against those of similar businesses and industry averages.
Also called comparative analysis.
Beta coefficient (.). A measure of the risk of one investment relative to the risk of a collection (portfolio) of investments.
Bond. Long-term debt issued by a business or governmental unit and generally sold in $1,000 or $5,000 increments to a large number of individual investors.
Book value. The value of a business s assets, liabilities, and equity as reported on the balance sheet. In other words, the value in accordance with generally accepted accounting principles (GAAP).
Breakeven analysis. A type of analysis that estimates the amount of some variable (such as volume or price or variable cost rate) needed to break even. See Accounting; Economic breakeven.
Budget. A detailed plan, in dollar terms, of how a business and its subunits will acquire and utilize resources during a specified period of time.
Budgeting. The process of preparing and using a budget, which is a detailed plan (in dollar terms) that specifies how resources will be obtained and used during some future period.
Build-up method. A method for estimating the cost of equity for a small business that starts with a base rate and then adds premiums to account for size, liquidity, and unique risk characteristics.
Bundled (global) payment. The fee-for-service payment of a single amount for the complete set of services required to treat a single episode.
Glossary 689 Business risk. The risk inherent in the operations of a business, assuming it uses zero-debt financing.
Call provision. A provision in a bond indenture (contract) that gives the issuing company the right to redeem (call) the bonds prior to maturity.
Call risk premium (CRP). The premium that debt investors add to the base rate to compensate for bearing call risk.
Capital. The funds raised by a business that will be invested in assets, such as land, buildings, and equipment, that support the organizational mission.
Capital asset pricing model (CAPM). An equilibrium model that specifies the relationship between a stock s value and its market risk as measured by beta.
Capital budgeting. The process of analyzing and choosing new long-term assets such as land, buildings, and equipment.
Capital budgeting decisions. The process of selecting a business s capital (long-term asset) investments. The list of investments chosen constitutes a business s capital budget.
Capital gain (loss). The profit (loss) from the sale of certain investments at more (less) than their purchase price.
Capital gains yield. The percentage capital gain (loss) over some period, defined as the price appreciation (loss) divided by the beginning-of-period price.
Capital rationing. The situation that occurs when a business has more attractive capital investment opportunities than it has capital to invest.
Capital structure. The structure of a business s financing mix as shown on the balance sheet. Often expressed as the percentage of debt financing, for example, 35 percent debt.
Capitation. A reimbursement methodology that is based on the number of covered lives as opposed to the amount of services provided.
Cash accounting. The recording of economic events when a cash exchange takes place.
Cash budget. A schedule that lists a business s expected cash inflows, outflows, and net cash flows for some future period.
Charge-based reimbursement. A fee-for-service reimbursement method based on charges (chargemaster prices).
Chargemaster. A list of all items and services provided by a health services organization containing their gross (list) prices.
Chart of accounts. A document that assigns a unique numerical identifier to every account of an organization.
Classified stock. The term used to distinguish between stock classes when a business uses more than one type of common stock.
690 Glossary Coefficient of variation. A statistical measure of an investment s stand-alone risk calculated by dividing the standard deviation of returns by the expected return. The result is the amount of stand-alone risk per unit of return. See Standard deviation.
Common size analysis. A technique to analyze a business s financial statements that expresses income statement items and balance sheet accounts as percentages rather than in dollars.
Comparative analysis. The comparison of key financial and operational measures of one business with those of comparable businesses or industry averages. Also called benchmarking.
Compensating balance. A minimum checking account balance that a business must maintain to compensate the bank for other services or loans.
Compounding. The process of finding the future value of a lump sum, an annuity, or a series of unequal cash flows.
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.
Conventional budgeting. An approach to budgeting that uses the previous budget as the starting point. See Zero-based budgeting.
Corporate bond. Debt issued (sold) by for-profit businesses, as opposed to governmental or tax-exempt (municipal) bonds.
Corporate cost of capital. The weighted average of a business s capital (financing) costs. Also, the discount rate that reflects the overall (average) risk of the entire business.
Corporate risk. A type of portfolio risk. The portion of the riskiness of a business project that cannot be diversified away by holding the project as part of the business s portfolio of projects. See Diversifiable risk.
Corporation. A legal business entity that is separate and distinct from its owners (or community) and managers.
Correlation. The movement relationship between two variables.
Correlation coefficient. A standardized measure of correlation that ranges from .1 (variables move perfectly opposite of one another) to +1 (variables move in perfect synchronization).
Cost. A resource use associated with providing or supporting a specific service.
Cost allocation. The process by which overhead costs are assigned (allocated) to individual departments.
Cost center. A business unit that does not generate revenues, and hence only its costs can be measured. See Profit center.
Cost driver. The basis on which a cost pool is allocated; for example, square footage for facilities costs.
Glossary 691 Cost pool. A group of overhead costs to be allocated; for example, facilities costs or marketing costs.
Cost-based reimbursement. A fee-for-service reimbursement method based on the costs incurred in providing services.
Costly trade credit. The credit taken by a company from a vendor in excess of the free trade credit. See Free trade credit.
Cost-to-charge ratio (CCR). A ratio used to estimate the overhead costs of individual services. Defined as the ratio of indirect (overhead) costs to charges (or alternatively, to service revenues).
Coupon (interest) rate. The stated annual rate of interest on a bond, which is equal to the coupon payment divided by the par value.
Coupon payment. The dollar amount of annual interest on a bond.
Credit policy. Generically, a business s rules and regulations regarding granting credit and collecting from buyers that take credit. For healthcare providers, the business s policy regarding self-pay and indigent patients.
Credit terms. The statement of terms that extends credit to a buyer.
Cross-subsidization (price shifting). The pricing approach wherein some payers are charged more than full costs to make up for other payers that are paying less than full costs.
Current asset. An asset that is expected to be converted into cash within one accounting period (often a year). See Fixed assets.
Current Procedural Terminology (CPT) codes. Codes applied to medical, surgical, and diagnostic procedures.
Dashboard. A format for presenting a business s key performance indicators that resembles the dashboard of an automobile. See Key performance indicator.
Debenture. An unsecured bond, meaning one that has no assets pledged as security (collateral).
Debt capacity. The amount of debt considered to be optimal for the business (the target capital structure).
Debt management ratios. A group of ratios that measure the extent of a business s financial leverage (capital structure).
Debt ratio. A debt utilization ratio that measures the proportion of debt (versus equity) financing. Typically defined as total debt (liabilities) divided by total assets.
Default. Occurs when a borrower fails to make a promised debt payment. Note that technical default occurs when the borrower fails to meet one of the restrictions in the loan agreement but is still making the required payments.
Default risk premium (DRP). The premium that creditors demand (add to the base interest rate) for bearing default risk. The greater the default risk, the higher the default risk premium.
692 Glossary Depreciation. A noncash charge against earnings on the income statement that reflects the wear and tear on a business s fixed assets (property and equipment).
Direct cost. A cost that is tied exclusively to a subunit, such as the salaries of laboratory department employees. When a subunit is eliminated, its direct costs disappear. See Indirect (overhead) cost.
Direct method. A cost allocation method in which all overhead costs are allocated directly from the overhead departments to the patient services departments with no recognition that overhead services are provided to other support departments. See Step-down method; Reciprocal method.
Discounting. The process of finding the current (present) value of a lump sum, an annuity, or a series of unequal cash flows.
Diversifiable risk. The portion of the risk of an investment that can be eliminated by holding the investment as part of a diversified portfolio. See Corporate risk.
Dividend reinvestment plan (DRIP). A plan under which the dividends paid to a stockholder are automatically reinvested in the company s common stock.
Dividend yield. The annual dividend divided by current stock price.
Divisional cost of capital. The discount rate (hurdle rate or opportunity cost rate) that reflects the unique risk of a division within a corporation.
Double entry system. The system used to make accounting journal entries.
Called double entry because each transaction has to be entered in at least two different accounts.
Du Pont analysis. A financial statement analysis tool that decomposes return on equity into three components: profit margin, total asset turnover, and equity multiplier.
Economic breakeven. Economic breakeven occurs when revenues are sufficient to cover all accounting costs plus provide a specified profit level. See Accounting breakeven.
Effective annual rate (EAR). The interest rate that, under annual compounding, produces the same future value as was produced by more frequent compounding.
Efficient markets hypothesis (EMH). The theory that (1) stocks are always in equilibrium and (2) it is impossible for investors to consistently earn excess returns (beat the market).
Equity. The book value of the ownership position in a business, where book value is the value that appears on a business s financial statements. In other words, the value according to GAAP.
Expected rate of return. The return expected, in a statistical sense, on an investment when the purchase is made.
Expense budget. A budget that focuses on the costs of providing goods or services.
Glossary 693 Expenses. The costs of doing business. Or, the dollar amount of resources used in providing services.
Fee-for-service. A reimbursement methodology that provides payment each time a service is provided. See Capitation.
Financial accounting. The field of accounting that focuses on the measurement and communication of the economic events and status of an entire organization.
See Managerial accounting.
Financial Accounting Standards Board (FASB). A private organization whose mission is to establish and improve the standards of financial accounting and reporting for private businesses.
Financial asset. 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.
Financial leverage. The use of fixed cost financing; typically debt financing for healthcare providers.
Financial management. The field of finance that provides the theory, concepts, and tools used by healthcare managers to make financial decisions. See Accounting.
Financial plan. The portion of the operating plan that focuses on the finance function.
Financial risk. In an investment context, the risk that the return on an investment will be less than expected. The greater the chance of earning a return far below that expected, the greater the risk. In a capital structure context, the risk added to a business (more precisely, to the business s owners) when debt financing is used. The greater the proportion of debt financing, the greater the financial risk.
Financial statement analysis. The process of using data contained in financial statements to make judgments about a business s financial condition.
Financial statements. Statements prepared by accountants that convey the financial status of an organization. The four primary statements are the income statement, balance sheet, statement of changes in equity, and statement of cash flows.
Fiscal year. The year covered by an organization s financial statements. It usually, but not necessarily, coincides with a calendar year.
Fixed assets. A business s long-term assets, such as land, buildings, and equipment.
Usually labeled net property and equipment on the balance sheet. See Current assets.
Fixed cost. A cost that is not related to the volume of services delivered, for example, facilities costs (within some relevant range). See Variable cost.
Flexible budget. A budget based on the static budget but adjusted to reflect realized volume. See Static budget.
694 Glossary Float. The difference between the balance shown on a business s (or individual s) checkbook and the balance shown on the bank s books.
Form 990. A form filed by not-for-profit organizations with the Internal Revenue Service that reports on governance and charitable activities.
Four Cs. A mnemonic for the basic finance activities: costs, cash, capital, and control.
Free trade credit. The amount of credit received from a supplier that has no explicit cost attached. In other words, credit received during the discount period. See Costly trade credit.
Full cost pricing. The process of setting prices to cover all costs plus a profit component. See Marginal cost pricing.
Fund accounting. A system for recording financial statement data that categorizes accounts as restricted or unrestricted.
Fund capital. Equity capital in a not-for-profit corporation; typically obtained from contributions and grants and by retaining earnings. On the balance sheet, often called net assets.
General ledger. The master listing of an organization s primary accounts, which record the transactions that ultimately are used to create a business s financial statements.
Generally accepted accounting principles (GAAP). The set of guidelines that has evolved to foster the consistent preparation and presentation of financial statements.
Health insurance exchange (HIE). An online marketplace created primarily by the states or the federal government that insurers use to post plan details and consumers use to purchase healthcare insurance.
Healthcare Common Procedure Coding System (HCPCS). A medical coding system that expands the CPT codes to include nonphysician services and durable medical equipment. See Current Procedural Terminology (CPT) codes.
Historical cost. In accounting, the purchase price of an asset.
Hurdle rate. The minimum required rate of return on an investment. Also called opportunity cost rate or discount rate.
Income statement. A financial statement, prepared in accordance with generally accepted accounting principles (GAAP), that summarizes a business s revenues, expenses, and profitability.
Incremental cash flow. A cash flow that arises solely from a project that is being evaluated and hence should be included in the project analysis. See Non- incremental cash flow.
Glossary 695 Indenture. A legal document that spells out the rights and obligations of both bondholders and the issuing corporation. In other words, the loan agreement for a bond.
Indirect (overhead) cost. A cost that is tied to shared resources rather than to an individual subunit of an organization; for example, facilities costs. See Direct costs.
Inflation premium (IP). The premium that debt investors add to the real risk- free (base) interest rate to compensate for inflation.
Inpatient prospective payment system (IPPS). The method, based on diagnosis, that Medicare uses to reimburse providers for inpatient services.
Interest (current) yield. The annual interest return on a bond, defined as the interest payment divided by the beginning-of-year price.
Interest rate risk. The risk to current debtholders that stems from interest rate changes. Interest rate risk has two components: price risk and reinvestment rate risk.
Internal rate of return (IRR). A return-on-investment (ROI) metric that measures expected rate of (percentage) return.
International Classification of Diseases (ICD) codes. Numerical codes for designating diseases plus a variety of signs, symptoms, and external causes of injury.
Investment grade bond. A bond with a BBB or higher rating. See Junk bond.
Investor-owned (for-profit) corporation. A corporation that is owned by shareholders who furnish capital and expect to earn a return on their investment.
Junk bond. A bond with a BB or lower rating. See Investment grade bond.
Just-in-time (JIT) approach. An approach to supply chain management that requires suppliers to deliver inventory items in relatively small quantities as they are needed, which reduces the amount of inventory stock held. There are several variations of JIT systems.
Key performance indicator (KPI). A financial statement ratio or operating indicator that is considered by management to be critical to mission success.
Liability. A fixed financial obligation of the business.
Limited liability partnership (LLP). A partnership form of organization that limits the professional (malpractice) liability of its partners.
Line of credit. A loan arrangement in which a bank agrees to lend some maximum amount to a business over some designated period.
696 Glossary Liquid asset. An asset that can be quickly converted to cash at its fair market value.
Liquidity premium (LP). The premium that debt investors add to the base interest rate to compensate for lack of liquidity.
Liquidity ratios. Ratios that measure the ability of a business to meet its cash obligations as they come due.
Lockbox. A post office box used by a business to receive checks at locations other than the corporate headquarters.
Managed care plan. A combined effort by an insurer and a group of providers with the purpose of both increasing quality of care and decreasing costs.
Managerial (management) accounting. The field of accounting that focuses on all levels within an organization and is used internally for managerial decision making. See Financial accounting.
Marginal cost. The cost of one additional unit of volume (for example, one more inpatient day or patient visit).
Marginal cost pricing. The process of setting prices to cover only marginal costs. See Full cost pricing.
Market portfolio. A portfolio that contains all publicly traded stocks. Often proxied by some market index, such as the S&P 500.
Market risk. A type of portfolio risk. The portion of the riskiness of a business project that cannot be diversified away by holding the stock of the company as part of a diversified portfolio. See Corporate risk.
Marketable securities. Securities that are held in lieu of cash. Typically safe, short-term securities such as Treasury bills. Called cash equivalents or short-term investments when listed on the balance sheet.
Maturity date. The date on which the principal amount of a loan must be repaid.
Medicaid. A federal and state government health insurance program that provides benefits to low-income individuals.
Medical coding. The process of transforming medical diagnoses and procedures into universally recognized numerical codes.
Medical home. A team-based model of care led by a personal physician who provides continuous and coordinated care throughout a patient s lifetime with a goal of maximizing health outcomes.
