FINAL FIN MGT

internal auditor

Staff member who monitors the effectiveness of an accounting system by verifying the system's internal control --Adequate internal control identifies and corrects errors in the accounting system as they occur and before the auditor finds the error

Electronic Data Interchange (EDI)

a method of payment in which the payer, such as Medicare, electronically transmits payment to the healthcare organization's bank and sends related information to the organization

revenue cycle

a multidisciplinary approach to reducing the amount in accounts receivable by effectively managing the production and payment cycles

inventory turnover

a ratio that measures how many times an organization goes through its inventory relative to its operating revenue --The average inventory turnover median for all hospitals reporting to Optum (2017) from 2015 audited financial statements was 53.1. --inventory turnover=(total operating revenue+other income)/inventory expense

two specific current assets:

accounts receivable and materials

comprehensive planning

integrates the strategic plan and the operational plan into one document. The advantage is the recognition that short-term objectives affect long-term goals.

Healthcare organizations typically divide capital expenditure budgets into two broad categories:

replacement and new

continuous budgets

sometimes called rolling budgets, are updated continuously so that year end never occurs. Department managers who manage wisely roll over their efforts to the next month.

continuous plans (rolling plans)

sometimes referred to as rolling plans, are updated continuously so that year end never occurs. Department managers who manage wisely roll over their efforts to the next month.

Costs related to inventory appear in two places on the healthcare organization's financial statements:

--First, inventory appears as a current asset on the organization's balance sheet. In this case, inventory, expressed as a dollar amount, represents the unused portion of inventory on hand for a given accounting period. --Second, inventory appears as expense items on the organization's statement of revenues and expenses. In this case, inventory, expressed as supplies, food, and drugs, represents the portion of inventory used for a given accounting period. The value of inventory on the balance sheet is based on the cost paid for the items in inventory. During the year, however, identical items of inventory will be purchased at different prices. Furthermore, some inventory items are expensed as the organization uses them. How does the materials manager determine which inventory items and related costs have been expensed and which inventory items and related costs are still in inventory? There are four commonly accepted methods of valuing inventory: first-in, first-out (FIFO); last-in, first-out (LIFO); weighted average; and specific identification. Each will produce a different value, and each has advantages and disadvantages

Sometimes healthcare organizations can convert outstanding accounts receivable into cash to meet short-term cash demands. There are two ways to do this:

factoring receivables and pledging receivables --- When an organization factors its accounts receivable, it sells the accounts at a discount to a bank or other agent, which then attempts to collect (and keeps the money). The advantage of factoring is that the organization receives the cash immediately, albeit at a discount. The disadvantage of factoring is that the organization loses control of the collection process, and the collection methods used by the bank or other agent may reflect poorly on the organization. ---When an organization pledges its receivables, it uses the receivables as collateral for a loan. The advantage of pledging accounts receivable is that the organization maintains control of the collection process. The disadvantage of using receivables to secure a loan is that the resulting interest rate on the loan is usually higher than the rate for other conventional loan

working capital policy

Sources and methods used to finance working capital, as well as the quantity of working capital to be maintained

step 15: convert volumes into revenues

The fifteenth step in the corporate planning process—the second step in the budgeting stage—is to convert volumes into patient revenues. Managers must consider whether the organization should budget revenues before or after the expense budget is completed. Historically, healthcare organizations have determined their expense budgets first and then set rates in their revenue budgets to cover the expenses, which is called cost-led pricing. However, healthcare organizations that are facing increasing proportions of fixed payment arrangements, such as prospective payment and premium payment (which essentially dictate the rate to the organization), may decide to calculate revenue first, which is called price-led costing. The organization then must adjust expenses to match the projected patient revenues.To project gross patient services revenues, projected production units are classified by payer and then multiplied by the projected charge that, at this point, usually includes a projected increase. Next, net patient services revenue is determined by deducting contractual allowances and charity care allowances and bad debt, if the organization recognizes significant portions of patient revenues at the time of service, even though the organization does not assess the patient's ability to pay at time of service. To project total revenues from operations, net patient services revenue is added to premium revenue, other revenue (e.g., parking, catering), and net assets released from restrictions and used for operations. Other projected changes in net assets that would be reported at the bottom of the statement of operations may also be available for operations

step 17: adjust revenues and expenses as necessary

The seventeenth step in the corporate planning process—the fourth and final step in the budgeting stage—is for the budget committee to determine whether budgeted net revenues are adequate to cover budgeted expenses. If budgeted expenses exceed budgeted net revenues, the budget committee may recommend to executive management ways to generate additional revenues or ways to reduce expenses. To cover the budget shortfall, executive management must decide whether to generate additional revenues and consider the possible effect of such action on expenses; whether to reduce expenses and consider the possible effect on quality and patient access; or whether to release funds from unrestricted net asset accounts to cover the loss.

variance analysis

An examination of the differences (variances) between budgeted and actual amounts; variance analysis requires managers to explain why budgeted and actual amounts do not match Variance analysis ensures accountability by requiring the managers who are respon-sible for the variances to explain why the variances occurred and what actions are being taken to ensure that favorable variances resume and negative variances do not recur.After the budget has been reviewed and approved, the healthcare organization can enter the capital budgeting stage of the corporate planning process

comprehensive budgeting

integrates all the budgets into one document. The advantage is the recognition that capital affects operations

comprehensive budgeting

integrates all the budgets into one document. The advantage is the recognition that capital affects operations.

The right kind of supplies for patient care can be determined by the materials manager with the help of a user committee. The right amount of supplies can be more difficult to project for three reasons:

time, uncertainties, and discontinuities --The time element refers to the fact that, for most supplies, a lag time exists between order-ing and receiving the supplies. --The demand for supplies fluctuates with volume and kind of patient; therefore, the demand for most healthcare supplies is uncertain. Because of uncertain demand, the materials manager must meet with each department manager to determine the actual necessity of every supply item. If the supply item is a lifesaving drug used in emergencies, for example, the materials manager will stock the item at a high level to ensure that the organization never runs out. This procedure is called a stock-out.If the supply in question is a seldom-used office supply, the materials manager will stock the item at a low level, if at all. This method of classifying inventory is the ABC inven-tory method, where items in category A represent 80 percent of the inventory value but only 20 percent of the items in inventory; category B represents 15 percent of the inventory value but 30 percent of the items in inventory; and category C represents only 5 percent of the inventory value but 50 percent of the items in inventory.If the organization is large or has sufficient influence over its vendors, the organization may use the just-in-time ( JIT) inventory method for some of its inventory items, mean-ing that the supply item is delivered immediately prior to use. With JIT, the organization has no, or very little, inventory on hand. --Discontinuities also affect the amount of supplies on hand. Discontinuities are disruptions to the inventory process, such as a new model of the supply item or a missed delivery. The organization must have enough stock on hand to deal with possible discontinuities.

Before effective budgeting can begin, the organization must meet several prerequisite requirements:

1. A sound organizational structure that ensures management accountability for the budgeting process 2. A well-defined chart of accounts that corresponds with the organizational structure 3. Prompt and accurate accounting systems that ensure financial responsibility for the budgeting process 4. A comprehensive management information system that captures nonfinancial information for each department 5. A budget director who is responsible for coordinating the budget process and who serves as chair of the budget committee 6. A budget committee that is responsible for establishing a budget manual and a budget calendar and assisting department managers in developing their department budgets. Budget committees usually consist of senior managers who represent the department managers in their divisions. 7. A budget manual that includes necessary strategic planning information; the organizational structure; the chart of accounts; a list of budget committee members who can assist department managers; budget forms and instructions; budget assumptions regarding items such as anticipated growth, inflation, and employee raises; and a budget calendar with important completion dates 8. The previous year's data regarding volumes, revenues, and expenses

Opportunities for improved revenue cycle management are usually found in the following five key areas:

1. Denials management (virtually all denials of payment by third-party payers are the result of administrative problems or clinical problems) 2. Follow-up on unpaid claims 3. Patient payments of copays and deductibles at point of service and enhanced methods of patient payments 4. Third-party payment compliance to ensure that payment received was the correct amount 5. Vendor contract coordination to ensure a broad-based evaluation of contract terms in relation to coordination of benefits

financial counseling should:

1. Tell the patient about the organization's credit-and-collection policies and how the policies pertain to the patient. 2. Investigate the patient's credit history and determine to what extent the patient can pay for anticipated services. 3. Help the patient evaluate alternative payment options, including, but not limited to, ◆credit cards; ◆bank loans, including home equity loans; ◆credit union loans; ◆cash from sale of assets; and ◆extended payment plans, with or without interest. 4. Follow up and resolve any pending financial transactions.

As reported by Runy (2004), the study listed the reasons most often stated by the hospital for not collecting money due from the patient at time of service:

1. Too hard and inaccurate to prorate patient account (copays), 36 percent 2. Patient liability unknown at time of service, 34 percent 3. Lack of automated method of prorating claims, 26 percent 4. Hospital policy does not allow it, 20 percent 5. Poor public relations, 20 percent 6. Staff uncomfortable asking for money, 14 percent 7. Not a significant amount of money, 4 percent --best-performing hospitals collected 31 per-cent of revenue due them from patients at time of service, while the national average was 16 percent

steps in budgeting stage:

22 steps; first 13 encompass the strategic planning and operational planning stages discussed in chapter 13.

cyclical pattern

A cyclical pattern is similar to a seasonal pattern; how-ever, the length of each cycle is longer than one year and cycles vary in length.

average collection period (days in accounts receivable)

A financial ratio that shows the average time a healthcare organization takes to collect money owed to it ---the term is formally defined as the number of days of operating revenue that an organization has due from its patient billings after deducting for contractual allowances, bad debt, and charity care. The average collection period median for all hospitals reporting to Optum (2017) from 2015 audited financial statements was 47.3 days. net accounts receivable/(net patient service revenue/365) ---The objective of managing the revenue cycle is to reduce the average collection period; the collection period does show direction; a smaller number is always better. One way to reduce the average collection period is to write off accounts as bad debt. However, writing off accounts prematurely may not be in the organization's best interest.

horizontal pattern

A horizontal pattern exists when the variable's value does not change over time.

beta coefficient

A measure of the statistical contribution of a causal variable to regression's causal power is the beta coefficient, which indicates the relative importance of each of the causal variables in explaining or predicting changes in the forecast variable. In multiple regression, the manager can use beta coefficients to decide which causal variables to retain and which to exclude. The manager should be cautioned regarding one flaw in multiple regression: multicollinearity, which is the phenomenon that occurs when causal variables relate to each other in addition to the relationship to the forecast variable.

random pattern

A random pattern exists when the variable's value changes, but in no predictable way

seasonal pattern

A seasonal pattern exists when the value of the variable fluctuates according to a seasonal influence, such as hour of the day, day of the week, week of the month, or month of the year.

