CSAF

Third Party Payers

1. Governmental Payers 2. Medicare Federal government program Provides coverage for elderly and permanently disabled individuals 3. Medicaid State and federal government program Provides coverage for economically disadvantaged individuals 4. Commercial Insurance Provides coverage for groups and individuals 5. Preferred Provider Organizations Provides coverage for groups and individuals Seeks to obtain favorable pricing by limiting providers 6. Health Maintenance Organizations ("HMO") Provides coverage for groups and individuals Accepts responsibility for providing all services

Types of Risks

6 TYPES

Use the discount method to determine how much money must be put in the bank today to have $1,000 in three years. The interest rate is 8% and the discount factor is 0.794.

794

Types of Debt Issue

A debt issue can either be a public offering or a private placement. A public offering is offered for general consumption. With a private placement, the lender is usually local, and both the lender and the borrower (the hospital) are identified up front.

Depository Account

A depository account accepts cash, checks, and electronic deposits, and typically funds the disbursement account. Companies receive immediate credit for cash and electronic deposits.

Calculating Gain or Loss

A gain or loss on the sale of a security is calculated by taking the difference between the security's acquisition cost and its current market value. A gain or loss is unrealized until the security is sold, at which point the gain or loss is realized. Generally, investment return should be evaluated based on comparative results for similar investments held over the same time period. One of the easiest ways to evaluate the performance of a portfolio is to compare it against a "benchmark" portfolio, a portfolio with similar characteristics. Common benchmark indices include the S&P 500, the Russell 2000, the EAFE (Europe, Asia, and the Far East), and the Lehman Aggregate Bond Index.

Types of Healthcare Providers

A long-term care facility is an establishment that houses chronically ill, usually elderly patients, and provides long-term skilled nursing care or intermediate care, rehabilitation, and other services. They are also called skilled nursing facilities or nursing homes. A durable medical equipment (DME) supplier is an entity engaged in providing equipment to patients needing assistance in a home setting following an illness or injury. The equipment is most often rented and used for a specified length of time. The type of DME that is required for a particular patient varies and is determined by a physician, who will write a prescription for the equipment, similar to a drug prescription, which is then filled by an authorized DME supplier. DME may include but is not limited to the following: iron lungs, oxygen tents, hospital beds, wheelchairs, blood-testing strips and blood glucose monitors for diabetics, potty chairs, canes, lifts, and other similar equipment. A home health agency (HHA) is a public or private agency or organization that is primarily engaged in providing skilled nursing services and other therapeutic services in a patient's home. Medicare certification for a home health agency can be granted if the agency provides skilled nursing services and at least one additional therapeutic service, usually physical or occupational therapy. A hospice agency is a public or private agency or organization that is primarily engaged in providing care to a patient who has been diagnosed by a physician with a disease that can no longer be treated or cured. Hospice care neither hastens nor postpones death and is focused on the belief that quality of life is as important as length of life.

Price Variance

A price variance determines the financial impact of the difference between the actual price paid for a certain supply and the budgeted price for the supply.

How Useful Is Ratio Analysis?

A real question is how good an indicator is ratio analysis in terms of predicting the future health of an organization? A number of studies have been done by research organizations to answer that question. These studies, carried out primarily by educators and researchers in colleges and university healthcare financial programs, have determined that ratio analysis is an effective predictor of failure and is, therefore, helpful for credit agencies.

Importance of Risk Analysis and Sound Governance

A thorough risk analysis is a key component of good investment governance. Critically evaluating the potential negative outcomes helps the health system set appropriate expectation of portfolio volatility. The governing body can then focus on the impact of bad outcomes and the ability of the system to withstand and adapt to adverse events. Considering adverse potential helps the organization from making ad hoc and rushed decisions in difficult times.

Volume Variance

A volume variance determines the difference between budgeted and actual units of service provided.

Which ratio measures the relationship between revenue and assets to determine the financial efficiency of an organization's operations?

Activity ratios

Activity-Based costing

Activity-based costing (ABC) is a method of determining product costs using cost drivers or activity measures, that cause indirect costs to be incurred. Ideal cost drivers are activities that pertain to each procedure in varying amounts. Activity-based costing is generally considered a more accurate costing method than the proportionate allocation method. It is, however, often more expensive to determine due to the necessary data collection.

A budgeting process develops assumptions for the following:

Admissions or patient visits Change in admissions or visits Average length of stay Changes in length of stay Total expense per visit or admission Inflationary impact on total expense per admission or visit Full-time equivalent staffing (FTE) per admission or visit Impact of productivity initiatives on FTE per admission or visit Average labor cost per FTE Impact of average wage increases on average labor cost per FTE Net revenue per admission or patient visit Change in net revenue per admission or patient visit

Negotiated or Historical Standard

Advantages Easy to develop Less expensive Less disruptive than a customized standard Department involvement and understanding may be better than with a predetermined standard, but less than with a customized standard Disadvantages Less precise than customized standards Difficult to obtain agreement for change predictions based on historical results

Customized or Engineered Standard

Advantages More precise More supportable by individual data specific to the entity Offer the opportunity for departmental improvement because they are based on the actual activity or procedure at hand Disadvantages Very expensive Time consuming to develop Difficult to understand

Predetermined or Synthetic Standard

Advantages Minimal development time and cost Ease of development and implementation Not based on specific items and not specific to an individual facility Disadvantages Not customized, thus less precise Not as well accepted May not be applicable directly to an individual department within a specific facility

Evaluating Capital Investments

After the capital investment has been incorporated into the long-range capital budget, the organization must plan for the financing of the investment. In making this decision, the organization should consider all alternatives available. As a rule, the best alternative is usually the lowest cost alternative; however, there are other factors to consider. This course considers four alternatives: Equity financing Joint ventures Lease arrangements Debt financing

Aggregate Excess Loss Insurance

Aggregate excess loss insurance covers the entire risk pool, rather than each individual within the risk pool. It provides protection against losses caused by utilization fluctuations and is particularly useful for providers with little catastrophic coverage. Aggregate coverage begins at the attachment point, where costs exceed a designated amount per member per month. Aggregate costs in excess of that amount will be covered by the policy. The provider is at risk for the difference between the capitation premium per member per month and the attachment point.

When a hospital's actual patient census is greater than budgeted, the management views this as favorable. Generally, the effect on the actual expenses being less than the budgeted amounts is:

Also favorable

Public Stock Offering

An advantage of a public stock offering is that it can usually generate a higher price for the securities than private placement. It can give you the ability to get more money for the shares that are issued. Furthermore, stock options can then be used in employee incentive plans as a motivational tool. The disadvantages of going public with a stock offering include: Potential loss of control of the company. The cost of a public offering is significant. The ongoing cost of a public report is significant

The Budgeting Process and Strategic Plans

An effective budgeting process should be incorporated into the overall planning process beginning with the highest level strategic initiatives, from which concrete tactics are developed translated into an operating plan. An annual operating budget should be part of a long-range financial plan projecting operating results, capital requirements, and cash availability for several years into the future. The organization should forecast income statements and balance sheets as part of the planning cycle to demonstrate that the financial health of the organization will be maintained or strengthened by the long-range plan

Variances

An effective management reporting process requires that significant variances be explained and clarified by cause. Volume variance determines the financial impact of a difference between the actual volume and the budget volume. There may be rate variances, which would result from variance between the budgeted rate and actual rate charged for the procedure. There may also be price variances, which result from a variance in the price of a supply compared to that assumed in the budget. The last type is efficiency variances, a variance in the amount of labor or supplies used for each procedure.

Efficiency Variance

An efficiency variance determines the financial impact of a difference between the budgeted labor hours per unit of service and the actual labor used per unit of service.

Measuring Productivity

An objective of the budgeting and reporting process is to identify areas where corrective action may be appropriate. Management must determine that resources are being used efficiently. To best accomplish this, an objective methodology to evaluate and measure productivity should be used, those results should then be compared to actual productivity with a predetermined standard or benchmark. Labor is generally the single biggest expense component of a healthcare provider, and it is critical to constantly measure and evaluate productivity. A department's statistical profile can be compared with that of similar departments with national or regional averages, with standards developed using management (industrial) engineering techniques.

