Financial Resources Ch. 11

how is the useful life of a long-lived asset determined?

1. accountants use tables that list the usefulness of various classes of assets

net income vs cash flow

1. although net income is an important measure of profitability, an organization's financial condition, at least in the short run, depends more on the actual cash that flows into and out of the business than it does on reported profitability 2. because of accrual accounting, reported revenue is not the same as cash revenue 3. same logic applies to expenses -few of the values reported as expenses on the I/S are the same as the actual cash outflows -- nothing was paid out for depreciation expense 4. can net income be converted to net cash flow--the actual amount of cash generated during the year? -as a rough estimate, net cash flow can be thought of as net income plus noncash expenses -non-cash expenses: expenses that are listed on the I/S that do not represent actual cash outlays -the most prominent non-cash expense is depreciation net income + noncash expense = net cash flow 5. to be more realistic, businesses must plan to generate net income, in addition to the accumulated depreciation funds, sufficient to replace existing assets in the future at inflated costs or to expand (grow) the business 6. the greater the difference between the reported values and cash values, the less reliable is the net cash flow estimate

financial statement regulation and standards

1. as a result of the Great Depression, federal government began regulating the content of the financial information 2. this regulation is based on the theory that financial information constructed and presented according to standardized rules allows investors and other stakeholders to make the best informed decisions

calculating depreciation expense

1. depreciation expense, like all other financial statement entries, is calculated in accordance with GAAP 2. the calculation typically uses the straight line method: a method for calculating the depreciation expense of a long lived asset that assumes the loss of value is constant overtime (follows a straight line) asset's annual depreciation expense = cost of the asset-salvage value --------------------------------- # of useful years

annual reports

1. financial statements usually are distributed to the public as part of a business's annual report 2. annual report: a report issued annually by a business that contains descriptive information about operations over the past year and several years of historical financial statements 3. many organizations make their annual reports available on their websites 4. in addition, for profit corporations with publicly traded stock must submit financial information, including financial statements, to the Securities and Exchange Commission (SEC) which in turn makes the information available to the public

depreciation expense

1. fixed assets: buildings and equipment that provide goods and services 2. acquisition cost not reported as an expense but rather as an asset 3. the logic of not reporting the cost of such assets when purchased is that it would be improper to allocate the acquisition costs of long-lived assets to a single accounting period because these assets are used to produce revenues for many years 4. to match the cost of long-lived assets to the revenues produced by such assets, accountants use the concept of depreciation expense which amortizes (spreads out) the cost of a long-lived asset over many years (most use "cost" and "expense" interchangeably but for accountants they have different meanings--cost (original cash outlay) expense (allocation of that cost over time)

Regulations and Standards: external audit

1. for large organizations, the final step in the financial statement preparation process is the external audit 2. external audit: an examination of a business's financial statements by an outside party to ensure that the statements follow GAAP and are a fair representation of the economic status of the business 3. the results of the external audit are reported in a letter attached to the financial statements stating whether or not the statements are judged to be a fair presentation of the business's financial status as specified by GAAP 4. continuous negotiation, compromise, and interpretation, and the organizations involved are continuously reviewing and revising the standards to ensure that they stay relevant as business operations and financing sources evolve overtime

premium revenue

1. in a fee-for-service environment, providers offer healthcare services that are paid for on the basis of utilization 2. premium revenue: revenue arising from capitated patients as opposed to fee-for-service patients -instead of patient revenue for a fee-for-service 3. some may have both 4. the key difference is that premium revenue is reported at the start of each contract payment period (typically at the beginning of the month), while patient service is reported when services are provided 5. thus, premium revenue represents an obligation on the payer side

charity care

1. in addition to services provided to paying patients, some services have been provided as charity care 2. charity care: care provided to patients who do not have the capacity to pay 3. not reflected in the I/S for "revenue"

financial accounting

1. involves identifying, measuring, recording, and communicating the economic events and status of an entire organization 2. this information is summarized and presented in a set of financial statements -income statement, balance sheet, and the statement of cash flows -often financial accounting is called the "language of business" 3. the notes that follow the statements typically are extensive and contain a wealth of information that supplements the statements -these notes (footnotes) provide details that are left out of the primary documents -the note system ensures that important information is provided to financial statement users without clogging up the actual statements with excessive details

problems can arise when translating physical assets and economic events

1. many problems can arise when translating physical assets and economic events into accounting numbers 2. many assets are based on historical costs and prices, so the assets such as inventories may be spoiled, obsolete, or even missing; land, buildings, and equipment may have current values that are much higher than their historical costs; and money owed to the business may be uncollectible 3. also, some liabilities--such as obligations to make lease payments--may not even show up in the numbers 4. costs that are reported may be understated or overstated, and some costs, such as depreciation, do not even represent current cash expenses

