HEALTHCARE FINANCE

HEALTHCARE FINANCE

FINANCE
FIFTH EDITION
JUDITH J. BAKER, PhD, CPA
R.W. BAKER, JD
NEIL R. DWORKIN, PhD
Basic Tools For Nonfinancial Managers
HEALTH CARE
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Library of Congress Cataloging-in-Publication Data
Names: Baker, Judith J., author. | Baker, R. W., author. | Dworkin, Neil R., author.
Title: Health care finance : basic tools for nonfinancial managers / Judith Baker, R.W. Baker, and Neil R. Dworkin.
Description: Fifth edition. | Burlington, Massachusetts : Jones & Bartlett Learning, [2018] | Includes
bibliographical references and index.
Identifiers: LCCN 2016054734 | ISBN 9781284118216 (pbk.)
Subjects: | MESH: Financial Management | Health Facilities–economics | Health Facility Administration |
United States
Classification: LCC RA971.3 | NLM W 80 | DDC 362.1068/1–dc23
LC record available at https://lccn.loc.gov/2016054734
6048
Printed in the United States of America
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iii
© LFor/Shutterstock
New to This Edition……………………………………………………………………………………………….xvii
Preface……………………………………………………………………………………………………………….. xix
Acknowledgments ………………………………………………………………………………………………… xxi
About the Authors ………………………………………………………………………………………………. xxiii
PART I—HEALTHCARE FINANCE OVERVIEW…………………………………………………………. 1
Chapter 1 Introduction to Healthcare Finance …………………………………………………….. 3
The History ……………………………………………………………………………………………. 3
The Concept………………………………………………………………………………………….. 4
How Does Finance Work in the Healthcare Business? ……………………………….. 4
Viewpoints……………………………………………………………………………………………… 4
Why Manage?…………………………………………………………………………………………. 5
The Elements of Financial Management………………………………………………….. 5
The Organization’s Structure ………………………………………………………………….. 5
Two Types of Accounting ………………………………………………………………………… 7
Information Checkpoint…………………………………………………………………………. 9
Key Terms………………………………………………………………………………………………. 9
Discussion Questions………………………………………………………………………………. 9
Notes…………………………………………………………………………………………………….. 9
Chapter 2 Four Things the Healthcare Manager Needs to Know About
Financial Management Systems ………………………………………………………11
What Does the Manager Need to Know?…………………………………………………. 11
How the System Works in Health Care……………………………………………………. 11
The Information Flow…………………………………………………………………………… 12
Basic System Elements…………………………………………………………………………… 14
The Annual Management Cycle…………………………………………………………….. 18
Communicating Financial Information to Others…………………………………… 20
Information Checkpoint……………………………………………………………………….. 20
Key Terms…………………………………………………………………………………………….. 20
Discussion Questions…………………………………………………………………………….. 20
Notes…………………………………………………………………………………………………… 21
Table of Contents
iv Table of Contents
Chapter 3 The Digital Age: Changing the Landscape of Healthcare
Finance ………………………………………………………………………………………23
High-Tech and High-Touch Approaches………………………………………………… 23
Patient Engagement……………………………………………………………………………… 23
Social Media…………………………………………………………………………………………. 24
Resource Allocation ……………………………………………………………………………… 25
Changes in Health Information Technology…………………………………………… 25
Population Health and the Digital Age: Crossing at
the Intersection………………………………………………………………………………… 26
Additional Trends and Complexities: Other Delivery Systems………………….. 27
Summary …………………………………………………………………………………………….. 27
Information Checkpoint……………………………………………………………………….. 28
Key Terms…………………………………………………………………………………………….. 28
Other Acronymns…………………………………………………………………………………. 28
Discussion Questions…………………………………………………………………………….. 28
Notes…………………………………………………………………………………………………… 28
PART II—RECORD FINANCIAL OPERATIONS………………………………………………………..31
Chapter 4 Assets, Liabilities, and Net Worth………………………………………………………..33
Overview ……………………………………………………………………………………………… 33
What Are Examples of Assets? ……………………………………………………………….. 34
What Are Examples of Liabilities? ………………………………………………………….. 35
What Are the Different Forms of Net Worth? ………………………………………….. 35
Information Checkpoint……………………………………………………………………….. 36
Key Terms…………………………………………………………………………………………….. 36
Discussion Questions…………………………………………………………………………….. 36
Chapter 5 Revenues (Inflow)……………………………………………………………………………37
Overview ……………………………………………………………………………………………… 37
Receiving Revenue for Services……………………………………………………………… 37
Sources of Healthcare Revenue……………………………………………………………… 39
Grouping Revenue for Planning and Control…………………………………………. 42
Information Checkpoint……………………………………………………………………….. 45
Key Terms…………………………………………………………………………………………….. 45
Discussion Questions…………………………………………………………………………….. 45
Notes…………………………………………………………………………………………………… 46
Chapter 6 Expenses (Outflow)………………………………………………………………………….47
Overview ……………………………………………………………………………………………… 47
Disbursements for Services……………………………………………………………………. 48
Grouping Expenses for Planning and Control………………………………………… 48
Cost Reports as Influencers of Expense Formats……………………………………… 52
Information Checkpoint……………………………………………………………………….. 53
Key Terms…………………………………………………………………………………………….. 54
Discussion Questions…………………………………………………………………………….. 54
Notes…………………………………………………………………………………………………… 54
Table of Contents v
Chapter 7 Cost Classifications ………………………………………………………………………….55
Distinction Between Direct and Indirect Costs………………………………………… 55
Examples of Direct Cost and Indirect Cost……………………………………………… 56
Responsibility Centers…………………………………………………………………………… 57
Distinction Between Product and Period Costs……………………………………….. 60
Information Checkpoint……………………………………………………………………….. 61
Key Terms…………………………………………………………………………………………….. 61
Discussion Questions…………………………………………………………………………….. 61
Notes…………………………………………………………………………………………………… 61
PART III—TOOLS TO ANALYZE AND UNDERSTAND FINANCIAL OPERATIONS ………63
Chapter 8 Cost Behavior and Break-Even Analysis ……………………………………………….65
Distinctions Among Fixed, Variable, and Semivariable Costs……………………. 65
Examples of Variable and Fixed Costs…………………………………………………….. 69
Analyzing Mixed Costs ………………………………………………………………………….. 71
Contribution Margin, Cost-Volume-Profit, and Profit-Volume Ratios………… 73
Information Checkpoint……………………………………………………………………….. 78
Key Terms…………………………………………………………………………………………….. 78
Discussion Questions…………………………………………………………………………….. 78
Notes…………………………………………………………………………………………………… 79
Chapter 9 Understanding Inventory and Depreciation Concepts ……………………………81
Overview: The Inventory Concept………………………………………………………….. 81
Inventory and Cost of Goods Sold (“Goods” Such as Drugs) ……………………. 82
Inventory Methods……………………………………………………………………………….. 83
Inventory Tracking ……………………………………………………………………………….. 84
Inventory Distribution Systems………………………………………………………………. 86
Calculating Inventory Turnover …………………………………………………………….. 87
Overview: The Depreciation Concept…………………………………………………….. 88
Book Value of a Fixed Asset and the Reserve for Depreciation …………………. 88
Computing Tax Depreciation………………………………………………………………… 92
Information Checkpoint……………………………………………………………………….. 93
Key Terms…………………………………………………………………………………………….. 93
Discussion Questions…………………………………………………………………………….. 93
Notes…………………………………………………………………………………………………… 93
Appendix 9-A A Further Discussion of Accelerated and
Units of Service Depreciation Computations………………………………………. 95
Accelerated Book Depreciation Methods……………………………………………….. 95
Chapter 10 Staffing: Methods, Operations, and Regulations………………………………….103
Staffing Requirements ………………………………………………………………………… 103
FTEs for Annualizing Positions ……………………………………………………………. 103
Number of Employees Required to Fill a Position: Another Way to
Calculate FTEs ……………………………………………………………………………….. 106
Regulatory Requirements Regarding Staffing……………………………………….. 111
vi Table of Contents
Summary……………………………………………………………………………………………. 113
Information Checkpoint……………………………………………………………………… 114
Key Terms…………………………………………………………………………………………… 114
Discussion Questions…………………………………………………………………………… 114
Notes…………………………………………………………………………………………………. 114
PART IV—REPORT AND MEASURE FINANCIAL RESULTS……………………………………..117
Chapter 11 Reporting as a Tool ………………………………………………………………………..119
Understanding the Major Reports ……………………………………………………….. 119
Balance Sheet …………………………………………………………………………………….. 119
Statement of Revenue and Expense……………………………………………………… 120
Statement of Changes in Fund Balance/Net Worth ………………………………. 122
Statement of Cash Flows ……………………………………………………………………… 123
Subsidiary Reports………………………………………………………………………………. 124
Summary……………………………………………………………………………………………. 125
Information Checkpoint……………………………………………………………………… 125
Key Terms…………………………………………………………………………………………… 126
Discussion Questions…………………………………………………………………………… 126
Notes…………………………………………………………………………………………………. 126
Chapter 12 Financial and Operating Ratios as Performance
Measures…………………………………………………………………………………..127
The Importance of Ratios……………………………………………………………………. 127
Liquidity Ratios…………………………………………………………………………………… 129
Solvency Ratios …………………………………………………………………………………… 130
Profitability Ratios………………………………………………………………………………. 132
Information Checkpoint……………………………………………………………………… 134
Key Terms…………………………………………………………………………………………… 134
Discussion Questions…………………………………………………………………………… 134
Chapter 13 The Time Value of Money ……………………………………………………………….135
Purpose ……………………………………………………………………………………………… 135
Unadjusted Rate of Return………………………………………………………………….. 135
Present-Value Analysis…………………………………………………………………………. 136
Internal Rate of Return……………………………………………………………………….. 137
Payback Period …………………………………………………………………………………… 137
Evaluations…………………………………………………………………………………………. 138
Resources…………………………………………………………………………………………… 139
Information Checkpoint……………………………………………………………………… 139
Key Terms…………………………………………………………………………………………… 139
Discussion Questions…………………………………………………………………………… 139
Note…………………………………………………………………………………………………… 140
Appendix 13-A Present-Value Table
(The Present Value of $1.00) …………………………………………………………… 141
Table of Contents vii
Appendix 13-B Compound Interest Table: Compound Interest
of $1.00 (The Future Amount of $1.00)……………………………………………. 143
Appendix 13-C Present Value of an Annuity of $1.00…………………………… 145
PART V—TOOLS TO REVIEW AND MANAGE COMPARATIVE DATA……………………….147
Chapter 14 Trend Analysis, Common Sizing, and Forecasted Data …………………………149
Common Sizing………………………………………………………………………………….. 149
Trend Analysis…………………………………………………………………………………….. 150
Analyzing Operating Data……………………………………………………………………. 151
Importance of Forecasts………………………………………………………………………. 152
Operating Revenue Forecasts………………………………………………………………. 153
Staffing Forecasts ……………………………………………………………………………….. 156
Capacity Level Issues in Forecasting……………………………………………………… 158
Summary……………………………………………………………………………………………. 160
Information Checkpoint……………………………………………………………………… 160
Key Terms…………………………………………………………………………………………… 160
Discussion Questions…………………………………………………………………………… 160
Notes…………………………………………………………………………………………………. 160
Chapter 15 Using Comparative Data………………………………………………………………….161
Overview ……………………………………………………………………………………………. 161
Comparability Requirements……………………………………………………………….. 161
A Manager’s View of Comparative Data ………………………………………………… 162
Uses of Comparative Data……………………………………………………………………. 163
Making Data Comparable……………………………………………………………………. 168
Constructing Charts to Show the Data ………………………………………………….. 171
Information Checkpoint……………………………………………………………………… 173
Key Terms…………………………………………………………………………………………… 173
Discussion Questions…………………………………………………………………………… 174
Note…………………………………………………………………………………………………… 174
PART VI—CONSTRUCT AND EVALUATE BUDGETS ……………………………………………..175
Chapter 16 Operating Budgets …………………………………………………………………………177
Overview ……………………………………………………………………………………………. 177
Budget Viewpoints………………………………………………………………………………. 178
Budget Basics: A Review………………………………………………………………………. 179
Building an Operating Budget: Preparation …………………………………………. 180
Building an Operating Budget: Construction ……………………………………….. 181
Working with Static Budgets and Flexible Budgets ………………………………… 183
Budget Construction Summary ……………………………………………………………. 186
Budget Review ……………………………………………………………………………………. 186
Information Checkpoint……………………………………………………………………… 187
Key Terms…………………………………………………………………………………………… 187
viii Table of Contents
Discussion Questions…………………………………………………………………………… 187
Notes…………………………………………………………………………………………………. 188
Appendix 16-A Creating a DRG Budget for Respiratory Care:
The Resource Consumption Approach…………………………………………….. 189
Background ……………………………………………………………………………………….. 189
A DRG Budget for Respiratory Care …………………………………………………….. 190
Notes…………………………………………………………………………………………………. 193
Appendix 16-B Reviewing a Comparative Operating Budget
Report……………………………………………………………………………………………. 195
The Comparative Report to Review………………………………………………………. 195
Checklist Questions and Answers for the Comparative Budget
Review……………………………………………………………………………………………. 196
Chapter 17 Capital Expenditure Budgets ……………………………………………………………197
Overview ……………………………………………………………………………………………. 197
Creating the Capital Expenditure Budget …………………………………………….. 197
Budget Construction Tools………………………………………………………………….. 198
Funding Requests……………………………………………………………………………….. 200
Evaluating Capital Expenditure Proposals…………………………………………….. 202
Information Checkpoint……………………………………………………………………… 203
Key Terms…………………………………………………………………………………………… 203
Discussion Questions…………………………………………………………………………… 204
Note…………………………………………………………………………………………………… 204
Appendix 17-A A Further Discussion of Capital Budgeting
Methods…………………………………………………………………………………………. 205
Assumptions……………………………………………………………………………………….. 205
Payback Method …………………………………………………………………………………. 205
Unadjusted Rate of Return (AKA Accountant’s Rate of Return) …………….. 206
Net Present Value ……………………………………………………………………………….. 207
Internal Rate of Return……………………………………………………………………….. 207
PART VII—TOOLS TO PLAN, MONITOR, AND CONTROL FINANCIAL STATUS……..209
Chapter 18 Variance Analysis and Sensitivity Analysis……………………………………………211
Variance Analysis Overview………………………………………………………………….. 211
Three Types of Flexible Budget Variance ……………………………………………… 211
Two-Variance Analysis and Three-Variance Analysis Compared………………. 212
Three Examples of Variance Analysis……………………………………………………. 214
Summary……………………………………………………………………………………………. 218
Sensitivity Analysis Overview………………………………………………………………… 218
Sensitivity Analysis Tools ……………………………………………………………………… 218
Summary……………………………………………………………………………………………. 222
Information Checkpoint……………………………………………………………………… 222
Key Terms…………………………………………………………………………………………… 222
Discussion Questions…………………………………………………………………………… 222
Note…………………………………………………………………………………………………… 222
Table of Contents ix
Chapter 19 Estimates, Benchmarking, and Other Measurement Tools …………………….223
Estimates Overview……………………………………………………………………………… 223
Common Uses of Estimates …………………………………………………………………. 223
Example: Estimating the Ending Pharmacy Inventory …………………………… 224
Example: Estimated Economic Impact of a New Specialty in a
Physician Practice …………………………………………………………………………… 225
Other Estimates………………………………………………………………………………….. 226
Importance of a Variety of Performance Measures………………………………… 226
Adjusted Performance Measures Over Time…………………………………………. 227
Benchmarking……………………………………………………………………………………. 227
Economic Measures ……………………………………………………………………………. 229
Measurement Tools…………………………………………………………………………….. 229
Information Checkpoint……………………………………………………………………… 231
Key Terms…………………………………………………………………………………………… 231
Discussion Questions…………………………………………………………………………… 232
Note…………………………………………………………………………………………………… 232
Chapter 20 Understanding the Impact of Data Analytics and Big Data …………………….233
Introduction ………………………………………………………………………………………. 233
Defining Data Analytics……………………………………………………………………….. 233
Two Basic Approaches to Data Analytics……………………………………………….. 235
Data Analytics and Healthcare Analytics Serve Many Purposes……………….. 236
Data Mining……………………………………………………………………………………….. 237
Impacts of Healthcare Analytics ………………………………………………………….. 238
Challenges for Healthcare Analytics …………………………………………………….. 239
Information Checkpoint……………………………………………………………………… 239
Key Terms…………………………………………………………………………………………… 239
Discussion Questions…………………………………………………………………………… 240
Notes…………………………………………………………………………………………………. 240
PART VIII—FINANCIAL TERMS, COSTS, AND CHOICES ……………………………………….243
Chapter 21 Understanding Investment and Statistical Terms Used in Finance ……………..245
Investment Overview…………………………………………………………………………… 245
Cash Equivalents…………………………………………………………………………………. 245
Governmental Guarantor: The FDIC……………………………………………………. 246
Long-Term Investments in Bonds…………………………………………………………. 246
Investments in Stocks………………………………………………………………………….. 248
Privately Held Companies Versus Public Companies……………………………… 248
Investment Indicators …………………………………………………………………………. 249
Statistics Overview ………………………………………………………………………………. 250
Commonly Used Statistical and Other Mathematical Terms…………………… 251
Information Checkpoint……………………………………………………………………… 254
Key Terms…………………………………………………………………………………………… 254
Discussion Questions…………………………………………………………………………… 255
Notes…………………………………………………………………………………………………. 255
x Table of Contents
Chapter 22 Business Loans and Financing Costs ………………………………………………….257
Overview of Capital Structure………………………………………………………………. 257
Sources of Capital……………………………………………………………………………….. 257
The Costs of Financing ……………………………………………………………………….. 258
Management Considerations About Real Estate Financing…………………….. 259
Management Decisions About Business Loans………………………………………. 260
Information Checkpoint……………………………………………………………………… 260
Key Terms…………………………………………………………………………………………… 260
Discussion Questions…………………………………………………………………………… 260
Appendix 22-A Sample Amortization Schedule ……………………………………. 261
Chapter 23 Choices: Owning Versus Leasing Equipment……………………………………….263
Purchasing Equipment ……………………………………………………………………….. 263
Leasing Equipment …………………………………………………………………………….. 263
Buy-or-Lease Management Decisions……………………………………………………. 264
Accounting Principles Regarding Leases………………………………………………. 268
Information Checkpoint……………………………………………………………………… 269
Key Terms…………………………………………………………………………………………… 269
Discussion Questions…………………………………………………………………………… 269
Note…………………………………………………………………………………………………… 269
PART IX—STRATEGIC PLANNING: A POWERFUL TOOL………………………………………271
Chapter 24 Strategic Planning and the Healthcare Financial Manager……………………..273
Major Components of the
Strategic Plan: Overview………………………………………………………………….. 273
Introduction ………………………………………………………………………………………. 273
Six Major Components ……………………………………………………………………….. 273
Varied Approaches to Strategic Planning ……………………………………………… 275
Examples of Mission, Vision, and Value Statements……………………………….. 276
Recognizing a Special Status or Focus Within the Statements ………………… 276
Financial Emphasis Within the Statements……………………………………………. 278
Relaying the Message ………………………………………………………………………….. 279
The Strategic Planning Cycle and Its Process Flow ………………………………… 281
Process Flow for Creating Goals, Objectives,
and Action Plans…………………………………………………………………………….. 281
Process Flow for Creating Action Plans and Their
Performance Measures……………………………………………………………………. 282
The Planning Cycle Over Time ……………………………………………………………. 283
Managers’ Responsibilities ………………………………………………………………….. 284
Federal Governmental Agencies Must Prepare Strategic Plans ………………. 285
Why are Federal Planning Requirements Important to Us? ……………………. 285
Introduction: Requirements, Plans, and Performance…………………………… 285
An Example: The VA Office of Information Technology IT Strategic
Planning Cycle ……………………………………………………………………………….. 288
Introduction ………………………………………………………………………………………. 288
Table of Contents xi
The VA Office of Information Technology IT Strategic Planning Cycle:
An Example …………………………………………………………………………………… 288
The VA Planning Cycle’s Process Flow………………………………………………….. 288
Planning Cycle Definitions for this Example…………………………………………. 290
Management Responsibilities Within the Planning Cycle ………………………. 291
Tools for Strategic Planning: Situational Analysis
and Financial Projections………………………………………………………………… 292
Situational Analysis……………………………………………………………………………… 293
Financial Projections for Strategic Planning …………………………………………. 294
Case Study: Strategic Financial Planning in Long-Term Care …………………. 296
Appendix 24-A: Sample SWOT Worksheets and Question Guides…………… 296
Information Checkpoint……………………………………………………………………… 296
Key Terms…………………………………………………………………………………………… 297
Discussion Questions…………………………………………………………………………… 297
Notes…………………………………………………………………………………………………. 297
Appendix 24-A Sample SWOT Worksheets and Question Guides…………. 299
Introduction ………………………………………………………………………………………. 299
Scoring Summary Sheet for EHR Adoption and Implementation…………… 299
Three Internal Worksheets for Strengths and Weaknesses……………………… 299
Internal Worksheet for EHR Information
Technology (IT) Staff …………………………………………………………………….. 300
Internal Worksheet for Other Staff Involved in EHR……………………………… 302
Internal Worksheet for Technology and Capital Funding ………………………. 302
External Worksheet for Opportunities and Threats……………………………….. 304
Chapter 25 Putting It All Together: Creating a Business Plan That Is Strategic………….309
Overview ……………………………………………………………………………………………. 309
Elements of the Business Plan ……………………………………………………………… 309
Preparing to Construct the Business Plan……………………………………………… 310
The Service or Equipment Description ………………………………………………… 310
The Organization Segment …………………………………………………………………. 310
The Marketing Segment ……………………………………………………………………… 311
The Financial Analysis Segment…………………………………………………………… 311
The “Knowledgeable Reader” Approach to Your Business Plan………………. 313
The Executive Summary ……………………………………………………………………… 314
Assembling the Business Plan………………………………………………………………. 314
Presenting the Business Plan ……………………………………………………………….. 314
Strategic Aspects of Your Business Plan…………………………………………………. 315
Information Checkpoint……………………………………………………………………… 315
Key Terms…………………………………………………………………………………………… 316
Discussion Questions…………………………………………………………………………… 316
Chapter 26 Understanding Strategic Relationships: Health Delivery Systems,
Finance, and Reimbursement ………………………………………………………317
Introduction ………………………………………………………………………………………. 317
Defining Health Delivery Systems ……………………………………………………….. 317
xii Table of Contents
Defining the Area of Healthcare Finance……………………………………………… 319
Defining the Area of Healthcare Reimbursement …………………………………. 320
Strategic Relationship Between the Healthcare Delivery System and
Finance………………………………………………………………………………………….. 321
The Strategic Relationship Between Finance and Reimbursement…………. 323
Third-Party Reimbursement and Government Expenditures: Another
Strategic Relationship……………………………………………………………………… 325
A New Focus on the Relationship Between Finance and Healthcare
Delivery………………………………………………………………………………………….. 327
Reimbursement and Physicians: An Ongoing Strategic Challenge………….. 327
Information Checkpoint……………………………………………………………………… 328
Key Terms…………………………………………………………………………………………… 329
Other Acronyms…………………………………………………………………………………. 329
Discussion Questions…………………………………………………………………………… 329
Notes…………………………………………………………………………………………………. 330
PART X—INFORMATION TECHNOLOGY AS A FINANCIAL AND STRATEGIC TOOL…..331
Chapter 27 Understanding Value-Based Health Care and Its Financial and Digital
Outcomes………………………………………………………………………………….333
The Value-Based Concept: Introduction ………………………………………………. 333
Value-Based Progress in the Private Sector ……………………………………………. 334
Value-Based Progress in the Public Sector …………………………………………….. 335
Value-Based Education Efforts……………………………………………………………… 337
Value-Based Legislative Reform……………………………………………………………. 338
Quality Measurement: The Concept…………………………………………………….. 341
Value-Based Public Reporting in the Private Sector……………………………….. 343
Value-Based Public Reporting in the Public Sector ……………………………….. 344
Financial Outcomes ……………………………………………………………………………. 346
Digital Outcomes………………………………………………………………………………… 347
Value-Based Strategic Planning by the Private Sector …………………………….. 349
Value-Based Strategic Planning by the Public Sector ……………………………… 350
Conclusion: The Future………………………………………………………………………. 354
Information Checkpoint……………………………………………………………………… 354
Key Terms…………………………………………………………………………………………… 355
Other Acronyms…………………………………………………………………………………. 355
Discussion Questions…………………………………………………………………………… 355
Notes…………………………………………………………………………………………………. 355
Chapter 28 New Payment Methods and Measures:
MIPS and APMs for Eligible Professionals …………………………………….361
Introduction ………………………………………………………………………………………. 361
Legislative Reform and MACRA: An Overview………………………………………. 362
Payment Choices: MIPS Versus APMs …………………………………………………… 363
MIPS Incentives………………………………………………………………………………….. 363
How Are MIPS Physicians and Other Eligible Professionals Paid? …………… 366
Table of Contents xiii
MIPS Composite Performance Score……………………………………………………. 367
MIPS Performance Categories …………………………………………………………….. 368
How MIPS Scoring Works……………………………………………………………………. 370
MIPS Required Reporting Affects Payment ………………………………………….. 373
Data Submission…………………………………………………………………………………. 374
APM Incentives—(Choice #2)……………………………………………………………… 375
Eligible Professionals Within APMs………………………………………………………. 376
How Are Advanced APM EPs Paid? ………………………………………………………. 378
How Significant Participation Works…………………………………………………….. 380
Advanced APM Participation Standards ………………………………………………. 380
Scoring Standard for APMs………………………………………………………………….. 381
Creating Physician-Focused Payment Models (PFPMS) …………………………. 382
Building the Measurement Development Plan for MIPS and APMs:
Developing New Quality Measures …………………………………………………… 382
Timelines for Developing Quality Measures………………………………………….. 383
A Framework for MACRA Quality Measurement …………………………………… 384
Conclusion: Benefits and Costs of the Quality Payment Program……………. 388
Three Incentive Programs as They Existed Before MIPS: A Reference ……. 389
Alternative Payment Models: A Reference…………………………………………….. 390
Information Checkpoint……………………………………………………………………… 392
Key Terms…………………………………………………………………………………………… 392
Discussion Questions…………………………………………………………………………… 393
Notes…………………………………………………………………………………………………. 393
Appendix 28-A Meaningful Use: Modified and Streamlined with
a New Name …………………………………………………………………………………… 397
How Meaningful Use Has Evolved ……………………………………………………….. 397
Changes to Allowable MU Stages …………………………………………………………. 398
Changes to Meaningful Use Requirements ………………………………………….. 400
Conclusion: Advancing Care Information Becomes
the New Meaningful Use …………………………………………………………………. 401
Acronyms…………………………………………………………………………………………… 403
Notes…………………………………………………………………………………………………. 403
Chapter 29 Standardizing Measures and Payment in Post-Acute Care: New
Requirements ……………………………………………………………………………405
The Impact Act: New Directions for Post-Acute Care …………………………….. 405
Why Focus Attention on Post-Acute Care? ……………………………………………. 407
A New Alternative Payment Model for Four Care Settings ……………………… 408
Standardized Data and Interoperability: The Keys to PAC Reform………….. 410
Standardizing Assessment and Measure Domains for PAC Providers ………. 411
Electronic Reporting Timelines for PAC Providers………………………………… 413
Public Reporting: Impact Act Requirements…………………………………………. 414
Impact Act Benefits and Costs: A Summary …………………………………………… 415
Meeting Strategic Goals ………………………………………………………………………. 415
Conclusion: Innovation in the Digital Age ……………………………………………. 416
The Future: Change Is Inevitable…………………………………………………………. 418
xiv Table of Contents
Information Checkpoint……………………………………………………………………… 418
Key Terms…………………………………………………………………………………………… 419
Other Acronyms…………………………………………………………………………………. 419
Discussion Questions…………………………………………………………………………… 419
Notes…………………………………………………………………………………………………. 419
Chapter 30 ICD-10 Implementation Continues: Finance and Strategic Challenges
for the Manager …………………………………………………………………………421
ICD-10 E-Records Overview and Impact……………………………………………….. 421
Overview of the ICD-10 Coding System ………………………………………………… 421
ICD-10-CM and ICD-10-PCS Codes………………………………………………………. 421
E-Record Standards and the ICD-10 Transition……………………………………… 422
ICD-10 Benefits and Costs……………………………………………………………………. 423
ICD-10 Implementation: Systems Affected and Technology Issues………….. 425
Understand Technology Issues and Problems ………………………………………. 426
An Example: Comparison of Old and New Angioplasty Codes……………….. 428
ICD-10 Implementation: Training and Lost Productivity Costs ………………. 428
Who Gets Trained on ICD-10? ……………………………………………………………… 428
Costs of Training ………………………………………………………………………………… 429
Costs of Lost Productivity ……………………………………………………………………. 430
Introduction: About ICD-10 Key Performance Indicators ……………………… 430
Key Performance Indicators to Assess ICD-10 Progress………………………….. 431
Using KPIs to Track ICD-10 Implementation Progress ………………………….. 432
Reviewing KPI Results…………………………………………………………………………. 434
Creating Action Plans to Deal with Problems………………………………………… 435
Building Specific Action Plans to Correct Deficiencies…………………………… 435
ICD-10 Implementation: Situational Analysis………………………………………… 437
Implementation Planning Recommendations………………………………………. 437
Situational Analysis Recommendations ………………………………………………… 438
Commencing an Information Technology SWOT Matrix for ICD-10 ……… 440
Summary……………………………………………………………………………………………. 441
Information Checkpoint……………………………………………………………………… 441
Key Terms…………………………………………………………………………………………… 441
Discussion Questions…………………………………………………………………………… 442
Notes…………………………………………………………………………………………………. 442
Appendix 30-A ICD-10 Conversion Costs for a Midwestern
Community Hospital………………………………………………………………………..445
Authors’ Note …………………………………………………………………………………….. 445
Introduction ………………………………………………………………………………………. 445
The Scenario………………………………………………………………………………………. 445
Note…………………………………………………………………………………………………… 446
PART XI—CASE STUDIES…………………………………………………………………………………….447
Chapter 31 Case Study: The Doctor’s Dilemma …………………………………………………..449
The Offer: “Sell Your Practice to Us”…………………………………………………….. 449
Table of Contents xv
Seeking to Understand Healthcare Finance Reform ……………………………… 449
Researching Acquisition Viewpoints and Industry Trends ……………………… 450
Considering Other Physicians’ Reactions……………………………………………… 451
What Will Dr. Matthews Decide?…………………………………………………………… 451
Notes…………………………………………………………………………………………………. 451
Chapter 32 Case Study: Strategic Financial Planning in Long-Term Care …………………453
Background ……………………………………………………………………………………….. 453
Framework of the Board’s Mandate ……………………………………………………… 453
Industry Profile…………………………………………………………………………………… 454
Feasibility Determination…………………………………………………………………….. 454
Notes…………………………………………………………………………………………………. 457
Chapter 33 Case Study: Metropolis Health System……………………………………………….459
Background ……………………………………………………………………………………….. 459
MHS Case Study …………………………………………………………………………………. 461
Appendix 33-A Metropolis Health System’s Financial Statements
and Excerpts from Notes…………………………………………………………………. 471
Excerpts from Metropolis Health System Notes to Financial
Statements …………………………………………………………………………………….. 477
Appendix 33-B Comparative Analysis Using Financial Ratios and
Benchmarking Helps Turn Around a Hospital in the Metropolis
Health System ………………………………………………………………………………………. 483
Appendix 33-C Proposal to Add a Retail
Pharmacy to a Hospital in the Metropolis Health System …………………… 489
PART XII—MINI-CASE STUDIES …………………………………………………………………………..495
Chapter 34 Mini-Case Study 1: The Economic Significance of Resource
Misallocation: Client Flow Through the Women, Infants,
and Children Public Health Program……………………………………………..497
Confronting the Operational Problem…………………………………………………. 497
The Environment……………………………………………………………………………….. 497
The Peak-Load Problem ……………………………………………………………………… 498
Method………………………………………………………………………………………………. 499
Results……………………………………………………………………………………………….. 499
Chapter 35 Mini-Case Study 2: Technology in Health Care: Automating
Admission Processes …………………………………………………………………..503
Assess Admissions Process……………………………………………………………………. 503
Areas to Automate………………………………………………………………………………. 504
Fax and Document Management…………………………………………………………. 504
Communication Is Important………………………………………………………………. 504
Referral Tracking and Approval …………………………………………………………… 505
Analyzing Referral Activity ………………………………………………………………….. 505
Hours Saved……………………………………………………………………………………….. 505
xvi Table of Contents
Appendix A Checklists ……………………………………………………………………………………..507
Glossary ………………………………………………………………………………………………………………511
Examples and Exercises, Supplemental Materials, and Solutions…………………………………..525
Examples and Exercises………………………………………………………………………………………… 525
Supplementary Materials: The Mechanics of Percentage Computations…………………… 578
Solutions to Practice Exercises………………………………………………………………………………. 578
Index ………………………………………………………………………………………………………………….591
xvii
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New to This Edition
The Fifth Edition continues to provide practical information, with examples taken from real life in the healthcare
finance world. For example, we have added the following:
NEW MATERIAL IN THE 5TH EDITION:
• Chapter 3 “The Digital Age: Changing the Landscape of Healthcare Finance”—This new chapter is about
understanding the impact of data analytics and big data, along with other important trends in the changing landscape of healthcare finance. It is important to recognize that digital advancements in health care
are the drivers that enable innovation.
• Chapter 26 “Understanding Strategic Relationships: Health Delivery Systems, Finance and
Reimbursement”—This new chapter focuses upon describing the strategic relationships between and
among health delivery systems, finance, and reimbursement. This chapter assists a manager in recognizing both differences and interrelationships and in applying this recognition to their own organization’s
structure.
• Chapter 27 “Understanding Value-Based Health Care and Its Financial and Digital Outcomes”—Valuebased performance, the subject of this new chapter, is particularly important because it is the key to both
improving patient care and reforming payment systems. Healthcare organizations should define what
value means and make sure that definition is shared across the entire entity.
• Chapter 28 “New Payment Methods and Measures: MIPS and APMs for Eligible Professionals”—This new
chapter highlights significant legislation and regulations that change payment methods and performance
measures for physicians and other eligible professionals. The new payment method for physicians hinges
upon proper reporting of new performance measures. The new system is a true reform, as it replaces a
physician payment system that has been in effect for decades.
• Appendix 28-A “Meaningful Use: Modified and Streamlined with a New Name”—This new appendix describes the evolution of meaningful use before and after its transition into the new physician performance
measures that are described in Chapter 28.
• Chapter 29 “Standardizing Measures and Payment in Post-Acute Care: New Requirements”—This new
chapter is about important legislation and regulations that standardize measures and require studies about
payment reform for post-acute care. This means performance measures for skilled nursing facilities, home
health agencies, inpatient rehabilitation facilities, and long-term care hospitals are being standardized.
Models for a patient-centered payment system that cuts across all four care settings are also being created.
• Chapter 30 “ICD-10 Implementation Continues: Finance and Strategic Challenges for the Manager”—This
updated chapter focuses upon challenges for the manager within ICD-10 implementation. An all-new
section introduces useful Key Performance Indicators that are used to assess an organization’s ICD-10
implementation progress.
Other new material in this edition includes the following:
• Chapter 9 “Understanding Inventory and Depreciation Concepts”—A new section about drug distribution systems in use in hospitals has been added to this chapter.
• Chapter 10 “Staffing: Methods, Operations, and Regulation”—A new section has been added describing
legislation that requires reporting “verifiable and auditable” payroll information for the “Nursing Compare” website, along with information about existing Certificate of Need regulations.
xviii New to This Edition
• Appendix 16-A “Creating A DRG Budget for Respiratory Care: The Resource Consumption
Approach”—This new appendix sets out a step-by-step DRG budget methodology.
• Appendix 16-B “Reviewing a Comparative Operating Budget Report”—This new appendix describes the
review of a section from an actual operating budget report.
• Chapter 21 “Understanding Investment and Statistical Terms Used in Finance”—This chapter was originally only about investment terms; it now has a new section about understanding statistical terms.
• Chapter 31 “Case Study: The Doctor’s Dilemma”—This new case study is about a physician deciding
whether or not to sell his practice to a health delivery system.
MATERIAL OMITTED FROM THIS EDITION
• Two Fourth Edition chapters and a Fourth Edition appendix have been omitted because they are becoming
outdated. This includes the following: Chapter 24 “Information Technology and EHR: Adoption Requirements, Initiatives, and Management Decisions” has been replaced with the new value-based chapter.
• Appendix 24-A Accordingly, the e-Prescribing (eRx) appendix has also been omitted because the incentive program is ending.
• Chapter 25 “Electronic Health Records Framework: Incentives, Standards, Measures, and Meaningful
Use” has been omitted because the incentives are ending.
• Relevant additions and deletions have been made to the “Examples and Exercises” section.
To summarize: A fundamental theme in the Fifth Edition is that healthcare financing is embracing the digital
age. This is manifested by its coverage of electronic health records (EHRs), data analytics, value-based health
care, and social media, among other topics. In this era of population health and the resulting need for clinical
integration, data-driven collaboration has the potential to improve outcomes and lower costs, as well as more
effectively engage the patient. The upshot: Everything is connected.
xix
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Preface
Our world of work is divided into three parts: the healthcare consultant, the instructor, and the writer. Over
the years, we have taught managers in seminars, academic settings, and corporate conference rooms. Most of
the managers were mid-career adults, working in all types of healthcare disciplines. We taught them and they
taught us. One of the things they taught us was this: A nonfinancial manager pushed into dealing with the world
of finance often feels a dislocation and a change of perspective, and that experience can be both difficult and
exciting. We have listened to their questions and concerns as these managers grapple with this new world. This
book is the result of their experiences, and ours.
The book is designed for use by a manager (or future manager) who does not have an educational background in financial management. It has long been our philosophy that if you can truly understand how a thing
works—whatever it is—then you own it. This book is created around that philosophy. In other words, we intend
to make financial management transparent by showing how it works and how a manager can use it.
USING THE BOOK
All our examples are drawn from the healthcare industry. Thus users will find examples and exercises covering
many types of healthcare settings and providers, including hospitals, clinics, physician practices, long-term care
facilities, and home health agencies.
Standard Elements
Each chapter within these parts contains the following four elements:
• “Progress Notes” set out learning objectives at the beginning of each chapter.
• An “Information Checkpoint” segment at the end of each chapter tells the user three things: information
needed, where this information can be obtained, and how this information can be used.
• A “Key Terms” section follows the “Information Checkpoint.” Every Key Term is defined in the Glossary;
it is also bold faced the first time it appears in the text.
• The “Discussion Questions” segment inquires about practical uses of chapter material and encourages
responses based upon experience.
Structure and Topics
The book is structured in 12 parts, as follows.
Part I: Healthcare Finance Overview [Three chapters; one is new]
Part II: Record Financial Operations [Four chapters]
Part III: Tools To Analyze and Understand Financial Operations [Three chapters plus appendix; new text added to
two chapters]
Part IV: Report and Measure Financial Results [Three chapters plus three appendices]
Part V: Tools to Review and Manage Comparative Data [Two chapters]
Part VI: Construct and Evaluate Budgets [Two chapters plus two new appendices]
Part VII: Tools to Plan, Monitor, and Control Financial Status [Three chapters; one is new]
Part VIII: Financial Terms, Costs, and Choices [Three chapters; one entire new section]
xx Preface
Part IX: Strategic Planning: A Powerful Tool [Three chapters plus one appendix; one chapter is new]
Part X: Information Technology As A Financial and Strategic Tool [Four chapters plus two appendices; three chapters and
one appendix are all new and the fourth chapter has been substantially revised. In addition, two previous chapters
and a previous appendix that have become outdated have been omitted and replaced in the Fifth Edition.]
Part XI: Case Studies [One new case study about the doctor’s dilemma,one case study about strategic financial
planning in long-term care, and a group of four interrelated case studies about the Metropolis Health
System]
Part XII: Mini-Case Studies [Two mini-case studies; one concerns resource misallocation in a public health clinic
and the other is about automating admissions processes]
More About the Metropolis Health System Case Studies
A group of four case studies about the Metropolis Health System (MHS) represents a comprehensive suite of
information. This section includes the major case study about the system, followed by an appendix containing an
MHS financial statement and excerpts from notes. A second case study appendix shows how one MHS hospital
was turned around using comparative analysis of benchmarks and statistical data. A third case study appendix
describes a detailed proposal to add a retail pharmacy to another of the MHS hospitals. The Metropolis grouping thus provides an interactive suite of case study material.
Supplemental Resources
At the back of the book you will find additional resources as follows, all of which have been updated for the Fifth
Edition:
• An Appendix containing Checklists
• A Glossary
• Examples and Exercises, with Solutions
• Other Supplemental Materials
xxi
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Acknowledgments
With this edition we welcome Dr. Neil R. Dworkin as our coauthor. Neil brings a formidable combination of both
educational and practical on-the-ground experience in health care. He also brings fresh viewpoints that are as
valuable as his career achievements.
The Fifth Edition has evolved with the help of numerous instructors and students who give us feedback; we
listen. We owe a great debt of thanks to Mike Brown, our long-suffering and understanding publisher. And
we thank our Fifth Edition first readers, including Teresa Schroder, AuD, CCC-A, along with others who prefer
to be anonymous; you know who you are. The continuing support and suggestions of Janet Feldman, PhD,
RN, Vice President, Qualitas Associates, along with certain continuing technical support provided by Colleene
McMurphy, CPA, of McMurphy and Associates, are also appreciated.
The input from finance sessions we taught as Adjunct Faculty at Texas Woman’s University in Dallas also
contributed to shaping the content of the Fifth Edition. Our continued gratitude goes to Craig Sheagren, Senior
Vice President/CFO, McDonough District Hospital, Macomb, Illinois; and Nancy M. Borkowski, PhD, Professor, Department of Professional Management/Health Management, St. Thomas University, Miami, Florida, for
their encouragement, information, suggestions, and assistance with the original concept of the book. We also
thank John Brocketti, Chief Financial Officer, SUMA Health System, Akron, Ohio; Christine Pierce, Partner,
The Resource Group, Cleveland, Ohio; and Dr. Frank Welsh, Cincinnati, Ohio, for their ongoing information
and suggestions.
Many others also contributed suggestions, recommendations, and information to help shape and refine the
initial concept. We continue to acknowledge these individuals, listed below, including their original affiliations:
Ian G. Worden, CPA, Regional Vice President of Finance/CFO, PeaceHealth, Eugene, Oregon
Carol A. Robinson, Medical Records Director, Titus Regional Medical Center, Mt. Pleasant, Texas
John Congelli, Vice President of Finance, Genesee Memorial Hospital, Batavia, New York
Charles A. Keil, Cost Accountant, Genesee Memorial Hospital, Batavia, New York
George O. Kimbro, CPA, CFO, Hunt Memorial Hospital District, Greenville, Texas
Bob Gault, Laboratory Director, Hunt Memorial Hospital District, Greenville, Texas
Ted J. Stuart, Jr., MD, MBA, Northwest Family Physicians, Glendale, Arizona
Mark Potter, EMS Director, Hopkins County Memorial Hospital, Sulphur Springs, Texas
Leonard H. Friedman, PhD, Assistant Professor, Coordinator, Health Care Administration Program, Oregon
State University, Corvallis, Oregon
Patricia Chiverton, EdD, RN, Dean, University of Rochester School of Nursing, Rochester, New York
Donna M. Tortoretti, RNC, Chief Operating Officer, Community Nursing Center, University of Rochester
School of Nursing, Rochester, New York
Billie Ann Brotman, PhD, Professor of Finance, Department of Economics and Finance, Kennesaw State University, Kennesaw, Georgia

