Opener image: © A1Stock/Shutterstock
Financial Information and the
Decision-Making Process
LEARNING OBJECTIVES
After studying this chapter, you should be able to do the following:
1. Describe the importance of financial information in healthcare organizations.
2. Discuss the uses of financial information.
3. List the users of financial information and their uses for it.
4. Describe the financial functions within an organization.
5. Discuss the common ownership forms of healthcare organizations, along with their advantages and
disadvantages.
REAL-WORLD SCENARIO
In 1946, a small band of hospital accountants formed the American Association of Hospital Accountants (AAHA).
They were interested in sharing information and experiences in their industry, which was beginning to show signs
of growth. First published in 1947, a small educational journal was created in an attempt to disseminate information of interest to their members. Ten years later, in 1956, the AAHA’s membership had grown to over 2,600
members. The real growth, however, was still to come with the advent of Medicare financing in 1965.
With the dramatic growth of hospital revenues came an escalation in both the number and functions delegated
to the hospital accountant. Hospital finance had become much more than just billing patients and paying invoices.
Hospitals were becoming big businesses with complex and varied financial functions. They had to arrange funding
of major capital programs, which could no longer be supported through charitable campaigns. Cost accounting
and management control were important functions for the continued financial viability of their firms. Hospital
accountants soon evolved into hospital financial managers, and so in 1968 the AAHA changed its name to the
Hospital Financial Management Association (HFMA).
The hospital industry continued to boom through the late 1960s and 1970s. Third-party insurance became the
norm for most of the American population. Patients either received insurance through governmental programs
1
CHAPTER 1
The healthcare industry’s expansion is a trend
visible even to individuals outside the healthcare system. The hospital industry, the major component of
the healthcare industry, consumes about 6.3% of the
gross domestic product; other types of healthcare systems, although smaller than the hospital industry, are
expanding at even faster rates. TABLE 1-1 lists the types
of major healthcare institutions and indexes their
relative size.
Learning Objective 1
Describe the importance of financial information in
healthcare organizations.
The rapid growth of healthcare facilities providing direct medical services has substantially increased
the numbers of decision makers who need to be
familiar with financial information. Effective decision making in their jobs depends on an accurate
interpretation of financial information. Many healthcare decision makers involved directly in healthcare
delivery—doctors, nurses, dietitians, pharmacists,
radiation technologists, physical therapists, inhalation therapists—are medically or scientifically trained
but lack education and experience in business and
finance. Their specialized education, in most cases,
did not include courses such as accounting. However,
advancement and promotion within HCOs increasingly entails assumption of administrative duties,
requiring almost instant, knowledgeable reading of
financial information. Communication with the organization’s financial executives is not always helpful. As
such as Medicare and Medicaid or obtained it as part of the benefit program at their place of employment. Hospitals were clearly no longer quite as charitable as they once were. There was money, and plenty of it, to finance
the growth required through increased demand and the new evolving medical technology. By 1980, HFMA was
a large association with 19,000 members. Primary offices were located in Chicago, but an important office was
opened in Washington, DC, to provide critical input to both the executive and legislative branches of government.
On many issues that affected either government payment or capital financing, HFMA became the credible voice
that policymakers sought.
The industry adapted and evolved even more in the 1980s as fiscal pressure hit the federal government. Hospital payments were increasing so fast that new systems were sought to curtail the growth rate. Prospective payment
systems were introduced in 1983, and alternative payment systems were developed that provided incentives for
treating patients in an ambulatory setting. Growth in the hospital industry was still rapid, but other sectors of
health care began to experience colossal growth rates, such as ambulatory surgery centers. More and more, health
care was being transferred to the outpatient setting. The hospital industry was no longer the only large corporate
player in health care. To acknowledge this trend, the HFMA changed its name in 1982 to the Healthcare Financial Management Association to reflect the more diverse elements of the industry and to better meet the needs of
members in other sectors.
In 2015, HFMA had over 39,000 members in a wide
variety of healthcare organizations (HCOs). The
daily activities of their members still involve basic
accounting issues—patient bills must still be created
and collected, payroll still needs to be met—but strategic decision-making is much more critical in today’s
environment. It would be impossible to imagine any
organization planning its future without financial projections and input. Many HCOs may still be charitable
from a taxation perspective, but they are too large to
depend upon charitable giving to finance their business future. Financial managers of healthcare firms
are involved in a wide array of critical and complex
decisions that will ultimately determine the destiny of
their firms.