Operating

An operating budget, prepared on a departmental or service basis, places responsibility for meeting budget targets on departmental or service managers, where greater direct control of resources resides. It is responsible primarily for controlling expenses and to a lesser extent, for meeting revenue targets. Variances from budget highlight deviations requiring investigation, explanation, and impact evaluation. This allows management to manage by exception and focus only on those activities producing operating results that vary from plan to plan.

Operating Lease

An operating lease is one in which the hospital is liable for the leasing cost for the term of the lease. Equipment and lease renewal options are determined by the fair market value of the equipment. The hospital does not have any ownership right during or after the leasing period.

Market Comparison

Another approach is called the market comparison (appraisal) approach. Here you compare the recent sale prices or income characteristics of similar properties within a specific geographic market to the facility or property in question. Again, you are looking at what the value is in today's market for a particular building, piece of equipment, or operation.

Types of Long-Term Debt

Another decision to be made is what kind of debt will be offered. Two common types of long-term debt are revenue bonds and general obligation bonds: Revenue bonds depend on the revenue stream generated by the issuer to provide for repayment. General obligation bonds are generally regarded as more secure and, therefore, carry a lower interest rate. General obligation bonds may not be available to private healthcare organizations. Recently, large healthcare organizations have begun to utilize participating bonds to raise additional capital with the added benefits of establishing closer alignment with their medical staff.

Uses of Ratio Analysis

Another use is assessing debt capacity. As facilities position themselves for the delivery models of the future, more are taking on additional debt to re-purpose or enhance their facilities and services to where they think the market will be. Ratio analysis will help an organization to decide how much of a debt burden it can feasibly assume.

Which use of ratio analysis will help an organization decide how much of a debt burden it can feasibly assume?

Assessing debt capacity

Managed care arrangements generally result in providers:

Assuming greater financial risk for the level of services provided

Bond Collateral

Bond collateral can be in the form of a mortgage on the facility and/or a pledge of gross revenues or accounts receivable. The result is that these assets cannot be pledged to other creditors without creating a default. Covenants involving financial ratios must be considered part of future capital plans. This ensures that future changes to the capital or operating structure will not create a technical default. A default occurs when an organization fails to meet one of the terms in its financing agreement. Bond covenants may limit flexibility to move in a particular strategic direction at a later date. For this reason, the lender must consider these obligations in evaluating the cost and benefits of issuing the debt.

Break-even point

Break-even point is the volume number of units when the marginal revenue covers the fixed cost opportunity; The break-even point is the level of sales volume of a product producing the exact amount of Contribution margin needed to cover fixed costs

Three Methods of Preparing a Cash Budget

CASH RECEIPTS AND DISEMBURSEMENTS METHODS ADJUSTED NET INCOME METHOD WORKING CAPITAL DIFFERENTIAL METHOD

Cancellation and Advantages

Cancellation A noncancelable lease can be canceled under the following conditions: Occurrence of some remote contingency Permission of the lessor Payment by the lessee of a penalty sufficient that the continuation of the lease at inception appears reasonably assured Advantages Some advantages of leasing are that: Working capital is conserved for other purposes Budgetary control is facilitated Tax benefits may be realized The project may be financed 100% The lessee has greater flexibility in replacing equipment that has become technologically obsolete

Capitation

Capitation (often referred to as global payment risk) accounting involves a predetermined amount paid per enrollee per period without regard to the amount, type, or frequency of service rendered to the enrollee. The provider is paid for each enrollee assigned to them rather than being paid for the service used by the patient. The provider recognizes capitation payments as other operating revenue and not patient service revenue.

Carve-Out Excess Loss Insurance

Carve-out excess loss insurance provides individualized coverage for provider groups with specific needs. For example, a group of cardiac surgeons might negotiate for all open heart surgeries for a managed care organization. This group is at a higher risk for adverse selection since there are fewer of these kinds of cases. Carve-out policies address this risk by combining aspects of per-person and aggregate excess loss coverage.

Banking Services

Commercial banks have developed products and services to assist in concentrating available cash balances to maximize the return on balances that may be available for a short period of time. Controlled Disbursement Account Depository Account Concentration Account and Zero Balance Account Sweep Account

Competitive environment and market position

Competitive environment and market position: Typically acute care, major teaching, and regional research institutions would be looked at more favorably than specialty or primary care community institutions. The concern here is primarily the institution's resistance to economic change and its ability to adapt to technological change as well.

Replacement Cost

Consider the cost or replacement cost approach. Under this approach, you determine the replacement cost for a building or a piece of equipment or the replacement cost for starting up an operation. You restate historical dollars (what was spent years ago) into today's dollars. Then you once again determine a present value for that decision, as shown in the example provided in the earlier part of the course

What option is NOT a method used to prepare a cash budget?

Control flow of cash funds method

Semi-Fixed Variabloe

Costs change with volume, but not in direct proportion to the volume; rather, they follow a stair-step pattern. An example of this type of change in a hospital setting would be salary cost in an acute staffing area. If you have a 20-bed acute area with an occupancy of five patients, you would not need any more staffing than you would for one patient. However, when the sixth patient is admitted to the service area, you would have to add an additional full time equivalent (FTE) and the additional FTE along with the previous staff could provide services for as many as 10 occupants at that service level. Then, again, once you get to the 11th occupant, you would have to add another FTE, and so forth

Semi-Variable Cost Pattern

Costs that vary in direct relation to volume after a minimal level of activity has been reached. An example of semi-variable cost behavior in healthcare organizations is the telephone expense, where a monthly access and service charge is paid initially, no matter what the volume is, and then each time a long distance or local phone call is made, an additional charge is assessed. This, therefore, exhibits the behavior of fixed costs initially and variable costs thereafter.

Fixed Cost Pattern

Costs that, in the short run, do not change with changes in volume. Examples would be depreciation, long-term lease expense, or amortization of incurred financing costs.

Credit Risk

Could the company default or go bankrupt?

Who uses ratio analysis in its purest form for evaluating debt offerings or applications for borrowing money?

Creditors

An indication of how long an organization can support operations with no inflows of cash is referred to as ____________.

Days Cash on Hand

Days Cash on Hand

Days cash on hand reflects the extent to which cash is physically on hand at any point in time, in terms of days of average operating expenses, excluding depreciation and amortization expense. The days cash on hand is a very important factor looked at by crediting agencies. Organizations should have substantial amounts of cash on hand in order to meet future principal and interest payments. Days cash on hand equals cash and marketable securities, again divided by one day's operating expenses. This indicates how long an organization can support operations with no additional inflow of cash from other current assets. This is viewed as a safety margin and should be high and above the median.

Days in Patient Accounts Receivable (Net)

Days in patient accounts receivable (net) is concerned with how long it takes to collect receivables. It is net patient accounts receivable divided by net patient service revenue, net of bad debt expense, divided by 365 days. This indicates how many days of revenue, net of bad debt expense have not been collected. It is preferable for this ratio to be down and to be below the median.

This course discusses four alternative sources of capital:

Debt financing Equity financing Joint ventures Capital lease financing

DEBT

Debt is the general term used to describe a variety of obligations that require the borrower to repay borrowed money over a period of time with interest. Debt is usually recorded in instruments such as bonds, notes, and mortgages. More specific terms include: Principal, which is the amount of the loan. Interest, which is a rental fee for use of the principal. [Note: Both principal and interest must be paid to the lender at specified times pursuant to the terms and conditions of the loan.] Debt service, which is the required payments of principal and interest. Annual debt service, which is the required payments of principal and interest for any given year. Total debt service, which is the sum of all debt service payments under the obligation.

Which one of the following is NOT a method used to quantify the value of assets?

Debt restructuring method

Difference and Disadvantages

Difference One thing that distinguishes operating leases from capital leases is whether the lessee is building up equity in the equipment being leased; if the answer is yes, it is a capital lease. Disadvantages A disadvantage of leasing is that the cost of extending the lease for the entire useful life of the equipment may be more than the actual purchase price. For this reason, it is important that the healthcare organization not underestimate the useful life of the equipment. Other disadvantages of leasing include the following: Interest costs are usually higher with a lease than with a debt. Third parties will recognize a full lease payment as an allowable cost only if the lease is identified as a "true" (operating) lease. The leasing company frequently passes the cost of property taxes to the lessors. This is an additional expense for nonprofit organizations, which are usually exempt from property taxes.