xxiii
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About the Authors
Judith J. Baker, PhD, CPA, has worked with healthcare systems, costing, finance, and reimbursement throughout her career. With over 40 years’ experience in health care, she is a co-founder of Resource Group, Ltd., a
healthcare consulting firm. As a CMS contractor, she has assisted in validation of costs for new programs and for
rate setting and has also consulted on cost report design. More recently, she has provided activity-based costing,
rate setting, and organizational systems expertise to national clients within the healthcare industry.
Judith’s doctorate is in human and organizational systems, with a concentration in healthcare costing systems. She has served as adjunct faculty at the University of Texas at Houston and the Texas Woman’s University
in Dallas, as well as the University of Rochester School of Nursing and the Case Western Reserve University Francis Payne Bolton School of Nursing.
Judith has written numerous peer-reviewed articles and has served as Consulting Editor for Aspen Publishers,
Inc. Her books include Activity-Based Costing and Activity-Based Management for Health Care, Prospective Payment for
Long-Term Care, Prospective Payment for Home Health Agencies, Management Accounting for Health Care Organizations
(with Robert Hankins) and Essentials of Cost Accounting for Health Care Organizations (with Steven Finkler and
David Ward). She is Editor Emeritus of the quarterly Journal of Healthcare Finance.
R. W. Baker, JD, is also a co-founder of Resource Group, Ltd., a healthcare consulting firm. He has more than
40 years of experience in health care and has designed, directed, and administered numerous financial impact
studies for healthcare providers. His early studies centered around facility-specific MDS data collection and
analysis. He and his firm subcontracted to the HCFA/CMS Nursing Home Case Mix and Quality Demonstration
for over nine years. More recently he has designed, implemented, and managed a series of national time studies
for pharmaceutical and medical device clients.
R. W. is the editor of continuing professional education seminar manuals and training manuals for facility
personnel and for research staff members. He served as a Consulting Editor with Aspen Publishers, Inc. and is
co-author of A Step-by-Step Guide to the Minimum Data Set (with Dr. Janet Feldman).
Neil R. Dworkin, PhD, is Emeritus Associate Professor of Management at Western Connecticut State University, where he was Coordinator of the Masters in Health Administration Program and where he taught Strategic
Management, Finance, Marketing, Health Policy, and Health Delivery Systems. He is presently an adjunct faculty
member at Charter Oak State College, which is part of the Connecticut State University System and where he
teaches Continuous Quality Improvement in Health Care and Health Care Systems and Administration.
Neil has hospital administration experience, and has been a nursing home administrator in New York and
Connecticut. He has over 40 years’ experience in the healthcare field. He was the lead author in a three-article
series on “Managerial Socialization in Short-Term Hospitals” that was published in Hospital Topics and Problems
and Perspectives in Management. Neil has also served as an editor of The Journal of Health Administration Education.

PART
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Healthcare
Finance
Overview
I

Progress Notes
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3
CHAPTER
Introduction to
Healthcare Finance
THE HISTORY
Financial management has a long and distinguished
history. Consider, for example, that Socrates wrote about
the universal function of management in human endeavors
in 400 b.c. and that Plato developed the concept of specialization for efficiency in 350 b.c. Evidence of sophisticated
financial management exists from much earlier times: the
Chinese produced a planning and control system in 1100
b.c., a minimum-wage system was developed by Hammurabi
in 1800 b.c., and the Egyptians and Sumerians developed
planning and record-keeping systems in 4000 b.c.
1
Many managers in early history discovered and rediscovered managerial principles while attempting to reach their
goals. Because the idea of management thought as a discipline had not yet evolved, they formulated principles of
management because certain goals had to be accomplished.
As management thought became codified over time, however, the building of techniques for management became
more organized. Management as a discipline for educational purposes began in the United States in 1881. In that
year, Joseph Wharton created the Wharton School, offering college courses in business management at the University of Pennsylvania. It was the only such school until 1898,
when the Universities of Chicago and California established
their business schools. Thirteen years later, in 1911, 30 such
schools were in operation in the United States.2
Over the long span of history, managers have all sought
how to make organizations work more effectively. Financial
management is a vital part of organizational effectiveness.
This text’s goal is to provide the keys to unlock the secrets
of financial management for nonfinancial managers.
After completing this chapter,
you should be able to
1. Discuss the three viewpoints
of managers in organizations.
2. Identify the four elements of
financial management.
3. Understand the differences
between the two types of
accounting.
4. Identify the types of organizations.
5. Understand the composition
and purpose of an organization chart.
3
CHAPTER
1
THE CONCEPT
A Method of Getting Money in and out of the Business
One of our colleagues, a nurse, talks about the area of healthcare finance as “a method of getting money in and out of the business.” It is not a bad description. As we shall see, revenues represent inflow and expenses represent outflow. Thus, “getting money in” represents the inflow
(revenues), whereas “getting money out” (expenses) represents the outflow. The successful
manager, through planning, organizing, controlling, and decision making, is able to adjust the
inflow and outflow to achieve the most beneficial outcome for the organization.
HOW DOES FINANCE WORK IN THE HEALTHCARE BUSINESS?
The purpose of this text is to show how the various elements of finance fit together: in other
words, how finance works in the healthcare business. The real key to understanding finance is
understanding the various pieces and their relationship to each other. If you, the manager, truly
see how the elements work, then they are yours. They become your tools to achieve management success.
The healthcare industry is a service industry. It is not in the business of manufacturing, say,
widgets. Instead, its essential business is the delivery of healthcare services. It may have inventories of medical supplies and drugs, but those inventories are necessary to service delivery, not
to manufacturing functions. Because the business of health care is service, the explanations
and illustrations within this book focus on the practice of financial management in the service
industries.
VIEWPOINTS
The managers within a healthcare organization will generally have one of three views: (1) financial, (2) process, or (3) clinical. The way they manage will be influenced by which view they
hold.
1. The financial view. These managers generally work with finance on a daily basis. The reporting function is part of their responsibility. They usually perform much of the strategic
planning for the organization.
2. The process view. These managers generally work with the system of the organization.
They may be responsible for data accumulation. They are often affiliated with the information system hierarchy in the organization.
3. The clinical view. These managers generally are responsible for service delivery. They
have direct interaction with the patients and are responsible for clinical outcomes of the
organization.
Managers must, of necessity, interact with one another. Thus, managers holding different views
will be required to work together. Their concerns will intersect to some degree, as illustrated by
Figure 1–1. The nonfinancial manager who understands healthcare finance will be able to interpret and negotiate successfully such interactions between and among viewpoints.
4 Chapter 1 Introduction to Healthcare Finance
In summary, financial management is a
discipline with a long and respected history.
Healthcare service delivery is a business, and
the concept of financial management assists
in balancing the inflows and outflows that
are a part of the business.
WHY MANAGE?
Business does not run itself. It requires a
variety of management activities in order to
operate properly.
THE ELEMENTS OF FINANCIAL
MANAGEMENT
There are four recognized elements of financial management: (1) planning, (2) controlling, (3)
organizing and directing, and (4) decision making. The four divisions are based on the purpose
of each task. Some authorities stress only three elements (planning, controlling, and decision
making) and consider organizing and directing as a part of the controlling element. This text
recognizes organizing and directing as a separate element of financial management, primarily
because such a large proportion of a manager’s time is taken up with performing these duties.
1. Planning. The financial manager identifies the steps that must be taken to accomplish
the organization’s objectives. Thus, the purpose is to identify objectives and then to identify the steps required for accomplishing these objectives.
2. Controlling. The financial manager makes sure that each area of the organization is following the plans that have been established. One way to do this is to study current reports
and compare them with reports from earlier periods. This comparison often shows where
the organization may need attention because that area is not effective. The reports that
the manager uses for this purpose are often called feedback. The purpose of controlling
is to ensure that plans are being followed.
3. Organizing and directing. When organizing, the financial manager decides how to use
the resources of the organization to most effectively carry out the plans that have been
established. When directing, the manager works on a day-to-day basis to keep the results
of the organizing running efficiently. The purpose is to ensure effective resource use and
provide daily supervision.
4. Decision making. The financial manager makes choices among available alternatives. Decision making actually occurs parallel to planning, organizing, and controlling. All types
of decision making rely on information, and the primary tasks are analysis and evaluation. Thus, the purpose is to make informed choices.
THE ORGANIZATION’S STRUCTURE
The structure of an organization is an important factor in management.
Figure 1–1 Three Views of Management Within an
Organization.
Financial
Clinical
Process
The Organization’s Structure 5
Organization Types
Organizations fall into one of two basic types: profit oriented or nonprofit oriented. In the
United States, these designations follow the taxable status of the organizations. The profitoriented entities, also known as proprietary organizations, are responsible for paying income
taxes. Proprietary subgroups include individuals, partnerships, and corporations. The nonprofit organizations do not pay income taxes.
There are two subgroups of nonprofit entities: voluntary and government. Voluntary
nonprofits have sought tax-exempt status. In general, voluntary nonprofits are associated
with churches, private schools, or foundations. Government nonprofits, on the other hand,
do not pay taxes because they are government entities. Government nonprofits can be
(1) federal, (2) state, (3) county, (4) city, (5) a combination of city and county, (6) a hospital
taxing district (with the power to raise revenues through taxes), or (7) a state university
(perhaps with a teaching hospital affiliated with the university). The organization’s type may
affect its structure. Exhibit 1–1 summarizes the subgroups of both proprietary and nonprofit
organizations.
Organization Charts
In a small organization, top management will be able to see what is happening. Extensive measures and indicators are not necessary because management can view overall operations. But in
a large organization, top management must use the management control system to understand
what is going on. In other words, to view operations, management must use measures and indicators because he or she cannot get a firsthand overall picture of the total organization.
As a rule of thumb, an informal management control system is acceptable only if the
manager can stay in close contact with all aspects of the operation. Otherwise, a formal
system is required. In the context of health
care, therefore, a one-physician practice
(Figure 1–2) could use an informal method,
but a hospital system (Figure 1–3) must use a
formal method of management control.
The structure of the organization will affect its financial management. Organization
charts are often used to illustrate the structure
of the organization. Each box on an organization chart represents a particular area of
management responsibility. The lines between
the boxes are lines of authority.
In the health system organization chart illustrated in Figure 1–3, the president/chief
executive officer oversees seven senior vice
presidents. Each senior vice president has vice
presidents reporting to him or her in each
Profit Oriented—Proprietary
Individual
Partnership
Corporation
Other
Nonprofit—Voluntary
Church Associated
Private School Associated
Foundation Associated
Other
Nonprofit—Government
Federal
State
County
City
City–County
Hospital District
State University
Other
Exhibit 1–1 Types of Organizations
6 Chapter 1 Introduction to Healthcare Finance
particular area of responsibility designated on the chart. These vice presidents, in turn, have an
array of other managers reporting to them at varying levels of managerial responsibility.
The organization chart also shows the degree of decentralization within the organization.
Decentralization indicates the delegating of authority for decision making. The chart thus illustrates the pattern of how managers are allowed—or required—to make key decisions within
the particular organization.
The purpose of an organization chart, then, is to indicate how responsibility is assigned to
managers and to indicate the formal lines of communication and reporting.
TWO TYPES OF ACCOUNTING
Financial
Financial accounting is generally for outside, or third party, use. Thus, financial accounting emphasizes external reporting. External reporting to third parties in health care includes, for example, government entities (Medicare, Medicaid, and other government programs) and health
plan payers. In addition, proprietary organizations may have to report to stockholders, taxing
district hospitals have to report to taxpayers, and so on.
Financial reporting for external purposes must be in accordance with generally accepted
accounting principles. Financial reporting is usually concerned with transactions that have already occurred: that is, it is retrospective.
Managerial
Managerial accounting is generally for inside, or internal, use. Managerial accounting, as its
title implies, is used by managers. The planning and control of operations and related performance measures are common day-by-day uses of managerial accounting. Likewise, the reporting of profitability of services and the pricing of services are other common ongoing uses
of managerial accounting. Strategic planning and other intermediate and long-term decision
making represent an additional use of managerial accounting.3
Managerial accounting intended for internal use is not bound by generally accepted accounting principles. Managerial accounting deals with transactions that have already occurred,
but it is also concerned with the future, in the form of projecting outcomes and preparing budgets. Thus, managerial accounting is prospective as well as retrospective.
Two Types of Accounting 7
Figure 1–2 Physician’s Office Organization Chart.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Reception
Scheduling
Billing
Accounting
Front
Office
Physician’s
Assistant
Registered
Nurse
Clinical
Services
Physician
8 Chapter 1 Introduction to Healthcare Finance
Figure 1–3 Health System Organization Chart.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Metropolis
Health System
President/CEO
Sr. Vice President
Service Delivery
Operations/COO
Inpatient
Operations
Ambulatory
Operations
Other
Operations
Operations
TQI
Sr. Vice President
Human Resources
Human Resources
Operations
HR Planning
& Placement
Learning
Services
Sr. Vice President
Medical
Management
Physician
Benefits
Physician
Recruitment
Integration
Sr. Vice President
General Counsel
Legal
Affairs
Risk
Management
Sr. Vice President
Human Affairs
Community
Outreach
Community
Health Council
Community Health
Improvement
Programs
Sr. Vice President
Information
Systems/CIO
Info Systems
Operations
Data
Management
Info Systems
Development
Sr. Vice President
Finance/CFO
Central
Business Office
Finance
Insurance
Managed Care
Real Estate
Facilities/
Development
Physician
TQI
INFORMATION CHECKPOINT
What is needed? Reports for management purposes.
Where is it found? With your supervisor.
How is it used? To manage better.
What is needed? Organization chart.
Where is it found? With your supervisor or in the administrative offices.
How is it used? To better understand the structure and lines of authority in
your organization.
KEY TERMS
Controlling
Decision Making
Financial Accounting
Managerial Accounting
Nonprofit Organization (also see Voluntary Organization)
Organization Chart
Organizing
Planning
Proprietary Organization (also see Profit-Oriented Organization)
DISCUSSION QUESTIONS
1. What element of financial management do you perform most often in your job?
2. Do you perform all four elements? If not, why not?
3. Of the organization types described in this chapter, what type is the one you work for?
4. Have you ever seen your company’s organization chart? If so, how decentralized is it?
5. If you receive reports in the course of your work, do you believe that they are prepared
for outside (third party) use or for internal (management) use? What leads you to
believe this?
NOTES
1. C. S. George, Jr., The History of Management Thought, 2nd ed. (Englewood Cliffs, NJ: Prentice Hall, 1972), 1–27.
2. Ibid., 87.
3. S. Williamson et al., Fundamentals of Strategic Planning for Healthcare Organizations
(New York: The Haworth Press, 1997).
Notes 9

Progress Notes
© LFor/Shutterstock
CHAPTER
Four Things the Healthcare Manager Needs to Know
About Financial
Management Systems
WHAT DOES THE MANAGER NEED TO KNOW?
Financial management is both an art and a science. You, as
a manager, need to perceive the structure and reasoning
that underlies management actions. To do so, you need to
be able to answer the following four questions:
1. What are the four segments that make a financial
management system work?
2. How does the information flow?
3. What are the basic system elements?
4. What is the annual management cycle for reporting
results?
This chapter provides answers to each of these four questions. It also discusses how to communicate financial
information to others. This ability is a valuable skill for a
successful manager.
HOW THE SYSTEM WORKS IN HEALTH CARE
The information that you, as a manager, work with is only one
part of an overall system. To understand financial management, it is essential to recognize the overall system in which
your organization operates. An order exists within the system,
and it is generally up to you to find that order. Watch for how
the information fits together. The four segments that make a
healthcare financial system work are (1) the original records,
(2) the information system, (3) the accounting system, (4) and
the reporting system. Generally speaking, the original records
provide evidence that some event has occurred; the information system gathers this evidence; the accounting system records the evidence; and the reporting system produces reports
After completing this chapter,
you should be able to
1. Understand that four
segments make a financial
management system work.
2. Follow an information flow.
3. Recognize the basic system
elements.
4. Follow the annual
management cycle.
11
CHAPTER
2
CHAPTER
of the effect. The healthcare manager needs to know that these separate elements exist and that
they work together for an end result.
THE INFORMATION FLOW
Structure of the Information System
Information systems can be simplistic or highly complex. They can be fully automated or semiautomated. Occasionally—even today—they can still be generated by hand and not by computer. (This last instance is becoming rare and can happen today only in certain small and
relatively isolated healthcare organizations that are not yet required to electronically submit
their billings.)
We will examine a particular information system and point out the basics that a manager
should be able to recognize. Figure 2–1 shows information system components for an
ambulatory care setting. This complex system uses a clinical and financial data repository; in
other words, both clinical and financial data are fed into the same system. An automated medical record is also linked to the system. These are basic facts that a manager should recognize
about this ambulatory information system.
In addition, the financial information, both outpatient and any relevant inpatient, is fed
into the data repository. Scheduling-system data also enter the data repository, along with any
relevant inpatient care plan and nursing information. Again, all of these are basic facts that a
manager should recognize about this ambulatory care information system.
These items have all been inputs. One output from the clinical and financial data repository
(also shown in Figure 2–1) is insurance verification for patients through an electronic data
Figure 2–1 Information System Components for an Ambulatory Care Setting.
OP, Outpatient; IP, Inpatient; OR, Operating Room.
Managed Care Systems
–Enrollment/eligibility
–Utilization management
–Demand management
–Algorithmic scheduling
support
Insurance
Verification
EDI
Link
Enterprise-Wide
Master Patient Index
Interface Engine
Clinical and Financial
Data Repository
Practice Management
System Scheduling
Ancillary Scheduling
Patient Accounting System
Financial (OP and IP)
OR Scheduling
Other Provider
Inpatient System
–Clinical order entry
–IP care plans
–IP nursing
Chart
Tracking
(IP and OP)
A
u
t
o
m
a
t
e
d
M
e
d
i
c
a
l
R
e
c
o
r
d
12 Chapter 2 Four Things the Healthcare Manager Needs to Know
information (EDI) link to insurance company databases. Insurance verification is daily operating information. Another output is decision-making information for managed care strategic
planning, including support for demand, utilization, enrollment, and eligibility, plus some statistical support. The manager does not have to understand the specifics of all the inputs and
outputs of this complex system, but he or she should recognize that these outputs occur when
this ambulatory system is activated.
Function of Flowsheets
Flowsheets illustrate, as in this case, the flow of activities that capture information.1 Flowsheets
are useful because they portray who is responsible for what piece of information as it enters
the system. The manager needs to realize the significance of such information. We give, as an
example, obtaining confirmation of a patient’s correct address. The manager should know that
a correct address for a patient is vital to the smooth operation of the system. An incorrect address will, for example, cause the billing to be rejected. Understanding this connection between
deficient data (e.g., a bad address) and the consequences (the bill will be rejected by the payer
and thus not be paid) illustrates the essence of good financial management knowledge.
We can examine two examples of patient information flows. The first, shown in Figure 2–2,
is a physician’s office flowsheet for address confirmation. Four different personnel are
involved, in addition to the patient. This physician has computed the cost of a bad address
as $12.30 to track down each address correction. He pays close attention to the handling of
this information because he knows there is a direct financial management consequence in his
operation.
Figure 2–2 Physician’s Office Flowsheet for Address Confirmation.
Initiates
Call
Mark
Superbill
if Change
Mark
Superbill
if Change
Patient
Enter
Corrected
Address in
Computer
Copy
Insurance
Card
Instruct
Patient
to
Correct
Financial
Data
Check
Address
Insurance
Review
Patient
Records
Record
Message
Receive
Call
Phone Intake
Entry/Exit
Receptionist
Ask
Address
Change
Ask
Address
Change
Medical
Assistant
Ask
Address
Change
Doctor
Type
Chart
Label
Coder
Ask
Insurance
Change
The Information Flow 13
The second example, shown in Figure 2–3, is a health system flowsheet for verification of
patient information. This flowsheet illustrates the process for a home care system. In this case,
the flow begins not with a receptionist, as in the physician office example, but with a central
database. This central database downloads the information and generates a summary report
to be reviewed the next day. Appropriate verification is then made in a series of steps, and any
necessary corrections are made before the form goes to the billing department. The object
of the flow is the same in both examples: that is, the billing department must have a correct
address to receive payment. But the flow is different within two different systems. A manager
must understand how the system works to understand the consequences—then good financial
management can prevail.
BASIC SYSTEM ELEMENTS
To understand financial management, it is essential to decipher the reports provided to the
manager. To comprehend these reports, it is helpful to understand certain basic system elements that are used to create the information contained in the reports.
Chart of Accounts—The Map
The chart of accounts is a map. It outlines the elements of your company in an organized manner. The chart of accounts maps out account titles with a method of numeric coding. It is designed to compile financial data in a uniform manner that the user can decode.
Figure 2–3 Health System Flowsheet for Verification of Patient Information.
Central intake enters
demographics at time
referral received
Patient Accounts
Clerk generates
Patient Information
Summary next day
Data downloads to
CDB overnight
Information on Patient
Information Summary
verified by
care manager at next
visit
Correct information
written in by staff
Information
Correct?
Form is placed in
appropriate
care manager’s
mailbox
Form turned in to
Patient Accounts
Representative
Data in CDB’s central
intake updated
by Patient Accounts
Representative
Form placed in
billing folder
New labels generated
if necessary
Yes No
14 Chapter 2 Four Things the Healthcare Manager Needs to Know
The groupings of accounts in the chart of accounts should match the groupings of the organization. In other words, the classification on the organization chart (as discussed in the
previous chapter) should be compatible with the groupings on the chart of accounts. Thus, if
there is a human resources department on your facility’s organization chart, and if expenses are
grouped by department in your facility, then we would expect to find a human resources grouping in the chart of accounts.
The manager who is working with financial data needs to be able to read and comprehend
how the dollars are laid out and how they are gathered together, or assembled. This assembly
happens through the guidance of the chart of accounts. That is why we compare it to a map.
Basic guidance for healthcare charts of accounts is set out in publications such as that of
Seawell’s Chart of Accounts for Hospitals.
2 However, generic guides are just that—generic. Every
organization exhibits differences in its own chart of accounts that express the unique aspects
of its structure. We examine three examples to illustrate these differences. Remember, we are
spending time on the chart of accounts because your comprehension of detailed financial data
may well depend on whether you can decipher your facility’s own chart of accounts mapping in
the information forwarded for your use.
The first format, shown in Exhibit 2–1, is a basic use, probably for a smaller organization. The
exhibit is in two horizontal segments, “Structure” and “Example.” There are three parts to the
account number. The first part is one digit and indicates the financial statement element. Thus,
our example shows “1,” which is for “Asset.” The second part is two digits and is the primary
subclassification. Our example shows “10,” which stands for “Current Asset” in this case. The
third and final part is also two digits and is the secondary subclassification. Our example shows
“11,” which stands for “Petty Cash—Front Office” in this case. On a report, this account number
would probably appear as 1-10-11.
The second format, shown in Exhibit 2–2, is full use and would be for a large organization.
The exhibit is again in two horizontal segments, “Structure” and “Example,” and there are now
Exhibit 2–1 Chart of Accounts, Format I
Structure
X XX XX
Financial Primary Secondary
Statement Subclassification Subclassification
Element
Example
1 10 11
Asset Current Petty Cash—
Asset Front Office
(Financial
Statement (Primary (Secondary
Element) Subclassification) Subclassification)
Basic System Elements 15
two line items appearing in the Example section. This full-use example has five parts to the account number. The first part is two digits and indicates the entity designator number. Thus, we
conclude that there is more than one entity within this system. Our example shows “10,” which
stands for “Hospital A.” The second part is two digits and indicates the fund designator number.
Thus, we conclude that there is more than one fund within this system. Our example shows
“10,” which stands for “General Fund.”
The third part of Exhibit 2–2 is one digit and indicates the financial statement element.
Thus, the first line of our example shows “4,” which is for “Revenue,” and the second line of
our example shows “6,” which is for “Expense.” (The third part of this example is the first part
of the simpler example shown in Exhibit 2–1.) The fourth part is four digits and is the primary
subclassification. Our example shows 3125, which stands for “Lab—Microbiology.” The number
3125 appears on both lines of this example, indicating that both the revenue and the expense
belong to Lab—Microbiology. (The fourth part of this example is the second part of the simpler example shown in Exhibit 2–1. The simpler example used only two digits for this part, but
this full-use example uses four digits.) The fifth and final part is two digits and is the secondary
subclassification. Our example shows “03” on the first line, the revenue line, which stands for
“Payer: XYZ HMO” and indicates the source of the revenue. On the second line, the expense
line, our example shows “10,” which stands for “Clerical Salaries.” Therefore, we understand
that these are the clerical salaries belonging to Lab—Microbiology in Hospital A. (The fifth part
of this example is the third and final part of the simpler example shown in Exhibit 2–1.) On a
report, these account numbers might appear as 10-10-4-3125-03 and 10-10-6-3125-10. Another
optional use that is easier to read at a glance is 10104-3125-03 and 10106-3125-10.
Exhibit 2–2 Chart of Accounts, Format II
Structure
XX XX X XXXX XX
Entity Fund Financial Primary Secondary
Designator Designator Statement Subclassification Subclassification
Element
Example
10 10 4 3125 03
Hospital General Revenue Lab—Microbiology Payer: XYZ HMO
A Fund
10 10 6 3125 10
Hospital General Expense Lab—Microbiology Clerical Salaries
A Fund
(Entity (Fund (Financial (Primary (Secondary
Designator) Designator) Statement Subclassification) Subclassification)
Element) Element)
16 Chapter 2 Four Things the Healthcare Manager Needs to Know
Because every organization is unique and because the chart of accounts reflects that uniqueness, the third format, shown in Exhibit 2–3, illustrates a customized use of the chart of accounts. This example is adapted from a large hospital system. There are four parts to its chart
of accounts number. The first part is an entity designator and designates a company within the
hospital system. The fund designator two-digit part, as traditionally used (see Exhibit 2–2), is
missing here. The financial statement element one-digit part, as traditionally used (see Exhibit
2–2), is also missing here. Instead, the second part of Exhibit 2–3 represents the primary classification, which is shown as an expense category (“Payroll”) in the example line. The third part of
Exhibit 2–3 is the secondary subclassification, representing a labor subaccount expense designation (“Regular per-Visit RN”). The fourth and final part of Exhibit 2–3 is another subclassification that indicates the department within the company (“Home Health”). On a report for this
organization, therefore, the account number 21-7000-2200-7151 would indicate the home care
services company’s payroll for regular per-visit registered nurses (RNs) in the home health department. Finally, remember that time spent understanding your own facility’s chart of accounts
will be time well spent.
Books and Records—Capture Transactions
The books and records of the financial information system for the organization serve to capture
transactions. Figure 2–4 illustrates the relationship of the books and records to each other. As a
single transaction occurs, the process begins. The individual transaction is recorded in the appropriate subsidiary journal. Similar such transactions are then grouped and balanced within
the subsidiary journal. At periodic intervals, the groups of transactions are gathered, summarized, and entered in the general ledger. Within the general ledger, the transaction groups
Exhibit 2–3 Chart of Accounts, Format III
Structure
XX XXXX XXXX XXXX
Company Expense Subaccount Department
Category
(Entity (Primary (Secondary (Additional
Designator) Classification) Subclassification) Subclassification)
Example
21 7000 2200 7151
Home Payroll Regular Home Health
Care per-Visit RN
Services
(Company) (Expense (Subaccount) (Department)
Category)
Basic System Elements 17
are reviewed and adjusted. After such review and adjustment, the transactions for the period
within the general ledger are balanced. A document known as the trial balance is used for this
purpose. The final step in the process is to create statements that reflect the transactions for the
period. The trial balance is used to produce the statements.
All transactions for the period reside in the general ledger. The subsidiary journals are so
named because they are “subsidiary” to the general ledger: in other words, they serve to support
the general ledger. Figure 2–5 illustrates this concept. Another way to think of the subsidiary
journals is to picture them as feeding the general ledger. The important point here is to understand the source and the flow of information as it is recorded.
Reports—The Product
Reports are more fully treated in a subsequent chapter of this text (see Chapter 11). It is sufficient at this point to recognize that reports are the final product of a process that commences
with an original transaction.
THE ANNUAL MANAGEMENT CYCLE
The annual management cycle affects the type and status of information that the manager is
expected to use. Some operating information is “raw”—that is, unadjusted. When the same
information has passed further through the system and has been verified, adjusted, and
Figure 2–4 The Progress of a Transaction.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Individual Transaction
[begins process]
Individual Transaction
Is Recorded
Similar Transactions
Are Grouped and Balanced
Groups of Transactions
Are Gathered and Summarized
Summarized Groups of Transactions
Are Reviewed and Adjusted
Adjusted and Reviewed Transactions
for Period Are Balanced
Statements Reflecting Transactions Are Created
[ends process]
Creates
Original Record
Into
Subsidiary Journals
Within the
Subsidiary Journals
Into the
General Ledger
Within the
General Ledger
Trial Balance Is Produced
from the General Ledger
for This Purpose
Statements Are Produced
from the Trial Balance
18 Chapter 2 Four Things the Healthcare Manager Needs to Know
balanced, it will usually vary from the initial raw data. These differences are a part of the process
just described.
Daily and Weekly Operating Reports
The daily and weekly operating reports generally contain raw data, as discussed in the preceding paragraph. The purpose of such daily and weekly reports is to provide immediate operating
information to use for day-to-day management purposes.
Quarterly Reports and Statistics
The quarterly reports and statistics generally have been verified, adjusted, and balanced. They
are called interim reports because they have been generated some time during the reporting
period of the organization and not at the end of that period. Managers often use quarterly reports as milestones. A common milestone is the quarterly budget review.
Annual Year-End Reports
Most organizations have a 12-month reporting period known as a fiscal year. A fiscal year, therefore, covers a period from the first day of a particular month (e.g., January 1) through the last
day of a month that is one year, or 12 months, in the future (e.g., December 31). If we see a
heading that reads, “For the year ended June 30,” we know that the fiscal year began on July
1 of the previous year. Anything less than a full 12-month year is called a “stub period” and is
fully spelled out in the heading. If, therefore, a company is reporting for a three-month stub
period ending on December 31, the heading on the report will read, “For the three-month period ended December 31.” An alternative treatment uses a heading that reads, “For the period
October 1 to December 31.”
Annual year-end reports cover the full 12-month reporting period or the fiscal year. Such
annual year-end reports are not primarily intended for managers’ use. Their primary purpose
is for reporting the operations of the organization for the period to outsiders, or third parties.
Figure 2–5 Recording Information: Relationship of Subsidiary Journals to the General Ledger.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Payroll
Journal
Accounts
Receivable
Journal
Cash
Receipts
Journal
Cash
Disbursements
Journal
Accounts
Payable
Journal
GENERAL LEDGER
SUBSIDIARY JOURNALS
THE BOOKS
The Annual Management Cycle 19
Annual year-end reports represent the closing out of the information system for a specific
reporting period. The recording and reporting of operations will now begin a new cycle with a
new year.
COMMUNICATING FINANCIAL INFORMATION TO OTHERS
The ability to communicate financial information effectively to others is a valuable skill. It is
important to
• Create a report as your method of communication.
• Use accepted terminology.
• Use standard formats that are accepted in the accounting profession.
• Begin with an executive summary.
• Organize the body of the report in a logical flow.
• Place extensive detail into an appendix.
The rest of this book will help you learn how to create such a report. Our book will
also sharpen your communication skills by helping you better understand how heathcare
finance works.
INFORMATION CHECKPOINT
What is needed? An explanation of how the information flow works in
your unit.
Where is it found? Probably with the information system staff; perhaps in the
administrative offices.
How is it used? Study the flow and relate it to the paperwork that you handle.
KEY TERMS
Accounting System
Chart of Accounts
General Ledger
Information System
Original Records
Reporting System
Subsidiary Journals
Trial Balance
DISCUSSION QUESTIONS
1. Have you ever been informed of the information flow in your unit or division?
2. If so, did you receive the information in a formal seminar or in an informal manner, oneon-one with another individual? Do you think this was the best way? Why?
20 Chapter 2 Four Things the Healthcare Manager Needs to Know
3. Do you know about the chart of accounts in your organization as it pertains to information you receive?
4. If so, is it similar to one of the three formats illustrated in this chapter? If not, how is it
different?
5. Do you work with daily or weekly operating reports? With quarterly reports and statistics?
6. If so, do these reports give you useful information? How do you think they could be
improved?
NOTES
1. J. J. Baker, Activity-Based Costing and Activity-Based Management for Health Care (Gaithersburg,
MD: Aspen Publishers, Inc., 1998).
2. L. V. Seawell, Chart of Accounts for Hospitals (Chicago: Probus Publishing Company, 1994).
Notes 21