This text is intended to improve decision makers’
understanding and use of financial information in the
healthcare industry. It is not an advanced treatise in
accounting or finance but an elementary discussion
of how financial information in general and healthcare industry financial information in particular are
interpreted and used. It is written for individuals who
are not experienced healthcare financial executives.
Its aim is to make the language of healthcare finance
readable and relevant for general decision makers in
the healthcare industry.
Three interdependent factors have created the
need for this text:
1. Rapid expansion and evolution of the
healthcare industry
2. Healthcare decision makers’ general lack of
business and financial background
3. Financial and cost criteria’s increasing
importance in healthcare decisions
2 Chapter 1 Financial Information and the Decision-Making Process
TABLE 1-1 Healthcare Expenditures 2008–2024*
Type of Expenditure 2008 2010 2012 2014 2016 2024
Hospital care 728.9 814.9 898.5 978.3 1,087.3 1,755.1
Physician and clinical services 486.5 519.0 565.3 615.0 666.5 1,034.8
Other professional services 64.0 69.8 76.8 85.5 96.0 155.4
Dental services 102.4 105.4 110.0 114.5 123.5 183.4
Other health, residential, and
personal care
113.5 128.5 140.1 153.0 167.1 251.1
Home health care 62.3 71.2 77.1 81.9 91.7 156.0
Nursing care facilities and
continuing care retirement
communities
132.6 143.0 152.2 160.2 176.1 274.4
Prescription drugs 242.7 256.2 264.4 305.1 343.2 564.3
Durable medical equipment 34.9 37.0 41.3 44.2 48.2 76.9
Other non-durable medical
products
49.5 51.2 53.7 58.4 62.6 98.7
Personal Health Care 2,017.3 2,196.2 2,379.4 2,596.1 2,862.2 4,550.1
Government administration 29.4 30.5 34.2 39.9 45.5 82.2
Net cost of private health insurance 140.7 152.3 165.3 200.4 235.4 384.3
Government public health activities 71.5 75.5 74.8 78.7 86.2 137.7
Health Consumption
Expenditures
2,258.9 2,454.5 2,653.6 2,915.3 3,229.3 5,154.2
Research 44.0 48.7 48.0 45.9 48.7 72.0
Structures and equipment 111.2 101.0 115.7 118.9 124.7 198.9
National Health Expenditures 2,414.1 2,604.1 2,817.3 3,080.1 3,402.6 5,425.1
Gross Domestic Product 14,718.6 14,964.4 16,163.2 17,418.9 18,821.2 27,648.0
National Health Expenditures
to GDP
16.4% 17.4% 17.4% 17.7% 18.1% 19.6%
Hospital Care to GDP 5.0% 5.4% 5.6% 5.6% 5.8% 6.3%
*Values are in US$ in billions.
Centers for Medicare and Medicaid Services, Office of the Actuary
Financial Information and the Decision-Making Process 3
possible or feasible actions. In many cases, the actual
course of action followed may essentially be no action;
decision makers may decide to make no change from
their present policies. It should be recognized, however, that both action and inaction represent policy
decisions.
FIGURE 1-1 shows how information is related to
the decision-making process and gives an example to
illustrate the sequence. Generating information is the
key to decision making. The quality and effectiveness
of decision making depend on accurate, timely, and
relevant information. The difference between data
and information is more than semantic: data become
information only when they are useful and appropriate to the decision. Many financial data never become
information because they are not viewed as relevant or
are unavailable in an intelligible form.
For the illustrative purposes of the ambulatory
surgery center (ASC) example in Figure 1-1, only two
possible courses of action are assumed: to build or not
to build an ASC. In most situations, there may be a
continuum of alternative courses of action. For example, an ASC might vary by size or by facilities included
in the unit. In this case, prior decision making seems
to have reduced the feasible set of alternatives to a
more manageable and limited number of analyses.
Once a course of action has been selected in the
decision-making phase, it must be accomplished.