Medicare. A federal government health insurance program that primarily provides benefits to individuals aged 65 or older.
Modified internal rate of return (MIRR). A project ROI measure similar to IRR but using the assumption of reinvestment at the cost of capital.
Monte Carlo simulation. A computerized risk analysis technique that uses continuous distributions to represent the uncertain input variables.
Glossary 697 Moral hazard. The problem faced by insurance companies because individuals are more likely to use unneeded health services when they are not paying the full cost of those services.
Mortgage bond. A bond issued by a business that pledges real property (land and buildings) as collateral.
Municipal bond (muni). A tax-exempt bond issued by a governmental entity such as a state, city, or healthcare financing authority.
Net assets. The dollar value, according to GAAP, of a business s assets after subtracting the business s liabilities. In not-for-profit businesses, the term often is used on the balance sheet in place of equity.
Net income. The total earnings of a business, including both operating and nonoperating income.
Net patient accounts receivable (receivables). The amount of money billed for services provided but not yet collected.
Net present social value (NPSV). The present value of a project s social value.
Added to the financial net present value (NPV) to obtain a project s total value.
Net present value (NPV). A return-on-investment (ROI) metric that measures the time value adjusted expected dollar return. See Internal rate of return (IRR); Modified internal rate of return (MIRR).
Net working capital. A liquidity measure equal to current assets minus current liabilities.
Nominal (stated) interest rate. The interest rate stated in a debt contract. It does not reflect the effect of any compounding that occurs more frequently than annually. See Periodic interest rate.
Nonincremental cash flow. A cash flow that does not stem solely from a project that is being evaluated. Nonincremental cash flows are not included in a project analysis. See Incremental cash flow.
Nonoperating income. The earnings of a business that are unrelated to core activities. For a healthcare provider, the most common sources are contributions and investment income. See Operating income.
Operating budget. A single budget that combines both the revenue and expense budgets.
Operating income. The earnings of a business directly related to core activities.
For a healthcare provider, earnings related to patient services. See Nonoperating income.
Operating indicator. A ratio that focuses on operating data rather than financial data.
Operating indicator analysis. The process of using operating indicators to help explain a business s financial condition.
698 Glossary Operating margin. Operating income divided by net operating revenues. It measures the amount of operating profit per dollar of operating revenues and focuses on the core activities of a business. See Total (profit) margin.
Operating plan. An organizational road map for the future, often for five years but with most detail for the first year. Operating plans must be based on and consistent with the guidance provided in the organization s strategic plan.
Opportunity cost. The cost associated with alternative uses of the same funds.
For example, if money is used for one investment, it is no longer available for other uses, so an opportunity cost arises.
Opportunity cost rate. The rate of return expected on alternative investments similar in risk to the investment being evaluated. Also called hurdle rate.
Optimal capital structure. The mix of debt and equity financing that management believes to be most appropriate for the business. Generally based on both quantitative and qualitative factors. See Target capital structure.
Ordinary (regular) annuity. An annuity with payments occurring at the end of each period. See Deferred annuity.
Partnership. A nonincorporated business entity that is created by two or more individuals.
Par value. The stated, or face, value of a bond. Generally, the principal amount that must be repaid to the issuer.
Patient service revenue. Revenue that stems solely from the provision of patient services. In some situations, may only reflect revenue from fee-for- service patients.
Payback period. The number of years it takes for a business to recover its investment in a project without considering the time value of money.
Payment (PMT). In time value analysis, the dollar amount of an annuity cash flow.
Per diem payment. A fee-for-service reimbursement method that pays a set amount for each inpatient day.
Percentage change analysis. A technique to analyze a business s financial statements that expresses the year-to-year changes in income statement items and balance accounts as percentages.
Periodic interest rate. In time value of money analysis, the interest rate per period. For example, 2 percent quarterly interest, which equals an 8 percent stated (annual) rate. See Stated interest rate.
Perpetuity. An annuity that lasts forever (has no maturity date).
Poison pill. A provision in a company s charter that makes it an unattractive hostile takeover target.
Population health management. The concept that the health of all individuals is improved when the health of the entire population is improved.
Glossary 699 Portfolio. A number of individual investments held collectively.
Portfolio risk. The riskiness of an individual investment when it is held as part of a diversified portfolio as opposed to held in isolation.
Post-audit. The feedback process in which the performance of projects previously accepted is reviewed and actions are taken if performance is below expectations.
Preemptive right. The right that gives current shareholders the opportunity to purchase any newly issued shares (in proportion to their current holdings) before they are offered to the general public.
Premium revenue. Patient service revenue that stems from capitated patients as opposed to fee-for-service patients.
Present value (PV). The beginning amount (current worth) of an investment of a lump sum, an annuity, or a series of unequal cash flows.
Price risk. The risk that rising interest rates will lower the values of outstanding debt. See Interest rate risk; Reinvestment rate risk.
Price risk premium (PRP). The premium that debt investors add to the base rate to compensate for bearing price risk.
Price setter. A business that has the power to set the market prices for its goods or services.
Price taker. A business that has no power to influence the prices set by the marketplace (or by government payers).
Private placement. The sale of newly issued securities to a single investor or small group of investors.
Probability distribution. All possible outcomes of a random event along with their probabilities of occurrence. For example, the probability distribution of rates of return on a proposed investment.
Profit analysis. A technique applied to an organization s cost and revenue structure that analyzes the effect of volume changes on costs and profits. Also called CVP (cost-volume-profit) analysis.
Profit and loss (P&L) statement. A statement that summarizes the revenues, expenses, and profitability of either the entire organization or a subunit of it.
Can be formatted in different ways for different purposes and does not conform to GAAP.
Profit center. A business unit (in our examples, typically a department) that generates revenues as well as costs, and hence its profitability can be measured.
See Cost center.
Profitability index (PI). A project return on investment (ROI) measure defined as the present value of cash inflows divided by the present value of outflows. It measures the number of dollars of inflow per dollar of outflow (on a present value basis), or the bang for the buck. Profitability ratios. A group of ratios that measure different dimensions of a business s profitability.
700 Glossary Project cost of capital. The discount rate (hurdle rate or opportunity cost rate) that reflects the unique risk of a project.
Project scoring. An approach to project assessment that considers both financial and nonfinancial factors.
Promissory note. A document that specifies the terms and conditions of a loan.
Also called loan agreement or, in the case of bonds, indenture.
Proprietorship. A simple form of business owned by a single individual. Also called sole proprietorship.
Prospective payment. A fee-for-service reimbursement method that is established beforehand by the third-party payer and, in theory, not related to costs or charges.
Provider. An organization that provides healthcare services (treats patients).
Proxy fight. An attempt to take control of a corporation by soliciting the votes (proxies) of current shareholders.
Public offering. The sale of newly issued securities to the general public through an investment banker.
Pure play approach. A method for estimating the base cost of equity for a small business whereby the cost of equity of a similar large, publicly traded business is used as a proxy value.
Ratio analysis. The process of creating and analyzing ratios from financial statement and other data to help assess a business s financial condition.
Real asset. A physical asset, such as a medical practice or a piece of diagnostic equipment, that has the potential to generate future cash inflows.
Real risk-free rate (RRF). The rate of interest on a riskless investment in the absence of inflation.
Realized rate of return. The return achieved on an investment when it is terminated.
Reciprocal method. A cost allocation method that recognizes all of the overhead services provided by one support department to another. See Direct method; Step-down method.
Reinvestment rate risk. The risk that falling interest rates will lower the returns on cash flows from bond investments that are reinvested during the life of the bond (or investment horizon). See Interest rate risk; Price risk.
Relative value unit (RVU). A measure of the amount of resources consumed to provide a particular service. When applied to physicians, a measure of the amount of work, practice expenses, and liability costs associated with a particular service.
Relative value unit (RVU) method. A method for estimating the overhead costs of individual services based on the intensity of the service provided as measured by RVUs.
Glossary 701 Relevant range. The range of volume expected over some planning period.
Alternatively, the range over which fixed costs remain constant if volume falls outside the relevant range, the fixed cost estimate may be invalid.
Reserve borrowing capacity. The practice of businesses to use less than the theoretical optimal amount of debt to ensure easy access to new debt at reasonable interest rates regardless of circumstances.
Restrictive covenant. A provision in a bond indenture or loan agreement that protects the interests of lenders by restricting the actions of management.
Return on equity (ROE). Net income divided by the book value of equity.
Measures the dollars of earnings per dollar of equity investment.
Return on investment (ROI). The estimated financial return on an investment.
In capital budgeting analysis, ROI can be measured either in dollars or percentage (rate of) return.
Revenue budget. A budget that focuses on the revenues of an organization or its subunits.
Revenue cycle. The set of recurring activities and related information processing required to provide patient services and collect for those services.
Revenue recognition principle. The concept that revenues must be recognized in the accounting period in which they are realizable and earned.
Rights offering. The mechanism by which new common stock is offered to existing shareholders. Each stockholder receives an option (right) to buy a specific number of new shares at a given price.
Risk aversion. The tendency of individuals and businesses to dislike risk. The implication of risk aversion is that riskier investments must offer higher expected rates of return to be acceptable.
Risk-adjusted discount rate (RADR). A discount rate that accounts for the specific riskiness of the investment being analyzed.
Risk-free rate (RF). The rate of interest on a riskless investment when inflation effects are considered.
Salvage value. The expected market value of an asset (project) at the end of its useful life.
Scenario analysis. A project risk analysis technique that examines alternative outcomes, generally three, as opposed to only the most likely outcome.
Schedule H. An attachment to Form 990 filed by not-for-profit hospitals that gives additional information on charitable activities.
Securities and Exchange Commission (SEC). The federal government agency that regulates the sale of securities and the operations of securities exchanges.
Also has overall responsibility for the format and content of financial statements.
Security market line (SML). The portion of the capital asset pricing model (CAPM) that specifies the relationship between market risk and required rate of return.
702 Glossary Sensitivity analysis. A project analysis technique that assesses how changes in a single input variable, such as utilization, affect profitability.
Stakeholder. A party that has an interest, often financial, in a business. Stakeholders can be affected by the business s actions, objectives, or policies.
Stand-alone risk. The riskiness of an investment that is held in isolation as opposed to held as part of a portfolio (collection of investments).
Standard deviation (.). A statistical measure of the variability (dispersion) of a probability distribution about the mean (expected value). See Coefficient of variation.
Statement of cash flows. A financial statement that focuses on the cash flows that come into and go out of a business.
Statement of changes in equity. A financial statement that reports how much of a business s income statement earnings flows to the balance sheet equity account.
Static budget. A budget that is prepared at the beginning of a planning period.
Statistics budget. A budget that contains the patient volume and resource need assumptions used in all other budgets.
Step-down method. A cost allocation method that recognizes some of the overhead services provided by one support department to another. See Direct method; Reciprocal method.
Strategic plan. A document that defines the business s long-term direction along with the resources needed to get there.
Strategic value. The value of future investment opportunities that can be undertaken only if the project currently under consideration is accepted.
Sunk cost. A cost that has already occurred or is irrevocably committed. Sunk costs are nonincremental to project analyses and hence should not be included.
Supply chain management. The management of the procurement, storage, and utilization of supplies. Also called materials management.
Target capital structure. The capital structure (mix of debt and equity) that a business strives to achieve and maintain over time. Generally the same as (or very close to) the optimal capital structure.
Target costing. For price takers, the process of reducing costs (if necessary) to the point where a profit is earned on the market-determined price.
Tax-exempt (not-for-profit) corporation. A corporation that has a charitable purpose, is tax exempt, and has no owners. Also called nonprofit corporation.
Term loan. Long-term debt financing obtained directly from a financial institution, often a commercial bank.
Terminal value. When a project s cash flows are arbitrarily truncated, an estimate of the value of the cash flows beyond the truncation point.
Glossary 703 Third-party payer. A generic term for any outside party, typically an insurance company or a government program, that pays for part or all of a patient s healthcare services.
Time line. A graphical representation of time and cash flows. May be an actual line or cells on a spreadsheet.
Time value analysis. The use of time value of money techniques to value future cash flows. Sometimes called discounted cash flow analysis.
Time-driven activity-based costing (TDABC). An approach to costing that focuses on the entire cost of a patient s cycle of care rather than on the cost of individual services.
Total (profit) margin. Net income divided by total revenues. It measures the amount of total profit per dollar of total revenues. See Operating margin.
Trade credit. The credit offered to businesses by suppliers (vendors) when credit terms are offered.
Trade-off model. A capital structure model that hypothesizes that a business s optimal capital structure balances the costs and benefits associated with debt financing.
Traditional costing. The top-down approach to costing that first identifies costs at the department level and then (potentially) assigns these costs to individual services. See Activity-based costing (ABC).
Trend analysis. A ratio analysis technique that examines the value of a ratio over time to see if it is improving or deteriorating.
Trustee. An individual or institution, typically a commercial bank, that represents the interests of bondholders.
Underlying cost structure. The relationship between an organization s fixed costs, variable costs, and total costs. Also just called cost structure.
Value-based purchasing (VBP). An approach to provider reimbursement that rewards quality of care rather than quantity of care.
Variable cost. A cost that is directly related to the volume of services delivered.
For example, the cost of clinical supplies. See Fixed cost.
Variable cost rate. The variable cost of one unit of output (volume).
Variance. The difference between what actually happened and what was expected to happen.
Variance analysis. A technique used in budgeting in which realized values are compared with budgeted values to help control operations.
Yield to call (YTC). The expected rate of return on a debt security assuming it is held until it is called.
704 Glossary Yield to maturity (YTM). The expected rate of return on a debt security assuming it is held until maturity.
Zero-balance account (ZBA). A bank account having a zero balance established by a business to handle disbursements of a particular type. Funds are transferred to ZBAs from a master account as needed to cover the checks written.
Zero-based budgeting. An approach to budgeting that starts with a clean slate and requires complete justification of all budget items. See Conventional budgeting.
Zero-coupon bond. A bond that pays no interest. It is bought at a discount from par value, so its return comes solely from price appreciation (selling at a price greater than the purchase price or receiving the face value at maturity).
INDEX Note: Italicized page locators refer to exhibits.