Progress Notes
© LFor/Shutterstock
CHAPTER
The Digital Age:
Changing the
Landscape of
Healthcare Finance
HIGH-TECH AND HIGH-TOUCH APPROACHES
Healthcare systems are using high-tech and high-touch
approaches to reach patients where they are and with what
they need in an attempt to meet the challenges of patient
engagement. Digital platforms, including mobile apps and
social networks, are changing customer interactions and
expectations.
We characterize the current state of online technology
as Web 2.0, which goes beyond simply letting people access
information on the Internet (as was the case in the early
days of the Internet). The current state is now characterized
by greater user interactivity and collaboration, more pervasive network connectivity, and enhanced communication
channels.1
Social media, such as Facebook and Twitter, are the outgrowth of Web 2.0. The challenge to a healthcare organization’s marketing staff is to determine how to harness social
media to reach customers and turn social media content
into business value.
PATIENT ENGAGEMENT
Central to understanding the changes that are now occurring
due to the variety of digital impacts and changes in health
information technology is the concept of patient engagement. Technology and patient engagement go hand-in-hand.
An overarching objective of the healthcare digital age is to
make patient engagement more meaningful and effective.
The Engaged Patient
A truly engaged patient is one who is an active partner in his
or her own health care. It stands to reason that primary care
After completing this chapter,
you should be able to
1. Understand what drives
changes to health
information technology.
2. Identify types of high-tech
and high-touch digital
approaches.
3. Identify the digital impact
areas for patient
engagement.
4. Define digital media.
5. Understand the difference
between EMR and EHR.
6. Recognize how to effectively
manage population health.
This chapter explores major
digital age influences that are
impacting healthcare finance.
23
CHAPTER
3
CHAPTER
would be the specialty wherein this concept can most effectively be operationalized. Patients
who are punctual with their annual checkup and those with chronic diseases like diabetes who
are adhering to their regimens would be considered engaged patients.
Jacqueline Fellows assembled a comprehensive list of digital impact areas under the rubric
of “Patient Engagement Investments” and examined them by setting (e.g., hospital, physician
organization) and by net patient revenue.2 Among the areas that attracted the most interest
were patient portals, patient access to medical records, telemedicine, remote monitoring, and
telehealth to track patient health status.
The major factors driving the growth of the telehealth market appear to be the rise in aging
and chronically ill population and the shortage of physicians in some areas of the country.
However, there are reimbursement issues that must be overcome, which also encompass
telemedicine.
Rapid Change
Mobile technology has the potential to help healthcare providers manage risk, encourage
healthy behaviors, and engage with consumers. Garmin (producers of GPS programs), along
with various partners, has launched new products including a wide range of “wearables” to help
people reach their health and wellness goals. In one example, OffTheScale (OTS) has entered
into partnership with Garmin and its innovative healthcare platform that fights against obesity
and other chronic diseases. OTS provides a Garmin wearable device that measures steps taken
and combines it with user data to calculate distance walked and calories burned.3
Leaders in performance technology such as Garmin also produce remote monitoring
devices for patients with other conditions such as diabetes and heart failure. These types of
mobile technology have the true potential to improve wellness and to lower healthcare costs.4 It is
essential, however, that the devices and systems that are flooding the market (including apps)
be properly studied or vetted through clinical trials.
SOCIAL MEDIA
Recognizing the importance of social media is a first step in bringing a hospital, for example,
into the digital world. Social media can help a hospital manage the patient experience, connect
with community members and potential patients before they arrive, and manage their care
transactions after they leave. Providing an alternative mode of communication can help make
patient interactions more comfortable and less clinical. The intersection of health care and
social media is unavoidable. Social networks, blogs, discussion forums, and other social and
digital media highlight these alternative modes of communication.
Digital Media
Digital media may be defined as any type of information stored in a computer or mobile device,
including data, voice, and video.5 A common misconception related to social media is that it
requires the creation of additional content. Any content that is being used for print media
(newsletters, information packets, marketing materials, or other promotional items) can be
repurposed for digital media. An effective social media strategy is integral to managing a healthcare organization’s reputation.
24 Chapter 3 The Digital Age
What Do the Data Show?
It is estimated that between 70% and 75% of Internet users in the United States seek healthcare
information on line.6 According to a 2014 study, nearly 95% of hospitals had a Facebook page,
and just over 50% had a Twitter account.7 For all the good that may come from patients and
healthcare consumers use of social media, there are also risks and challenges. For example, it
can be difficult to control the quality of information that appears on patient social networks. In
addition, patient privacy and security of health-related information are major concerns.
RESOURCE ALLOCATION
The types of resources needed to grow a healthcare organization’s digital brand are technological and human resources-related. In addition, with the locus of responsibility for social media
typically residing in a marketing and/or communications department in a healthcare organization, full-time employee staff costs dedicated to electronic media should result in additional
budgetary expenses. These staff expenses are in addition to the cost of establishing and maintaining a website (purchasing a domain name, hosting fees, etc.). A website is a collection of
related Web pages, images, videos, or other digital assets that are addressed with a common
domain name or internet protocol (IP) address in an IP-based network.8 That said, in today’s
competitive environment, it isn’t enough just to have a Web presence. Instead, healthcare organizations need to have online visibility.
CHANGES IN HEALTH INFORMATION TECHNOLOGY
The changes that are occurring in health information technology are driven by health informatics, or the application of information technology to healthcare delivery. These changes
include the following:
• More open, cloud-based systems that facilitate data sharing
• Mobile devices and sensors that enable increased participation by patients
• Adoption of digital or electronic health records
Still another major technology change involves data mining. Electronic records are increasingly
being mined and analyzed to uncover new medical knowledge, promote evidence-based treatments, and determine the clinical and cost-effectiveness of care.9
(For additional information on
data mining, see the chapter entitled, “Understanding the Impact of Data Analytics and Big Data.”)
EMRs and EHRs
At the center of the health information technology evolution is the electronic health record
(EHR). A distinction has been made between the electronic medical record (EMR) and the
EHR. The EMR is essentially the digital version of the traditional paper chart, the electronic
record of a particular physician’s office. The EHR ideally represents the total health status of
the patient across all providers.10
Incorporating EMRs and EHRs into clinical practice will require large investments in new
technology, in addition to changes in existing systems and processes. These barriers tend to slow
EHR adoption rates. Moreover, in some instances, this technology may serve as a distraction
Changes in Health Information Technology 25
during care delivery. On the other hand, the hope is that EHRs will realize their potential to
improve quality, reduce medical errors, and lower administrative costs.
Interoperability
Interoperability, or the ability of two or more information systems to “talk” to each other
(exchange data), is the key to the future success of EHRs as is the effectiveness of health
information exchanges (HIEs). These exchanges are a key component of health informatics through which information from various electronic record systems is shared according to
nationally recognized standards.
POPULATION HEALTH AND THE DIGITAL AGE: CROSSING AT THE
INTERSECTION
Population health is now center stage in healthcare delivery, and it is transforming the industry.
This represents an industry-wide shift in focus; while health care used to be transactional and
focused on the individual, population health emphasizes outcomes—not just of a single patient,
but of an entire population.
This concept is being operationalized through the advent of Accountable Care Organizations (ACOs) and their rapid growth and maturation. ACOs are groups of hospitals, doctors,
and other healthcare providers who come together voluntarily to provide coordinated, highquality care to their (primarily) Medicare patients. At the time of this writing, there are approximately 750 ACOs in operation, covering 23.5 million lives.11
The Challenge
To fully appreciate the challenge, one must understand what the essence of population health
is. First, the provider has to define the population. Then, the care that the population is
receiving must be determined. Next, identify what gaps exist when comparing the care that the
population is receiving with the care that the population requires. Finally, the delivery system
should be able to address the care gaps.12 Improving the health of populations is one element
of the well-regarded Institute For Healthcare Improvement’s “Triple Aim,” the other two being
improving the patient experience and reducing the per-capita cost of health care.13 Taken
together, the three elements describe an approach to optimizing health system performance.
Assessing Information Technology Capabilities
In order to effectively engage in population health management, healthcare organizations
will have to assess their information technology (IT) capabilities and address the gaps therein.
Glaser14 maintains that efficient data sharing among multiple providers will be key; hospitals
working with other organizations such as provider groups, post-acute providers, and social services. That data will have to be combined to formulate a complete picture of the patient in
order to determine care planning, predict utilization patterns, and assess risk.
These imperatives go beyond the functionality of EHRs and envision real-time population
health management solutions that are intended to work in tandem with that certified technology.
26 Chapter 3 The Digital Age
Most assuredly, the use of big data analytics will be part of the enabling platform, as well as cloudbased applications and telemedicine.
ADDITIONAL TRENDS AND COMPLEXITIES: OTHER DELIVERY SYSTEMS
The trends and complexities related to population health and the digital age involve other
delivery systems. Most notably among them are urgent care, retail medicine clinics, and behavioral health.
Urgent Care Medicine
The growth and development of urgent care medicine has not been unexpected. For many
patients, there are long waits in the emergency room for nonemergent care, and there has been
a concomitant shortage of primary care physicians in parts of the country. Since 2008, the number of urgent care facilities has increased from 8,000 to 9,300.15
Further evidence of the continuing maturation of this type of care is that many centers are
now seeking accreditation. Urgent care centers offer imaging and other services not found in
retail outlets. However, the challenge therein lies in the ability of the centers to share clinical
data with a patient’s primary care physician in a timely manner for continuity of care purposes.
Retail Medicine Clinics
Retail medicine clinics may be found in drugstores, grocery chains, and even airports. They are
typically small clinics staffed by Nurse Practitioners. Retail health clinics, by definition, are clinics in which the consumer pays the provider directly at the point of sale.16 Hospital systems are
increasingly opening satellite care centers in retail locations, either partnering with chains like
Walmart on in-store centers or going it alone. Many consumers of retail medicine are uninsured
individuals looking for a fixed cost-of-care. There are also regulatory concerns and questions
about quality of care.
Behavioral Health
Behavioral health presents a myriad of unique challenges in the digital age. The nature of
behavioral health care (mental health care) makes the application of current health IT challenging. The use of EHRs in behavioral health is limited because of strict privacy concerns,
which cause persistent barriers to information sharing.17 Thus, few behavioral health organizations have formal linkages or agreements to securely share their information. A recent survey
found that while 97% of U.S. hospitals and 74% of physicians have implemented interoperable
EHRs, only 30% of behavioral health providers have implemented these systems.18
SUMMARY
Within the heathcare finance world, it is important to recognize the impact and consequences
of the Digital Age. To be successful today, managers must work toward fully recognizing and
understanding these significant trends.
Summary 27
INFORMATION CHECKPOINT
What Is Needed? Your healthcare organization’s online visibility.
Where Is It Found? Websites, blogs, discussion forums, Facebook, Twitter, and/or
LinkedIn.
How Is It Used? The particular online visibility sources will vary depending
upon your organization’s media strategy.
KEY TERMS
Digital Media
Electronic Health Record (EHR)
Electronic Medical Record (EMR)
Health Information Technology
Patient Engagement
Population Health
Social Media
OTHER ACRONYMNS
ACO: Accountable Care Organization
HIE: Health Information Exchange
IP: Internet Protocol
IT: Information Technology
DISCUSSION QUESTIONS
1. Does your organization have a social media marketing plan?
2. Are you aware of how widespread the use of electronic health records (EHRs) is in your
organization? Is it embraced by the medical staff?
3. Does your organization have a population health strategy?
NOTES
1. “Web 2.0,” WhatIs.com, http://whatis.techtarget.com/definition/Web-20-or-Web-2,
accessed January 5, 2016.
2. J. Fellows, “Meeting the Challenge of Patient Engagement,” Health Leaders, 18, no 6
(2015): 12–26.
3. OffTheScale, www.prnewswire.com/news-releases/groundbreaking-healthcare-platform
-offthescale-partners-with-Garmin-300136825.html, accessed September 2, 2015, and
http://site.garmin.com/en-US/wellness, accessed September 19, 2016.
28 Chapter 3 The Digital Age
4. Ibid.
5. Society for Healthcare Strategy & Market Development, A Hospital Leadership Guide to
Digital & Social Media Engagement (Chicago: American Hospital Association, 2015).
6. J. Glaser, “Five Reasons to ‘Like’ Patients Use of Social Media,” H&HN, April 11, 2016,
http://www.hhnmag.com/articles/7090-five-reasons-to-like-patients-use-of-social-media
7. Ibid.
8. C. B. Thielst, Social Media in Healthcare: Connect, Communicate, Collaborate (Chicago:
Health Administration Press, 2010).
9. M. L. Braunstein, Contemporary Health Informatics (Chicago: American Health Information Management Association, 2014).
10. Ibid.
11. J. Glaser, “All Roads Lead to Population Health Management,” H&HN, June 13, 2016,
http://www.hhnmag.com/articles/7332-all-roads-lead-to-population-health-management
12. M. Zeis, “Toward Population Health,” Health Leaders, 16, no 8 (2013): 24–28.
13. Institute for Healthcare Improvement, http://www.ihi.org/engage/tripleaim/pages
/default.aspx, accessed June 18, 2016.
14. J. Glaser (Op.Cit), June 19, 2016.
15. American Academy of Urgent Care Medicine, “Future of Urgent Care,” aaucm.org
/about/future/default.aspx, accessed June 18, 2016.
16. “How Retail Medicine Lost its Way,” Managed Healthcare Executive, June 17, 2015,
managedhealthcareexecutive.modernmedicine.com/managed-healthcare-executive
/news/how-retail-medicine-lost-its-way
17. P. A. Ranallo, A. M. Kilbourne, A. S. Whatley, and H. A. Pincus, “Behavioral Health Information Technology: From Chaos to Clarity,” Health Affairs, 35, no 6 (2016): 1106–1113.
18. Ibid.
Notes 29

PART
© LFor/Shutterstock
Record Financial
Operations
II

OVERVIEW
Assets, liabilities, and net worth are part of the language of
finance. As such, it is important to understand both their
composition and how they fit together. Short definitions
appear below, followed by examples.
Assets
Assets are economic resources that have expected future
benefits to the business. In other words, assets are what the
organization owns and/or controls.
Liabilities
Liabilities are “outsider claims” consisting of economic obligations, or debts, payable to outsiders. Thus, liabilities are
what the organization owes, and the outsiders to whom the
debts are due are creditors of the business.
Net Worth
“Insider claims” are also known as owner’s equity, or net
worth. These are claims held by the owners of the business.
An owner has a claim to the entity’s assets because he or she
has invested in the business. No matter what term is used,
the sum of these claims reflects what the business is worth,
net of liabilities—thus “net worth.”
The Three-Part Equation
An accounting equation reflects a relationship among
assets, liabilities, and net worth as follows: assets equal
33
Progress Notes
© LFor/Shutterstock
CHAPTER
4
CHAPTER
After completing this chapter,
you should be able to
1. Recognize typical assets.
2. Recognize typical liabilities.
3. Understand net worth
terminology.
4. See how assets, liabilities,
and net worth fit together.
Assets, Liabilities,
and Net Worth
liabilities plus net worth. The three pieces must always balance among themselves because this
is how they fit together. The equation is as follows:
Assets 5 Liabilities 1 Net Worth
WHAT ARE EXAMPLES OF ASSETS?
All of the following are typical business assets.
Examples of Assets
Cash, accounts receivable, notes receivable, and inventory are all assets. If the Great Lakes
Home Health Agency (HHA) has cash in its bank account, that is an economic resource—an
asset. The HHA is owed money for services rendered; these accounts receivable are also an
economic resource—an asset. If certain patients have signed a formal agreement to pay the
HHA, then these notes receivable are likewise economic resources—assets. All types of business
receivables are assets. The Great Lakes HHA also has an inventory of medical supplies (dressings, syringes, IV tubing, etc.) that are used in its day-to-day operations. This inventory on hand
is an economic resource—an asset. Land, buildings, and equipment are also assets. Exhibit 4–1
summarizes asset examples.
Short-Term Versus Long-Term Assets
Assets are often labeled either “current” or “long-term” assets. Current is another word
for “short-term.” If an asset can be turned into cash within a 12-month period, it is current, or short term. If, on the other hand, an asset cannot be converted into cash within a
12-month period, it is considered long term. In our Great Lakes HHA example, accounts
receivable should be collected within 1 year and thus should be current assets. Likewise,
the inventory should be converted to business use within 1 year; thus, it too is considered
short term.
Classification of the note receivable depends on the length of time that payment is promised. If the entire note receivable will be paid within 1 year, it is a short-term asset. Consider, however, what would happen if the note is to be paid over 3 years. A portion of the
note—that amount to be paid in the coming 12 months—will be classified as short-term,
or current, and the rest of the note—that amount to be paid further in the future—will be
classified as long-term.
The land, building, and equipment will
generally be classified as long-term because
these assets will not be converted into cash in
the coming 12 months. Buildings and equipment are also generally stated at a net figure
called book value, which reduces their historical cost by any accumulated depreciation.
(The concept of depreciation is discussed in
Chapter 8.)
Exhibit 4–1 Asset Examples
Cash
Accounts receivable
Notes receivable
Inventory
Land
Buildings
Equipment
34 Chapter 4 Assets, Liabilities, and Net Worth
WHAT ARE EXAMPLES OF LIABILITIES?
All of the following are typical business liabilities.
Examples of Liabilities
Accounts payable, payroll taxes due, notes payable, and mortgages payable are all liabilities.
The Great Lakes HHA owes vendors for medical supplies it has purchased. The amount owed
to the vendors is recognized as accounts payable. When the HHA paid its employees, it withheld
payroll taxes, as required by the government. The payroll taxes withheld are due to be paid
to the government and thus are also a liability. The HHA has borrowed money and signed a
formal agreement and thus the amount due is a liability. The HHA also has a mortgage on its
building. This mortgage is likewise a liability. In other words, debts are liabilities. Exhibit 4–2
summarizes liability examples.
Short-Term Versus Long-Term Liabilities
Liabilities are also usually labeled as either “current” (short-term) or “long-term” liabilities. In
this case, if a liability is expected to be paid within a 12-month period, it is current, or shortterm. If, however, the liability cannot reasonably be expected to be paid within a 12-month
period, it is considered long-term. In our Great Lakes HHA example, accounts payable and
payroll taxes due should be paid within 1 year and thus should be labeled as current liabilities.
Classification of the note payable depends on the length of time that payment is promised.
If the HHA is going to pay the entire note payable within 1 year, it is a short-term liability. But
consider what would happen if the note is to be paid over 3 years. A portion of the note—that
amount to be paid in the coming 12 months—will be classified as short-term, or current, and
the rest of the note—that amount to be paid further in the future—will be classified as longterm. The mortgage will be treated slightly differently. That portion to be paid within the coming 12 months will be classified as a short-term liability, while the remaining mortgage balance
will be labeled as long-term.
WHAT ARE THE DIFFERENT FORMS OF NET WORTH?
Net worth—the third part of the accounting equation—is labeled differently, depending
on the type of organization. For-profit organizations will have equity accounts with which
to report their net worth. (Equity is the ownership right in property or the money value of
property.) For example, a sole proprietorship or a partnership’s net worth may simply be
labeled as “Owners’ Equity.” A corporation,
on the other hand, will generally report two
types of equity accounts: “Capital Stock” and
“Retained Earnings.” Capital stock represents
the owners’ investment in the company, indicated by their purchase of stock. Retained
earnings, as the name implies, represents undistributed company income that has been
left in the business.
Exhibit 4–2 Liability Examples
Accounts payable
Payroll taxes due
Notes payable
Mortgage payable
Bonds payable
What Are the Different Forms of Net Worth? 35
Not-for-profit organizations will generally
use a different term such as “Fund Balance”
to report the difference between assets and
liabilities in their report. This is presumably
because nonprofits should not, by definition,
have equity. Governmental entities in the
United States may also use the term “Fund
Balance” in their reports. Exhibit 4–3 summarizes terminology examples for net worth as
just discussed.
INFORMATION CHECKPOINT
What is needed? A report that shows the balance sheet for your organization.
Where is it found? Probably with your supervisor.
How is it used? Study the balance sheet to find the assets and liabilities. Check
the equity section to see whether equity is listed as net
worth or as fund balance.
KEY TERMS
Assets
Equity
Fund Balance
Liabilities
Net Worth
DISCUSSION QUESTIONS
1. Do you ever work with balance sheets in your current position?
2. If so, is the balance sheet you receive for your department only or for the entire organization? Do you know why this reporting method (departmental versus entire organization)
was chosen by management?
3. If you receive a copy of the balance sheet, is one distributed to you once a month, once
a year, or on some other more irregular basis? What are you supposed to do with it upon
receipt?
4. Do you think the balance sheet report you receive gives you useful information? How do
you think it could be improved?
Exhibit 4–3 Net Worth Terminology Examples
For-profit sole proprietors or partnerships:
Owners’ Equity
For-profit corporations:
Capital Stock
Retained Earnings
Not-for-profit (nonprofit) companies:
Fund Balance
36 Chapter 4 Assets, Liabilities, and Net Worth
Progress Notes
© LFor/Shutterstock
CHAPTER
Revenues (Inflow)
OVERVIEW
Revenue represents amounts earned by an organization:
that is, actual or expected cash inflows due to the organization’s major business. In the case of health care, revenue is
mostly earned by rendering services to patients. Revenue
flows into the organization and is sometimes referred to as
the revenue stream.
Revenue is generally defined as the value of services
rendered, expressed at the facility’s full established rates.
For example, hospital A’s full established rate for a certain
procedure is $100, but Giant Health Plan has negotiated
a managed care contract whereby the plan pays only $90
for that procedure. The revenue figure—the full established rate—is $100. Revenues can be received in the form
of cash or credit. Most, but not all, healthcare revenues are
received in the form of credit.
RECEIVING REVENUE FOR SERVICES
One way that revenue is classified is by whether payment
is received before or after the service is delivered. The
amount of revenue received for services is often influenced
by this classification.
Payment After Service Is Delivered
The traditional payment method in health care is that of
payment after service is delivered. Two basic types of payment after service is delivered are discussed in this section:
fee for service and discounted fee for service. One evolved
from the other.
After completing this chapter,
you should be able to
1. Understand how receiving
revenue for services is a
revenue stream.
2. Recognize contractual
allowances and discounts
and their impact on revenue.
3. Understand the differences in
sources of healthcare
revenue.
4. See how to group revenue
for planning and control.
37
5
CHAPTER
1. Fee for service. The truly traditional U.S. method of receiving revenue for services is fee
for service. The provider of services is paid according to the service performed. Before
the 1970s, with very few exceptions, fee for service was the dominant method of payment
for health services in the United States.1
2. Discounted fee for service. In this variation on the original fee for service, a contracted
discount is agreed upon. The organization providing the services then receives a payment
that is discounted in accordance with the contract. Sometimes the contract contains fee
schedules. A large provider of services can have many different contracts, all with different discounted contractual arrangements. Many variations are therefore possible.
Payment Before Service Is Delivered
Traditional payment methods in the United States have begun to give way to payment before
service is delivered. There are multiple names and definitions for such payment. We have chosen to use a general descriptive term for payment received before service is delivered: predetermined per-person payment. The payment method itself and its rate-setting variations are
discussed in this section.
1. Predetermined per-person payment. Payment received before service is delivered is generally at an agreed-upon predetermined rate. Payment, therefore, consists of the predetermined rate for each person covered under the agreement. Thus, the amount received
is a per-head or per-person count at a particular point in time.
2. Rate-setting differences. Different agreements can use varying assumptions about the
group to be served, and these variations will affect the rate-setting process. Numerous
variations are therefore possible.
Contractual Allowances and Other Deductions from Revenue
Revenues are recorded at the organization’s full established rates, as previously discussed. Those
amounts estimated to be uncollectible are considered to be deductions from revenues and are
recorded as such on the books of the organization. (For purposes of the external financial statements released for third-party use, reported revenue must represent the amounts that payers [or
patients] are obligated to pay. Therefore, the terms gross revenue and deductions from revenue
will not be seen on external statements. The discussion that follows, however, pertains to the books
and records that are used for internal management, where these classifications will be used.)
Contractual allowances are the difference between the full established rate and the agreedupon contractual rate that will be paid. Contractual allowances are often for composite services.
Take the case of hospital A as an example. As discussed in the overview to this chapter, hospital
A’s full established rate for a certain procedure is $100, but Giant Health Plan has negotiated a
managed care contract whereby the plan pays only $90 for that procedure. The $10 difference
between the revenue figure ($100) and the contracted amount that the plan pays ($90) represents the contractual allowance.
It is not uncommon for different plans to pay different contractual rates for the same service.
This practice is illustrated in Table 5–1, which shows contractual rates to be paid for visit codes
99213 and 99214 for 10 different health plans. Note the variations in rates.
38 Chapter 5 Revenues (Inflow)
The second major deduction from revenue
classification is an allowance for bad debts,
also known as a provision for doubtful accounts. (Again, for purposes of the external
financial statements released for third-party
use, the provision for doubtful reports must
be reported separately as an expense item.
The discussion that follows, however, still pertains to the books and records that are used
for internal management, where the classification of deductions from revenue will be used.)
The allowance for bad debts is charged with
the amount of services received on credit (recorded as accounts receivable) that are estimated to result in credit losses.
Beyond contractual allowances and a provision for bad debts, the third major deduction
from revenue classification is charity service.
Charity service is generally defined as services
provided to financially indigent patients.
SOURCES OF HEALTHCARE REVENUE
Healthcare revenue in the United States comes from a variety of public programs (governmental sources) and private payers. The sources of healthcare revenue are generally termed payers.
Payer mix—the proportion of revenues realized from the different types of payers—is a measure that is often included in the profile of a healthcare organization. For example, “Hospital
A has a payer mix that includes 40% Medicare and 33% Medicaid” might be part of the profile.
Governmental Sources
The Medicare Program
Title XVIII of the Social Security Act is commonly known as Medicare. Actually entitled “Health
Insurance for the Aged and Disabled,” Medicare legislation established a health insurance program for the aged in 1965. The program was intended to complement other benefits (such as
retirement, survivors’, and disability insurance benefits) under other titles within the Social
Security Act.
The Medicare program currently has four parts. The first part, known as Part A, is hospital
insurance (HI) and is funded primarily by a mandatory payroll tax. The second part, known as
Part B, is called supplementary medical insurance (SMI). SMI is voluntary and is funded primarily by insurance premiums (usually deducted from monthly Social Security benefit checks
of those enrolled) supplemented by federal general revenue funds. Guidelines determine both
the services to be covered and the eligibility of the individual to receive the services under the
Medicare program. Medicare claims (billings) are processed by fiscal agents who act on behalf
Sources of Healthcare Revenue 39
Table 5–1 Variations in Physician Office Revenue
for Two Visit Codes
Visit Codes
Payer 99213 99214
FHP $25.35 $35.70
HPHP 42.45 58.85
MC 39.05 54.90
UND 39.90 60.40
CCN 44.00 70.20
MAYO 45.75 70.75
CGN 10.00 10.00
PRU 39.05 54.90
PHCS 45.00 50.00
ANA 38.25 45.00
Rates for illustration only.
of the federal government. These fiscal agents, known as Medicare Administrative Contractors
(MACs), process both Part A (HI) and Part B (SMI) Medicare claims.
Medicare’s third part, Part C, is known as “Medicare Advantage.” Medicare Advantage consists of managed care plans, private fee-for-service plans, preferred provider organization plans,
and specialty plans. Although Medicare Advantage is offered as an alternative to traditional
Medicare, coverage must never be less than what Part A and Part B (traditional Medicare)
would offer the beneficiary.
Medicare’s fourth part, Part D, is the prescription drug benefit, effective as of January 1,
2006. The prescription drug benefit represents expanded coverage. It is a voluntary program
that requires payment of a separate premium and contains cost-sharing provisions.
The Medicare program covers approximately 95% of the U.S. aged population along with
certain eligible individuals receiving Social Security disability benefits.2 Medicare is an important source of healthcare revenue to most healthcare organizations.
The Medicaid Program
Title XIX of the Social Security Act is commonly known as Medicaid. Medicaid legislation established a federal and state matching entitlement program in 1965. The program was intended to
provide medical assistance to eligible needy individuals and families.
The Medicaid program is state specific. The federal government has established broad national guidelines. Each state has the power to set eligibility, service restrictions, and payment
rates for services within that state. In doing so, each state is bound only by the broad national
guidelines. Medicaid policies are complex, and considerable variation exists among states. The
federal government is responsible for a certain percentage of each state’s Medicaid expenditures; the specific amount due is calculated by an annual formula. The state pays the providers
of Medicaid services directly. Thus, the source of Medicaid revenue to a healthcare organization
is considered to be the state government’s Medicaid program representative.
The Medicaid program is the largest U.S. government program providing funds for medical
and health-related services for the poor.3 Therefore, although the proportion of Medicaid services within the payer mix may vary, Medicaid is a source of healthcare revenue in almost every
healthcare organization.
Other Programs
There are numerous other sources of federal, state, and local revenues for healthcare
organizations. Generally speaking, for most organizations, none of the other revenue sources
will exceed the Title XVIII and Title XIX programs just discussed. Other programs include
the Department of Veterans’ Affairs health programs, workers’ compensation programs, and
state-only general assistance programs (versus the federal-and-state jointly funded Medicaid
program). Still other public programs are school health programs, public health clinics, maternal and child health services, migrant healthcare services, certain mental health and drug and
alcohol services, and special programs such as Native American healthcare services.
Managed Care Sources
In the 1970s, managed care began to appear in healthcare models in the United States. An
all-purpose definition of managed care is: managed care is a means of providing healthcare
services within a network of healthcare providers. The responsibility to manage and provide
40 Chapter 5 Revenues (Inflow)
high-quality and cost-effective health care is delegated to this defined network of providers.4
A central concept of managed care is the coordination of all healthcare services for an individual. In general, managed care plans receive a predetermined amount per member in
premiums.
Types of Plans
The most prevalent type of managed care plan today is the health maintenance organization
(HMO). Members enroll in the HMO. They prepay a fixed monthly amount; in return, they
receive comprehensive health services. The members must use the providers who are designated by the HMO; if they go outside the designated providers, they must pay all or a large
part of the cost themselves. The designated providers of services in turn contract with the
HMO to provide services at agreed-upon rates. Several different forms of HMOs have evolved
over time.
The preferred provider organization (PPO) is a type of plan found across the United States.
It consists of a group of providers called a panel. The panel members are an approved group of
various types of providers, including hospitals and physicians. The panel is limited in size and
generally has utilization review powers. If the patients in a PPO use health providers who are not
within the PPO itself, they must pay a higher amount in deductibles and coinsurance.
Types of Contracts
In the case of an HMO, the designated providers of health services contract with the HMO to
provide services at agreed-upon rates. The different types of HMOs—including the staff model,
the group model, the network model, the point-of-service model, and the individual practice association (IPA) model—have various methods of arriving at these rates. A PPO contracts with its
selected group, who are all participating payers, to buy services for its eligible beneficiaries on
the basis of discounted fee for service. A large healthcare facility will have one or more individuals responsible for managed care contracting.5
Other Revenue Sources
A considerable amount of healthcare revenue is still realized from sources other than Title
XVIII, Title XIX, and managed care:
• Commercial insurers. Generally speaking, conventional indemnity insurers, or commercial insurers, simply pay for the eligible health services used by those individuals who pay
premiums for healthcare insurance. They do not tend to have a say in how those health
services are administered.
• Private pay. This is payment by patients themselves or by the families of patients. Private
pay is more prevalent in nursing facilities and in assisted-living facilities than in hospital
settings. Physicians’ offices also receive a certain amount of private pay revenue.
• Other. Additional sources of revenue for healthcare facilities include donations ­received
by voluntary nonprofit organization, tax revenues levied by governmental nonprofit organizations, and grant funding.
Healthcare revenue is often reported to managers by source of the revenue. Table 5–2 presents such a revenue summary. This example covers all types of sources discussed in this section.
Both dollar totals and proportionate percentages by source are reported.
Sources of Healthcare Revenue 41
GROUPING REVENUE FOR
PLANNING AND CONTROL
Grouping revenue by different classifications
is an effective method for managers to use
the information to plan and to control. In the
preceding paragraphs, we have seen revenue
reported by source. Other classification examples are now discussed.
Revenue Centers
A revenue center classification is one form of a
responsibility center. In a responsibility center,
the manager is responsible, as the name implies, for a particular set of activities. In the case of a
revenue center, a particular unit of the organization is given responsibility for generating revenues
to meet a certain target. Actually, the responsibility in the healthcare setting is more for generating
volume than for generating a specific revenue dollar amount. (The implication is that the volume
will, in turn, generate the dollars.) Revenue centers tend to occur most often in special programs
where volume is critical to survival of the program.
Care Settings
Grouping revenue by care setting recognizes the different sites at which services are delivered. The
most basic grouping by care settings is inpatient versus ambulatory services. Exhibit 5–1, however,
illustrates a six-way classification of care setting revenues within a health system. In this case, hospital
inpatient, hospital outpatient, off-site clinic, skilled nursing facility, home health agency, and hospice
are all accounted for. A percentage is shown for each. This type of classification is useful for a brochure or a report that profiles the different types of healthcare services offered by the organization.
Exhibit 5–1 Revenues by Care Setting
42% 38% 4%
Hospital Hospital Off-Site
Inpatient Outpatient Clinic
8% 6% 2%
Skilled Home Hospice
Nursing Health
Facility Agency
Service Lines
In traditional cost accounting circles, a product line is a grouping of similar products.6 In the
healthcare field, many organizations opt instead for “service line” terminology. A service line is
a grouping of similar services. Strategic planning sometimes sets out service lines.
42 Chapter 5 Revenues (Inflow)
Table 5–2 Sample Monthly Statement of Revenue
by Source
Summary Year to Date %
Private revenue $100,000 2.9
HMO revenue 560,000 16.7
Medicare revenue 1,420,000 42.4
Medicaid revenue 820,000 24.5
Commercial revenue 400,000 12.0
Other revenue 50,000 1.5
Total $3,350,000 100.0%
Hospitals
A number of hospitals have adopted the major
diagnostic categories (MDCs) as service lines.
One advantage of MDCs is that they are a
universal designation in the United States.
MDCs also have the advantage of possessing
a standard definition. In another approach to
service line classification, a hospital recently
updated its strategic plan and settled on
five service lines: (1) medical, (2) surgical,
(3) women and children, (4) mental health,
and (5) rehabilitation (neuro-ortho rehab)
(Figure 5–1).7
Long-Term Care
A continuing care retirement community
(CCRC) can use its various levels of care as
a starting point. Thus, the CCRC usually has
four service lines, listed in the descending order of resident acuity: (1) skilled nursing facility,
(2) nursing facility, (3) assisted living, and (4) independent living. The skilled nursing facility
provides services for the highest level of resident acuity, and the independent living provides
services for the lowest level of resident acuity. One adjustment to this approach includes isolating subacute services from the remainder of skilled nursing facility services. Another adjustment
involves splitting independent living into two categories, one for Housing and Urban Development (HUD)–subsidized independent housing and the other for private-pay independent
housing. Figure 5–2 illustrates CCRC service lines by acuity level.
