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AUPHA/HAP Editorial Board for Undergraduate Studies

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Theresa Barry, PhD Arcadia University

Karen Dielmann, EdD Pennsylvania College of Health Sciences

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Thomas Gariepy, PhD Stonehill College

Jennifer B. Groebner, EdD Governors State University

Michael H. Kennedy, PhD, FACHE University of Texas Health Science Center at Tyler

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Health Administration Press, Chicago, Illinois

Association of University Programs in Health Administration, Washington, DC

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Health Administration Press, Chicago, Illinois

Association of University Programs in Health Administration, Washington, DC

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Your board, staff, or clients may also benefit from this book’s insight. For more information on quantity discounts, contact the Health Administration Press Marketing Manager at (312) 424-9450.

This publication is intended to provide accurate and authoritative information in regard to the subject matter covered. It is sold, or otherwise provided, with the understanding that the publisher is not engaged in render- ing professional services. If professional advice or other expert assistance is required, the services of a competent professional should be sought.

The statements and opinions contained in this book are strictly those of the author and do not represent the official positions of the American College of Healthcare Executives, the Foundation of the American College of Healthcare Executives, or the Association of University Programs in Health Administration.

Copyright © 2018 by the Foundation of the American College of Healthcare Executives. Printed in the United States of America. All rights reserved. This book or parts thereof may not be reproduced in any form without written permission of the publisher.

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Library of Congress Cataloging-in-Publication Data

Names: Nowicki, Michael, 1952– author. Title: Introduction to the financial management of healthcare organizations / Michael Nowicki. Description: Seventh edition. | Chicago, Illinois : HAP/AUPHA, Health Administration Press ; Washington, DC : Association of University Programs in Health Administration, [2018] | Includes bibliographical references and index. Identifiers: LCCN 2017014442 (print) | LCCN 2017011815 (ebook) | ISBN 9781567939057 (ebook) | ISBN 9781567939064 (xml) | ISBN 9781567939071 (epub) | ISBN 9781567939088 (mobi) | ISBN 9781567939040 (print : alk. paper) Subjects: LCSH: Hospitals—Business management. | Hospitals—Finance. | Health facilities—Business management. | Health facilities—Finance. Classification: LCC RA971.3 (print) | LCC RA971.3 .N69 2018 (ebook) | DDC 362.11068/1—dc23 LC record available at https://lccn.loc.gov/2017014442

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Health Administration Press Association of University Programs A division of the Foundation in Health Administration of the American College of 1730 M Street, NW Healthcare Executives Suite 407 One North Franklin Street Washington, DC 20036 Suite 1700 (202) 763-7283 Chicago, IL 60606-3529 (312) 424-2800

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I dedicate this book to my parents who, by their actions more than their words, instilled in me the value of lifelong learning. From my mother, I learned that effort is a reward in itself. From my father, I learned that correct answers count, always.

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v i i

BRIEF CONTENTS

Preface ……………………………………………………………………………………………………..xvii

Acknowledgments ………………………………………………………………………………….xviii

Part I: Financial Management

Chapter 1 Financial Management in Context ………………………………………………… 3

Chapter 2 Organization of Financial Management ……………………………………….. 31

Chapter 3 Financial Analysis and Management Reporting ……………………………… 49

Chapter 4 Tax Status of Healthcare Organizations ………………………………………… 75

Part II: Operating Revenue

Chapter 5 Third-Party Payment …………………………………………………………………. 93

Chapter 6 Medicare ……………………………………………………………………………….. 120

Chapter 7 Medicaid ……………………………………………………………………………….. 150

Chapter 8 Cost Accounting …………………………………………………………………….. 157

Chapter 9 Reimbursement ………………………………………………………………………. 198

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v i i i B r i e f C o n t e n t s

Part III: Working Capital

Chapter 10 Managing Working Capital ………………………………………………………. 229

Chapter 11 Managing Revenue Cycle …………………………………………………………. 252

Chapter 12 Managing Materials …………………………………………………………………. 269

Part IV: Resource Allocation

Chapter 13 Strategic and Operational Planning ……………………………………………. 295

Chapter 14 Budgeting ………………………………………………………………………………. 312

Chapter 15 Capital Budgeting …………………………………………………………………… 335

Part V: Healthcare Reform: Past, Present, and Future

Chapter 16 Healthcare Reform Trends ……………………………………………………….. 365

Appendix: Answers to Self-Quizzes ……………………………………………………… 389

Case Study: Hays County Integrated Delivery System ……………………….. 395

List of Abbreviations ……………………………………………………………………………… 409

Glossary ………………………………………………………………………………………………….. 415

References ………………………………………………………………………………………………. 433

Index ……………………………………………………………………………………………………….. 459

About the Author …………………………………………………………………………………… 483

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i x

DETAILED CONTENTS

Preface ……………………………………………………………………………………………………..xvii

Acknowledgments ………………………………………………………………………………….xviii

Part I: Financial Management

Chapter 1 Financial Management in Context ………………………………………………… 3

Learning Objectives …………………………………………………………………….. 3 Introduction ………………………………………………………………………………. 4 Purpose of Healthcare Financial Management …………………………………. 5 Major Objectives of Healthcare Financial Management ……………………. 8 Quality Assessment and Healthcare Financial Management …………….. 10 Effects of Quality on Profitability ………………………………………………… 13 Organizational Ethics and Healthcare Financial Management ………….. 13 Value of Healthcare Financial Management ………………………………….. 15 Effect of Financial Management on the Changing

Face of Healthcare ……………………………………………………………… 16 Chapter Key Points …………………………………………………………………… 16 Discussion Questions ………………………………………………………………… 17 Appendix 1.1: Financial Accounting Outline ………………………………… 18

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Appendix 1.2: Economics Outline ………………………………………………. 22 Appendix 1.3: Statistics Outline ………………………………………………….. 28

Chapter 2 Organization of Financial Management ……………………………………….. 31

Learning Objectives …………………………………………………………………… 31 Introduction …………………………………………………………………………….. 32 Governing Body ……………………………………………………………………….. 33 Organizations Designed to Integrate Care …………………………………….. 46 Chapter Key Points …………………………………………………………………… 47 Discussion Questions ………………………………………………………………… 47

Chapter 3 Financial Analysis and Management Reporting ……………………………… 49

Learning Objectives …………………………………………………………………… 49 Introduction …………………………………………………………………………….. 50 Steps in Financial Analysis ………………………………………………………….. 50 Operating Indicators …………………………………………………………………. 66 Financial Analysis and Annual Reports …………………………………………. 67 Chapter Key Points …………………………………………………………………… 68 Discussion Questions ………………………………………………………………… 68 Notes ……………………………………………………………………………………… 69 Practice Problems and Self-Quizzes ……………………………………………… 70

Chapter 4 Tax Status of Healthcare Organizations ………………………………………… 75

Learning Objectives …………………………………………………………………… 75 Introduction …………………………………………………………………………….. 76 Rationale for Tax-Exempt Status …………………………………………………. 76 Community Benefit and Tax-Exempt Status …………………………………. 78 Judicial Challenges to Tax-Exempt Status …………………………………….. 80 IRS Challenges to Tax-Exempt Status ………………………………………….. 82 Legislative Challenges to Tax-Exempt Status …………………………………. 84 Chapter Key Points …………………………………………………………………… 87 Discussion Questions ………………………………………………………………… 87 Notes ……………………………………………………………………………………… 88

Recommended Readings—Part I ………………………………………………………………. 89

Part II: Operating Revenue

Chapter 5 Third-Party Payment …………………………………………………………………. 93

Learning Objectives …………………………………………………………………… 93 Introduction …………………………………………………………………………….. 94