Academic health centers, 33 Acceleration of receipts, 603 4 Accountable care organizations (ACOs), 24 25, 29; bundled payments and, 64; capitated payments to, 180; cost reduction and, 234; data analytics and, 27; forms of, 24; payment through, 24 25; shared savings program of, 51, 63 Accounting, 10; accrual (basis), 86 87, 109 10; definition of, 8; inflation, 664; relationship to financial management, 8 Accounting breakeven, 173, 175, 177, 189, 197, 249, 250; differentiated from economic breakeven, 172, 189 Accounting entity, 82, 83, 109 Accounting identity (or basic accounting equation), 121, 148 Accounting income statements, vs.
cash flow, 524 Accounting methods, 85 87; accrual accounting, 86 87; cash accounting, 85 86 Accounting period, 83, 109 Accounting rate of return (ARR), 546 Account(s): charts of, 88, 110; clas sification of, 88 89; contra, 128; definition of, 88; permanent, 88; primary, 88; subsidiary, 88; temporary, 89 Accounts payable, 131, 140, 623 26; as costly trade credit, 625, 626, 632; finance charges on, 626; as free trade credit, 625, 632; payments of, 146 47 Accounts receivable financing, 629 30, 631, 632 Accreditation: of hospitals, 32 Accrual (basis) accounting, 86 87, 109 10 Accrual(s), 131; as short-term financing source, 623, 631 Accrued expenses, 131 Accumulated depreciation, 127 28 Activity, relationship to cost, 161 Activity-based costing (ABC) method, 255; definition of, 239; final aggregation of activity costs per visit, 242; illustration of, 239 40; implementing, steps in, 239; initial data and allocation rate calculation, 241 Administrative costs, 264, 627 Admission rates: decrease in, 32 Adult day care, 36 Adventist Health System/Sunbelt, 473 Adverse opinions, of auditors, 80 Adverse selection: health insurance and, 42, 65 Advertising: accounts payable for, 146 47; purchased with credit, 145 Aetna, 45 Affordable Care Act. See Patient Protection and Affordable Care Act (ACA) 706 Index Aging schedules, 616, 617, 619, 631 AICPA Audit and Accounting Guide (American Institute of Certified Public Accountants), 79 Alachua County Health Facilities Authority (Florida): bond sales by, 401 Alice s Adventures in Wonderland (Carroll), 4 Allocation rate, 205, 207; definition of, 204; equation, 207 Allowable costs: cost-based reimbursement and, 52 All patient case-mix index, 662 Almanac of Hospital Financial and Operating Indicators, 655 Ambulatory care services, 13; overview of, 34 35; technology and, 34 Ambulatory payment classifications (APCs), 69 Ambulatory surgery centers (ASCs), 34, 35; Medicare reimbursement for, 69 American College of Healthcare Exec utives (ACHE), 14 American Heart Association, 9 American Hospital Association: char ity care guidelines of, 19; hospital service plans and, 45 American Institute of Certified Public Accountants (AICPA), 79, 109 American Red Cross, 9, 18 Amortization schedule, 349 Amortized loans, 348 49, 395 96 Annual percentage rate (APR), 337 Annual percentage yield (APY), 337 Annual reports, 89 Annuities: definition of, 320, 339; due, 320, 322 25, 339; future value (FV) of, 320 21, 322; ordinary (deferred), 320 22, 339; payment of, 320; as perpetuities, 325 26; present value (PV) of, 320, 321 22, 324 Arguments: spreadsheet solutions, 312, 313 Asset accounts: restricted, 136 Asset management (activity) ratios, 652 55, 668, 679; average age of plant, 654 55; days in patient accounts receivables, 654; definition of, 652; fixed asset turnover ratio, 653; total asset turnover ratio, 653 54 Assets: basic accounting equation of, 121; categories of, 123 29; conversion into cash, 123; definition of, 120, 148; infrastructure, 130; liquid, 407; maturity of, 120, 148; net, 133 36, 149; operating leverage and, 199; other, 129; rightto- use, 132; total, 121, 122, 133; written off, 128; zero-return, 128.
See also Current assets; Financial assets; Fixed assets; Real assets Assets divestment: capital budgeting analysis of, 525 Asset structure: debt financing and, 485, 486 Asset utilization, 657 Association for Health Care Philanthropy, 445 46 Associations: professional, 16 Assured Guaranty Corporation, 430 Asymmetric information, 458; adverse-selection problem and, 42 Auditors, 80; non-audit services of, 81 Auditor s opinions, 80 Automated Clearing House (ACH), 604 Average age of plant, 654 56 Average collection period (ACP), 614 16, 631, 654 Average cost per test, 195 Average daily billings (ADBs), 614, 615, 616 Average fixed costs, 195 Average length of stay (ALOS), 662 Bad debt losses: differentiated from charity care, 93; provision for, 94, 124, 125 Index 707 Balanced Budget Act of 1997, 71 Balance sheets, 119, 122, 600; accounting identity of, 121; assets section of, 120, 122, 123 29; common size, 680, 681; definition of, 120, 148; equity section of, 120, 122, 129, 133 35, 135; inflation effects and distortions in, 665; liabilities section of, 120, 122, 129 33; overview of, 120 22; percentage change analysis in, 682; property and equipment value listed on, 127; relationship with income statements, 91, 120, 149; timing of, 121; transactions section of, 143 47, 149; use in financial statement analysis, 147 48, 645 Banking: concentration, 604, 630; historical foundations of, 76; investment, 471 73 Bank loans, 142, 628, 632; with three-year maturity, 132 Bank of America Merrill Lynch, 401 Bankruptcy, 78, 627; default-related, 129 30 Bar codes, 622 Bartering, 76 Base case: in sensitivity analysis, 567, 571 Base case analysis, 166, 181 Basic accounting equation, 121, 143 Bastiat, Frederic, 319 Behavioral finance, 459 Behaviors: impact of health insurance on, 43 Benchmarking/benchmarks, 665 66, 669; definition of, 665; of financial risks, 459; illustration of, 666 Benefits: as income statement item, 96 Beta (.) coefficients, 371 74, 385, 494, 495; definition of, 371; illustration, 372 Big data, 27 Bigger fool theory of investment, 450 Billed charges (or charges), 52, 65 Biotechnology firms: risk and, 352 Biotechnology industry: subsectors in, 8 Black swan event, 582 Blue Cross and Blue Shield of Florida, 86 Blue Cross/Blue Shield, 44 45, 65 Blue sky laws, 470 Board of directors, 78; of investor- owned corporations, 17 Board of trustees: for not-for-profit corporations, 19. See also Trustees Bond insurance, 430 31 Bond issues, 396; trustees of, 402, 423 Bond pools, 400 Bonds: after-tax yield on, 400; call provisions for, 399, 403, 423; call risk premiums on, 407 8; coupon (interest) rate of, 411; credit ratings of, 403 5, 423; debt service requirements of, 412; debt valuation of, 412 17; definition of, 316, 396, 423; definitions related to, 411 12; expected rate of return on, 418; floating-rate, 397, 399; going rates of, 411; indentures on, 402, 423; interest (annual) yield on, 416; interest rate risk and, 420 22; interest rates on, 397, 415, 416, 417; investment grade, 403; junk, 403; maturity date of, 411; mortgage, 398, 423; new issues vs. outstanding, 411; 100year, 316 17; outstanding, 411; par value of, 411; payment-in-kind (PIK), 398; price risk premiums on, 407; private vs. public placement on, 401; repayment of par on, 424; seasoned issue, 411; step- up provisions of, 398; unsecured (debentures), 398 99; yield to call on, 418; yield to maturity on, 418, 424; zero-coupon, 397, 422. See also Corporate bonds; Municipal bonds; Treasury bonds 708 Index Bond valuation: basic model of, 412 17; interest rate risk in, 420 22; over time, 416 17, 417; reinvestment rate risk in, 420; with semiannual compounding, 418 20 Bonuses: profitability and, 219 Book depreciation, 98, 534 Book value, 128, 133 Bottom line, 102, 149 Bottom-up (participatory) budgets, 279, 295 Breakeven analysis, 171 75, 187; in capital budgeting, 537 39, 545; definition of, 171, 189; relationship between forecasted profit and loss (P&L) statement and, 174 Breakeven point, 171, 173, 174, 196; under capitation, 184, 186, 187 88; in discounted fee-for-service environment, 176, 177, 178; operating leverage and, 199 Breakeven volume, 171, 172, 182, 183 Budgeting: definition of, 269, 276, 294, 295; middle-out, 278; value of, 276 77. See also Capital budgeting analysis Budgets: bottom-up, 278, 279, 295; conventional, 277 78, 295; definition of, 10, 269; expense, 281, 295; flexible, 287 88, 289, 295; master, 280; middle-out, 279; operating, 282 84, 283, 295; revenue, 281, 295; rolling, 286 87; static, 286, 287, 289, 295; statistics, 280 81, 295; timing of, 277; top- down, 278, 279, 295; zero-based, 278, 295. See also Capital budgets Build-up method, 505 7, 511 Bundled (global) pricing, 57, 66 Bundled payment plans: objective of, 64 Bundled payments, 53 Businesses: concept of, 9 10; defini tion of, 9; differentiated from pure charities, 9 10, 28. See also Corporations Business organizations: alternative legal forms of, 14 16 Business (practice) managers, 13, 28 Business risk, 508; definition of, 483 Bylaws: of corporations, 16 Calculator solutions: for amortized loans, 348; in annuities due calculations, 322 25; for bond valuation, 413, 414, 415; in compounding, 309 10; in discounting, 315 16; for effective annual rate, 336 37; financial risk on personal investments, 353; future value (FV) of annuities, 320 21; future value (FV) of an annuity due, 322 23; future value of a lump sum, 310; historical data vs. forecasted distributions and, 361; present value (PV) of annuities, 321 22; present value (PV) of an annuity due, 324; in return-on-investment (ROI) analysis, 331; semiannual bond valuation, 419; in semiannual compounding, 334, 335; solving for interest rate and time, 345, 346; uneven cash flow stream analysis, 327 30; yield to maturity on a bond, 418 Call premiums, 403, 423 Call provisions, 399, 403, 423 Call risk premiums (CRPs), 407 8, 423 Cannibalization, 252, 526 Capital, 391; definition of, 11, 393; divisional cost of, 509, 585 86, 587, 591; forms of, 393, 422; historical cost of, 489; impairment of, 128 29; investors as sources of, 77; marginal cost of, 489; permanent, 488; project cost of, 508, 509, 562, 581, 587, 587, 590; total, 683. See also Corporate cost of capital Capital asset pricing model (CAPM), 405, 493 95, 498, 500, 510; Index 709 advantages and disadvantages of, 383 84; definition of, 380, 386; security market line (SML) equation of, 381 82, 386, 493, 495 Capital budgeting: definition of, 10 11, 519, 551 Capital budgeting analysis: breakeven analysis in, 537 39, 545; cash flow estimation in, 523 29; decision process in, 519 20; effects on existing business lines, 526; financial analysis in, 521 22; merger analysis and, 551; net present social value (NPSV) model on, 546 48, 553; in not-for-profit businesses, 521 22, 545 49; overview of, steps in, 522, 551; post-audits in, 549 50, 553; project classifications in, 520 21; project scoring in, 548 49, 549, 553; return on investment (profitability) analysis in, 539 44, 552; of staff reduction, 551. See also Project risk analysis Capital budgeting decision process:
certainty equivalent (CE) method in, 578 79, 590; overview of, 586 88; risk-adjusted discount rate (RADR) method in, 579 80, 590 Capital budgeting decisions: definition of, 519 Capital budgets: definition of, 586 Capital costs: definition of, 92 Capital gains, 394, 422, 438, 453; definition of, 356 Capital gains yield, 416, 462 Capital investments, 10, 28, 275, 508, 511, 518, 561. See also Capital budgeting Capitalization ratios: debt ratio, 649 50; debt-to-capitalization ratio, 650 51 Capitalized expected earnings stream, 447 Capital losses: definition of, 356 Capital markets: access to, 136 Capital rationing, 588 89, 591 Capital structure, 98, 149; basics of, 476; definition of, 476; financial flexibility theory of, 484; of for- profit businesses, 480 85; industry averages of, 485; of not-for-profit businesses, 485 87; optimal (target), 476, 482 83, 485, 510; trade-off model of, 480 81, 481 Capital structure theory, 480 83, 481, 486 Capitation, 65; breakeven point under, 184, 186, 187 88; comparison with fee-for-service reimbursement, 54, 184, 189; contribution margin under, 184; definition of, 52, 66; fixed cost under, 181, 182, 183, 186; liquidity of current assets under, 126; membership (enrollees) under, 183 85; price setting under, 251, 251 55, 252, 254; profit and loss statement analysis of, 185, 185 87; provider incentives under, 54, 57; total variable cost under, 182; utilization under, 181 83, 182; variable cost rate under, 181, 182, 183, 184, 186; volume under, 181, 182, 183, 186 Capitation contracts: as premium revenue source, 94 Capitation premium rates: fee-for-service approach to, 184 85; setting of, 251 55 CareDX, Inc., 468 Carroll, Lewis, 4 Carrying costs, 127 Case mix: basis of, 662 Case-mix groups (CMGs), 70 Cash: cash equivalents vs., 123; conversion from current assets, 123; definition of, 11; liquidity of, 125 26; as nonearning asset, 601; shorter-term investments vs., 124; total, 125 Cash (basis) accounting, 85 86, 109; advantages of, 86; definition of, 85; use by states and cities, 130 710 Index Cash budgets, 605 10, 631; collections worksheet in, 606, 607; creating, 606; definition of, 606; expected values in, 610; liquidity planning and, 609; net cash gain (loss) of, 608; supplies worksheet of, 608; surplus/deficit summary component of, 608; target cash balance and, 608 Cash equivalents, 124, 610; liquidity of, 123, 125 26 Cash flow: cumulative, 537, 538; effect of taxes on, 105; of for-profit organizations, 105 6; net income conversion to, 103 4, 110. See also Cash flow estimation; Statement of cash flows Cash flow coverage (CFC) ratio, 651 52 Cash flow estimation: vs. accounting income, 524; bias in, 530; in capital budgeting, 523 37; cash flow timing in, 524; changes in current accounts, 527; example of, 529 37; for for-profit businesses, 534 35; incremental cash flow, 523, 537, 551; inflation effects in, 527 28, 552; MRI system, 529 31, 531, 532, 536; nonincremental cash flow, 525; for not-for-profit businesses, 531, 533 34; opportunity costs in, 317 18, 525 26, 551; principles of, 523; project life factor in, 524 25; replacement analysis and, 537; salvage value in, 525; shipping, installation, and related costs, 526 27; strategic value and, 528 29, 552; sunk costs in, 525, 551; time value analysis of, 306 Cash flow register, 328 Cash flows: expected, discount and sum for, 410; nonnormal, 544; normal, 544; spreadsheet range of, 328 Cash flow stream: assessing riskiness of, 410; in debt valuation, 409 10; setting required rate of return on, 410; uneven, 327 30 Cash management, 601 5; acceleration of receipts, 603 4; costs and benefits of, 605; disbursement control in, 604 5; float management in, 602 3; goal of, 601, 630 Cash managers: responsibilities of, 13 Cash outflow: adjusting for risk, 582 84, 591; uncertainty in, 585 Casualty insurance setting: moral hazard cases in, 42 Catholic Health Initiatives, 18 Centers for Medicare & Medicaid Services (CMS), 47; ambulatory payment classifications and, 69 Certainty equivalent (CE) method, 578 79, 590 Charge-based reimbursement, 55, 56; definition of, 52; discounted, 53; provider incentives under, 52 Charge lag days metric: revenue cycle and, 618 Chargemaster: definition of, 52; prices, 93, 94 Charitable contributions: as equity capital source, 445, 446, 462; non- operating income as, 100 Charitable organizations: definition of, 18; tax code definition of, 18. See also Charities Charities, pure, differentiated from businesses, 9 10, 28 Charity care, 94, 124; differentiated from bad debt losses, 93; guidelines and requirements for, 94; of not-for-profit hospitals, 20; as qualification for tax-exempt status, 18 Charters: of corporations, 16 Chart of accounts, 88, 110 Check Clearing for the 21st Century Act, 602 3 Chief executive officers (CEOs): concerns of, 14; financial statement certification by, 81; responsibilities of, 12, 28 Index 711 Chief financial officers (CFOs): corporate cost of capital estimated by, 586; financial statement certification by, 81; responsibilities of, 12, 28 Chronic care: Patient Protection and Affordable Care Act and focus on, 51 Churning, 55 56 Cities: financial status reporting by, 130 Citigroup, 457, 471 Classified stocks, 441 42 Clinical integration: Patient Protection and Affordable Care Act and, 26 27 Clinical laboratories, 34 Closely held corporation, 461 Coca-Cola: bonds issued by, 297 Coding. See Medical coding (classification) Coefficient of variation (CV), 562, 571 Coinsurance: Medicare supplement insurance (Medigap) and, 47; moral hazard problem and, 43 44 Collateralized mortgage obligations, 430 Collections float, 602 Columbia/HCA. See HCA Commercial health insurance, 45, 65 Commercial paper, 124 Common size analysis, 659, 668, 680, 681, 682 Common stockholders: rights and privileges of, 438, 440, 461 Common stocks, 17; classified, 441 42; direct purchase plans for, 444, 461; dividend reinvestment plans, 444, 461; employee stock purchase plans for, 443, 461; market for, 467 68; new, selling of, 442 44; private placements of, 443, 461; public offerings of, 443, 461; residual earnings and, 438; rights offerings, 442, 461; types of, 441 42; unlisted, 467; valuation of, 447 55 Community benefit, 19, 20 Community Health Systems, 17, 34 Comparative analysis, 654, 655, 666, 668 Comparative data, 666, 669 Compensating balances, 628, 632 Compensation. See Salaries Component financing costs, 488 Compounding: annual, 333 34; defi nition of, 307, 338; power of, 312; semiannual, 334 35; stated vs.