Figure 5–2 Long-Term Care Service Lines.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Skilled Nursing
Facility
Nursing
Facility
Assisted
Living
Independent
Living
Nonsubsidized
Subsidized
Balance of SNF
Subacute
Home Care
Numerous categories of service delivery can be considered “home care.” A practical approach
was taken by one home care entity—part of a health system—that defined its “key functions.”
Key functions can in turn be converted to service lines (Figure 5–3).
Grouping Revenue for Planning and Control 43
Figure 5–1 Hospital Service Lines.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Women
&
Children
Mental Health
Medical
Surgical
Rehabilitation
Figure 5–3 Home Care Service Lines.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Infusion Therapy
Mental Health
Pulmonary
Maternity Services
Wound Care
Diabetes Education
Standard Home Care Special Services Home Care
Physician Groups
Service delivery for physician groups will vary,
of course, with the nature of the group itself.
A generic set of service lines is presented in
Figure 5–4.
Other Service Designations
Other classifications may meet the needs of
particular organizations. Columbia/HCA is
now reported to classify its services in a disease
management approach. The classification consists of eight disease management areas: (1)
cancer, (2) cardiology, (3) diabetes, (4) behavioral health, (5) workers’ compensation, (6)
women’s services, (7) senior care, and (8) emergency services.8
Other Types of Revenue Groupings
Other healthcare organizations may have revenue groupings that are not service lines. An entity
that provides services is able to choose service lines as a method of grouping its revenue. But if
the entity sells or makes a product (rather than providing services), its revenue will have to be
classified differently. Two examples within the healthcare industry follow: a retail pharmacy and a
pharmaceutical manufacturer.
Figure 5–4 Physician’s Group Service Lines.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Office Visits
Surgical
Procedures
Emergency
Medicine
Laboratory
Radiology
44 Chapter 5 Revenues (Inflow)
Retail Pharmacy
A retail pharmacy’s revenue primarily comes from sales. A typical retail pharmacy may group
revenues into three major categories of sales: Prescription Drugs, Nonprescription (Over-theCounter, or OTC) Drugs, and Other Merchandise. (The major category of “Other Merchandise”
would then have subcategories such as Cosmetics, Greeting Cards, Gifts, etc.)
Pharmaceutical Manufacturer
A pharmaceutical manufacturer’s revenue groupings would likewise be specific to its type of
healthcare business. These organizations are producing a product rather than providing a service.
Its major categories of revenues will probably be by type of drug manufactured. The next subcategory might then either be national versus international revenues, or perhaps a classification of
revenues by U.S. geographic region.
In summary, the entity’s revenue classification system, whatever it may be, must be consistent
with the current structure and purpose of the organization.
INFORMATION CHECKPOINT
What is needed? A report that shows revenue in your organization.
Where is it found? With your supervisor.
How is it used? Examine the report to find various revenue sources; look for
how the contractual allowances and discounts are handled
on the report.
What is needed? A report that groups revenue by some type of classification.
Where is it found? With your supervisor, or in the information services division.
How is it used? Examine the report to discover the methods that are used for
grouping. You will probably find that these groupings are
used for performance measures. They can also be used for
control and planning.
KEY TERMS
Discounted Fee for Service
Fee for Service
Managed Care
Medicaid Program
Medicare Program
Payer Mix
Revenue
DISCUSSION QUESTIONS
1. Does your organization receive revenue mainly in the form of payment after service is
delivered or payment before service is delivered?
Discussion Questions 45
2. Why do you think this is so?
3. What do you believe the proportion of revenues from different sources is for your organization?
4. Do you believe that this proportion (payer mix) will change in the future? Why?
5. What grouping of revenue do you believe your organization uses (revenue centers, care
settings, service lines, other)?
6. From your perspective, would there be a better grouping possible? If so, why do you think
it is not used?
NOTES
1. Texas Medical Association, American Medical Association, Texas Medical Foundation,
and Texas Osteopathic Medical Association, A Guide to Forming Physician-Directed Managed
Care Networks (Austin, TX: Texas Medical Association, 1994), 3.
2. Health Care Financing Administration, Health Care Financing Review: Medicare and Medicaid Statistical Supplement (Baltimore, MD: U.S. Department of Health and Human Services, 1997), 8.
3. Ibid., 9.
4. D. I. Samuels, Capitation: New Opportunities in Healthcare Delivery (Chicago: Irwin
Professional Publishing, 1996), 20–21.
5. D. E. Goldstein, Alliances: Strategies for Building Integrated Delivery Systems (Gaithersburg,
MD: Aspen Publishers, Inc., 1995), 283; and Texas Medical Association, American Medical Association, Texas Medical Foundation, and Texas Osteopathic Medical Association,
A Guide to Forming Physician-Directed Managed Care Networks (Austin, TX: Texas Medical Association, 1994), 4–6.
6. C. Horngren et al., Cost Accounting: A Managerial Emphasis, 9th ed. (Englewood Cliffs, NJ:
Prentice Hall, 1998), 116.
7. When ICD-10 is fully implemented, it is possible that the term “major diagnostic categories” (MDCs) may have to be replaced with some other universal designation. Whether
these hospitals will change the names of their service line designations to match the new
titles is unknown at this point. We do know it will take time to decide upon such a change
and then additional time to implement the change.
8. A. Sharpe and G. Jaffe, “Columbia/HCA Plans for More Big Changes in Health-Care
World,” Wall Street Journal, 28 May, 1997, A8.
46 Chapter 5 Revenues (Inflow)
Progress Notes
© LFor/Shutterstock
CHAPTER
Expenses (Outflow)
OVERVIEW
Expenses are the costs that relate to the earning of revenue.
Another way to think of expenses is as the costs of doing
business. Just as revenues represent the inflow into the organization, so do expenses represent the outflow—a stream of
expenditures flowing out of the organization. Examples of
expenses include salary expense for labor performed, payroll tax expense for taxes paid on the salary, utility expense
for electricity, and interest expense for the use of money.
In fact, expenses are expired costs—costs that have been
used up, or consumed, while carrying on business. Revenues and expenses affect the equity of the business. The
inflow of revenues increases equity, whereas the outflow of
expenses decreases equity. In nonprofit organizations, the
term is fund balance rather than equity. This is because a
nonprofit organization, by its nature, is not in business to
make a profit. Thus, it should not have equity. However, the
principle of inflow and outflow remains the same. In the
case of nonprofits, the inflow of revenues increases fund balance, and the outflow of expenses decreases fund balance.
Many managers use the terms expense and cost
interchangeably. Expense in its broadest sense includes
every expired (used up) cost that is deductible from revenue. A narrower interpretation groups expenses into categories such as operating expenses, administrative expenses,
and so on. Cost is the amount of cash expended (or property transferred, services performed, or liability incurred)
in consideration of goods or services received or to be
received. As we have already said, costs can be either
expired or unexpired. Expired costs are used up in the current period and are thus matched against current revenues.
Unexpired costs are not yet used up and will be matched
against future revenues.1
After completing this chapter,
you should be able to
1. Understand the distinction
between expense and cost.
2. Understand how
disbursements for services
represent an expense stream
(an outflow).
3. Follow how expenses are
grouped in different ways for
planning and control.
4. Recognize why cost reports
have influenced expense
formats.
47
6
CHAPTER
For example, an electric bill for $500 is recorded in the books of the clinic as an expense.
The administrator sees the $500 as the cost of electricity for that month in the clinic. And
the administrator is actually correct in seeing the $500 as a cost because it has been used up
(expired) within the month.
Confusion also exists in healthcare reporting over the term cost versus the term charges.
Charges are revenue, or inflow. Costs are expenses, or outflow. Charges add; costs take away.
Because the two are inherently different, they should never be intermingled.
DISBURSEMENTS FOR SERVICES
There are two types of disbursements for services:
1. Payment when expense is incurred. If an expense is paid for at the point where it is incurred, it does not enter the accounts payable account. In large organizations, it is relatively rare to see payments when expenses are incurred. The only place where this usually
occurs is the petty cash fund.
2. Payment after expense is incurred. In most healthcare organizations, expenses are paid
at a later time and not at the point when the expense is incurred. If this is the case, the
expense is recorded in the accounts payable account. It is cleared from accounts payable
when payment is made. One measurement of operations is “days in accounts payable,”
whereby the operating expenses for the organization are reduced to a rate per day and
compared with the amount in accounts payable.
GROUPING EXPENSES FOR PLANNING AND CONTROL
Cost Centers
A cost center is one form of a responsibility center. In a responsibility center, the manager is
responsible, as the name implies, for a particular set of activities. In the case of a cost center, a
particular unit of the organization is given responsibility for controlling costs of the operations
over which it holds authority. The medical records division is an example of a cost center. The
billing and collection office might be another example. A cost center might be a division, an
office, or an entire department, depending on how the organization is structured.
In healthcare organizations, it is common to find departments as cost centers. This is often a
logical way to designate a cost center because the lines of authority are generally organized by
department. Cost centers can then be grouped into larger groups that have something in common. Within this method of grouping, the manager of a cost center may receive his or her own
reports and figures, but not those of the entire group. The director or officer that is in charge of
all of those particular departments receives the larger report that contains multiple cost centers.
The chief executive officer receives a total report because he or she is ultimately responsible for
overseeing the operations of all of the cost centers involved in that segment of the organization.
Exhibit 6–1 illustrates this concept. It contains 20 different cost centers, all of which are revenue producing. The 20 cost centers are divided into two groups: nursing services and other
professional services. There are five cost centers in the nursing services group, ranging from
operating room to obstetrics–nursery. There are 15 cost centers in the other professional services group. In the hospital that uses the grouping shown in Exhibit 6–1, however, not all of
48 Chapter 6 Expenses (Outflow)
the 20 cost centers are departments. Some
are divisions within departments. For example, EKG and EEG operate out of the same
department but are two separate cost centers.
Exhibit 6–2 shows 11 different cost centers
that are not directly revenue producing. (The
dietary department yields some cafeteria revenue, but that revenue is not central to the
major business of the organization, which is
to provide healthcare services.) The 11 cost
centers are divided into two groups: general
services and support services. The 6 cost centers in the general services group happen to
all be departments in this hospital. (Other
hospitals might not have security as a separate department. The other cost centers—
dietary, maintenance, laundry, housekeeping,
and medical records—would be separate
departments.) The 5 cost centers in the support services group include a “general” cost
center that contains administrative costs; the
remaining 4 are related to employee salaries
and wages. These 4 are insurance, Social Security taxes, employee welfare, and pension cost
centers, all of which will probably be in the
same department. It is the prerogative of management to set up cost centers specific to the
organization’s own needs and preferences. It is
the responsibility of management to make the
cost centers match the proper lines of authority.
Exhibit 6–2 illustrates two categories of
healthcare expense: general services and support. A third related category is operations
expense. An operations expense provides service directly related to patient care. Examples are radiology expense and drug expense. A general services expense provides services necessary to maintain the patient, but the service is not
directly related to patient care. Examples are laundry and dietary. Support services expenses, on
the other hand, provide support to both general services expenses and operations expenses. A
support service expense is necessary for support, but it is neither directly related to patient care
nor is it a service necessary to maintain the patient. Examples of support services are insurance
and payroll taxes.
Diagnoses and Procedures
It is common to group expenses by diagnoses and procedures for purposes of planning and
control. This grouping is beneficial because it matches costs against common classifications
Exhibit 6–1 Nursing Services and Other
Professional Services Cost Centers
Nursing Services Cost Center
Routine Medical-Surgical $390,000
Operating Room 30,000
Intensive Care Units 40,000
OB–Nursery 15,000
Other 35,000
Total $510,000
Other Professional Services
Cost Center
Laboratory $220,000
Radiology 139,000
CT Scanner 18,000
Pharmacy 128,000
Emergency Service 89,000
Medical and Surgical Supply 168,000
Operating Rooms and
Anesthesia 142,000
Respiratory Therapy 48,000
Physical Therapy 64,000
EKG 16,000
EEG 1,000
Ambulance Service 7,000
Substance Abuse 43,000
Home Health and Hospice 120,000
Other 12,000
Total $1,215,000
Grouping Expenses for Planning and Control 49
of revenues. Much of the revenue in many
healthcare organizations is designated by
either diagnoses or procedures. One prevalent method groups costs into cost centers
by major diagnostic categories (MDCs). The
23 MDCs serve as the basic classification system for diagnosis-related groups (DRGs).
(Each DRG represents a category of patients. This category contains patients whose
resource consumption, on statistical average,
is equivalent. DRGs are part of the prospective payment reimbursement methodology.)
Exhibit 6–3 provides a listing of the 23 MDCs.2
(The number of MDCs may increase when
ICD-10 coding is fully implemented.)
How does the hospital use the MDC grouping? Exhibit 6–4 shows a departmental and
cost center grouping in actual use. This hospital uses 27 cost center codes: the 23 MDCs
plus 4 other codes (“Special Drugs,” “HIV,”
“Unassigned,” and “Outpatient”). The special
drugs and HIV cost centers represent highcost elements that management wants to track
separately. Unassigned is a default category and should have little assigned to it. Outpatient is a
separate cost center at the preference of management.
Exhibit 6–5 illustrates the grouping of costs for MDC 18 (Infectious Diseases). The hospital’s departmental code is 18, per Exhibit 6–4. The DRG classification, ranging from
415 to 423, appears in the next column. The description of the particular DRG appears in the
third column, and the related cost appears in the fourth and final column. These costs can now
be readily matched to equivalent revenues.
Outpatient services in particular are generally designated by procedure codes. Procedure
codes, known as Current Procedural Terminology (CPT) codes, are commonly used to group
cost centers for outpatient services. (CPT codes represent a listing of descriptive terms and
identifying codes for identifying medical services and procedures performed.) However,
procedures can be—and are—also used for purposes of grouping inpatient costs, generally
within a certain cost center. A hospital example of reporting radiology department costs by
procedure code appears in Table 6–1. In this example, the procedure code is in the left column, the description of the procedure is in the middle column, and the departmental cost
for the particular procedure appears in the right column. These costs can now be readily
matched to equivalent revenue.
Care Settings and Service Lines
Expenses can be grouped by care setting, which recognizes the different sites at which services are delivered. “Inpatient” versus “outpatient” is a basic type of care setting grouping. Or
expenses can be classified by service lines, a method that groups similar services.3
Exhibit 6–2 General Services and Support
Services Cost Centers
General Services Cost Center
Dietary $97,000
Maintenance 92,000
Laundry 27,000
Housekeeping 43,000
Security 5,000
Medical Records 30,000
Total $294,000
Support Services Cost Center
General $455,000
Insurance 24,000
Social Security Taxes 112,000
Employee Welfare 188,000
Pension 43,000
Total $822,000
50 Chapter 6 Expenses (Outflow)
If revenues are grouped by care setting or by
service line, as discussed in the previous chapter, then expenses should also be grouped by
these categories. In that way, matching of revenues and expenses can readily occur. A more
detailed discussion of care settings and service
lines, with examples, was presented in the preceding chapter.
Programs
A program can be defined as a project that
has its own objectives and its own program
Exhibit 6–3 Major Diagnostic Categories
MDC 1 Diseases and Disorders of the
Nervous System
MDC 2 Eye
MDC 3 Ear, Nose, Mouth, and Throat
MDC 4 Respiratory System
MDC 5 Circulatory System
MDC 6 Digestive System
MDC 7 Hepatobiliary System and
Pancreas
MDC 8 Musculoskeletal System and
Connective Tissue
MDC 9 Skin, Subcutaneous Tissue,
and Breast
MDC 10 Endocrine, Nutritional, and
Metabolic
MDC 11 Kidney and Urinary Tract
MDC 12 Male Reproductive System
MDC 13 Female Reproductive System
MDC 14 Pregnancy, Childbirth, and
the Puerperium
MDC 15 Newborns and Other
Neonates with Conditions
Originating in the Perinatal Period
MDC 16 Blood and Blood-Forming
Organs and Immunological
Disorders
MDC 17 Myeloproliferative and
Poorly and Differentiated
Neoplasms
MDC 18 Infections and Parasitic
Diseases (Systemic or
Unspecified Sites)
MDC 19 Mental Diseases and Disorders
MDC 20 Alcohol/Drug Use and Alcohol/Drug-Induced Organic
Mental Disorders
MDC 21 Injuries, Poisoning, and Toxic
Effect of Drugs
MDC 22 Burns
MDC 23 Factors Influencing Health
Status and Other Contacts
with Health Services
Exhibit 6–4 Hospital Departmental Code List
Based on Major Diagnostic Categories
1 Nervous System
2 Eye
3 Ear, Nose, Mouth, and Throat
4 Respiratory System
5 Circulatory System
6 Digestive System
7 Hepatobiliary System
8 Musculoskeletal System and
Connective Tissue
9 Skin, Subcutaneous Tissue, and Breast
10 Endocrine, Nutritional, and
Metabolic
11 Kidney and Urinary Tract
12 Male Reproductive System
13 Female Reproductive System
14 Obstetrics
15 Newborns
16 Immunology
17 Oncology
18 Infectious Diseases
19 Mental Diseases
20 Substance Use
21 Injury, Poison, and Toxin
22 Burns
23 Other Health Services
24 Special Drugs
25 HIV
26 Unassigned
59 Outpatient
Grouping Expenses for Planning and Control 51
indicators. Within management’s functions of
planning, controlling, and decision making,
the program must stand on its own. A program
is often funded separately and for finite periods
of time. For example, funds from a grant might
fund a specific project for—as an example—
three years. Often programs—especially those
funded separately from the revenue stream of
the main organization—have to arrange their
expenses in a special format that is specified by
the entity that provides the grant funds.
Program expenses should be grouped in
such a way that they are distinguishable. Also,
if such programs have been specially funded,
the reporting of their expenses should not be
commingled. An example of a program cost
center is given in Exhibit 6–6. This cost center
example has received special funds and must
be reported separately, as shown.
COST REPORTS AS INFLUENCERS
OF EXPENSE FORMATS
Cost reports are required by both the Medicare program (Title XVIII) and the Medicaid
program (Title XIX). Every provider participating in the program is required to file
an annual cost report. A selection of providers who must file cost reports is illustrated in
Table 6–2. The arrangement of expense headings on the cost reports has been primarily
consistent since the advent of such reports
Exhibit 6–5 Example of Hospital Departmental Costs Classified by Diagnoses, MDC, and DRG
Hospital Departmental Code DRG Description Cost
18 INFECTIOUS DISEASES 415 O/R—INFECT/PARASITIC DIS $4,000
18 INFECTIOUS DISEASES 416 SEPTICEMIA 17 10,000
18 INFECTIOUS DISEASES 417 SEPTICEMIA 0–17 20,000
18 INFECTIOUS DISEASES 418 POSTOP/POSTTRAUMA INFECT 2,000
18 INFECTIOUS DISEASES 419 FEVER—UKN ORIG 17W/C 3,000
18 INFECTIOUS DISEASES 420 FEVER—UKN ORIG 17W/OC 6,000
18 INFECTIOUS DISEASES 421 VIRAL ILLNESS 17 4,000
18 INFECTIOUS DISEASES 422 VIR ILL/FEVER UNK 0–17 1,000
18 INFECTIOUS DISEASES 423 OT/INFECT/PARASITIC DX 3,000
Exhibit 6–6 Program Cost Center: Southside
Homeless Intake Center
Program: Southside Homeless
Intake Center
Department: Feeding Ministry
For the Month of: January 2XXX
Raw Food $14,050
Dietary Supplies 200
Paper Supplies 300
Minor Equipment 50
Consultant Dietitian 50
Utilities 300
Telephone 50
Program Total $15,000
Table 6–1 Example of Radiology Department
Costs Classified by Procedure Code
Procedure
Code
Procedure
Description
Department
Cost
557210 Ribs, Unilateral $ 60,000
557230 Spine Cervical Routine 125,000
557280 Pelvis 33,000
557320 Limb—Shoulder 55,000
557360 Limb—Wrist 69,000
557400 Limb—Hip, Unilateral 42,000
557410 Limb—Hip, Bilateral 14,000
557430 Limb—Knee Only 62,000
Total $460,000
52 Chapter 6 Expenses (Outflow)
in 1966. Therefore, this standard and traditional arrangement has strongly influenced the arrangement of expenses in many healthcare information systems.
The cost report uses a method of cost finding. Its focus is what is called a cost center. The
concept is not the same as the type of responsibility center “cost center” that has been discussed earlier in this chapter. Instead, the cost-finding “cost center” is, broadly speaking, a
type of cost pool used in the cost-finding process. The primary purpose of the cost pool/cost
center in cost finding is to assist in allocating overhead.
The central worksheets for cost finding are Worksheet A, Worksheet B, and Worksheet B-1.
Worksheet A contains the basic trial balance of all expenses for the facility. (Trial balances are
discussed in a preceding chapter.) The beginning trial balance is reflected in the first three
columns:
[Column 1] [Column 2] [Column 3]
“Salaries” 1 “Other” 5 “Total”
(all other expenses)
The trial balance is grouped at the outset into cost center categories. The placement of these
categories and their respective line items on the page stay constant throughout the flow of
Worksheets A, B, and B-1. The cost centers are grouped into seven categories:
1. General service
2. Inpatient routine service
3. Ancillary service
4. Outpatient service
5. Other reimbursable
6. Special purpose
7. Nonreimbursable
The line items within these seven categories represent the long-lived traditional arrangement that has strongly influenced the arrangement of expenses in so many healthcare information systems.
INFORMATION CHECKPOINT
What is needed? A report that shows expense in your organization.
Where is it found? With your supervisor.
How is it used? Examine the report to find various types of expenses; look for
how the expense flow is handled on the report.
Table 6–2 Selected Cost Report Forms
Type Form
Hospital and Hospital Healthcare Complex CMS 2552-10
Skilled Nursing Facility and Skilled Nursing Facility Complex CMS 2540-10
Home Health Agencies CMS 1728-94
Cost Reports as Influencers of Expense Formats 53
What is needed? A report that groups expenses by some type of classification.
Where is it found? With your supervisor or in the information services division.
How is it used? Examine the report to discover the methods that are used for
grouping. You will probably find that these groupings are
used for performance measures. They can also be used for
control and planning.
KEY TERMS
Cost
Diagnoses
Expenses
Expired Costs
General Services Expenses
Support Services Expenses
Operations Expenses
Procedures
Unexpired Costs
DISCUSSION QUESTIONS
1. Have you worked with cost centers in your duties? If so, how have you been exposed to
them?
2. Have you had to manage from a cost center type of report? If so, how was it categorized?
3. Do you believe that grouping expenses by diagnoses and procedures (based on type of
services provided) is better to use for control and planning than grouping expenses by
care setting (based on location of service provided)?
4. If so, why?
5. What grouping of expenses do you believe your organization uses (traditional cost centers, diagnoses/procedures, care settings, other)?
6. From your perspective, would there be a better grouping possible? If so, why do you think
it is not used?
NOTES
1. S. A. Finkler, Essentials of Cost Accounting for Health Care Organizations, 2nd ed. (Gaithersburg,
MD: Aspen Publishers, Inc., 1999).
2. At the time of this writing, 23 major diagnostic categories (MDCs) serve as the basic classification system for diagnosis-related groups (DRGs). When ICD-10 is fully implemented, it is
probable that the number of MDCs will be increased. It is also possible that the terminology
itself (MDCs) may be changed to some other designation.
3. G. F. Longshore, “Service-line Management/Bottom-line Management for Health Care,” Journal of Health Care Finance, 24, no. 4 (1998): 72–79.
54 Chapter 6 Expenses (Outflow)
Progress Notes
© LFor/Shutterstock
CHAPTER
Cost Classifications
DISTINCTION BETWEEN DIRECT
AND INDIRECT COSTS
Direct costs can be specifically associated with a particular
unit or department or patient. The critical distinction for
the manager is that the cost is directly attributable. Whatever the manager is responsible for—that is, the unit, the
department, or the patient—is known as a cost object.
The somewhat vague definition of a cost object is any
unit for which a separate cost measurement is desired. It
might help the manager to think of a cost object as a cost
objective instead.1 The important thing is that direct costs
can be traced. Indirect costs, on the other hand, cannot
be specifically associated with a particular cost object. The
controller’s office is an example of indirect cost. The controller’s office is essential to the overall organization itself,
but its cost is not specifically or directly associated with providing healthcare services. The critical distinction for the
manager is that indirect costs usually cannot be traced, but
instead must be allocated or apportioned in some manner.2
Figure 7–1 illustrates the direct–indirect cost distinction.
To summarize, it is helpful to recognize that direct costs
are incurred for the sole benefit of a particular operating
unit—a department, for example. As a rule of thumb, if the
answer to the following question is “yes,” then the cost is a
direct cost: “If the operating unit (such as a department)
did not exist, would this cost not be in existence?”
Indirect costs, in contrast, are incurred for the overall operation and not for any one unit. Because they are
shared, indirect costs are sometimes called joint costs or
common costs. As a rule of thumb, if the answer to the following question is “yes,” then the cost is an indirect cost:
“Must this cost be allocated in order to be assigned to the
unit (such as a department)?”
After completing this chapter,
you should be able to
1. Distinguish between direct
and indirect costs.
2. Understand why the
difference is important to
management.
3. Understand the composition
and purpose of responsibility
centers.
4. Distinguish between product
and period costs.
55
7
CHAPTER
EXAMPLES OF DIRECT COST
AND INDIRECT COST
It is important for managers to recognize
direct and indirect costs and how they are
treated on reports. Two sets of examples
illustrate the reporting of direct and indirect
costs. The first example concerns a rehab cost
center; the second concerns an ambulance
service center.
Table 7–1 represents a report of both direct
cost and indirect cost for a rehab cost center.
The report concerns three types of therapy—
physical, occupational, and speech therapy—
and a total. In this report, the manager
can observe the proportionate differences
between direct and indirect costs and can also
see the differences among the three types of
therapies.
Greater detail is provided to the manager in Table 7–2, which presents the method of allocating indirect costs and the result of such allocation. Managers should notice that the “Total
Indirect Costs” in Table 7–2 carry forward and become the “Indirect Costs” in Table 7–1. Thus,
this report showing allocation of indirect costs is considered a subsidiary report because it is
supporting, or subsidiary to, the preceding main report. This use of one or more supporting reports to reveal details behind the main report is quite common in managerial reports.
The allocation of indirect costs subsidiary report contains quite a lot of information. It shows
what particular expenses (clerical salaries, administrative salaries, computer services) are contained in the $185,000 total. It also shows how each of these expenses are allocated across the
three separate types of therapy. And the report also shows how each item was allocated; see the
Allocation Key containing codes A, B, and C. The basis for allocation is presented in the Key
(A 5 number of visits; B 5 proportion of direct costs, by percentage; C 5 number of computers
in service) and the computation detail by therapy type is also noted. This set of tables is worthy
of further study by the manager.
Figure 7–1 Assigning Costs to the Cost Object.
Cost Object
Are
Allocated
to
Are
Traced
to
Direct
Costs
Indirect
Costs
56 Chapter 7 Cost Classifications
Table 7–1 Examples of Rehab Cost Center Direct and Indirect Cost Totals
Rehab Cost Centers Direct Cost Indirect Cost Total
Physical Therapy (PT) $410,000 $107,500 $517,500
Occupational Therapy (OT) 190,000 44,000 234,000
Speech Therapy (ST) 120,000 33,500 153,500
Total $720,000 $185,000 $905,000
Note: Direct Cost proportions, rounded, are as follows:
PT = 57%/OT = 26%/ST = 17%/Total = 100%
Courtesy of J. J. Baker and R. W. Baker, Dallas, Texas.
Exhibit 7–1 sets out the direct costs for an ambulance service center. These costs, as direct
costs, are what the organization’s managers believe can be traced to the specific operation of the
freestanding center. Exhibit 7–2 sets out the indirect costs for a freestanding ambulance service
center. These costs are what the organization’s
managers believe are not directly attributable
to the specific operation of the freestanding
center. The decisions about what will and what
will not be considered direct or indirect costs
will almost always have been made for the
manager.3 What is important is that the manager understand two things: first, why this is
so, and second, how the relationship between
the two works. Remember the rule of thumb
discussed earlier in this chapter. If the answer
to the following question is “yes,” then the cost
is a direct cost: “If the operating unit (such as
a department) did not exist, would this cost
not be in existence?”
RESPONSIBILITY CENTERS
We previously discussed revenue centers,
whereby managers are responsible for generating revenue (or volume). We also previously
discussed cost centers, whereby managers are
Exhibit 7–1 Example of Ambulance Direct
Costs
Ambulance salaries & benefits $32,500
RN salaries & benefits 9,600
Vehicle expense 21,300
Supplies 5,000
Uniforms 1,200
Employee education 3,900
Purchased services 1,900
Purchased maintenance 2,600
Utilities & telephone 5,000
Vehicle depreciation 15,000
Miscellaneous expense 2,000
Total direct costs $100,000
Exhibit 7–2 Example of Ambulance Indirect
Costs
Administrative costs $12,000
Facility costs 8,000
Total indirect costs $20,000
Responsibility Centers 57
Table 7–2 Example of Indirect Costs Allocated to Rehab Cost Center
Clerical
Salaries
Administrative
Salaries
Computer
Services
Total Indirect
Cost
Allocation Basis: A B C
Indirect Cost to Be Allocated $60,000 $50,000 $75,000 $185,000
Allocated to:
Physical Therapy (PT) 34,000 28,500 45,000 107,500
Occupational Therapy (OT) 16,000 13,000 15,000 44,000
Speech Therapy (ST) 10,000 8,500 15,000 33,500
Proof Total $60,000 $50,000 $75,000 $185,000
Allocation Key:
A = # Visits (Volume): PT = 8500/OT = 4000/ST = 2500/Total = 15,000 (15,000 x $4.00 = $60,000)
B = Proportion of Direct Costs: PT = 57%/OT = 26%/ST = 17%/Total = 100% (% x $50,000)
C = # Computers in Service: PT = 9/OT = 3/ST = 3/Total = 15 (15 x $5,000 each = $75,000)
Courtesy of J. J. Baker and R. W. Baker, Dallas, Texas.
responsible for managing and controlling cost. The responsibility center (R/C) makes a manager responsible for both the revenue/volume (inflow) side and the expense (outflow) side of a
department, division, unit, or program. In other words, the manager is responsible for generating
revenue/volume and for controlling costs. Another term for responsibility center is profit center.
We will examine the type of information a manager receives about his or her own
responsibility center by reviewing the Westside Center operations. Westside Center offers two
basic types of services: an ambulatory surgery center (ASC) and a rehabilitation center. The
management of Westside is overseen by Bill, the director. Joe manages the ambulatory surgery
center. Bonnie manages the rehabilitation center. Denise, a part-time radiologist, provides radiology services on an as-needed basis. Joe, Bonnie, and Denise, the managers, all report to Bill,
the director. Figure 7–2 illustrates the managerial relationships.
To restate the relationships shown in Figure 7–2, Joe manages a responsibility center for
ambulatory surgery services. Bonnie manages a responsibility center for rehabilitation services.
These services represent the business of Westside Center. Denise manages the radiology services, but this is not a responsibility center in the Westside organization. Instead, it is a support
center. Bill, the director, manages a bigger responsibility center that includes all of the functions just described, plus the general and administrative support center.
Bill, the director, receives a managerial
report, shown in Exhibit 7–3. Bill’s “Director’s
Summary” contains the data for the entire
Westside operation.
Figure 7–3 illustrates the reports received
by each manager at Westside. Joe’s report
for the ambulatory surgery center is at the
top right of Figure 7–3. His report shows the
controllable revenues he is responsible for
($225,000), less the controllable expenses he
is responsible for ($155,000). The difference
is labeled “ASC Responsibility Center Surplus”
on his report. The surplus amounts to $70,000
($225,000 minus $155,000).
Exhibit 7–3 Director’s Summary of Westside
ASC and Rehab Responsibility Center
ASC R/C Surplus $70,000.00
Rehab R/C Surplus 85,000.00
Less G&A Support Ctr (80,000.00)
Less Radiology Support Ctr (20,000.00)
Net Surplus $55,000.00
Courtesy of Resource Group, Ltd., Dallas,
Texas.
Figure 7–2 Lines of Managerial Responsibility at Westside Center.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Westside
Center
Director
Westside
Ambulatory
Surgery Center
Responsibility
Center
Manager
General &
Administrative
Support Center
Radiology
Support Center
Manager
Westside
Rehab Center
Responsibility
Center
Manager
58 Chapter 7 Cost Classifications
Bonnie’s report for the rehabilitation center is the second report on the right of Figure 7–3.
Her report shows the controllable revenues she is responsible for ($300,000), less the controllable expenses she is responsible for ($215,000). The difference is labeled “Rehab Responsibility Center Surplus” on her report. The surplus amounts to $85,000 ($300,000 minus $215,000).
Figure 7–3 Westside Costs by Responsibility Center.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Director’s Summary of
Westside ASC & Rehab Center
ASC R/C Surplus $70,000.00
Rehab R/C Surplus 85,000.00
Less G&A Support Ctr (80,000.00)
Less Radiology Support Ctr (20,000.00)
Net Surplus $55,000.00
Westside ASC
Responsibility Center
Therapy Manager
Controllable revenues:
Patient fees $300,000.00
Controllable expenses:
Wages 120,000.00
Payroll taxes, other fringes 30,000.00
Billable supplies 50,000.00
Medical supplies 10,000.00
Continuing education 3,000.00
Licenses and permits 2,000.00
Total expenses 215,000.00
Rehab R/C surplus $85,000.00
Westside ASC
Responsibility Center
Medical/Surgical Manager
Controllable revenues:
Patient fees $225,000.00
Controllable expenses:
Wages 100,000.00
Payroll taxes, other fringes 25,000.00
Billable supplies 20,000.00
Medical supplies 10,000.00
Total expenses 155,000.00
ASC R/C surplus $70,000.00
General & Administrative
Support Center
Salaries $40,000.00
Payroll taxes, other fringes 10,000.00
Office supplies 1,200.00
Telephone 2,400.00
Rent 10,800.00
Utilities 4,800.00
Insurance 1,200.00
Depreciation 9,600.00
Total expenses $80,000.00
Radiology Support Center
Radiology Manager
Salaries $12,000.00
Payroll taxes, other fringes 3,000.00
Radiology supplies 5,000.00
Total expenses $20,000.00
Responsibility Centers 59
Denise’s report for radiology services is at the bottom right of Figure 7–3. Her report shows
the controllable expenses she is responsible for, which amount to $20,000. Her report shows
only expenses because it is a support center, not a responsibility center. Therefore, Denise is
responsible for expenses but not for revenue/volume.
Bill, the director, receives a report for the general and administrative (G&A) expenses, as
shown second from the bottom on the right of Figure 7–3. This report shows the G&A controllable expenses that Bill himself is responsible for at Westside, which amount to $80,000. The
G&A report shows only expenses because it also is a support center, not a responsibility center.
Therefore, Bill is responsible for expenses but not for revenue/volume in the case of G&A.
However, Bill is also responsible for the entire Westside operation. That is, the overall Westside operation is his responsibility center. Therefore, Bill’s director’s summary, reproduced on
the left side of Figure 7–3, contains the results of both responsibility centers and both support centers. The surplus figures from Joe and Bonnie’s reports are positive figures of $70,000
and $85,000, respectively. The expense-only figures from Bill’s G&A support center report and
from Denise’s radiology support center report are negative figures of $80,000 and $20,000,
respectively. Therefore, to find the result of operations for Bill’s entire Westside operation, the
$80,000 and the $20,000 expense figures are subtracted from the surplus figures to arrive at a
net surplus for Westside of $55,000.
Although the lines of managerial responsibility will vary in other organizations, the relationships between and among responsibility centers, support centers, and overall supervision will
remain as shown in this example.
DISTINCTION BETWEEN PRODUCT AND PERIOD COSTS
Product costs is a term that was originally associated with manufacturing rather than with services.
The concept of product costs assumes that a product has been manufactured and placed into
inventory while waiting to be sold. Then, whenever that product is sold, the product is matched with
revenue and recognized as a cost. Thus, cost of sales is the common usage for manufacturing firms.
(The concept of matching revenues and expenses has been discussed in a preceding chapter.)
Period costs, in the original manufacturing interpretation, are not connected with the manufacturing process. They are matched with revenue on the basis of the period during which the
cost is incurred (thus period costs). The term comes from the span of time in which matching
occurs, known as time period.
Service organizations have no manufacturing process as such. The business of healthcare service organizations is service delivery, not the manufacturing of products. Although the overall
concept of product versus period cost is not as vital to service delivery, the distinction remains
important for managers in health care to know.
In healthcare organizations, product cost can be viewed as traceable to the cost object of the
department, division, or unit. A period cost is not traceable in this manner. Another way to view
this distinction is to think of product costs as those costs necessary to actually deliver the service,
whereas period costs are costs necessary to support the existence of the organization itself.
Finally, medical supply and pharmacy departments do have inventories on hand. In their case,
a product is purchased (rather than manufactured) and placed into inventory while waiting to
be dispensed. Then, whenever that product is dispensed, the product is matched with revenue
and recognized as a cost of providing the service to the patient. Therefore, the product cost
concept is important to managers of departments that hold a significant amount of inventory.
60 Chapter 7 Cost Classifications
INFORMATION CHECKPOINT
What is needed? Example of a management report that uses direct/indirect cost.
Where is it found? With your supervisor, in administration, or in information services.
How is it used? To track operations directly associated with the unit.
What is needed? Example of a management report that uses responsibility centers.
Where is it found? With your supervisor, in administration, or in information services.
How is it used? To reflect operations that a manager is specifically responsible for
and to measure those operations for planning and control.
KEY TERMS
Cost Object
Direct Cost
Indirect Cost
Joint Cost
Responsibility Centers
DISCUSSION QUESTIONS
1. In your own workplace, can you give a good example of a direct cost? An indirect cost?
2. What is the difference?
3. Does your organization use responsibility centers?
4. If not, do you think they should? Why?
5. If so, do you believe the responsibility centers operate properly? Would you make
changes? Why?
NOTES
1. C. Horngren et al., Cost Accounting: A Managerial Emphasis, 9th ed. (Englewood Cliffs, NJ:
Prentice Hall, 1998), 70.
2. J. J. Baker, Activity-Based Costing and Activity-Based Management for Health Care (Gaithersburg,
MD: Aspen Publishers, Inc., 1998).
3. D. A. West, T. D. West, and P. J. Malone, “Managing Capital and Administrative (indirect)
Costs to Achieve Strategic Objectives: The Dialysis Clinic versus the Outpatient Clinic,” Journal of Health Care Finance, 25, no. 2 (1998): 20–24.
Notes 61