accounts payable

Accounts payable is money owed but not yet paid to vendors for services and products already received by the organization

accounts receivable

Accounts receivable is money due to the organization from patients and third parties for services that the organization has already provided. ---The Healthcare Financial Management Association (HFMA) says that inadequate or incorrect information gathered at this stage is the single greatest reason for not billing or collecting accounts receivable in a timely manner (HFMA 1998). According to HFMA, unless the care is emergent in nature, treatment should not begin until this stage is completed. From a legal perspective, the organization is not required to initiate treatment—absent an emergency—if the patient is unable to pay.1 However, after the organization has initiated treatment, it cannot terminate treatment solely based on the patient's inability to pay. ---During care, the organization should post charges in a prompt and accurate manner. The medical record, which is in the hands of clinicians at this point, should document all phases of the patient's care. The medical record is the primary source of clinical data required for reimbursement from most third parties. Utilization review by the utilization review nurse or discharge planner ensures that the care provided to the patient is appropriate and will be reimbursed by the patient or a third party. The organization should conduct utilization review during care, called concurrent review, as well as after care, called retrospective review.During the care-completed phase, sometimes referred to as discharged but not final billed, the medical record is transferred from the clinicians to the medical record department. --The patient's record is analyzed for completeness, abstracted, and coded. The medical record department adds transcriptions from the physician, including final diagnosis.On completion of the medical record, the payment cycle begins. In the bill print phase, a claim form is completed. Any previously agreed-on discounts, such as contractual discounts with the insurance company, are applied at this time, which changes the figure from a gross receivable to a net receivable. In the bill submission phase, a claim is sent from the organization to the patient and/or third-party payer. ---The bill collection phase also applies to bills that were not paid on time. The organization makes additional efforts to collect the bill, such as letters, phone calls, and e-mails, and if those don't work, it can submit the account to a collection agency. The organization's credit-and-collection policy and relevant federal and state laws should cover the extent to which the organization and collection agency should seek payment. The organization's board should also play a role in deciding how aggressively to pursue overdue bills. If a patient does not pay even after these efforts, the organization may decide to write off the bill as a bad debt. The Affordable Care Act of 2010 (ACA) has regulations that direct how aggressively a nonprofit hospital can collect bills of patients who meet the hospital's financial assistance policy --Costs associated with accounts receivable include a carrying cost, a routine credit-and-collection cost, and a delinquency cost -----steps in managing are policies and procedures, accounting system, medical record system (Traditionally, HIM departments were not involved with the medical record until after discharge. With the advent of Medicare prospective payment, hospitals needed a preliminary diagnosis-related group (DRG) assignment at patient admission; needed to monitor use during the patient stay; and needed to interface the patient billing system with the medical record system to determine cost per DRG. Completing the medical record in a timely fashion is still important, particularly as required for Joint Commission accreditation. The penalty for delinquent medical records—limits on or suspension of medical staff privileges—has always been difficult to enforce because of the financial effect on the hospital caused by limiting physician privileges. How-ever, from the accounts receivable perspective, emphasis has changed from promptness to accuracy of medical records.Some of the pressure to complete the medical record in a timely fashion has diminished with the increase in fixed payments, such as DRGs. Also, hospitals are no longer required to have a signed physician attestation before submitting a Medicare claim. Finally, as electronic medical records have become more common, medical records turnaround time has improved.), credit and collection policy

accrued wages payable

Accrued wages payable is money owed but not yet paid to employees for work already performed for the organization

forecast rationale

After preparing the forecast content, the manager must prepare the forecast rationale, which is an explanation of how the situation will evolve from its current state to its forecasted state. The forecast rationale clarifies the result of the forecasting process, provides a basis for evaluating the forecasting process, and provides a basis from which future forecasts can be made

last-in, first-out (LIFO)

An inventory valuation system that assumes that the last items put into the inventory will be the first taken out. Thus, the value of the remaining inventory is based on the cost of the earliest additions to the inventory --LIFO produces an inventory of older items. The total cost of inventory is determined by multiplying the unit cost of the oldest items in inventory by the number of units in inventory.

specific identification

An inventory valuation system that determines the actual value of each inventory item --Specific identification is used when inventory items are easy to identify and when the cost of each inventory item is high

prerequisites to budgeting

Before effective budgeting can begin, the organization must meet several prerequisite requirements, the first four of which were introduced in chapter 13 related to planning: 1. A sound organizational structure that ensures management accountability for the budgeting process 2. A well-defined chart of accounts that corresponds with the organizational structure 3. Prompt and accurate accounting systems that ensure financial responsibility for the budgeting process 4. A comprehensive management information system that captures nonfinancial information for each department 5. A budget director who is responsible for coordinating the budget process and who serves as chair of the budget committee 6. A budget committee that is responsible for establishing a budget manual and a budget calendar and assisting department managers in developing their department budgets. Budget committees usually consist of senior managers who represent the department managers in their divisions. 7. A budget manual that includes necessary strategic planning information; the organizational structure; the chart of accounts; a list of budget committee members who can assist department managers; budget forms and instructions; budget assumptions regarding items such as anticipated growth, inflation, and employee raises; and a budget calendar with important completion dates 8. The previous year's data regarding volumes, revenues, and expenses

design characteristics (budgeting) (it's in planning as well)

Budgeting can also be classified by design characteristics; these characteristics also apply to the design characteristics of planning.

types of budgets

Budgeting can be classified by management approach and by design characteristics. Many of the following budget classifications also apply to planning

budgeting

Budgeting is the process of converting the operating plan (discussed in chapter 13) into monetary terms. In addition to converting the operating plan into monetary terms for planning purposes, budgeting is an important way for managers to exert control. Budgets become a control standard against which superiors can easily measure the performance of subordinates. Budgeting is also an excellent opportunity for the finance staff to educate the nonfinance department managers about the relationship of revenues, expenses, and capital expenditures to the overall financial well-being of the organization.Sequentially, budgeting occurs after the steps in operational planning (described in chapter 13) have been completed. Budget information therefore does not bias operating information, especially in not-for-profit healthcare organizations. Department managers should prioritize objectives in the operating plan based on community need, not organizational profitability.

incremental budgeting

Budgeting only for changes, such as new equipment. The assumption in incremental budgeting is that current budget is already optimal -requires budgeting only for changes such as new equipment, new positions, and new programs. Incremental budgeting assumes that all current operations, including positions and equipment, are essential to the continued mission of the organi-zation and that all current operations are working at peak performance. The advantages of incremental budgeting are its ease, the minimal time commitment required to prepare the budget, and the support of a larger organizational culture. The main disadvantage is the assumption that all current operations are essential in a healthcare environment that is changing rapidly

zero-base budgeting

Budgeting that requires all operations to be justified anew; nothing in the current budget is assumed to be already optimal -takes nothing for granted and requires rejusti-fication for existing equipment, positions, and programs, as well as justification for new equipment, positions, and programs.1 Therein lies the principal advantage of zero-base budgeting: In a rapidly changing environment where reimbursement is moving away from cost-based approaches and moving toward prospective payment per case or per enrollee, zero-base budgeting can eliminate unnecessary costs and improve margins. Disadvantages are numerous and include the large time commitment, employee fear and anxiety, and the administrative and communication requirements

management approach (budgeting)

Budgets can be classified by management approach, either with top-down or bottom-up budgeting. In top-down budgeting, as in top-down planning, senior management develops the budget with little or no input from department managers. The advantage of this design is that senior management may be in the best position to objectively view the future; the disadvantage is that budget implementation may be difficult if subordinates have little or no input.In bottom-up budgeting, subordinates develop the budget and submit it to senior management for approval. The advantage to bottom-up budgeting, as with bottom-up planning, is the commitment to the budget by those who developed it. The disadvantage is that subordinates may not be in the best position to view the future.In most cases, a combination of top-down and bottom-up designs is used—senior management decides on budget parameters, and subordinates submit plans within those parameters.

carrying cost

Carrying cost is the cost of holding an inventory of items. When an organization holds items in inventory, carrying costs include an opportunity cost at least equal to the average cost of inventory holdings P(Q/2), derived by multiplying the price of the item P by the average number of items in inventory Q/2, multiplied by the interest rate I at which the organization could have invested: Opportunity cost = IP (Q/2) Carrying cost also includes a holding cost. Holding cost includes the costs of storing, securing, and insuring the items in inventory, and it is derived by multiplying the holding cost per unit (H) by the quantity Q ordered each time: Holding cost = HQ Therefore, carrying cost can be derived by adding holding cost HQ and opportunity cost IP(Q/2): Carrying cost = HQ + IP (Q/2)

current liabilities

Current liabilities include accrued wages payable and accounts payable

access to capital/credit

Facing rising demand for capital caused by aging facilities, the need for expansion, and the introduction of new technologies, many healthcare organizations may not have access to the capital they need. In 2012, the American Hospital Association reported that, in Moody's credit outlook for hospitals, "the preponderance of credit factors facing the industry is unequivocally negative, and is expected to remain negative for at least the next several years" (AHA 2012). Likewise Standard & Poor's (2013) reported a negative outlook for hospitals in the near future; however, it raised its credit rating from negative to stable in 2016, largely due to declines in charity care attributable to the Affordable Care Act. One of the most significant factors affecting an organization's ability to access the capital markets is the organization's creditworthiness. The healthcare industry relies on rat-ing agencies such as Standard & Poor's, Moody's, and Fitch to measure creditworthiness using both objective criteria and subjective assessments of organizations and the markets in which they operate.

tax reform act of 1986

Finally, in the mid-1980s to early 1990s, government efforts to slow capital costs paid off. The Tax Reform Act of 1986 lowered the tax deductibility for charitable gifts and restricted or increased the cost of acquiring capital through tax-exempt bond markets.

Two key reasons materials and inventory is so important:

First and most important, an organization must have the right kind and the right amount of supplies on hand for patient care. Second, effective materials management helps control cost

operational planning

For the strategic direction of the organization to be useful, the organization's managers must translate the strategic direction into small, measurable steps to be taken during the next year. Operational planning is the process of translating the strategic plan into a year's objectives. Budgeting is the process of expressing the operating plan in monetary terms and is covered in chapter 14. Many organizations have difficulty determining where strategic planning ends and operational planning begins, and where operational planning ends and budgeting begins.Three characteristics distinguish strategic planning from operational planning: 1. Planning horizon: Strategic planning is for the next three to ten years, and operational planning is for the next year. 2. Principal participants: The governing body and executive management develop the strategic plan; the department managers develop or have significant input in the operational plan. 3. Objectives: Strategic planning lists primary objectives common to the entire organization, and the operating plan lists secondary objectives by division or department.

financing capital expenditures

Healthcare organizations can use cash generated from philanthropy, funded depreciation, operating surpluses, and debt to finance capital expenditures. Generally speaking, the organization should use funded depreciation to finance replacement equipment and should use philanthropy, operating surpluses, or debt to finance new equipment.

permanent working capital

Healthcare organizations obtain their permanent working capital (the minimum amount of working capital that is always on hand) from the owners to cover start-up costs. In the case of government organizations, the initial working capital comes from the government entity through taxes or bonds. In the case of not-for-profit organizations, the initial working capital comes from the community or religious order through tax-exempt bonds. In some cases, working capital may come from philanthropy. In the case of for-profit organizations, the initial working capital comes from the sale of stock

strategic planning

In a 2006 survey of 138 Texas hospitals, 13 percent did not have a strategic plan; for the hospitals that did have a strategic plan, 50 percent did not delegate the responsibility for the plan to the chief executive officer (CEO). The average board member involvement was rated at 4.86 on a 7.0 scale. All three characteristics—existence of a strategic plan, delegation of plan responsibilities to the CEO, and board member involvement in the development of the strategic plan—had a statistically significant effect on higher financial performance

step 9: develop secondary, or department, objectives

In the ninth step in the corporate planning process—the first step in the operational planning stage—department managers develop secondary, departmental objectives to support the strategic plan of the organization: ◆Department objective setting should be participative. Meaningful employee participation in planning improves both morale and the chances of meeting objectives. ◆Department objectives should be rigorous but attainable. The department will not progress if the objectives are easily attainable, but the department may not attempt objectives that seem too difficult. ◆Department objectives should be verifiable and/or measurable to ensure progress and to reward those responsible for the progress. For Joint Commission accreditation purposes, the manager and subordinates should discuss desired outcomes and their indicators. One method of developing department objectives is Peter Drucker's management by objectives (MBO), introduced during the 1950s (Drucker 2008). In a nutshell: (1) the manager provides subordinates with a general overview of the work to be accomplished in the coming year, (2) the subordinates propose objectives, and (3) the objectives are negotiated until final agreement. Reported advantages of MBO include directing work activity toward organizational goals, reducing conflict and ambiguity, providing clear standards for control and performance appraisals, and improving motivation. MBO is not without disadvantages, including burdensome procedures and paperwork; overemphasis on quantitative objectives at the possible expense of qualitative objectives; suboptimization of performance; and illusionary participation, which means that managers give the perception of participation, but the participation lacks meaningful substance, often because the subordinates sense that decisions have already been made.