effective interest rates in, 335 38 Comptrollers: responsibilities of, 12 13, 28 Computerized inventory control sys tems, 620 21 Concentration banking, 604, 630 Consolidation of healthcare organi zations: Patient Protection and Affordable Care Act and, 26 Constant growth dividend valuation model, 496 Constant growth model, 450, 452, 453, 462 Constant growth stock valuation, 450 55; equation, 451 52; expected rate of return in, 452 55, 495 96 Consumption: time preferences for, 394, 422 Continuous budgets, 286 Continuous probability distributions, 573 Contra accounts, definition of, 89 Contra assets, 128 Contract management, 11 Contractual allowances, 93 Contribution margin, 170 71, 173, 175, 251; under capitation, 184; definition of, 170, 189; marginal, 180; operating leverage and, 197; projected base case, 171, 171 Contributions, as nonoperating income, 100 712 Index Control, as finance activity, 11 Controlled disbursement accounts, 605, 630 Controllers. See Comptrollers Conventional budgeting, 277 78, 295 Convergence, of financial accounting standards, 80 Conversion factor, 61 Copayments: Medicare supplement insurance (Medigap) and, 47; moral hazard problem and, 43 Corporate beta (.), 374, 379, 385, 563 Corporate bonds, 400, 401, 403, 423; definition of, 397; maturities of, 397 Corporate cost of capital (CCC), 501 9, 511, 561, 584, 586, 683, 684; component cost estimation of, 488; definition of, 488; economic interpretation of, 507 9; estimation of, 502, 511; of for-profit businesses, 502 3; general formula for, 502; inflation effects and, 528; of not-for-profit businesses, 503; of small businesses, 504 7; tax effects, 488 89 Corporate risk, 377, 379, 380, 590; comparison with market risk, 375 76; definition of, 374, 385, 563; of large investor-owned businesses, 378; of not-for-profit businesses, 379, 385; relationship to market and stand-alone risk, 564; of small investor-owned businesses, 378, 385 Corporations, 15 16, 29; advantages of, 15 16; alternate ownership of, 17 20; bylaws of, 16; charters of, 16; closely held, 461; definition of, 15; disadvantages of, 16; limited liability of, 16; professional, 16; publicly owned, 462, 467 Correlation, 366; definition of, 365 Correlation coefficient, 365, 366 Cost: allowable, 52; classification of, 161 62, 189; definition of, 11, 161 Cost accounting: relationship to managerial and financial accounting, 160 Cost allocation, 202 23; activity- based costing (ABC) method of, 239 40; basic principles of, 204 7, 222 23; best method of, 213; changing to more effective cost driver, 219 22, 220; cost drivers in indirect cost, 214; cost pools, 204; definition of, 202; departmental profitability and, 217 19; direct method of, 208, 209, 224; goal of, 203, 222, 223; of indirect costs in patient services illustration, 218, 218; methods of, 208, 208 17, 224; overhead ratio and, 222 23; process of, 206, 206 7; reciprocal method of, 208, 208, 209, 210, 224; step-down method of, 208, 208, 209, 210, 224, 230 32; traditional costing method of, 238 39 Cost-based reimbursement, 55, 65; definition of, 52 Cost behavior: managerial accounts basis, 162; in profit analysis, 162 65, 165 69; relevant range of, 161 Cost behavior graphs, 165, 168 Cost benefit, 84 85, 109 Cost centers, 210 Cost containment, 12; charge-based reimbursement and, 56; cost allocation and, 203; cost driver incentives for, 205, 224; unbundling and, 57; value-based purchasing and, 56 Cost control: cost drivers and, 205 Cost drivers: characteristics of, 205; choosing, 222; cost control incentive, 205, 224; definition of, 204, 224; direct method illustration, 210, 211, 212, 212, 213, 214, 215; fairness of, 205, 224; for housekeeping costs, 204, 206 7; identifying, 204 5, 206; in indirect cost allocation, 214; more Index 713 effective, changing to, 219 22; two tests to be met by, 222 23, 224 Costly trade credit, 625, 626, 632 Cost of capital: divisional, 509, 585 86, 587, 591; project, 508, 509, 562, 581, 587, 591. See also Cost of equity capital Cost of debt, 489 91 Cost of equity capital: definition of, 492, 510 Cost of equity capital estimation, 492 501; capital asset pricing model (CAPM) method, 493 95, 498, 510; choices related to, 500; debt cost plus risk premium approach, 497 98, 510; discounted cash flow (DCF) method, 495 97, 498, 510; for for-profit businesses, 492 98; for not-for-profit businesses, 498 501 Cost pools, 204, 205, 222, 224; definition of, 204; direct method illustration, 210, 211, 214, 215; for housekeeping costs, 206, 206 7 Cost reimbursement: effect on finance function, 12 Cost structure: contract analysis and, 267 68; effect on financial risk, 187 88; graph, 165; illustration:
fixed and variable costs, 163; matching revenue structure and, 188; relationship to economies of scale, 198 99 Cost-to-charge ratio (CCR) method, 255; assumptions related to, 235; charges vs. revenues in, 236 37, 238; definition of, 235; differentiated from relative value unit (RVU) method, 237; equation, 235 36 Cost-to-collect metric: revenue cycle and, 617 Cost variance, 290, 291, 292 Cost-volume-profit (CVP) analysis, 166, 168, 168, 169, 171, 181, 182, 189, 196 Coupon (interest) rate, 411 Coupon payment, 411, 412 Coupon rate bonds: long- and short- term, at different market interest rates, 421 Coverage ratios: cash flow coverage ratio, 651 52; times interest earned ratio, 651 Credit: advertising purchased with, 145; lines of, 628 29, 632; services rendered for, 144 45; supplies purchased with, 144; terms of, 624 Credit cards: true cost rate for, 337; value of float and, 603 Credit enhancement, 430 31 Creditors, 77, 393; financial risk of, 352; liability claims of, 129 Credit policy, 624 Credit ratings, 403 5, 423; changes in, 405; criticisms of, 404 5; debt financing limits set by, 484; Fitch Ratings, 403; importance of, 404 5; Moody s Investors Service, 403; profitability measures and, 499; rating criteria of, 404; Standard & Poor s (S&P), 403 Credits: in double entry accounts, 89 Credit spreads, 405 Credit terms, 131 Critical access hospitals (CAHs), 52; Medicare reimbursement, 71 Cross-subsidization (price shifting), 247 48, 256 Cumulative cash flow, 537, 538 Current accounts: capital budgeting and changes in, 527, 552 Current accounts management, 11, 28, 599; overview of, 600 601; primary goal of, 600 Current asset management, 599; prudent, benefits of, 126 27 Current assets, 123 26, 599; conversion into cash, 123; definition of, 123, 148; liquidity of, 123; minimization of, 125; other, 125 Current cost accounting, 664 714 Index Current liabilities, 130 31, 132, 148 Current liability management, 527, 623 30; accounts payable (trade credit), 623 26; accruals, 623; short-term financing, 627 30 Current portion of long-term debt, 132 Current Procedural Terminology (CPT) codes, 58 59, 66 Current ratio, 647 48; definition of, 402 Dashboards, 667, 669 Data, comparative, 666, 669 Data analytics, 27 Data security, 27 Days-cash-on-hand ratio, 648 49 Days in patient accounts receivable, 615, 654 Days sales outstanding (DSO), 654 Debentures, 398 99, 423 Debits: in double entry accounts, 89 Debt: after-tax cost of, 489, 491, 510; before-tax cost of, 488, 490, 491, 498, 502, 510; as capital, 393, 422; component cost of, 488; cost of, 481, 482, 489 91, 497; tax-exempt, 489, 490, 491; use in healthcare sector, 486. See also Long-term debt; Short-term debt Debt capacity, 485, 510, 585 Debt contracts, 402 3; restrictive covenants of, 402 Debt-cost-plus-risk-premium approach, 497 98, 500, 504 5, 510 Debt financing, 9, 391, 393; actual financing costs and, 504; vs. all- equity financing, 486; asset structure and, 485, 486; business risk in, 476, 508; effect on accounting risk and return, 476 80; limits on, 484; by overleveraged businesses, 485, 487; relationship to assets, 485; relationship to business risk, 478, 481, 482, 483 84, 486; reserve borrowing capacity and, 484; return on equity under, 479 80; tax benefits of, 478, 480, 488 89; trade-off model of, 480 81, 481, 510; by underleveraged businesses, 486, 487 Debtholders: financial risk of, 352 Debt management (capital structure) ratios, 649 52, 668, 679; capitalization ratios, 649 51; coverage ratios, 651 52 Debt maturities: yield curve information and, 431 33, 432 Debt rating agencies, 484 Debt ratio, 69 650, 147, 148 Debt securities: credit ratings of, 403 5, 423; interest rate risk and, 420; required rate of return on, 408 Debt service requirements, 399, 412 Debt-to-assets ratio, 147 Debt-to-capitalization ratio, 650 51 Debt utilization, 657 Debt valuation, 409 22; basic bond valuation model, 412 17; general model of, 409 11; interest rate risk in, 420 22; with semiannual compounding, 418 20 Decision making: financial risk and, 352; managerial accounting and, 160 Decision tree analysis, 565 Deductibles: Medicare supplement insurance (Medigap) and, 47 Default: definition of, 129, 398; technical, 402 Default risk premium (DRP), 406, 423 Deferred call, 403 Degree of operating leverage (DOL), 187; calculating, 198; high, double- edged sword of, 198 99 Departmental costs, 201; cost allocation and, 202 3; direct vs. indirect (overhead) costs, 201 2; intrasupport department relationships and, 208, 209, 213 14; other support Index 715 departments and cost allocation methods, 208 Departmental profitability: cost allocation and, 217 19 Depreciation: accumulated, 127 28; definition of, 97; funded, 127; on net income and cash flow for for- profit businesses, 105 6 Depreciation cash flow, 104 Depreciation expense, 97 98, 110, 127 29 Depreciation shield, 106, 110, 111 Derivative contracts, 430 Diagnoses: case mix values assigned to, 662; up coding of, 56 Diagnosis codes, 58 Diagnosis-related group (DRG) sys tem, 53 Diagnostic imaging centers, 34 Direct costs: in activity-based costing (ABC) method, 240; definition of, 202, 223; direct method illustration, 215, 216; vs. indirect (overhead) costs, 201 2, 223; profit analysis of, 218, 218, 219 Direct format, statement of cash flows, 138 Direct method, of cost allocation, 208, 209, 224; illustration of, 210 17, 211, 212, 214, 216, 219 Direct purchase plans, 444, 461 Disbursement control, 604 5 Disbursement float, 602 Discounted cash flow (DCF) mea sures, 493, 498, 500, 510; internal rate of return (IRR), 541 42; net present value (NPV), 539 40, 542 Discounted charge reimbursement, 56 Discounted charges, 53 Discounted expected earnings stream, 447, 462 Discounted fee-for-service environment:
evaluating alternative strategies: short- and long-term, 178 79; impact of accepting proposal, 177 78; impact of rejecting proposal, 176 77; marginal analysis in, 179 80; profit analysis in, 175 80 Discounted payback, 538 Discounted rate schedules, 53 Discounting: definition of, 314, 339; at work, 316 17 Discount rate, risk-adjusted (RADR), 579 80, 581 Discounts: financial statement notes on, 93; on Treasury bills (T-bills), 353 Discounts lost, 624 Disney: bonds issued by, 297 Diversifiable risk, 385; definition of, 368; portfolio risk vs., 368 70 Diversification: portfolio, 368, 369 Dividend reinvestment plans (DRIPs), 444, 461 Dividends, 394, 422, 438 40; annual, 438; definition of, 18; expected, as basis of stock values, 496 97; expected, as sale basis for stock value, 449 50, 452, 462; payment of, illustration for, 438 40, 439; probability of, 356; social, 547 Dividend valuation model, 496; defi nitions for, 448 49 Dividend yield, 449, 454 Divisional costs of capital, 509, 585 86, 587, 591 Dollar: as basic monetary unit, 83 Dollar cost analysis, 683 84 Dollar return, 330 31 Donations. See Charitable contributions Dot-com bubble, 458 Double apportionment, 230 Double entry system, 89, 110 Du Pont analysis/equation, 656 59, 668, 682 Early intervention programs, 37 Earnings before interest and taxes (EBIT), 651, 683 Earnings per share (EPS), 452 716 Index eCom, 622 Economic breakeven, 171, 175, 189; pricing for, 249, 250 Economic income of business: measuring, 102 Economic value added (EVA), 640, 682 85; formula for, 683; improving, 685 Economies of scale: relationship to high degree of operating leverage, 198 99 Effective annual rate (EAR), 336 38, 339 Efficiency variance, 292 Efficient markets hypothesis (EMH), 456 59, 462; forms of, 456 57; managerial decisions and, 458 Elderly population: increase in, 36; as long-term care users, 36 Electronic check clearing, 603 Electronic claims processing, 603 Emeritus Senior Living, 17 Employee groups: group policies and, 45 Employee stock purchase plans, 443, 461 EPCglobal, 622 Equipment: cash purchase of, 144; as fixed asset, 97; shipping and installation costs of, 526 27 Equity, 488; as balance sheet item, 120, 129, 133 35, 135; basic accounting equation of, 121; definition of, 120, 149; as net assets, 133 36; as nonliability capital, 393; statement of changes in, 107, 108, 111; terms for, 133 Equity capital, 393, 422, 684; cost of, 481, 482, 492 501, 498; vs. debt financing, 486, 487 Equity financing, 391, 437; of for- profit businesses, 438 41; of investor-owned corporations, 445, 446; of not-for-profit corporations, 445 46, 462 Equity multiplier, 657 Equity ratio, 650 Essential health benefits, 50 Excel: time value analysis with, 312 Expected capital gains yield, 449, 462 Expected constant growth rate, in dividends, 452 Expected dividend return, 448 Expected dividend yield, 449, 462 Expected earnings stream, 447, 462 Expected rate of return: on bonds, 418; calculating, 359; in constant growth stock valuation, 452 55; definition of, 358; on portfolios, 362 63, 363; security market line and, 381; on stocks, 380, 455 56, 462, 495 96 Expected values, 385, 610; of a probability distribution, 359; in sensitivity analysis, 567 Expense budgets, 281, 295 Expense control, 657 Expense-matching principle, 84, 97, 109 Expenses, 95 99, 110; accrued (accruals), 87; definition of, 95, 110; functional classification of, 95; as income statement component, 91, 92, 96 97; natural classification of, 95; operating, 92; operating budget and, 284; payment of, 145 External audits, 80 Facebook, 461 Face value, 353, 397, 411 Factoring: or selling, accounts receivable, 629 Factors: definition of, 629 Fair market value (fair value): of longterm securities investments, 126 FASB Accounting Standards Codification, 79 Federal government: budgetary policy of, 434; fiscal year of, 83. See also specific agencies and departments Federal hospital mortgage insurance, 430 Index 717 Federal hospitals, 33 Federal Housing Administration (FHA), 430 Federal Reserve Board, 396, 434, 435, 468, 469, 493 Fedwire, 604 Fee-for-service equivalent revenue, 254 Fee-for-service prices, on individual services, 249 50 Fee-for-service reimbursement, 65; accountable care organizations and, 24; comparison with capitation reimbursement, 54, 184, 189; definition of, 52; in inpatient capitation rate setting, 251 55; medical coding and, 57 59; provider incentives under, 57 Fidelity Investments, 457 Finance: definition of, 8; role in health services organizations, 10 12, 28 Finance departments: structure of, 12 13 Finance function: effect of cost reimbursement on, 12; healthcare providers and, 22 Financial accounting: art and science of, 80; conceptual framework of, 82 85; definition of, 75; differentiated from managerial accounting, 159 60; goal of, 82, 109; historical foundations of, 75 77; as language of business, 75; regulation and standards in, 78 81, 109; transparency in, 81; users of, 77 78, 109 Financial accounting information and data: recording and compiling, 88 90 Financial Accounting Standards Board (FASB), 79, 80, 109, 665 Financial accounting systems: goal of, Financial analysis: in capital budgeting, 521 22. See also Financial condition analysis; Financial ratio analysis Financial assets: definition of, 126, 305; general valuation model of, 410 Financial condition analysis, 639 69; benchmarking in, 665 66; dashboards, 667; economic value added (EVA) measure in, 682 85; financial ratio analysis, 643 59; limitations of, 664 65, 669; operating indicator analysis, 660 63; performance indicators in, 667 Financial crisis of 2008, 430 Financial decision making: risk aversion and, 355 56 Financial flexibility, 484 Financial implications, 14, 28 Financial Industry Regulatory Authority (FINRA), 470 Financial interests, 77 Financial intermediaries, 395 Financial leverage, 649, 657; definition of, 478 Financial management, 10; definition of, 8. See also Short-term financial management Financial performance: organizational goals for, 270; variance analysis based control of, 285 87 Financial plan: definition of, 275; sections of, 295 Financial planning, 269, 274 75; schedule, 276 Financial ratio analysis, 108 9, 111, 643 59; asset management (activity) ratios, 652 55; average age of plant ratio, 654 55; debt management (capital structure) ratios, 649 52; Du Pont analysis, 656 59; limitations to, 664 65; liquidity ratios, 647 49; market/book ratio, 679 80; price/earnings (PE) ratio, 679; profitability ratios, 644 47 Financial reporting: as finance activity, 10, 28 Financial risk, 351, 385; cost structure effects on, 187 88; definition of, 355, 483; expected and realized 718 Index rates of return and, 357 59; illustration of, 353 55; interpretation of risk measures in, 378 80; management of, 11; many faces of, 352; portfolio risk and return, 361 71; probability distribution in, 356 57; relevance of risk measures for, 377 79; size of investment relationship in, 360; stand-alone risk, 359 61.