Implementing a decision may be extremely complex.
In the ASC example, carrying out the decision to
build the unit would require enormous management
effort to ensure that the projected results are actually
obtained. Periodic measurement of results in a feedback loop, as in Figure 1-1, is a method commonly
used to make sure that decisions are actually implemented according to plan.
As previously stated, results that are forecast are
not always guaranteed. Controllable factors, such as
a result, nonfinancial executives often end up ignoring
financial information.
Governing boards, which are significant users of
financial information, are expanding in size in many
healthcare facilities, in some cases to accommodate
demands for more consumer representation. This
trend can be healthy for both the community and the
facilities. However, many board members, even those
with backgrounds in business, are being overwhelmed
by financial reports and statements. There are important distinctions between the financial reports and
statements of business organizations, with which some
board members are familiar, and those of healthcare
facilities. Governing board members must recognize
these differences if they are to carry out their governing missions satisfactorily.
The increasing importance of financial and cost
criteria in healthcare decision making is the third factor creating a need for more knowledge of financial
information. For many years, accountants and others
involved with financial matters have been caricatured
as individuals with narrow vision, incapable of seeing the forest for the trees. In many respects, this may
have been an accurate portrayal. However, few individuals in the healthcare industry today would deny
the importance of financial concerns, especially cost.
Payment pressures from payers, as described in the
beginning-of-chapter scenario, underscore the need
for attention to costs. Careful attention to these concerns requires knowledgeable consumption of financial information by a variety of decision makers. It is
not an overstatement to say that inattention to financial criteria can lead to excessive costs and eventually
to insolvency.
The effectiveness of financial management in
any business is the product of many factors, such as
environmental conditions, personnel capabilities,
and information quality. A major portion of the total
financial management task is the provision of accurate, timely, and relevant information. Much of this
activity is carried out through the accounting process.
An adequate understanding of the accounting process
and the data generated by it are thus critical to successful decision making.
▸ Information and Decision
Making
The major function of information in general and
financial information in particular is to oil the
decision-making process. Decision making is basically
the selection of a course of action from a defined list of FIGURE 1-1 Information in the Decision-Making Process
SEQUENCING EXAMPLE
Financial forecasts of a
proposed ASC
Develop or not develop
the ASC
ASC is developed
Significant financial
losses occur
Information
Decision making
Implementation
of decision
Results
4 Chapter 1 Financial Information and the Decision-Making Process
▸ Uses and Users of Financial
Information
As a subset of information in general, financial information is important in the decision-making process.
In some areas of decision making, financial information is especially relevant. For our purposes, we
identify five uses of financial information that may be
important in decision making:
1. Evaluating the financial condition of an
entity
2. Evaluating stewardship within an entity
3. Assessing the efficiency of operations
4. Assessing the effectiveness of operations
5. Determining the compliance of operation
with directives
Financial Condition
Evaluation of an entity’s financial condition is probably
the most common use of financial information. Usually, an organization’s financial condition is equated
with its viability or capacity to continue pursuing its
stated goals at a consistent level of activity. Viability is
a far more restrictive term than solvency; some HCOs
maybe solvent but not viable. For example, a hospital
may have its level of funds restricted so that it must
reduce its scope of activity but still remain solvent. A
reduction in payment rates by a major payer may be
the vehicle for this change in viability.
Assessment of the financial condition of business
enterprises is essential to our economy’s smooth and
efficient operation. Most business decisions in our
economy are directly or indirectly based on perceptions of financial condition. This includes the largely
nonprofit healthcare industry. Although attention
is usually directed at organizations as whole units,
assessment of the financial condition of organizational divisions is equally important. In the ASC
failure to adhere to prescribed plans, and uncontrollable circumstances, such as a change in reimbursement, may obstruct planned results.
Decision making is usually surrounded by uncertainty. No anticipated result of a decision is guaranteed. Events may occur that have been analyzed but
not anticipated. A results matrix concisely portrays
the possible results of various courses of action, given
the occurrence of possible events. TABLE 1-2 provides
a results matrix for the sample ASC; it shows that
approximately 50% utilization will enable this unit to
operate in the black and not drain resources from other
areas. If forecasting shows that utilization below 50% is
unlikely, decision makers may very well elect to build.