R^2

Introduction➤to➤the➤Financial➤Management➤of➤Healthcare➤Organizations320The coefficient of determination, symbolized by R2, indicates the proportion of the variance of the forecast variable that is explained by the regression statistic. When given a choice between two or more regression statistics, the manager should select the statistic that maximizes the coefficients of determination. The causal variables in regression may include time, leading economic indicators, demographic factors, or any other variables that might exhibit a causal relationship with the forecast variable.

lease versus purchase decisions

Lease versus purchase decisions are made after the decision to acquire the equipment; therefore, the lease versus purchase decision is in fact a financing decision. Generally, there are two types of leases: operating leases and capital leases. Operating leases are for periods shorter than the equipment's useful life and are common for copy machines, desktop computers, and cars. Capital leases are for the equipment's approximate useful life and usually include provisions for the lessee to purchase the equipment at the end of the lease period.Lease decisions have several advantages over purchase decisions and can provide the lessee with more flexibility, more financing options for other equipment, more protection from unexpected events such as changes in technology, and more and better maintenance. In the case of for-profit healthcare organizations, capital leases can provide the same tax advantages as equipment purchases.Lease decisions have several disadvantages over purchase decisions—including penal-ties for early lease termination and the requirement that the property be maintained in good working condition—and leases are generally more expensive than the purchase decision because lessors must make a profit and cover their risk of loss.Exercise 15.1 gives a simple way of analyzing the costs associated with a nonprofit facility either purchasing or leasing a $1.3 million magnetic resonance imaging machine by applying a PV of 10 percent to both decisions (a for-profit facility would have tax shields, or reductions in the amount of income taxes paid, due to the tax deductibility of depreciation and interest expense).

inventory performance

Low values indicate overstocking and thus an inappropriate investment in nonproductive assets. This ratio does show directionality; higher values are considered to be better. Because of their size, healthcare systems enjoy considerable purchasing power and often receive medical supplies on consignment. This means that the vendors do not charge the system until the supply item is used, so inventory value is very low.

trend pattern

Many series of data collected over time will exhibit trend, seasonal, cyclical, horizontal, and random patterns. A trend pattern exists when the value of the variable consistently increases or decreases over time

debt

Moody's downgraded a record amount of debt held by not-for-profit hospitals in 2012. In downgrading the debt, Moody's noted a challenging operating environment, increasing debt loads, declining liquidity, greater competition, and management and governance issues. Historically, size has insulated large systems from downgrades; however, in 2012 the majority of the downgraded debt ($13 out of the $20 billion) belonged to just three large systems. In addition to size of system, the following characteristics have typically led to stronger bond ratings (Kutscher 2013): ◆Effective management and governance ◆Improved and sustained operating performance ◆Strong and liquid investment portfolios and management of debt structure risks ◆Favorable market demographics and market share ◆Favorable change in organizational or legal structure With many hospitals at debt capacity, credit markets limiting the extension of credit, and operating and investment margins declining, many future capital expenditures will be financed through hospital consolidations, including mergers, acquisitions, and joint ven-tures (Grauman, Harris, and Martin 2010; Commins 2016), which makes the planning and budgeting functions all the more crucial. Sometimes leasing is considered as another method of financing a capital expenditure.

corporate planning

Most healthcare organizations have moved away from facility planning—planning based on their own needs—which was popular under retroactive, cost-based reimbursement. They have instead adopted a business planning approach based on market needs, called corporate planning. Corporate planning consists of four major stages: 1. Strategic planning: determines the organization's overall direction in the next three to ten years 2. Operational planning: converts the strategic plan into the next year's objectives 3. Budgeting: converts the operating plan into budgets for revenues, expenses, and cash 4. Capital budgeting: converts the operating plan into budgets for capital expenditures the corporate planning process consists of 22 steps that progress through the four stages within the planning horizon

ordering cost

Ordering cost O is the administrative cost associated with placing a single order for the inventory item. Ordering cost includes the costs of ◆writing specifications, ◆soliciting bids, ◆evaluating and awarding bids, ◆preparing and signing the contract, ◆preparing the purchase order, ◆receiving the items, and ◆accounting for and paying the invoice. --Total ordering cost associated with an inventory item is dependent on the number of orders placed for the item. The number of orders is derived by dividing demand by the size of a single order, called quantity Q. (# of orders= Demand/Quantity) Total ordering cost for an item in inventory is then derived by multiplying the number of orders per year by the ordering cost: total ordering cost= (D/Q)O

payback period analysis

Payback period is the number of years necessary for cash flows to recover the original investment. Payback period analysis is easy to calculate (see problem 15.1), but it is the least sophisticated of the three analyses because it does not take into account the effects of time on money

planning

Planning as a management function is the process of deciding in advance what must be done in the future. Planning consists of establishing the goals, objectives, policies, procedures, methods, and rules necessary to achieve the purposes of the organization. Planning precedes, and serves as a framework for, the other management functions of organizing, staffing, influencing, and controlling. Effective planning is a continuous process; managers are responsible for planning for the appropriate use of resources in their areas of responsibility in concert with the operational and strategic direction of the organization. In the absence of effective planning, managers would engage in random activities. In healthcare organizations where customers demand a high degree of predictable outcomes, such random activities on the part of managers would have a disastrous effect --First, the organization must have a sound organizational structure that ensures management accountability for the planning process. --Second, the organization must have a well-defined chart of accounts that corresponds with the organizational structure. --Third, the organization must have a prompt and accurate accounting system that ensures financial accountability for the planning process. --Fourth, the organization must have a comprehensive management information system that captures nonfinancial information for each department

management approach

Planning can also be classified by management approach, or top-down versus bottom-up planning. These approaches correspond closely with top-down and bottom-up budgeting, to be discussed in chapter 14. In top-down planning, senior management, which includes the division heads or vice presidents, develops the plan with little or no input from sub-ordinates. The advantage of such a design is that senior management may be in the best position to objectively view the future. The disadvantage of the top-down design is that plan implementation may be difficult if subordinates have little or no input.In bottom-up planning, subordinates develop the plan and submit it to senior management for approval. The advantage to bottom-up planning is the commitment to the plan by those who developed it. The disadvantage is that subordinates may not be in the best position to view the future.1In most cases, a combination of the top-down and bottom-up designs is used, with senior management deciding on plan parameters and subordinates submitting plans within those parameters.

temporary working capital

Sometimes healthcare organizations have an unexpected increase in business that depletes their working capital reserves. When that happens, they need temporary working capital, which comes from equity, debt,or trade credit. --For instance, the category of accrued wages payable is typically due every 14 days and accounts payable is typically due every 30 days, but accounts receivable may take as long as 60 days to collect. If the organization does not have enough cash to meet its obligations while waiting for the accounts receivable to be paid, it may need an infusion of cash from new investment (equity) or the bank or other lender (debt); or it may need to ask its creditors to extend its payment deadlines or enlarge its credit line (trade credit). ---Debt should not be used for permanent working capital needs, nor should it be used for temporary working capital needs unless there is reasonable assurance that the debt can be repaid. For instance, in situations where healthcare organizations lack the working capital necessary to pay employees and vendors because of a decline in business, increasing debt may be a mistake unless alternative sources of funds exist from which the debt can be repaid

affordable care act

The ACA imposes requirements on tax-exempt hospitals regarding billing and collections. Hospital financial assistance policy requirements such as the following must be adopted, implemented, and publicized: ◆Criteria for granting financial assistance to patients ◆The basis for calculating the amount charged to patients and limitations on charges to patients eligible for financial assistance, including charging no more than the lowest amount charged to insured patients ◆A method for applying for assistance ◆Debt collection actions, including the avoidance of extraordinary collection efforts until eligibility for financial assistance is determined ◆Availability of emergency care regardless of the patient's ability to qualify for financial assistance

fair credit reporting act

The Fair Credit Reporting Act governs the permissible uses of credit reports. The act lists the ways credit reports can be obtained, including by court order, by permission of the consumer, and by legitimate business need. Information that must be removed from credit reports and the time at which that information must be removed follows (HFMA 2012): ◆Bankruptcies after ten years ◆Judgments after seven years or when the statute of limitations expires, whichever is longer ◆Paid tax liens after seven years ◆Collection accounts or those charged to profit and loss after seven years ◆Arrests, indictments, or convictions after seven years ◆Other adverse items after seven years

fair debt collection practices act

The Fair Debt Collection Practices Act applies only to third-party collectors. As long as the healthcare organization collects its own debts, the act does not apply. If the organization contracts with a collection agency, or operates a collection agency under another name, the act does apply. The act deals with four key bill-collecting practices: 1. Skiptracing: Governs how the debt collector communicates with consumers owing the debt and under what conditions a debt collector can communicate with others regarding the debt 2. Collector communication:Governs when debt collectors can communicate with consumers 3. Harassment:Identifies certain behaviors and actions by debt collectors that may be considered harassment and are therefore prohibited 4. Deceptive or false representations:Prohibits misleading representation designed to intimidate the consumer

tax reform act of 1986

The Tax Reform Act of 1986 limited the tax deduction individuals were able to take for donations; as a result, philanthropy to healthcare organizations declined. The decline in philan-thropy paralleled an increase in debt financing because of two federal government policies. First, Medicare reduced the risk associated with debt financing by reimbursing 100 percent of the interest on debt used for capital expenditures (which ended in 1992 when capital and interest associated with capital became part of the DRG formula). Second, the Nixon administration encouraged debt financing by allowing local governments to create taxing authorities that issued tax-exempt bonds. As a result of these two policies, hospitals and many other healthcare organizations have relied on debt financing significantly more than other industries have.

truth in lending act

The Truth in Lending Act establishes disclosure rules for sales involving consumer credit. It requires a written agreement and four or more installments. In addition, the lending organization must disclose the following under Regulation Z: ◆Annual percentage rate ◆Amount of the finance charge ◆Amount of the principal ◆Amount for each payment ◆Number of payments ◆Total of all payments ◆Late-charge arrangements ◆Prepayment arrangements ◆An opportunity for the debtor to receive an itemization of how the payments are to be applied

compounding

The action of adding interest to interest on an investment --Compounding is used to determine the amount of income that investments will generate. Compounding is a way of looking at a present amount of money, called present value (PV), and calculating the future amount of money, called future value (FV), using the following formulas: FV=PV(1+i)^n FV=PV(1+i/m)^mn m=number of times compounded each year

production units

The best measures of what an entity is producing. For examples, patient days and admissions are both considered production units for a hospital

steps in budgeting stage

The budgeting stage is a key part of the corporate planning process that was introduced in chapter 13. The entire process has 22 steps, the first 13 of which encompass the strategic planning and operational planning stages discussed in chapter 13. The four steps of the budgeting stage are discussed in this chapter. The final five steps, which make up the capital budgeting stage, will be covered in the next chapter

capital budgeting stage

The capital budgeting stage is the final part of the 22-step corporate planning process that was introduced in chapter 13 (see exhibit 13.1) and a crucial follow-up to the budgeting stage discussed in chapter 14: Budgeting must be concluded to determine funds available for capital expenditures.