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History of Third-Party Payment ………………………………………………….. 94 Managed Care Organizations ……………………………………………………… 97 HMOs ……………………………………………………………………………………. 99 Post–Managed Care ………………………………………………………………… 100 State Healthcare Reform ………………………………………………………….. 102 National Healthcare Reform …………………………………………………….. 103 Methods of Payment ……………………………………………………………….. 104 Bad Debt and Charity Care ………………………………………………………. 107 Cost Shifting ………………………………………………………………………….. 108 Problem 5.1: Cost-Shifting/Cost-Cutting Problem ………………………. 111 Chapter Key Points …………………………………………………………………. 114 Discussion Questions ………………………………………………………………. 114 Practice Problems and Self-Quizzes ……………………………………………. 115

Chapter 6 Medicare ……………………………………………………………………………….. 120

Learning Objectives …………………………………………………………………. 120 Introduction …………………………………………………………………………… 121 Eligibility ………………………………………………………………………………. 121 Benefits …………………………………………………………………………………. 122 Financing ………………………………………………………………………………. 123 Reimbursement to Providers …………………………………………………….. 125 Expenditures ………………………………………………………………………….. 128 Health Insurance Portability and Accountability Act of 1996 …………. 136 Affordable Care Act of 2010 ……………………………………………………… 138 Fraud and Abuse …………………………………………………………………….. 139 Chapter Key Points …………………………………………………………………. 144 Discussion Questions ………………………………………………………………. 144 Notes ……………………………………………………………………………………. 145 Appendix 6.1: Federal Safe Harbors …………………………………………… 147

Chapter 7 Medicaid ……………………………………………………………………………….. 150

Learning Objectives …………………………………………………………………. 150 Introduction …………………………………………………………………………… 151 Benefits …………………………………………………………………………………. 151 Financing ………………………………………………………………………………. 152 Expenditures ………………………………………………………………………….. 153 Expansion ……………………………………………………………………………… 153 Fraud and Abuse …………………………………………………………………….. 155 Chapter Key Points …………………………………………………………………. 156 Discussion Questions ………………………………………………………………. 156 Note …………………………………………………………………………………….. 156

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Chapter 8 Cost Accounting …………………………………………………………………….. 157

Learning Objectives …………………………………………………………………. 157 Introduction …………………………………………………………………………… 158 Methods of Classifying Costs ……………………………………………………. 158 Methods of Allocating Costs …………………………………………………….. 161 Methods of Assembling Costs …………………………………………………… 164 Problem 8.1: Differential Cost Analysis ………………………………………. 166 Methods of Determining Product Costs ……………………………………… 167 Problem 8.2: Job-Order Costing ……………………………………………….. 169 Problem 8.3: Activity-Based Costing ………………………………………….. 171 Relationship of Costs to Volume and Revenue …………………………….. 175 Problem 8.4: Breakeven Analysis ……………………………………………….. 177 Problem 8.5: Breakeven Analysis for Capitated Revenue ……………….. 178 Chapter Key Points …………………………………………………………………. 179 Discussion Questions ………………………………………………………………. 179 Practice Problems and Self-Quizzes ……………………………………………. 180

Chapter 9 Reimbursement ………………………………………………………………………. 198

Learning Objectives …………………………………………………………………. 198 Introduction …………………………………………………………………………… 199 Historical Context …………………………………………………………………… 199 Healthcare Pricing Comes Under Public Scrutiny ………………………… 201 Methods of Setting Charges ……………………………………………………… 204 Problem 9.1: RVU Method of Setting Charges ……………………………. 204 Problem 9.2: Hourly Rate Method of Setting Charges ………………….. 206 Strategic Charge Setting …………………………………………………………… 206 Problem 9.3: Surcharge Method of Setting Charges ……………………… 207 Methods of Reimbursement to Providers ……………………………………. 208 Reimbursement Under the ACA of 2010 ……………………………………. 209 Reimbursement Under the PAMA of 2014 ………………………………… 210 Reimbursement Under MACRA of 2015 ……………………………………. 210 Chapter Key Points …………………………………………………………………. 210 Discussion Questions ………………………………………………………………. 211 Notes ……………………………………………………………………………………. 211 Appendix 9.1: Cost-Shift Pricing ……………………………………………….. 214 Practice Problems and Self-Quizzes ……………………………………………. 215

Recommended Readings—Part II …………………………………………………………… 225

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x i i i D e t a i l e d C o n t e n t s

Part III: Working Capital

Chapter 10 Managing Working Capital ………………………………………………………. 229

Learning Objectives …………………………………………………………………. 229 Introduction …………………………………………………………………………… 230 Definition of Working Capital …………………………………………………… 230 Importance of Working Capital ………………………………………………… 231 Sources of Working Capital………………………………………………………. 231 Financing Temporary Working Capital Needs …………………………….. 232 Problem 10.1: Interest on Short-Term Loans ………………………………. 233 Problem 10.2: Effective Annual Interest Rates on Trade Credit ………. 234 Managing Cash Flow ………………………………………………………………. 235 Cash Budget …………………………………………………………………………… 236 Problem 10.3: Calculating the Future Value of an Investment ……….. 237 Evaluating Working Capital and Cash Performance ……………………… 239 Chapter Key Points …………………………………………………………………. 241 Discussion Questions ………………………………………………………………. 242 Notes ……………………………………………………………………………………. 242 Practice Problems and Self-Quizzes ……………………………………………. 243

Chapter 11 Managing Revenue Cycle …………………………………………………………. 252

Learning Objectives …………………………………………………………………. 252 Introduction …………………………………………………………………………… 253 Distinguishing Revenue Cycle from Accounts Receivable ………………. 253 Importance of Accounts Receivable ……………………………………………. 255 Management of the Revenue Cycle ……………………………………………. 256 From Accounts Receivable Management to Revenue Cycle

Management …………………………………………………………………… 263 Financing Accounts Receivable………………………………………………….. 264 Federal Laws Governing Accounts Receivable ……………………………… 264 Evaluating Revenue Cycle Performance ………………………………………. 266 Chapter Key Points …………………………………………………………………. 267 Discussion Questions ………………………………………………………………. 267 Notes ……………………………………………………………………………………. 268

Chapter 12 Managing Materials …………………………………………………………………. 269

Learning Objectives …………………………………………………………………. 269 Introduction …………………………………………………………………………… 270

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x i v D e t a i l e d C o n t e n t s

Definitions of Inventory Management and Materials Management ………………………………………………………. 270

Importance of Materials Management ………………………………………… 270 Inventory Valuation ………………………………………………………………… 271 Costs of Inventory …………………………………………………………………… 272 Problem 12.1: Inventory Valuation ……………………………………………. 273 Economic Order Quantity and Reorder Point ……………………………… 276 Problem 12.2: Economic Order Quantity Qe, Total Cost TC,

and Reorder Point ……………………………………………………………. 277 Managing Inventory When Uncertain Demand Exists ………………….. 278 Evaluating Inventory Performance …………………………………………….. 279 Problem 12.3: Reorder Point Under Conditions of Uncertainty …….. 280 Chapter Key Points …………………………………………………………………. 280 Discussion Questions ………………………………………………………………. 281 Note …………………………………………………………………………………….. 281 Practice Problems and Self-Quizzes ……………………………………………. 282

Recommended Readings—Part III ………………………………………………………….. 291

Part IV: Resource Allocation

Chapter 13 Strategic and Operational Planning ……………………………………………. 295

Learning Objectives …………………………………………………………………. 295 Introduction …………………………………………………………………………… 296 Definition of Planning ……………………………………………………………… 296 Prerequisites to Planning ………………………………………………………….. 296 Types of Planning …………………………………………………………………… 296 Corporate Planning …………………………………………………………………. 298 Strategic Planning …………………………………………………………………… 299 The Planning Process ……………………………………………………………….. 299 Value of Strategic Planning ………………………………………………………. 306 Operational Planning ………………………………………………………………. 307 Evaluating Plan Performance …………………………………………………….. 309 Chapter Key Points …………………………………………………………………. 310 Discussion Questions ………………………………………………………………. 311 Notes ……………………………………………………………………………………. 311

