Healthcare expenses continue to rise.  In our last article, we discussed some of the inherent issues associated with healthcare economics.  I received a few emails from readers indicating a desire to learn more about the fundamentals of healthcare finance.   So consider this article an introduction to healthcare finance for those that are not business trained.  After all, many of you in a few years will be sitting across the table with Administrators discussing bonuses and augmentation based on financial performance.

 

Today, most healthcare leaders are in a tough position, balancing costs, decisions and providing services for the community.  Running a healthcare business is not easy.  How many businesses do you know that provide a service to customers, as ordered by independent individuals (Providers) and paid for by a third party, and yet operate on large amount of cash tied up in accounts receivable for several months?

None.

Yet, the rising cost of caring for uninsured, underinsured and the indigent threaten the financial health of most healthcare organizations.  Providing care for these individuals under current reimbursement systems make it difficult for organizations to carry out their mission of caring for patients in their respective communities.  Charity care and write-offs count for the top financial problems facing most healthcare organizations.

So what types of healthcare organizations are there, anyways?

There are three types of healthcare organizations that you should be aware of: for-profit, not-for-profits and academic centers.

I.) Not-for-Profit facilities are associated with community-based organizations.   They are tax-exempt under a 501(c)(3).

2.) For-Profit facilities are taxable.  Their primary focus is on generating a return for shareholders.  These are individuals, or companies that own part of the institution.

3.) Academic Centers.  Their primary focus is teaching new healthcare professionals and focusing on research.

How the money comes in and goes out…The Accounting Cycle.

Monies in a healthcare organization comes in through revenue and leaves through expenses.

Expenses– These are costs incurred for the operations of the services within the organization.  Typically, purchases are requested and then pushed electronically to a Purchasing department through an accounting code.  Upon approval, the Purchasing department sends a purchase order and communicates to the vendor.  Once the items are received by the institution and an invoice received, accounts payable will match the invoice and purchase order and pay the vendor.

Revenue Cycle– How the money comes in

Revenue in healthcare is generated once services are provided to patients.  This process is quite complex as the below suggests:

In English, please?

Dumbing down the above: When a patient is seen, all healthcare organizations place a “charge capture” for the services provided meaning that the charges are generated.  This goes out to the Insurance companies on behalf of the patient.  The insurance carrier adjudicates the claim and the Provider (healthcare organization) will write off discounts based on a pre-existing contract with the insurance carrier.  Insurance companies or Payors negotiate these contracts based on purchasing power i.e. they may say, “Acme Healthcare, we want to provide our subscribers with your services.  We have 20,000 subscribers in your area (in-network) that can utilize your service.  In return we want X% discount.”  These discounts are benchmarked against Medicare rates.  So the healthcare organization is then “reimbursed” or paid one of several ways.

Reimbursement Methods

So monies come in from payment for services provided by healthcare organizations also known as “reimbursement.”  There are several methodologies of reimbursement.  Here are the major ones you should understand:

*Managed Care:  There are three Managed Care Plans that you should be aware of and probably have heard of but do not know quite what they mean:

• Health Maintenance Organizations (HMO) usually only pay for care within the network. You choose a primary care doctor who coordinates most of your care.
• Preferred Provider Organizations (PPO) usually pay more if you get care within the network, but they still pay a portion if you go out of network
• Point of Service (POS) plans let you choose between an HMO or a PPO each time you need care

Healthcare Accounting 101

There are three forms of accounting that you should know of or at least be aware of if ever in a place where financials are being discussed:

1.) Cash-Basis– This form of accounting realizes income and expenses only when monies are physically received or spent.

Example:

Revenue: Patient visits March 28^th, but Provider gets monies from visit on April 20^th.  The revenue is recorded in April’s books when it received the cash. Expense: Vaccines purchased on March 28^th, but it is received April 15^th, the expense is recorded in April’s books after reconciling office confirms receipt of vaccines.

2.) Accrual-Basis- This form of accounting realizes income and expenses only when it is “earned” not when it is physically received or spent.

Example:

Revenue: Patient visits March 28^th, but Provider gets monies from visit on April 20^th.  The revenue is recorded in March’s books as Accounts Receivable. Expense: Vaccines purchased on March 28^th, but it is received April 15^th, the expense is recorded in March’s books as Accounts Payable.

3.) Fund-Basis– This is often used by Government entities and Academic Centers.  It specifies funds for different types of uses.  For example, some may be broken down by State Funds and Business Funds, where State is allocated to things like Fringes for employees and Business is allocated for things like operating expenses for doing businesses.

 

Healthcare Finance 101

There are two financial statements in which you should be familiar with: The Balance Sheet and the Income Statement.