A good information system should enable decision
makers to choose those courses of action that have the
highest expectation of favorable results. Based on the
results matrix of Table 1-2, a good information system
should, specifically, do the following
■ List possible courses of action.
■ List events that might affect the expected results.
■ Indicate the probability that those events will
occur.
■ Estimate the results accurately, given an action/
event combination (e.g., profit in Table 1-2).
One thing an information system does not do is
evaluate the desirability of results. Decision makers
must evaluate results in terms of their organizations’
preferences or their own. For example, construction of
an ASC may be expected to lose $400,000 per year, but
it could provide a needed community service. Weighing these results and determining criteria is purely a
decision maker’s responsibility—not an easy task, but
one that can be improved with accurate and relevant
information.
Learning Objective 2
Discuss the uses of financial information.
TABLE 1-2 Results Matrix for the ASC
Possible Events (Utilization Percentages)
Alternative Actions 25% Usage 50% Usage 75% Usage
Build the ASC $400,000 loss $10,000 profit $200,000 profit
Do not build the ASC 0 profit 0 profit 0 profit
Uses and Users of Financial Information 5
difficult, there is a tendency to place less emphasis on
effectiveness and more on efficiency. This may result
in the delivery of unnecessary services at an efficient
cost. For example, development of outpatient surgical
centers may reduce costs per surgical procedure and
thus create an efficient means of delivery. However,
the necessity of those surgical procedures may still be
questionable.
Compliance
Finally, financial information may be used to determine whether compliance with directives has taken
place. The best example of an organization’s internal
directives is its budget, an agreement between two
management levels regarding use of resources for a
defined time period. External parties may also impose
directives, many of them financial in nature, for the
organization’s adherence. For example, rate-setting or
regulatory agencies may set limits on rates determined
within an organization. Financial reporting by the
organization is required to ensure compliance.
Learning Objective 3
List the users of financial information and their uses
for it.
TABLE 1-3 presents a matrix of users and uses of
financial information in the healthcare industry. It
identifies areas or uses that may interest particular
decision-making groups. It does not consider relative
importance.
Not every use of financial information is important in every decision. For example, in approving a
HCO’s rates, a governing board may be interested in
only two uses of financial information: (1) evaluation
of financial condition and (2) assessment of operational efficiency. Other uses may be irrelevant. The
board wants to ensure that services are being provided
efficiently and that the rates being established are
sufficient to guarantee a stable or improved financial
condition. As Table 1-3 illustrates, most healthcare
decision-making groups use financial information to
assess financial condition and efficiency.
▸ Financial Organization
It is important to understand the management structure of businesses in general and HCOs in particular.
FIGURE 1-2 outlines the financial management structure of a typical hospital.
example, information on the future financial condition of the unit is valuable. If continued losses from
this operation are projected, impairment of the financial condition of other divisions in the organization
could be in the offing.
Assessment of financial condition also includes
consideration of short-run versus long-run effects.
The relevant time frame may change, depending on
the decision under consideration. For example, suppliers typically are interested only in an organization’s short-run financial condition because that is the
period in which they must expect payment. However,
investment bankers, as long-term creditors, are interested in the organization’s financial condition over a
much longer time period.
Stewardship
Historically, evaluation of stewardship was the most
important use of accounting and financial information systems. These systems were originally designed
to prevent the loss of assets or resources through
employees’ malfeasance. This use is still very important. In fact, the relatively infrequent occurrence of
employee fraud and embezzlement may be due in part
to the deterrence of well-designed accounting systems.
Efficiency
Efficiency in healthcare operations is becoming an
increasingly important objective for many decision
makers. Efficiency is simply the ratio of outputs to
inputs, not the quality of outputs (good or not good)
but the lowest possible cost of production. Adequate
assessment of efficiency implies the availability of standards against which actual costs may be compared. In
many HCOs, these standards may be formally introduced into the budgetary process. Thus a given nursing unit may have an efficiency standard of 4.3 nursing
hours per patient day of care delivered. This standard
may then be used as a benchmark to evaluate the relative efficiency of the unit. If actual employment were
6.0 nursing hours per patient day, management would
be likely to reassess staffing patterns.