Chapter 14 Budgeting ………………………………………………………………………………. 312

Learning Objectives …………………………………………………………………. 312 Introduction …………………………………………………………………………… 313

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Definition of Budgeting ……………………………………………………………. 313 Prerequisites to Budgeting ………………………………………………………… 313 Types of Budgets …………………………………………………………………….. 314 Steps in the Budgeting Stage …………………………………………………….. 316 Problem 14.1: Linear Regression and Estimation …………………………. 319 Evaluating Budget Performance ………………………………………………… 325 Exercise 14.1: Budgeting Exercise ………………………………………………. 326 Chapter Key Points …………………………………………………………………. 330 Discussion Questions ………………………………………………………………. 330 Notes ……………………………………………………………………………………. 330 Practice Problems and Self-Quizzes ……………………………………………. 332

Chapter 15 Capital Budgeting …………………………………………………………………… 335

Learning Objectives …………………………………………………………………. 335 Introduction …………………………………………………………………………… 336 Definition of Capital Expenditures ……………………………………………… 337 Types of Capital Expenditure Budgets………………………………………… 338 Steps in the Capital Budgeting Stage ………………………………………….. 338 Problem 15.1: Payback Period …………………………………………………… 341 Problem 15.2: Calculating the Present Value……………………………….. 342 Problem 15.3: NPV/IRR Calculation …………………………………………. 344 Financing Capital Expenditures…………………………………………………. 345 Lease Versus Purchase Decisions ……………………………………………….. 347 Evaluating Capital Budgeting Performance …………………………………. 347 Exercise 15.1: Lease Versus Purchase Decision Exercise …………………. 348 Chapter Key Points …………………………………………………………………. 349 Discussion Questions ………………………………………………………………. 350 Notes ……………………………………………………………………………………. 350 Practice Problems and Self-Quizzes ……………………………………………. 352

Recommended Readings—Part IV ………………………………………………………….. 361

Part V: Healthcare Reform: Past, Present, and Future

Chapter 16 Healthcare Reform Trends ……………………………………………………….. 365

Learning Objectives …………………………………………………………………. 365 National Healthcare Reform …………………………………………………….. 366 State Reform ………………………………………………………………………….. 377 Free-Market Reform ………………………………………………………………… 379 The Future of Healthcare …………………………………………………………. 380

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Chapter Key Points …………………………………………………………………. 384 Discussion Questions ………………………………………………………………. 384 Notes ……………………………………………………………………………………. 385

Recommended Readings—Part V ……………………………………………………………. 386

Appendix: Answers to Self-Quizzes ……………………………………………………… 389

Case Study: Hays County Integrated Delivery System ……………………….. 395

List of Abbreviations ……………………………………………………………………………… 409

Glossary ………………………………………………………………………………………………….. 415

References ………………………………………………………………………………………………. 433

Index ……………………………………………………………………………………………………….. 459

About the Author …………………………………………………………………………………… 483

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x v i i

PREFACE

Introduction to the Financial Management of Healthcare Organizations is intended to be the primary textbook in introductory courses in healthcare financial management at both the undergraduate and graduate levels as well as a reference book for program graduates and other practicing healthcare managers. The purpose of this book is to introduce students and managers in positions other than finance to the fundamental concepts and skills nec- essary to succeed as managers in an increasingly competitive employment environment.

For instance, program graduates find employment in a variety of healthcare set- tings. Therefore, the focus of this book—as well as the title of the book—extends beyond the hospital. Program graduates consistently report a deficiency in quantitative skills; this book includes problems representing key concepts. Traditional-age students report a need to apply the quantitative skills introduced in financial management. To address both of these concerns, this book includes mini-case studies within chapters, practice problems at the ends of many chapters, and a comprehensive case study at the end of the book.

Introduction to the Financial Management of Healthcare Organizations is part of Health Administration Press’s Gateway to Healthcare Management series. The textbooks in this series are geared specifically to students who are new to healthcare management.

In this edition, Part I includes an overview of financial management; the organization of financial management, including updated information on job responsibilities and salaries; financial analysis and management reporting; and the tax status of healthcare organizations, including the most recent court cases differentiating for-profit and not-for-profit hospitals.

Part II includes information about third-party payers and payment methodologies; Medicare and Medicaid, including updated laws pertaining to these public programs as

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x v i i i P r e f a c e

well as federal government settlements with providers on fraud and abuse allegations; cost accounting and analysis; and reimbursement, including charge setting.

Part III covers the management and financing of working capital; the management of the revenue cycle, including the distinction between the revenue cycle and accounts receivable; and materials management.

Part IV focuses on resource allocation and includes strategic, strategic financial, and operational planning; budgeting; and capital budgeting.

Finally, Part V provides an analysis of trends that will affect healthcare organizations in the future, including healthcare cost projections and the need for entitlement reform. The Affordable Care Act (ACA) of 2010 and the Medicare Access and CHIPS Reauthori- zation Act (MACRA) of 2015 are discussed throughout the book but more prominently in Parts II and V.

Each part of the book includes its own recommended reading list. A running glos- sary of important terms accompanies each chapter and is compiled at the end of the book; a list of acronyms used in the text is also included at the end of the book. At the end of every chapter, important points and discussion questions encourage students to summarize what they are learning and put it into their own words. The chapters are modular to allow instructors to either delete specific chapters or assign the chapters in an order based on individual preference or classroom requirements.

I hope you find Introduction to the Financial Management of Healthcare Organizations relevant, current, and easy to understand.

Acknowledgments I would like to gratefully acknowledge those who assisted me in this seventh edition: my wife, Tracey, and our kids, Hannah and David, who have often sacrificed time with Dad so that I could write; my many students over the years, who have challenged me to find a better way to explain, teach, and evaluate the understanding of difficult concepts; Thamarai Selvi Sundararajan, my graduate assistant, who helped proofread the book and provided the valuable supplemental materials; Texas State University for continuing to support faculty research efforts; and Dick Clarke, president emeritus of HFMA, who in ways too numer- ous to mention has always supported my academic career. Finally, special thanks to those at Health Administration Press who have made this seventh edition what it is.

—Michael Nowicki

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x i x P r e f a c e

Instructor resources Thisbook’sinstructorresourcesincludeatestbankofmultiplechoicequestions; additionalshort-answerandfill-in-the-blankquestions;PowerPointslidesinboth

outlineandSocraticformats;andanswerguidesforthein-bookdiscussion questions,mini-cases,andend-of-bookcase.

Forthemostup-to-dateinformationaboutthisbookanditsinstructorresources, gotoache.org/HAPandbrowseforthebookbyitstitleorauthorname.

Thisbook’sinstructorresourcesareavailabletoinstructorswhoadoptthisbook foruseintheircourse.Foraccessinformation,pleasee-mailhapbooks@ache.org.

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PA RT I

FINANCIAL MANAGEMENT

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3

Learning Objectives

C H A P T E R 1

FINANCIAL MANAGEMENT IN CONTEXT

After completing this chapter, you should be able to do the following:

➤➤ Understand➤the➤purpose➤of➤healthcare➤organizations

➤➤ Relate➤the➤purpose➤of➤healthcare➤financial➤management➤to➤the➤purpose➤of➤the➤organization

➤➤ Understand➤the➤objectives➤of➤healthcare➤financial➤management

➤➤ Apply➤quality➤assessment➤to➤healthcare➤financial➤management

➤➤ Apply➤organizational➤ethics➤to➤healthcare➤financial➤management

➤➤ Examine➤the➤value➤of➤healthcare➤financial➤management➤to➤the➤management➤functions➤and➤

the➤changing➤face➤of➤healthcare

➤➤ Review➤background➤accounting,➤economics,➤and➤statistics➤information➤(appendixes➤1.1,➤1.2,➤

and➤1.3)

No matter where you are in the healthcare finance arena, there are opportunities

to move things forward, to act, to resist complacency, to refuse to allow yourself to

think that things won’t ever change. As finance professionals we all have strengths

that will serve our organizations well in these times of change.