PART
© LFor/Shutterstock
Tools to Analyze
and Understand
Financial
Operations
III

Progress Notes
© LFor/Shutterstock
CHAPTER
65
8
CHAPTER
DISTINCTIONS AMONG FIXED, VARIABLE,
AND SEMIVARIABLE COSTS
This chapter emphasizes the distinctions among fixed,
variable, and semivariable costs because this knowledge is
a basic working tool in financial management. The manager needs to know the difference between fixed and variable costs to compute contribution margins and break-even
points. The manager also needs to know about semivariable
costs to make good decisions about how to treat these costs.
Fixed costs are costs that do not vary in total when activity levels (or volume) of operations change. This concept is
illustrated in Figure 8–1. The horizontal axis of the graph
shows number of residents in the Jones Group Home, and
the vertical axis shows total monthly fixed cost in dollars. In
this graph, the total monthly fixed cost for the group home
is $3,000, and that amount does not change, whether the
number of residents (the activity level or volume) is low or
high. A good example of a fixed cost is rent expense. Rent
would not vary whether the home was almost full or almost
empty; thus, rent is a fixed cost.
Variable costs, on the other hand, are costs that vary in
direct proportion to changes in activity levels (or volume)
of operations. This concept is illustrated in Figure 8–2. The
horizontal axis of the graph shows number of residents in
the Jones Group Home, and the vertical axis shows total
monthly variable cost in dollars. In this graph, the monthly
variable cost for the group home changes proportionately
with the number of residents (the activity level or volume)
in the home. A good example of a variable cost is food
for the group home residents. Food would vary directly,
depending on the number of individuals in residence; thus,
food is a variable cost.
After completing this chapter,
you should be able to
1. Understand the distinctions
among fixed, variable, and
semivariable costs.
2. Be able to analyze mixed
costs by two methods.
3. Understand the computation
of a contribution margin.
4. Be able to compute the costvolume-profit (CVP) ratio.
5. Be able to compute the
profit-volume (PV) ratio.
Cost Behavior
and Break-Even
Analysis
Semivariable costs vary when the activity levels (or volume) of operations change, but not in
direct proportion. The most frequent pattern of semivariable costs is the step pattern, where
the semivariable cost rises, flattens out for a bit, and then rises again. The step pattern of semivariable costs is illustrated in Figure 8–3. The horizontal axis of the graph shows number of
residents in the Jones Group Home, and the vertical axis shows total monthly semivariable cost.
In this graph, the behavior of the cost line resembles stair steps: thus, the “step pattern” name
for this configuration. The most common example of a semivariable expense in health care is
supervisors’ salaries. A single supervisor, for example, can perform adequately over a range of
rises in activity levels (or volume). When another supervisor has to be added, the rise in the step
pattern occurs.
It is important to know, however, that there are two ways to think about fixed cost. The usual
view is the flat line illustrated on the graph in Figure 8–1. That flat line represents total monthly
cost for the group home. However, another perception is presented in Figure 8–4. The top view
of fixed costs in Figure 8–4 is the usual flat line just discussed. The bottom view is fixed cost per
resident. Think about the figure for a moment: the top view is dollars in total for the home for
Figure 8–1 Fixed Costs—Jones Group Home.
0
$1,000
$2,000
$3,000
$4,000
$5,000
0 10 20 30 40 50 60
Number of Residents
Total Monthly Fixed Cost
Figure 8–2 Variable Cost—Jones Group Home.
0
$1,000
$2,000
$3,000
$4,000
0 10 20 30 40 50 60
Number of Residents
Total Monthly Variable Cost
66 Chapter 8 Cost Behavior and Break-Even Analysis
Figure 8–3 Semivariable Cost—Jones Group Home.
0
$3,000
$6,000
$9,000
$12,000
0 10 20 30 40 50 60
Number of Residents
Total Semivariable Cost
Figure 8–4 Two Views of Fixed Costs.
0
$100
$200
$300
$400
0 10 20 30 40 50 60
Number of Residents
Fixed Cost per Resident
Fixed Cost per Resident
0
$1,000
$2,000
$3,000
$4,000
$5,000
0 10 20 30 40 50 60
Number of Residents
Total Monthly Fixed Cost
Total Monthly Fixed Cost
Distinctions Among Fixed, Variable, and Semivariable Costs 67
the month, and the bottom view is fixed-cost dollars by number of residents. The line is no longer flat but declines because this view of cost declines with each additional resident.
We can also think about variable cost in two ways. The usual view of variable cost is the diagonal line rising from the bottom of the graph to the top, as illustrated in Figure 8–2. That steep
diagonal line represents monthly cost varying in direct proportion with number of residents
in the home. However, another perception is presented in Figure 8–5. The top view of variable
costs in Figure 8–5 represents total monthly variable cost and is the usual diagonal line just
discussed. The bottom view is variable cost per resident. Think about this figure for a moment:
the top view is dollars in total for the home for the month, and the bottom view is variable-cost
dollars by number of residents. The line is no longer diagonal but is now flat because this view
of variable cost stays the same proportionately for each resident. A good way to think about
Figures 8–4 and 8–5 is to realize that they are close to being mirror images of each other.
Semifixed costs are sometimes used in healthcare organizations, especially in regard to
staffing. Semifixed costs are the reverse of semivariable costs: that is, they stay fixed for a
time as activity levels (or volume) of operations change, but then they will rise; then they will
plateau; then they will rise. Thus, semifixed costs can exhibit a step pattern similar to that of
variable costs.1 However, the semifixed cost “steps” tend to be longer between rises in cost. In
Figure 8–5 Two Views of Variable Costs.
0 10 20 30 40 50 60
Number of Residents
Variable Cost per Resident
Variable Cost per Resident
0
$10,000
$20,000
$30,000
$40,000
0 10 20 30 40 50 60
Number of Residents
Total Monthly Variable Cost
Total Monthly Variable Cost
0
$200
$400
$600
$800
68 Chapter 8 Cost Behavior and Break-Even Analysis
summary, both semifixed and semivariable costs have mixed elements of fixed and variable
costs. Thus, both semivariable and semifixed costs are called mixed costs.
EXAMPLES OF VARIABLE AND FIXED COSTS
Studying examples of expenses that are designated as variable and fixed helps to understand the differences between them. It should also be mentioned that some expenses
can be variable to one organization and fixed to another because they are handled differently
by the two organizations. Operating room fixed and variable costs are illustrated in Table 8–1.
Examples of Variable and Fixed Costs 69
Table 8–1 Operating Room Fixed and Variable Costs
Account Total Variable Fixed Equipment
Social Security $ 60,517 $ 60,517 $ $
Pension 20,675 20,675
Health Insurance 8,422 8,422
Child Care 4,564 4,564
Patient Accounting 155,356 155,356
Admitting 110,254 110,254
Medical Records 91,718 91,718
Dietary 27,526 27,526
Medical Waste 2,377 2,377
Sterile Procedures 78,720 78,720
Laundry 40,693 40,693
Depreciation—Equipment 87,378 87,378
Depreciation—Building 41,377 41,377
Amortization—Interest (5,819) (5,819)
Insurance 4,216 4,216
Administration 57,966 57,966
Medical Staff 1,722 1,722
Community Relations 49,813 49,813
Materials Management 64,573 64,573
Human Resources 31,066 31,066
Nursing Administration 82,471 82,471
Data Processing 17,815 17,815
Fiscal 17,700 17,700
Telephone 2,839 2,839
Utilities 26,406 26,406
Plant 77,597 77,597
Environmental Services 32,874 32,874
Safety 2,016 2,016
Quality Management 10,016 10,016
Medical Staff 9,444 9,444
Continuous Quality Improvement 4,895 4,895
EE Health 569 569
Total Allocated $1,217,756 $600,822 $529,556 $87,378
Reproduced with the permission of Wolters Kluwer Law & Business from J.J. Baker, Activity-Based Costing and Activity-Based Management for Health Care, p. 191, © 1998, Aspen Publishers, Inc.
Thirty-two expense accounts are listed in
Table 8–1: 11 are variable, 20 are designated
as fixed by this hospital, and 1, equipment
depreciation, is listed separately.2 (The separate listing is because of the way this hospital’s accounting system handles equipment
depreciation.)
Another example of semivariable and
fixed staffing is presented in Table 8–2. The
costs are expressed as full-time equivalent
staff (FTEs). Each line-item FTE will be multiplied times the appropriate wage or salary
to obtain the semivariable and fixed costs
for the operating room. (The further use of FTEs for staffing purposes is fully discussed
in the chapter on staffing.) The supervisor position is fixed, which indicates that this is the
minimum staffing that can be allowed. The single aide/orderly and the clerical position are
also indicated as fixed. All the other positions—technicians, RNs, and LPNs—are listed as
semivariable, which indicates that they are probably used in the semivariable step pattern
that has been previously discussed in this chapter. This table is a good example of how to
show clearly which costs will be designated as semivariable and which costs will be designated
as fixed.
Another example illustrates the behavior of a single variable cost in a doctor’s office. In Table 8–3,
we see an array of costs for the procedure code 99214 office visit type. Nine costs are listed. The
first cost is variable and is discussed momentarily. The other eight costs are all shown at the
same level for a 99214 office visit: supplies, for example, is the same amount in all four columns.
The single figure that varies is the top line, which is “report of lab tests,” meaning laboratory
reports. This cost directly varies with the proportion of activity or volume, as variable cost has
been defined. Here we see a variable cost at work: the first column on the left has no lab report,
and the cost is zero; the second column has one lab report, and the cost is $3.82; the third column has two lab reports, and the cost is $7.64; and the fourth column has three lab reports, and
70 Chapter 8 Cost Behavior and Break-Even Analysis
Table 8–2 Operating Room Semivariable and
Fixed Staffing
Job Positions
Total No.
of FTEs Semivariable Fixed
Supervisor 2.2 2.2
Techs 3.0 3.0
RNs 7.7 7.7
LPNs 1.2 1.2
Aides, orderlies 1.0 1.0
Clerical 1.2 1.2
Totals 16.3 11.9 4.4
Table 8–3 Office Visit with Variable Cost of Tests
99214 99214 99214 99214
Service Code No Test 1 Test 2 Tests 3 Tests
Report of lab tests $0.00 $3.82 $7.64 $11.46
Fixed overhead $31.00 $31.00 $31.00 $31.00
Physician 11.36 11.36 11.36 11.36
Medical assistant 1.43 1.43 1.43 1.43
Bill 0.45 0.45 0.45 0.45
Checkout 1.00 1.00 1.00 1.00
Receptionist 1.28 1.28 1.28 1.28
Collection 0.91 0.91 0.91 0.91
Supplies 0.31 0.31 0.31 0.31
Total visit cost $47.74 $51.56 $55.38 $59.20
the cost is $11.46. The total cost rises by the same proportionate increase as the increase in the
first line.
ANALYZING MIXED COSTS
It is important for planning purposes for the manager to know how to deal with mixed costs
because they occur so often. For example, telephone, maintenance, repairs, and utilities are
all actually mixed costs. The fixed portion of the cost is that portion representing having the
service (such as telephone) ready to use, and the variable portion of the cost represents a
portion of the charge for actual consumption of the service. We briefly discuss two very simple
methods of analyzing mixed costs, then we examine the high–low method and the scatter
graph method.
Predominant Characteristics and Step Methods
Both the predominant characteristics and the step method of analyzing mixed costs are quite
simple. In the predominant characteristic method, the manager judges whether the cost is
more fixed or more variable and acts on that judgment. In the step method, the manager examines the “steps” in the step pattern of mixed cost and decides whether the cost appears to be
more fixed or more variable. Both methods are subjective.
High–Low Method
As the name implies, the high–low method of analyzing mixed costs requires that the cost be
examined at its high level and at its low level. To compute the amount of variable cost involved,
the difference in cost between high and low levels is obtained and is divided by the amount of
change in the activity (or volume). Two examples are examined.
The first example is for an employee cafeteria. Table 8–4 contains the basic data required for
the high–low computation. With the formula described in the preceding paragraph, the following steps are performed:
1. Find the highest volume of 45,000 meals at a cost of $165,000 in September (see Table
8–4) and the lowest volume of 20,000 meals at a cost of $95,000 in March.
2. Compute the variable rate per meal:
No. of Cafeteria
Meals Cost
Highest volume 45,000 $165,000
Lowest volume 20,000 95,000
Difference 25,000 70,000
3. Divide the difference in cost ($70,000) by the difference in number of meals (25,000) to
arrive at the variable cost rate:
$70,000 divided by 25,000 meals 5 $2.80 per meal
Analyzing Mixed Costs 71
4. Compute the fixed overhead rate as
follows:
a. At the highest level:
Total cost $165,000
Less: variable portion
[45,000 meals 3 $2.80 @] (126,000)
Fixed portion of cost $ 39,000
b. At the lowest level
Total cost $ 95,000
Less: variable portion
[20,000 meals 3 $2.80 @] (56,000)
Fixed portion of cost $ 39,000
c. Proof totals: $39,000 fixed portion at
both levels
The manager should recognize that large
or small dollar amounts can be adapted to
this method. A second example concerns
drug samples and their cost. In this example,
a supervisor of marketing is concerned about
the number of drug samples used by the various members of the marketing staff. She uses the
high–low method to determine the portion of fixed cost. Table 8–5 contains the basic data
required for the high–low computation. Using the formula previously described, the following
steps are performed:
1. Find the highest volume of 1,000 samples at a cost of $5,000 (see Table 8–5) and the lowest volume of 750 samples at a cost of $4,200.
2. Compute the variable rate per sample:
No. of
Samples Cost
Highest volume 1,000 $5,000
Lowest volume 750 4,200
Difference 250 $ 800
3. Divide the difference in cost ($800) by the
difference in number of samples (250) to
arrive at the variable cost rate:
$800 divided by 250 samples 5
$3.20 per sample
4. Compute the fixed overhead rate as follows:
a. At the highest level:
Total cost $5,000
Less: variable portion
[1,000 samples 3 $3.20 @] (3,200)
Fixed portion of cost $1,800
72 Chapter 8 Cost Behavior and Break-Even Analysis
Table 8–4 Employee Cafeteria Number of Meals
and Cost by Month
Month
No. of
Meals
Employee
Cafeteria Cost
($)
July 40,000 164,000
August 43,000 167,000
September 45,000 165,000
October 41,000 162,000
November 37,000 164,000
December 33,000 146,000
January 28,000 123,000
February 22,000 91,800
March 20,000 95,000
April 25,000 106,800
May 30,000 130,200
June 35,000 153,000
Table 8–5 Number of Drug Samples and Cost for
November
Rep. No. of Samples Cost ($)
J. Smith 1,000 5,000
A. Jones 900 4,300
B. Baker 850 4,600
G. Black 975 4,500
T. Potter 875 4,750
D. Conner 750 4,200
b. At the lowest level
Total cost $4,200
Less: variable portion
[750 samples 3 $3.20 @] (2,400)
Fixed portion of cost $1,800
c. Proof totals: $1,800 fixed portion at both levels
The high–low method is an approximation that is based on the relationship between the
highest and the lowest levels, and the computation assumes a straight-line relationship. The
advantage of this method is its convenience in the computation method.
CONTRIBUTION MARGIN, COST-VOLUME-PROFIT, AND PROFIT-VOLUME
RATIOS
The manager should know how to analyze the relationship of cost, volume, and profit. This
important information assists the manager in properly understanding and controlling operations. The first step in such analysis is the computation of the contribution margin.
Contribution Margin
The contribution margin is calculated in this way:
% of Revenue
Revenues (net) $500,000 100%
Less: variable cost (350,000) 70%
Contribution margin $150,000 30%
Less: fixed cost (120,000)
Operating income $30,000
The contribution margin of $150,000 or 30%, in this example, represents variable cost
deducted from net revenues. The answer represents the contribution margin, so called because
it contributes to fixed costs and to profits.
The importance of dividing costs into fixed and variable becomes apparent now, for a contribution margin computation demands either fixed or variable cost classifications; no mixed
costs are recognized in this calculation.
Cost-Volume-Profit (CVP) Ratio or Break Even
The break-even point is the point when the contribution margin (i.e., net revenues less variable costs) equals the fixed costs. When operations exceed this break-even point, an excess of
revenues over expenses (income) is realized. But if operations does not reach the break-even
point, there will be an excess of expenses over revenues, and a loss will be realized.
The manager must recognize there are two ways of expressing the break-even point: either by
an amount per unit or as a percentage of net revenues. If the contribution margin is expressed
as a percentage of net revenues, it is often called the profit-volume (PV) ratio. A PV ratio example follows this cost-volume-profit (CVP) computation.
Contribution Margin, Cost-Volume-Profit, and Profit-Volume Ratios 73
The CVP example is given in Figure 8–6. The data points for the chart come from the contribution margin as already computed:
% of Revenue
Revenues (net) $500,000 100%
Less: variable cost (350,000) 70%
Contribution margin $150,000 30%
Less: fixed cost (120,000)
Operating income $30,000
Three lines were first drawn to create the chart. They were total fixed costs of $120,000,
total revenue of $500,000, and variable costs of $350,000. (All three are labeled on the chart.)
The break-even point appears at the point where the total cost line intersects the revenue line.
Because this point is indeed the break-even point, the organization will have no profit and no
loss but will break even. The wedge shape to the left of the break-even point is potential net
loss, whereas the narrower wedge to the right is potential net income (both are labeled on the
chart).
CVP charts allow a visual illustration of the relationships that is very effective for the manager.
Profit-Volume (PV) Ratio
Remember that the second method of expressing the break-even point is as a percentage of net
revenues and that if the contribution margin is expressed as a percentage of net revenues, it
Figure 8–6 Cost-Volume-Profit (CVP) Chart for a Wellness Clinic.
Courtesy of Resource Group, Ltd., Dallas, Texas.
0
$100
$200
$300
$400
$500
0 1000 2000 3000 4000 5000
Variable Cost
Line
Fixed Cost
Line
Break-Even
Point
Revenue
Line
Net
Operating
Income
Net
Loss
Fixed Costs Variable Costs
Number of Visits
Revenue (in thousands of dollars)
74 Chapter 8 Cost Behavior and Break-Even Analysis
is called the profit-volume (PV) ratio. Figure 8–7 illustrates the method. The basic data points
used for the chart were as follows:
Revenue per visit $100.00 100%
Less variable cost per visit (70.00) 70%
Contribution margin per visit $ 30.00 30%
Fixed costs per period $120,000
$30.00 contribution margin per visit divided by $100 price per visit 5 30% PV Ratio
Figure 8–7 Profit-Volume (PV) Chart for a Wellness Clinic.
Courtesy of Resource Group, Ltd., Dallas, Texas.
+100
+90
+80
+70
+60
+50
+40
+30
+20
+10
0
–10
–20
–30
–40
–50
–60
–70
–80
–90
–100
–110
–120
–130
–140
–150
+100
+90
+80
+70
+60
+50
+40
+30
+20
+10
0
–10
–20
–30
–40
–50
–60
–70
–80
–90
–100
–110
–120
–130
–140
–150
Net Loss
(under break-even point)
Net Income
(over break-even point)
Net
Income
Net Loss
(due to
unrecovered
fixed costs)
Safety
Cushion
(before
break-even
point)
0 100 200 300 400 500 600 700
Revenue (in thousands of dollars)
Projected
Revenues
Break-Even
Point
Fixed Costs
Recovered
Contribution Margin, Cost-Volume-Profit, and Profit-Volume Ratios 75
On our chart, the profit pattern is illustrated by a line drawn from the beginning level of
fixed costs to be recovered ($120,000 in our case). Another line has been drawn straight across
the chart at the break-even point. When the diagonal line begins at $120,000, its intersection
with the break-even or zero line is at $400,000 in revenue (see left-hand dotted line on chart).
We can prove out the $120,000 versus $400,000 relationship as follows. Each dollar of revenue
reduces the potential of loss by $0.30 (or 30% 3 $1.00). Fixed costs are fully recovered at a revenue level of $400,000, proved out as $120,000 divided by .30 = $400,000. This can be written
as follows:
.30R 5 $120,000
R 5 $400,000 [120,000 divided by .30 = 400,000]
The PV chart is very effective in planning meetings because only two lines are necessary
to show the effect of changes in volume. Both PV and CVP are useful when working with the
effects of changes in break-even points and revenue volume assumptions.
Contribution margins are also useful for showing profitability in other ways. An example
appears in Figure 8–8, which shows the profitability of various DRGs, using contribution margins as the measure of profitability. Case volume (the number of cases of each DRG) is on the
vertical axis of the matrix, and the dollar amount of contribution margin per case is on the
horizontal axis of the matrix.3
Figure 8–8 Profitability DRG Volume/Margin Matrix.
Modified from R. Hankins and J. J. Baker, Management Accounting for Health Care Organizations (Sudbury, MA: Jones &
Bartlett, 2004), 189.
0 $1,000 $2,000 $3,000 $4,000 $5,000
Profitability DRG Volume/Margin Matrix
$6,000
0
50
100
150
200
250
300
450
400
350
Contribution Margin Per Case
Case Volume
DRG
089
DRG
127
DRG
088
DRG
014
DRG
116
DRG
430
DRG
462
Input key:
DRG $
014 $900
088 2,000
089 1,500
127 2,800
116 4,000
430 5,600
462 3,100
76 Chapter 8 Cost Behavior and Break-Even Analysis
Scatter Graph Method
In performing a mixed-cost analysis, the manager is attempting to find the mixed cost’s average rate of variability. The scatter graph method is more accurate than the high–low method
previously described. It uses a graph to plot all points of data, rather than the highest and
lowest figures used by the high–low method. Generally, cost will be on the vertical axis of the
graph, and volume will be on the horizontal axis. All points are plotted, each point being
placed where cost and volume intersect for that line item. A regression line is then fitted to
the plotted points. The regression line basically represents the average—or a line of averages.
The average total fixed cost is found at the point where the regression line intersects with the
cost axis.
Two examples are examined. They match the high–low examples previously calculated.
Figure 8–9 presents the cafeteria data. The costs for cafeteria meals have been plotted on
the graph, and the regression line has been fitted to the plotted data points. The regression
line strikes the cost axis at a certain point; that amount represents the fixed cost portion of
the mixed cost. The balance (or the total less the fixed cost portion) represents the variable
portion.
The second example also matches the high–low example previously calculated. Figure 8–10
presents the drug sample data. The costs for drug samples have been plotted on the graph, and
the regression line has been fitted to the plotted data points. The regression line again strikes
the cost axis at the point representing the fixed-cost portion of the mixed cost. The balance
(the total less the fixed cost portion) represents the variable portion. Further discussions of this
method can be found in Examples and Exercises at the back of this book.
The examples presented here have regression lines fitted visually. However, computer
programs are available that will place the regression line through statistical analysis as a
function of the program. This method is called the least-squares method. Least squares
means that the sum of the squares of the deviations from plotted points to regression line
is smaller than would occur from any other way the line could be fitted to the data: in other
words, it is the best fit. This method is, of course, more accurate than fitting the regression
line visually.
Figure 8–9 Employee Cafeteria Scatter Graph.
$195
$185
$175
$165
$155
$145
$135
$125
$115
$105
$95
$85
20,000 30,000 40,000 50,000
Volume
(Number of Meals)
Cost
(in thousands of dollars)
Contribution Margin, Cost-Volume-Profit, and Profit-Volume Ratios 77
INFORMATION CHECKPOINT
What is needed? Revenues, variable cost, and fixed cost for a unit, division,
DRG, and so on.
Where is it found? In operating reports.
How is it used? Use the multiple-step calculations in this chapter to compute
the CPV or the PV ratio; use to plan and control operations.
KEY TERMS
Break-Even Analysis
Cost-Profit-Volume
Contribution Margin
Fixed Cost
Mixed Cost
Profit-Volume Ratio
Semifixed Cost
Semivariable Cost
Variable Cost
DISCUSSION QUESTIONS
1. Have you seen reports in your workplace that set out the contribution margin?
2. Do you believe that contribution margins can help you manage in your present work? In
the future? How?
3. Have you encountered break-even analysis in your work?
Figure 8–10 Drug Sample Scatter Graph for November.
$5,250
$5,000
$4,750
$4,500
$4,250
$4,000
$3,750
$3,500
$3,250
$3,000
500 600 700 800 900 1000 1100
Volume
(Samples)
Cost
78 Chapter 8 Cost Behavior and Break-Even Analysis
4. If so, how was it used (or presented)?
5. How do you think you would use break-even analysis?
6. Do you believe your organization could use these analysis tools more often than is now
happening? What do you believe the benefits would be?
NOTES
1. C. Horngren et al., Cost Accounting: A Managerial Emphasis, 9th ed. (Englewood Cliffs, NJ:
Prentice Hall, 1998).
2. J. J. Baker, Activity-Based Costing and Activity-Based Management for Health Care (Gaithersburg,
MD: Aspen Publishers, Inc., 1998).
3. It is possible that the term “diagnosis-related groups” (DRGs) may be changed to some new
terminology as a consequence of ICD-10 implementation.
Notes 79

Progress Notes
© LFor/Shutterstock
CHAPTER
Understanding
Inventory and
Depreciation Concepts
OVERVIEW: THE INVENTORY CONCEPT
This overview concerns both the inventory concept and
types of inventories.
Concept of Inventory in Healthcare Organizations
“Inventory” includes all the items (goods) that an organization has for sale in the normal course of its business.
Inventory is an asset, owned by the company. It appears on
the balance sheet as a current asset, because the individual
items that compose the inventory are expected to be “used”
(sold) within a 12-month period.
Types of Inventory in Healthcare Organizations
Various healthcare organizations (or departments within
organizations) deal with inventory and must account for it.
The hospital gift shop and the cafeteria, for example, own
inventory and must account for it. All pharmacies (hospitalbased, retail brick-and-mortar, or mail order pharmacies)
own inventory in the normal course of their business.
In manufacturing companies, inventory typically consists of three parts: raw materials, work in progress, and the
finished goods that are for sale. We might think that most
inventory items for sale in a healthcare organization are not
manufactured, but are finished goods instead. However,
consider this example: the hospital cafeteria purchases
flour, eggs, butter, and so on (raw materials), mixes the
ingredients (work in progress), and produces a cake (finished goods) that is for sale. (Another example might be a
pharmacy that compounds drugs.)
After completing this chapter,
you should be able to
1. Understand the interrelationship between inventory and
cost of goods sold.
2. Understand the difference
between LIFO and FIFO
inventory methods.
3. Be able to calculate inventory
turnover.
4. Understand the interrelationship between depreciation
expense and the reserve for
depreciation.
5. Understand how to compute
the net book value of a fixed
asset.
6. Be able to identify the five
methods of computing book
depreciation.
81
9
CHAPTER
INVENTORY AND COST OF GOODS SOLD (“GOODS” SUCH AS DRUGS)
The interrelationship between inventory and cost of goods sold is at the heart of the inventory
concept.
Turning Inventory into Cost of Goods (or Drugs) Sold
The completed inventory item (“finished goods”) is sold. That is how an item moves out of inventory and is recognized as cost. When the item is recognized as cost, it becomes “cost of goods
sold.” (Also note that different terminology may be used. In some organizations cost of goods
sold is called “cost of sales.”) For a business such as a retail pharmacy, the cost of inventory sold
to its customers is the largest single expense of the business.
Recording Inventory and Cost of Goods (or Drugs) Sold
Recording inventory and cost of goods (or drugs) sold is a sequence of events. Figure 9–1 illustrates the sequence as follows:
• Beginning inventory (inventory at the start of the period) is recorded.
• Purchases during the period are recorded.
• Beginning inventory plus purchases equal “cost of goods available for sale.”
• Ending inventory (inventory at the end of the period) is recorded.
• Cost of goods available for sale less ending inventory equals “cost of goods sold.”
Purchases added to inventory will typically include “freight in,” or the shipping costs to
deliver the items to you. Any discounts received on the purchases should be subtracted from the
purchase cost. Thus the purchases become “net purchases”; that is, net of discounts.
Sometimes the ending inventory is estimated. An example of “Estimating the Ending Pharmacy Inventory” is shown in the chapter about estimates and benchmarking.
Inventory
Recorded
Purchases
Recorded Calculated Calculated Inventory
Recorded
Beginning
Inventory
Net
Purchases
Cost of Goods
Available
for Sale
Ending
Inventory
Cost of Goods
Sold + = − =
Purchases + Freight In − Discounts = Net
Figure 9–1 Recording Inventory in the Accounting Cycle.
82 Chapter 9 Understanding Inventory and Depreciation Concepts
Gross Margin Computation
Gross margin equals revenue from sales less the cost of goods sold. Gross margin is often
expressed as a percentage. Thus, a pharmacy’s gross margin might appear as follows:
Sales 100%
Cost of goods (drugs) sold 65%
Gross margin 35%
An organization’s gross margin percentage can be readily compared to industry standards.
INVENTORY METHODS
How is the inventory to be valued? The two most commonly used inventory valuation methods
are First-In, First-Out (FIFO) and Last-In, First-Out (LIFO). The method chosen will affect the
organization’s financial statements, as explained in the following sections.
First-In, First-Out (FIFO) Inventory Method
The First-In, First-Out, or FIFO inventory costing method, recognizes the first costs placed into
inventory as the first costs moved out into cost of goods sold when a sale occurs. How will this
method affect the organization’s financial statements? Under FIFO, the ending inventory figure will be higher (because when the oldest inventory moves out first, the ending inventory will
be based on the costs of the latest purchases, which we assume will have cost more). Exhibit 9–1
illustrates this effect.
Last-In, First-Out (LIFO) Inventory Method
The Last-In, First-Out, or LIFO inventory costing method, recognizes the latest, or last, costs
placed into inventory as the first costs moved out into cost of goods sold when a sale occurs.
How will this method affect the organization’s financial statements? Under LIFO, the ending
inventory figure will be lower (because when the latest inventory moves out first, the ending
inventory will be based on costs of the earliest purchases, which we assume will have cost less).
Exhibit 9–2 illustrates this effect.
Other Inventory Treatments
Two other inventory treatments deserve mention, as follows.
Weighted Average Inventory Method
This inventory costing method is based on the weighted average cost of inventory during the
period. (The weighted average inventory method is also called the “average cost method.”) The
weighted average inventory cost is determined as follows: divide the cost of goods available for
sale by the number of units available for sale.
Inventory Methods 83
Assumptions FIFO Inventory Effect
Sales (Revenue) 20 units @$25 5 $500
Cost of Sales:
Beginning Inventory 10 units @$5 5 $50
Plus: Purchases 10 units @$10 5 $100 &
10 units @$15 5 $150 250
Subtotal $300
Less: Ending Inventory 10 units @$15 5 (150)
Cost of Sales 150
Gross Profit $350
Operating Expenses (50)
Earnings Before Tax $300
Income Tax (90)
Earnings After Tax $210
Note: Ending inventory computed as number of units in the beginning inventory plus
number of units purchased less number of units sold–count oldest units sold first.
Exhibit 9–1 FIFO Inventory Effect
No Method: Inventory Never Recognized
This inventory costing method is no method at all. That is, inventory is never recognized. For
example, a physician’s office may expense all drug purchases as supplies at the time of purchase
and never count such drugs as inventory. This treatment might be justified when such supplies were only a small part of the practice expenses. However, if the physician is purchasing
very expensive drugs and administering them in the office (infusing expensive drugs is a good
example), then not recognizing any such drugs being held as inventory on the financial statements is misleading.
INVENTORY TRACKING
The two most typical inventory-tracking systems are described as follows.
Perpetual Inventory System
With a perpetual inventory system, the healthcare organization keeps a continuous, or perpetual, record for every individual inventory item. Thus the amount of inventory on hand can
84 Chapter 9 Understanding Inventory and Depreciation Concepts
be determined at any time. (A real-time system is a variation of the perpetual inventory system,
whereby transactions are entered simultaneously.)
A perpetual inventory system requires, of course, a specific identification method for each
inventory item. Bar coding is often used for this purpose. You are most likely to find a perpetual
inventory system in the pharmacy department of a hospital.
Periodic Inventory System
With a periodic inventory system, the healthcare organization does not keep a continuous
record that identifies every individual inventory item on hand. Instead, at the end of the
period the organization physically counts the inventory items on hand. Then costs per item
are attached to the inventory counts in order to arrive at the cost of the inventory at the end of
the period (the ending inventory).
Necessary Adjustments
Certain inventory adjustments will commonly become necessary, as discussed here.
Exhibit 9–2 LIFO Inventory Effect
Assumptions LIFO Inventory Effect
Sales (Revenue) 20 units @$25 5 $500
Cost of Sales:
Beginning Inventory 10 units @$5 5 $50
Plus: Purchases 10 units @$10 5 $100 &
10 units @$15 5 $150 250
Subtotal $300
Less: Ending Inventory 10 units @$5 5 (50)
Cost of Sales 250
Gross Profit $250
Operating Expenses (50)
Earnings Before Tax $200
Income Tax (60)
Earnings After Tax $140
Note: Ending inventory computed as number of units purchased plus number of units
in the beginning inventory less number of units sold–count newest units sold first.
Inventory Tracking 85
Shortages
When the periodic inventory results are compared to the inventory balance on the financial statements, it is not uncommon to find that the actual physical inventory amount is
less than the amount recorded on the books. This difference, or shortage, is commonly
termed “shrinkage.” The inventory amount on the books must be reduced to the actual
amount per the periodic inventory, and the resulting shrinkage cost must be recorded as
an expense.
Obsolete Items
Most inventories will inevitably come to contain certain obsolete items. For example, the pharmacy inventory will contain drugs that have “sell by” or “use by” expiration dates. Obsolete
inventory items should be discarded. Their cost must be removed from the cost of inventory on
hand, and the resulting obsolescence cost must be recorded as an expense.
INVENTORY DISTRIBUTION SYSTEMS
The ability to track inventory is directly impacted by the type of documentation required for
removing items from inventory. Different types of inventory require different types of distribution systems. Thus, removing an item from a particular type of inventory needs documentation
that varies according to the level of permission and scrutiny required.
Distribution Using Sign-Off Forms
For example, drawing light bulbs from the Maintenance Department inventory does not require
a high level of permission and/or scrutiny. In one facility’s inventory distribution method, such
a requisition for light bulbs must always be attached to a Maintenance Department work order.
Some responsible person has signed off on this work order, and it shows the reason for the
inventory request. This method not only allows for inventory tracking, but also indicates who
was responsible for generating the order.
The distribution system for medical devices held in inventory typically requires a different
type of requisition. (One reason: Medical devices are more expensive than light bulbs.) The
inventory requisition is usually triggered by the doctor’s orders, and more than one level of
sign-off is typically required before the device is delivered to the operating room. Thus, tracking
this inventory item may require multiple steps.
Distribution Using Robotic Technology
This discussion about technology methods of inventory distribution centers upon drug distribution within a facility.
Background
Relative to drugs or pharmaceutical inventory, it should be noted that there are some characteristics that differentiate the pharmaceutical inventory from the rest of a hospital’s inventory
control mechanisms. The unit-dose drug distribution system is a particular example. In unitdose dispensing, medication is dispensed in a package that is ready to administer to the patient.
86 Chapter 9 Understanding Inventory and Depreciation Concepts
Unit-dose dispensing of medication was developed in the 1960s to support nurses in medication
administration and to reduce the waste of increasingly expensive medications.1
Robotic Automation
Although the unit-dose system provides many safeguards and advantages in delivering medications, as a manual system it is highly labor intensive. Automation has been developed to support
the patient care advantages of the system at a decreased cost, with pharmacy using robotics for
the bin-filling process. Advantages of the robotic cart‐filling method include improved accuracy in medication dispensing and accounting. Disadvantages include high startup costs partly
resulting from needed facility renovations, high continuing support costs, significant pharmacy
space requirements, and limited robot capacity.2
Cost/Benefit of a Robot
Capital expense or lease costs for robotic technology are high, limiting use to larger hospitals.
The decision to purchase and implement an automated bin fill system should be based on
a keen and insightful analysis of the financial benefits, return on investment, and potential for
demonstrated improvements in service quality and patient care. Although the cost of a robot
continues to decrease, information systems and other support costs will remain high enough to
make the decision to purchase or lease a robot hard to justify in many cases.
CALCULATING INVENTORY TURNOVER
Inventory turnover is a ratio that shows how fast inventory is sold, or “turns over.” The computation is in two steps as follows. Figure 9–2 illustrates the sequence.
Step 1. First compute “Average Inventory”:
Beginning Inventory plus Ending Inventory divided by two equals Average Inventory
Step 2. Next compute “Inventory Turnover”:
Cost of Goods Sold (or Cost of Sales) divided by Average Inventory equals Inventory Turnover
For example,
Step 1. $100,000 (beginning inventory) plus $150,000 (ending inventory) divided by 2 equals
$125,000 (average inventory).
Cost of Goods
Sold
Average
Inventory
Inventory
Turnover
divided
by
equals
Beginning
Inventory plus 2 equals Ending
Inventory
divided
by
Actual
Inventory
Answer is a
ratio that shows
how fast the
inventory is sold
Figure 9–2 Calculating Inventory Turnover.
Calculating Inventory Turnover 87
Step 2. $500,000 (cost of goods sold, or cost of sales) divided by $125,000 (average inventory)
equals 4.0 (inventory turnover).
An organization’s inventory turnover ratio can be readily compared to industry standards.
OVERVIEW: THE DEPRECIATION CONCEPT
Depreciation expense spreads, or allocates, the cost of a fixed asset over the useful life of that
asset, as discussed here.
Fixed Assets and Depreciation Expense
Fixed assets, also known as long-term assets, are classified as long term and placed on the balance sheet as such because they will not be converted into cash in the coming 12 months. The
purchase of a fixed asset is a capital expenditure. (Capital expenditures involve the acquisition
of assets that are long lasting, such as buildings and equipment.) “Capitalizing” means recording these assets as long-term assets on the balance sheet.
We recognize the cost of owning buildings and equipment through depreciation expense.
When the cost is spread, or allocated, over a period of years, each year’s financial statements (for
that period of years) recognize some portion of the cost, expressed as depreciation expense.
Useful Life of the Asset
The useful life determines the period over which the fixed asset’s cost will be spread. For example, a piece of laboratory equipment is purchased for $20,000. It has a useful life of five years. So
depreciation expense is recognized in each of the five years until the $20,000 is used up.
Salvage Value
Before depreciation expense can be calculated, we need to know whether the fixed asset will
have salvage value at the end of the depreciated period. Salvage value, also known as residual
value or scrap value, represents any expected cash value of the asset at the end of its useful life.
If the laboratory equipment is expected to have a salvage value of $1,000 at the end of its fiveyear useful life, then $19,000 will be spread over the five-year life as depreciation expense, and
the $1,000 will remain undepreciated at the end of that time.
BOOK VALUE OF A FIXED ASSET AND THE RESERVE FOR DEPRECIATION
This section describes important interrelationships between and among depreciation expense,
the reserve for depreciation, and net book value of an asset.
The Reserve for Depreciation
Depreciation expense over the years is accumulated into the reserve for depreciation. In other
words, the reserve for depreciation holds the cumulative amount of depreciation expense
that has been recognized over time, beginning with the date that the fixed asset was acquired.
88 Chapter 9 Understanding Inventory and Depreciation Concepts
Another way to think about this is to view the reserve for depreciation as holding all the depreciation expense that has been recognized and recorded over the useful life of the asset.
Interrelationship of Depreciation Expense and the Reserve for Depreciation
Depreciation expense for the year is recorded in the income statement. At the same time, an
equivalent amount is added to the cumulative amount that has been accumulating within the
reserve for depreciation on the balance sheet. These amounts should balance each other; that
is, if $25,000 is recognized as depreciation expense in the income statement, then $25,000
should be added to the reserve for depreciation on the balance sheet. This interrelationship is
illustrated in Figure 9–3.
Net Book Value of a Fixed Asset
The net book value (also known as book value) of a fixed asset is a balance sheet figure that
represents the remaining undepreciated portion of the fixed asset cost. The term derives from
value recorded on the books—thus “book value.”
The net book value of a fixed asset is computed as follows:
• Determine the original cost of the fixed asset on the balance sheet.
• Subtract the reserve for depreciation, which has accumulated depreciation expense as it
has been recognized.
• The result equals net book value at that point in time (Figure 9–4).
Also note that fully depreciated fixed assets may still remain on the books if they are still
in use. A fully depreciated fixed asset, of course, means that the depreciable cost has been
exhausted because all the depreciation expense over the asset’s useful life has already been
Figure 9–3 Interrelationship of Depreciation Expense and Reserve for Depreciation in the Accounting
Cycle.
Income Statement
Depreciation Expense
$25,000
This year’s
depreciation expense is
recognized on the
Income Statement
Balance Sheet
Reserve for Depreciation
$25,000
An equivalent amount is
added to the cumulative
Reserve for Depreciation
on the Balance Sheet
Book Value of a Fixed Asset and the Reserve for Depreciation 89
recognized. Thus, the net book value would either be zero or would amount to the remaining
salvage value of the asset.
Five Methods of Computing Book Depreciation
Just as “book value” means value that is recorded on the organization’s books, “book depreciation” means depreciation that is recorded on the books. Book depreciation is the depreciation
expense recorded in the financial accounting records and reflected on the financial statements.
“Tax depreciation,” on the other hand, is depreciation that is computed for tax purposes and
is reflected on the applicable tax returns of the organization. Tax depreciation methods are
discussed in the final section of this chapter.
You as a manager will most likely be using book depreciation in your planning, control, and
decision making. Five methods of computing book depreciation are described below.
Straight-Line Depreciation Method
The straight-line depreciation method assigns an equal or even amount of depreciation expense
over each year (or period) of the asset’s useful life. The expense is thus spread evenly—or in
a straight line—over the life of the asset. Table 9–1 illustrates the straight-line depreciation
method applied to a fixed asset costing $10,000 with a 5-year useful life and no salvage value.
The depreciation expense would thus equal $2,000 for each of the 5 years ($10,000 divided by
5 equals $2,000 per year).
Table 9–2 illustrates the straight-line depreciation method applied to a fixed asset costing $10,000 with a 5-year useful life and a $1,000 salvage value. The depreciation expense
would thus equal $1,800 for each year in this example, because we must leave $1,000 at the
end of the asset’s 5-year life ($10,000 less $1,000 equals $9,000 divided by 5 equals $1,800
per year.)
If the asset was acquired in the second half of the year, in some cases only a half-year of depreciation will be recognized in Year 1. If this is the case, the remaining half-year of depreciation
will be recognized in Year 6, in order to fully depreciate the asset.
Accelerated Book Depreciation Methods
As the name would imply, accelerated book depreciation methods write off more depreciation in the first part of the asset’s useful life. Thus, they “accelerate” recognizing depreciation expense. Three accelerated depreciation methods are briefly described here. Further
details about the computations for each method appear in Appendix 9-A at the end of this
chapter.
Figure 9–4 Net Book Value Computation.
Building & Equipment
Cost
Represents Fixed Asset
cost on the
Balance Sheet
Less Reserve for Depreciation
Accumulates depreciation
expense as it is recognized
Net Book Value
Represents remaining
undepreciated
Fixed Asset cost
Equals
90 Chapter 9 Understanding Inventory and Depreciation Concepts
Sum-of-the-Year’s Digits (SYD) Method The Sum-of-the-Year’s Digits (SYD) accelerated depreciation
method computes depreciation by multiplying the depreciable cost of the asset by a fraction.
Double-Declining Balance (DDB) Method The Double-Declining Balance (DDB) accelerated
depreciation method computes depreciation by multiplying the asset’s net book value at the
beginning of each year by a constant percentage, or factor. In the case of DDB, the constant
factor is twice the straight-line rate (thus “double-declining”).
150% Declining Balance (150% DB) Method The 150% Declining Balance (150% DB) accelerated
depreciation method also computes depreciation by multiplying the asset’s net book value
at the beginning of each year by a constant percentage, or factor. In the case of 150% DB,
however, the constant factor is half again or 150% of the straight-line rate.
Units of Service or Units of Production (UOP) Depreciation Method
The Units of Service or Units of Production (UOP) method computes depreciation by assigning
a fixed amount of depreciation to each unit of service or output that is produced by equipment.
Table 9–1 Straight-Line Depreciation: Five-Year Life with No Salvage Value
Cost
(to Be Depreciated)
Depreciation
Expense
per Year*
Accumulated
Depreciation
(Reserve for
Depreciation)
$10,000
Year 1 $2,000 $2,000
Year 2 2,000 4,000
Year 3 2,000 6,000
Year 4 2,000 8,000
Year 5 2,000 10,000
*$10,000 divided by 5 years = $2,000 per year.
Table 9–2 Straight-Line Depreciation: Five-Year Life with Salvage Value
Cost
(to Be Depreciated)
Depreciation
Expense
per Year*
Accumulated
Depreciation
(Reserve for
Depreciation)
Net Remaining
Undepreciated Cost
(Net Block Value)
$10,000 $10,000
Year 1 $1,800 $1,800 8,200
Year 2 1,800 3,600 6,400
Year 3 1,800 5,400 4,600
Year 4 1,800 7,200 2,800
Year 5 1,800 9,000 1,000**
*$9,000 divided by 5 years = $1,800 per year.
**Remaining salvage value.
Book Value of a Fixed Asset and the Reserve for Depreciation 91
“Units of Production” is a manufacturer’s term for manufacturing, or producing, a product.
“Units of Service” more properly describes the medical equipment providing services in healthcare organizations.
Instead of a useful life in years, equipment depreciated by the UOP method is assigned a
fixed total amount of units of service. This fixed amount is the overall total for the life of the
equipment. Then the number of units of service actually provided each year is depreciated.
COMPUTING TAX DEPRECIATION
The following discussion about tax depreciation is general in nature and is not to be utilized as
tax advice. Any additional details about tax depreciation are beyond the scope of this text.
Overview
“Tax depreciation,” as previously defined, means depreciation that is computed for tax purposes and is reflected on the applicable tax returns of the organization. The methods of tax
depreciation in effect at the time of this writing fall under the Modified Accelerated Cost Recovery System as described here.
Modified Accelerated Cost Recovery System (MACRS)
The Modified Accelerated Cost Recovery System (MACRS) is currently used to depreciate most
business and investment property for tax purposes. MACRS presently consists of two depreciation systems, both of which are briefly described here.
General Depreciation System (GDS)
The General Depreciation System (GDS) is the method generally used under the U.S. Internal Revenue Service rules and regulations, although there are certain exceptions. GDS provides
nine property classifications for useful life, including 3-, 5-, 7-, and 10-year property, and 15-, 20-,
and 25-year property, along with residential rental property and nonresidential real property. For
example, computers, calculators, and copiers fall into the 5-year property classification while office
furniture and fixtures such as desks, files, and safes fall into the 7-year property classification.3
The GDS method allows double-declining balance, 150% declining balance, and the straightline method of depreciation, depending upon what type of property is being depreciated. For
example, nonfarm 3-, 5-, 7-, and 10-year property can use any of the three methods in most (but
not all) circumstances.4
Alternative Depreciation System (ADS)
The Alternative Depreciation System (ADS) is required for particular properties including,
for example, any tax-exempt use property.5 ADS uses fixed ADS recovery periods, along with
straight-line depreciation. ADS can also be used for certain eligible property, even though the
property in question could come under GDS (certain restrictions apply).6
The tax law changes rapidly; thus, modifications to the tax depreciation methods described
in this section may have been placed into effect at any point in time. More information can be
obtained from the recent Internal Revenue Service Publication 946 “How to Depreciate Property.”
92 Chapter 9 Understanding Inventory and Depreciation Concepts
INFORMATION CHECKPOINT
What is needed? A depreciation schedule that includes depreciation expense,
reserve for depreciation, and net book value.
Where is it found? With your supervisor or in the accounting and/or administration offices.
How is it used? To reflect depreciation expense in order to complete the income statement.
KEY TERMS
Book Value
Depreciation
FIFO
Inventory
Inventory Turnover
LIFO
Salvage Value
Useful Life (of an asset)
DISCUSSION QUESTIONS
1. Do you or your supervisor have to deal with inventory? If so, please describe.
2. Have you ever had to count physical inventory? If so, please describe the process.
3. Do you or your supervisor have to deal with depreciation expense? If so, please describe.
4. Have you ever had to compute depreciation expense? If so, please describe the
circumstances.
NOTES
1. Agency for Healthcare Research and Quality. “National Healthcare Disparities Report,
2013, Chapter 10. Access to Health Care.” Content last reviewed May 2014, http://www
.ahrq.gov/research/findings/nhqrdr/nhdr13/chap10.html
2. L. F. Wolper, Health Care Administration: Managing Organized Delivery Systems (5th ed.)
(Sudbury, MA: Jones & Bartlett Publishers, 2011).
3. Department of the Treasury, Internal Revenue Service. How to Depreciate Property. Publication 946 (Washington, DC: U.S. Government, 2011).
4. Ibid., Table 4-1.
5. Ibid., “Required Use of ADS.”
6. Ibid., “Election of ADS.”
Notes 93