Which option is NOT a primary input for asset allocation models that construct the asset allocation alternatives?

Diversification

Types of Equity Financing

Equity financing is not as common in the healthcare industry as in other industries. However, there are for-profit healthcare entities that may choose to use equity financing. In the non-profit sector, equity can be raised through donations or grants. There are advantages and disadvantages to equity funding. One advantage is that increasing the equity in a company enhances its ability to raise more capital via debt. As we saw earlier in this course, a debt-to-equity ratio above one makes borrowing harder. If you can increase the equity part of that equation, you can obviously borrow more.

Which statement is NOT true regarding equity financing?

Equity financing is very common in the healthcare industry.

Cash Budget

Evaluating investment alternatives requires that an organization have information available regarding cash forecasting, cash management, and investments. Adequate liquidity to meet daily cash needs must be available at all times. However, carrying larger balances of cash than are likely to be required by the actual needs of the entity is likely to result in lower returns. In order to foresee the need for loan and investment transactions and plan accordingly, a cash budget or forecast may be prepared. This is a forecast of the expected cash transactions within a designated period of time

Leasing vs. Financing

Example continued on the next page. Typically, leasing is more expensive than acquisition through financing. Consider the cost of purchasing $5,000 worth of lab equipment and incurring operating costs of $1,000 each year for five years, compared with the cost of leasing the outside service at $2,500 a year

Which one of the following options is a managed care product that is easy to evaluate?

Fee-for-service

Fee-for-Service Contracts

Fee-for-service contracts are fairly easy to evaluate; the proposed discount would be compared to the contribution margin for the related services at the expected utilization levels. If the contract proposes a fee schedule, the analysis would require cost estimates for each scheduled rate. It is likely that some of the procedures will have a positive contribution margin and others will have a negative contribution margin. In this case, it will be necessary to consider the projected volumes for each procedure to determine the aggregate revenue and cost in order to assess the potential financial impact of the contract. If the contract proposes a case rate, the provider should develop a corresponding case cost, using historical treatment protocols for similar cases. Again, the costs included in the analysis would depend on the incremental business the contract would provide. Case costs can also be used to estimate per diem cost, using historical lengths-of-stay for similar cases.

Fee-for-Service

Fee-for-service is billing by health providers for each service performed in specific amounts. Amounts may be a percentage of list charges. There is a set amount for each service per the contract.

Financial factors

Financial factors: Here rating agencies look for indicators of past performance and the future ability of the organization to pay debt service (the debt service capacity test).

Which budget type is prepared under the assumption of a single activity or volume level?

Fixed

Which budget type is prepared under various assumptions that would include the range of volumes that could reasonably be expected?

Flexible

Categories of Ratio Analysis

Following are broad categories of ratios, as well as examples that are typically used in the healthcare industry. The following information is summarized in a table at the end of the section. The broad categories of ratios are: Profitability Ratios Liquidity Ratios Activity Ratios Capital Structure Ratios

What is the primary purpose of measuring productivity?

For management to determine if resources are being used efficiently

Fixed Budgets

For the most part, we have assumed the budgets developed are fixed. That is, the budget is prepared under the assumption of a single activity or volume level, the most likely level given all available information at the time the budget is prepared. A fixed budget usually covers a defined period of time, usually a year. The difficulty with this approach is that the budgeted volume is not likely to occur for any given department, particularly when annual projections are spread for monthly reporting purposes. If the volume variances are significant, it is very difficult to assess performance to budget because of the variability of costs in relation to volumes.

All of the following are true of a bond transaction working group, except:

Generally the issuer, the borrower, and the underwriter are only represented by legal counsel at the end of the process.

A machine costs us $15,000. We will have a net income of $6,000 in year 1, $6,000 in year 2, $2,500 in year 3, and $2,500 in year 4. The salvage value of the equipment is $2,000. Assuming we can borrow money at 15%, and the discount factors are 0.870 for year 1, 0.756 for year 2, 0.658 for year 3, and 0.572 for year 4, should we buy the equipment?

Good job! You selected the correct answer. Since the discounted value is less than the cost of the equipment, purchase of the equipment is not a good economic decision. Here are the calculations: End of Year Net Income Discount Factor Present Value 1 2 3 4 Salvage value $6,000 $6,000 $2,500 $2,500 $2,000 X X X X X 0.870 0.756 0.658 0.572 0.572 = = = = $5,220 $4,536 $1,645 $1,430 $1,144 Total (discounted) income $13,975 NO

Service-Line Costing

Healthcare organizations have developed product lines based on major diagnostic categories (for example, diseases of the digestive system or obstetric procedures). The advantage of analyzing results by diagnostic category is that it develops an estimate of total resources consumed, including resources consumed in shared departments

Selecting a Financial Institution

Healthcare organizations should consider including some or all of the features shown on the previous pages in their cash management system. The ability to support these activities should be considered when developing a relationship with a financial institution. Some selection criteria for a financial institution include: Location Size Type of institution Variety of services Cost of banking services provided Management of the bank or financial institution Flexibility of the institution to meet needs Selecting a Financial Institution An assessment of the financial institution's suitability would include an evaluation of the following: Investment services Borrowing facilities Transactions processing facilities Consultative services Special services Cost of services Responsiveness/adaptability to the organization's needs Once the organization has determined that the cash available exceeds the expected need for cash, the organization should consider enhancing the rate of return on its excess cash by creating a diversified investment portfolio. The organization should begin by assessing its tolerance for risk and seek out approaches for controlling investment risk while maximizing the return. With so much at stake in today's environment, health care organizations should always be seeking to improve performance in the cash and investment management area.

Quantifying Anticipated Revenues and Costs

Healthcare providers should develop different modeling tools depending on the reimbursement method proposed in the contract. However, in any proposed contract, the provider should quantify the anticipated revenues as well as the cost of providing the proposed services at the projected utilization levels.

Which statistical factor is typically used by healthcare organizations in their operating budgets?

Historical statistics

Statistical Operating Budget

Historical statistics Historical relationship of department/services volume Anticipated effects of new programs Clinical practice patterns and any addition of physicians or other professionals Demographic trends Marketing efforts Process improvements Technical developments Changes in regulatory environment Covered lives in global payment risk programs

Political or Legal Risk

How sensitive is the security to the external environment?

Types of Leases cAPITAL

In a capital lease, all of the benefits and risks of ownership have been effectively transferred to the lessee, except the lessee doesn't get title to the asset or any value at the end of the lease. The lessor recovers the full price of the equipment, plus an interest factor, during the lease period. A lease (as defined by FASB statement #13) is classified as a capital lease if it meets any one of the following four criteria: Capital Lease The lease contains a bargain purchase option. The lease contains a transfer of ownership to the lessee by the end of the lease term. The lease term is equal to 75% or more of the estimated economic life of the lease property and the beginning of the lease term does not fall within the last 25% of that life. The present value of the lease payments is greater than 90% of the fair market value of the item being leased.

Uses of Ratio Analysis

In a healthcare organization (and in fact in any type of organization), assessing the short-range and long-range financial plans of the organization begins by establishing high-level strategic goals. Those two plans help to determine whether a facility is on target with its strategic plan and provide the information to indicate where there are deviations from that plan. In analyzing both short-range and long-range financial plans that are tied to those strategic plans, ratio analysis is very important. The first concern one might have is with profitability. Profitability ratios will help to assess whether an organization is meeting strategic goals and objectives.

Analyzing the Financial Impact

In analyzing the financial impact of a contract, the provider should consider whether it will result in additional business or will convert existing business to a new reimbursement methodology. In the former, only incremental or marginal costs would be considered, as long as excess capacity exists. The contract would be considered profitable as long as the proposed rates exceed the marginal cost of providing the service. If the contract will not bring additional business or if the provider has no excess capacity, it becomes important to analyze what the cost structure would be with and without the business covered by the contract. All overhead or fixed costs that would be eliminated if the contract were lost or added to provide sufficient capacity for the projected volume increase would be considered in the total cost to determine profitability.