other expense

1. may have a catch all category "other" 2. small general and admin expenses 3. often have notes to explain

historical perspective: gross revenue vs net revenue

1. no longer the revenue then deduction but now the net of the discounts and charity care

nonoperating income

1. non-operating income is the income of a healthcare provider that is unrelated to the provision of patient services 2. example: contributions and earnings from securities investments -charitable contributions that can be used immediately (spent now) are reported as non-operating income. -however, contributions that create a permanent endowment fund, and hence, are not available for immediate use, are not reported on the I/S 3. investment income which stems from two primary sources: -healthcare businesses usually have funds available that exceed the minimum necessary to meet current cash expenses -this "excess" is invested in short-term, interest-earnings securities -NFP excess from endowment funds--invested in securities -reported as investment income 4. non-operating income is not central to the core business 5. over reliance on non-operating income to create profitability could mask operational inefficiencies that, if not corrected, could lead to future financial problems 6. note: that the costs associated with creating non-operating income are not separately reported 7. also note: that the I/S of some providers do not contain a separate section titled "non-operating income"

profitability measures

1. operating income from operating revenues (patient service activities) -net income: profits from all activities (for profits) or excess or revenues over expenses (by NFPs) 2. profitability, as measured either by operating income or net income, may be positive or negative 3. expenses>revenues, you have an operating loss or net loss -generally, the greater the profitability of a business, the better is the business's financial position 4. although operating income and net income are important measures of a business's profitability, several other measures are also used 5. the income statement, then, summarizes the ability of an organization to generate profits revenue-expenses = profit 6. the explanatory and supplemental information contained in the notes is as important to read and understand as is the actual I/S

historical foundation

1. people began to specialize, trade, and form a simple banking system 2. economy began to grow and so did lending and there was no way to assess the assets backing up the loans 3. they also needed away for expressing income 4. in addition, owners required reports to see how effectively their own enterprises were being operated, and governments needed information for use in assessing taxes 5. for all these reasons, a need arose for financial statements, for accountants to prepare the statements, and for auditors to verify the accuracy of the accountants' work 6. the original reasons for these statements still apply: bankers and other investors need the information to make intelligent investment decisions, managers rely on it to operate their organizations efficiently, and taxing authorities use it to assess taxes in an equitable manner

financial statements development

1. primarily financial statements were developed primarily to meet the information needs of outside parties; the owners and managers of an organization, including its board of directors (trustees) are also important users of these statements 2. managers are involved not only in creating financial statements but also in assessing current financial condition and formulating plans to ensure that the organization will be able to support its mission in the future

a look ahead: financial condition analysis

1. ratio analysis: the process of creating and analyzing ratios from the data contained in a business's financial statements and elsewhere to help assess financial condition 2. values found on the financial statements are combines to form ratios that economic meaning and hence help managers and investors interpret the numbers examples: -profit margin = net income/total revenues -operating margin = operating income/operating revenues

other operating revenue

1. revenue that is related to patient services (ex. cafeteria sales) but not directly tied to the provision of clinical services

revenues

1. revenues represent both the cash received to date and the unpaid obligations of payers for services provided during the period 2. for healthcare businesses, revenues result mostly from the provision of patient services, although some revenues result from non-operating (financial activities, such as interest earned on investments and contributions (NFP providers) 3. more leeway in how the I/S is constructed so they tend to vary somewhat in presentation 4. from illustration: Park Ridge homecare: operating revenues and nonoperating revenues 5. a description of the policies regarding revenue recognition often appear in the notes to the financial statements -ex. Park ridge's financial statement notes -patient service revenue -charity care -bad debt loss provision -more extensive notes about these sections

income statements of investor-owned firms

1. same as NFPs except -section for tax payments 2. ownership plays only a minor role in the presentation of financial statement data 3. for the most part, the difference exist in financial statements because of lines of business than because of ownership

regulation and standards: SEC

1. securities and exchange commission (SEC) 2. the government agency that regulates the sale of securities and the content and format of financial statements for large, stockholder-owned corporations 3. in addition, NFP corporations must file financial statements with state authorities that conform to SEC standards 4. most For-profit small businesses that are not technically bound by SEC established guidelines still follow these standards to ensure uniformly of presentation of financial data 5. the end result is that most businesses create SEC-conforming financial statements

regulations and standards: Generally Accepted Accounting Principles (GAAP)