R^2

The coefficient of determination, symbolized by R2, indicates the proportion of the variance of the forecast variable that is explained by the regression statistic. When given a choice between two or more regression statistics, the manager should select the statistic that maximizes the coefficients of determination. The causal variables in regression may include time, leading economic indicators, demographic factors, or any other variables that might exhibit a causal relationship with the forecast variable. A measure of the statistical contribution of a causal variable to regression's causal power is the beta coefficient, which indicates the relative importance of each of the causal variables in explaining or predicting changes in the forecast variable. In multiple regression, the manager can use beta coefficients to decide which causal variables to retain and which to exclude. The manager should be cautioned regarding one flaw in multiple regression: multicollinearity, which is the phenomenon that occurs when causal variables relate to each other in addition to the relationship to the forecast variable

delinquency cost

The cost incurred by the organization for the patient not paying on time. These costs can include the costs associated with turning the account over to a collection agency or with writing off the account to bad debt.

overstock cost

The cost of carrying more inventory than demand calls for --(expressed formulaically as L) is the cost associated with having more than enough inventory holdings to meet demand. Overstock cost includes the carrying cost associated with stocking items for additional accounting periods until the organization uses and expenses the items.

step 18: identify and prioritize requests

The eighteenth step in the corporate planning process—the first step in the capital budget-ing stage—is for the budget committee to identify and prioritize all capital requests. Typically, the budget committee asks department managers, including the chief of medical staff services (included with department managers in this chapter discussion), to list the capital equipment and buildings needed and to justify the resources needed. After the department managers have provided a list, the budget committee prioritizes the list on the basis of community need and compliance with the strategic plan as initial criteria.

step 8: develop the strategic financial plan

The eighth step in the corporate planning process and the last step in the strategic plan-ning stage is for the governing body and CEO to develop the strategic financial plan. The strategic financial plan is the link between the strategic plan, which looks three to ten years out, and the operating plan, which looks one year out. In essence, the strategic financial plan is the quantification of a series of strategic planning policy decisions that will answer whether the organization can make progress toward accomplishing its strategic plan over the next ten years. These decisions are based on the answers to the following questions regarding the five-year planning horizon: ◆How much cash should the organization have five years from now (days cash on hand ratio)? ◆How much debt can the organization afford to take on five years from now (debt service coverage ratio)?◆What profitability targets are necessary to meet the cash and debt metrics identified (operating margin and excess margin ratios)? ◆What is the required level of operating change necessary to meet the profitability targets identified (projected increases in net revenues and decreases in operating expenses)? ◆What are the organization's strategic capital requirements over the next five years (five-year capital spending projection)? ◆What is the financing method for the capital necessary to meet the capital requirements identified (debt, equity, lease, or philanthropy)?All of the industry ratios identified earlier can be obtained by rating agencies, which might rate the hospital in the future if part of the financing will be dependent on bonds. Progress toward these ratios is also an excellent way for the governing board to evaluate the CEO on an annual basis (Nowicki 2004).

step 11: develop procedures

The eleventh step in the corporate planning process—the third step in the operational planning stage—is for department managers and supervisors to develop procedures, which are guides to action. Procedures are derived from policies, but they are considerably more specific. Procedures identify in a step-by-step fashion how to accomplish a policy. Good procedures are the result of a detailed analysis of how best to accomplish the intent of the policy. Good procedures provide the manager or supervisor with a consistent and uniform performance appraisal.

step 5: establish strategic thrusts

The fifth step in the corporate planning process and the strategic planning stage is for executive management to establish strategic thrusts, or goals, which are broad statements of significant results that the organization wants to achieve related to its vision. Strategic thrusts should be limited in number, stable and enduring, and, taken together, comprehensive to the point that they provide meaningful results for all components of the organization's mission

step 1: validate mission and strategic interpretations

The first step in the corporate planning process—also the first of the eight steps in the strategic planning stage—is for the executive management team, which includes the governing body and the CEO, to validate the organization's mission. The mission is a broad statement of organizational purpose that can be easily communicated throughout both the organization and the community. Because mission statements are broad, organizations should not need to change them frequently; mission statements should survive to the end of the planning horizon. A study of more than 200 Fortune 500 companies identified common characteristics of effective mission statements (Pearce and David 1987). The mission statements: ◆target customers and markets, ◆indicate the principal services delivered by the organization, ◆specify the geographic area in which the organization intends to operate, ◆identify the organization's philosophy, ◆confirm the organization's self-image, and ◆express the organization's desired public image. Strategic interpretations provide the means for executive management to interpret the mission statement by recognizing the changing character of the healthcare industry and the changing needs of the community. Strategic interpretations may also prioritize organizational purposes when the mission statement includes multiple purposes that might conflict when operationalized. Strategic interpretations are seldom directly stated in any form and are more often represented in the actions of executive management. For instance, executive management may show a preference for one purpose over another through the budget allocation process.

step 14: project volumes (sometimes called statistical budget)

The fourteenth step in the corporate planning process—the first step in the budgeting stage—is to project volumes for the budget year. This step is often called the statistical budget, and it is sometimes part of the operating plan. Typically, the budget committee will give its projections of the organization's production units to department managers in the budget manual. Department managers use the organization's production units to calculate department production units that are specific to each department. For instance, the radiology department manager must be able to determine how many radiology procedures are generated for every 100 admissions.

step 4: formulate the vision

The fourth step in the corporate planning process and the strategic planning stage is for the executive management team to formulate a vision—a view of the future that the team members think gives the organization the best chance of accomplishing its mission. Executive management bases its vision on the information obtained from assessing the external and internal environments. It must communicate its vision throughout the organization. Effective vision statements have certain characteristics in common, as described in the still-timely text Thriving on Chaos: Handbook for a Management Revolution (Peters 1988). They should ◆be inspiring first of all to employees, but also to customers; ◆be clear, challenging, and about excellence; ◆make sense to the community, be flexible, and stand the test of time; ◆be stable, but change when necessary; ◆provide direction in a chaotic environment; ◆prepare for the future while honoring the past; and ◆be easily translated into action.

evaluating budget performance

The governing body of the organization should review the budget annually and evaluate the chief executive officer (CEO) on the basis of organizational compliance with the budget. Likewise, the CEO should review senior management quarterly and evaluate senior man-agers based on divisional compliance with the budget. Senior management should review department managers monthly and evaluate departmental compliance with the budget.The most common method of evaluating budget performance is variance analysis, which compares budgeted production units, revenues, and expenses to actual production units, revenues, and expenses, typically monthly. Labor variance analysis, including hours and expense, may be completed every two weeks in conjunction with payroll. The variance is the amount of the difference between the actual and budgeted amount: variance=actual-budgeted For production units and revenue, positive variances are favorable and negative variances are unfavorable: Revenue variance = Actual revenue - Budgeted revenue For expenses, negative variances are favorable and positive variances are unfavorable: Expense variance = Actual expense - Budgeted expense

evaluating plan performance

The governing body of the organization should review the strategic plan on an annual basis and evaluate the CEO based on progress in accomplishing primary objectives. Likewise, executive management should review the operating plan, probably on a monthly or quarterly basis. It should also evaluate department managers on the basis of their progress in accomplishing secondary objectives and compliance with policies, procedures, methods, and rules. The Joint Commission requires that hospitals have a planned, systematic, hospital-wide approach to process design and performance measurement, assessment, and improvement. The relevant standard requires leaders to "establish priorities for performance improvement" in the following ways: 1. Leaders set priorities for performance improvement activities and patient health outcomes. 2. Leaders give priority to high-volume, high-risk, or problem-prone processes for performance improvement activities. 3. Leaders reprioritize performance improvement activities in response to changes in the internal or external environment.Budgeting, the next step in the corporate planning process, begins once the strategic and operating plans have been approved; budgeting consists of converting the operating plan into monetary terms.

inventory management

The management and control of items that have an expected useful life of fewer than 12 months

causal models

The manager may use causal models when the forecast variable is dependent on a causal, or independent, variable. The most common statistical method used in causal models is regression analysis, which mathematically describes an average relationship between a forecast variable and one or more causal variables. For instance, the manager can use a regression line based on past volumes over time to predict future volumes

time-series methods

The manager may use time-series methods when the past behavior of a variable is available to predict the future behavior of the variable. Time-series methods do little to account for causal relationships; rather, they attempt to identify historical patterns that are likely to be repeated in the future. The manager may use regression for long-term forecasts and time-series methods for forecasts of less than one year

time-series methods

The manager may use time-series methods when the past behavior of a variable is available to predict the future behavior of the variable. Time-series methods do little to account for causal relationships; rather, they attempt to identify historical patterns that are likely to be repeated in the future. The manager may use regression for long-term forecasts and time-series methods for forecasts of less than one year.Many series of data collected over time will exhibit trend, seasonal, cyclical, horizon-tal, and random patterns. A trend pattern exists when the value of the variable consistently increases or decreases over time. A seasonal pattern exists when the value of the variable fluctuates according to a seasonal influence, such as hour of the day, day of the week, week of the month, or month of the year. A cyclical pattern is similar to a seasonal pattern; how-ever, the length of each cycle is longer than one year and cycles vary in length. A horizontal pattern exists when the variable's value does not change over time. A random pattern exists when the variable's value changes, but in no predictable way (Berenson and Levine 1993).After preparing the forecast content, the manager must prepare the forecast rationale, which is an explanation of how the situation will evolve from its current state to its forecasted state. The forecast rationale clarifies the result of the forecasting process, provides a basis for evaluating the forecasting process, and provides a basis from which future forecasts can be made.

step 19: project cash flows

The nineteenth step in the corporate planning process—the second step in the capital budgeting stage—is for the department managers to project, and the budget committee to confirm, cash flows for each capital expenditure request. In cases of replacement equipment, this is a relatively easy step in that revenues (Volumes × Charge per procedure), expenses (Volumes × Expense per procedure), and resulting cash flow (Revenues - Expenses) already exist. However, the department manager must indicate any changes in revenue or expenses that will occur with the replacement equipment. --For new equipment, or equipment that the organization has never had before, revenues and expenses may be difficult to project. The department manager can obtain volumes in a number of ways. --First, if the organization is currently using an outside service that will be replaced by the new equipment, the department manager can obtain volumes from accounts pay-able. If the organization is not currently using an outside service, the department manager can administer a questionnaire to potential users or complete a medical record review to determine how many patients would have used the new equipment had it been available.For expensive equipment such as computed tomographic scanners, manufacturers will assist in the medical record review; however, the department manager should review manufacturer projections carefully because manufacturers have a vested interest and may overproject volumes. The department manager can obtain charge information from neigh-boring facilities or insurance companies. The department manager can also obtain expense information from neighboring facilities or the manufacturer. If the manager obtains the information from the manufacturer, it is a good idea to confirm it with other organizations that use the same equipment—manufacturers should be willing to provide client lists.For equipment that does not generate revenue, department managers can still project cash flow by using salary savings, utility savings, and so on.Previously incurred costs, or sunk costs, and costs that would be incurred regardless of the budget outcome should not be included in cash-flow projections.