Medical Staff Characteristics

In evaluating medical staff characteristics, a rating agency typically will examine the following areas: The number of active and associate staff members, by specialty Their ages Physician satisfaction survey results Recruitment practices The number of board-certified physicians on staff

Joint Ventures

In response to the increasing cost of debt financing and the shrinking supply of available capital in recent years, hospitals have begun to look for other sources of capital. The one vehicle that is becoming increasingly popular as a source of outside capital is the joint venture. Joint ventures between tax-exempt healthcare entities and individuals or for-profit groups are now common in the industry in various forms. Joint ventures with physicians strengthen the relationship between the hospital and physician

Borrowing Alternatives to Traditional Long-Term Debt

Independent physicians' office buildings cannot be financed through tax-exempt borrowing. For interest on debt received by the lender to be exempt from federal income tax, the debt must be issued by a state or a political subdivision of a state. Some states have established agencies, or authorities, just for that purpose. Non-profit entities must use such an authority for their debt to be tax exempt. Non-profit entities must use a conduit issuer for their debt to be tax exempt. However, if the organization, or the specific debt issue, does not meet the tax-exempt criteria, there are many forms of taxable debt also available.

Overhead

Indirect costs; Examples may include administrative and general costs, maintenance, etc.

There are two components to cash management: internal and external.

Internal cash management incorporates the cash budget discussed earlier with the long-range cash projections created by the organization's strategic plans. External cash management primarily involves the commercial banking functions.

Five Components

Internal controls include the following five interrelated components that affect management's objectives in each of the three categories noted on the previous slide. A total of 17 codified principles exist to support application of 5 internal control components: Control Environment Risk Assessment Control Activities Information and Communication Monitoring

Types of Equity Financing

Internal equity financing is usually the least expensive source of capital funds. The operating and non-operating income and any cash reserves of the institution are used to finance the capital investment. Most organizations develop their operating budgets in tandem with their capital budgets in order to maximize their ability to finance capital acquisitions this way. External equity financing is usually a more expensive source of capital funds. It is traditionally accomplished through the sale of stock. External equity financing means financing by giving an ownership interest in the institution to the provider of funding. This is clearly distinguished from debt financing, where a certain principal sum will be borrowed and that sum will be paid back along with interest.

Evaluating Capital Projects

It is common for healthcare organizations to identify more potential uses for capital dollars than the cash projections can support. When this happens, management must rely on an objective process to validate and prioritize all capital requests.

Which type of payment method is intended to cover all inpatient services utilized for each procedure (e.g., joint replacement) while the beneficiary is in the hospital?

It is common to develop more than one per diem rate, depending on the type of service provided and the volume of resources consumed. For example, there can be a different rate for medical and surgical patients. Or, it is possible to negotiate one rate for the first two days of admission and then a lower rate for the remainder of the stay.

What are covenants?

Legal obligations on the borrower that are intended to protect the lender against default by the borrower.

Covenants

Like all debt, healthcare bond issues place legal obligations on the borrower that are intended to protect the lender against default by the borrower. These obligations are covenants usually negotiated by the borrower and lender. In general, the stronger the credit rating, the fewer the covenants required. Covenants may include a definition of the collateral, performance (debt service) requirements, liquidity, and restrictions on future indebtedness.

Liquidity Ratios

Liquidity ratios can be viewed just as you would your own personal finances. These assets are available to meet your short-term obligations, whether they are ongoing bills, car loans, school loans, or mortgage payments. Putting it in the context of a healthcare organization, there are a variety of ratios. The six liquidity ratios are: Current Quick Acid test Days in patients accounts receivable (net) Average payment period Days cash on hand

Which of the following is not one of the current trends moving away from the fee for service delivery payment system:

MIPS Comprehensive Care for Joint Replacement (CJR) Accountable Care Organizations (ACO) Resource Based Relative Value System (RBRVS) ANSWER: RBRVS

Risk-Sharing Arrangement

Managed care arrangements have required providers to assume more of the economic risks that accompany healthcare delivery. With the exception of fee-for-service contracts, which are becoming much less prevalent, the provider receives a set reimbursement amount, regardless of the services performed. In a per diem contract, the hospital is at risk for shorter, more resource intensive inpatient stays. Where case rates have been negotiated, the hospital is at risk for higher acuity admissions that are more costly. In both of these examples, physician practice patterns can significantly impact the profitability of the institutional provider. Because of this interrelationship, payers are creating contracts that provide incentives for the physicians and institutional providers to align practice patterns to achieve high-quality, cost-effective care. The most common technique is to create a risk-sharing arrangement—a risk pool that is shared by the providers based on predetermined performance goals.

Management capability

Management capability, meaning the depth and experience of management in several areas.

Management Reporting

Management reporting is the effective communication of actual- to-budget performance to all levels of management so results are understood, corrective actions can be identified if necessary, and on-going decision-making is enhanced. Responsibility reports are a key element in management reporting and include information on statistics, and revenues and expenses for each cost center or division. They are sent to appropriate members of the management team, and can include a budget vs. actual report and variances associated with the budget for that period. On a monthly basis, department heads provide explanations for their variances. An effective responsibility reporting process includes a financial assessment containing pertinent data to assess operations for the period under review (current month, year-to-date, or both). It typically includes actual and budget information, and variances from budget for each general ledger revenue and direct expense account.

Activity Ratios

Measures the relationship between revenue and assets. Activity Ratios Total asset turnover Fixed asset turnover Current asset turnover Inventory turnover

Medical staff characteristics

Medical staff characteristics, meaning the relative strengths and vulnerability of the staff relative to the size of the facility.

Case Rate

Medicare reimbursement introduced the concept of a case rate where preadmission testing and inpatient services are reimbursed based on the diagnostic grouping into which the case falls. There is a fixed dollar amount of reimbursement associated with each diagnosis-related group (DRG) regardless of resources consumed. Many commercial carriers have adopted this methodology, negotiating flat amounts for certain types of cases. More recently, payers have been negotiating global case rates for certain cases (for example, open heart surgeries) that include professional fees and home care services, as well as preadmission and inpatient services

Uses of Ratio Analysis

Monitoring debt covenant compliance is another use of ratio analysis. Most organizations with debt have debt covenants that require them to maintain certain financial ratios to remain in compliance. Therefore, on an on-going basis, organizations will be monitoring those covenants via ratio analysis.

Selecting Money Managers Determining Needs

Most healthcare organizations do not have in-house expertise to evaluate potential investments and recommend choices to maximize return while minimizing risk. Healthcare organizations will purchase this expertise by hiring one or more professional investment portfolio managers. This is typically done by the board of directors/trustees and is second in importance only to establishing the investment policy itself. The organization's board of directors should consider these factors in selecting and evaluating investment portfolio managers: The amount of funds available to put into a managed portfolio and the ultimate need for the funds The qualifications of the prospective managers The cost for managing the funds The level of experience and approach to managing the types of assets allowed by the policy

Controlled Disbursement Accounts

Most large commercial banks provide notification of checks clearing, thus facilitating cash position management. This type of account is known as a controlled disbursement account.

Types of Cash Budgets

Normally, a cash budget is prepared for each month of the budget period. But where cash balances are low or profit margins are thin, the budget may be prepared on a weekly or daily basis. Short-Term Cash Budgets versus Long-Term Cash Budgets Short-Term Cash Budgets Long-Term Cash Budgets A short-term cash budget covers a period of one year or less. A long-term cash forecast or budget covers a period beyond a year. A short-term cash budget is particularly useful to planning daily operations. A long-term cash budget is useful in formulating overall financial policies. Short-term forecasts are less tentative. Long-term forecasts are more tentative and contain fewer details. To achieve its maximum value, a long-term forecast should be integrated into a long-run program that should include a forecast of earnings and plans for capital expansion.

Sweep Account

Once the cash balances have been accumulated into a single account, the organization can authorize the bank to "sweep" all collected balances at the end of each day and invest those balances overnight. The following morning, the funds are swept back into the account and are available for use. Banks frequently invest these funds in money market accounts, short-term treasury certificates, commercial paper, and other low-risk investments.