See also Corporate risk Financial services department: direct method illustration, 212, 212, 214, 216; more effective cost drivers and, 219 22, 220; step-down method illustration, 230 32, 231 Financial statement analysis: common size analysis, 659; comparative and trend analysis, 655; definition of, 639, 668; financial ratio analysis, 643 55; percentage change analysis, 659. See also Generally accepted accounting principles (GAAP) Financial statements, 75; accounting methods for, 85 87; assumptions related to, 82 83, 109; constraints related to, 84 85, 109; under debt financing, 476 78, 477; definition of, 10; fraudulent, 81; leasing and, 132; managers creation and use of, 78; need for, 76; notes section of, 89; preparation costs related to, 84 85; preparation of, 82; principles related to, 83 84, 109; quarterly, 83; semiannual, 83. See also Balance sheets; Income statements; Statement of cash flow; Statement of changes in equity Financing decisions, 11 Fiscal year, 83 Fitch Ratings, 403 501(c)(3) or (4) corporations, 18 Five-period time line, 306 Five Prime Therapeutics, Inc., 468 Five-year plans, 271, 295 Fixed assets: definition of, 127; depre ciation expense of, 97, 127 29 Fixed asset turnover (utilization) ratio, 653 Fixed costs, 166, 166, 195, 196; under capitation, 181, 182, 183, 186; cost structure illustration, 163; definition of, 161, 189; in operating budget, 284; profit and loss (P&L) statement, 169, 170, 171, 171; relationship to volume, 161 62, 164, 165, 199; relevant range of, 161 Fixed cost variance, 292, 293 Flexible budgets, 286, 287 88, 289, 295 Float: credit cards and, 603; definition of, 602, 630 Floating (variable) interest rate, 396, 397 Float management, 602 3, 630 Florida Blue, 45, 46 Flotation costs, 471, 490 Ford, 17 Foreclosure: on bond issues, 402 Form 990, 19, 29 For-profit businesses and corporations, 17; cash flow estimation for, 534 35; corporate cost of capital for, 502 3; cost of equity for, 492 98; effective cost of debt for, 491; equity financing for, 438 41; income tax filing by, 19; taxes and depreciation on net income and cash flow for, 105 6. See also Investor-owned businesses and corporations Founders shares, 442 Four Cs, 11, 28 Fraud, 81 Free trade credit, 625, 632 Full cost pricing, 246, 256 Full costs, 210 Full-disclosure principle, 84, 109 Functional classification: expense reporting and, 95 Functions: spreadsheet software, 312 Function wizard, 312 Index 719 Fund accounting, 136 37, 137, 149 Fund capital, 393, 422, 499, 500, 501, 510; definition of, 437 Funded depreciation, 127 Funds: definition of, 136 Future cash flows: time lines and analyses involving, 307 Future value (FV): of annuities, 320 21; of an annuity due, 322 23; of lump sum compounding, 307 8, 309, 310, 338; of uneven cash flow streams, 329 30 Gambler s fallacy, 364 Gatekeeper role: of primary care physicians, 37 General acute hospitals, 33 General administration: direct method illustration, 212, 212, 214, 216 General creditors: debenture holders as, 398 General ledgers, 88, 110 Generally accepted accounting principles (GAAP), applications of, 119, 122, 169, 280, 524; accrual accounting, 85, 110; auditor s opinions, 80; definition of, 79, 109; depreciation expense calculation, 97; economic activity as defined by, 142; economic income measurements, 102; expense reporting, 95; financial accounting assumptions, principles, and constraints, 82 85; financial statements and, 640; fund accounting, 137; guidance given under, 80; lease reporting, 132; operating income definition, 100; supplementary information, 90 General obligation bonds, 399 General valuation model, 409 11 Genetic Research, Inc., 442 Glazier s fallacy, 319 Global Data Synchronization, 622 Global payments, 54 Goals: organizational, 21 23, 272 74, 275; qualitative, 273 Going concerns, 82, 109 Going public, 468 Going rate, on bonds, 411 Government: as healthcare provider, 46; as health insurance provider, 46. See also Federal government Government Accounting Standards Board (GASB), 79, 130 Government agencies: differentiated from businesses, 10. See also specific agencies Governmental entities: financial status reporting by, 130 Governmental hospitals, 17, 33 Government bonds. See Treasury bonds (T-bonds) Government grants, 486; as equity capital source, 445, 462 Graham, Benjamin, 459 Grants: as equity capital source, 445, 462 Great Depression, 78, 664 Green Bay Packers, 445 Gross prices, 93 Gross property and equipment, 127, 141 Group policies: commercial health insurance and, 45 GS1 standards, 622 HCA, 17, 34; bonds issued by, 297 Healthcare Common Procedure Coding System (HCPCS), 59, 69 Health Care Entities (American Institute of Certified Public Accountants), 79 Healthcare finance: definition of, 7 8, 28; introduction to, 3 29 Healthcare Financial Management Association, 14, 79; Principles and Practices Board of, 79 Healthcare managers. See Managers Healthcare providers: definition of, 7; finance function of, 22; matching cost structure to revenue structure by, 188; as price setters, 245, 720 Index 246, 256; as price takers, 244 45, 256; receivables management and, unique problems for, 618 20. See also Physicians Healthcare reform, 23 27; adverse selection and, 42; definition of, 29; health insurance and, 49 51; impact on integrated delivery systems, 24; reimbursement methods and, 62 64, 66. See also Patient Protection and Affordable Care Act (ACA) Healthcare sector: debt use in, 486; major subsectors within, 7 8 Healthcare services: responsibility for payment issue and, 43 Health information technology, 26 27 Health insurance: adverse selection and, 42; commercial, 45; healthcare reform and, 49 51; managed care plans, 48; origin of, 44; private insurers, 44 46; public insurers, 46 47 Health insurance exchanges (HIEs), 23, 24; types of, 50 Health insurance industry: components of, 7; not-for-profit ownership in, 17 Health maintenance organizations (HMOs), 48, 65 Health services: settings of, 13, 29, 32 37 Health services industry: components of, 7 HealthSouth, 17, 81 Hedging, 369 High-deductible health plans (HDHPs), 51 Historical cost, 83, 109; of capital, 489; of fixed assets, 127 Historical cost accounting: disadvan tages with, 664 Holding period, 422 Home equity loans, 55 Home health care services, 34, 36; Medicare reimbursement for, 71 Horizontally integrated systems, 13 Hospice industry: not-for-profit ownership in, 17 Hospice programs, 36 Hospital-acquired conditions: Medicare penalties for, 64 Hospital industry: aggregate aging schedule, 619; receivables mix, 619 Hospitals, 13; accreditation of, 32; captive health plans, price setting, and, 247 48; critical access, 52, 71; decline in number of, 32; for-profit, 17; housekeeping cost drivers and, 206; licensure of, 32; ownership of, 17, 33; risk and, 352; size of, 33; types and functions of, 32 33 Hospital service plans, 45 Hospital Value-Based Purchasing program, 56 Hostile takeovers, 440, 441 Housekeeping cost allocation: cost drivers for, 204, 206 7, 212 13; cost pools for, 206 7; direct method illustration, 211, 212, 213, 214, 215, 216; process of, 206 7 Humana, 45 Human resources: direct method illustration, 212, 212, 214, 215 Hurdle rate, 488, 504, 508, 511 Ibbotson Associates, 494 IBM, 17 Illinois Supreme Court, 20 Illiquid securities, 407 Impairment of capital, 128 29 Income statements, 90 92, 119; common size, 680, 681; costs reported on, 91 92, 110; under debt financing, 477, 478 79, 479; definition of, 91; differentiated from profit and loss (P&L) statements, 169; expenses section of, 91, 92, 96 97, 110; inflation effects and distortions in, 665; of investor-owned Index 721 businesses, 105, 105 6; percentage change analysis in, 682; profitability section of, 91, 92, 110; relationship with balance sheets, 91, 120, 149; relationship with statement of cash flows, 138, 142; revenue section of, 91, 92 95, 110; title section of, 91; use in financial statement analysis, 108 9 Income taxes: exemption from, 18, 19 Incremental cash flow, 523, 537, 551 Incremental cost, 180 Indemnification: insurance and, 42, 65 Indentures, 402, 423 Indigent patients, 93. See also Charity care Indirect cost allocation: cost drivers in, 214, 215; cost pools in, 214, 214 Indirect costs: cost-to-charge ratio and, 235 37; definition of, 202; vs. direct costs, 201 2, 223; profit analysis of, 218, 218, 219. See also Cost allocation Indirect format, statement of cash flows, 138 Individual mandate: Patient Protection and Affordable Care Act and, 50 Industry committees, 79 Inflation, 422; as capital budgeting consideration, 527 28, 530, 552; earnings per share and, 452; effect on interest rates, 334, 395, 434, 435; investment risk and, 353 54; prime rate changes and, 396; strategic value of, 528 Inflation accounting, 664 65 Inflation premium (IP), 406, 423, 431 Inflow terminal value, 543 Informational efficiency: of securities markets, 456 60 Infrastructure assets, 130 Initial denial rate metric: revenue cycle and, 617 Initial public offering (IPO), 468 Innovation, market for, 461 Inogen, Inc., 468 Inpatient full-time equivalents (FTEs) per occupied bed, 663 Inpatient prospective payment system (IPPS), 59 61, 66, 69 Inpatient rehabilitation facilities:
Medicare reimbursement, 70 Insiders, 457, 469, 470 Installation costs: for new equipment, 526 27 Institutional investors, 467 Insurance: characteristics of, 41 42, 65; concepts of, 40 41; as income statement component, 96; moral hazard and, 42 44. See also Health insurance Integrated delivery systems (IDSs), 12; accountable care organizations and, 24; benefits of, 36 37; definition of, 36; managed care contracts with, 37 Interest (current) yield: on bond, 416 Interest expenses, 98 Interest rate: on bonds, 397, 415, 416, 417; bond valuation over time, 416 17, 417; cash management and, 605; components of, 405 9; on credit lines, 629; on debt securities, 408 9, 423, 431 33, 432; default risk premium and, 406, 423; definition of, 394; economic factors influencing, 434 35; fixed, 396, 397; forecasting, 433, 458; inflation premium and, 406, 423; inverted (or abnormal) yield curve of, 431; liquidity premium and, 407, 423; on long-term loans, 395; on mutual funds, 611; nominal (stated), 336, 339; periodic, 337, 339; private vs. public placement, 401; real risk-free, 406; risk-free, 406, 423; Rule of 72 and, 347; on short-term debt, 627, 631; term structure of, 431 33; and time, solving for, 345 47; 722 Index variable (floating), 396, 397; yield curve of, 431 33, 432, 433 Interest rate risk, 420 22, 424; com ponents of, 420; definition of, 420 Intermediate care facilities (ICFs), 35 Internal rate of return (IRR), 332 33, 552; comparison with net present value, 542; definition of, 541; for evaluating corporate merger opportunities, 551; modified, 542 44, 553; in scenario analysis, 571; in sensitivity analysis, 567; of stand-alone risk, 562 Internal Revenue Service (IRS), 50; Form 990, 19, 29; Tax Code Section 501(c)(3) or (4) of, 18; tax depreciation regulations, 98 International Accounting Standards Board (IASB), 80 International Classification of Diseases (ICD), 58, 66 International Financial Reporting Standards (IFRS), 80 Interstate offerings, of new securities, 469 Inventory: as current asset, 125, 126; stockless, 621 Inventory management, 620. See also Supply chain management Investment bankers, 471 72 Investment banking process, 471 73 Investment grade bonds, 403 Investment horizon, 352, 422, 424 Investment income: sources of, 100 101 Investment opportunities, 317, 394, 422 Investments: expected rate of return on, 358, 362 63, 363; multiple, 366 68; by owners, 143 44; portfolio of, 361; realized rate of return on, 358; risk and return as separate attributes of, 360; risk free (or risk- less), 353; single, 367, 370; standalone risk of, 359 61; volatility of, 371 74, 373 Investor-owned businesses and corporations:
capital structure of, 480 85; corporate cost of capital for, 502 3; cost of equity for, 492 98; differentiated from not- for-profit corporations, 18; equity financing sources for, 445, 446; income statements of, 105, 105 6, 110; large, financial risk of, 378; link between economic value added (EVA) and business value of, 684; long-term investments of, 127; net income of, 102; overview of, 17 18, 34; privately held, 33; publicly held, 33; shareholder wealth maximization goal of, 21, 22, 29; small, financial risk of, 378 79; stakeholders of, 77; stockholders of, 17, 29; tax laws and, 534 35, 552 Investor-owned hospitals, 17; as percentage of all hospitals, 34 Investors: categories of, 77; as financial accounting information users, 77, 78; financial interests of, 77; institutional, 467; risk tolerance of, 355; sophisticated, 443 Issuance expenses, 471 Joint Commission: hospital accreditation by, 32; nursing home accreditation by, 36 Joint venture decisions, 12 Journal entries, 89 JPMorgan Chase & Co., 471 Junior liens, 398 Junior mortgages, 398 Junk bonds, 403 Just-in-time (JIT) supply chain management, 621, 631 Kaiser Foundation, 18 Key performance indicators (KPIs), 667, 669 Kindred Healthcare, 17, 54 Laboratory: direct method illustration, 210, 211, 216 Labor unions: group policies and, 45 Labor variance, 292, 293 Index 723 Law of large numbers, 65; pooling of losses and, 41 Lead underwriter, 472 Lease liabilities, 132 Lease payment expenses: as income statement component, 96 97 Leasing: financial statements and, 132 Lenders, 77, 129 Length of stay (LOS), 662 Leverage, 198 Liabilities: as balance sheet item, 120, 122, 129 33, 148; basic accounting equation of, 121; professional, 15, 16; total, 121, 132 33 Licensure: of ambulatory care facilities, 35; of hospitals, 32; of nursing homes, 36 Liens: junior, 398 Life care centers, 36 Limited liability companies (LLCs), 16 Limited liability partnerships (LLPs), 16 Lines of credit, 628 29, 632 Liquid assets, 407 Liquidation, 129 30; not-for-profit corporations and, 18 Liquidation value, 524 Liquidity: of current assets, 123, 125 26; current ratio and measure of, 402; payback as measure of, 538 39 Liquidity premium (LP), 407, 423, 506, 511 Liquidity ratios, 647 49, 668, 679; current ratio, 647 48; days cash on hand, 648 49 Loan agreements, 402 Loans, 393; amortized, 348 49; historical foundations of, 76; longterm (or term), 395 96; mechanics of, 131 32 Lockboxes, 603, 604, 630 Long-term care: overview of, 35 36 Long-term care facilities, 13 Long-term debt, 131 32, 148, 393 427, 424, 431, 433, 434, 488; advantages of short-term debt over, 627; common types of, 395 401; current portion of, 132; debt contracts for, 402 3 Long-term-debt-to-capitalization ratio, 650 Long-term investments, 126 27 Long-term liabilities, 131 32, 148 Long-term loans, 395 96 Losses: pooling of, insurance and, 41 Lottery winnings: payment choices, 322 Lump sum, future value of: See Compounding; present value of: See Discounting Magellan Health, 352 Maintenance margins, 470 Malpractice insurance expenses, 66 Malpractice liability: limited, 16 Managed care organizations (MCOs):