Debora Kuchka-Craig, 2011 chair of the Healthcare

Financial Management Association

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I n t r o d u c t i o n ➤ t o ➤ t h e ➤ F i n a n c i a l ➤ M a n a g e m e n t ➤ o f ➤ H e a l t h c a r e ➤ O r g a n i z a t i o n s4

IntroductIon Successful organizations, whether for-profit, not-for-profit, or governmental, have two things in common: (1) a congruent and well-understood organizational purpose, and (2) a functional management team. The purpose of this introductory chapter is to describe financial management in healthcare organizations within the context of organizational purpose and a competent management team.

orgAnIzAtIonAl PurPose

Organizational purpose is often determined by the owner. While a community-owned, not-for-profit healthcare organization’s purpose is to provide healthcare services to the com- munity, a corporate-owned (via stockholders) for-profit healthcare organization’s purpose is to provide profit for the owner.

By necessity, most organizations have more than one organizational purpose. For instance, even though a not-for-profit healthcare organization’s purpose is to provide health- care services to the community, the organization must survive economically—meaning that it must generate sufficient revenue to offset expenses and allow for growth. A for-profit healthcare organization’s purpose is to provide profit for the owner; however, the organi- zation must meet its customers’ needs—meaning it must keep the physicians, patients, employers, and insurance companies satisfied.

Most healthcare organizations also have secondary purposes—for example, many government-owned healthcare organizations provide large-scale medical education programs.

To maintain congruence, the management team must communicate the organiza- tional purpose or purposes not only to the employees but also to owners, customers, and other important constituents. When multiple purposes are present, the management team must prioritize the purposes.

HeAltHcAre mAnAgement teAm

In its broadest context, the objective of healthcare management is to accomplish the organizational purposes. Doing so is not as simple as it sounds, especially if the health- care organization’s purposes are “to provide the community with the services it needs, at a clinically acceptable level of quality, at a publicly responsive level of amenity, at the least possible cost” (Berman, Kukla, and Weeks 1994, 5). Healthcare managers must identify, prioritize, and often resolve these sometimes contradictory purposes in a politi- cal environment that involves the organization’s governing board and medical staff; in a regulatory environment that involves licensing and accrediting agencies; and in an economic environment that involves increasing competition, resulting in demands for lower prices and higher quality.

Competent healthcare managers attempt to accomplish the organizational purposes by planning, organizing, staffing, directing, and controlling (called the management

management functions

The➤key➤functions➤of➤

a➤manager,➤including➤

planning,➤organizing,➤

staffing,➤directing,➤and➤

controlling.

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C h a p t e r ➤ 1 : ➤ F i n a n c i a l ➤ M a n a g e m e n t ➤ i n ➤ C o n t e x t 5

functions) and through communicating, coordinating, and decision making (called the management connective processes). For more information on the management functions and connective processes, see Dunn and Haimann’s Healthcare Management (Dunn 2016).

With the exception of nursing home administrators, no licensure requirements are needed to be a practicing healthcare manager. However, facility-accrediting organizations such as The Joint Commission require healthcare managers to possess such education and experience as required by the position. Moreover, formal educational programs for healthcare management do exist at both the undergraduate and graduate levels. Undergraduate pro- grams can seek program review and approval from the Association of University Programs in Health Administration. Graduate programs can seek program review and accreditation from the Commission on Accreditation of Healthcare Management Education. Furthermore, healthcare managers can seek membership and certification in professional associations, including the American College of Healthcare Executives (ACHE), which has more than 48,000 members, more than 9,000 of whom are certified as Fellows of the American Col- lege of Healthcare Executives (FACHE) (ACHE 2016a).

PurPose of HeAltHcAre fInAncIAl mAnAgement The purpose of healthcare financial management is to provide accounting and finance information that helps healthcare managers accomplish the organization’s purposes. No licensure requirements are needed to be a practicing healthcare financial manager. Facility- accrediting organizations such as The Joint Commission rarely provide requirements for healthcare financial managers; they often hold the organization’s chief executive officer (CEO) responsible for financial management.

Formal educational programs for healthcare financial management are not com- mon and usually exist as postgraduate certificate programs. The chief financial officers of most large healthcare organizations possess a master’s degree in business administration, a bachelor’s degree in accounting, and a certificate in public accounting and have healthcare experience. For formal continuing education and certification in healthcare financial man- agement, healthcare financial managers can seek membership and certification in healthcare professional associations, including the Healthcare Financial Management Association (HFMA). HFMA has more than 40,000 affiliates, including 1,332 certified healthcare financial professionals (CHFPs) and 1,663 members certified as fellows of the Healthcare Financial Management Association (FHFMA) (HFMA 2016b).

AccountIng

Accounting is generally divided into two major areas: financial accounting and managerial accounting. The primary purpose of financial accounting is to provide accounting informa- tion, generally historical in nature, to external users, including owners, lenders, suppliers, the government, and insurers.

management

connective processes

Management➤functions➤

that➤connect➤elements➤

of➤the➤healthcare➤

organization,➤including➤

communicating,➤

coordinating,➤and➤

decision➤making.

The Joint Commission

The➤primary➤accrediting➤

body➤for➤healthcare➤

organizations.

Healthcare Financial

Management

Association (HFMA)

Association➤of➤

healthcare➤financial➤

managers;➤confers➤

four➤certifications:➤

certified➤revenue➤

cycle➤representative,➤

certified➤technical➤

specialist,➤certified➤

healthcare➤financial➤

professional,➤

and➤fellow➤of➤the➤

Healthcare➤Financial➤

Management➤

Association.

financial accounting

A➤type➤of➤accounting➤

that➤provides➤historical➤

accounting➤information➤

to➤external➤users.

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Accounting information prepared for external use must follow formats established by the American Institute of Certified Public Accountants (AICPA) and other, similar organizations and must follow generally accepted accounting principles used for stan- dardization. The 1996 AICPA Audit and Accounting Guide for Health Care Organizations (AICPA 1996) established four basic financial statements that hospitals should prepare for external users:

1. A consolidated balance sheet

2. A statement of operations

3. A statement of changes in equity

4. A statement of cash flows

The primary purpose of managerial accounting is to provide accounting informa- tion, generally current or prospective in nature, to internal users, including managers. Such accounting information supports the planning and control management functions. In this way, managerial accounting is the link between financial accounting and the manager. Managerial accounting, or accounting information prepared for internal use, requires no prescribed format and therefore varies greatly among organizations. Managerial accounting

managerial accounting

A➤type➤of➤accounting➤

that➤provides➤

accounting➤information,➤

generally➤current➤or➤

prospective➤in➤nature,➤

to➤internal➤users.

CRITICAL CONCEPTS Measurements

Healthcare➤financial➤managers➤monitor➤many➤measurements.➤Among➤the➤most➤common➤

are➤the➤following:

•➤ Admissions:➤The➤number➤of➤patients,➤excluding➤newborns,➤accepted➤for➤inpatient➤

service

•➤ Average daily census:➤The➤average➤number➤of➤inpatients,➤excluding➤newborns,➤

receiving➤care➤each➤day➤during➤the➤reporting➤period

•➤ Average length of stay (ALOS):➤Derived➤by➤dividing➤the➤number➤of➤inpatient➤days➤

by➤the➤number➤of➤admissions

•➤ Occupancy rate:➤The➤ratio➤of➤average➤daily➤census➤to➤the➤average➤number➤of➤

statistical➤(set➤up➤and➤staffed➤for➤use)➤beds

!