Determining Debt Capacity

Once the organization has an idea of what kind of debt will have the most advantages, it should consider how much debt could realistically be borrowed. The first step in determining how much can be borrowed is performing a debt capacity test. This will assess the current structure of the organization's debt and the potential for additional borrowings in the future

Managing Cash

One of the most important factors determining the financial strength of a healthcare organization is its cash reserves. These reserves form a cushion to protect creditors if the operating environment were to deteriorate. Cash is a significant asset and must be managed. The challenge is to maximize returns while ensuring that there is cash on hand for day-to-day operations. Management must have a sound way of predicting short-term cash needs. Financial assets that aren't expected to be used in day-to-day operations can be invested in longer term securities. These securities should create higher returns.

The three main types of control budgets in the budgeting process are:

Operating Capital Cash

Which control budget places the responsibility for meeting budget targets on departmental or service managers?

Operating budget

Capital Budget

Organizations develop a capital budget to determine the amount of resources needed to provide for major non-operating expenses. Capital items may include building needs, technology, equipment and other items that are not part of operations. For the capital budget, there are generally a minimum of two components: Maintenance capital is required to maintain a program or facilities at an existing level. Strategic capital involves the expansion of existing programs, the initiation of new programs and services, or both.

In order to discount cash flow, you need to know:

Payment flow and interest rate

Provider Excess Loss Insurance Per-Person Excess Loss Insurance

Per-person excess loss insurance, also known as specific excess loss insurance, is the most common and familiar coverage available. Per-person excess loss insurance reimburses the provider once costs for an individual patient exceed a specified threshold or deductible. This coverage is designed to protect the provider against large and unforeseen claims for the population defined in the policy. These policies generally include maximum limits, one for each individual patient, and an overall policy limit. These limits should match the exposure that is assumed under the managed care contract.

Which component is NOT a considered assumption in the budgeting process?

Physician prescriptions

Which option is NOT a long-term debt (bond)?

Placement

Valuation Methods

Prior to determining the alternative sources of capital, an organization must find a way to quantify the value of the assets to be acquired. When the investment is significant, the actual value of the assets should be established using one of three valuation methods: Discounted cash flow method Replacement cost method Market comparison method

Service Line Costing Profitability Analysis

Product-line costing can also be useful in assessing the profitability of a proposed managed care contract and in developing carve-out rates for specific types of cases (for example, open-heart surgeries and bone marrow transplants).

Which ratio generally deals with the income statement, revenues and expenses, and how those relate to the organization's financial health?

Profitability

Which option is NOT a general category of provider excess loss insurance?

Quality Indicators

Quality Indicators

Quality indicators are also monitored to ensure patient care standards are maintained. These arrangements treat providers more equitably by allowing them to share in both utilization risk and reward. It also holds providers accountable for overuse of resources by transferring utilization risk, up to the risk pool amount, to the provider.

The healthcare industry relies on _________________ to quantify creditworthiness.

Rating agencies

Financial Factors

Rating agencies will look at an organization's historical financial trends, the stability of performance from year to year, and the reasons behind any erratically negative trends. There is always a tendency to focus on the following factors: Liquidity The ability to pay The most current debt needs Cash balances Debt service coverage Days of cash on hand Percentage of revenue from types of payers

Management Capability

Rating agencies will look at certain key areas when evaluating the skill and ability of a hospital's management team. They'll examine management's track record in the following areas: Working with medical staff Providing leadership Managing budgets Controlling financial and personnel resources Defining the institution's role and visions Setting strategic plans Ability to deliver on promises Length of service with institution

What Is Ratio Analysis?

Ratio analysis is an indicator of past performance. It is used to analyze historically what has occurred in a particular organization by taking specific financial measures and converting them into ratios. It also is a good measure of the present state of an organization's financial health.

Uses of Ratio Analysis

Ratio analysis is useful in the pricing of services. Healthcare organizations are looking outward because of the competitive environments and comparing ratios to similar or competitive organizations. For example, ratio analysis can determine whether pricing is generally lower or higher than similar organizations.

Why Was Ratio Analysis Developed?

Ratio analysis was developed primarily for the purpose of credit evaluation. Ratios provide an indication of the financial health of an organization at one point in time.

Evaluating Capital Investments

Regardless of the valuation method used, every capital investment proposal that is to be evaluated from a financial perspective requires information on the following four quantifiable factors: Cash Outflow The amount of cash required to plan and implement an investment proposal. Cash Inflow Incremental net revenues associated with the capital investment decision, including any cost savings, and the impact of cost-based reimbursement and/or taxation. Cost-based providers will share in any capital investment that reduces cost. For tax-based providers, any dollar of profit will be reduced by the tax. Economic Life Estimated time period that the investment will provide positive returns. Opportunity Cost of Funds The benefits that would be received from the next best alternative use of the investment funds. Typically this is expressed in terms of an interest rate, either the cost of borrowing funds or your internal cost of capital, and it becomes the discount rate used for present value calculations.

Variable Cost

Responds, in total, more or less in direct proportion to changes in volume. An example is the relationship between supply costs and outpatient or patient days. For most healthcare organizations, a majority of supply costs will vary directly with volume.

Responsibility Accounting

Responsibility accounting is the assignment or allocation of cost to the individual manager who is primarily responsible for making decisions about those costs. Once the primary responsibility for incurring a specific cost has been established, various management reports, such as departmental expense reports, can be developed to assess a manager's effectiveness. An Example The budget manager has provided you with your monthly responsibility report and has asked you to do the following: Analyze the unfavorable variances in wage expense and medical supplies. Explain the reasons for these material variances between actual and budget.

Which of the following types of debt depend on the revenue stream generated by the issuer to provide for repayment?

Revenue bonds

The hospital staffing for a regular acute unit is an example of __________________

Semi-fixed or stepped variable cost

Which of the following is NOT a type of expense variance?

Stepped Variable

Organizations should have a clear plan as to why they are in business and how they can stay in business in the future. What is such a plan called?

Strategic plan

Uses of Ratio Analysis

Summarization of financial data: There are tremendous amounts of financial data in healthcare organizations, and to determine whether the organization is deviating from its historical performance (whether planned or not), use of financial ratio analysis is helpful to summarize the data into a form that is easily understandable and usable. Data must be put into a format that can be used to create actionable and understandable information.

A hospital would want to undertake a debt restructuring by either retiring or reacquiring existing debt for the following four reasons:

Take advantage of lower interest rates. Change collateral restrictions, that is, restrictive covenants in an existing agreement. Allow acquisition of other assets. This means packaging existing debt with new money debts, in order to be able to acquire new assets, new buildings, or new equipment. Better fit debt service requirements to current operations.

The wage variance is determined by:

The "difference in the budgeted and actual average wage per hour" times the "actual paid hours."

How much would an organization have to put in the bank today at 8% interest to get a stream of four years of payments of $2,000 each year?

The $2,000 paid at the end of year one would earn interest for one year and would be multiplied by a discount factor of 0.926. The $2,000 paid at the end of year two would be multiplied by a discount factor of 0.857, and so on.

Private Placement

The advantage of a private placement is that, since there is only one lender, the costs of arranging the issue are lower. Also, the borrower and the lender can define what is mutually important. A disadvantage might be that the private placement lender could require a particular covenant to be more restrictive than a public offering would require.

Diversification

The best way to achieve an increased rate of return while minimizing volatility is to create a diversified portfolio of asset classes. Diversification exists because the returns of different asset classes do not always move up or down at the same time or in the same magnitude. As a consequence, there are times when some asset classifications are doing well and make up for the underperformance of others.

Cash Budget

The cash budget is the product of the operating and capital budgets, predicts the cash flow, cash availability, and the income generated from operations and other sources of cash. All three of these budgets are highly interrelated. The operating plan impacts the capital budget and capital budget impacts the operating budgets. The operating budgets determine the cash availability and the cash availability influences the capital budget.

Profitability Ratios

The contractual discount percentage is concerned with the deductions that are taken from revenue. An analogy in other industries would be sales returns or allowances. The denominator, in this case, is gross patient service revenue. In other industries, it would be gross sales revenue. Markup measures how the price of services exceeds expenses in order to make a profit. Operating margin is concerned with the amount of profit that is generated from operations. Non-operating gains over net income (that is, excess of revenue over expenses), calculates the extent to which net income is being supported by activities that are incidental to primary operations. The reported income index is a measure of how much of the income in a current year is reflective of the change in net assets. The change in net assets should be due to net income, with the exception of restricted funds that are received from philanthropic activities. Restricted funds flow directly through the net assets and not through the income statement. The normal value for the reported income index will usually be 1. If it is less than 1, operations are being supported by significant external contributions. Return on total assets, just as we would expect, measures how effectively assets are working in generating profits for the entity. Return on equity measures the magnitude of earnings produced by an organization's equity base.