contracts with integrated delivery systems, 37 Managed care plans, 53, 65; definition of, 48; overview of, 48; prompt payment laws and, 620 Managed fee-for-service plans, 48 Management accounting, 160 Management variance, 292, 292, 293 Managerial accounting, 159 90; basics of, 159 61; cost behavior component of, 162; definition of, 159; differentiated from financial accounting, 159 60. See also Profit analysis Managerial control process: variance analysis essential to, 285 Managers: concerns of, 14, 22, 29; operating leverage and influence of, 199; patient accounts, 13, 619; responsibilities of, 159 Managing underwriter, 472 Marginal analysis, 179 80, 189 Marginal contribution margin, 180 Marginal cost, 179; of capital, 489 Marginal cost pricing, 246 48, 249 50 724 Index Margin calls, 470 Margin requirements: for purchase of securities, 469 70 Marketable securities, 124, 630 31; holding, primary reasons for, 610; management of, 610 11; safety of, 611 Market beta (.), 375, 380, 385, 451, 452, 493 Market/book ratio, 679 80 Market portfolio, 380, 493; definition of, 368 Market risk, 377, 590; comparison with corporate risk, 375; definition of, 375, 385, 563; of large investor-owned businesses, 378; not-for-profit businesses and, 379; relationship to stand-alone and corporate risks, 564; of small investor-owned businesses, 379 Market risk premium, 381; estimating, 494 Market value ratios, 679 80 Master budgets, 280 Materiality constraint, 84, 109, 125 Mature businesses: valuation of com mon stocks and, 447 48 Maturity, of assets, 120, 149 Maturity date: definition of, 411 Mayo Clinic, 18, 445 Median values, 645 Medicaid: definition of, 47; marginal costs and, 247; overview of, 47; Patient Protection and Affordable Care Act and expansion of, 50 51; price shifting and, 247 Medicaid patient group: price setting under capitation and, 253 Medicaid reimbursement: as financial concern, 14; set amount of, 93 Medical coding (classification): definition of, 57, 66; diagnosis codes, 58; procedure codes, 58 59 Medical equipment and supplies industry, 8 Medical Group Management Association (MGMA), 61 Medical home, 51; definition of, 25, 29; key characteristics of, 25 26 Medical technology: impact on ambulatory care, 34 Medicare, 50; case-mix index, 662; cost-based reimbursement and, 52; definition of, 46; marginal costs and, 247; overview of, 46 47; Part A, 46; Part B, 46; Part C (Medicare Advantage Plans), 46; Part D, 46; readmission reduction program, 64 Medicare Administrative Contractor (MAC) jurisdictions, 47 Medicare Advantage Plans, 46 Medicare patient group: price setting under capitation and, 251 Medicare payment percentage measure, 662 Medicare reimbursement, 244; for ambulance services, 78; ambulatory surgery centers, 69; charge- master prices and, 93; critical access hospitals, 71; as financial concern, 14; for home health care, 36, 71; for hospice services, 72; for hospital inpatient services, 59 61, 60; inpatient rehabilitation facilities, 70; for outpatient hospital services, 69, 70; for physician services, 61 62, 62; prospective payment system of, 53; provider incentives under, 54; for psychiatric hospital services, 70; set amount of, 93; for skilled nursing facility services, 71; step-down method and, 232; value-based purchasing and, 56, 63 Medicare severity diagnosis-related groups (MS-DRGs), 60, 66 Medicare supplement insurance (Medigap), 47 MEDNAX, 17 Membership: in capitated plans, 183 84, 184, 186 87 Index 725 Merger analysis: valuation of target company and, 551 Mergers: capital budgeting analysis of, 551 Merrill Lynch, 471 Metrics: good, characteristics of, 618; for monitoring specific revenue cycle activities, 617 18; primary purpose of, 614, 631 Micro-level costs, 233 Microsoft, 17 Middle-out budgeting, 279 Military personnel: health insurance for, 46 Minnesota Health Systems, Inc., 450, 451, 453, 455 Missed payments, 402 Mission statements, 270 71, 295; of not-for-profit corporations, 22 23 Modified Accelerated Cost Recovery System (MACRS): tax depreciation and, 534 35 Modified cash basis accounting, 86 Modified internal rate of return (MIRR), 542 44, 543, 553; in scenario analysis, 571; in sensitivity analysis, 567; of stand-alone risk, 562 Monetary units, basic, 83, 109 Money: cost of, 394 95, 422 Money market mutual funds, 124 Montana Medical Center: price setting under capitation, 251 55 Monte Carlo fallacy, 364 Monte Carlo simulation, 565, 572, 573 76, 590; advantages of, over scenario analysis, 576; definition of, 573 Moody s Investors Service, 403 Moral hazard: insurance and, 42 44, Mortgage bonds, 398, 423 Mortgages: junior, 398 Muni bonds. See Municipal bonds Municipal bonds, 397, 403, 423; credit enhancement of, 430; definition of, 399 401; serial form of, 399; tax-exempt status of, 400; types of, 399 Mutual benefit societies, 44 Mutual funds, 467; interest rates on, 611 NASDAQ, 467 National Medical Enterprises, 473 Natural classification: expense reporting and, 95 Negative variance, 290 Negotiated charges, 65, 53 Net assets, 133 36, 149; definition of, 133; permanently restricted, 137, 137, 149; restricted, 136; temporarily restricted, 137, 137, 149; unrestricted, 137, 137, 149. See also Equity Net cash gain, cash budget, 608 Net float, 602 Net income, 119; as bottom line, 102, 149; cash flow vs., 103 4, 110; definition of, 101, 110; as income statement item, 101 2 Net income to cash flow conversion, 103 4 Net operating income, 99 Net operating profit after taxes (NOPAT), 683, 684, 685 Net patient accounts receivable, 124, 140 Net patient service revenue, 93, 110 Net present social value (NPSV): in capital budgeting, 546 48, 552, 553; definition of, 546; equation, 547 Net present value (NPV): in bond valuation, 413; comparison with internal rate of return, 542; definition of, 539; differential risk-adjusted, 579; for evaluating corporate merger opportunities, 551; in Monte Carlo simulation, 573 74, 575, 590; project cost 726 Index of capital and, 587; in return on investment (profitability) analysis, 331, 539 40; in scenario analysis, 570 71, 572; in sensitivity analysis, 567, 568, 569; of stand-alone risk, 562, 590; in uneven cash flow stream analysis, 328 29 Net price per discharge measure, 661 Net property and equipment, 127, 128. See also Fixed assets Net working capital, 599; definition of, 123 Net worth, 133 New York Stock Exchange (NYSE), 467 Nominal (stated) interest rate, 336 Noncash expense: depreciation as, 98 Nonconstant growth stock valuation, 455 Nonincremental cash flows, 525 Nonoperating income: definition of, 100, 110; as income statement component, 100 1 Nonprofit corporations, 18. See also Not-for-profit businesses and corporations Nonspontaneous funds, 628 Notes payable, 130, 628 Notes section, of financial statements, 89 Not-for-profit businesses and corporations, 4, 29; capital budgeting analysis in, 521 22, 545 49; capital structure of, 485 87; cash flow estimation for, 531, 533 34; corporate cost of capital for, 503; cost of equity to, 498 501; definition of, 18; differentiated from investor- owned corporations, 18; Du Pont and ratio analyses applied to, 658; economic value added (EVA) and, 684; equity in, 445 46; financial information about, 19; financial risk of, 379; fund accounting and, 136; income statements of, 105, 110; Internal Revenue Service regulations regarding, 19; mission statements of, 22 23, 270 71; net assets (equity) of, 134 36; net income of, 102; organizational goals of, 21 23; overview of, 18 20; stakeholders of, 21, 29; tax-exempt status of, 18, 19 Not-for-profit hospitals, 17; charitable mission of, 20, 33; equity capital for, 446; as percentage of all hospitals, 17, 33; tax subsidies for, 20 Nursing home industry: not-for-profit ownership in, 17 Nursing homes: levels of care offered by, 35; licensure of, 36; Medicaid- based revenues of, 47; types of, 36 Objective risk, 582 Occupancy rate (percentage) measure, 661 62 Off-balance-sheet financing, 132 Offering price, of stocks, 472 Official statements, 400 Ohio: charity care requirements in, 20 Operating budgets: constructing, 282 84, 283; definition of, 282, 295; purpose of, 284 Operating expenses: definition of, 92 Operating income, 119; calculation of, 99 100; definition of, 99, 110; as income statement component, 99 100; as operating cash flow source, 139 40 Operating indicator analysis, 660 65, 668; all patient case-mix index, 662; average length of stay (ALOS) measure in, 662; definition of, 639; inpatient full-time equivalents (FTEs) per occupied bed measure in, 663; limitations to, 664 65; net price per discharge measure in, 661; occupancy rate (percentage) measure in, 661 62; percentage measure in, 662; profit per discharge measure in, 660 61; salary per full-time equivalent (FTE) measure in, 663 Index 727 Operating indicators: categories and definition of, 660 Operating leverage, 196 99 Operating margin, 108, 646 Operating plans: definition of, 271, 295; outline for, 272 Operating revenues, 92, 110 Operational planning, 271 74; orga nizational goals and, 272 74; orga nizational objectives and, 274 Opportunity cost: definition of, 317 Opportunity cost principle, 492 Opportunity cost rate, 314, 318, 319, 325, 488 Opportunity costs, 326, 507; in capital budgeting, 500, 501, 525 26, 551; in debt valuation, 410 Optimal capital structure: definition of, 476, 510; identifying, in practice, 483 85 Optimal range, identifying for busi ness, 482 Option pricing techniques, 447 Ordinary (regular) annuity, 320, 339 Organizational goals, 21 23, 272 74, 295 Organizational objectives, 271, 274 Other assets, reporting, 129 Other current assets, value of invento ries within, 125 Other revenue, 110; examples of, 95 Outcome and Assessment Information Set (OASIS), 71 Outflows: definition of, 306 Outlier payments, 61 Outpatient care services. See Ambula tory care services Outpatient prospective payment sys tem (OPPS), 69 Outstanding bonds, 411 Overhead costs, 202, 210; of hospitals vs. ambulatory care facilities, 34; allocation of, 203, 214, 214; better cost driver and reduction in, 219 22; step-down method illustration, 230, 231 Overhead ratio, 222 23 Over-the-counter (OTC) stock market, 467, 470 Overutilization of healthcare services:
coinsurance, copayments, and, 43 44 Owner s net worth, 133 Parable of the broken window (Bastiat), 319 Participatory budgeting, 279, 295 Partnerships, 29; definition of, 15; disadvantages of, 15; limited liability, 16; taxation of, 15 Partners worth, 133 Par value (par), 353, 397; definition of, 411 Patient accounts managers, 619; responsibilities of, 13 Patient capture, 36 Patient-centered medical home. See Medical home Patient Protection and Affordable Care Act (ACA): accountable care organizations and, 24 25; adverse selection and, 42; benefits of, 24; clinical integration and, 26 27; data analytics and, 27; focus on chronic care and, 51; health insurance exchanges and, 50; high- deductible health plans and, 51; individual mandate and, 50; industry consolidation and, 26; insurance standards specified in, 49 50; major aims of, 23 24; Medicaid expansion under, 50 51; medical home and, 25 26; new insurance markets and, 51; population health management and, 26; staffing shortages and, 27 Patient safety: medical home model of, 25 Patient service revenue, 93 Patient services: direct method illustration, 213, 214, 214, 215; profitability projections, 217 18, 218 728 Index Patient volume forecasting: revenue budgets and, 281; statistics budgets and, 280 Payables centralization, 604, 630 Payback: in capital budgeting, 537 39; definition of, 537; discounted, 538 Payback period, 537, 552 Payment-for-value methodologies:
medical home and, 25 26 Payments: accrual accounting concept of, 86 87; for amortized loans, 348; of annuities, 320; lottery winnings, 322; periodic interim payments (PIPs), 52 Pennsylvania: hospitals property tax exemptions in, 20 Pension funds, 467 Percentage change analysis, 659, 668, 682, 683 Percentage return, 332 33 Per diagnosis reimbursement, 53, 66 Per diem overhead rate, 205 Per diem payment, 53, 66 Perfectly competitive market, 244 Perfect negative correlation, 365 Perfect positive correlation, 365 Performance improvement: good met rics and, 618 Periodic interest rate, 337, 339 Periodic interim payments (PIPs), 52 Periodicity, 83 Permanent accounts, 88 Permanent capital, 488 Permanently restricted net assets, 137 Per member per month (PMPM) pre miums: for capitated rate setting, 254 55, 282; as contract analysis consideration, 264 Perpetuities, 325 26; definition of, 325, 339 Per procedure reimbursement, 53, 56, 65 Pharmaceutical industry: subsectors in, 8 Physical assets, 75, 76. See also Real assets Physician compensation: relative value units and, 61, 66 Physicians: impact on hospital financial conditions, 34; medical home and, 25 Physician services: Medicare payment rates, 61 62, 62 PILOTS (payments in lieu of taxes), 20 Planning: definition of, 269, 294; as finance activity, 10, 28. See also Operational planning; Strategic planning Pledging, of accounts receivable, 629 Point-of-service collection rate metric:
revenue cycle and, 617 Point-of-service distribution, 622 Poison pill provision, in company charter, 440 41 Pooling of losses: insurance and, 41 Pools, 469 Population health management: definition of, 26 Portfolio: required rate of return on, 380 Portfolio beta (.): equation, 377; relationship between component betas and, 376 77 Portfolio returns, 362 63 Portfolio risk, 372; to business owners, 375 76; comparison with stand-alone risk, 363; definition of, 368, 385; diversifiable risk vs., 368 70; implications for investors, 370; measurement of, 371 76; multiple, 366 68; of single investment, 365; size and, 367; of two investments, 363 66. See also Corporate risk; Market risk Portfolios, 385; definition of, 361; expected rate of return on, 362 63, 363; volatility of, 371, 372; well-diversified, 368, 370 Positive variance, 290 Post-audits, 549 50, 553; definition of, 550; purposes of, 550 Index 729 Posting, to accounts, 88, 110 Preadmission certification, 48 Precertification, 612 Preemptive right: of common stockholders, 441, 442 Preexisting conditions: Patient Protection and Affordable Care Act and, Preferred provider organizations (PPOs), 48 Preferred stock, 438 Premium revenue, 94 95, 110 Premiums: adverse selection and increase in, 42; call, 402, 423; call risk, 407 8, 423; coinsurance, copayments, and, 43 44; default risk, 406, 423; high-deductible health plans and, 51; inflation, 406, 423, 431; liquidity, 407, 423, 506, 511; per member per month (PMPM), 254 55, 282; price risk, 407; size, 506, 511 Prescription drug coverage: Medicare Part D and, 46 Present value of a lump sum, 339; discounting, 313 16; equation, 314 Present value (PV): of annuities, 321 22; of an annuity due, 324 25; in bond valuation, 412, 413, 414; of costs at discount rate, 583, 583 84; definition of, 307; of perpetuity, 325, 326; of uneven cash flow streams, 327 29 Prevention, integrated delivery systems and, 37 Preventive care: Patient Protection and Affordable Care Act and, 24 Price breakeven: equation, 250 Price/earnings ratio (P/E), 679 Price risk, 420, 421, 423, 424 Price risk premiums, 407 Price setters: definition of, 245; healthcare providers as, 245, 246, 256 Price setting: under capitation, 251, 251 55, 252, 254; hospitals, captive health plans, and, 247 48; on individual services, 249 50; with scenario analysis, 255 Price shifting (cross-subsidization), 247 48, 256 Price system, 394 Price takers: definition of, 244; providers as, 244 45, 256 Price transparency: types of, 50 Price variance, 290, 291, 293, 293 Pricing: cross-subsidization (price shifting), 247 48; full cost, 246; marginal cost, 246 48; strategies for, 246 48 Pricing and service decisions, 256; activity-based costing (ABC) used in, 234, 239 40, 255; costing illustration, service level, 234 35; cost-to-charge ratio (CCR) used in, 234, 235 37, 255; importance of, 234; price setting strategies for, 246 48; regarding individual services, 249 50; relative value units (RVUs) used in, 234, 237 38, 255; setting managed care premium rates, 247 48; time-driven activity-based costing (TDABC) used in, 234, 240, 243, 256 Pricing decisions: definition of, 233 Primary accounts, 88 Primary care physicians: gatekeeper role of, 37; increasing supply of, Patient Protection and Affordable Care Act and, 27 Primary care services: as integrated care system focus, 37 Primary market offering, 468 Prime rate, 396 Principal portion, of loan, 132 Principles and Practices Board (Healthcare Financial Management Association), 79 Privacy of patient information, 27 Private health insurance exchanges, 50 Private hospitals: investor-owned.
See Investor-owned hospitals; 730 Index Not-for-profit hospitals; Private not-for-profit hospitals Private insurers, 44 46, 65 Private not-for-profit hospitals, 33 Private placements: of common stocks, 443, 461; definition of, 401; term loans as, 395 Probability, 356 Probability distribution, 356 57; defi nition of, 356; expected value of, 359 Probability of occurrence, 356, 357 Procedure codes, 58 59 Procedures: up coding of, 56 Professional associations (PAs), 16; group policies and, 45. See also spe cific associations Professional corporations (PCs), 16 Profitability: bonuses and, 219; of core operations, 99; as income statement component, 91, 92, 110; net income measures of, 101 2; operating income measures of, 99 100; relationship between risk analysis and, 572. See also Net income Profitability analysis: as managerial accounts basis, 160. See also Return on investment (ROI) analysis Profitability index (PI), 589 Profitability ratios, 644 47, 668, 679; definition of, 644; operating margin, 646; return on assets, 646; return on equity, 647; total margin, 644 46 Profit analysis, 165 71; for break- even point estimation, 171; in a capitated environment, 180 87, 251 55; contribution margin of, 170 71; cost behavior in, 162 65; definition of, 165, 189; in a discounted fee-for-service environment, 175 80; operating leverage and, 196 99. See also Breakeven analysis; Profit and loss (P&L) statements Profit and loss (P&L) statements, 159 70; base case forecasted, 169, 170, 171; in a capitated environment, 185, 185 87, 251, 251, 252; definition of, 169; differentiated from income statements, 169; in a discounted fee-for-service environment, 176, 176 77, 177; four-variable model for, 170, 172; operating budgets and, 284; operating leverage and, 197, 198; projected, 169 70, 174, 189; relationship between breakeven analysis and, 174; volume levels of, 170 Profit centers, 210 Profit margins, 644; definition of, 217 Profit-per-discharge measure, 660 61 Profit variance, 289, 290 Project cost of capital, 508, 509, 562, 581, 587, 587, 590 Project risk analysis, 561 91; adjusting cash outflows for risk in, 582 84; divisional costs of capital in, 585 86, 591; incorporating risk into decision process, 577 80; making final decision in, 581 82; Monte Carlo simulation in, 565, 573 76, 590; qualitative risk assessment in, 576 77, 590; risk illustration of, 565, 566; scenario analysis in, 565, 570 73, 571, 590; sensitivity analysis in, 565, 567 70, 568, 590; types of risk in, 562 63, 589; ultimate goal in, 561 Projects: corporate beta (.) of, 374 Project scoring, 548 49, 549, 553 Promissory notes, 402, 628, 632 Property: as fixed asset, 97 Property taxes: exemptions from, 19, 20, 33 Proprietorships, 14 15, 29; definition of, 14; disadvantages of, 15; organizational goals of, 21 Proprietor s net worth, 133, 149 Prospective payment systems: definition of, 53, 65; provider incentives under, 56 Index 731 Prospectus, 469 Provena Covenant Hospital, Urbana, Illinois, 20 Provider incentives, 54, 56; under alternative reimbursement methodologies, 55 57 Provider plan, 48 Providers. See Healthcare providers Proxy, 440, 469 Proxy ballots, 17 Proxy fights, 440 Prudential, 457 Psychiatric hospital services: Medicare reimbursement for, 70 Public health insurance exchanges, 50 Public Health Service, 46 Public hospitals, 33 Public insurers, 46 47, 65 Publicly held corporations, 467; definition of, 462; organizational goals of, 21 Public offerings, of stocks, 395, 443, 461 Pure play approach: to debt cost estimation, 505, 511 Qualified opinions, of auditors, 80 Qualitative risk assessment: in project risk analysis, 576 77, 590 Quality, of healthcare: Hospital Value- Based Purchasing program for, 56; medical home model of, 25; as organizational goal, 272 Quality-based clinician compensation, 63 Quantitative risk assessment, 576, 577 Radiology services: direct method illustration, 210, 211, 213, 215, 216 Random events, effect on portfolio risk, 370 Random losses: payment only for, 41 Rate of return, 332; beta coefficient (.) illustration, 372; constant growth model estimation of, 450 52; effective annual rate (EAR), 336 38; expected, 358, 359; on investment, 354; realized, 358; required, 351; risk-free, 380; on stock, 455 56; true, 333 34; for two proposed projects, 357 Rate variance, 292 Rating agencies. See Credit ratings Ratio analysis: definition of, 643. See also Financial ratio analysis Readmission reduction program, 64 Real assets: definition of, 126, 305; general valuation model of, 410 Realized rate of return: definition of, 358 Realized volume: flexible budget and, 287, 288 Real risk-free rate (RRF), 406, 423 Recapture, of excess tax benefit, 535 Receipts: acceleration of, 603 4 Receivables, 124; collection of, 603 4 Receivables management, 613 20, 619 Receivables quality: definition of, 614 Recessions: interest rates during, 434 35 Reciprocal method: of cost allocation, 208, 208, 209, 210, 224 Redemption: calling bond for, 403 Red herring prospectus, 469 Reform. See Healthcare reform Registration quality score metric: rev enue cycle and, 617 Registration statement, 469 Regular default, 402 Regulatory issues: in financial account ing, 78 81, 109 Rehabilitation/sports medicine centers, 34 Reimbursement: alternative methods of, 55 57; as financial concern, 14; generic methodologies of, 52 54; healthcare reform and effect on, 62 64, 66; medical coding and, 57 59; specific methods of, 59 62.
See also Capitation; Fee-for-service 732 Index reimbursement; Medicare reimbursement; Prospective payment systems; Third-party payers Reinvestment of earnings, 102, 134 Reinvestment rate risk, 420, 421, 424 Relative value unit (RVU) method:
definition of, 237; differentiated from cost-to-charge ratio (CCR) method, 237; goal of, 238; service analysis, 239 Relative value units (RVUs), 237, 238, 255; physician compensation and, 61, 62, 66 Relevant range: definition of, 161; semi-fixed costs and, 195; under- lying cost structure and, 170 Remote disbursement, 605 Replacement analysis: cash flow analy sis for, 537 Replacement cost accounting, 664 Required rate of return, 351; on bonds, 412; on debt securities, 408; estimating, 494; on portfolio, 380; relationship between risk and, 380 84; security market line and, 381; setting on cash flow stream, 410; on stocks, 380 Required return, 351 Reserve borrowing capacity, 484 Residential care facilities (RCFs), 35 36 Resident service revenue, 95 Residual earnings: stockholders claims on, 17, 29, 438 40, 461 Resource-based relative value scale (RBRVS), 69, 237; physician services and, 61, 66 Resource utilization groups (RUGs), 71 Restricted asset and net asset accounts, 136 Restrictive covenants, 402, 423 Retailers, 473 Retained earnings, 135 Return on assets (ROA), 646, 657 Return on equity (ROE), 647, 655; business risk and, 483 84; under debt financing, 479 80, 511; debt rating and, 499 500; definition of, 478; Du Pont analysis of, 656 59; organizational objectives and, 274; standard deviation of, 483 84 Return on investment (ROI): definition of, 539; dollar return, 330 31, 339; internal rate of return, 332 33; rate of return, 332, 339 Return on investment (ROI) analysis:
internal rate of return in, 541 42, 552; modified internal rate of return in, 542 44; net present value in, 539 40, 542, 552; time value analysis in, 330 33 Returns: standard deviation of, 360 61 Revenue-based allocation schemes:
benefits of, 221 Revenue bonds, 399, 401, 423 Revenue budgets, 281, 295 Revenue cycle: definition of, 611, 631 Revenue cycle activities: after-service activities, 612 13, 631; at-service activities, 612, 631; before-service activities, 612, 631; continuous activities, 612, 631; phases in, 611 13, 631; specific, monitoring of, 617 18 Revenue cycle management, 11, 28, 275, 611 20; goal of, 613; in medical practices, 613; monitoring performance in, 613 20 Revenue recognition principle, 83 Revenue reporting: in the past, 94 Revenues, 94, 110; in cost-to-charge ratio (CCR) method, 236 37, 238; as income statement component, 91, 92 95; other, 95, 110; patient service, 93 Revenue structure: matching cost structure and, 188 Revenue variance, 290, 291 Revolving credit agreement (or revolver), 628, 632 Rights offerings, 442, 461 Index 733 Right-to-use assets, 132 Risk, 422; adjusting cash flows for, 582 84, 591; generic definition of, 353; as interest rate determining factor, 394, 399; objective vs.
subjective, 582 83; relationship between required return and, 380 84. See also Financial risk Risk-adjusted discount rate (RADR) method, 579 80, 590 Risk analysis: relationship between profitability and, 572; three elements in, 561 Risk aversion, 370, 382, 384; definition of, 355; implications of, for financial decision making, 355 56 Risk-free investments, 353 Risk-free rate (RF), 380, 383, 406, 423, 497; security market line and, 381 Riskless investments, 353 Risk neutral, 355 Risk premium: on stock, 381 Risk (profit) margin, 265 Risk/return trade-off, 460 61, 462 Risk seeker, 355 Risk transfer: insurance plans and, 41, 65 Rolling budgets, 286 87 Routine care: direct method illustra tion, 210, 211, 216 Rule of 72, 347 Rural hospitals, 33 Safety. See Patient safety Salaries: as income statement item, 96; salary per full-time equivalent (FTE), 663 Salvage value, 97, 525, 534, 535, 568, 568, 574, 575 Sarbanes-Oxley Act (SOX): provisions of, 81 Scenario analysis, 255, 565, 570 73, 571, 590; definition of, 570; Monte Carlo simulation s advantage over, 576; number of scenarios in, 577 Schedule H: definition of, 19 Sebelius, Kathleen, 56 Secondary market, 468 Second surgical opinions, 48 Securities: as cash flow source, 141; financial risk associated with, 352; general valuation model of, 410; illiquid, 407. See also Bonds; Common stocks; Portfolio risk; Stocks Securities and Exchange Commission (SEC), 396, 400; regulatory powers of, 78 79, 109, 443, 468 69, 470, 472; transparency definition of, 81 Securities management: of marketable securities, 610 11 Securities markets: equilibrium of, 455 56; informational efficiency of, 456 60; regulation of, 468 70 Security market line (SML) equation, 382, 451, 493, 494, 495; definition of, 381, 386; graphical form of, 382 83, 384 Select Medical, 17 Self-employed population: health insurance exchanges and, 50 Self-insurance, 41, 45 46, 65 Selling groups, 472 73 Semi-fixed costs, 162, 195 96, 196 Semi-variable costs, 195 Sensitivity analysis, 565, 590; advantages of, 569 70; definition of, 567; limitations, as risk assessment tool, 569; in project analysis, 567, 567 70, 568 Service decisions: analyses of, 256, 264 68; definition of, 234. See also Pricing and service decisions Shared savings programs, 51, 63 64 Shareholders: of investor-owned corporations, 17 18. See also Stockholders Shareholder wealth maximization, 21, 22, 29; implication for financial risk, 378 Shipping costs: for new equipment, 526 27 734 Index Short-term debt, 130, 393, 431, 433, 434, 488, 627 30; advantages and disadvantages of, 627 28, 631; advantages over long-term debt, 627; compensating balances and, 628, 632; lines of credit and, 628 29, 632; secured, 629 30, 632 Short-term financial management:
cash budget in, 605 10; cash management in, 601 5; goal of, 601; long-term securities management in, 627, 628; marketable securities management in, 610 11; revenue cycle management in, 611 20; supply chain management in, 620 23 Short-term investments, 124, 610 Size premiums, 506, 511 Skilled nursing facilities (SNFs), 35; Medicare reimbursement for, 71 Small businesses: corporate cost of capital for, 504 7; organizational goals of, 21 Social dividends, 547 Social Security, 46 Sole proprietorships: definition of, 14.