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topics such as budgeting and inventory control require knowledge of economics, statistics, and operations research.

Many managerial accountants believe that cost accounting—the study of costs, including methods for classifying, allocating, and identifying costs—is either synonymous with or a subset of managerial accounting. Others argue that cost accounting includes all managerial accounting and also requires some financial accounting. Cost accounting and managerial accounting also include topics that could be considered finance.

fInAnce

Historically, the purpose of finance has been to borrow and invest the funds necessary for the organization to accomplish its purpose. Today, the purpose of finance is to analyze the information provided by managerial accounting to evaluate past decisions and make sound assessments regarding the future of the organization (Finkler 2003). Finance uses techniques such as ratio analysis and capital analysis and requires knowledge of financial and managerial accounting (see appendix 1.1), economics (see appendix 1.2), statistics (see appendix 1.3), and operations research. Exhibit 1.1 shows the relationship of finance to the aforementioned supporting disciplines.

cost accounting

The➤study➤of➤costs,➤

including➤methods➤of➤

classifying,➤allocating,➤

and➤identifying➤costs.

capital analysis

A➤process➤to➤determine➤

how➤much➤a➤capital➤

expenditure➤will➤cost➤

and➤what➤return➤it➤will➤

generate.

ratio analysis

Evaluation➤of➤an➤

organization’s➤

performance➤by➤

computing➤the➤

relationships➤of➤

important➤line➤items➤in➤

the➤financial➤statements.

exHIbIt 1.1 Financial Management Relationships

Other disciplines

Operations research

Economics Statistics

Cost accounting

Managerial accounting

Financial management

Finance Financial

accounting

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mAjor objectIves of HeAltHcAre fInAncIAl mAnAgement In this section, we will examine six major objectives of healthcare financial management: (1) to generate income, (2) to respond to regulations, (3) to facilitate relationships with third-party payers, (4) to influence the method and amount of payment, (5) to monitor physicians, and (6) to protect tax status.

generAte Income

While the purpose of healthcare financial management is to provide accounting and finance information that assists healthcare management in accomplishing the organization’s objec- tives, all organizations have at least one objective in common: to survive and grow. Orga- nizations in other industries might refer to this objective as maximizing owners’ wealth; healthcare organizations typically refer to it as maintaining community services. In either event, the organization will be of little use if it cannot afford to continue to operate.

Therefore, the most important objective of healthcare financial management is to generate a reasonable net income (i.e., the difference between collected revenue and expenses) by investing in assets and putting the assets to work.

resPond to regulAtIons

Although financial management in healthcare organizations has similar objectives to that of organizations in other industries, different objectives also exist. The government regulates healthcare to a significant degree because healthcare organizations are in a position to take advantage of the sick and the elderly; regulation protects individuals who cannot protect themselves. Federal, state, and local governments pay more than 55 percent of all health insurance expenditures and therefore have a vested interest in ensuring that government money is well spent (Martin et al. 2016). Healthcare organizations must also be accredited or certified to qualify for reimbursement from many third-party payers and to qualify for loans from certain lenders. Therefore, the second objective of healthcare financial man- agement is to respond to the myriad of regulations in a timely and cost-effective manner.

fAcIlItAte relAtIonsHIPs wItH tHIrd-PArty PAyers

The third objective of healthcare financial management is to facilitate the organization’s relationship with each third-party payer, such as an insurance company, that will pay all or a portion of the bill. Private health insurance, Medicare, and Medicaid account for more than 82 percent of all personal health consumption expenditures (Martin et al. 2016). Financial management must be responsive to third-party payers and in many ways must treat third-party payers as customers because the third party pays the bill. At the same time,

net income

The➤difference➤between➤

collected➤revenues➤and➤

expenses;➤a➤reasonable➤

amount➤is➤considered➤

the➤most➤important➤

objective➤of➤healthcare➤

financial➤management.

third-party payer

An➤agent➤of➤the➤patient➤

(the➤first➤party)➤that➤

contracts➤with➤a➤

provider➤(the➤second➤

party)➤to➤pay➤all➤or➤a➤

portion➤of➤the➤bill➤to➤

the➤patient.

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financial management must be attentive to the patient because the patient has influence over the third-party payer and in some cases may be partially responsible for the bill.

Influence metHod And Amount of PAyment

The fourth objective of healthcare financial management is to influence the method and amount of payment chosen by third-party payers. Third-party payers are becoming increas- ingly aggressive in asking healthcare organizations for discounts if they provide large numbers of patients. In certain cases, healthcare organizations are discounting prices below costs to maintain market share.

Some third-party payers, such as Medicare, are asking healthcare organizations to assume part of the financial risk for the patient by agreeing to a prospective payment, or, in other words, agreeing in advance to a price for providing care to a patient. Healthcare organizations lose money if they provide care that costs more than the prospective payment.

Some third-party payers are asking healthcare organizations to assume risk by agreeing to a capitated price (i.e., a price per head or subscriber) before the subscriber actually needs care. Capitated prices put healthcare organizations at risk for the cost of care, if needed.

monItor PHysIcIAns

The fifth objective of healthcare financial management is to monitor physicians and their potential financial liability to the organization. In 2015 (the most recent year for which data were available at time of publication), professional services including physicians, dentists, and other professionals accounted for 30.9 percent of all personal healthcare expenditures (Martin et al. 2017). However, physicians influence much of the healthcare spending that is not directly attributed to them. For example, physicians order the patient admission, the diagnostic testing and treatment for the patient, and the patient discharge. Healthcare financial management must ensure through the utilization review process that physician ordering patterns are consistent with what the patient needs. In addition, healthcare finan- cial management must ensure through the credentialing process and the risk management process that the healthcare organization using more healthcare has minimized its exposure to legal liability for a physician’s possible negligent actions.

Protect tAx stAtus

The sixth major objective of healthcare financial management is to protect the organiza- tion’s tax status. For-profit healthcare organizations seek ways to reduce their tax liability, and not-for-profit healthcare organizations try to protect their tax-exempt status. Protect- ing tax-exempt status has become more difficult as state and local governments seek new

prospective payment

A➤payment➤system➤in➤

which➤a➤healthcare➤

organization➤accepts➤a➤

fixed,➤predetermined➤

amount➤to➤treat➤a➤

patient,➤regardless➤

of➤the➤true➤ultimate➤

cost➤of➤that➤treatment.➤

Diagnosis-related➤

groups➤(DRGs)➤are➤one➤

type➤of➤prospective➤

payment;➤Medicare➤

pays➤hospitals➤a➤fixed➤

amount➤for➤an➤episode➤

of➤treatment➤based➤on➤

that➤treatment’s➤DRG.

capitated price

A➤healthcare➤payment➤

system➤in➤which➤an➤

organization➤accepts➤a➤

monthly➤payment➤from➤

a➤third-party➤payer➤for➤

each➤individual➤covered➤

by➤that➤payer’s➤plan,➤

regardless➤of➤whether➤

a➤given➤individual➤

is➤treated➤in➤a➤given➤

month.➤Also➤known➤as➤

capitation,➤it➤provides➤a➤

financial➤incentive➤to➤a➤

healthcare➤organization➤

to➤keep➤its➤population➤

from➤using➤more➤

healthcare➤services➤

than➤necessary➤because➤

the➤organization➤profits➤

only➤if➤the➤total➤cost➤of➤

treating➤the➤specified➤

population➤falls➤below➤

the➤total➤capitated➤price➤

provided➤by➤the➤third-

party➤payer.