Effectiveness
Assessment of the effectiveness of operations is concerned with the attainment of objectives through production of outputs, not the relationship of outputs to
cost. Measuring effectiveness is much more difficult
than measuring efficiency because most organizations’ objectives or goals are typically not stated quantitatively. Because measurement of effectiveness is
6 Chapter 1 Financial Information and the Decision-Making Process
TABLE 1-3 Users and Uses of Financial Information
Uses of Financial Information
Users Financial
Condition
Stewardship Efficiency Effectiveness Compliance
External
Healthcare coalitions X X X
Unions X X
Rate-setting organizations X X X X
Creditors X X X
Third-party payers X X X
Suppliers X X
Public X X X
Internal
Governing board X X X X X
Top management X X X X X
Departmental management X
FIGURE 1-2 Financial Organization Chart of a Typical Hospital
Controller Director of Patient
Accounting
Director of Material
Management
Director of Patient
Registration
Director of
Financial Reporting
and Disbursements
Director of
Financial Analysis
Senior Vice-President
and Chief Financial
Officer
Director of Corporate
Compliance and Risk
Management
Learning Objective 4
Describe the financial functions within an organization.
Financial Executives International has categorized financial management functions as either
controllership or treasurership. Although few HCOs
have specifically identified treasurers and controllers
at this time, the separation of duties is important to
the understanding of financial management. The following describes functions in the two categories designated by Financial Executives International, along
Financial Organization 7
are three main types organizations (adapted from the
American Institute of Certified Public Accountants’
Audit and Accounting Guide Health Care Organizations, 2015):
■ Not-for-profit, business-oriented organizations
■ For-profit healthcare entities
• Investor-owned • Professional corporations/professional associations • Sole proprietorships
• Limited partnerships • Limited liability partnerships/limited liability
companies
■ Governmental healthcare organizations
These three main types of firms differ in terms of
ownership structure. Additionally, different HCOs
require slightly different sets of financial statements.
Not-for-Profit, Business-Oriented
Organizations
Not-for-profit HCOs are owned by the entire community rather than by investor–owners. Unlike its
for-profit counterpart, the primary goal of a not-forprofit (also referred to as a nonprofit) organization is
not to maximize profits, but to serve the community
in which it operates through the healthcare services
it provides. Not-for-profit HCOs must be run as a
business, however, in order to ensure their long-term
financial viability. With an annual budget of more
than $20 billion, Ascension Healthcare is an example
of one of the largest not-for-profit HCOs.
Not-for-profit organizations (described in Sec.
501(c)(3) of the Internal Revenue Code) usually are
exempt from federal income taxes and property taxes.
In return for this favorable tax treatment, not-for-profit
organizations are expected to provide community
benefit, which often comes in the form of providing
more uncompensated care (vis-à-vis for-profit firms),
setting lower prices, or by offering services that, from
a financial perspective, might not be viable for forprofit firms. In addition to patient revenue in excess of
expenses, not-for-profits can additionally be funded
by tax-exempt debt, grants, donations, and investments by other nonprofit firms.
The primary advantage of the not-for-profit form
of organization is its tax advantage. It also typically
enjoys a lower cost of equity capital compared with
for-profit firms. The main disadvantage of this form of
organization is that not-for-profits have more limited
access to capital. Nonprofits cannot raise capital in the
equity markets.
with an example of the type of activities conducted
within each of these functions:
1. Controllership
(a) Planning for control: Establish budgetary systems (Chapters 13 and 16)
(b) Reporting and interpreting: Prepare
financial statements (Chapter 9)
(c) Evaluating and consulting: Conduct
cost analyses (Chapter 14)
(d) Administrating taxes: Calculating
payroll taxes owed
(e) Reporting to government: Submit Medicare bills and cost reports
(Chapter 2 and 6)
(f) Protecting assets: Develop internal
control procedures
(g) Appraising economic health: Analyze
financial statements (Chapters 11
and 12)
2. Treasurership
(a) Providing capital: Arrange for bond
issuance (Chapter 21)
(b) Maintaining investor relations: Assist
in analysis of appropriate dividend
payment policy (for-profit firms)
(Chapters 20 and 21)
(c) Providing short-term financing: Arrange
lines of credit (Chapters 22 and 23)
(d) Providing banking and custody:
Manage overnight and short-term
funds transfers (Chapters 22 and 23)
(e) Overseeing credits and collections:
Establish billing, credit, and collection policies (Chapters 2 and 22)
(f) Choosing investments: Analyze capital investment projects (Chapter 19)
(g) Providing insurance: Managing funds
related to self-insurance program
Learning Objective 5
Discuss the common ownership forms of healthcare
organizations, along with their advantages and
disadvantages.