collection period

The number of days between the time of service and the time of payment --The objective of managing the revenue cycle is to reduce the collection period, which is the number of days between the time of service and the time of payment. An obvious way to reduce the collection period is to collect as much money as possible as soon as service is provided. Management of the revenue cycle includes four steps, involving policies and procedures, an accounting system, a medical record system, and a credit-and-collection policy

factoring receivables

The practice of selling accounts receivable to a third party at a discount. The third party attempts to collect the accounts and keeps the money

step 2: assess the external environment

The second step in the corporate planning process and the strategic planning stage is to assess the external environment, including factors that might have an effect on present or future performance. To maintain objectivity and guard against vested interests, a govern-ing body or outside consultants should be responsible for assessing both the external and internal environments. The first part of the assessment should include a determination on the direction of the industry as a whole by investigating national trends. Some of the cur-rent national trends for the healthcare industry include: ◆decreasing reimbursement from federal and state health programs as government tries to slow rising healthcare costs; ◆increasing popularity of managed care programs (and capitation), especially among payers including employers; ◆increasing consolidation as a result of competition; ◆continuing expansion into businesses outside the traditional healthcare industry; ◆increasing growth in outpatient care, preventive care, and innovative alternative delivery systems; ◆declining numbers of rural and public teaching hospitals; and ◆decreasing numbers of uninsured patients as the Affordable Care Act (ACA) is implemented and more people are insured. The second part of the external environment assessment should determine the direction of the local market and should investigate the following elements: ◆Demographic and socioeconomic characteristics of the primary and secondary service areas and their effect on present and future utilization patterns ◆Key economic and employment indicators and their effect on present and future utilization patterns ◆Patient migration patterns, to determine from where patients and potential patients come ◆Market share statistics for key competitors, to determine market strengths and weaknesses ◆Competitor profiles, including strengths and weaknesses, use by service, use by payer, exclusive and other managed care contracts, extent of horizontal and vertical integration, potential expansion plans, and cost comparisons ◆A managed care profile, to determine present and future managed care penetration ◆A physician profile, to determine numbers, ages, and specialists available in the market Any significant differences between national trends identified in the first part of the external environment assessment and the local trends identified in the second part of the external environment assessment should be thoroughly analyzed to determine the reasons for the differences.

step 7: develop primary, or core, objectives

The seventh step in the corporate planning process and the strategic planning stage is for executive management to develop primary, or core, objectives that support the strategic thrusts or goals. Primary objectives should encompass the entire organization. Organizations have several primary objectives; the real challenge lies in balancing them.

step 16: convert volumes into expense requirements

The sixteenth step in the corporate planning process—the third step in the budgeting stage—is to convert volumes into expense requirements: labor expense with benefits, non-labor expense, and overhead expense. Department managers should have budget histories that indicate labor expense with benefits per production unit. They should also have budget histories for nonlabor expense per production unit, which includes supplies, travel, and repairs. The budget director should have budget histories for overhead expense for the organization. Staffing mix is the proportional combination of full-time, part-time, and temporary workers and should be reviewed by the department manager; department skill mix, which is the proportional combination of skilled positions, should also be reviewed by managers. Most departments have a variety of tasks requiring a variety of skills performed by a variety of positions paid a variety of wages. The department manager's job is to match the tasks to the positions in the most cost-effective manner possible. After the department managers have reviewed staffing mix and skill mix and have made any necessary changes, they must consider the effect of employee raises on their expense budget. The budget committee should provide department managers with information regarding cost-of-living raises, merit raises, and bonuses. Merit raises are designed to motivate employees toward, and reward employees for, meritorious performance. Merit raises as a motivator are dependent on the amount of the raise and the likelihood that superiors will judge performance as meritorious. Merit raises are expensive for organizations because the amount of the raise is built into the employee's base pay for future years.Organizations typically give merit raises in conjunction with employee performance appraisals on employment anniversaries. Assuming that employment anniversaries occur in equal distribution throughout the year, the effect on the department budget will be 50 percent of the total amount for merit raises, and the budget should be adjusted accordingly. For instance, if the department manager can give 5 percent raises to meritorious employees on their employ-ment anniversaries, and all the department's employees are meritorious, the annual effect on the department will be 2.5 percent, assuming that 50 percent of the employment anniversaries are in the first half of the budget year and 50 percent of the employment anniversaries are in the second half of the budget year.Bonuses are designed to motivate employees in much the same way as merit raises. However, using bonuses as a motivator is dependent on the amount of the bonus, the likelihood that superiors will judge performance "bonus-worthy," and the proportion of employees receiving the bonus. For instance, if all employees receive bonuses, motivation resulting from the bonus will be low because everyone receives a bonus. If 1 out of 100 employees receives a bonus, motivation will be low because the chance of being rewarded for bonus-worthy performance is low. However, if 1 out of 7 employees receives a bonus, motivation as a result of the bonus will be maximized because the chances of receiving a bonus are realistic. Organizations typically award bonuses at the end of the budget year, and the funds come from the organization, not the department; budgeting the effect of bonuses, therefore, is relatively easy.After budgeted department wages have been adjusted for changes in staffing mix, skill mix, and employee raises, department managers multiply the budgeted wages and benefits per production unit by the number of production units projected for the budget year to determine the total budgeted wages and benefits for the department.Department managers should have budget histories that indicate nonlabor expense per production unit and should review those figures to determine whether they can reduce expenses. Managers should review supply use to ensure that generic supplies are used when-ever possible. The pharmacy manager should provide information on the use of generic medicines and work with the pharmacy committee to maintain a formulary with as many generics and as few brand-name pharmaceuticals as possible. The pharmacy manager should also establish security measures to ensure that narcotics are secure. Department managers should review travel expenses and bring training programs to the organization whenever possible to reduce travel expense. Department managers should review repair expense and maintenance agreements, and replace equipment when feasible. The manager of materials management should provide department managers with an estimate of anticipated cost increases in supplies, repairs, and travel as a result of contract renewals or inflation.After department managers have reduced nonlabor expense wherever possible, department managers multiply the nonlabor expense per production unit by the number of production units projected for the budget year to determine the total budgeted nonlabor expense for the department.Largely, overhead expenses for the organization (such as depreciation, heating and cooling, insurance premiums, and so on) do not fluctuate with production units. Therefore, the budget committee determines the overhead expenses for the budget year after reviewing historical data to determine whether adjustments are necessary.

step 6: identify critical success factors

The sixth step in the corporate planning process and the strategic planning stage is for executive management to identify critical success factors that will measure progress toward achieving the plan (Dunn 2016). The assessment of the environment should introduce both strategic thrusts and critical success factors. Critical success factors are organization specific, but most healthcare organizations will include critical success factors from the following areas: ◆Inpatient use and market share ◆Outpatient use and market share ◆Managed care use and market share ◆Medical staff profiles and activity levels ◆Accessibility indicators ◆Cost-effectiveness indicators ◆Efficiency indicators ◆Quality indicators

step 10: develop policies

The tenth step in the corporate planning process—the second step in the operational planning stage—is for department managers to develop policies (broad guides to thinking) that provide subordinates with general guidelines for decision making. Policies are the most common type of plan at the department level (Dunn 2016). According to Dunn, good policies have the following characteristics: ◆They are issued by top management and provide managers with general guidelines for decision making. ◆They are flexible, so managers can apply them to normal and abnormal circumstances.2 ◆They are stated simply and clearly. Policies should not require complex interpretation. ◆They are communicated so that both managers and subordinates are aware of them. Most policies are written, which helps ensure consistent understanding ◆They are consistent with one another. Inconsistency among policies or in the application and enforcement of policies will affect morale and will likely detract from accomplishing objectives. Inconsistencies frequently occur in the enforcement of organizational policies between departments, and they can have dire consequences.

step 3: assess the internal environement

The third step in the corporate planning process and the strategic planning stage is for the governing body or outside consultants to assess the internal environment, including factors that might have an effect on performance either now or in the future. The first part of the assessment should determine the direction of the organization by investigating organizational trends. Some of the organizational trends for analysis might include: ◆patient composition, including utilization patterns (i.e., patient days, outpatient visits, admissions, discharges, lengths of stay, age, payer, patient origin); ◆medical staff composition, including use patterns by specialty, age, practice (solo versus group), admissions, lengths of stay, and board certification; ◆agreements with payers and managed care organizations; ◆a financial assistance policy that is readily available to the public; ◆financial ratios, including liquidity, profitability, activity, capital structure, and operating ratios (see chapter 3); and ◆Joint Commission quality measures and safety indicators Some organizations use a SWOT (strengths, weaknesses, opportunities, and threats) analysis to assess the internal environment. A SWOT analysis forces the organization to identify its strengths and weaknesses during internal assessment. Then the organization identifies opportunities for additional market penetration with existing or new programs and threats from competitors that might reduce the organization's chances for success (Dunn 2016).The ACA requires tax-exempt hospitals to complete a community health needs assessment every three years and to make the assessment, along with audited financial statements, available to the public. The assessment must include a treasurer review of community benefit and an explanation for why certain community health needs are not being addressed. The presumption is that community health needs should be met and financed with the difference between tax savings and the cost of providing community benefit.

step 13: develop rules

The thirteenth step in the planning process—the fifth and final step in the operational planning stage—is for department managers to develop rules, which are statements that either require or forbid an action or inaction. The manager or supervisor has some flexibility in the application and enforcement of policies, procedures, and methods—but not rules. Good rules are those that everyone sees as clearly necessary for the proper order and functioning of the department.

float period

The time between when a check is written and when it is presented for payment

total cost

The total cost TC formula produces the minimum costs associated with keeping a specific item in inventory for a period of one year, and it is derived by adding purchasing cost PD, total ordering cost (D/Q)O, carrying cost (HQ + IP[Q/2]), stock-out cost S, and overstock cost L: total cost= PD+(D/Q)O+(HQ+IP[Q/2]+S+L The total cost formula can provide a basis for a variety of real-world situations the manager may face. For instance, a vendor offers a manager a 10 percent discount on price if the vendor can reduce the number of deliveries per year to four. In this situation, the total cost TC formula changes based on the new information: price P becomes P - 10 percent, and quantity Q becomes D4. After reworking the TC formula, if adjusted total cost is less than the original total cost, the manager should accept the vendor's offer.Here's another example. If the manager has $10,000 budgeted for an inventory item and must ask the vendor for a discount on price, TC is $10,000, and the unknown variable is price P. But before calculating the total cost formula in this example, the economic order quantity Qe must be calculated.

step 12: develop methods

The twelfth step in the corporate planning process—the fourth step in the operational planning stage—is for department managers and supervisors to develop methods to accomplish the procedures. Methods are detailed, uniform actions with specific instructions and predictable outcomes

step 20: perform financial analysis

The twentieth step in the corporate planning process—the third step in the capital budgeting stage—is for the budget committee or the chief financial officer (CFO) to perform financial analyses on the requests. Before Medicare stopped reimbursing capital at cost, few healthcare organizations performed any significant financial analyses on equipment because in the risk-free environment of cost-based reimbursement, healthcare organizations and their lenders were guaranteed a return on capital expenditures regardless of whether they used the equipment. In a 1973 study of large hospitals, only 8 percent of the hospitals calculated the net present value of a capital expenditure before purchasing it (William and Rakich 1973). Some hospitals had two of everything in case the first broke (they preferred capital expense to labor and repair expenses). As the Medicare reimbursement for capital costs was folded into the DRG formula during the 1990s as a result of the OBRA of 1990, healthcare organizations found them-selves competing with other industries for limited capital funds. Healthcare organizations no longer had cost-based reimbursement to put up as collateral, and as a result, lending institutions required financial analyses to ensure that the capital expenditure would generate sufficient revenue to repay the loan. As a result, net present value and return on investment calculations are completed on most capital expenditures today. This section defines and explains how to calculate several analyses that are used to measure the benefit-to-cost ratio. In theory, these analyses are benefit-cost analyses, which are based on the Pareto optimality, or a condition in which changes occur only if they improve the benefits more than they increase the costs. In benefit-cost analysis, both costs and benefits are variable, as opposed to cost-effectiveness analysis, where either costs or benefits are held constant. In their simplest forms, benefit-cost analysis is the ratio of discounted benefits to discounted costs, and cost-effectiveness analysis is the benefits obtained for a particular cost. BENEFIT-COST or COST-EFFECTIVENESS The typical financial analyses for capital expenditures are payback period analysis, net present value analysis, and internal rate of return analysis.