Identifying the Costs of Managed Care Contracts

The costs for any managed care plan fall into two categories: medical benefits costs and administrative costs, including reinsurance premiums. The first step in analyzing a proposed contract is to clearly identify which costs are covered by the contract.

Current, Quick, and Acid Test Ratios

The current, quick, and acid test ratios all represent slightly different variations on your current assets and current liabilities and how you are able to meet those current obligations. The current ratio is current assets over current liabilities. In general, a higher number is best, because it indicates sufficient current assets to satisfy current liabilities. From a financial management standpoint, however, many financial advisors and CFOs would like to see that ratio lower, indicating the ability to keep receivables and other current assets low and investing cash more productively. Next are the quick ratio and the acid test ratio. Keep in mind that all three of these liquidity ratios are highly related. The current ratio is the highest level. The quick ratio indicates how quickly the assets may be converted to cash. Cash and cash equivalents, marketable securities, and accounts receivable can be readily converted to cash. The acid test ratio, the most restrictive test on liquidity, indicates the assets that can be immediately converted into cash. Only cash and marketable securities, therefore, are used in this calculation. The accounts receivable might take a little bit longer to convert, so we omit it from the acid test ratio. The denominator in all three of these ratios is current liabilities

Definition of Internal Control

The definition of internal control is taken from Internal Control—Integrated Framework published by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). COSO provides a flexible and adaptable set of tools for assessing, monitoring, and strengthening an organization's comprehensive system of internal control. Issued in 1992 and most recently in 2013, COSO is the leading internal control framework used by organizations in the United States. The recent issue recognizes the following business environment changes have occurred since 1992 - globalization, virtualization, regulation, technological innovation, increasing complexity. The COSO framework defines internal control broadly: Internal control is a process—affected by an entity's board of directors, management, and other personnel—designed to provide reasonable assurance regarding the achievement of objectives in the following categories: Inherent in this definition are the concepts of safeguarding assets and stewardship of resources.

Contribution Margin

The difference between marginal revenue and marginal cost; Contribution margin goes toward supporting fixed costs; if it exceeds that, it goes to profit.

What amount of money would you have to put in the bank today to have $1,000 three years from now, assuming that you have an 8% rate of return or interest rate?

The discount factor for three years at 8% is 0.794, so you simply multiply $1,000 by 0.794 to get the amount you need to invest today: $794. If you did that, in three years at 8%, you would have $1,000 in your account.

Discounted Cash Flow Method

The discounted cash flow method is nothing more than simply discounting or converting future income or expense streams to a present value, that is, to today's dollars. This method allows you to compare several investment opportunities on a common basis. In order to use the discounted cash flow method, you need to know the payment flow or payment pattern and the interest rate. The interest rate used should reflect the cost of money and the risk associated with the project. If you know those two items, then you will be able to discount the cash flow.

Debt Restructuring

The discussion up to this point has assumed that the borrower intends to acquire additional capital. However, depending on its credit rating and current capital markets, a borrower may want to retire existing debt with debt that may be more advantageous. In the past, debt restructuring was often accomplished through debt refunding. In refunding, you borrowed enough new debt to pay off the existing debt today. The accounting rules allowed organizations to recognize a debt extinguishment only when the borrower was legally relieved of the obligation to repay the lender, by making payment under the terms of the loan agreement, or by reacquiring the debt securities from the bond holders.

Capital structure ratios are evaluated by long-term creditors and bond rating agencies.

The equity financing ratio reflects the extent to which assets are funded through equity versus through debt. The cash flow to total debt ratio is a key statistic used by many lending or crediting agencies. It helps determine how much available cash there will be to pay off the debt. The long-term debt to equity is also a statistic that is widely used by a variety of sources. A related term is equity to total capitalization. Instead of comparing debt to equity, you compare debt to equity plus debt. That is also known as the debt capitalization ratio. These are variations on the same numbers. Fixed assets financing reflects the extent to which debt is financed through your net fixed assets. Times interest earned quantifies how much income is generated to cover interest costs and then, expanding on that, debt service coverage quantifies how much income is generated to cover both principal and interest payments. Debt service coverage is also very much used by crediting and rating agencies and is generally a covenant in most financial debt documents.

Adjusted Net Income Method

The estimated statement of income and expense provides the starting point for this method. Expected net income is first adjusted for all noncash transactions to arrive at estimated income or loss on a cash basis. Second, this amount is adjusted for cash transactions that do not affect the income calculation. For example, depreciation expense is added to estimated earnings since it does not require a cash outlay, and the excess of expected collections over revenues for the period are also added to adjusted earnings in determining total expected cash receipts.

Return on Investment

The expected return from an investment is correlated to the risk profile. Investors expect to be compensated for assuming higher levels of risk. Investment decisions all revolve around evaluating risk relative to the price and expected return for the investment. While it is difficult to quantify risk, it is easy to calculate the return of an investment. The formula to calculate the return is income plus realized gains minus realized losses. That result is then annualized over the period held divided by the carrying value of the investment.

The components of an operating budget are: fin

The expense budget accounts for the quantities and types of resources to be used to achieve the projected statistical volumes. Staffing levels should be determined on a departmental basis. Key pieces of data are the number of staff, classifications (clerical, nursing, supervisory, and so on), pay rates for each, number of full-time equivalent employees, and total salary cost associated with this staff. The expense budget also includes a compilation of supply and service budget amounts, a listing of the various types or categories of supplies to be consumed, services to be utilized, and the dollar amounts to be expended for each category.

Return and Risk

The first step in determining an appropriate asset allocation is to establish return expectations for the asset classes along with a brief explanation of their relevance to asset allocation. In order to create asset allocation alternatives, it is necessary to project the probable performance of the asset classes to be used in the allocation. The expected returns are the best estimates of the average annual percentage increases in the values of each of the asset classes over the long term, as well as the risks associated with each of the asset classes. One of the primary considerations in assigning a probable return is the actual return over a long-term horizon. While past performance does not guarantee future performance, the relationship of relative actual returns for each of the asset classes will probably be relevant. It is important to understand that these are the expectations of future performance and are therefore subject to uncertainty. The degree of uncertainty for each of the asset classes is called the risk or volatility of the asset class and is qualified by the statistical term known as standard deviation.

Which option is false concerning return on investment?

The formula to calculate the return is losses plus realized gains minus realized income.

Credit Rating Criteria

The healthcare industry relies on rating agencies to quantify creditworthiness. This is done using objective and measurable criteria, as well as assessments of the internal and external business environments. The agencies develop comparative ratings based on the likelihood that a borrower will be able to repay principal and interest as scheduled. Not all bonds are rated; however, the purchasers of unrated bonds will evaluate credit risk using a similar approach. Because the credit rating will significantly impact the cost and availability of capital financing, it is important to prepare and maintain a credit analysis. This analysis will allow the organization to compare its recent financial performance to relevant national standards.

Investment Portfolio Management

The key ingredient in this review is the prudent matching of long-term assets and prospective financial needs by examining different asset allocation strategies. The objective is to select a formal investment policy for each fund that will produce the highest possible returns at the lowest possible level of risk.

Projecting Cash Needs

The key to cash management is the understanding of cash needs, and the way to understand needs is by creating a cash budget. The following components are incorporated in a cash budget: The ability of the organization to manage the overall revenue cycle, which determines how quickly the organization receives cash from third-party payers The healthcare organization's projection of costs Variability in activities that impact both revenues and expenses Regularly recurring or periodic expenses, such as utilities and taxes Timing of capital purchases The purpose of these projections is to identify when excess cash might be available for investing or when to time maturities of your investment portfolio to create additional operating cash.