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revenue sources, and tax-exempt status has come under judicial and public scrutiny (see chapter 4).

QuAlIty Assessment And HeAltHcAre fInAncIAl mAnAgement The healthcare industry has long had difficulty with defining quality:

Quality➤.➤.➤.➤you➤know➤what➤it➤is,➤yet➤you➤don’t➤ know➤what➤it➤is.➤But➤that’s➤self-contradictory.➤ But➤some➤things➤are➤better➤than➤others.➤That➤is,➤ they➤have➤more➤quality.➤But➤when➤you➤try➤to➤say➤ what➤that➤quality➤is,➤apart➤from➤the➤things➤that➤

have➤it,➤it➤all➤goes➤poof!➤There’s➤nothing➤to➤talk➤about.➤But➤if➤you➤can’t➤say➤what➤quality➤ is,➤then➤for➤all➤practical➤purposes,➤it➤doesn’t➤exist➤at➤all.➤But➤for➤all➤practical➤purposes➤it➤ does➤exist.➤What➤else➤are➤the➤grades➤based➤upon?➤Why➤else➤would➤people➤pay➤fortunes➤ for➤some➤things➤and➤throw➤others➤in➤the➤trash➤pile?➤Obviously,➤some➤things➤are➤better➤ than➤others➤.➤.➤.➤but➤what’s➤the➤‘betterness?’➤.➤.➤.➤So➤round➤and➤round➤you➤go,➤spinning➤ mental➤wheels➤and➤nowhere➤finding➤any➤place➤to➤get➤traction.➤(Pirsig➤1974,➤179)

Since the 1970s, healthcare organizations have responded to serious pressure to define quality. In the early 1970s, accrediting agencies and third-party payers applied this pressure. In the late 1970s and early 1980s, the consumer movement added pressure. In the late 1980s through the present, competition has added pressure. Economists predict that the pressure will continue as competition drives prices to their lowest—and relatively equal—point, and the market will force healthcare organizations that survive to compete on quality in addition to price. Healthcare organizations have responded to this pressure with two contrasting strategies: either a proactive strategy that attempts to adopt a com- prehensive view of quality or a reactive strategy that attempts to limit views of quality to views developed by others.

ProActIve strAtegy

Healthcare organizations that have adopted a proactive strategy have developed multiple meas- ures of quality, including direct and indirect measures that go beyond the minimum measures required by accrediting organizations (Conrad and Blackburn 1985). Direct measures of quality assume that the organization can define and measure quality itself. These measures include the following:

MINI-CASE STUDY✓

Suppose➤you➤were➤recently➤hired➤to➤manage➤a➤new➤primary➤care➤

physician’s➤office.➤The➤physician’s➤office➤will➤be➤located➤down-

town➤in➤a➤major➤metropolitan➤area➤with➤significant➤competition.➤

You➤need➤to➤establish➤the➤organization’s➤purpose➤and➤financial➤

objectives.➤What➤items➤should➤you➤consider➤in➤establishing➤the➤

organization’s➤purpose?➤What➤organizational➤purpose➤should➤

you➤suggest➤to➤the➤physician➤owners?➤What➤should➤the➤financial➤

objectives➤of➤the➤organization➤be?

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1. Goal-based measures assess quality by the progress made toward the goals of the strategic and operating plans. The key advantage of goal-based measures is that they focus attention on success or failure.

2. Responsive measures assess quality by customer opinion. The key advantage of responsive measures is that they understand quality from the customer’s point of view.

3. Decision-making measures assess quality by evaluating decisions. The key advantage of decision-making measures is that they direct accountability to the decision maker.

4. Connoisseurship measures allow quality to be assessed by expert opinion, such as accreditation. The key advantage of connoisseurship measures is that they inspire high credibility.

Indirect measures of quality assume that the organization cannot define and measure quality itself but can define and measure the results of quality. These measures include the following:

1. Resource measures assume that price reflects quality. The key advantage of resource measures is that they provide quantitative data that are readily available.

2. Outcome measures assume that results reflect quality. The key advantage of outcome measures is the emphasis on results.

3. Reputational measures assume that public perception reflects quality. The key advantage of reputational measures is that they produce ratings for the public.

4. Value-added measures assume that process reflects quality. The key advantage of value-added measures is that, after adjusting for input and output, they focus on process, which the organization can control.

reActIve strAtegy

Healthcare organizations that have adopted a reactive strategy have responded in several ways to accrediting agencies and quality consultants, including

◆ ensuring quality by centralizing quality efforts in a quality assurance department, then decentralizing quality efforts to clinical departments, and then further decentralizing quality efforts to all departments;

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◆ ensuring quality by studying clinical outcomes, then studying clinical processes, then studying all outcomes and all processes, and finally studying key outcomes and key processes;

◆ improving quality by continuous attention and total management; and

◆ assessing quality by identifying key processes and desired outcomes.

Since 1986, The Joint Commission has focused on quality, the customer, work processes, measurements, and improvements. To its primary goal of accrediting healthcare organizations, The Joint Commission added the goal of developing and implementing a national performance measurement database. For a description of the current require- ments regarding performance measures and performance measure data, consult the chapter “Performance Measurement and the ORYX Initiative (PM)” in the Joint Commission’s Comprehensive Accreditation Manual for Hospitals (Joint Commission 2016).

In response to the Institute of Medicine’s report To Err Is Human (IOM 1999) that as many as 98,000 Americans die each year as a result of errors in hospitals, The Joint Commission announced a new set of patient safety and medical error reduction standards that took effect July 1, 2001 (Joint Commission 2001). The IOM report was reinforced by three 2006 studies that measured not only deaths caused by hospital-acquired infections but also the increased costs associated with preventable hospital errors (Conn 2006). The Joint Commission standards required accredited hospitals (Lovern 2001) to

◆ make their doctors tell patients when they receive substandard care or care that differs significantly from anticipated outcomes;

◆ implement an organization-wide patient safety program with procedures for immediate response to medical errors;

◆ report to the hospital’s governing body at least once annually on the occurrence of medical errors; and

◆ revise patient satisfaction surveys to ask patients how the organization can improve patient safety.

In July 2002, The Joint Commission approved the first National Patient Safety Goals (NPSGs) for hospitals. The NPSGs help accredited organizations address specific areas of concern regarding patient safety. Each goal includes a number of evidence- or expert- based requirements. Each year the goals are reevaluated, and the goals may be continued or replaced based on new patient safety priorities. The 2016 Joint Commission NPSGs for hospitals include the following (Joint Commission 2016):

◆ Improve the accuracy of patient identification.

◆ Improve the effectiveness of communication among caregivers.

National Patient Safety

Goals (NPSGs)

A➤set➤of➤goals➤

established➤by➤The➤

Joint➤Commission➤to➤

address➤safety➤areas➤

of➤special➤concern➤for➤

hospitals.

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◆ Improve the safety of using medications.

◆ Reduce the harm associated with clinical alarm systems.

◆ Reduce the risk of healthcare-associated infections.

◆ Identify safety risks inherent in the hospital’s patient population.

National Patient Safety Goals for other types of healthcare providers can be accessed via The Joint Commission website at www.jointcommission.org/standards_information/npsgs.aspx.

In conjunction with the NPSGs, The Joint Commission also introduced the Universal Protocol for Preventing Wrong Site, Wrong Procedure, and Wrong Person Surgery. The Universal Protocol applies to all surgical and invasive nonsurgical procedures and requires that hospitals conduct a preprocedure verification process, mark the procedure site, and perform a time-out before the procedure (Joint Commission 2016).