step 21: identify nonfinancial benefits

The twenty-first step in the corporate planning process—the fourth step in the capital budgeting stage—is for the department manager requesting the capital expenditure to identify nonfinancial benefits for the request. Examples of nonfinancial benefits could include community need or medical staff politics. Even if the organization is buying equipment just to please a valuable physician, the organization should still complete a financial analysis to determine the equipment's loss, which will need to be subsidized elsewhere

step 22: evaluate benefits and make decisions

The twenty-second and last step in the corporate planning process—the fifth and final step in the capital budgeting stage—is for the budget committee to evaluate the financial and nonfinancial benefits for each request and make decisions. The budget committee can use a decision matrix with weighted criteria similar to that shown in exhibit 15.2. When constructing a decision matrix, criteria are listed on the horizontal axis, and the capital expenditure requests are listed on the vertical axis. To improve the chances that the ultimate decision will be fair, criteria should be determined and perhaps weighted before evaluating the capital expenditure requests using the criteria. Implicit in the decision-making process is an evaluation of the decision. Many healthcare organizations use their internal audit departments to review capital expenditure decisions and the justifications of the department managers to determine their accuracy. Internal auditors can review the actual volumes, revenues, and expenses to determine whether the projections used to support the decisions were accurate

use of experts

The use of experts depends on the manager's ability to identify and secure the services of appropriate experts. Then, the manager must consider the advantages and disadvantages of using experts in preparing the forecast. Using experts is usually quick and relatively inexpensive. However, different experts may develop different, yet valid, opinions about the future. Which expert is correct? To address this disadvantage, managers can choose a variety of models to obtain their opinion (Reeves, Bergwall, and Woodside 1984): ◆A task force brings together several experts who provide collective input. ◆The Delphi technique gathers information from a group of dispersed experts with anonymity and limited interaction. ◆The Delbecq technique, or nominal group process, is similar to the Delphi technique, except that the group of experts meets face-to-face for discussion and to present and defend their forecasts. ◆Questionnaires are used to gather responses to questions from a large group of experts. ◆Permanent panels maintain a group of experts who can be used for several forecasts over time ◆Essay writing obtains opinions from experts in a format that can be used for preparing the forecast rationale. ◆Computer-facilitated group processes can reveal and "parallel process" more contributions from a greater number of participants than is possible using manual facilitation techniques alone. In addition to relying on expert opinion regarding the future, a manager may apply probability statistics to the expert opinion. Another derivative of using expert opinion is the program evaluation and review technique (PERT). This technique requires estimates of optimistic (O), pessimistic (P), and most likely (ML) future scenarios. These three estimates are weighted to calculate an expected value that equals: (O+P+4ML)/6

value of strategic planning

The value of strategic planning lies in its systematic approach to dealing with an uncertain future. Many organizations become disillusioned with strategic planning when their plans are not met. These plans often have too narrow a focus—the narrower the focus, the less likely an organization is to accomplish the plan. Strategic planning that establishes the organization's overall direction without attempting to be specific has the following benefits: ◆It integrates the mission, vision, strategic thrusts, and primary objectives as described in the strategic plan with the secondary objectives, policies, procedures, methods, and rules of the operating plan. ◆It provides a process and time frame for making strategic decisions. ◆It provides a framework for the operating plan, budget, and capital budget.

forecasting

To project future volumes under conditions of uncertainty, most managers rely on forecasting, which is the process to determine what alternative scenarios are likely to occur in the future, given what managers know about the past and present. According to the classic work of Reeves, Bergwall, and Woodside (1984), to forecast, the manager must first prepare the forecast content, which is a description of the specific situation in question. Next, the manager must prepare the forecast rationale, which is an explanation of how the situation will evolve from its current state to its forecasted state -- Introduction➤to➤the➤Financial➤Management➤of➤Healthcare➤Organizations318In preparing the forecast content, the manager first identifies content items, which are descriptions of important occurrences, such as admissions, patient days, and outpatient visits. Next, the manager must measure the current status of content items. The final step of the forecast content is to identify the expected state of the content items in the future budget period. Although forecast content often produces quantifiable data, the manager also must consider the effect of the following subjective factors on the forecast content ◆Political factors ◆Social factors ◆Economic factors ◆Technological factors ◆Personal health factors ◆Environmental health factorsA manager may use several forecasting techniques to prepare the forecast content, including the use of experts, causal models, and time-series methods.

certificate-of-need legislation and section 1122 of the social security amendments of 1974

Two programs were enacted in 1974 in attempts to slow the growth in healthcare capital costs. Certificate-of-need legislation (PL 93-641 as the National Health Planning and Resources Development Act of 1974) and Section 1122 of the Social Security Amendments of 1974 both compelled hospitals to get permission from a government entity before major capital expenditures. However, these programs did little to slow capital growth

evaluating capital budgeting performance

When evaluating capital budgeting performance, several ratios are used to determine how much debt an organization can incur: debt to capitalization ratio; Debt to capitalization, or long-term debt to capitalization, is an indicator of the long-term debt divided by the long-term debt plus net assets. Higher values imply a greater reliance on debt financing as a percentage and may imply a reduced ability to carry addi-tional debt. The debt-to-capitalization median for all hospitals reporting to Optum (2017) for 2015 audited financial statements was 23.7. average age of plant; Average age of plant provides an indicator in years of the age of a healthcare organization's fixed assets. Higher values reflect an older plant and equipment and indirectly may imply a difficulty in competing with "newer" healthcare organizations; lower values reflect a newer plant and equipment. The median average age of plant for all hospitals reporting to Optum (2017) for 2015 audited financial statements was 11.48.

investment policy

a board-approved policy that directs the chief financial officer or controller in making short-term investment decisions --The investment policy should include objectives of investment, authority for investment, and types of investments to be made. Typically, the types of investments to be made include US Treasury bills, money market funds, and commercial certificates of deposit, all of which provide both liquidity, in the event the organization needs the money invested on short notice, and financial security.

cash budget

a cashflow management tool that predicts the timing and amount of cash flows and systematically examines the cost implications of each alternative

liquidity

a characteristic of an investment that pertains to how quickly it can be converted to cash --Cash is considered the most liquid current asset, followed by cash equivalents, short-term investments, and accounts receivable. Prepaid expense is considered the least liquid current asset; inventories are only slightly more liquid than prepaid expense

balanced budget act of 1997

also had a stifling effect on the access to capital, as many hospitals were forced to use funds earmarked for capital projects to subsidize operations because of reduced reimbursements from Medicare. Reflecting this effect, bond downgrades outnumbered bond upgrades by rating agencies during this time until 2005, when reimbursement began to improve. This effect inspired a series of studies published by the Healthcare Financial Management Association beginning in 2003 and ending in 2006. The studies found that larger hospitals, newer hospitals, and hospitals that belonged to systems had broader access to capital than other hospitals did. The following strategies were recommended to compete for capital (HFMA 2004): ◆Be distinctive. ◆Hold onto physicians. ◆Focus on core service lines. ◆Improve quality of care. ◆Protect profits. ◆Integrate strategic and financial plans. ◆Establish/fine-tune policies regarding charity care. The studies went on to predict that the major trends to affect capital in healthcare organizations in the future would be competition, payment, and technology. To afford technology in the future, hospitals must have operating margins that exceed 2 percent, the studies stated (HFMA 2004).APA (American Psychological Assoc.)Nowicki, M. (2018). Introduction to the Financial Management of Healthcare Organizations, Seventh Edition: Vol. Seventh edition. Health Administration Press.

net working capital

although working capital is the organization's total current assets, net working capital is the difference between current assets and current liabilities. Net working capital is an important measure of an organization's ability to meet its current liabilities, or its short-term debt-paying capacity

first-in, first-out (FIFO)

an inventory valuation system that assumes that the first items put into inventory will be the first taken out. Thus, the value of the remaining inventory is based on the cost of the latest additions to inventory --FIFO produces an inventory of newer items. The total cost of inventory is determined by multiplying the unit cost of the newest items in inventory by the number of units in inventory

weighted average

an inventory valuation system that uses an average of the costs of inventory items to determine the value of inventory --This method determines the average cost of items placed in inventory and then multiplies the average cost by the number of units in inventory

working capital

an organization's current assets; the assets available to run the organization in the short term; total current assets; other short term assets --is important because it is the catalyst that makes fixed or long-term assets productive. For instance, although fixed and long-term assets consist of buildings and equipment, the buildings and equipment cannot be productive or produce revenue unless working capital in the form of employees and inventory is introduced. The costs of the employees and inventory, as well as the costs of the building and equipment in the form of depreciation, are reflected in the bill to the patient or the patient's insurance company. Until the bill is paid, the amount is carried as an account receivable. When the bill is paid, part of the money is used to start the process again. ---Sufficient amounts of working capital enable organizations to pay their employees and vendors on time and thus help ensure good employee and vendor relations. Sufficient amounts of working capital also demonstrate to lenders that organizations have sufficient resources to repay loans and are therefore creditworthy ---Sources of working capital include money invested in the organization (equity), net income, borrowed money (which is an increase in noncurrent liabilities), and the sale of a noncurrent asset, such as a building or piece of equipment. ----At some point in a healthcare organization's life cycle, the organization's collected revenues will surpass its expenses. After this point, future working capital needs should be funded by net income. In addition to working capital, other demands on net income will arise. For-profit organizations, for instance, will use portions of net income to pay stockholders' dividends and retain part of the income for future expansion. Not-for-profit organizations will use portions of net income to fund reserves and expansion.

discrete budgets

apply to a fixed period of time, usually a year. At the end of the year, a new budget begins. Discrete budgets are relatively easy to prepare, but budgeting in 12-month increments can be difficult because circumstances often change. Furthermore, discrete budgets can be challenging to some managers who know that if they are efficient and spend less than originally budgeted, they may receive less money in the following year's budget

discrete plans

apply to a fixed period of time, usually a year. At the end of the year, a new plan begins. Discrete plans are relatively easy to prepare, but it can be difficult to plan things in 12-month increments because circumstances often change. Furthermore, discrete plans can be challenging to some managers who know that if they exceed objectives at the end of the year, they will receive new, more rigorous objectives for the coming year.

capital expenditures

are defined by an organization in its capital expenditures policy, and as a result, the definitions vary. Generally speaking, capital expenditures are purchases of land, buildings, and equipment used for operations; are not for resale; have a useful life of more than one year; cost $5,000 or more; and are subject to depreciation, with the exception of land, which is not depreciated unless the use of the land harms the future use of the land. Capital expenditures are classified into the following categories: ◆Land, including all costs associated with acquiring land and making it ready for use (the cost of the land itself cannot be depreciated unless the use of the land harms the future use of the land) ◆Land improvements, including all costs associated with sidewalks, parking lots, driveways, and fencing ◆Buildings, including all costs associated with constructing or buying buildings ◆Fixed equipment, including all costs associated with equipment that is permanently attached to the building, such as the plumbing system, furnace, and air conditioners ◆Major movable equipment that has a useful life of three years or more and has a unit cost of $5,000 or more ◆Major repairs that benefit future periods and/or extend the useful life of the building or equipment (ordinary repairs are expensed)

lock box

in healthcare, a system in which payments from patients are mailed directly to the bank, which credits the healthcare organization's account more quickly than if the check had been mailed to the organization

production units

are the best measures of what an entity is producing. For example, hospitals produce patient days and admissions (both of which are called production units), but neither reflects severity of illness or the volume of outpatient work produced by the hospital. The unit used to show severity of illness (SOI), a factor that affects resource consumption, will vary—many hospitals have adopted diagnosis-related groups (DRGs) or another severity index.3 Regarding the volume of outpatient work produced by the hospital, either outpatient work needs to be captured separately as outpatient visits and with the related revenues and expenses, or the inpatient production unit must be adjusted to reflect outpatient work produced. Regardless of which production units are chosen by the organization, the units must be reported by payer to project both gross and net revenues by payer

continuous budgets (rolling budgets)

are updated continuously so that year end never occurs. Department managers who manage wisely roll over their efforts to the next month.