▸ Forms of Business
Organization
More so than in most other industries, firms in the
healthcare industry consist of a wide array of ownership and organizational structures. In health care, there
8 Chapter 1 Financial Information and the Decision-Making Process
corporate level and the shareholder level (so-called
double taxation). The company pays corporate income
tax and the shareholder pays both tax on dividends
paid by the company and gains made on the sale of the
company’s stock.
A professional corporation (PC), also called
a professional association (PA), is a corporate form
for professionals who wanted to have the advantages
of incorporation. A PC does not, however, shield its
owners from professional liability. PCs and PAs have
been widely used by physicians and other healthcare
professionals.
Sole proprietorships are unincorporated businesses owned by a single individual. They do not necessarily have to be small businesses. Solo practitioner
physicians often are sole proprietors. The main advantages are easy and inexpensive to set up, no sharing
of profits, total control, few government regulations,
no special income taxes, and that they are easy and
inexpensive to dissolve. Its two main disadvantages
are unlimited liability and limited access to capital.
Partnerships are unincorporated businesses
with two or more owners. Group practices of physicians sometimes were set up using this form. There
are now a wide variety of partnership forms. They are
easy to form, are subject to few government regulations, and are not subject to double taxation. On the
downside, partnerships have unlimited liability, are
difficult to dissolve, and create potential for conflict
among the partners.
In a limited partnership (LP) there is at least one
general partner who has unlimited liability for the LP’s
debts and obligations. LPs offer limited liability to the
limited partners along with tax flow-through treatment. The disadvantage to LPs is that they require a
general partner who remains fully liable for the LP’s
debts and obligations.
A limited liability company (LLC), also called
a limited liability partnership (LLP), is a business
entity that combines the tax flow through treatment
characteristics of a partnership (i.e., no double taxation) with the liability protection of a corporation. In
an LLC, the liability of the general partner is limited.
LLCs are flexible in the sense that they permit owners
to structure allocations of income and losses any way
they desire, so long as the partnership tax allocation
rules are followed.
Governmental Healthcare Organizations
Governmental HCOs are public corporations, typically
owned by a state or local government. They are operated
for the benefit of the communities they serve. A variation on this type of ownership is the public benefit
While for-profit firms are becoming increasingly
prevalent in many sectors of health care, not-for-profits
still dominate the hospital sector. About 80% of
hospitals are not-for-profit. In the future, however,
this sector may witness the growth of investor-owned
organizations, owing mainly to their easier access to
capital that will be necessary for adapting to the rapid
changes in the healthcare system.
For-Profit Healthcare Entities
The main objective of most for-profit firms is to earn
profits that are distributed to the investor–owners of
the firms or reinvested in the firm for the long-term
benefit of these owners.
For-profit hospital management must strike a
balance between their fiduciary responsibilities to
the owners of the company and their other mission
of providing acceptable-quality healthcare services to
the community. For-profit firms have a wide variety
of organization and ownership structures. For-profit
firms that buy and sell shares of their company stocks
on the open market are referred to as publicly traded
companies. A major advantage of being publicly
traded is the ability to raise equity capital through the
sale of company stocks. Publicly traded firms are subject to reporting requirements and regulation by the
Securities and Exchange Commission (SEC). For-profit
firms may also be privately held, meaning the shares
of the company are held by relatively few investors and
are not available to the general public. Privately held
companies also have far few reporting requirements
to the SEC. Large for-profit firms are typically publicly
traded. However, there are exceptions. For example,
HCA, Inc. is a national for-profit healthcare services
company headquartered in Nashville, Tennessee. Prior
to 2005, HCA was the largest publicly traded hospital
company. In 2005, HCA was purchased by a private
equity firm and converted from a publicly traded to
privately held company. HCA, Inc. returned to publicly traded status in 2010 and remains the largest forprofit hospital company, with 16 hospitals and 43,275
licensed beds. In its fiscal year ending December 31,
2015, the company had after-tax income of $2.1 billion.