Balance Sheet– Represents a “snapshot” in time of an entities liabilities (bills and debts) as well as assets and equity (ownership after payment of liabilities).   It is termed a “Balance” sheet since the entities must equal: That is Assets = Liabilities + Equity.

Below is an example of a Balance Sheet for a fictitious company: Acme Healthcare

Tell me what I need to know!

Be aware of the Assets on the left and Liabilities and Equity on the right side of the balance sheet. Realize the importance of Current Assets, which includes cash, accounts receivable and inventory.

Ideally, organizations want to keep about 3 months operating expenses in cash should something catastrophic occur.  You will see other color coded notes in the balance sheet above.

When looking at a balance sheet, two of the most important things you want to get a feel for are a company’s liquidity and solvency.

Liquidity is a company’s ability to pay its bills (debts).

Analysis: Current Ratio= Current Assets/Current Liabilities.  A good ratio (there is variance among industries) is around 1.5-2.0. So for our example above, Acme Healthcare, its current ratio is $5.24M/$3.75M for 12/2012, or about 1.4.  It is on the lower side, but still not too shabby.

Solvency is a company’s ability to meet long-term debts.

Analysis: Debt to Equity Ratio= Total Liabilities/Total Equity. A high debt to equity ratio indicates that a company has financed its growth with debt (not necessarily bad, but not ideal).  Ideal for healthcare is between 0.5-2.  So four example above, Acme healthcare, its debt to equity ratio is $9.75M/$9.23M or about 1.05, meaning that Acme has not taken significant amount of debt to grow its operations.

 

Income Statement- This reports the financial performance of the entity over a period of time.  It details the revenues (incoming monies) and the expenses (out-going monies) for operation of the organization.

The best way to learn about an income statement is to look at a real-world example.  Our friends at Acme Healthcare have been so kind to disclose their Income Statement for December 2012 Year-To-Date below:

 

Tell me what I need to know!

This may seem daunting for many of you that have never seen an Income Statement before.  Spend a few minutes reading the below while starring at the Income Statement above and I promise you will learn something from this.

First, you will see several columns: Both Accounting Methods: Accrual and Actual,  Budget, Variance = Budget – Actual, both on a monthly and YTD basis.

Running down the line items (Column B):

The first line on any income statement is the Revenue or Gross Patient Charges . This figure is the amount of money a business brought in during the time period covered by the income statement. It has nothing to do with profit. If you owned a pizza parlor and sold 10 pizzas for $10 each, you would record $100 of revenue regardless of your profit or loss. The revenue figure is important because a business must bring in money to turn a profit. If a company has less revenue, all else being equal, it’s going to make less money.

The next line is Contractuals. This represents the amount of money tied into the pre-existing contracts between the Provider (Acme in this situation) and the Payors/Insurance companies.

You will see that the next line, Patient Collections.  This is simply, Patient Collections= Gross Patient Charges – Contractuals.

Collection Rate: This is simply the Patient Collections divided by the Gross Patient Charges.  Realize then that this organization is collecting 40ish percent of the services it bills for.  Many people find that staggering, yet it is a harsh reality of many healthcare organizations.

Relative Value Unit (RVU): A unit-less value that measures physician productivity.  It is broken down into four types: 1.) Work 2.) Practice Expense 3.) Malpractice Expense and 4.) total.  It is often utilized by management to compare amongst similar Practices across the nation.  Oftentimes, these are utilized for compensation structure including things like Productivity packages. For more information including benchmarks, check out the Medical Group Management Association.

Patient Collection is carried down the Income Sheet and then added with Contract Income (income from partnerships, provider coverages, etc) to yield Total Income.

Underneath Total Income are the Expenses: inclusive of Salaries of Providers and Staff, Benefits and Augmentation of both groups (all of this is clumped into “Total Labor Expense”).

Below this Non-Payroll Expenses are totaled yielding Total Expenses by adding Non-Payroll Expenses and Total Labor Expense.

Net Income is derived by taking the Total Income – Total Expenses.  Losses are reported with brackets (). So for example, using Accrual basis, for the month of December 2012, Acme Healthcare lost $329,000 and Actual basis was $399,000. We can see that Acme Healthcare budgeted a loss of $529,000, so they are doing better than budget.  One can speculate that perhaps Acme has recruited new Physicians, and anticipates a loss from these operational developments.

Provider Level

Most organizations break this down by “Profit Centers.”  These “Profit Centers” are individual Providers, since from a business perspective, the Providers are the source of incoming revenue.  Healthcare leaders breakdown income statements by Provider to better assess individual Provider performance.  Below is an example of a Provider’s individual Income Statement at Acme Healthcare:

 

I realize that these article is packed with information and to some of you this may seem like a foreign language.  As always, if you have any questions, feel free to comment below or email me.

 

 

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