The Joint Commission’s 2016 hospital accreditation manual featured a new chapter entitled “Patient Safety Systems,” the stated intent of which was “to provide health care organiza- tions with a proactive approach to designing or redesigning a patient-centered system that aims to improve quality of care and patient safety, an approach that aligns with the Joint Commission’s mission and its standards.” The new chapter reflects the Joint Commission’s understanding that patient safety and quality are “inextricably linked” (Joint Commission 2016, PS-1).

effects of QuAlIty on ProfItAbIlIty Deming and others have long argued that quality improvements lead to higher profitability. Deming introduced the following chain reaction analogy: Improvements in quality (fewer errors) lead to improvements in productivity, which lead to lower costs, which lead to lower prices, which lead to improved market position, which leads to increased volumes, which lead to increased profit (Deming 1982).

Significant evidence shows that improved quality has led to improved profitability in healthcare. Solucient ranked the nation’s top 100 hospitals using clinical measures (now ranked by Truven Health Analytics—an IBM Company). In 2003, Modern Healthcare for the first time reported financial data for the top 100 hospitals. These hospitals consistently out- performed their peer group hospitals on both the clinical and financial measures.

orgAnIzAtIonAl etHIcs And HeAltHcAre fInAncIAl mAnAgement The Joint Commission and healthcare profes- sional associations such as ACHE and HFMA

MINI-CASE STUDY✓

Suppose➤that➤you➤are➤the➤administrator➤of➤a➤nursing➤home➤

owned➤by➤a➤for-profit➤parent➤corporation➤that➤owns➤30➤nursing➤

homes.➤You➤have➤been➤asked➤by➤the➤board➤of➤directors➤of➤the➤

parent➤corporation➤to➤explain➤how➤your➤quality➤initiatives➤will➤

improve➤profitability.➤What➤is➤your➤presentation?

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have long emphasized organizational ethics. Sev- eral Joint Commission standards require health- care organizations to have mechanisms in place to address ethical issues related to such topics as patient rights and management responsibilities. Ethical issues concerning patient rights include informed consent, patient confidentiality, and the patient’s right to participate in care decisions and end-of-life decisions. Ethical issues concern- ing management responsibilities include resource allocation, conflicts of interest, and patient billing practices.

Resource allocation decisions by managers often conflict with the decisions made by physicians and other clinicians. Managers typically represent a utilitarian view of ethics, best represented by the phrase “the greatest good for the greatest number.” This view allows managers to sacrifice the use of resources for one patient to maintain resources for other patients, given the assumption that resources for the healthcare organization are limited. Clinicians typically represent a deontological view of ethics, which means that their deci- sions are governed by their duties to patients, which take precedence over the ends-based decision making of the manager. This continuous conflict seems to keep resource allocation decisions somewhat balanced.

Conflicts of interest occur when an individual owes duties to two or more persons or organizations and when meeting a duty to one somehow harms the other (Darr 2011). Perhaps the worst examples of conflict of interest involve the conflict between a manager’s duties to the organization and a manager’s duties to self, such as when managers use their positions of authority for personal gain. Even the perception of impropriety may cause a loss of credibility (Nowicki and Summers 2001). This is especially true in financial manage- ment, where contracts for services and products are awarded to vendors who may attempt to buy influence with a lunch or a gift.

For the most part, patient billing practices, especially for Medicare and Medicaid, are covered by law; however, even certain legal practices have ethical ramifications. For instance, how long should a healthcare organization hold a patient’s deposit after the insurance company pays in full? State law on this issue and overpayments by commercial insurance companies is nonexistent or varies widely. Although a healthcare organization may be under no legal obligation to refund overpayments by insurance companies, is keep- ing someone else’s money ethical? Many healthcare organizations use ethics committees to provide answers to these and other billing questions. Although healthcare organizations are not required to organize ethics committees, committees are a useful way to solicit com- munity input on billing issues.

MINI-CASE STUDY✓

Imagine➤that➤you➤manage➤a➤four-physician➤office➤practice➤in➤a➤

competitive➤neighborhood.➤Vendors➤often➤bring➤ lunches➤and➤

gifts➤ for➤ your➤ staff➤ and➤ samples➤ of➤ prescription➤ medications➤

that➤the➤physicians➤then➤give➤to➤patients.➤Could➤any➤of➤these➤

practices➤pose➤a➤problem?➤If➤so,➤why?

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vAlue of HeAltHcAre fInAncIAl mAnAgement Healthcare financial management provides accounting information and financial techniques that allow managers to perform the management functions and the management connective processes and therefore accomplish the organizational objectives. In addition, healthcare financial management also has direct value to these functions, as explained in the following list of management functions (Dunn 2016).

◆ Planning: After the governing body completes the strategic plan and senior management completes the operating plan, financial management is often responsible for completing the operating budget and capital budget. The operating budget often provides the incentives to plan properly.

◆ Organizing: Financial management provides a chart of accounts based on the organizational chart that identifies revenue centers and cost centers. Together with the organizational chart, this chart of accounts provides the basis for responsibility accounting, which is the ability to hold department managers responsible for their revenues and expenses.

◆ Staffing: Financial management often staffs a variety of departments and processes important to the healthcare organization. Departments such as medical records and information systems are currently being placed under the supervision of financial management, in addition to departments such as accounting, admitting, and materials management, which have been traditionally under financial management. The increasing importance of nontraditional departments in the billing process appears to justify this trend.

◆ Directing: Financial management provides rewards and penalties to motivate others to accomplish the organization’s purposes.

◆ Controlling: Perhaps the responsibility closest to the overall function of financial management, the control of the budget, financial reports, financial policies and procedures, and financial audits allows financial management to monitor performance and take the appropriate corrective action when performance is unsatisfactory.

These management functions mean little without the management connective processes to integrate the functions.

Communicating and coordinating are important to financial management for both reporting and advising. Also important is coordinating the relationships between, for example, revenue and expenses, capital budgets and operating budgets, and volumes and prices and collected revenues.

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Decision making is important to financial management as a direct measure of quality. Governing boards, CEOs, and outside sources such as independent auditors often judge the quality of financial management on the basis of the decisions and recommendations made by financial management. The advantage of this view of quality is that it holds the decision maker accountable. The disadvantage is that it assumes rational decision making. Decisions made in healthcare financial management are often based on politics or other criteria that are unknown to the evaluator of the decision. Therefore, a decision may be evaluated as bad on the basis of the known facts, but it may be evaluated as good on the basis of other criteria unknown to the evaluator.

effect of fInAncIAl mAnAgement on tHe cHAngIng fAce of HeAltHcAre Many observers say that financial management is the most important predictor of whether healthcare organizations will survive in the current competitive climate and beyond. Health- care is one of several industries that society has allowed to grow beyond the industry’s ability to produce efficiently—other industries include agriculture during the 1970s, the auto industry during the 1980s, the petroleum industry during the 1990s, the financial services industry during the first decade of the twenty-first century, and higher education during the 2010s. The recession that began in 2008 affected healthcare organizations as much as it affected many other industries, and the passage of the Affordable Care Act in 2010 created entirely new financial challenges. The implications of this reform on healthcare finance may not be fully known for many years, but at least three elements of the legislation were expected to profoundly affect the financial situation of healthcare organizations: the increase in the number of individuals with health insurance; the changing reimbursement structures; and the explicit linking of reimbursement with quality measures.

Clearly, only the well-managed healthcare organizations will survive this changing situation; financial management will be instrumental in their survival.

➤➤ Whereas➤an➤organization➤may➤have➤more➤than➤one➤organizational➤purpose,➤

the➤financial➤purpose➤of➤the➤organization➤is➤to➤provide➤accounting➤and➤finance➤

information➤that➤helps➤healthcare➤managers➤accomplish➤the➤organization’s➤purposes.