Capital Structure Ratios

The last series of ratios are the capital structure ratios. As mentioned earlier, these ratios are becoming one of the most important types of analyses because more and more facilities are incurring more debt as they posture for the future. Capital structure ratios are commonly used by lenders, bond rating agencies, and, as mentioned earlier, by management and boards. The amount of debt that a healthcare facility can incur is carefully monitored via the use of these ratios. Capital structure ratios include the following: Equity financing Cash flow to total debt Long-term debt to equity Debt capitalization ratio Fixed assets financing Times interest earned Debt service coverage

Provisions or the structure of the financing

The legal provisions or the structure of the financing, that is, the security (if any) behind the bonds and the bondholders. Agencies will look for a specified set of legally enforceable requirements.

Users of Ratio Analysis

The list begins with the board of directors/trustees/ commissioners. Board members who spend only a few hours a month in that fiduciary role have a difficult time analyzing all of the operational or financial data that is presented to them.Board members are good examples of individuals who use ratio analysis to determine whether the organization that they're overseeing has historically been financially sound, is currently sound, and can be expected to remain so in the future. Management is probably the primary user of ratio analysis. Management also has a great deal of information to assimilate and digest to determine whether or not their course of action and their plans are enhancing the financial position of their organization. Middle and service line management may also use different ratio analyses on a more focused level to determine whether their operating goals and objectives are being achieved and whether the efficiencies that they have budgeted for are actually being realized. For example, patient accounts managers will look at a variety of receivables statistics and ratios to determine how well their employees are actually performing. Health systems agencies are another user group. These government agencies may be analyzing a hospital's proposal for a particular capital project. They may be using ratio analysis to determine the overall financial health of the organization and to decide whether or not a service that the entity is proposing to add will enhance the financial strength and viability of the organization, or, alternatively, whether it will detract significantly from it. Creditors developed the science of ratio analysis and use it in its purest form for evaluating either debt offerings or applications for borrowing from a bank or other financing organizations. We will go into further detail about creditors and their use of key statistics later in this section. Employee unions are another user of ratio analysis. If a union for a healthcare system or organization is involved in negotiations with management, they clearly will be using financial ratio analysis to determine the overall health of the organization and to decide for themselves whether or not that facility is in a position to provide team members with additional benefits and compensation. Lastly, rate regulators in states that have rate setting mechanisms in which health care organizations (primarily hospitals) request increases in rates for their non-governmental payers, will use ratio analysis to assess the validity of requested increases. Those bodies typically will use ratio analysis to help determine the overall price increase an organization is allowed.

Maturity or Liquidity Risk

The more quickly an asset can be converted to cash, the lower the investment risk.

Quality and Risk-Based Payment

The most common type of risk-sharing arrangement is a quality and risk-based payment. Quality and risk-based payment plans develop medical benefit budgets for each of the primary benefit categories. The payer withholds a portion of the provider payments in a risk pool fund and rewards providers for the efficiency by returning the withheld amounts as well as a share in budgetary surpluses, based on individual performance.

Average Payment Period

The next ratio is average payment period. Think about how many days you take to pay your personal bills. Average payment period is current liabilities divided by the amount of operating expenses, with depreciation subtracted, per day. Depreciation is subtracted because it is a non-cash item. It is generally preferable for the average payment period to be low and below the median. Average payment period reflects the time required to satisfy obligations to vendors.

Funding Portfolios

The organization may have more than one investment policy, depending on the number of investment funds and the ultimate use of the funds. If there are multiple entities or funds, there may be one policy for each. Most not-for-profit healthcare institutions have three or four distinct funding portfolios: Funded depreciation reserves Self-insurance trusts Endowments or foundations Employee retirement plans

Investment Policy Statements

The organization should carefully formulate an investment policy. This policy will establish a framework to make investment decisions and evaluate results.

Payback Method

The payback method permits a rough evaluation of a proposed expenditure for new equipment in terms of the length of time required for the equipment to pay for itself by producing net cash inflow equal to the initial investment outlay. The computation is illustrated in the evaluation of capital expenditures below. In this case, it would appear that the equipment would pay for itself in about 2.7 years. Capital expenditure proposals can be ranked, at least tentatively, by the length of time required to pay back the investment. The major fault of the method is its failure to consider the time value of money.

Per Diem Rate

The per diem rate covers all inpatient services utilized while the beneficiary is in the hospital. It is common to develop more than one per diem rate, depending on the type of service provided. For example, it is common to have a different rate for medical and surgical patients. Or, it is possible to negotiate one rate for the first two days of admission and then a lower rate for the remainder of the stay. This recognizes that the majority of resources are consumed in the first 48 hours of a hospital stay.

Pertinent Planning Issues

The pertinent planning issues (i.e., capital preservation, inflation protection, and liquidity versus long-term growth) differ considerably depending on the portfolio being considered. Pension plan liabilities can be strictly defined and must meet requirements of the Employee Retirement and Income Security Act (ERISA) if the plan is subject to ERISA, as well as actuarial and other requirements. Ideally, the investment policy would define how the organization intends to match the maturity of the investments with the projected need for the proceeds.

Purpose and Use of a Cash Budget

The primary purposes of a cash budget are: Identify cash requirements and cash sources for a certain period of time. Control the flow of cash funds. Other specific uses of a cash budget include the following: Indicate the time and extent funds are needed to meet maturing obligations, interest payments, etc. Assist in planning for the funding of capital acquisitions. Determine the extent and duration of funds required from outside sources and permit the securing of more advantageous loans. Assist in securing credit from banks and improve the general credit position of the business. Determine the extent and probable duration of funds available for investment. Plan the reduction of bonded indebtedness or other loans. Coordinate the financial needs of subsidiaries and divisions.

Asset Allocation Modeling

The returns, risks, and correlation, as described previously, are the primary inputs for asset allocation models that construct the asset allocation alternatives. With this information, these models weight the asset classes so that they achieve a range of possible returns, given whatever constraints are placed on the model. There are a variety of ways to weight the assets to achieve these returns. The value of such a model is that it weights them in such a way that the return is achieved with a minimum of volatility. Optimal Portfolios Allocations achieving a given rate of return at the least amount of risk are known as "optimal" portfolios. Such models should also take into account any minimum or maximum acceptable level to be allocated to each asset class or groups of asset classes based on the objectives of the organization for the particular portfolio. Sophisticated Asset Models Sophisticated asset models find the optimal portfolios by considering not only the return and volatility of all asset classes individually, but also the correlation between the asset classes. The model should develop a range of alternative portfolios that falls within the stated minimum and maximum for each asset class under consideration, along with a probable return for each portfolio and the associated risk. Once the alternatives are presented, the trustees or investment committee should select a particular portfolio as a target, balancing returns against volatility.

The components of an operating budget are: cont

The revenue budget is a set of calculations that determines the gross amounts to be generated by charging healthcare services. Units of service (from the statistical budget) multiplied by the appropriate charge rates (prices) result in gross revenue. In most instances, covered lives or risk based programs are pre-set amounts which may be prospective in nature or have a retrospective reconciliation feature. Budgets are prepared for contractual allowances, discounts to insurance companies and managed care organizations, uncompensated care, and bad debts. (Bad debts are now classified in the deductions from revenue section of the Statement of Operations, as noted in FASB Accounting Standards Update No. 2011-07.) Another operating revenue budget is created for cafeteria and gift shop proceeds, parking lot profits, etc

Estimate Interest Rate

The second step in assessing debt capacity is to estimate the interest rate creditors will require, based on the risk of lending to the organization. The interest rate will influence the size of the annual debt service as well as the impact on financial performance. The interest rate will generally be determined by obtaining a credit rating from a rating agency or through credit enhancement by a bank or by purchasing bond insurance. Even when debt is issued without a rating, the investors will informally evaluate the creditworthiness of the issuer. As part of the planning process, therefore, it is important to consider those factors used to establish a credit rating.

Asset Allocation Theory

The selection of the asset allocation is one of the most important decisions the trustees for any healthcare organization can make. It is the major determinant of both the long-term rate of return and the volatility of the organization's asset values. There are two facets to the asset allocation decision: Identification of the investment alternatives to be considered Selection of a targeted asset allocation that best meets the investment objectives The identification of a range of acceptable asset allocations consists of projecting the probable future performance of the various asset classes to be considered. These projections are then used to produce allocations with the most desirable characteristics. Once created, each proposed asset allocation could be evaluated in light of the overall investment objectives and then the most appropriate one chosen.