© LFor/Shutterstock
ACCELERATED BOOK DEPRECIATION METHODS
As the name would imply, accelerated book depreciation methods write off more depreciation in the first part of the asset’s useful life. Thus, they “accelerate” recognizing depreciation
expense. The computations of three accelerated depreciation methods are described in this
appendix as follows.
Sum-of-the-Year’s Digits (SYD) Method
The Sum-of-the-Year’s Digits (SYD) accelerated depreciation method computes depreciation
by multiplying the depreciable cost of the asset by a fraction. The fraction is the mechanism by
which the acceleration is computed. It is calculated as follows:
• The numerator of the SYD fraction starts with the asset’s useful life expressed in
years and decreases by one each year thereafter. (Thus, for a five-year useful life, the
numerators are 5, 4, 3, 2, and 1 respectively.)
• The denominator of the SYD fraction is the sum of the years’ digits of the asset’s life.
(Thus, for a five -year useful life, the sum of 5 + 4 + 3 + 2 + 1 equals 15, which is the
denominator.)
Table 9-A–1 illustrates the computation for each year. The depreciable cost of $10,000 is divided
by 15 to arrive at $666.66. Thus, one-fifteenth or $666.66 is multiplied by 5 for the first year ($3,333
depreciation expense), by 4 for the second year ($2,667 depreciation expense), and so on.
Double-Declining Balance (DDB) Method
The Double-Declining Balance (DDB) accelerated depreciation method computes depreciation by multiplying the asset’s net book value at the beginning of each year by a constant percentage, or factor. In the case of DDB, the constant factor is twice the straight-line rate (thus
“double-declining”).
Table 9-A–2 illustrates the computation for each year of a five-year useful life with no salvage
value. The double-declining factor is computed as follows:
• $10,000 cost of the fixed asset divided by the asset’s useful life of 5 years equals 20% or a
factor of 0.20.
• Multiply the 0.20 by 2 (or double) to arrive at the 0.40 double-declining factor.
APPENDIX
9-A A Further Discussion
of Accelerated and Units of Service Depreciation
Computations
95
Table 9-A–1 Sum-of-the-Years’ Digits Depreciation: Five-Year Life with No Salvage Value
Depreciation Computation
Sum-of- Accumulated Net Remaining
the-Years’ Annual Depreciation Undepreciated
Cost Depreciable Cost Digits* Depreciation (Reserve for Cost
(to Be Depreciated) (for Computation) Fraction** Expense Depreciation) (Net Book Value)
$10,000
Year 1 $10,000 5/15 $3,333 $3,333 $6,667
Year 2 10,000 4/15 2,667 6,000 4,000
Year 3 10,000 3/15 2,000 8,000 2,000
Year 4 10,000 2/15 1,333 9,333 667
Year 5 10,000 1/15 667 10,000 -0-
*Sum-of-the-Years’ Digits = 15 = (1 + 2 + 3 + 4 + 5).
**One-fifteenth of $10,000 = $666.66.
×
=
96 Chapter 9 Understanding Inventory and Depreciation Concepts
×
=
Table 9-A–2 Double-Declining Balance Depreciation: Five-Year Life with No Salvage Value
Depreciation Computation
Double Accumulated Net Remaining
Carry-forward Declining Annual Depreciation Undepreciated
Cost Book Value Balance Depreciation (Reserve for Cost
(to Be Depreciated) (for Computation) Factor Expense Depreciation) (Net Book Value)
$10,000
Year 1 $10,000 0.40* $4,000 $4,000 $6,000
Year 2 6,000 0.40 2,400 6,400 3,600
Year 3 3,600 0.40 1,440 7,840 2,160
Year 4 2,160 S/L** 1,080 8,920 1,080
Year 5 1,296 S/L 1,080 10,000 -0-
*$10,000 divided by 5 years equals 0.20 times 2 (double) equals 0.40 factor.
**Double-Declining Balance changes to straight-line method when straight-line yields a higher depreciation. (See Table 9-A–3.)
Accelerated Book Depreciation Methods 97
The computation continues as follows:
• For Year 1, $10,000 times 0.40 equals $4,000 Year 1 depreciation expense. Accumulated
depreciation for Year 1 also equals $4,000. The accumulated depreciation of $4,000 is
subtracted from the $10,000 cost to arrive at the net remaining undepreciated cost, or net
book value, of $6,000 at the end of Year 1.
• For Year 2, the factor of 0.40 is multiplied times the $6,000 net book value to equal $2,400
Year 2 depreciation expense. The Year 2 depreciation of $2,400 is added to the accumulated depreciation for a total of $6,400 ($4,000 plus $2,400 equals $6,400). The $6,400 is
subtracted from the $10,000 cost to arrive at the net remaining undepreciated cost, or net
book value, of $3,600 at the end of Year 2.
• For Year 3, the factor of 0.40 is multiplied times the $3,600 net book value to equal $1,440
Year 3 depreciation expense. The Year 3 depreciation of $1,440 is added to the accumulated depreciation for a total of $7,840 ($6,400 plus $1,440 equals $7,840). The $7,840 is
subtracted from the $10,000 cost to arrive at the net remaining undepreciated cost, or net
book value, of $2,160 at the end of Year 3.
The declining balance method has a peculiarity in that it switches back to the straight-line
method at the point where the straight-line computation yields a higher annual depreciation
than does the declining balance computation. Thus, as we arrive at Year 4 in this example, we
must test the double-declining computation against the straight-line computation.
• To compute Year 4 double declining, the factor of 0.40 is multiplied times the net book
value of $2,160 to arrive at a DDB of $864.
• To compute a comparative Year 4 by the straight-line method, the remaining net book
value of $2,160 is divided by the remaining years of useful life, which in this case would be
2 years. Thus $2,160 divided by 2 years equals straight-line depreciation per year for Year
4 and for Year 5 of $1,080 per year.
• The Year 4 straight-line method is greater ($1,080) than the Year 4 DDB ($864). Thus
the switch to straight line is made for the remaining Year 4 and Year 5, as illustrated in
Table 9-A–2.
The point at which the straight-line method overtakes the declining balance method varies,
of course, with the method and with the number of years of useful life. Table 9-A–3 illustrates
Table 9-A–3 Declining Balance Rates by Property Class
Property Class Method Declining Balance Rate Year*
3-year 200% DB 66.667% 3rd
5-year 200% DB 40.000% 4th
7-year 200% DB 28.571% 5th
10-year 200% DB 20.00% 7th
15-year 150% DB 10.0% 7th
20-year 150% DB 7.5% 9th
*Indicates the first year for which the straight-line depreciation method gives an equal or greater deduction.
Reproduced from Internal Revenue Service, Publication 964, “How to Depreciate Property,” p. 43.
98 Chapter 9 Understanding Inventory and Depreciation Concepts
the first year for which the straight-line depreciation method gives an equal or greater deduction. (Note that the Five-year Property Class [or Useful Life Class] for 200% declining balance
[or double-declining balance] shows the fourth year as the point at which the switch to straight
line would be made. This is consistent with our example in Table 9-A–2.)
150% Declining Balance Method
The 150% Declining Balance (150% DB) accelerated depreciation method also computes
depreciation by multiplying the asset’s net book value at the beginning of each year by a constant percentage, or factor. In the case of 150% DB, however, the constant factor is half again or
150% of the straight-line rate.
Table 9-A–4 illustrates the computation for each year of a five-year useful life with no salvage
value. The 150% DB factor is computed as follows:
• $10,000 cost of the fixed asset divided by the asset’s useful life of 5 years equals 20% or a
factor of 0.20.
• Multiply the 0.20 by 150% (or half again) to arrive at the 0.30 150% DB factor.
The 150% DB computation follows the same pattern as the double-declining example just
described, with two exceptions:
• The factor applied is 0.30 per year, as just explained.
• The 150% DB switches to straight line in Year 3 instead of Year 4 as in the previous
example.
Units of Service or Units of Production (UOP) Depreciation Method
The Units of Service or Units of Production (UOP) method computes depreciation by assigning a fixed amount of depreciation to each unit of service or output that is produced by equipment. The “Units of Production” is a manufacturer’s term for manufacturing, or producing, a
product. “Units of Service” more properly describes the medical equipment providing services
in healthcare organizations.
Instead of a useful life in years, equipment depreciated by the UOP method is assigned a
fixed total amount of units of service. This fixed amount is the overall total for the life of the
equipment. Then the number of units of service actually provided each year is depreciated.
Table 9-A–5 illustrates the UOP method. The depreciation per unit of service is computed
as follows:
• The total depreciable units of service over 5 years are determined to be 5,000 units. The
equipment cost to be depreciated of $10,000 is divided by 5,000 units to arrive at depreciation of $2.00 per unit.
• Units of Service in Year 1 total 1,000. Thus 1,000 units times $2.00 per unit equals $2,000
Year 1 depreciation.
• Units of Service in Year 2 total 900. Thus 900 units times $2.00 per unit equals $1,800 Year
2 depreciation.
The computation continues in this manner until the total 5,000 units of service are exhausted.
The equipment is then fully depreciated.
Accelerated Book Depreciation Methods 99
Table 9-A–4 150% Declining Balance Depreciation: Five-Year Life with No Salvage Value
Depreciation Computation
150% Accumulated Net Remaining
Carry-Forward Declining Annual Depreciation Undepreciated
Cost Book Value Balance Depreciation (Reserve for Cost
(to Be Depreciated) (for Computation) Factor Expense Depreciation) (Net Book Value)
$10,000
Year 1 $10,000 0.30* $3,000 $3,000 $7,000
Year 2 7,000 0.30 2,100 5,100 4,900
Year 3 4,900 S/L** 1,663 6,733 3,267
Year 4 3,267 S/L 1,633 8,366 1,634
Year 5 1,634 S/L 1,634 10,000 -0-
*$10,000 divided by 5 years equals 0.20 times half again (150%) equals 0.30 factor.
**150% Declining Balance changes to straight-line method when straight-line yields a higher depreciation.
×
=
100 Chapter 9 Understanding Inventory and Depreciation Concepts
Table 9-A–5 Units of Service (Units of Production) Depreciation: Five-Years of Service with No Salvage Value
Depreciation Computation
Accumulated Net Remaining
Annual Depreciation Undepreciated
Cost Units of Service Depreciation Depreciation (Reserve for Cost
(to Be Depreciated) per Year per Unit Expense Depreciation) (Net Book Value)
$10,000
Year 1 $1,000 $2.00* $2,000 $2,000 $8,000
Year 2 900 2.00 1,800 3,800 6,200
Year 3 800 2.00 1,600 5,400 4,600
Year 4 1,100 2.00 2,200 7,600 2,400
Year 5 1,200 2.00 2,400 10,000 -0-
Total Units 5,000
*$10,000 divided by total units (5,000) equals depreciation per unit of $2.00.
×
=
Accelerated Book Depreciation Methods 101

Progress Notes
© LFor/Shutterstock
Staffing: Methods,
Operations, and
Regulations
STAFFING REQUIREMENTS
In most businesses, a position is filled if the employee works
five days a week, generally Monday through Friday. But in
health care, many positions must be filled, or covered, all
seven days of the week. Furthermore, in most businesses,
a position is filled for that day if the employee works an
eight-hour day—from 9:00 am to 5:00 pm, for example. But
in health care, many positions must also be filled, or covered, 24 hours a day. The patients need care on Saturday
and Sunday, as well as Monday through Friday, and patients
need care around the clock, 24 hours a day.
Thus, healthcare employees work in shifts. The shifts are
often 8-hour shifts, because three such shifts times 8 hours
apiece equals 24-hour coverage. Some facilities have gone
to 12-hour shifts. In their case, two 12-hour shifts equal
24-hour coverage. The manager is responsible for seeing
that an employee is present and working for each position
and for every shift required for that position. Therefore,
it is necessary to understand and use the staffing measurement known as the full-time equivalent (FTE). Two different approaches are used to compute FTEs: the annualizing
method and the scheduled-position method. Full-time
equivalent is a measure to express the equivalent of an
employee (annualized) or a position (staffed) for the full
time required. We examine both methods in this chapter.
FTEs FOR ANNUALIZING POSITIONS
Why Annualize?
Annualizing is necessary because each employee that is eligible for benefits (such as vacation days) will not be on duty
for the full number of hours paid for by the organization.
After completing this chapter,
you should be able to
1. Understand the difference
between productive time and
nonproductive time.
2. Understand computing fulltime equivalents to
annualize staff positions.
3. Understand computing fulltime equivalents to
fill a scheduled position.
4. Tie cost to staffing.
5. Describe regulatory
requirements that affect
staffing.
103
10
CHAPTER
Annualizing thus allows the full cost of the position to be computed through a burden approach.
In the burden approach, the net hours desired are inflated, or burdened, in order to arrive at
the gross number of paid hours that will be needed to obtain the desired number of net hours
on duty from the employee.
Productive Versus Nonproductive Time
Productive time actually equates to the employee’s net hours on duty when performing the
functions in his or her job description. Nonproductive time is paid-for time when the employee
is not on duty: that is, not producing and therefore “nonproductive.” Paid-for vacation days,
holidays, personal leave days, and/or sick days are all nonproductive time.1
Exhibit 10–1 illustrates productive time (net days when on duty) versus nonproductive time
(additional days paid for but not worked). In Exhibit 10–1, Bob, the security guard, is paid for
260 days per year (total paid days) but works for only 235 days per year. The 235 days are productive time, and the remaining 25 days of holidays, sick days, vacation days, and education days
are nonproductive time.
Exhibit 10–1 Metropolis Clinic Security Guard Staffing
The Metropolis laboratory area has its own security guard from 8:30 am to 4:30 pm
seven days per week. Bob, the security guard for the clinic area, is a full-time Metropolis
employee.
He works as follows:
1. The area assigned to Bob is covered seven days per week for every week of the year.
Therefore,
Total days in business year 364
2. Bob doesn’t work on weekends (104)
(2 days per week 3 52 weeks 5 104 days)
Bob’s paid days total per year amount to 260
(5 days per week 3 52 weeks 5 260 days)
3. During the year Bob gets paid for:
Holidays 9
Sick days 7
Vacation days 7
Education days 2
(25)
4. Net paid days Bob actually works 235
Jim, a police officer, works part time as a security guard for the Metropolis laboratory
area. Jim works on the days when Bob is off, as follows:
Weekends 104
Bob’s holidays 9
Bob’s sick days 7
Bob’s vacation days 7
Bob’s education days 2
129
5. Paid days Jim works 129
6. Total days lab area security guard position is covered 364
104 Chapter 10 Staffing: Methods, Operations, and Regulations
FTE for Annualizing Positions Defined
For purposes of annualizing positions, the definition of FTE is as follows: the equivalent of one
full-time employee paid for one year, including both productive and nonproductive (vacation,
sick, holiday, education, etc.) time. Two employees each working half-time for one year would
be the same as one FTE.
Staffing Calculations to Annualize Positions
Exhibit 10–2 contains a two-step process to perform the staffing calculation by the annualizing
method. The first step computes the net paid days worked. In this step, the number of paid days
per year is first arrived at; then paid days not worked are deducted to arrive at net paid days
worked. The second step of the staffing calculation converts the net paid days worked to a factor. In the example in Exhibit 10–2, the factor averages out to about 1.6.
This calculation is for a 24-hour around-the-clock staffing schedule. Thus, the 364 in the step
2 formula equates to a 24-hour staffing expectation. Exhibit 10–3 illustrates such a master staffing plan.
Exhibit 10–2 Basic Calculation for Annualizing Master Staffing Plan
Step 1: How Many Net Paid Days Are Worked?
(a) A business year has 364 days.
(b) In this example the employee works five days per week. The other two days
off are not paid for. Thus two days off per week times 52 weeks equals 104
nonpaid days.
(c) Therefore, the number of paid days per year equals 364 less 104, or 260 days.
(d) But not all paid days per year are worked. In this example, each employee
(RN, LPN, and Nurse Assistant [NA]) receives 35 personal leave days.
(The personal leave days are intended to include holidays, sick leave,
and vacation days.)
(e) In addition, these employees are entitled to continuing professional education
(CPE) days. These are also paid days not worked, as follows: RNs 5 5 days;
LPNs 5 3 days; NAs 5 2 days.
(f) Therefore the net paid days worked are as follows:
RN 5 260 days (35) (5) 5 220
LPN 5 260 days (35) (3) 5 222
NA 5 260 days (35) (2) 5 223
Step 2: How Are Net Paid Days Worked Converted to a Factor?
The factor is calculated by dividing total days in the business year (364) by the net paid
days worked, as follows:
RN 5 364/220 5 1.6545
LPN 5 364/222 5 1.6396
NA 5 364/223 5 1.6323
Courtesy of J. J. Baker and R. W. Baker, Dallas, Texas.
FTEs for Annualizing Positions 105
NUMBER OF EMPLOYEES REQUIRED
TO FILL A POSITION: ANOTHER WAY
TO CALCULATE FTES
Why Calculate by Position?
The calculation of number of FTEs by the
scheduled-position method—in other words,
to fill a position—is used in controlling, planning, and decision making. Exhibit 10–4 sets
out the schedule and the FTE computation.
A summarized explanation of the calculation in Exhibit10–4 is as follows. One full-time
employee (as shown) works 40 hours per week. One 8-hour shift per day times 7 days per week
equals 56 hours on duty. Therefore, to cover 7 days per week, or 56 hours, requires 1.4 times a
40-hour employee (56 hours divided by 40 hours equals 1.4), or 1.4 FTEs.
Staffing Calculations to Fill Scheduled Positions
The term “staffing,” as used here, means the assigning of staff to fill scheduled positions. The
staffing measure used to compute coverage is also called the FTE. It measures what proportion
of one single full-time employee is required to equate the hours required (i.e., full-time equivalent) for a particular position. For example, the cast room has to be staffed 24 hours a day, 7
days a week because it supports the emergency room, and therefore has to provide service at
any time. In this example, the employees are paid for an 8-hour shift. The three shifts required
to fill the position for 24 hours are called the day shift (7:00 am to 3:00 pm), the evening shift
(3:00 pm to 11:00 pm), and the night shift (11:00 pm to 7:00 am).
Exhibit 10–4 Staffing Requirements Example
Emergency Department Scheduling for Eight-Hour Shifts:
24-Hour Scheduling
Shift 1 Shift 2 Shift 3
Day Evening Night 5 Total
Position:
Emergency Room Intake 1 1 1 5 3 8-hour shifts
To Cover Position
7 Days per Week
Equals FTEs of: 1.4 1.4 1.4 5 4.2 FTEs
One full-time employee works 40 hours per week. One 8-hour shift per day times 7 days
per week equals 56 hours on duty. Therefore, to cover 7 days per week or 56 hours
requires 1.4 times a 40-hour employee (56 hours divided by 40 hours equals 1.4),
or 1.4 FTEs.
Exhibit 10–3 Master Staffing Plan for
Nursing Unit
8-Hour Shifts RNs LPNs NAs
Day Shift 3 1 6
Evening Shift 2 2 5
Night Shift 1 2 2
24-Hour Total 6 5 13
Courtesy of J.J. Baker and R.W. Baker,
Dallas, Texas.
106 Chapter 10 Staffing: Methods, Operations, and Regulations
One 8-hour shift times 5 days per week equals a 40-hour work week. One 40-hour work week
times 52 weeks equals a person-year of 2,080 hours. Therefore, one person-year of 2,080 hours
equals a full-time position filled for one full year. This measure is our baseline.
It takes seven days to fill the day shift cast room position from Monday through Sunday, as
required. Seven days is 140% of five days (seven divided by five equals 140%), or, expressed
another way, is 1.4. The FTE for the day shift cast room position is 1.4. If a seven-day schedule is
required, the FTE will be 1.4.
This method of computing FTEs uses a basic 40-hour work week (or a 37-hour work week,
or whatever is the case in the particular institution). The method computes a figure that will
be necessary to fill the position for the desired length of time, measuring this figure against the
standard basic work week. For example, if the standard work week is 40 hours and a receptionist
position is to be filled for just 20 hours per week, then the FTE for that position would be 0.5
FTE (20 hours to fill the position divided by a 40-hour standard work week). Table 10–1 illustrates the difference between a standard work year at 40 hours per week and a standard work
year at 37.5 hours per week.
Tying Cost to Staffing
In the case of the annualizing method, the factor of 1.6 already has this organization’s vacation,
holiday, sick pay, and other nonproductive days accounted for in the formula (review Exhibit
10–2 to check out this fact). Therefore, this factor is multiplied times the base hourly rate (the
net rate) paid to compute cost.
In the case of the scheduled-position method, however, the FTE figure of 1.4 will be multiplied times a burdened hourly rate. The burden on the hourly rate reflects the vacation, holiday, sick pay, and other nonproductive days accounted for in the formula (review Exhibit 10–4
to see the difference). The scheduled-position method is often used in the forecasting of new
programs and services.
Actual cost is attached to staffing in the books and records through a subsidiary journal
and a basic transaction record. Exhibit 10–5 illustrates a subsidiary journal in which employee
hours worked for a one-week period are recorded. Both regular and overtime hours are noted.
No. of Annual Hours No. of Annual Hours
Job Position No. of FTEs Paid at 2,080 Hours* Paid at 1,950 Hours**
Supervisor 2.2 4,576 4,290
Techs 3.0 6,240 5,850
RNs 7.7 16,016 15,015
LPNs 1.2 2,496 2,340
Aides, orderlies 1.0 2,080 1,950
Clerical 1.2 2,496 2,340
Totals 16.3 33,904 31,785
*40 hours per week × 52 weeks = 2,080.
**37.5 hours per week × 52 weeks = 1,950.
Table 10–1 Calculations to Staff the Operating Room
Number of Employees Required to Fill a Position: Another Way to Calculate FTEs 107
Exhibit 10–5 Example of a Payroll Register
Metropolis Health System
Payroll Register
Week Ended June 10, ____
Deductions
Hours Worked Federal Employee Base Overtime Gross Income Social Medicare Net
No. Name Regular Overtime Total Rate Pay Premiums Earnings Tax Security Tax Pay
1071 J.F. Green 40 2 42 14.00 588.00 14.00 602.00 90.30 37.32 8.73 465.65
1084 C.B. Brown 40 40 14.00 560.00 560.00 84.00 34.72 8.62 432.66
1090 K.D. Grey 40 40 10.00 400.00 400.00 60.00 24.80 6.16 309.04
1092 R.N. Black 40 5 45 10.00 450.00 25.00 475.00 71.25 29.45 6.89 367.41
Courtesy of Resource Group, Ltd., Dallas, Texas.
108 Chapter 10 Staffing: Methods, Operations, and Regulations
The hourly rate, base pay, and overtime premiums are noted, and gross earnings are computed. Deductions are noted and deducted from gross earnings to compute the net pay for
each employee in the final column.
Exhibit 10–6 illustrates a time card for one employee for a week-long period. This type of
record, whether it is generated by a time clock or an electronic entry, is the original record
upon which the payroll process is based. Thus, it is considered a basic transaction record. In this
example, time in and time out are recorded daily. The resulting regular and overtime hours are
recorded separately for each day worked. Although the appearance of the time card may vary,
and it may be recorded within a computer instead of on a hard copy, the essential transaction is
the same: this recording of daily time is where the payroll process begins.
Exhibit 10–7 represents an emergency department staffing report. Actual productive time is
shown in columns 1 and 2, with regular time in column 1 and overtime in column 2. Nonproductive time is shown in column 3, and columns 1, 2, and 3 are totaled to arrive at column 4,
labeled “Total [actual] Hours.” The final actual figure is the FTE figure in column 5.
The report is biweekly and thus is for a 2-week period. The standard work week amounts
to 40 hours, so the biweekly standard work period amounts to 80 hours. Note the first line
Metropolis Health System
Time Card
Employee J.F. Green No. 1071
Department 3 Week ending June 10
Regular Overtime Hours
Day In Out In Out In Out Regular Overtime
Monday 8:00 12:01 1:02 5:04 8
Tuesday 7:56 12:00 12:59 5:03 6:00 8:00 8 2
Wednesday 7:57 12:02 12:58 5:00 8
Thursday 8:00 12:00 1:00 5:01 8
Friday 7:59 12:01 1:01 5:02 8
Saturday
Sunday
Total regular hours 40
Total overtime 2
Courtesy of Resource Group, Ltd., Dallas, Texas.
Exhibit 10–6 Example of a Time Record
Number of Employees Required to Fill a Position: Another Way to Calculate FTEs 109
PR 2301
Biweekly Comparative Hours Report
for the Payroll Period Ending Sept. 20, ____
Dept. No. 3421
Emergency Room
Actual
Productive Budget Variance
Job
Code
Regular
Time
(1)
Overtime
(2)
NonProductive
(3)
Total
Hours
(4)
FTEs
(5)
Productive
(6)
NonProductive
(7)
Total
Hours
(8)
FTEs
(9)
Number
Hours
(10)
Number
FTEs
(11)
Percent
(12)
Mgr Nursing Service 11075 80 0 0 80 1.0 69.8 10.2 80 1 0 0 0
Supv Charge Nurse 11403 383.2 0.1 79 462.3 5.8 456 64 520 6.5 57.7 0.7 11.1%
Medical Assistant 12007 6.2 0 0 6.2 0.1 0 0 0 0 –6.2 –0.1 100.0%
Staff RN 13401 2010.5 32.8 285.8 2329.1 29.1 2012.8 240.8 2253.6 28.2 –75.5 –0.9 –3.4%
Relief Charge Nurse 13403 81.9 4.3 0 86.2 1.1 0 0 0 0 –86.2 –1.1 100.0%
Orderly/Transporter 15483 203.8 38 20 261.8 3.3 279.8 35.3 315.1 3.9 53.3 0.6 16.9%
ER Tech 22483 244.6 27.5 67.9 340 4.3 336.2 34.5 370.7 4.6 30.7 0.3 8.3%
Secretary 22730 58.1 0 0 58.1 0.7 50.5 5.9 56.4 0.7 –1.7 0.0 –3.0%
Unit Coordinator 22780 555.1 35.6 74.9 665.6 8.3 505.4 53.8 559.2 7 –106.4 –1.3 –19.0%
Preadmission Testing
Clerk
22818 0 6.5 0 6.5 0.1 0 0 0 0 –6.5 –0.1 100.0%
Patient Registrar 22873 617.5 78.6 105.7 801.8 10.0 718.2 57.8 776 9.7 –25.8 –0.3 –3.3%
Lead Patient Registrar 22874 0 0 0 0 0.0 73.8 6.2 80 1 80.0 1.0 100.0%
Patient Registrar
(weekend)
22876 36.7 0 0 36.7 0.5 0 0 0 0 –36.7 –0.5 100.0%
Overtime 29998 0 0 0 0 0.0 38.5 0 38.5 0.5 38.5 0.5 100.0%
Department Totals 4277.6 223.4 633.3 5134.3 64.3 4541 508.5 5049.5 63.1 –84.8 –1.2 0.0
Courtesy of Resource Group, Ltd., Dallas, Texas.
Exhibit 10–7 Comparative Hours Staffing Report
110 Chapter 10 Staffing: Methods, Operations, and Regulations
item, which is for the manager of the emergency department nursing service. The actual hours
worked in column 4 amount to 80, and the actual FTE figure in column 5 is 1.0. We can tell
from this line item that the second method of computing FTEs—the FTE computation to fill
scheduled positions—has been used in this case. Columns 7 through 9 report budgeted time
and FTEs, and columns 10 through 12 report the variance in actual from budget. The budget
and variance portions of this report structure will be more thoroughly discussed in the chapter
about operating budgets.
In summary, hours worked and pay rates are essential ingredients of staffing plans, budgets,
and forecasts. Appropriate staffing is the responsibility of the manager.
REGULATORY REQUIREMENTS REGARDING STAFFING
As if staffing a healthcare organization wasn’t complex enough because of the typical need to
cover 24 hours a day, there are regulatory requirements that impact staffing configurations.
The IMPACT Act Staffing Report Requirements
This complexity is no more apparent than in the new (2016) skilled nursing facility staffing
requirements embodied in P.L. 113-185, the Improving Medicare Post-Acute Care Transformation Act of 2014 (the IMPACT Act). In essence, the Centers for Medicare and Medicaid Services
(CMS) are now seeking improved reporting on nursing home staffing.
Regulatory Specifics About Staffing Reports
The first set of regulatory specifics is contained in the Final Rule for the FY 2016 Prospective Payment System under the heading “Staffing Data Collection.”2 The regulation had its
genesis in the Affordable Care Act, P.L. 111-148. Section 1128I(g) specifies that a facility is
required to “electronically submit…direct care staffing information, including information
for agency and contract staff, based on payroll and other verifiable and auditable data in a
uniform format according to specifications established by the Secretary in consultation with
(stakeholders).”3
The direct care staffing information submitted to CMS then appears on the Nursing Home
Compare website.4 Note the phrase “verifiable and auditable data.” Previously, facilities could
self-report such staffing information, but this information did not have to be “verifiable and
auditable.”
Additional Reporting Requirements
Additional requirements are also spelled out in the statute. Specifications in the CMS regulation state that the following must be included in the report:
• The category of work a certified employee performs (such as whether the employee is a
registered nurse, licensed practical nurse, licensed vocational nurse, certified nursing assistant, therapist, or other medical personnel)
• Resident census data
• Information on resident case mix
• Information on employee turnover and tenure
• The hours of care provided by each category of certified employees per resident per day5
Regulatory Requirements Regarding Staffing 111
This information must be reported on a regular basis. Also, information for agency and contract staff must be kept separate from the information submitted for employee staffing.
We draw your attention to the two phrases requiring the following: the category of work
a certified employee performs and the hours of care provided by each category of certified
employees per resident per day. What can your organization do to ensure compliance with
these requirements that is both “verifiable and auditable”?
For example, which documentation within your system should be retained? To what level
of detail should it be retained, and for how long? What guidance can be found, either
from government sources or from your professional organizations? And if such guidance is
made available, how do your own records compare? What adjustments or additions should
be made?
We can also expect that these specific requirements will evolve over time. While the first set
of regulatory specifics is set out within the FY 2016 PPS final rule, we can expect that refinements to these requirements will be forthcoming over each succeeding year, as experience provides evidence for the needed adjustments.
Funding Provided for Report Improvements
The IMPACT Act provides a one-time allocation of $11 million to implement these improvements to the Nursing Home Compare website.6 (Additional details about the Nursing Home
Compare website and its 5-Star Rating appear in the chapter titled, “Standardizing Measures
and Payment in Post-Acute Care: New Requirements”.)
From a public domain perspective, Medicare.gov/Nursing Home Compare serves as a useful
reference enabling consumers to assess staffing results among Medicare and Medicaid participating nursing homes. Staffing data are submitted by the facility and are adjusted for the needs
of nursing home residents.
State Certificate-of-Need (CON) Laws and Regulations
Additional regulatory sources have had an impact on staffing. Central to health planning in the
United States are Certificate-of-Need (CON) regulations. To place CON in its proper context, a
brief overview of health planning is in order.
Health Planning Background
Shortly after Medicare was enacted into law in 1965, the Comprehensive Health Planning
and Services Act (CHP) was passed in 1966. It was noteworthy insofar as it encouraged states
to use health planning to remedy geographic disparities in access to care. This was an application of planning that went beyond just allocating funds for hospital construction as in the
historically important Hospital Survey and Construction Act of 1946, popularly known as the
Hill–Burton Act.7
Planning was carried out by state-level CHP-A agencies and local CHP-B agencies. The former was charged with developing a statewide, comprehensive plan for the delivery of health
services in each state; the latter were responsible for assessing the health-services needs of populations in their designated areas, determining the availability of resources, and developing a
plan that specified what was required to meet those needs.8
While it is beyond the scope of this text to analyze in depth why the CHP program didn’t
deliver as promised, suffice it to say that it had no resource development component. Resources
112 Chapter 10 Staffing: Methods, Operations, and Regulations
that were necessary to meet a community’s needs had to be sought outside the CHP program’s
parameters. In effect, then, CHP’s impact on staffing was immeasurable.
Congress sought to rectify CHP’s shortcomings by enacting the National Health Planning
and Resources Development Act in 1974. The Act created state-level organizations that were
charged with developing and implementing the state health plan. Operationally, though, it was
the health systems agencies (HSAs), local organizations, that served a regulatory function. They
were charged with developing annual plans to improve health services in their regions.9
The Certificate-of-Need (CON) Program
The regulatory leverage that states used to act on proposals for changes in health services was
(and is) the Certificate-of-Need (CON) program. The program was originally aimed at hospitals
and nursing homes that were permitted to spend funds on services, facilities, and equipment
only if a need had been identified in the HSA plan for their region. The basic assumption
underlying CON regulation is that excess capacity (in the form of facility overbuilding) directly
results in healthcare price inflation.10 The 1974 law required all 50 states to have a structure in
place involving the submitting of proposals and obtaining approval from a state health planning agency.
In 1986, the National Health Planning and Resources Development Act was repealed, along
with its federal funding. Despite numerous changes since, 36 states retain some type of CON
program, law, or agency according to the National Conference of State Legislatures.11 These
states tend to concentrate activities on outpatient facilities and long-term care. This is largely
due to the trend toward free-standing, physician-owned facilities that constitute an increasing
segment of the healthcare market.
How Do CON-Related Regulations Affect Staffing?
State CON-related regulations affect staffing across different types of facilities. For example, if a
hospital CON is filed seeking approval for a new surgical wing, staffing needs must be included
in the application along with facility and equipment requirements. If a nursing home is seeking to expand its bed capacity, new staff such as RNs, LPNs, and possibly even therapists will be
required. If a home care agency is seeking to increase its geographic reach and expand its program capacity, new nursing–related and social work staff will be required.
A prime example of state regulatory requirements on minimum staffing levels in nursing
homes may be found in Nursing Home Staffing Standards in State Statutes and Regulations.12
It depicts minimum staffing standards for skilled nursing or nursing facilities. For example, for
every state it lists three variables:
1. A Sufficient Staff Statement (i.e., Licensed to meet the needs of individual residents)
2. Staff Requirement (i.e., RN, LPN/LVN per hour/per bed)
3. Direct Care Requirements (i.e., Two people on duty at all times)
This site is a useful planning tool.
SUMMARY
Staffing operations throughout the U.S. are obviously impacted by regulations about staffing
and staffing reports. And desired expansion and related operational issues in 36 states are naturally affected by applicable certificate of need requirements.
Summary 113
INFORMATION CHECKPOINT
What is needed? The original record of time and the subsidiary journal
summary.
Where is it found? The original record can be found at any check-in point; the
subsidiary journal summary can be found with a supervisor
in charge of staffing for a unit, division, and so on.
How is it used? It is reviewed as historical evidence of results achieved. It is
also reviewed by managers seeking to perform future staffing in an efficient manner.
KEY TERMS
Certificate of Need (CON)
Full-Time Equivalents (FTEs)
Nonproductive Time
Productive Time
Staffing
DISCUSSION QUESTIONS
1. Are you or your immediate supervisor responsible for staffing?
2. If so, do you use a computerized program?
3. Do you believe a computerized program is better? If so, why?
4. Does your organization report time as “productive” and “nonproductive”?
5. If not, do you believe it should? What do you believe the benefits would be?
6. If your state has certificate-of-need (CON) regulations in place, has your organization
made a CON request in the recent past? If so, was it successful? Please describe.
NOTES
1. J. J. Baker, Prospective Payment for Long-Term Care: An Annual Guide (Gaithersburg, MD:
Aspen Publishers, Inc., 1999).
2. 80 FR 46462 (Aug. 4, 2015).
3. Ibid.
4. “What is Nursing Home Compare?”, Medicare.gov, http://www.medicare.gov/nursing
homecompare/About/What-Is-NHC.html
5. 80 FR 46462.
6. SSA Sec. 1819(i).
7. R. I. Field, Health Care Regulation in America: Complexity, Confrontation, and Compromise (New York, NY: Oxford University Press, 2007).
114 Chapter 10 Staffing: Methods, Operations, and Regulations
8. P. L. Barton, Understanding the U.S. Health Services System (4th ed.) (Chicago, IL: Health
Administration Press, 2010).
9. Field, Health Care Regulation.
10. Ibid.
11. National Conference of State Legislatures, “CON—Certificate of Need State Laws,”
http://www.ncsl.org/research/health/con-certificate-of-need-state-laws.aspx, accessed
June 9, 2016.
12. Charlene Harrington, “Nursing Home Staffing Standards in State Statutes and Regulations,”
The National Long-Term Care Ombudsman Resource Center, http://ltcombudsman
.org/uploads/files/support/Harrington-state-staffing-table-2010_(1).pdf, accessed
June 12, 2016.
Notes 115