Both publicly traded and privately held for-profit
firms are often referred to as “investor-owned” firms.
Investor-owned firms are owned by risk-based
equity investors who expect the managers of the corporation to maximize shareholder wealth. Most large
for-profit firms use this legal form. Investor-owned
firms have a relative advantage in terms of financing.
In addition to debt, for-profit firms can raise funding
through risk-based equity capital. They enjoy limited liability, but their earnings are taxed at both the
Forms of Business Organization 9
References
Nicholson, S., Pauly, M. V., Burns, L. R., Baumritter, A., & Asch,
D. A. (2000). Measuring community benefits provided by forprofit and nonprofit hospitals. Health Affairs, 19(6), 168.
might be pressured to return some of the surplus to
the community, to reduce prices, or to initiate programs that are not financially advisable.
▸ SUMMARY
The healthcare sector of our economy is growing
rapidly in both size and complexity. Understanding
the financial and economic implications of decision
making has become one of the most critical areas
encountered by healthcare decision makers. Successful decision making can lead to a viable operation capable of providing needed healthcare services.
Unsuccessful decision making can and often does lead
to financial failure. The role of financial information
in the decision-making process cannot be overstated.
It is incumbent on all healthcare decision makers to
become accounting-literate in our financially changing healthcare environment.
organization. Assets (and accumulated earnings) of
a nonprofit public benefit corporation belong to the
public or to the charitable beneficiaries the trust was
organized to serve. In 1999, for example, the Nassau
County Medical Center (NCMC), a 1,500-bed healthcare system on Long Island, New York, converted from
county ownership to a public benefit corporation. The
purpose of the conversion was to give NCMC greater
autonomy in its governing board and decision making
so that it could compete more effectively with the area’s
large private hospitals and networks.
In some cases, governmental HCOs may have
access to an additional revenue source through taxes—
an option not available to other not-for-profit HCOs.
Similar to other not-for-profits, government HCOs are
not able to raise funds through equity investments and
they are exempt from income taxes and property taxes.
Governmental HCOs can face political pressures
if their earnings become too great. Rather than reinvesting their surplus in productive assets, the hospital
ASSIGNMENTS
1. Only in recent years have hospitals begun to develop meaningful systems of cost accounting. Why did they not
begin such development sooner?
2. Your hospital has been approached by a major employer in your market area to negotiate a preferred provider
arrangement. The employer is seeking a 25% discount from your current charges. Describe a structure that you
might use to summarize the financial implications of this decision. Describe the factors that would be critical in
this decision.
3. What type of financial information should be routinely provided to board members?
SOLUTIONS AND ANSWERS
1. Prior to 1983, most hospitals were paid actual costs for delivering hospital services. With the introduction of
Medicare’s prospective payment system for inpatient care in 1983 and outpatient care in 2000, hospitals now
receive prices based on diagnosis-related groupings and ambulatory patient classifications that are fixed in
advance. Cost control and, therefore, cost accounting are critical in a fixed-price environment. The expansion of
managed care has further restricted revenue and fostered greater interest in costing.
2. This problem could be set up in a results matrix (see Table 1-2). The two actions to be charted are to accept or
to reject the preferred provider arrangement opportunity. Possible events would center on the magnitude of
volume changes, for example, to lose 1,000 patient days or to gain 500 patient days. A key concern in estimating
the financial impact would be the hospital’s incremental revenue and incremental cost positions. In short, how
large would the revenue reduction and cost reduction be if significant volume were lost? Actuarial gains or losses
of business would be functions of the hospital’s market position.
3. Board members do not need to see detailed financial information that relates to their established plans to ensure
that the plans are being met. If significant deviations have occurred more details may be necessary to take
corrective action or to modify established plans.
10 Chapter 1 Financial Information and the Decision-Making Process