fixed plans

assume that volumes, and related revenues and variable expenses, remain constant during the year. Fixed plans are easy to project, but they are unrealistic for healthcare organizations, whose volumes fluctuate during the year and whose variable expenses, which are dependent on volumes, account for about half of an organization's operating expenses

fixed budgets

assume that volumes, related revenues, and variable expenses remain constant during the year. Fixed budgets are easy to project, but they are unrealistic for healthcare organizations whose volumes fluctuate during the year and whose variable expenses, which are dependent on volumes, account for about half of an organization's operating expenses

trade credit

credit extended to an organization by vendors ---In using trade credit, the cost involved is either the cost of forgoing an incentive to pay on time or the cost of a late fee. Many vendors offer an incentive, or discount, if the organization pays on time. The term 2-10,net 30 means that the organization receives a 2 percent discount off the net payment normally due within 30 days if it pays within ten days. Applying 2-10, net 30 to a $100 purchase means that if the organization pays within ten days, the vendor will discount the purchase to $98. If the organization pays during days 11 to 30, the organization must pay $100. Thus, the organization is effectively paying $2 in interest to delay paying the bill for a couple of weeks. ---Trade credit is usually expensive and should only be used to finance temporary working capital needs if it is the least costly alternative

discrete plans

discrete budgets apply to a fixed period of time, usually a year. At the end of the year, a new budget begins. Discrete budgets are relatively easy to prepare, but budgeting in 12-month increments can be difficult because circumstances often change. Furthermore, discrete budgets can be challenging to some managers who know that if they are efficient and spend less than originally budgeted, they may receive less money in the following year's budget.

vertical analysis

evaluates the internal structure of the organization by comparing important line items to a base number. For instance, vertical analysis could be used to show what percentage of gross revenue is net revenue, bad debt, charity care, or contractual allowance. After ratio analysis, horizontal analysis, and vertical analysis are complete, the organization can make trend and industry comparisons.

horizontal analysis

evaluates the trend in the line items by focusing on the percentage change over time

social security amendments of 1983

introduced Medicare prospective payment, which was designed to slow Medicare costs by reimbursing hospitals and other healthcare providers on the basis of predetermined payments rather than reimbursing costs after the fact. However, those amendments did not affect capital costs because until 1992 capital costs were reimbursed on the basis of cost, which meant that if Medicare approved a capital expenditure, it would pay its portion of the expenditure whether the piece of equipment was used or not. For example, if Medicare normally covered 30 percent of a hospital's costs and the hospital acquired a new X-ray machine, Medicare would pay for 30 percent of that X-ray machine even if it were never used.

just-in-time (JIT) inventory method

inventory method in which supply items are delivered immediately prior to use

planning process

involves 13 steps

ratio analysis

is the most common form of comparison and evaluates an organization's performance through computing and showing the relationships of important line items found in the financial statements.

strategic planning

long-range planning that anticipates where an organization will be in 3 to 10 years ---forces managers to anticipate where they want the healthcare organization to be in three to ten years; to identify the resources that will be necessary to get there; and to preview the provision of healthcare services at the end of the planning horizon. Strategic planning also provides the starting point for the operating plan and budget.The governing board has the overall responsibility for strategic planning for the organization, but it should actively seek input from the organization's stakeholders, which are those constituents with a vested interest in the organization. Certainly, the community (which may be represented by the board members), the medical staff, and organization employees should provide input. While a strategic plan is mandated by both Medicare and The Joint Commission, healthcare organizations sometimes offer excuses for not fully engaging in the planning process. Excuses range from a lack of time to a rapidly changing future. Paradoxically, if organizations spent more time planning, they would end up having more time to execute the plans. Organizations with serious planning processes position themselves to control the turbulent future, rather than simply react to it. Often financial management, including the chief financial officer (CFO), is not involved in the planning process until the budgeting stage. The CFO might be viewed as an impediment to the vision needed for the strategic plan to work. However, the CFO is necessary to provide input to the strategic financial plan—that is, the ability of the organization to fund the capital and operating costs necessary to make the strategic plan successful.

financial analysis

methods used by investors, creditors, and management to evaluate past, present, and future financial performance of an organization ---1. Establish the facts in the organization. 2. Compare the facts in the organization over time and also to facts in other similar organizations. 3. Use perspective and judgment to make decisions regarding the comparisons. ---The first step, establishing the facts, usually relates to a review of the organization's financial statements, the accuracy of which has been confirmed by independent auditors. The second step, comparing the facts over time and comparing the facts to similar organizations, includes ratio analysis, horizontal analysis, and vertical analysis. Ratio analysis is the most common form of comparison and evaluates an organization's performance through computing and showing the relationships of important line items found in the financial statements. Typically, there are four kinds of ratios: liquidity, profitability, activity,and capital structure. Horizontal analysis evaluates the trend in the line items by focusing on the percentage change over time. Vertical analysis evaluates the internal structure of the organization by comparing important line items to a base number. For instance, vertical analysis could be used to show what percentage of gross revenue is net revenue, bad debt, charity care, or contractual allowance. After ratio analysis, horizontal analysis, and vertical analysis are complete, the organization can make trend and industry comparisons. The third step of financial analysis, using perspective and judgment to make decisions regarding the comparisons, uses the information obtained in the first two steps, coupled with information derived from the decision maker's unique perspective and judgment. Decisions that may at first be at odds with the information provided in the first two steps may make perfect sense based on pressures from internal and external constituents, including medical staffs, employers, regulators, donors, and others.

debt

money that is borrowed by an organization

omnibus budget reconciliation act (OBRA) of 1990

moved capital costs to prospective payment over a ten-year implementation period. These acts slowed capital growth markedly

purchasing cost

purchasing cost PD is the total cost paid to vendors for a specific item during an accounting period, or year. (Purchasing cost =price of the item P x per unit paid to the vendor by the demand D, or the annual amount of the item used) Purchasing cost = PD

equity

ownership claim against total assets; the difference between assets and liabilities in a for-profit organization

design characteristics

planning can also be classified by design characteristics, which also correspond closely with the design characteristics of budgeting

Planning can be classified by the three characteristics:

planning horizon, management approach, and design characteristics

budgeting

process of converting the operating plan into monetary terms

book overdraft

process of transferring money from an interest-bearing account to the checking account as the money is drawn ---The organization uses the float period to transfer money from an interest-bearing account to the checking account as the money is drawn, a process called book overdraft. With the increased use of electronic funds transfer, float periods become less relevant.

incremental budgeting

requires budgeting only for changes such as new equipment, new positions, and new programs. Incremental budgeting assumes that all current operations, including positions and equipment, are essential to the continued mission of the organization and that all current operations are working at peak performance. The advantages of incremental budgeting are its ease, the minimal time commitment required to prepare the budget, and the support of a larger organizational culture. The main disadvantage is the assumption that all current operations are essential in a healthcare environment that is changing rapidly

incremental planning

requires planning only for changes, such as new equipment, new positions, and new programs. Incremental planning assumes that all current operations, including positions and equipment, are essential to the continued mission of the organization and that all current operations are working at peak performance. The advantages are the ease of incremental planning, the minimal time commitment required to plan, and the support of a larger organizational culture. The principal disadvantage of incremental planning is the assumption that all current operations are essential in a healthcare environment that is changing so rapidly

limited-in-scope budgeting

segregates the budgets. Most organizations integrate the budgets at the executive management level of the organization, but the issue is at what level of the organization the budgets should be integrated. For instance, many healthcare organizations do not show department managers revenue information because they believe that the department managers will not under-stand the difference between billed revenue and collected revenue, or that the organization uses department revenue to cover expenses in departments that do not generate revenue. -Another reason department managers might not be shown revenue information is because department managers cannot effect changes in revenue, which is a function of volumes ordered by the physicians multiplied by rates set by the chief financial officer. A similar case can be made regarding whether department managers should be shown indirect expenses

limited-in-scope budgeting

segregates the budgets. Most organizations integrate the budgets at the executive management level of the organization, but the issue is at what level of the organization the budgets should be integrated. For instance, many healthcare organizations do not show department managers revenue information because they believe that the department managers will not under-stand the difference between billed revenue and collected revenue, or that the organization uses department revenue to cover expenses in departments that do not generate revenue. Another reason department managers might not be shown revenue information is because department managers cannot effect changes in revenue, which is a function of volumes ordered by the physicians multiplied by rates set by the chief financial officer. A similar case can be made regarding whether department managers should be shown indirect expenses.

limited-in-scope planning

segregates the plans. Most organizations integrate the plans at the board and executive management level of the organization, but the issue is the level at which the plans should be segregated.

directionality

statistical property for numbers that always improve in one direction and always worsen in the other direction --Trend comparisons assess the organization's present and past ratios, trends, and percentages to determine the organization's financial performance over time. However, trend comparisons only work with ratios, trends, and percentages that show directionality; this means that the numbers are always better as they move in one direction and always worse as they proceed in the other direction

coordination of benefits

step in the billing process during which the order of insurance company liability is identified for accounts that have multiple insurance companies

critical success factors

subgoals of a plan, monitored during performance management to measure progress of the overall plan

flexible budgets

take into account fluctuations in volumes, at least within ranges expressed as probabilities, and adjust variable expenses accordingly.

flexible plans

take into account fluctuations in volumes, at least within ranges expressed as probabilities, and adjust variable expenses accordingly.

zero-base planning

takes nothing for granted and requires rejustification for existing equipment, positions, and programs, as well as justification for new equipment, positions, and programs. Therein lies the principal advantage of zero-base planning: In a rapidly changing environment where reimbursement is moving away from cost-based approaches toward prospective payment per case or per enrollee, zero-base planning can eliminate unnecessary programs and improve operations. Disadvantages include the large time commitment required, employee fear and anxiety, and significant administrative and communication requirements

zero-base budgeting

takes nothing for granted and requires rejustification for existing equipment, positions, and programs, as well as justification for new equipment, positions, and programs.1 Therein lies the principal advantage of zero-base budgeting: In a rapidly changing environment where reimbursement is moving away from cost-based approaches and moving toward prospective payment per case or per enrollee, zero-base budgeting can eliminate unnecessary costs and improve margins. Disadvantages are numerous and include the large time commitment, employee fear and anxiety, and the administrative and communication requirements

Four federal laws govern accounts receivable:

the Fair Debt Collection Practices Act, the Truth in Lending Act, the Fair Credit Reporting Act, and the ACA.

future value

the anticipated value of an investment at a given point in the future, taking into account factors such as interest rate, time, and the frequency of compounding

credit-and-collection cost

the cost incurred by the organization for billing and collecting during the organization's average payment cycle --If patients paid at the time of service, the organization would generate only one bill per patient. When the organization extends credit, it incurs the cost of sending additional bills and reminders

carrying cost

the cost incurred by the organization for extending credit to the patient after the organization has provided services ---If patients paid at the time of service, the organization would have the funds on hand to either invest or pay current liabilities. Thus, the carrying cost is the amount of money the organization would have earned had it been able to invest that money at a given interest rate, or the amount of money the organization must pay in interest to borrow funds to pay current liabilities

stock-out cost

the cost of running out of inventory on an item, such as the cost of making a rush order --S is the cost associated with having insufficient inventory holdings to meet demand (i.e., running out of the item in inventory). Stock-out cost includes the purchasing costs and ordering costs associated with a stat (immediate) order, and the intangible costs of loss of goodwill among the organization's medical staff and patients. If the stock-out results in injury or death for the patient, the stock-out cost would include the cost associated with this adverse event. The stock-out cost is derived on a case-by-case basis.

present value

the current value of an investment

cash flow

the difference between cash receipts (inflows) and cash disbursements (outflows) for a given accounting period

cash flow

the difference between cash receipts and cash disbursements for a given accounting period—is also known as the management of the cash conversion cycle --In healthcare organizations, cash outflows consist of employee wages and supply expenses; cash inflows consist of patient revenues. The objective of managing cash flow is to always have the right amount of cash on hand by maximizing and expediting cash inflows and minimizing and delaying cash outflows.