The components of an operating budget are:

The statistic budget is a forecast of the relevant activity level for each department. It defines the volume of business for the year and is expressed in terms such as patient days, admissions, visits, covered members or lives, etc. Development of the revenue and expense budgets is based upon the statistic budget. Typically, the terms used to express units of service, or volume, are the same terms that are used for billing purposes. A common approach is to express the following four statistics: Number of visits Number of procedures Number of relative value units Number of relative value units per visit Number of covered lives

efficiency variance

The variance in the "labor hours per unit of service" times the "actual units of service" times the "budgeted average wage rate."

Budget Methodologies

The zero-based budget builds on the premise that no department or program exists forever. It builds projections for volumes, revenues, labor costs, supply costs, and other operating expenses. It is based on the most current pieces of information available with respect to each revenue or expense category. The historical budget assumes current-year results will best predict what will happen in the future, unless modified by a specific projection. Current volumes and statistics are adjusted only by the overall assumptions, unless there is a specific reason for change. Success of this approach relies on the manager's ability to isolate unusual or nonrecurring activities included in the historical period or anticipate environmental changes specific to the department. However, forecasting based on historical trends in a rapidly changing environment can be unreliable. It is possible to develop a combination approach. The selected approach can be segregated based on departments or based on expense categories.

Return on Investment (ROI)/Internal Rate of Return Method (IRR)

There are different concepts of return on investment, and variations are found in the manner in which it is computed. The computation assumed here divides the net present value (NPV) by the original investment, or:

Long term debt

There are four major sources of long-term debt available to health care organizations: Tax exempt bonds Federal Housing Administration (FHA) insured mortgages Public taxable bonds Conventional mortgage financing Long-term debt is often obtained via a debt issue in the form of long- term bonds, usually tax-exempt finance offerings. Tax-exempt financing is usually the lowest cost debt available to a healthcare organization, but the organization must first qualify as a tax-exempt (non-profit) organization, and then must restrict the use of the proceeds for tax- exempt purposes. Proceeds cannot be used in any way that directly benefits an individual or a for-profit organization.

Standard Costing System (intro)

There are two principal uses for cost accounting: assist with price negotiations and identify opportunities to enhance financial performance. Cost accounting is used for management decision-making. The better the cost information, the better the decision-making. One of the best methods of developing cost information is to implement a standard costing system. Standard costs are those costs that should be incurred to produce a product. There are three main types of standards: Predetermined or Synthetic Standard Negotiated or Historical Standard Customized or Engineered Standard

Market or Price Risk

There is the possibility that the market may misjudge overall credit risk and either over-price or under-price a security relative to that risk.

Concentration Account and Zero Balance Account (ZBA)

These accounts are used together. Frequently, a healthcare organization uses unique depository accounts for different purposes or related entities. To efficiently invest all available funds, disbursement and depository account balances are cleared out each day and put into a single concentration account. This allows the organization to easily identify the total cash position on a day-to-day basis.

Net Present Value Method

This method takes into account the time value of money, that is, a dollar received in a future year is not worth as much as a dollar received today. The use of money has a value that, as shown in the example, is assumed to be 10%. In the following example, using the net present value method, the annual cash flows are converted to present value by application of present value factors assuming a 10% "cost of capital." As indicated, the investment proposal has a positive net present value. The present value of cash inflows exceeds the present value of cash outflows by $15,531, indicating the true rate of return is greater than 10%. Capital expenditures having the greatest net present values generally would be ranked highest.

Cash Receipts and Disbursements Method

This method, which is used most frequently, is essentially a projection of incoming and outgoing cash. This method contains a detailed listing of the sources of cash receipts and the nature of cash disbursements. This method is flexible and readily adaptable to both short-run and long-run projections. The cash forecast under this method is an effective instrument of control, since individual cash receipts and disbursements can be compared to budgeted amounts.

Which option is NOT a reason why a hospital would want to undertake a debt restructuring by either retiring or reacquiring existing debt?

To better fit debt service requirements to current government regulations

What is the purpose of an investment policy?

To establish a framework to make investment decisions and evaluate results

What is one primary purpose of a cash budget?

To identify cash requirements and cash sources for a certain period of time

Flexible Budgets

To maximize the benefits from budgeting as a control tool, many organizations have adopted flexible budgeting. The most common approach is to develop a series of fixed budgets prepared under various assumptions that would include the range of volumes that could reasonably be expected. Department managers would re-evaluate each cost component (labor, supplies, purchased services, for example) given the various volume assumptions and their own knowledge of cost behaviors for their departments

The Budgeting Process The organization must

Translate the high-level goals and objectives into department-specific budgets. Compile the collective information available to management involving market trends, the reimbursement environment, and technological developments internal resources. Identify critical interrelationships between key components so that the budget is internally consistent. For example, what impact will rate increases have on volume and reimbursement? Define what sources of information are available for each critical element.

Valuation Methods

Usually, you will be provided with the discount factors, and you must understand how to apply those factors. Again, present value is defined as the discounted future cash flows. You may need to determine future value, or what the future dollar value of an investment would be if you invest a set amount today and you know what the interest rate is going to be.

Which type of cost behavior varies more or less in direct proportion to volume?

Variable cost

Monitoring Productivity

Variable cost centers are assigned a primary workload statistic associated with an equivalent labor statistic. The labor statistic assigned is based on industry benchmarks or derived from high performing organizations. Each reporting period, the system reports "earned" labor hours, based on actual workload units incurred during the period, to actual labor hours. Other high cost areas have similar reporting mechanisms. Significant variances can be used to stimulate a more detailed analysis of causes and the potential for increased efficiencies

Revenue Operating Budget

Volume projections Acuity of patient services Third-party reimbursement environment Marketing strategies Other operating revenue Regulatory influences Cash flow budget (investment income) Local economy (charity)

Expense Operating Budget

Volume projections Productivity targets Patient acuity information Inflationary pressures Labor contracts and union activities Technological developments Supplies usage and cost trends New program needs Capital structure (interest costs) Capital investment (depreciation

Interest Rate Risk

What will happen to the underlying security if interest rates rise or fall?

Identifying Reimbursement at Risk

When modeling proposed managed care contracts, any reimbursement that is at risk must be identified. The extent to which risk-based reimbursement will ultimately be achieved is dependent on the performance of every other provider participating in the plan and the extent to which the participant incentives have been properly aligned.

Working Capital Differential Method

Working capital is generally defined as the excess of current assets over current liabilities. Under this method, estimated working capital at the end of each month is determined from expected service and revenue volume. From this amount, the working capital required for operations, exclusive of cash, and the necessary cash balance are deducted to determine the amount available for bank deposits and investment. In arriving at the working capital balances, standard valuations based on various levels of revenues and expenses are employed for receivables, inventories, and payables.

If a lessee is building up equity in equipment being leased, the lease is:

capital

Components of an Investment Policy

n investment policy should include all of the following components: Stated objective or purpose for the portfolio(s) Definition of who has the authority to act on behalf of the company Definition of types of investments to be included in the portfolio(s) An optimal allocation range for each component of the portfolio(s) Desired maturity for fixed investments Acceptable credit risk Formal adoption by board of directors/trustees with periodic updates

Debt-to-Equity Ratio

organization has current long-term debt of $1 million and an equity of $2 million, its debt-to-equity ratio is as shown: Debt-to-equity ratio = 1,000,000/2,000,000 = 0.50 A debt-to-equity ratio of one or less is generally acceptable; a ratio above one means the total amount of debt actually exceeds the total amount of equity or net asset/net position balance. Ratios above one will cause lenders to look more closely at whether to continue to lend money to the organization. As important as this leverage is, prospective lenders are also looking for an organization's ability to cover its debt service. Debt service coverage measures cash flow available to cover principal and interest payments after paying operating expense. The higher this number, the more likely an organization will be able to continue debt service payments. As an example, suppose your net profit after paying all your operating expenses (excluding interest and depreciation) is $1.5 million. Annual principal plus interest payments equal $0.5 million. Debt service coverage is: Debt service coverage = $1,500,000/$500,000 = 3