© LFor/Shutterstock
PART
IV
Report and Measure
Financial Results

Progress Notes
© LFor/Shutterstock
Reporting as a Tool
UNDERSTANDING THE MAJOR REPORTS
It is not our intention to convert you into an accountant.
Therefore, our discussion of the major financial reports
will center on the concept of each report and not on the
precise accounting entries that are necessary to make the
statement balance. The first concept we will discuss is that
of cash versus accrual accounting. In cash basis accounting, a transaction does not enter the books until cash is
either received or paid out. In accrual accounting, revenue is recorded when it is earned—not when payment
is received—and expenses are recorded when they are
incurred—not when they are paid.1 Most healthcare organizations operate on the accrual basis.
There are four basic financial statements. You can think
of them as a set. They include the balance sheet, the statement of revenue and expense, the statement of fund balance or net worth, and the statement of cash flows. The four
major reports we are about to examine—the financial statements—have been prepared using the accrual method.
BALANCE SHEET
The balance sheet records what an organization owns, what
it owes, and basically, what it is worth (although the terminology uses fund balance rather than worth or equity for nonprofit organizations). The balance sheet balances. That is,
the total of what the organization owns—its assets—equals
the combined total of what the organization owes and what
it is worth—its liabilities and its net worth, or its fund balance. This balancing of the elements in the balance sheet
can be visualized as
Assets 5 Liabilities 1 Net Worth/Fund Balance
After completing this chapter,
you should be able to
1. Review a balance sheet and
understand its components.
2. Review a statement of revenue and expense and understand its components.
3. Understand the basic concept of cash flows.
4. Know what a subsidiary
report is.
119
11
CHAPTER
Another characteristic of the balance sheet is that it is stated at a particular point in time.
A common analogy is that a balance sheet is like a snapshot: it freezes the figures and reports
them as of a certain date.
Exhibit 11–1 illustrates these concepts. A single date (not a period of time) is at the top of
the statement (this is the snapshot). The clinic balance sheet reflects two years in two columns,
with the most current date on the left and the prior period on the right. Total assets for the current left-hand column amount to $963,000. Total liabilities and fund balance also amount to
$963,000; the balance sheet balances. The total liabilities amount to $545,000 and the total fund
balances amount to $418,000. The total of the two, of course, makes up the $963,000 shown at
the bottom of the statement.
Three types of assets are shown: current assets; property, plant, and equipment; and other
assets. Current assets are supposed to be convertible into cash within one year—thus “current”
assets. Property, plant, and equipment, however, represent long-term assets. Other assets represent noncurrent items.
Two types of liabilities are shown: current liabilities and long-term debt. Current liabilities
are those expected to be paid within the next year—thus “current” liabilities. Long-term debt
is not due within a year. (In fact, most long-term debt is due over a period of many years.) The
amount of long-term debt that will be due within the next year ($52,000) has been subtracted
from the long-term debt amount and has been moved up into the current liabilities section.
This treatment is consistent with the concept of “current.”
Once again, because our intent is not to make an accountant of you, we will not be discussing
generally accepted accounting principles (GAAP) either. Financial accounting and the resulting reports intended for third-party use must be prepared in accordance with GAAP. However,
managerial accounting for internal purposes in the organization does not necessarily have to
adhere to GAAP. One of the requirements of GAAP is that unrestricted fund balances be separated from restricted fund balances on the statements, so you see two appropriate line items
(restricted and unrestricted) in the fund balance section.
We should also mention that the standards underlying generally accepted accounting
principles within the United States are produced by the Financial Accounting Standards
Board (FASB). Sometime in the (probable) near future U.S. publicly held companies may
be required to adopt certain international accounting standards as produced by the International Accounting Standards Board (IASB). Benefits would include global comparability
and consistency in accounting standards and financial reports while barriers to such adoption include funding, maintenance, application, and governance.2 Any further discussion of
these accounting issues is beyond the scope of this text.
STATEMENT OF REVENUE AND EXPENSE
The formula for a very condensed statement of revenue and expense would look like this:
Operating Revenue 2 Operating Expenses 5 Operating Income
A statement of revenue and expense covers a period of time (rather than one single date or
point in time). The concept is that revenue, or inflow, less expenses, or outflow, results in an
excess of revenue over expenses if the year has been good, or perhaps an excess of expenses
over revenue (resulting in a loss) if the year has been bad.
120 Chapter 11 Reporting as a Tool
Exhibit 11–2 sets out the result of operations for two years, with the most current period
in the left column. If the balance sheet is a snapshot, then the statement of revenue and
expenses is a diary, because it is a record of transactions over the period of a year. Operating
Exhibit 11–1 Westside Clinic Balance Sheet
Assets December 31, 2034 December 31, 2033
Current Assets
Cash and cash equivalents $190,000 $145,000
Accounts receivable (net) 250,000 300,000
Inventories 25,000 20,000
Prepaid Insurance 5,000 3,000
Total Current Assets $470,000 $468,000
Property, Plant, and Equipment
Land $100,000 $100,000
Buildings (net) 0 0
Equipment (net) 260,000 300,000
Net Property, Plant, and Equipment 360,000 400,000
Other Assets
Investments $133,000 $32,000
Total Other Assets 133,000 32,000
Total Assets $963,000 $900,000
Liabilities and Fund Balance
Current Liabilities
Current maturities of
long-term debt $52,000 $48,000
Accounts payable and
accrued expenses 293,000 302,000
Total Current Liabilities $345,000 $350,000
Long-Term Debt $252,000 $300,000
Less Current Maturities of
Long-Term Debt 252,000 248,000
Net Long-Term Debt 200,000 252,000
Total Liabilities $545,000 $602,000
Fund Balances
Unrestricted fund balance $418,000 $298,000
Restricted fund balance 0 0
Total Fund Balances 418,000 298,000
Total Liabilities and Fund Balance $963,000 $900,000
Statement of Revenue and Expense 121
revenues and operating expenses are set out first, with the result being income from operations of $115,000 ($2,000,000 less $1,885,000). Then other transactions are reported; in this
case, interest income of $5,000 under the heading “Nonoperating Gains (Losses).” The total
of $120,000 ($115,000 plus $5,000) is reported as an increase in fund balance. This figure
carries forward to the next major report, known as the statement of changes in fund balance.
STATEMENT OF CHANGES IN FUND BALANCE/NET WORTH
Remember that our formula for a basic statement of revenue and expense looked like this:
Operating Revenue 2 Operating Expenses 5 Operating Income
The excess of revenue over expenses flows back into equity or fund balance through the
mechanism of the statement of fund balance/net worth. Exhibit 11–3 shows a balance at the
first of the year, then it adds the excess of revenue over expenses (in the amount of $115,000)
For the Year Ending
Revenue December 31, 2034 December 31, 2033
Net Patient Service Revenue $2,000,000 $1,850,000
Total Operating Revenue $2,000,000 $1,850,000
Operating Expenses
Medical/surgical services $600,000 $575,000
Therapy services 860,000 806,000
Other professional services 80,000 75,000
Support services 220,000 220,000
General services 65,000 60,000
Depreciation 40,000 40,000
Interest 20,000 24,000
Total Operating Expenses 1,885,000 1,800,000
Income from Operations $115,000 $50,000
Nonoperating Gains (Losses)
Interest Income $5,000 $2,000
Net Nonoperating Gains 5,000 2,000
Revenue and Gains in Excess of
Expenses and Losses $120,000 $52,000
Increase in Unrestricted Fund Balance $120,000 $52,000
Exhibit 11–2 Westside Clinic Statement of Revenue and Expenses
122 Chapter 11 Reporting as a Tool
plus some interest income (in the amount of $5,000) to arrive at the balance at the end of
the year.
If you refer back to the balance sheet, you will see the $418,000 balance at the end of the year
appearing on it. So we can think of the balance sheet, the statement of revenue and expenses,
and the statement of changes in fund balance/net worth as locked together, with the statement of
changes in fund balance being the mechanism that links the other two statements.
But there is one more major report—the statement of cash flows—and we will examine it next.
STATEMENT OF CASH FLOWS
To perceive why a statement of cash flows is necessary, we must first revisit the concept of accrual
basis accounting. If cash is not paid or received when revenues and expenses are entered on the
books—the usual situation in accrual accounting—what happens? The other side of the entry
for revenues is accounts receivable, and the other side of the entry for expenses is accounts payable. These accounts rest on the balance sheet and have not yet been turned into cash. Another
characteristic of accrual accounting is the recognition of depreciation. A capital asset—a piece
of equipment, for example—is purchased for $20,000. It has a usable life of five years. So depreciation expense is recognized in each of the five years until the $20,000 is used up, or depreciated. (Land is an exception to this rule: it is never depreciated.) Depreciation is recognized
within each year as an expense, but it does not represent a cash expense. This is a concept that
now enters into the statement of cash flows.
Exhibit 11–4 presents the current period cash flow. In effect, this statement takes the accrual
basis statements and converts them to a cash flow for the period through a series of reconciling
adjustments that account for the noncash amounts.
Understanding the cash/noncash concept makes sense of this statement. The starting point
is the income from operations, the subtotal from the statement of revenue and expense. Depreciation and interest are added back, and changes in asset and liability accounts, both positive
and negative, are recognized. These adjustments account for operating activities. Next, capital
and related financing activities are addressed, then investing activities are adjusted. The result
is a net increase in cash and cash equivalents of $45,000 in our example. This figure is added to
the cash balance at the beginning of the year ($145,000) to arrive at the cash balance at the end
of the year ($190,000). Now refer back to the balance sheet, and you will find the cash balance
is indeed $190,000. So the fourth major report—the statement of cash flows—interlocks with
the other three major reports.
Exhibit 11–3 Westside Clinic Statement of Changes in Fund Balance
For the Year Ending
Statement of Changes in Fund Balance December 31, 2034 December 31, 2033
Balance First of Year $298,000 $246,000
Revenue in Excess of Expenses 115,000 50,000
Interest Income 5,000 2,000
Balance End of Year $418,000 $298,000
Statement of Cash Flows 123
SUBSIDIARY REPORTS
The subsidiary reports are just that; subsidiary to the major reports. These reports support
the major reports by providing more detail. For example, patient service revenue totals on the
Exhibit 11–4 Westside Clinic Statement of Cash Flows
Statement of Cash Flows For the Year Ending
December 31, 2034 December 31, 2033
Operating Activities
Income from Operations $115,000 $50,000
Adjustments to reconcile income from
operations to net cash flows from
operating activities
Depreciation and amortization 40,000 40,000
Interest expense 20,000 24,000
Changes in asset and liability accounts
Patient accounts receivable 50,000 2250,000
Inventories 25,000 25,000
Prepaid expenses and other assets 22,000 21,000
Accounts payable and accrued
expenses 29,000 185,000
Net Cash Flow from Operating Activities $209,000 $43,000
Cash Flows from Noncapital Financing Activities 0 0
Cash Flows from Capital and Related
Financing Activities
Acquisition of equipment $ 0 $ (300,000)
Proceeds from loan for equipment 0 300,000
Interest paid on long-term obligations 220,000 0
Repayment of long-term obligations 248,000 0
Net Cash Flows from Capital and Related
Financing Activities 268,000 0
Cash Flows from Investing Activities
Interest income received $5,000 $2,000
Investments purchased (net) 2101,000 0
Net Cash Flows from Investing Activities 296,000 2,000
Net Increase (Decrease) in Cash and Cash
Equivalents $45,000 $45,000
Cash and Cash Equivalents, Beginning of Year 145,000 100,000
Cash and Cash Equivalents, End of Year $190,000 $145,000
124 Chapter 11 Reporting as a Tool
statement of revenue and expenses are often expanded in more detail on a subsidiary report.
The same thing is true of operating expense. These reports are called “schedules” instead of
“statements”—a sure sign that they are subsidiary reports.
SUMMARY
The four major reports fit together; each makes its own contribution to the whole. A checklist
for balance sheet review (Exhibit 11–5) and a checklist for review of the statement of revenue
and expense (Exhibit 11–6) are provided.
Exhibit 11–6 Checklist for Review of the Statement of Revenue and Expense
1. What is the period reported on the statement of revenue and expense?
2. Is it one year or a shorter period? If it is a shorter period, why is that?
3. Are there large discrepancies in balances between the prior year operations and the
current year operations?
4. Did total operating revenue increase over the prior year?
5. Did total operating expenses increase, decrease, or stay about the same? Is any
particular line item unusually large or small?
6. Did income from operations increase, decrease, or stay about the same?
7. Are there unusual nonoperating gains or losses?
8. Did the current year result in an excess of revenue over expense? Is it as much as the
prior year?
9. Did long-term debt increase or decrease significantly over the prior year?
Exhibit 11–5 Checklist for the Balance Sheet Review
1. What is the date on the balance sheet?
2. Are there large discrepancies in balances between the prior year and the current year?
3. Did total assets increase over the prior year?
4. Did current assets increase, decrease, or stay about the same?
5. Did current liabilities increase, decrease, or stay about the same?
6. Did land, plant, and equipment increase or decrease significantly over the prior year?
7. Did long-term debt increase or decrease significantly over the prior year?
INFORMATION CHECKPOINT
What is needed? A set of financial statements, ideally containing the four major
reports plus subsidiary reports for additional detail.
Where is it found? Possibly in the files of your supervisor or in the finance office
or in the office of the administrator.
Information Checkpoint 125
How is it used? Study the financial statement to see how they fit together;
use the checklists included in this chapter to assist in your
review. Understanding how the statements work will give
you another valuable managerial tool.
KEY TERMS
Accrual Basis Accounting
Balance Sheet
Cash Basis Accounting
Statement of Cash Flows
Statement of Fund Balance/Net Worth
Statement of Revenue and Expense
Subsidiary Reports
DISCUSSION QUESTIONS
1. Can you give an example of an asset? A liability?
2. Does the concept of revenue less expense equaling an increase in equity or fund balance
make sense to you? If not, why not?
3. Are you familiar with the current maturity of long-term debt? What example of it can you
give in your own life (either at work or at home)?
4. Do you get a chance to review financial statements at your place of work? Would you like
to? Why?
NOTES
1. S. A. Finkler, et al., Essentials of Cost Accounting for Health Care Organizations, 3rd ed. (Sudbury MA: Jones & Bartlett Publishers, 2007).
2. K. Tysiac, “Still in Flux: Future of IFRS in U.S. Remains Unclear After SEC report,”
Journal of Accountancy (September 2012), www.journalofaccountancy.com/Issues/2012
/Sep/20126059.htm
126 Chapter 11 Reporting as a Tool
Progress Notes
© LFor/Shutterstock
CHAPTER
Financial and
Operating Ratios as Performance Measures
THE IMPORTANCE OF RATIOS
Ratios are convenient and uniform measures that are
widely adopted in healthcare financial management.
They are important because they are so widely used,
especially because they are used for credit analysis. But a
ratio is only a number. It has to be considered within the
context of the operation. There is another caveat: ratio
analysis should be conducted as a comparative analysis.
In other words, one ratio standing alone with nothing to
compare it with does not mean very much. When interpreting ratios, the differences between periods must be
considered, and the reasons for such differences should
be sought. It is a good practice to compare results with
equivalent computations from outside the organization—
regional figures from similar institutions would be a good
example of such outside sources. Caution and good managerial judgment must always be exercised when working
with ratios.
Financial ratios basically pull together two elements of
the financial statements: one expressed as the numerator
and one as the denominator. To calculate a ratio, divide the
bottom number (the denominator) into the top number
(the numerator). The Case Study that is entitled “Comparative Analysis (Financial Ratios and Benchmarking) Helps
Turn Around a Hospital” uses financial ratios as indicators
of financial position. We highly recommend that you spend
time with this Case Study, as it will add depth and background to the contents of this chapter.
In this chapter we examine liquidity, solvency, and profitability ratios. Exhibit 12–1 sets out eight basic ratios that
are widely used in healthcare organizations: four liquidity
types, two solvency types, and two profitability types. All are
discussed in this chapter.
After completing this chapter,
you should be able to
1. Understand four types of
liquidity ratios.
2. Understand two types of
solvency ratios.
3. Understand two types of
profitability ratios.
4. Successfully compute ratios.
127
12
CHAPTER
Exhibit 12–1 Eight Basic Ratios Used in Health Care
Liquidity Ratios
1. Current Ratio
Current Assets
Current Liabilities
2. Quick Ratio
Cash and Cash Equivalents 1 Net Receivables
Current Liabilities
3. Days Cash on Hand (DCOH)
Unrestricted Cash and Cash Equivalents
Cash Operation Expenses 4 No. of Days in Period (365)
4. Days Receivables
Net Receivables
Net Credit Revenues 4 No. of Days in Period (365)
Solvency Ratios
5. Debt Service Coverage Ratio (DSCR)
Change in Unrestricted Net Assets (net income)
1 Interest, Depreciation, Amortization
Maximum Annual Debt Service
6. Liabilities to Fund Balance
Total Liabilities
Unrestricted Fund Balances
Profitability Ratios
7. Operating Margin (%)
Operating Income (Loss)
Total Operating Revenues
8. Return on Total Assets (%)
EBIT (Earnings Before Interest and Taxes)
Total Assets
Courtesy of Resource Group, Ltd., Dallas, Texas.
128 Chapter 12 Financial and Operating Ratios as Performance Measures
LIQUIDITY RATIOS
Liquidity ratios reflect the ability of the organization to meet its current obligations. Liquidity
ratios measure short-term sufficiency. As the name implies, they measure the ability of the organization to “be liquid”: in other words, to have sufficient cash—or assets that can be converted
to cash—on hand.
Current Ratio
The current ratio equals current assets divided by current liabilities. For instance, consider this
example:
Current Assets 5 $120,000 5 2 to 1
Current Liabilities $60,000
This ratio is considered to be a measure of short-term debt-paying ability. However, it must
be carefully interpreted. The standard by which the current ratio is measured is 2 to 1, as
computed.
Quick Ratio
The quick ratio equals cash plus short-term investments plus net receivables divided by current
liabilities:
Cash and Cash Eqivalents 1 Net Receivables 5 $65,000 5 1.08 to 1
Current Liabilities $60,000
The standard by which the quick ratio is measured is generally 1 to 1. This computation, at
1.08 to 1, is a little better than the standard.
This ratio is considered to be an even more severe test of short-term debt-paying ability (even
more than the current ratio). The quick ratio is also known as the acid-test ratio, for obvious
reasons.
Days Cash on Hand
The days cash on hand (DCOH) equals unrestricted cash and investments divided by cash operating expenses divided by 365:
Unrestricted Cash and Cash Equivalents 5 $330,000 5 30 days Cash Operating Expenses $11,000
4 No. of Days in Period
There is no concrete standard for this computation.
This ratio indicates cash on hand in relation to the amount of daily operating expense. This
example indicates the organization has 30 days worth of operating expenses represented in the
amount of (unrestricted) cash on hand.
Liquidity Ratios 129
Days Receivables
The days receivables computation is represented as net receivables divided by net credit revenues divided by 365:
Net Receivables 5 $720,000 5 60 days Net Credit Revenue/No. of Days in Period $12,000
This computation represents the number of days in receivables. The older a receivable is, the
more difficult it becomes to collect. Therefore, this computation is a measure of worth as well
as performance.
There is no hard and fast rule for this computation because much depends on the mix of
payers in your organization. This example indicates that the organization has 60 days worth of
credit revenue tied up in net receivables. This computation is a common measure of billing and
collection performance. There are many “days receivables” regional and national figures to
compare with your own organization’s computation.
Figure 12–1 shows how the information for the numerator and the denominator of each
calculation is obtained. It takes the Westside Clinic balance sheet and the statement of revenue and expense that were discussed in the preceding chapter and illustrates the source
of each figure in the four ratios just discussed. The multiple computations for days cash on
hand and for days receivables are further broken down into a three-step process. If you study
Figure 12–1 and work with the Case Study entitled “Comparative Analysis (Financial Ratios
and Benchmarking) Helps Turn Around a Hospital”, you will soon master this process.
SOLVENCY RATIOS
Solvency ratios reflect the ability of the organization to pay the annual interest and principal
obligations on its long-term debt. As the name implies, they measure the ability of the organization to “be solvent”: in other words, to have sufficient resources to meet its long-term
obligations.
Debt Service Coverage Ratio
The debt service coverage ratio (DSCR) is represented as change in unrestricted net assets
(net income) plus interest, depreciation, and amortization divided by maximum annual debt
service:
Change in Unrestricted Net Assets (Net Income)
1 Interest, Depreciation, and Amortization 5 $250,000 5 2.5
Maximum Annual Debt Service $100,000
This ratio is universally used in credit analysis and figures prominently in the Mini-Case
Study.
Each lending institution has its particular criteria for the DSCR. Lending agreements often
have a provision that requires the DSCR to be maintained at or above a certain figure.
130 Chapter 12 Financial and Operating Ratios as Performance Measures
Figure 12–1 Examples of Liquidity Ratio Calculations.
Courtesy of Resource Group, Ltd, Dallas, Texas.
Assets December 31, 20X2
Current Assets
Cash and cash equivalents $190,000
Accounts receivable (net) 250,000
Inventories 52 ,000
Prepaid Insurance , 5 000
Total Current Assets $470,000
Property, Plant, and Equipment
Land $100,000
Buildings (net) 0
Equipment (net) 260,000
Net Property, Plant, and Equipment 360,000
Other Assets
Investments $133,000
133,000
Total Other Assets
Total Assets $963,000
Liabilities and Fund Balance
Current Liabilities
Current maturities of long-term debt $52,000
Accounts payable and accrued expenses 293,000
Total Current Liabilities $345,000
Long-Term Debt $252,000
Less Current Maturities of Long-Term Debt (52,000)
Net Long-Term Debt 200,000
Total Liabilities $545,000
Fund Balances
Unrestricted fund balance $418,000
Restricted fund balance 0
Total Fund Balances 418,000
Total Liabilities and Fund Balance $963,000
For the Year Ending
Revenue December 31, 20X2
Net patient service revenue
$2,000,000
Total operating revenue
$2,000,000
Operating Expenses
Medical/surgical services $600,000
Therapy services 860,000
Other professional services 80,000
Support services 220,000
General services 65,000
Depreciation 40,000
Interest 20,000
Total operating expenses
$1,885,000
Income from Operations $115,000
Nonoperating Gains (Losses)
Interest Income $5,000
Net nonoperating gains 5,000
Revenue and Gains in Excess of
Expenses and Losses $120,000
Increase in Unrestricted Fund Balance $120,000
470,000
345,000
= 1.362
Current Assets
Current Liabilities
1. Current Ratio
Step 2
1,845,000
365
= 5,055
Step 3
190,000
5,055
= 37.5 days
Step 1
1,885,000
(40,000)
1,845,000
190,000 + 250,000
345,000
= 1.275
Cash and Cash Equivalent +
Net Receivables
Current Liabilities
2. Quick Ratio
3. Days Cash on Hand (DCOH)
Unrestricted Cash and Cash Equivalents
Cash Operating Expenses divided by #
days in period (365)
Step 2
1,800,000
365
= 4,931
Step 3
250,000
4,931
= 50.7 days
Step 1
2,000,000
× 90%
1,800,000 4. Days Receivables
Net Receivables
Net Credit Revenue divided by # days in period (365)
Percent of Credit Revenues
Information obtained elsewhere
Statement of Revenue and Expenses
Balance Sheet
Solvency Ratios 131
Liabilities to Fund Balance (or Debt to Net Worth)
The liabilities to fund balance or net worth computation is represented as total liabilities divided by
unrestricted net assets (i.e., fund balances or net worth) or total debt divided by tangible net worth:
Total Liabilities 5 $2,000,000 5 0.80
Unrestricted Fund Balances $2,250,000
This figure is a quick indicator of debt load.
Another indicator that is more severe is long-term debt to net worth (fund balance), which is
computed as long-term debt divided by fund balance. This computation is somewhat equivalent
to the quick ratio discussed previously in its restrictiveness to net worth computation.
A mirror image of total liabilities to fund balance is total assets to fund balance, which is computed as total assets divided by fund balance.
Figure 12–2 shows how the information for the numerator and the denominator of each
calculation is obtained. This figure again takes the Westside Clinic balance sheet and statement
of revenue and expense that were discussed in the preceding chapter and illustrates the source
of each figure in the two solvency ratios just discussed, along with each figure in the two profitability ratios still to be discussed. When multiple computations are necessary, they are further
broken down into a two-step process.
PROFITABILITY RATIOS
Profitability ratios reflect the ability of the organization to operate with an excess of operating
revenue over operating expense. Nonprofit organizations may not call this result a profit, but
the measurement ratios are still generally called profitability ratios, whether they are applied to
for-profit or nonprofit organizations.
Operating Margin
The operating margin, which is generally expressed as a percentage, is represented as operating
income (loss) divided by total operating revenues:
Operating Income (Loss) 5 $250,000 5 5.0%
Total Operating Revenues $5,000,000
This ratio is used for a number of managerial purposes and also sometimes enters into credit
analysis. It is therefore a multipurpose measure. It is so universal that many outside sources are
available for comparative purposes. The result of the computation must still be carefully considered because of variables in each period being compared.
Return on Total Assets
The return on total assets is represented as earnings before interest and taxes (EBIT) divided
by total assets:
EBIT 5 $400,000 5 10%
Total Assets $4,000,000
132 Chapter 12 Financial and Operating Ratios as Performance Measures
Figure 12–2 Examples of Solvency and Profitability Ratio Calculations.
Courtesy of Resource Group, Ltd, Dallas, Texas.
Balance Sheet
Assets December 31, 20×2
Current Assets $190,000
Accounts receivable (net) 250,000
Inventories 25,000
Prepaid Insurance 5,000
Total Current Assets $470,000
Property,Plant and Equipment
Land $100,000
Buildings (net) 0
Equipment (net) 260,000
Net Property, Plant and Equipment 360,000
Other Assets
Investments $133,000
133,000
Total Other Assets
Total Assets $963,000
Liabilities and Fund Balance
Current Liabilities
Current maturities of long-term debt $52,000
Accounts payable and accrued expenses 293,000
Total Current Liabilities $345,000
Long-term Debt $252,000
Less current maturities of long-term debt –52,000
Net Long-term Debt 200,000
Total Liabilities $545,000
Fund Balances
Unrestricted fund balance $418,000
Restricted fund balance 0
Total Fund Balances 418,000
Total Liabilities and Fund Balance $963,000
Statement of Revenue and Expenses
For the Year Ending
Revenue December 31, 20×2
Net patient service revenue $2,000,000
Total operating revenue $2,000,000
Operating Expenses
Medical/surgical services $600,000
Therapy services 860,000
Other professional services 80,000
Support services 220,000
General services 65,000
Depreciation 40,000
Interest 20,000
Total operating expenses 1,885,000
Income from Operations $115,000
Nonoperating Gains (Losses)
Interest Income $5,000
Net nonoperating gains 5,000
Revenue and Gains in Excess of
Expenses and Losses $120,000
Increase in Unrestricted Fund Balance $120,000
Step 1 5. Return on Total Assets (%)
120,000
20,000
140,000
Step 2
140,000
963,000
= 14.54%
6. Operating Margin (%)
115,000
2,000,000
5.75%
7. Liabilities to Fund Balance
545,000
418,000
= 1.304
Step 1 8. Debt Service Coverage Ratio (DSCR)
120,000
20,000
40,000
180,000
Step 2
180,000 Maximum Annual Debt Service
72,000 Information derived elsewhere
= 2.5
EBIT (Earnings Before Interest and Taxes)
Total Assets
Operating Income (Loss)
Total Operating Revenues
Total Liabilities
Unrestricted Fund Balance
Change in Unrestricted Net Assets (net income)
plus Depreciation-Amortization
plus Interest
Maximum Annual Debt Service
Profitability Ratios 133
This is a broad measure in common use. Note the acronym EBIT, as its use is widespread in
credit analysis circles. (Some analysts use an alternative computation for Return on Total Assets.
They compute this ratio as Net Income divided by Total Assets.)
This concludes the description of solvency and profitability ratios. Again, if you study Figure
12–2 and work with the Case Study entitled “Comparative Analysis (Financial Ratios and Benchmarking) Helps Turn Around a Hospital”, you will master this process too.
INFORMATION CHECKPOINT
What is needed? Reports that use ratios as measures.
Where is it found? Possibly in your supervisor’s file; in the administrator’s office;
in the chief executive officer’s office.
How is it used? Use as a measure against outside benchmarks (as discussed in
this chapter); also use as internal benchmarks for departments/divisions/units; also use as benchmarks at various
points over time.
KEY TERMS
Current Ratio
Days Cash on Hand (DCOH)
Days Receivables
Debt Service Coverage Ratio (DSCR)
Liabilities to Fund Balance
Liquidity Ratios
Operating Margin
Profitability Ratios
Quick Ratio
Return on Total Assets
Solvency Ratios
DISCUSSION QUESTIONS
1. Are there ratios in the reports you receive at your workplace?
2. If so, do you use them? How?
3. If not, do you believe ratios should be on the reports? Which reports?
4. Can you think of good outside sources that could be used to obtain ratios for comparative purposes? If the outside information was available, what ratios would you choose to
use? Why?
134 Chapter 12 Financial and Operating Ratios as Performance Measures
Progress Notes
© LFor/Shutterstock
The Time Value
of Money
PURPOSE
The purpose of these computations is to evaluate the use
of money. The manager has many options as to where
resources of the organization should be spent.1 These calculations provide guides to assist in evaluating the alternatives.
UNADJUSTED RATE OF RETURN
The unadjusted rate of return is a relatively unsophisticated
return-on-investment method, and the answer is only an
estimate, containing no precision. The computation of the
unadjusted rate of return is as follows:
Average Annual Net Income 5 Rate of Return
Original Investment Amount
OR
Average Annual Net Income 5 Rate of Return
Average Investment Amount
The original investment amount is a matter of record.
The average investment amount is arrived at by taking the
total unrecovered asset cost at the beginning of estimated
useful life plus the unrecovered asset cost at the end of
estimated useful life and dividing by two. This method has
the advantage of accommodating whatever depreciation
method has been chosen by the organization. This method
is sometimes called the accountant’s method because information necessary for the computation is obtained from the
financial statements.
After completing this chapter,
you should be able to
1. Compute an unadjusted rate
of return.
2. Understand how to use a
present-value table.
3. Compute an internal rate of
return.
4. Understand the payback
period theory.
135
13
CHAPTER
PRESENT-VALUE ANALYSIS
The concept of present-value analysis is based on the time value of money. Inherent in this concept is the fact that the value of a dollar today is more than the value of a dollar in the future:
thus the “present value” terminology. Furthermore, the further in the future the receipt of
your dollar occurs, the less it is worth. Think of a dollar bill dwindling in size more and more
as its receipt stretches further and further into the future. This is the concept of present-value
analysis.
We learned about compound interest in math class. We learned that
$500 invested at the beginning of year 1
.05 earns interest (assumed) at a rate of 5% for one year,
$525 and we have a compound amount at the end of year 1 amounting to $525,
.05 which earns interest (assumed) at the rate of 5% for another year,
$551 and we have a compound amount at the end of year 2 amounting to $551
(rounded), and so on.
Using this concept, it is possible to restate the present values of $1 to be paid out or received
at the end of each of these years. It is possible to use equations, but that is not necessary
because we have present-value tables (also called “look-up tables,” because one can “look-up”
the answer). A present-value table is included at the end of this chapter in Appendix 13-A.
All of the figures on the present-value table represent the value of a dollar. The interest rate
available on this version of the table is on the horizontal columns and ranges from 1% to 20%.
The number of years in the period is on the vertical; in this version of the table, the number of
years ranges from 1 to 30. To look up a present value, find the column for the proper interest.
Then find the line for the proper number of years. Then trace down the interest column and
across the number-of-years line item. The point where the two lines meet is the number (or
factor) that represents the value of $1 according to your assumptions. For example, find the
year 10 by reading down the left-hand column labeled “Year.” Then read across that line until
you find the column labeled “10%.” The point where the two lines meet is found to be 0.3855.
The present value of $1 under these assumptions (10 year/10%) is about 38.5 cents (shown as
0.3855 on the table).
Besides using the look-up table, you can also compute this factor on a business analyst calculator. A reference to business analyst calculators is contained in the Appendix entitled “WebBased and Software Learning Tools.” This can be found at the end of this text. Besides using
either the look-up table or the business calculator, you can use a function on your computer
spreadsheet to produce the factor. The important point is this: no matter which method you
use, you should get the same answer.
Now that you have the present value of $1, by whichever method, it is simple to find the
present value of any other number. You merely multiply the other number by the factor you
found on the table—or in the calculator or the computer. Say, for example, you want to find the
present value of $8,000 under the assumption used above (10 years/10%). You simply multiply
$8,000 by the factor of 0.3855 you found in the table. The present value of $8,000 is $3,084 (or
$8,000 times 0.3855).
A compound interest table is also included at the end of this chapter in Appendix 13-B,
along with a table showing the present value of an annuity of $1.00 in Appendix 13-C, so that
you have the tools for computation at your disposal.
136 Chapter 13 The Time Value of Money
INTERNAL RATE OF RETURN
The internal rate of return (IRR) is another return on investment method. It uses a discounted
cash flow technique. The internal rate of return is the rate of interest that discounts future net
inflows (from the proposed investment) down to the amount invested. The return for a particular investment can therefore be known. The IRR recognizes the elements contained in the
previous two methods discussed, but it goes further. It also recognizes the time pattern in which
the earnings occur. This means more precision in the computation because IRR calculates from
period to period, whereas the other two methods rely on an average investment.
The IRR computation is not very complicated. The computation requires two assumptions
and three steps to compute. Assumption 1: Find the initial cost of the investment. Assumption
2: Find the estimated annual net cash inflow the investment will generate. Assumption 3: Find
the useful life of the asset (generally expressed in number of years, known as periods for this
computation). Step 1: Divide the initial cost of the investment (Assumption 1) by the estimated
annual net cash inflow it will generate (Assumption 2). The answer is a ratio. Step 2: Now use
the look-up table. Find the number of periods (Assumption 3). Step 3: Look across the line for
the number of periods and find the column that approximates the ratio computed in Step 1.
That column contains the interest rate representing the rate of return.
How is IRR used? It can take the rate of return obtained and restate it. The restated figure
represents the maximum rate of interest that can be paid for capital over the entire span of the
investment without incurring a loss. (You can think of that restated figure as a kind of breakeven point for investment purposes.) The fact that a rate of return can be computed is the
benefit of using an IRR method.
PAYBACK PERIOD
The payback period is the length of time required for the cash coming in from an investment
to equal the amount of cash originally spent when the investment was acquired. In other
words, if we invested $1,000, under a particular set of assumptions, how long would it take to
get our $1,000 back? The payback period concept is used extensively in evaluating whether
to invest in a plant and/or equipment. In that case, the question can be restated as follows: If
we invested $1,200,000 in a magnetic resonance imaging machine, under a particular set of
assumptions, how long would it take to get the hospital’s $1,200,000 back?
The assumptions are key to the computation of the payback period. In the case of equipment, volume of usage is a critical assumption and is sometimes very difficult to predict.
Therefore, it is prudent to run more than one payback period computation based on different
circumstances. Generally a “best case” and a “worst case” run are made.
The computation itself is simple, although it has multiple steps. The trick is to break it into
segments.
For example, Doctor Green is considering the purchase of a machine for his office
laboratory. It will cost $300,000. He wants to find the payback period for this piece of equipment. To begin, Dr. Green needs to make the following assumptions. Assumption 1: Purchase
price of the equipment. Assumption 2: Useful life of the equipment. Assumption 3: Revenue
the machine will generate per year. Assumption 4: Direct operating costs associated with earning the revenue. Assumption 5: Depreciation expense per year (computed as purchase price
per Assumption 1 divided by useful life per Assumption 2).
Payback Period 137
Dr. Green’s five assumptions are as follows:
1. Purchase price of equipment 5 $300,000
2. Useful life of the equipment 5 10 years
3. Revenue the machine will generate per year 5 $10,000 after taxes
4. Direct operating costs associated with earning the revenue 5 $150,000
5. Depreciation expense per year 5 $30,000
Now that the assumptions are in place, the payback period computation can be made. It is in
three steps, as follows:
Step 1: Find the machine’s expected net income after taxes.
Revenue (Assumption #3) $200,000
Less
Direct operating costs
(Assumption 4) $150,000
Depreciation
(Assumption 5) 30,000
180,000
Net income before taxes $20,000
Less income taxes of 50% 10,000
Net income after taxes $10,000
Step 2: Find the net annual cash inflow after taxes the machine is expected to generate (in
other words, convert the net income to a cash basis).
Net income after taxes $10,000
Add back depreciation (a noncash expenditure) 30,000
Annual net cash inflow after taxes $40,000
Step 3: Compute the payback period.
Investment $300,000 Machine Cost* 5 7.5 year
Net Annual $40,000**
Cash Flow
after Taxes
*Assumption 1 above
**per Step 2 above
The machine will pay back its investment under these assumptions in 7.5 years.
Payback period computations are very common when equipment purchases are being evaluated. The evaluation process itself is the final subject we consider in this chapter.
EVALUATIONS
Evaluating the use of resources in healthcare organizations is an important task. There are never
enough resources to go around, and it is important to use an objective process to evaluate which
Payback Period
138 Chapter 13 The Time Value of Money
investments will be made by the organization. A uniform use of a chosen method of evaluating
return on investment and/or payback period makes the evaluation process more manageable.
It is important to choose a method that is understood by the managers who will be using it.
It is equally important to choose a method that can be readily calculated. If a multiple-page
worksheet has to be constructed to set up the assumptions for a modestly priced piece of equipment, the evaluation method is probably too complex. This comment actually touches on the
cost-benefit of performing the evaluation.
Sometimes a computer program is chosen that performs a uniform computation of
investment returns and payback periods. Such a program is a suitable choice if the managers
who use it understand the printouts it produces. Understanding both input and output is key for
the managers. In summary, evaluations should be objective, the process should not be too cumbersome, and the responsible managers should understand how the computation was achieved.
RESOURCES
Three look-up tables are presented as appendices to this chapter. They include the following:
A. Present-Value Table (the present value of $1.00)
B. Compound Interest Table (the future value of $1.00)
C. Present Value of an Annuity of $1.00
These tables provide an ongoing resource for you.
INFORMATION CHECKPOINT
What is needed? Information sufficient to perform these calculations.
Where is it found? In the files of your supervisor; also in the office of the financial
analyst; probably also in the strategic planning office.
How is it used? To measure the time value of money.
KEY TERMS
Internal Rate of Return
Payback Period
Present-Value Analysis
Time Value of Money
Unadjusted Rate of Return
DISCUSSION QUESTIONS
1. Can you compute an unadjusted rate of return now? Would you use it? Why?
2. Are you able to use the present-value look-up table now? Would you prefer a computer to
compute it?
Discussion Questions 139
3. Have you seen the payback period concept used in your workplace? If not, do you think it
ought to be used? What are your reasons?
4. Have you had a chance to participate in an evaluation of an equipment purchase at
your workplace? If so, would you have done it differently if you had supervised the
evaluation? Why?
NOTE
1. S. Williamson et al., Fundamentals of Strategic Planning for Healthcare Organizations
(New York: The Haworth Press, 1997).
140 Chapter 13 The Time Value of Money
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141
Year 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091
2 0.9803 0.9613 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264
3 0.9706 0.9423 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513
4 0.9610 0.9238 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830
5 0.9515 0.9057 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209
6 0.9420 0.8880 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645
7 0.9327 0.8706 0.8131 0.7599 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132
8 0.9235 0.8535 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665
9 0.9143 0.8368 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241
10 0.9053 0.8203 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855
11 0.8963 0.8043 0.7224 0.6496 0.5847 0.5268 0.4751 0.4289 0.3875 0.3505
12 0.8874 0.7885 0.7014 0.6246 0.5568 0.4970 0.4440 0.3971 0.3555 0.3186
13 0.8787 0.7730 0.6810 0.6006 0.5303 0.4688 0.4150 0.3677 0.3262 0.2987
14 0.8700 0.7579 0.6611 0.5775 0.5051 0.4423 0.3878 0.3405 0.2992 0.2633
15 0.8613 0.7430 0.6419 0.5553 0.4810 0.4173 0.3624 0.3152 0.2745 0.2394
16 0.8528 0.7284 0.6232 0.5339 0.4581 0.3936 0.3387 0.2919 0.2519 0.2176
17 0.8444 0.7142 0.6050 0.5134 0.4363 0.3714 0.3166 0.2703 0.2311 0.1978
18 0.8360 0.7002 0.5874 0.4936 0.4155 0.3503 0.2959 0.2502 0.2120 0.1799
19 0.8277 0.6864 0.5703 0.4746 0.3957 0.3305 0.2765 0.2317 0.1945 0.1635
20 0.8195 0.6730 0.5537 0.4564 0.3769 0.3118 0.2584 0.2145 0.1784 0.1486
21 0.8114 0.6598 0.5375 0.4388 0.3589 0.2942 0.2415 0.1987 0.1637 0.1351
22 0.8034 0.6468 0.5219 0.4220 0.3418 0.2775 0.2257 0.1839 0.1502 0.1228
23 0.7954 0.6342 0.5067 0.4057 0.3256 0.2618 0.2109 0.1703 0.1378 0.1117
24 0.7876 0.6217 0.4919 0.3901 0.3101 0.2470 0.1971 0.1577 0.1264 0.1015
25 0.7798 0.6095 0.4776 0.3751 0.2953 0.2330 0.1842 0.1460 0.1160 0.0923
26 0.7720 0.5976 0.4637 0.3607 0.2812 0.2198 0.1722 0.1352 0.1064 0.0839
27 0.7644 0.5859 0.4502 0.3468 0.2678 0.2074 0.1609 0.1252 0.0976 0.0763
28 0.7568 0.5744 0.4371 0.3335 0.2552 0.1956 0.1504 0.1159 0.0895 0.0693
29 0.7493 0.5631 0.4243 0.3207 0.2429 0.1846 0.1406 0.1073 0.0822 0.0630
30 0.7419 0.5521 0.4120 0.3083 0.2314 0.1741 0.1314 0.0994 0.0754 0.0573
Present-Value Table
(The Present Value of $1.00) 13-A
APPENDIX
Year 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.9009 0.8929 0.8850 0.8772 0.8696 0.8621 0.8547 0.8475 0.8403 0.8333
2 0.8116 0.7972 0.7831 0.7695 0.7561 0.7432 0.7305 0.7182 0.7062 0.6944
3 0.7312 0.7118 0.6913 0.6750 0.6575 0.6407 0.6244 0.6086 0.5934 0.5787
4 0.6587 0.6355 0.6133 0.5921 0.5718 0.5523 0.5337 0.5158 0.4987 0.4823
5 0.5935 0.5674 0.5428 0.5194 0.4972 0.4761 0.4561 0.4371 0.4190 0.4019
6 0.5346 0.5066 0.4803 0.4556 0.4323 0.4104 0.3898 0.3704 0.3521 0.3349
7 0.4817 0.4523 0.4251 0.3996 0.3759 0.3538 0.3332 0.3139 0.2959 0.2791
8 0.4339 0.4039 0.3762 0.3506 0.3269 0.3050 0.2848 0.2660 0.2487 0.2326
9 0.3909 0.3606 0.3329 0.3075 0.2843 0.2630 0.2434 0.2255 0.2090 0.1938
10 0.3522 0.3220 0.2946 0.2697 0.2472 0.2267 0.2080 0.1911 0.1756 0.1615
11 0.3173 0.2875 0.2607 0.2366 0.2149 0.1954 0.1778 0.1619 0.1476 0.1346
12 0.2858 0.2567 0.2307 0.2076 0.1869 0.1685 0.1520 0.1372 0.1240 0.1122
13 0.2575 0.2292 0.2042 0.1821 0.1625 0.1452 0.1299 0.1163 0.1042 0.0935
14 0.2320 0.2046 0.1807 0.1597 0.1413 0.1252 0.1110 0.0985 0.0876 0.0779
15 0.2090 0.1827 0.1599 0.1401 0.1229 0.1079 0.0949 0.0835 0.0736 0.0649
16 0.1883 0.1631 0.1415 0.1229 0.1069 0.0930 0.0811 0.0708 0.0618 0.0541
17 0.1696 0.1456 0.1252 0.1078 0.0929 0.0802 0.0693 0.0600 0.0520 0.0451
18 0.1528 0.1300 0.1108 0.0946 0.0808 0.0691 0.0592 0.0508 0.0437 0.0376
19 0.1377 0.1161 0.0981 0.0829 0.0703 0.0596 0.0506 0.0431 0.0367 0.0313
20 0.1240 0.1037 0.0868 0.0728 0.0611 0.0514 0.0433 0.0365 0.0308 0.0261
21 0.1117 0.0926 0.0768 0.0638 0.0531 0.0443 0.0370 0.0309 0.0259 0.0217
22 0.1007 0.0826 0.0680 0.0560 0.0462 0.0382 0.0316 0.0262 0.0218 0.0181
23 0.0907 0.0738 0.0601 0.0491 0.0402 0.0329 0.0270 0.0222 0.0183 0.0151
24 0.0817 0.0659 0.0532 0.0431 0.0349 0.0284 0.0231 0.0188 0.0154 0.0126
25 0.0736 0.0588 0.0471 0.0378 0.0304 0.0245 0.0197 0.0160 0.0129 0.0105
26 0.0663 0.0525 0.0417 0.0331 0.0264 0.0211 0.0169 0.0135 0.0109 0.0087
27 0.0597 0.0469 0.0369 0.0291 0.0230 0.0182 0.0144 0.0115 0.0091 0.0073
28 0.0538 0.0419 0.0326 0.0255 0.0200 0.0157 0.0123 0.0097 0.0077 0.0061
29 0.0485 0.0374 0.0289 0.0224 0.0174 0.0135 0.0105 0.0082 0.0064 0.0051
30 0.0437 0.0334 0.0256 0.0196 0.0151 0.0116 0.0090 0.0070 0.0054 0.0042
142 Chapter 13 The Time Value of Money
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143
Year 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 1.010 1.020 1.030 1.040 1.050 1.060 1.070 1.080 1.090 1.100
2 1.020 1.040 1.061 1.082 1.102 1.124 1.145 1.166 1.188 1.210
3 1.030 1.061 1.093 1.125 1.156 1.191 1.225 1.260 1.295 1.331
4 1.041 1.082 1.126 1.170 1.216 1.262 1.311 1.360 1.412 1.464
5 1.051 1.104 1.159 1.217 1.276 1.338 1.403 1.469 1.539 1.611
6 1.062 1.120 1.194 1.265 1.340 1.419 1.501 1.587 1.677 1.772
7 1.072 1.149 1.230 1.316 1.407 1.504 1.606 1.714 1.828 1.949
8 1.083 1.172 1.267 1.369 1.477 1.594 1.718 1.851 1.993 2.144
9 1.094 1.195 1.305 1.423 1.551 1.689 1.838 1.999 2.172 2.358
10 1.105 1.219 1.344 1.480 1.629 1.791 1.967 2.159 2.367 2.594
11 1.116 1.243 1.384 1.539 1.710 1.898 2.105 2.332 2.580 2.853
12 1.127 1.268 1.426 1.601 1.796 2.012 2.252 2.518 2.813 3.138
13 1.138 1.294 1.469 1.665 1.886 2.133 2.410 2.720 3.066 3.452
14 1.149 1.319 1.513 1.732 1.980 2.261 2.579 2.937 3.342 3.797
15 1.161 1.346 1.558 1.801 2.079 2.397 2.759 3.172 3.642 4.177
16 1.173 1.373 1.605 1.873 2.183 2.540 2.952 3.426 3.970 4.595
17 1.184 1.400 1.653 1.948 2.292 2.693 3.159 3.700 4.328 5.054
18 1.196 1.428 1.702 2.026 2.407 2.854 3.380 3.996 4.717 5.560
19 1.208 1.457 1.754 2.107 2.527 3.026 3.617 4.316 5.142 6.116
20 1.220 1.486 1.806 2.191 2.653 3.207 3.870 4.661 5.604 6.728
25 1.282 1.641 2.094 2.666 3.386 4.292 5.427 6.848 8.632 10.835
30 1.348 1.811 2.427 3.243 4.322 5.743 7.612 10.063 13.268 17.449
Compound
Interest Table
Compound Interest of $1.00
(The Future Amount of $1.00)
13-B
APPENDIX
Year 12% 14% 16% 18% 20% 24% 28% 32% 40% 50%
1 1.120 1.140 1.160 1.180 1.200 1.240 1.280 1.320 1.400 1.500
2 1.254 1.300 1.346 1.392 1.440 1.538 1.638 1.742 1.960 2.250
3 1.405 1.482 1.561 1.643 1.728 1.907 2.067 2.300 2.744 3.375
4 1.574 1.689 1.811 1.939 2.074 2.364 2.684 3.036 3.842 5.062
5 1.762 1.925 2.100 2.288 2.488 2.932 3.436 4.007 5.378 7.594
6 1.974 2.195 2.436 2.700 2.986 3.635 4.398 5.290 7.530 11.391
7 2.211 2.502 2.826 3.185 3.583 4.508 5.629 6.983 10.541 17.086
8 2.476 2.853 3.278 3.759 4.300 5.590 7.206 9.217 14.758 25.629
9 2.773 3.252 3.803 4.435 5.160 6.931 9.223 12.166 20.661 38.443
10 3.106 3.707 4.411 5.234 6.192 8.594 11.806 16.060 28.925 57.665
11 3.479 4.226 5.117 6.176 7.430 10.657 15.112 21.199 40.496 86.498
12 3.896 4.818 5.936 7.288 8.916 13.215 19.343 27.983 56.694 129.746
13 4.363 5.492 6.886 8.599 10.699 16.386 24.759 36.937 79.372 194.619
14 4.887 6.261 7.988 10.147 12.839 20.319 31.691 48.757 111.120 291.929
15 5.474 7.138 9.266 11.074 15.407 25.196 40.565 64.350 155.568 437.894
16 6.130 8.137 10.748 14.129 18.488 31.243 51.923 84.954 217.795 656.840
17 6.866 9.276 12.468 16.672 22.186 38.741 66.461 112.140 304.914 985.260
18 7.690 10.575 14.463 19.673 26.623 48.039 85.071 148.020 426.879 1477.900
19 8.613 12.056 16.777 23.214 31.948 59.568 108.890 195.390 597.630 2216.800
20 9.646 13.743 19.461 27.393 38.338 73.864 139.380 257.920 836.683 3325.300
25 17.000 26.462 40.874 62.669 95.396 216.542 478.900 1033.600 4499.880 25251.000
30 29.960 50.950 85.850 143.371 237.376 634.820 1645.500 4142.100 24201.432 191750.000
144 Chapter 13 The Time Value of Money
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145
Periods 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Periods
1 0.980 0.962 0.943 0.926 0.909 0.893 0.877 0.862 0.848 0.833 1
2 1.942 1.886 1.833 1.783 1.736 1.690 1.647 1.605 1.566 1.528 2
3 2.884 2.775 2.673 2.577 2.487 2.402 2.322 2.246 2.174 2.107 3
4 3.808 3.630 3.465 3.312 3.170 3.037 2.914 2.798 2.690 2.589 4
5 4.713 4.452 4.212 3.993 3.791 3.605 3.433 3.274 3.127 2.991 5
6 5.601 5.242 4.917 4.623 4.355 4.111 3.889 3.685 3.498 3.326 6
7 6.472 6.002 5.582 5.206 4.868 4.564 4.288 4.039 3.812 3.605 7
8 7.325 6.733 6.210 5.747 5.335 4.968 4.639 4.344 4.078 3.837 8
9 8.162 7.435 6.802 6.247 5.759 5.328 4.946 4.607 4.303 4.031 9
10 8.983 8.111 7.360 6.710 6.145 5.650 5.216 4.833 4.494 4.193 10
15 12.849 11.118 9.712 8.560 7.606 6.811 6.142 5.576 5.092 4.676 15
20 16.351 13.590 11.470 9.818 8.514 7.469 6.623 5.929 5.353 4.870 20
25 19.523 15.622 12.783 10.675 9.077 7.843 6.873 6.097 5.467 4.948 25
Present Value of an
Annuity of $1.00 13-C
APPENDIX