See also Proprietorships Sophisticated investors: definition of, 443 SOX. See Sarbanes-Oxley Act Space utilization costs: as cost drivers, 212, 213 Special tax bonds, 399 Specialty hospitals, 33 S&P 500 Index, 380 Spreadsheet programs: for amortized loans, 348; for annuities due calculations, 323, 324; for bond valuation, 413 14, 415; constant growth model, 451; for effective annual rate, 336; for expected rate of return on constant growth stock, 453; financial risk of Treasury (T-)bill, 353; for future value (FV) of annuities, 321; future value (FV) of an annuity due, 323 24; historical data vs. forecasted distributions and, 361; internal rate of return (IRR), 541; modified internal rate of return (MIRR), 544; Monte Carlo simulation, 574, 575; net present value (NPV), 540; for present value (PV) of annuities, 322; present value (PV) of an annuity due, 324; rate of return on investment, 354; for return on investment analysis, 331 32; semiannual bond valuation, 419; for semiannual compounding, 334, 335; solving for interest rate and time, 346, 347; for time value analysis, 311 13; uneven cash flow stream analysis, 328, 330; yield to maturity on a bond, 418 Spreadsheet range, 328 Square footage costs: as cost drivers, 204, 205 Staffing: capital budgeting analysis of, 551; shortages in, Patient Protection and Affordable Care Act and, 27 Stakeholders: definition of, 77; of not- for-profit organizations, 21, 29. See also Stockholders Stand-alone risk, 359 61, 372, 377, 380, 385, 589 90; definition of, 359, 562; as diversifiable risk, 369; investors and, 370; of large investor-owned businesses, 378; measuring, 562; of not-for-profit businesses, 379; relationship to corporate and market risks, 564; relationship with portfolio risk, 363; scenario analysis of, 570, 572; sensitivity analysis and, 569; of small investor-owned businesses, 378 79; standard deviation of, 360 61 Standard deviation, 385; calculation of, steps in, 360 61; in Monte Index 735 Carlo simulation, 574; of one- investment portfolio risk, 365, 367; of return on equity with and without debt financing, 483 84; of stand-alone risk, 360 61, 370, 562; of three-investment portfolio risk, 367; of two-investment portfolio risk, 365 66, 367 Standard & Poor s (S&P) credit ratings, 403, 404, 420 Standards: budgeted values as, 285; in variance analysis, 289, 295 Start-up businesses: valuation of common stocks and, 447 Stated interest rate, 336, 339 Statement of activities, 91. See also Income statements Statement of cash flows, 138 42, 139; cash flows from financing activities section of, 139, 141 42, 149; cash flows from investing activities section of, 139, 141, 149; cash flows from operating activities section of, 139, 139 41, 149; comparison with income statements, 138, 142; definition of, 138, 149; example of, 640 42, 641; formats for, 138; net increase (decrease) in cash components of, 142, 149 Statement of changes in equity, 107, 108, 111 Statement of changes in net assets, 107, 108 Statement of financial position, 120.
See also Balance sheets Statement of operations, 91, 91, 644.
See also Income statements Statement of revenues and expenses, 91. See also Income statements States: financial status reporting by, 130; minimum amount of charity care legislation in, 19 20. See also names of specific states Static budgets, 286, 287, 289, 295 Statistics budgets, 280 81, 295 Step-down method: of cost allocation, 208, 208, 209, 210, 224; illustration of, 230 32, 231; Medicare reimbursement and, 232 Step-fixed (or step-variable) costs, 195 Step-up provisions: of bonds, 398 Stock companies, 17 Stock exchanges, 467 Stockholders: common, 438, 440; control of the firm and, 440 41, 461; financial risk of, 352, 378; implied, 352; of investor-owned corporations, 17 18, 29; preemptive right, 441, 442, 461; rights of, 17, 438, 440, 441, 461 Stockholders equity, 133, 135, 149 Stock investors: portfolio risk and implications for, 370. See also Stockholders Stock markets: beating, 459 60; efficiency of, 456 60; New York Stock Exchange (NYSE), 467; over-thecounter (OTC), 467, 470 Stock market transactions: categories of, 467 68 Stock option plans, 443 Stock-out, 621 Stock purchase plans, 443 Stock purchase right certificate, 442 Stock repurchases, 438 Stocks: capital gains on, 438; diversifiable risk and, 368; expected rate of return on, 380, 452 55, 455 56, 462, 495 96; future volatility of, 383; offering price of, 472; preferred, 438; required rate of return on, 380; risk premium on, 381; sale of, 438. See also Common stocks Straight-line method, of depreciation expense calculation, 97 98 Strategic planning, 270 71; mission statement and, 270 71; values statement and, 270; vision statement and, 271 736 Index Strategic plans: definition and purpose of, 270, 294 Strategic value, 528 29, 552 Stratified per diem rates, 53 Stretching, 625 Subjective risk, 582 Subprime mortgages, 430 Subsidiary accounts, 88 Sunk costs, 525, 551 Supplemental Security Income (SSI), 47 Supplies: accounts payable from, 146 47; expense in operating budget, 284; as income statement item, 96; purchased on credit, 144; use of, 145 46 Supplies variance, 293, 293 Supplies worksheet, 608 Supply chain management, 620 23, 631; base inventory level in, 621; definition of, 620; GS1 Standards for, 622; just-in-time, 621, 631; point-of-service distribution in, 622; safety stock in, 621; stockless inventory in, 621 Support departments: step-down method illustration, 230 32, 231 Surplus/deficit summary, cash budget, 608 T accounts, 89, 110 Take-downs: of credit lines, 628 Target capital structure, 501 2, 511; definition of, 482, 510; using, 487 Target costing, 248, 256 Taxable component cost of debt:
equation, 491 Tax book value, 535 Tax depreciation, 98, 534 Taxes: corporate form of organization, 16; debt financing and, 478, 480; on net income and cash flow for for-profit businesses, 105 6. See also Income taxes; Property taxes Tax-exempt corporations, 18, 19. See also Not-for-profit businesses and corporations Tax-exempt debt, 489, 491 Tax-exempt status: of municipal bonds, 400; of not-for-profit corporations, 18 20; of not-for-profit hospitals, 33 Tax laws: investor-owned businesses and, 534 35, 552 Tax subsidies: for not-for-profit hospitals, 19, 33 Technical defaults, 402 Technology: ambulatory care services and, 34 Temporarily restricted net assets, 137 Temporary accounts, 89 Tenet Healthcare, 34, 396, 468 Terminal value, 524 25 Term loans: advantages of, 396; amortization of, 395; definition of, 395, 423 Term structure of interest rates, 431 33 Tertiary care, 33 Texas: charity care requirements in, 20 Texas Health Plans, Inc., 443 Third-party payers: cash received from, 147; classification of, 44 47, 65; contract negotiations, 12; definition of, 4, 44; outpatient care and, 35; overview of, 44 47 Time-driven activity-based costing (TDABC) method, 234, 240, 243, 256; definition of, 243; steps in, 243 Time interest earned (TIE) ratio, 651 Time lines, 412 Time preferences for consumption, 394, 422 Time value analysis, 305 44; of annuities, 320 25; definition of, 305; with different compounding periods, 333 34; financial calculator use in, 309 11; lump sum Index 737 compounding illustration, 307 8; perpetuities, 325 26; of return on investment, 330 33; of semiannual compounding, 334 35; solving for interest rate in, 335 38; time line creation in, 306 7; uneven cash flow streams, 327 30, 339 Top-down budgets, 279, 295 Total assets, 133 Total asset turnover (utilization) ratio, 653 54, 657, 658 Total capital, 683 Total contribution margins, 170, 171, 251 Total costs: direct method illustration, 215, 216; profit analysis of, 166, 166 69, 168, 168, 218, 218; relationship to volume, 164, 165 Total fixed costs, 195 Total liabilities, 132 33 Total margin (or profit margin), 644, 645, 646 Total (profit) margin: definition of, 108 Total variable costs, 166, 167; under capitation, 182; relationship to volume, 163 64, 165, 165 Total variance, 289 Trade credit, 131; approximate cost of, 626. See also Accounts payable Trade-off model, 510; of capital structure, 480 81, 491; definition of, 480 Traditional costing: definition of, 238; as top-down allocation, 239 Transaction costs, 407 Transactions, 88, 110; in balance sheets, 143 47, 149 Transparency: in charity care, 19; in financial accounting, 81 Treasurers: responsibilities of, 13 Treasury bills (T-bills), 124; cost of equity and, 493; financial risk of, 353 55, 493; maturities of, 397 Treasury bonds (T-bonds), 401, 423; cost of equity and, 493, 494; definition of, 397; informational efficiency and, 456; interest rates on, 407; liquidity of, 407; maturities of, 397; price risk premiums on, 407; as safe investment, 420 29 Treasury notes (T-notes): maturities of, 397 Treasury securities: interest rates of different maturities, 431 33, 432 Trend analysis, 655, 668 TRICARE, 46 Trustees: of bond issues, 402, 423 Unbundled payments, 53 Unbundling, 57 Underlying cost structure, 162 65; definition of, 162, 189; equation for, 167; fixed and variable costs example, 163; relevant range and, 170; volume relationship to, 163 Understanding Healthcare Financial Management, 7th ed. (Gapenski & Pink), 565 Underwriting syndicates, 472, 473 Underwritten offerings, 471 Uninsured patients, charity care for.
See Charity care Uninsured population: Patient Protection and Affordable Care Act and, 27 Unique-risk premiums, 506, 511 United Auto Workers, 45 UnitedHealth Group, 45 Unqualified opinions, of auditors, 80 Unrestricted net assets, 137 Unsecured creditors claims, 129 Up coding: of procedures and diagnoses, 56 Urgent care centers, 34 Usage variance, 293 US Department of Defense (DOD), 46 US Department of Health and Human Services (HHS), 46, 47; 738 Index Hospital Value-Based Purchasing program of, 56 US Department of Housing and Urban Development (HUD), 430 31 US Department of Veterans Affairs (VA), 46 US Treasury, 397 Utilization: cost relationship of, 161; risk analysis illustration, 565 Utilization management, 264 68, 265 Utilization review, 48 Utilization variable costs: relationship to cost, 186 Value-based purchasing (VBP), 56; definition of, 63 Values statements, 270, 294 Variable cost rate, 189; under capitation, 181, 182, 183, 184, 186, 253 Variable costs, 195, 196; cost structure illustration, 163; definition of, 162, 189, 295; profit and loss (P&L) statement, 169, 170, 171, 171; profit analysis and, 166, 166, 167; relationship to volume, 162, 163 64, 165 Variance, 360; definition of, 285, 295 Variance analysis, 277; conducting, 289 93; definition of, 285, 295; flexible and static budgets in, 286, 295; illustration of, 286 87, 288; primary focus of, 285; process of, 285; purpose of, 294 Vertically integrated systems, 13 Vesting, 443 Virtual bundling, 64 Vision statement, 271, 295 Volatility: beta measures of, 371; corporate beta measures of, 374, 375, 376, 385; future, 383; of investments, 371 74, 373, 493; market beta measures of, 375, 376, 385 Volume: under capitation, 181, 182, 183, 186; cost relationship of, 161; Monte Carlo simulation and, 574, 575, 576; operating leverage and, 197 99; price relationship of, 250; profit analysis of, 165 66; relationship to fixed costs, 161 62, 164, 165, 199; scenario analysis and, 572; semi-fixed costs relationship and, 195 96; semi-variable costs and, 195; sensitivity analysis, 567; total cost relationship with, 164, 165; total variable costs relationship with, 163 64, 165, 165; underlying cost structure equation, 167; variable costs relationship with, 162, 163 64, 165 Volume-based allocation schemes: bias in, 221 Volume breakeven, 172, 173; definition of, 171; equation, 172 73 Volume projections, 282 Volume variance, 290, 291, 291, 292 Wages: accrued expenses and, 131 Walk-in care services. See Ambulatory care services Wall Street Journal, 54, 431, 494 Wash sales, 469 Wellness programs, 37 Wholesalers, 473 Workers compensation, 46 Working capital: definition of, 599 World Health Organization (WHO), 58 Written-off assets, 128 Yield curve, 397, 431, 432, 433, 434 Yield to call (YTC), 418 Yield to maturity (YTM), 418, 424; annual, 420; periodic (semiannual), 419 20 Young businesses: valuation of common stocks and, 447 Zero-balance accounts (ZBAs), 604 5, 630 Zero-based budgeting, 278, 295 Zero-coupon bonds, 397, 422 Zuckerberg, Mark, 461 ABOUT THE AUTHORS Louis C. Gapenski, PhD, is a professor of health services administration at the University of Florida. He is the author or coauthor of more than 20 textbooks on corporate and healthcare finance. Dr. Gapenski s books are used worldwide; his work has been published in Canadian and international editions as well as translated into Bulgarian, Chinese, French, Indonesian, Italian, Polish, Portuguese, Russian, and Spanish. In addition, he has published more than 40 journal articles related to corporate and healthcare finance.
Dr. Gapenski is an active member of the Association of University Programs in Health Administration, the American College of Healthcare Executives, and the Healthcare Financial Management Association. He has acted as academic adviser, chaired sessions, and presented papers at numerous national meetings. Additionally, Dr. Gapenski has been an editorial board member and reviewer for 12 academic and professional journals.
Kristin L. Reiter, PhD, is an associate professor in the Department of Health Policy and Management, Gillings School of Global Public Health, and a research fellow in the Cecil G. Sheps Center for Health Services Research, both at the University of North Carolina at Chapel Hill.
She received a BS degree in accounting from Northern Illinois University and a master of applied economics and PhD in health services organization and policy, with a concentration in corporate finance, from the University of Michigan. Prior to joining academia, she worked in public accounting serving not-for-profits and clients in the insurance industry.
Dr. Reiter teaches undergraduate- and graduate-level courses in healthcare accounting and financial management and is involved in research projects examining hospital financial performance and the business case for quality. In the past ten years, she has served on audit, finance, and advisory committees of several healthcare professional associations. She is an author or coauthor of more than 40 peer-reviewed articles, and she has presented to academic or professional audiences in the United States, France, and Canada.