Step 14: Project Volumes

the first step in the budgeting stage—is to project volumes for the budget year. This step is often called the statistical budget, and it is sometimes part of the operating plan. Typically, the budget committee will give its projections of the organization's production units to department managers in the budget manual. Department managers use the organization's production units to calculate department production units that are specific to each department. For instance, the radiology department manager must be able to determine how many radiology procedures are generated for every 100 admissions

gross receivable

the full amount a healthcare organization charges

net receivable

the gross receivable minus any negotiated discounts

planning horizon

the length of time management is looking into the future. Strategic plans look three to ten years into the future. Operating plans look one year into the future

materials management

the management and control of inventory, services, and equipment from acquisition to disposition ---Organizations further classify items into two major categories: patient care and administration. Items in patient care include medical supplies, surgical supplies, drugs, linens, and food. Items in administration include housekeeping supplies, office supplies, and other supplies not used for direct patient care. --The primary objective of materials management is to minimize the total cost associ-ated with materials while ensuring that the proper materials, meaning in both quality and quantity, are readily available for patient care and administration

internal rate of return (IRR)

the minimum return one needs to break even on an investment. it is the necessary net present value of an investment that, when added to the final market value of the investment, equals the current cost of the investment. --is the minimum return one needs to break even on an investment. IRR analysis calculates the discount rate of a capital expenditure where the discounted cash flows equal the expenditure's original investment, or the discount rate where the NPV is zero. Whereas discounted payback period analysis gives the manager an answer in years, and NPV analysis gives the manager an answer in dollars, IRR analysis gives the manager an answer as a percentage. Solving the NPV equation by hand is relatively simple, but solving the IRR is difficult without a calculator. Problem 15.3 shows how the healthcare manager can use a calculator to find NPV and IRR

Three factors set the healthcare industry apart from most other industries with regard to accounts receivable:

the nature of the services provided, the cost of the services provided, and the method of payment for the services provided.

economic order quantity

the number or amount of items that should be ordered each time to result in the minimum total inventory costs --EOQ or Qe, is the number or amount of items that should be ordered each time to result in the minimum total inventory costs associated with the item. The Qe formula is: Qe= squared thingy over 2DO/IP+2H The Qe model makes the following assumptions: ◆Demand is fixed and constant during the year. ◆Lead time for placing orders is constant. ◆No discounts are offered for quantity orders. ◆No stock-out or overstock costs exist. These assumptions may be unrealistic in most healthcare organizations. However, in organizations where demand fluctuates weekly, the fluctuations tend to cancel out so that seasonal demand, or annual demand, appears constant (Siegel and Shim 2006). Calculation of the reorder point RP requires knowledge of the lag time in receiving orders, or how many days occur between ordering an item and receiving the item. Thus, the reorder point in units is the demand during the lag time, and the reorder point in days is the lag time.

net present value

the present value of the future cash flow of an investment. NPV takes into account the fact that future cash flows are "discounted" to determine their present value --a commonly used financial analysis for capital expenditures that relies on discounting cash flows. Whereas discounted payback period gives the manager an answer in years, NPV gives the manager an answer in dollars. An NPV of zero means that the capital expenditure is generating discounted cash flows just sufficient to repay the original investment. If the NPV is positive, the expenditure is generating discounted cash flows in excess of the amount necessary to repay the original investment. If the NPV is negative, the expenditure is generating discounted cash flows insufficient to repay the original investment.NPV has some flaws (see Zelman et al. 2014)—the principal flaw seems to be determining the discount rate. Most theorists agree that NPV is superior to internal rate of return (IRR, discussed in the next section) as a method of evaluating capital expenditures. However, because IRR is a common method of evaluating capital expenditures in the real world, managers should be prepared to calculate both NPV and IRR.After managers understand the concept of discounting, they can apply discounting to payback period analysis, NPV analysis, and IRR analysis. Discounted payback period is similar to payback period except that the manager discounts the projected cash flows by discount factors for the expenditure's discount rate (see problem 15.2). Managers can find discount factors on a present value (PV) table

cash conversion cycle

the process of converting resources represented by cash outflows into products or services represented by cash inflows. in healthcare organizations, cash outflows consist of employee wages and supply expenses; cash inflows consist of patient revenues.

assignment of benefits

the process of transferring insurance benefits from patients to the healthcare organization; and third-party audits

capital costs

which are generally defined as purchases of land, buildings, and equipment (a more complete definition appears later in this chapter), make up a relatively small percentage of total organization costs—in hospitals, they are 6 to 10 percent. However, their importance in terms of rising healthcare costs and dictating current trends in acquisitions, mergers, joint ventures, and closings cannot be overstated. Under cost-based reimbursement from 1966 to 1983 (cost-based reimbursement continued for capital costs until 1990), capital costs for new equipment (38 to 40 percent of capital costs) and plants exploded with little resistance from regulation or the market.

forecasting

which is the process to determine what alternative scenarios are likely to occur in the future, given what managers know about the past and present. According to the classic work of Reeves, Bergwall, and Woodside (1984), to forecast, the manager must first prepare the forecast content, which is a description of the specific situation in question. Next, the manager must prepare the forecast rationale, which is an explanation of how the situation will evolve from its current state to its forecasted state. In preparing the forecast content, the manager first identifies content items, which are descriptions of important occurrences, such as admissions, patient days, and outpatient visits. Next, the manager must measure the current status of content items. The final step of the forecast content is to identify the expected state of the content items in the future budget period. Although forecast content often produces quantifiable data, the manager also must consider the effect of the following subjective factors on the forecast content: ◆Political factors ◆Social factors ◆Economic factors ◆Technological factors ◆Personal health factors ◆Environmental health factors A manager may use several forecasting techniques to prepare the forecast content, including the use of experts, causal models, and time-series methods.

According to the American Health Information Management Association (AHIMA), Cassidy (2012) identified the key elements of a coding compliance plan. Examples of the elements include the following:

◆A commitment from the organization to correctly report and assign codes ◆Sources of coding guidance ◆Positions with delegated authority to assign codes ◆Procedures to follow when assigned codes are not clear ◆Areas of risk that have been identified by compliance audits ◆Procedures to resolve coding disputes ◆Policies for developing and revising coding

use of experts and the models to hear opinions:

◆A task force brings together several experts who provide collective input. ◆The Delphi technique gathers information from a group of dispersed experts with anonymity and limited interaction. ◆The Delbecq technique, or nominal group process, is similar to the Delphi technique, except that the group of experts meets face-to-face for discussion and to present and defend their forecasts. ◆Questionnaires are used to gather responses to questions from a large group of experts. ◆Permanent panels maintain a group of experts who can be used for several forecasts over time ◆Essay writing obtains opinions from experts in a format that can be used for preparing the forecast rationale. ◆Computer-facilitated group processes can reveal and "parallel process" more contributions from a greater number of participants than is possible using manual facilitation techniques alone -----In addition to relying on expert opinion regarding the future, a manager may apply probability statistics to the expert opinion. Another derivative of using expert opinion is the program evaluation and review technique (PERT). This technique requires estimates of optimistic (O), pessimistic (P), and most likely (ML) future scenarios. These three estimates are weighted to calculate an expected value that equals (O+P+4ML)/6

Typical current assets:

◆Cash: Money on hand and money to which the organization has immediate access that is deposited in a bank. Cash equivalents are reported as cash and include investments with a maturity of three months or less (e.g., treasury bills, money market funds). ◆Short-term securities: Investments with a maturity date of less than one year. ◆Accounts receivable: Amounts due to the organization from patients and insurers for services that the organization has already provided.1 ◆Inventories: The value of supplies on hand that are properly presented as a current asset on the balance sheet. When inventories are used, they are presented as a supply expense on the statement of operations. ◆Prepaid expenses: Expenditures made by the hospital for goods and services not yet consumed or used in hospital operations (sometimes referred to as deferred expenses), such as rent and insurance premiums.

Budgets for new capital expenditures include requests to add buildings and equipment for a number of reasons:

◆Expanded services ◆Improved safety conditions ◆Reduced operating expenses ◆Improved patient care

Inventory costs are reflected in the following issues:

◆How much of an item to order each time ◆When to order the item ◆The cost of the item

Any healthcare organization whose key financial measures lie outside the industry benchmarks should review its revenue cycle practices. According to Guyton and Lund (2003), key benchmarks include the following:

◆Outstanding revenues that exceed the industry average of about 50 days ◆More than 15 percent of receivables exceeding 90 days ◆High management turnover in revenue-related areas ◆Evidence of cash-flow problems ◆Declining net-to-gross ratios

Basic steps in developing a cash budget for a specific period:

◆Prepare a list of all expected sources of cash inflows. ◆Estimate the amounts to be received from each source ◆Prepare a list of all expected sources of cash outflows. ◆Estimate the amounts to be expended to each source. ◆Calculate the period-end cash balance. ◆Determine how to finance deficit balances (see earlier section, "Financing Temporary Working Capital Needs") or invest surplus balances

Budgets for replacement capital expenditures include requests to replace existing buildings and equipment that are made for a number of reasons:

◆Scheduled replacement at the end of the useful life or when fully depreciated ◆Improved productivity ◆Improved quality ◆Required by regulation

Organization must have cash on hand for the following purposes:

◆Transactions:The expected demand for cash to pay employees and suppliers. ◆Precautions:The unexpected demand for cash to pay for emergencies and other unplanned events. ◆Speculations:The unexpected demand for cash when a vendor offers a price reduction or other good deal that the organization does not want to pass up. For example, sometimes a vendor offers a reduced price per unit if the organization buys a certain amount that exceeds its current needs

The credit-and-collection policy should also discuss billing procedures, including provisions for:

◆bill cutoff, which is the point at which the organization determines the bill is complete and ready for submission; ◆methods for encouraging prompt payment, such as interest assessment on late payments; and ◆follow-up billing, including both the format (i.e., how aggressive the language should be) and timing (i.e., how often the organization should mail reminders, called dunning notices).

the effective accounting system also:

◆identify and record all valid accounting transactions on a timely basis; ◆value these transactions in an appropriate manner; ◆identify the time period in which these transactions occur; and ◆disclose these transactions in the financial statements

In addition to serving as a basis for projecting volumes for budgeting purposes, department production units are used to:

◆measure and evaluate department productivity, ◆measure and evaluate employee productivity, ◆serve as the basis for calculating the cost of each procedure (see chapter 8), ◆serve as the basis for calculating the charge for each procedure, and ◆serve as the basis for determining staffing requirements and staffing schedules.