1. the SEC relies on other organizations such as the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants to develop and implement the rules and regulations 2. overtime, the regulating orgs developed guidelines called GAAP 3. GAAP: the set of guidelines which have evolved over time, that prescribes the content and format of financial statements 4. sets the rules for preparing financial statements

patient service revenues

1. the amount of revenue collected or expected to be collected as a direct result of providing patient services without considering potential bad debt losses 2. charge master will contain the charge code and gross price for each service (or product) -however, the charge master price rarely represents the amount of the provider expects to be paid for a particular service 3. discounts are accounted before the revenue is recorded on the I/S are net of discounts

interest expense

1. the final expense line on the I/S reports interest expense 2. obligation to pay lenders 3. the amount of interest expense reported by an organization is influenced primarily by its capital structure, which reflects the amount of debt that it uses 4. also, interest expense is affected by the borrower's credit worthiness, its mix of long term and short term debt, and the general level of interest rates

income statement basics

1. the income statement summarizes the operations of an organization with a focus on its revenues, expenses, and profitability 2. also called statement of operations or statement of revenues and expenses 3. most financial statements contain two or three years of data, with the most recent year presented first 4. the idea is that newer data is more important than older data 5. over a specified period of time

operating income

1. the most important information on the income statement is profitability 2. two different profit measures can be reported on the I/S 3. the first is the operating income operating income = total operating revenues-operating expenses 4. the general idea of operating income is to focus on revenues and expenses that are related to operations--the provision of patient services 5. many healthcare providers, especially large ones, have significant revenues that stem from non-patient service related activities, so it is useful to report the inherent profitability of the enterprise 6. operating income is an important measure of a healthcare business's profitability because it focuses on the core activities of the business 7. note that the operating income reported on the I/S is defined by GAAP and represents an estimate of the long run operating profitability of the business -it has some shortcomings--for one, it does not represent cash flow

stakeholders

1. the predominant users of financial statements are stakeholders (parties who have a financial interest in the organization and hence are concerned with its economic welfare 2. Not for profits: community; managers, staff physicians, employees, suppliers, creditors, patients, and even the community at large 3. for profits: have the same stakeholders plus the owners

net income

1. the second profitability measure is net income net income = operating income + non-operating income (NFP "excess revenue over expenses") 2. bottom-line: total profitability 3. turning a profit is essential for the long term viability of all businesses, including NFPs -NFPs must reinvest all earnings in the business 4. what happens to a business net income? -for the most part it is reinvested -FP can return a portion or all of its net income to owners in the form of dividend payments net income-dividends=retention (reinvested) 5. note that both operating income and net income measure profitability as defined by GAAP 6. furthermore, some of the I/S items are estimates and others do not represent actual cash revenues or costs

expenses

1. to produce revenues, businesses must incur expenses 2. the number and nature of expense items reported on the income statement, which depends on the nature and complexity of the organization, can vary widely 3. most readers of financial statements would prefer more rather than less because more insights can be gleaned if an organization reports revenues and expenses both by service breakdown (say, inpatient vs outpatient) and by type (say, supplies and salaries) 4. the I/S expense listing for ex supplies and drugs represents the cost of the items actually consumed in providing patient services (not cash actually paid)

reporting methods

1. two methods can be used to prepare financial statements: cash accounting and accrual accounting 2. although each method has its own set of advantages and disadvantages, GAAP requires the accrual method, so it dominates the preparation of financial statements 3. still many small businesses use the cash method, and knowledge of the cash method will help you understand the accrual method

accrual accounting

1. under accrual accounting, the economic event that creates the financial transaction, rather than the transaction itself, is the basis for reporting 2. think of the expectation and the period of time of being paid 3. so earned revenue is recognized in financial statements when a service has been provided that creates an expectation of payment, rather than when the payment is actually received 4. for healthcare providers, the payment obligation typically falls on the patient, a third-party payer, or both 5. taken cared of immediately, the revenue is in the form of cash -however, in most situations the bulk of the payment for services is not received until later--perhaps several months after the service is provided -in this situation, the revenue reported from the service does not indicate an immediate cash payment 6. the accrual accounting concept also applies to expenses (ex. payroll expenses)

cash accounting

1. under cash accounting, economic events are recognized when a financial transaction occurs (cash received or cash paid) 2. the core argument in favor of cash accounting is that the most important financial event is the receipt of cash, not the provision of the service and the resulting obligation to pay 3. to put it simply, cash accounting records the actual flow of money into and out of a business 4. cash accounting provides two advantages: -it is simple and easy to understand. No complex rules are required for the preparation of financial statements -it is closely aligned to accounting for income tax purposes, and hence, cash accounting statements are easy to translate into tax filing data 5. because of these advantages, some medical practices--typically smaller ones--use cash accounting 6. disadvantage: it does not present information on a business's revenue or cost obligations, which clearly affect financial condition

Introduction

1. we often do not readily consider what the costs involved: salaries, medical supplies, and interest 2. to be successful, these costs must be covered by revenues from patients and third-party payers (private and public insurance) 3. the bottom line is that a large number of economic (financial) events support the physical elements (facilities and people) of the business

bad debt loss

1. will be accounted for 2. revenue that is expected, but never collected, from patients (or 3rd party payers) who have the capacity to pay