➤➤ Among➤the➤major➤objectives➤of➤financial➤management➤relevant➤to➤any➤healthcare➤

manager➤(to➤generate➤income,➤to➤respond➤to➤regulations,➤to➤facilitate➤relationships➤

with➤third-party➤payers,➤to➤influence➤the➤method➤and➤amount➤of➤payment,➤to➤monitor➤

cHAPter key PoInts

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physicians,➤and➤to➤protect➤tax➤status),➤the➤one➤objective➤all➤organizations’➤financial➤

managers➤have➤in➤common➤is➤to➤survive➤and➤grow.

➤➤ Understanding➤the➤impact➤of➤quality➤on➤profitability➤can➤turn➤good➤managers➤into➤

great➤managers.

➤➤ Sound➤ethical➤reasoning➤should➤affect➤every➤decision,➤even➤financial➤decision➤making.

1.➤ Why➤is➤financial➤management➤important➤to➤the➤organization?

2.➤ What➤is➤the➤distinction➤between➤the➤purpose➤of➤healthcare➤management➤and➤the➤ purpose➤of➤healthcare➤financial➤management?

3.➤ How➤would➤you➤prioritize➤the➤major➤objectives➤of➤healthcare➤financial➤management?

4.➤ What➤are➤the➤major➤ethical➤theories,➤and➤how➤do➤they➤apply➤to➤the➤role➤of➤a➤healthcare➤ manager?

5.➤ Why➤should➤financial➤managers➤be➤concerned➤with➤quality➤initiatives➤in➤the➤healthcare➤ organization?

6.➤ How➤would➤you➤predict➤that➤financial➤management➤and➤the➤management➤functions➤ will➤be➤important➤as➤healthcare➤changes➤in➤the➤future?

dIscussIon QuestIons

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Appendix 1.1 Financial Accounting Outline

I.➤ Financial➤accounting➤is➤the➤science➤of➤preparing➤financial➤statements➤for➤use➤by➤ individuals➤and➤organizations➤external➤to➤the➤organization.

II.➤ Accounting➤equation➤ Total➤assets➤=➤Liabilities➤+➤Net➤assets

III.➤ Objectives➤of➤financial➤accounting A.➤ Provide➤information➤that➤is➤useful➤to➤present➤and➤potential➤investors,➤creditors,➤

and➤other➤decision➤makers. B.➤ Provide➤information➤about➤the➤economic➤resources➤of➤the➤healthcare➤

organization,➤the➤claims➤to➤those➤resources,➤and➤the➤effects➤of➤transactions,➤ events,➤and➤circumstances➤that➤change➤those➤resources.

C.➤ Provide➤information➤about➤a➤healthcare➤organization’s➤performance. D.➤ Provide➤information➤about➤how➤a➤healthcare➤organization➤generates➤and➤

expends➤cash,➤about➤its➤loans➤and➤repayment➤of➤loans,➤and➤about➤its➤capital➤ expenditures.

E.➤ Provide➤information➤about➤how➤a➤healthcare➤organization➤has➤discharged➤its➤ stewardship➤duties➤to➤its➤owners.

IV.➤ Accounting➤concepts A.➤ Entity—The➤healthcare➤organization➤stands➤apart➤from➤all➤other➤organizations➤

and➤is➤capable➤of➤taking➤on➤economic➤transactions. B.➤ Reliability—Accounting➤records➤must➤be➤based➤on➤information➤that➤is➤verifiable➤

from➤an➤independent➤source. C.➤ Cost➤valuation—Assets➤and➤services➤are➤recorded➤at➤actual,➤historical➤cost. D.➤ Going➤concern—The➤entity➤will➤operate➤long➤enough➤to➤recover➤the➤cost➤of➤its➤

assets. E.➤ Stable➤monetary➤unit—This➤is➤the➤basis➤for➤ignoring➤the➤effects➤of➤inflation➤in➤

short-term➤transactions. V.➤ Accounting➤principles

A.➤ Accrual➤accounting—Revenue➤is➤recorded➤when➤it➤is➤realized➤(i.e.,➤billed),➤and➤ expense➤is➤recorded➤when➤it➤contributes➤to➤operations.

B.➤ Cash➤accounting—Revenue➤and➤expenses➤are➤recorded➤when➤cash➤is➤actually➤ received➤or➤paid.

C.➤ Accounting➤period—This➤is➤a➤defined➤fiscal➤year➤or➤month. D.➤ Matching—Related➤revenue➤and➤expense➤should➤be➤reported➤in➤the➤same➤

accounting➤period. E.➤ Conservatism—Uncertainty➤dictates➤understating➤revenues➤and➤volumes➤that➤

lead➤to➤revenues,➤and➤overstating➤expenses. F.➤ Full➤disclosure—All➤economic➤transactions➤should➤be➤recorded.

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G.➤ Industry➤practices—Accounting➤principles➤are➤relatively➤unique➤to➤the➤ healthcare➤industry. 1.➤ Fund➤accounting—This➤allows➤not-for-profit➤and➤governmental➤healthcare➤

organizations➤to➤establish➤separate➤entities➤for➤specified➤activities.➤Typical➤ funds➤include➤operating➤or➤general➤funds,➤specific-purpose➤funds,➤plant- replacement➤funds,➤and➤endowment➤funds.➤Each➤fund➤is➤self-balancing➤in➤ that➤assets➤equal➤liabilities➤added➤to➤net➤fund➤balance.

2.➤ Contractual➤allowances—This➤is➤the➤revenue➤account➤that➤records➤the➤ difference➤between➤billed➤charges➤and➤the➤price➤a➤customer➤has➤agreed➤in➤ advance➤to➤pay➤via➤contract.

3.➤ Depreciation—This➤is➤the➤expense➤account➤that➤records➤the➤estimated➤cost➤ of➤an➤expiring➤asset.

4.➤ Funded➤depreciation—This➤is➤the➤amount➤saved➤to➤replace➤assets➤at➤the➤ end➤of➤their➤useful➤life.

5.➤ AICPA Audit and Accounting Guide for Health Care Organizations➤ a.➤ There➤were➤major➤changes➤in➤the➤1990➤edition.

1)➤ On➤the➤statement➤of➤revenues➤and➤expenses,➤operating➤revenue➤is➤ reported➤net➤of➤contractual➤allowances.

2)➤ On➤the➤statement➤of➤revenues➤and➤expenses,➤operating➤ revenue➤is➤reported➤net➤of➤charity➤care;➤however,➤the➤healthcare➤ organization’s➤policy➤for➤charity➤care,➤in➤addition➤to➤the➤level➤of➤ charity➤care,➤must➤be➤in➤the➤footnotes.

3)➤ On➤the➤statement➤of➤revenues➤and➤expenses,➤bad➤debt➤expense➤is➤ reported➤as➤an➤expense➤based➤on➤price.

4)➤ On➤the➤statement➤of➤revenues➤and➤expenses,➤donated➤assets➤are➤ reported➤at➤fair➤market➤value➤as➤of➤the➤date➤of➤the➤gift.

5)➤ On➤the➤statement➤of➤revenues➤and➤expenses,➤donated➤services➤are➤ reported➤as➤an➤expense,➤and➤a➤corresponding➤amount➤is➤reported➤ as➤a➤contribution,➤but➤only➤if➤the➤services➤are➤significant➤and➤ measurable.

b.➤ There➤were➤major➤changes➤in➤the➤1996➤edition. 1)➤ Changes➤were➤made➤to➤the➤basic➤financial➤statements.

a)➤ Balance➤sheet➤(consolidated) b)➤ Statement➤of➤operations c)➤ Statement➤of➤changes➤in➤equity d)➤ Statement➤of➤cash➤flows

2)➤ The➤balance➤sheet➤reports➤net➤assets. a)➤ Unrestricted b)➤ Temporarily➤restricted c)➤ Permanently➤restricted

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