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Tools to Review
and Manage Comparative Data
PART
V

Progress Notes
© LFor/Shutterstock
Trend Analysis,
Common Sizing, and
Forecasted Data
COMMON SIZING
The process of common sizing puts information on the
same relative basis. Generally, common sizing involves converting dollar amounts to percentages. If, for example, total
revenue of $200,000 equals 100%, then radiology revenue
of $20,000 will equal 10% of that total. Converting dollars
to percentages allows comparative analysis. In other words,
comparing the percentages allows a common basis of comparison. Common sizing is sometimes called “vertical analysis” (because the computation of the percentages is vertical).
Although such comparisons on the basis of percentages
can, and should, be performed on your own organization’s
data, comparisons can also be made between or among
various organizations. For example, Table 14–1 shows how
common sizing allows a comparison of liabilities for three different hospitals. In each case, the total liabilities equal 100%.
Then the current liabilities of hospital 1, for example, are
divided by total liabilities to find the proportionate percentage attributable to that line item (100,000 divided by 500,000
equals 20%; 400,000 divided by 500,000 equals 80%). When
all the percentages have been computed, add them to make
sure they add to 100%. If you use a computer, computation
of these percentages is available as a spreadsheet function.
Another example of comparative analysis is contained in
Table 14-2. In this case, general services expenses for three
hospitals are compared. Once again, the total expense for
each hospital becomes 100%, and the relative percentage for each of the four line items is computed ($320,000
divided by $800,000 equals 40% and so on). The advantage
of comparative analysis is illustrated by the “laundry” line
item, where the dollar amounts are $80,000, $300,000, and
$90,000 respectively. Yet each of these amounts is 10% of
the total expense for the particular hospital.
After completing this chapter,
you should be able to
1. Understand and use common
sizing.
2. Understand and use trend
analysis.
3. Understand five types of
forecast assumptions.
4. Understand capacity level
issues in forecasts.
149
14
CHAPTER
TREND ANALYSIS
The process of trend analysis compares figures over several time periods. Once again, dollar
amounts are converted to percentages to obtain a relative basis for purposes of comparison, but
now the comparison is across time. If, for example, radiology revenue was $20,000 this period
but was only $15,000 for the previous period, the difference between the two is $5,000. The difference of $5,000 equates to a 33.3% difference because trend analysis is computed on the earlier of the two years: that is, the base year (thus, 5,000 divided by 15,000 equals 33.3%). Trend
analysis is sometimes called “horizontal analysis” (because the computation of the percentage
of difference is horizontal).
An example of horizontal analysis is contained in Table 14–3. In this case, the liabilities of hospital 1 for year 1 are compared with the liabilities of hospital 1’s year 2. Current liabilities, for example,
were $100,000 in year 1 and are $150,000 in year 2, a difference of $50,000. To arrive at a percentage
of difference for comparative purposes, the $50,000 difference is divided by the year 1 base figure of
$100,000 to compute the relative differential (thus, 50,000 divided by 100,000 is 50%).
Table 14–1 Common Sizing Liability Information
Same Year for All Three Hospitals
Hospital 1 Hospital 2 Hospital 3
Current liabilities $100,000 20% $500,000 25% $400,000 80%
Long-term debt 400,000 80% 1,500,000 75% 100,000 20%
Total liabilities $500,000 100% $2,000,000 100% $500,000 100%
Table 14–3 Trend Analysis for Liabilities
Hospital 1
Year 1 Year 2 Difference
Current liabilities $100,000 20% $150,000 25% $50,000 50%
Long-term debt 400,000 80% 450,000 75% 50,000 12.5%
Total liabilities $500,000 100% $600,000 100% $100,000 –
Table 14–2 Common Sizing Expense Information
Same Year for All Three Hospitals
Hospital 1 Hospital 2 Hospital 3
General services expense
Dietary $320,000 40% $1,260,000 42% $450,000 50%
Maintenance 280,000 35% 990,000 33% 135,000 15%
Laundry 80,000 10% 300,000 10% 90,000 10%
Housekeeping 120,000 15% 450,000 15% 225,000 25%
Total GS expense $800,000 100% $3,000,000 100% $900,000 100%
150 Chapter 14 Trend Analysis, Common Sizing, and Forecasted Data
Another example of comparative analysis is contained in Table 14–4. In this case, general services expenses for two years in hospital 1 are compared. The difference between year 1
and year 2 for each line item is computed in dollars; then the dollar difference figure is divided
by the year 1 base figure to obtain a percentage difference for purposes of comparison. Thus,
housekeeping expense in year 1 was $120,000, and in year 2 was $180,000, resulting in a difference of $60,000. The difference amounts to 50% ($60,000 difference divided by $120,000 year
1 equals 50%). In Table 14–4, two of the four line items have negative differences: that is, year 2
was less than year 1, resulting in a negative figure. Also, the dollar figure difference is $100,000
when added down (subtract the negative figures from the positive figures; thus, $85,000 plus
$60,000 minus $10,000 minus $35,000 equals $100,000). The dollar figure difference is also
$100,000 when added across ($900,000 minus $800,000 equals $100,000).
ANALYZING OPERATING DATA
Comparative analysis is an important tool for managers, and it is worth investing the time to
become familiar with both horizontal and vertical analysis. Managers will generally analyze their
own organization’s data most of the time (rather than performing comparisons against other
organizations). With that fact in mind, we examine operating room operating data (no pun
intended) that incorporate both common sizing and trend analysis.
Table 14–5 sets out 32 expense items. The expense amount in dollars for each line item is set
out for the current year in the left column (beginning with $60,517). The expense amount in
dollars for each line item is set out for the prior year in the third column of the analysis (beginning with $68,177). The difference in dollars, labeled “Annual Increase (Decrease),” appears in
the sixth column of the analysis (beginning with [$7,660]). Vertical analysis has been performed
for the current year, and the percentage results appear in the second column (beginning with
4.97%). Vertical analysis has also been performed for the prior year, and those percentage results
appear in the fourth column (beginning with 5.70%). Horizontal analysis has been performed
on each line item, and those percentage items appear in the far right column (beginning with
12.66%). This table is a good example of the type of operating data reports that managers receive
for planning and control purposes.
Comparative analysis is especially important to managers because it creates a common
ground to make judgments for planning, control, and decision-making purposes. Using comparative data is the subject of the following chapter.
Table 14–4 Trend Analysis for Expenses
Hospital 1
Year 1 Year 2 Difference
General services expense
Dietary $320,000 40% $405,000 45% $85,000 26.5%
Maintenance 280,000 35% 270,000 30% (10,000) (3.5)%
Laundry 80,000 10% 45,000 5% (35,000) (43.5)%
Housekeeping 120,000 15% 180,000 20% 60,000 50.0%
Total GS expense $800,000 100% $900,000 100% $100,000 –
Analyzing Operating Data 151
IMPORTANCE OF FORECASTS
The dictionary defines “to forecast” as “to calculate or predict some future event or condition,
usually as a result of study and analysis of available pertinent data.”1
From the manager’s viewpoint, forecasted data are information used for purposes of planning for the future. Forecasting, to some degree or another, is often required when producing
budgets. (Budgets are the subject of two of the following chapters.) It is pretty simple today to
create “what if” scenarios on the computer. But the important thing for managers to remember
is that assumptions directly affect the results of forecasts.
Table 14–5 Vertical and Horizontal Analysis for the Operating Room
Comparative Expenses
Annual
12-Month 12-Month Increase % of
Account Current Year % Prior Year % (Decrease) Change
Social Security 60,517 4.97 68,177 5.70 (7,660) –12.66
Pension 20,675 1.70 23,473 1.96 (2,798) –13.53
Health Insurance 8,422 0.69 18,507 1.55 (10,085) –119.75
Child Care 4,564 0.37 4,334 0.36 230 5.04
Patient Accounting 155,356 12.76 123,254 10.30 32,102 20.66
Admitting 110,254 9.05 101,040 8.45 9,214 8.36
Medical Records 91,718 7.53 94,304 7.88 (2,586) –2.82
Dietary 27,526 2.26 35,646 2.98 (8,120) –29.50
Medical Waste 2,377 0.20 3,187 0.27 (810) –34.08
Sterile Procedures 78,720 6.46 70,725 5.91 7,995 10.16
Laundry 40,693 3.34 40,463 3.38 230 0.57
Depreciation—Equipment 87,378 7.18 61,144 5.11 26,234 30.02
Depreciation—Building 41,377 3.40 45,450 3.80 (4,073) –9.84
Amortization—Interest (5,819) –0.48 1,767 0.15 (7,586) 130.37
Insurance 4,216 0.35 7,836 0.65 (3,620) –85.86
Administration 57,966 4.76 56,309 4.71 1,657 2.86
Medical Staff 1,722 0.14 5,130 0.43 (3,408) –197.91
Community Relations 49,813 4.09 40,618 3.39 9,195 18.46
Materials Management 64,573 5.30 72,305 6.04 (7,732) –11.97
Human Resources 31,066 2.55 13,276 1.11 17,790 57.27
Nursing Administration 82,471 6.77 92,666 7.75 (10,195) –12.36
Data Processing 17,815 1.46 16,119 1.35 1,696 9.52
Fiscal 17,700 1.45 16,748 1.40 952 5.38
Telephone 2,839 0.23 2,569 0.21 270 9.51
Utilities 26,406 2.17 38,689 3.23 (12,283) –46.52
Plant 77,597 6.37 84,128 7.03 (6,531) –8.42
Environmental Services 32,874 2.70 37,354 3.12 (4,480) –13.63
Safety 2,016 0.17 2,179 0.18 (163) –8.09
Quality Management 10,016 0.82 8,146 0.68 1,870 18.67
Medical Staff 9,444 0.78 9,391 0.78 53 0.56
Continuous Quality Improvement 4,895 0.40 0 0.00 4,895 100.00
EE Health 569 0.05 1,513 0.13 (944) –165.91
Total Allocated 1,217,756 100.00 1,196,447 100.00 21,309 1.75
All Other Expenses 1,211,608 — — — — —
Total Expense 2,429,364 — — — — —
152 Chapter 14 Trend Analysis, Common Sizing, and Forecasted Data
Forecasts Versus Projections
Forecasts are different than projections, although both are considered to be “prospective”
and thus “future” financial statements. Forecasts are based on assumptions that are expected
to exist, and that reflect actions that are expected to occur. Projections, on the other hand,
are views further into the future. Because they are further into the future, we “project” future
events, projects, or operations using a set of presumed, or hypothetical, assumptions.
We are discussing forecasts in this chapter rather than projections. Therefore, these forecasts
are relatively short term and can be based on realistic assumptions that we expect to exist, along
with actions that we can reasonably expect to occur.
Forecasting Approaches
The approach to producing a forecast usually involves three different sources of information
and forecast assumptions:
• The first level derives from the personnel who are directly involved in the department or
unit. They know the operation and can provide important ground-level detail.
• The second level comes from electronic and statistical information, including trend analysis. Electronic reports can provide a thicket of information, and there is a skill to selecting
relevant information for forecasting purposes.
• The third level represents executive-level judgment that is typically applied to a preliminary
rough draft of the forecast. For example, adjusting volume upward or downward due to the
anticipated future impact of local competition would most likely be an executive-level judgment.
The amount and type of electronic information that is readily available greatly affects the
forecast difficulty. Electronic templates and standardized worksheets may also greatly influence
the final forecast results.
Common Types of Forecasts in Healthcare Organizations
The three most common types of forecasts found in most healthcare organizations include revenue
forecasts, staffing forecasts, and operating expense forecasts. (The operating expense forecast, which
is not as common, would generally cover those operating expenses other than labor.) This section
will discuss revenue and staffing forecasts, as they are what most managers will need to deal with.
OPERATING REVENUE FORECASTS
Operating revenue forecasts are inputs into the operating budget. Forecast types and their
assumptions are discussed in this section.
Types of Revenue Forecasts
Forecasts of revenue will cover varying time periods. Longer-range multi-year forecasts are
useful for executive decision making regarding the future of the organization. Figure 14–1
illustrates a multi-year forecast.
A single-year forecast is generally for the coming year and is thus a short-range forecast. Reliable forecasts of revenue are a vital part of the organization’s planning process and are an input
Operating Revenue Forecasts 153
into the operating budget. Figure 14–2 illustrates a short-range forecast. Note that the graph in
Figure 14–2 could be by month instead of by quarter as shown.
Building Revenue Forecast Assumptions
Five important issues regarding revenue forecast assumptions are discussed here.
Utilization Assumptions
In health care, significant changes in utilization patterns can be occurring that need to be taken
into account in the manager’s forecast assumptions. The inexorable shift to shorter lengths
of stay for hospital inpatients over the last decade is an example of a basic shift in utilization
patterns.
Patient Mix Assumptions
It is important to specify anticipated patient mix as well as his or her anticipated utilization or
volume. By “patient mix” we mean whether the individual is a Medicare patient, a Medicaid
patient, a patient covered by private insurance, or a private pay patient. When payers are thus
identified, this information allows the appropriate payments to be associated with the service
utilization assumptions.
Contractual Allowance Assumptions
The forecasted utilization of a service (or its volume) assumption is multiplied by the appropriate rate, or charges, in order to arrive at forecasted revenue stated in dollars. A word of
154 Chapter 14 Trend Analysis, Common Sizing, and Forecasted Data
Figure 14–1 Five-Year Operating Revenue Forecast.
$6,000,000
$5,000,000
$4,000,000
$3,000,000
$2,000,000
$7,000,000
$8,000,000
0 Year 1 Year 2 Year 3 Year 4
$1,000,000
Year 5
warning, however: revenue forecasted at “gross charges” is not a valid figure. Instead, revenue
stated at “allowed charges” is the proper figure to use. Virtually all payers, including Medicare, Medicaid, and private insurers, will pay a stipulated amount for a particular service. But
the amounts these different payers have agreed to pay for the same service will vary. How to
handle the issue? Through a contractual allowance, as defined here:
• Gross Charge: Amount for a service as shown on the claim form; a uniform charge generally greater than most expected payments received for the service.
• Allowed Charge: Net amount that the particular payer’s contract or participation agreement will recognize, or “allow,” for a certain service.
• Contractual Allowance: Difference (between the gross charge and the allowed charge) that
is recorded as a reduction of the gross charge within the accounting cycle.
(It should also be noted that part of the payer’s allowed charge is generally due from the patient,
and the remaining portion of the allowed charge is actually due from the payer.)
Trend Analysis Assumptions
One of the basic purposes of performing trend analysis is to compare data between or among
years and to see the trends. If such trends are found, then it makes sense to take them into
account in your forecast. A word of warning, however: the manager must determine whether
the data used for comparison in the trend analysis are comparable data.
Payer Change Assumptions
Trend analysis is retrospective; that is, it is using historical data from a past period. Forecasting
is prospective; that is, it is projecting into the future. If changes, say, in regulatory requirements
for payment are made this year, then that fact has to be taken into account.
Figure 14–2 One-Year Operating Revenue Forecast.
$1,500,000
$1,250,000
$1,000,000
$1,750,000
0 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Operating Revenue Forecasts 155
STAFFING FORECASTS
Staffing forecasts are also inputs into the operating budget. We have addressed staffing computations, costs, and reports in a previous chapter. This section builds upon that information in
order to produce a staffing forecast. Thus forecast considerations, components, and assumptions are addressed in this section.
Staffing Forecast Considerations
Staffing forecasts are a very common type of forecast required of managers. Three important
considerations when preparing staffing forecasts are discussed here.
Controllable Versus Noncontrollable Expenses
The concept of responsibility centers and controllable versus noncontrollable expenses
has been discussed earlier in this book. Essentially, controllable costs are subject to a manager’s own decision making, whereas noncontrollable costs are outside that manager’s
power. It is extremely difficult to make staffing forecasts with any degree of accuracy if
noncontrollable expenses are included in the manager’s forecast. The organization’s structure must be recognized and taken into account when setting up assumptions for staffing
forecasts. Shared services across lines of authority are workable in theory, but often do not
work in actuality. Figure 14–3 gives an example of the essential “business units” under the
supervision of a director of nurses. Note the responsibility centers and the support centers
on this organization chart.
Required Minimum Staff Levels
Regulatory healthcare standards may set minimum staff levels for providing service in a particular unit. These minimum levels cannot be ignored in the forecast process.
Figure 14–3 Primary Nursing Staff Classification by Line of Authority.
Courtesy of Resource Group, Ltd., Dallas, Texas.
Women’s
Health
Pediatric
Nursing
Ambulatory
Nursing
Medical
Surgical
Emergency
Nursing
TQI
Education
Recruitment
Support
Finance
Information
Systems
Support
Director
of
Nurses
156 Chapter 14 Trend Analysis, Common Sizing, and Forecasted Data
Labor Market Issues in Staffing Forecasts
We most often hear about a chronic lack of adequate staff, and certain parts of the country do
have a continual shortage of certain qualified professional healthcare staff. Yet other parts of
the country can have an overabundance during that same period. The status of the local labor
market has a direct impact on staffing forecasts. The impact is in dollars: when there are plenty
of staff available, the hourly rate to attract staff may go down, but when there is a shortage of
available qualified staff, the hourly rate has to go up. As strange as it may seem, this elemental
economic fact is sometimes not taken into account in forecasting assumptions.
Staffing Forecast Components
In many cases a staffing plan is first created, and the staffing forecast follows after the plan is
reviewed and refined. Four components are typically required, as follows. Figure 14–4 illustrates the sequence.
Scheduling Requirements
Scheduling requirements should encompass all hours and days required to cover each position.
For example, see the exhibit in the discussion about staffing (Chapter 10) that illustrates a
single security guard position and the number of units required.
Master Staffing Plan
The master staffing plan should include all units and all hours and days required to cover all
positions within the units. For example, see the exhibit in the discussion about staffing that
illustrates entire units by shift, covering 24 hours per day times 7 days a week.
Figure 14–4 Components of the Staffing Forecast.
Staffing Forecasts 157
Scheduling
Requirements
Master Staffing
Plan
Includes FTEs
required per shift
Net Paid Days
Worked per Year**
Total Paid Days per Year
Less
Paid Days Not Worked*
Annualized Master
Staffing Plan
Staffing
Forecast
FTEs Required per
Shift from Master
Staffing Plan
times
Annual Factor
equals
Annualized FTEs
Total days in the
business year divided
by net paid days
worked per year
equals
Annual Factor
=
=
*Paid Days Not Worked = Nonproductive Days
**Net Paid Days Worked = Productive Days
Computation Sequence to Annualize the Master Staffing Plan
The annualizing sequence is as follows. (This sequence is illustrated visually in Figure 14–4. An
example in worksheet form appears in the chapter about staffing.)
• Compute Productive and Nonproductive Days and Net Paid Days
The proportion of productive days (net paid days) versus nonproductive days (paid days
not worked) will be based on the organization’s policy as to paying for days not worked.
For example, see Step 1 in the Staffing chapter’s exhibit for such a computation, including “Net Paid Days.” (Holidays, sick days, vacation days, and education days composed the
“Paid Days Not Worked” in the worksheet example within the Staffing chapter’s exhibit.)
• Convert Net Paid Days Worked to an Annual Factor
The total days in the business year divided by net paid days worked equals a factor. Step 2
in the Staffing chapter’s exhibit illustrates this computation.
• Calculate the Annual FTEs Using the Factors
Finally, use the factor to calculate the FTEs required to fully cover the position’s shifts all year
long. For example, in the Staffing chapter’s exhibit, the RN FTE would be 1.6 (1.6106195).
The resulting staffing forecast reflects 24 hour per day 7 days per week annual FTEs to cover all
shifts.
CAPACITY LEVEL ISSUES IN FORECASTING
In the manufacturing industry, capacity levels relate to the production of, say, widgets. In the
world of health care, capacity relates to services; that is, the ability to produce or provide specific
healthcare services.
Space and Equipment Availability
The ability to provide services is automatically limited by the availability of both space and the
proper equipment to provide certain specific services. Forecasts need to take a realistic view of
these capacity levels.
Staffing Availability
Capacity is a tricky assumption to make in staffing forecasts. In some programs, particularly
those in a startup phase, overcapacity (too much staff available for the amount of work
required) is a problem. In some other organizations, under capacity (a chronic lack of
adequate staff) is the problem. Forecasting assumptions, in the best of all worlds, take these
difficulties into account. See the Mini-Case Study that demonstrates this problem of staffing
in the context of the Women, Infants, and Children (WIC) federal program.2
Example of Forecasting Maximum Service Capacity
Exhibit 14–1 illustrates the array of elements that should be taken into account when computing maximum capacity levels. This computation is important because your forecast should take
maximum capacity into account. (Alternative assumptions can also be made, of course. See the
sensitivity analysis discussion in a following chapter.)
158 Chapter 14 Trend Analysis, Common Sizing, and Forecasted Data
Exhibit 14–1 Capacity Level Checkpoints for an Outpatient Infusion Center
Outpatient Infusion Center Capacity Level Checkpoints
# infusion chairs……………………………… 3 chairs
# staff……………………………………………… 1 RN
# weekly operating hours…………………. 40 hours
# of hours per patient infusion…………. average 2 hours (for purposes of this example)
Work Flow Description
For each infusion the nurse must perform the following steps (generalized for this
purpose; actual protocol is more specific):
1. Obtain and review the patient’s chart
2. Obtain and prepare the appropriate drug for infusion
3. Interview the patient
4. Prepare the patient and commence the infusion
5. Monitor and record progress throughout the ongoing infusion
6. Observe the patient upon completion of the infusion
7. Complete charting
Work Flow Comments
It is impossible for one nurse to start patients’ infusions in all three chairs simultaneously. Thus the theoretical treatment sequence might be as follows:
• Assume one half-hour for patient number one’s Steps 1 through 4.
• Once patient number one is at Step 5, the nurse can begin the protocol for
patient number two.
• Assume another one half-hour for patient number two’s Steps 1 through 4.
• Once patient number two is at Step 5, theoretically the nurse can begin the
protocol for patient number three.
This sequence should work, assuming all factors work smoothly; that is, the appropriate
drugs in the proper amounts are at hand, the patients show up on time, and no one
patient demands an unusual amount of the nurse’s attention. (For example, a new
patient will require more attention.)
Daily Infusion Center Capacity Level Assumption
Patient scheduling is never entirely smooth, and patient reactions during infusions
are never predictable. Therefore, we realistically assume the following: Chair #1 5 3
patients per day, Chair #2 5 2 patients per day, and Chair #3 5 2 patients per day, for a
daily total of 7 patients infused.
Capacity Level Issues in Forecasting 159
SUMMARY
In summary, the ultimate accuracy of a forecast rests on the strength of its assumptions.
INFORMATION CHECKPOINT
What is needed? An example of a staffing forecast created in your organization.
Where is it found? In the files of the supervisor who is responsible for staffing.
How is it used? Use the example to learn the nature of the assumptions that
were used and the setup of the forecast itself.
KEY TERMS
Common Sizing
Controllable Expenses
Forecasts
Noncontrollable Expenses
Patient Mix
Trend Analysis
Vertical Analysis
DISCUSSION QUESTIONS
1. Do any of the reports you receive in the course of your work use trend analysis? Why do
you think so?
2. Do any of the reports you receive in the course of your work use common sizing? Why do
you think so?
3. Are you or your immediate supervisor involved with staffing decisions? If so, are
you aware of how staffing forecasts are prepared in your organization? Describe an
example.
4. Have you, in the course of your work, become involved in problems with capacity level
issues such as space and equipment availability? If so, would forecasting have assisted in
solving such problems? Describe why.
NOTES
1. Merriam Webster’s Collegiate Dictionary, 10th ed., s.v. “Forecast.”
2. B. A. Brotman, M. Bumgarner, and P. Prime, “Client Flow through the Women, Infants,
and Children Public Health Program,” Journal of Health Care Finance, 25, no. 1 (1998):
72–77.
160 Chapter 14 Trend Analysis, Common Sizing, and Forecasted Data
Progress Notes
© LFor/Shutterstock
Using Comparative Data
OVERVIEW
Comparative data can become an important tool for the
manager. It is important, however, to fully understand the
requirements and the uses of such data.
COMPARABILITY REQUIREMENTS
True comparability needs to meet three criteria: consistency, verification, and unit measurement. Each is discussed
in this section.
Consistency
Three equally important elements of consistency should be
considered as follows.
Time Periods
Time periods should be consistent. For example, a
10-month period should not be compared to a 12-month
period. Instead, the 10-month period should be annualized, as described within this chapter.
Consistent Methodology
The same methods should be used across time periods.
For example, the chapter about inventory discusses
the use of two inventory methods: first-in, first-out
(FIFO) versus last-in, first-out (LIFO). The same inventory method—one or the other—should always be used
consistently for both the beginning of the year and the
end of the year.
After completing this chapter,
you should be able to
1. Understand the three criteria
for true comparability.
2. Understand the four uses of
comparative data.
3. Annualize partial-year
expenses.
4. Apply inflation factors.
5. Understand basic currency
measures.
161
15
CHAPTER
Inflation Factors
Finally, if multiple years are being compared, should inflation be taken into account? The
proper application of an inflation factor is also described within this chapter.
Verification
Basically, can these data be verified? Is it reasonable? If an objective, qualified person reviewed
the data, would he or she arrive at the same conclusion and/or results? You may have to do a few
tests to determine if the data can in fact be verified. If so, you should retain your back-up data,
because it is the evidence that supports your conclusions about verification.
Monetary Unit Measurement
With regard to comparative data, we should ask: “Is all the information being prepared or
under review measured by the same monetary unit?” In the United States, we would expect all
the data to be expressed in dollars and not in some other currency such as euros (used in much
of Europe) or pounds (used in Britain and the United Kingdom). Most of the manager’s data
will automatically meet this requirement. However, currency conversions are an important part
of reporting financial results for companies that have global operations, and consistency in
applying such conversions can be a significant factor in expressing financial results.
A MANAGER’S VIEW OF COMPARATIVE DATA
It is important for the manager to always be aware of whether the data he or she is receiving (or
preparing) are appropriate for comparison. It is equally important for the manager to perform
a comprehensive review, as described here.
The Manager’s Responsibility
Whether you as a manager must either review or prepare required data, your responsibility is to
recall and apply the elements of consistency. Why? Because such data will typically be used for
decision making. If such data are not comparable, then relying upon them can result in poor
decisions, with financial consequences in the future. The actual mechanics of making a comparative review are equally important. The deconstruction of a comparative budget review follows.
Comparative Budget Review
The manager needs to know how to effectively review comparative data. To do so, the manager
needs to understand, for example, how a budget report format is constructed. In general, the
usual operating expense budget that is under review will have a column for actual expenditures,
a column for budgeted expenditures, and a column for the difference between the two. Usually,
the actual expense column and the budget column will both have a vertical analysis of percentages (as discussed in the preceding chapter). Each different line item will have a horizontal
analysis (also discussed in the preceding chapter) that measures the amount of the difference
against the budget.
162 Chapter 15 Using Comparative Data
Table 15–1 illustrates the operating expense budget configuration just described. Notice that
the “Difference” column has both positive and negative numbers in it (the negative numbers
being set off with parentheses). Thus, the positive numbers indicate budget overage, such as
the dietary line, which had an actual expense of $405,000 against a budget figure of $400,000,
resulting in a $5,000 difference. The next line is maintenance. This department did not exceed
its budget, so the difference is in parentheses; the maintenance budget amounted to $290,000,
and actual expenses were only $270,000, so the $20,000 difference is in parentheses. In this
case, parentheses are good (under budget) and no parentheses is bad (over budget).
USES OF COMPARATIVE DATA
Four common uses of comparisons that the manager will find helpful are discussed in this
section.
Compare Current Expenses to Current Budget
Managers are most likely to be responsible for comparing the current expenses of their department, division, unit, or program to their current budget. Of the four types of comparisons discussed in this section, this is the one most commonly in use.
Table 15–1 illustrates a comparison of actual expenses versus budgeted expenses. This format reflects both dollars and percentages, as is most common. Table 15–1 shows the grand
totals for each department (Dietary, Maintenance, etc.) contained in General Services expense
for this hospital. There is, of course, a detailed budget for each of these departments that adds
up to the totals shown on Table 15–1. Thus, for example, all the detailed expenses of the Laundry department (labor, supplies, etc.) are contained in a supporting detailed budget whose total
actual expenses amount to $45,000 and whose total budgeted expenses amount to $50,000.
The department manager will be responsible for analyzing and managing the detailed budgets of his or her own department. A manager at a higher level in the organization—the chief
financial officer (CFO), perhaps—will be responsible for making a comparative analysis of the
overall operations of the organization. This comparative analysis at a higher level will condense
each department’s details into a departmental grand total, as shown in Table 15–1, for convenience and clarity in review.
Table 15–1 Comparative Analysis of Budget Versus Actual
Hospital 1
Year 2 Actual Year 2 Budget Difference
$$ % $$ % $$ %
General Services Expense
Dietary $405,000 45 $400,000 46 $5,000 12.5
Maintenance 270,000 30 290,000 33 (20,000) (6.9)
Laundry 45,000 5 50,000 6 (5,000) (10.0)
Housekeeping 180,000 20 130,000 15 50,000 38.5
Total GS Expense $900,000 100 $870,000 100 $30,000 3.5
Uses of Comparative Data 163
The CFO may also convert this comparative data into charts or graphs in order to “tell the
story” in a more visual manner. For example, the total General Service expense in Table 15–1
can be readily converted into a graph. Figure 15–1 illustrates such a graph.
Compare Current Actual Expenses to Prior Periods in Own Organization
Trend analysis, as explained in the preceding chapter, allows comparison of current actual
expenses to expenses incurred in prior periods of the same organization. For example, consider total general services expenses of $800,000 for year 1 and $900,000 for year 2. The CFO
could easily convert this information into a graph, as shown in Figure 15–2. This information
might be even more valuable for decision-making input if the CFO used five years instead of the
two years that are shown here.
Compare to Other Organizations
Common sizing, as explained in the preceding chapter, allows comparison of your organization to other similar organizations. To illustrate, refer to the table in a preceding chapter
(Table 14–1) entitled “Common Sizing Liability Information.” Here we see the liabilities
of three hospitals that are the same size expressed in both dollars and in percentages.
Therefore, our CFO can convert the percentages into an informative graph, as shown in
Figure 15–3.
Be warned that the basis for some comparisons will be neither useful nor valid. For example,
see Figure 15–4. Here we have a graph of the grand totals from the table in a preceding chapter
(Table 14–2) entitled “Common Sizing Expense Information.” The percentages shown are for the
General Services departments of each hospital and have been common sized to percentages, as is
Figure 15–1 A Comparison of Hospital One’s Budgeted and Actual Expenses.
$820,000
$840,000
$860,000
$880,000
$900,000
$920,000
Year 2
Budgeted Expenses
$870,000
Year 2
Actual Expenses
$900,000
$800,000
164 Chapter 15 Using Comparative Data
perfectly correct. However, Figure 15–4 attempts to compare the total General Services expense
(the total of all four general services departments) in dollars. As we can see here, hospital 1 and
hospital 3 are both 100 beds, while hospital 2 is 400 beds. Obviously a 400-bed hospital will incur
much more expense than a 100-bed hospital, so this graph cannot possibly show a valid comparison among the three organizations.
Figure 15–3 A Comparison of Three 100-Bed Hospitals’ Long-Term Debt.
20%
40%
60%
80%
0%
100%
Hospital 1
(100 beds)
80%
Hospital 2
(100 beds)
75%
Hospital 3
(100 beds)
20%
Uses of Comparative Data 165
Figure 15–2 A Comparison of Hospital One’s Expenses Over Time.
$800,000
$600,000
$1,000,000
Year 1
$800,000
Year 2
$900,000
Figure 15–5 A Comparison of Three Hospitals’ Expenses per Bed.
Figure 15–4 A Comparison of Three Hospitals’ Total Expenses.
$1,000,000
$500,000
$1,500,000
$2,000,000
$2,500,000
$3,000,000
$0
$3,500,000
Hospital 1
(100 beds)
$800,000
Hospital 2
(400 beds)
$3,000,000
Hospital 3
(100 beds)
$900,000
$6,500
$7,000
$7,500
$8,000
$8,500
$9,000
$6,000
$9,500
Hospital 1
(100 beds)
$8,000
Hospital 2
(400 beds)
$7,500
Hospital 3
(100 beds)
$9,000
Instead, the CFO should find a standard measure that can be used as a valid basis for comparison. In this case, he or she can choose size (number of beds) for this purpose. The resulting graph
is shown in Figure 15–5. As you can see, hospital 1’s cost per bed is $8,000, computed as follows.
166 Chapter 15 Using Comparative Data
The total expense of $800,000 for hospital 1 is divided by 100 beds (its size) to arrive at the $8,000
expense per bed shown on the graph in Figure 15–5. Hospital 2 ($3,000,000 total expense divided
by 400 beds to equal $7,500 per bed) and hospital 3 ($900,000 total expense divided by 100 beds
to equal $9,000 per bed) have the same computations performed on their equivalent figures.
In actual fact, another step in this computation should be performed in order to make the
comparisons completely valid. A per-bed computation implies inpatient expenses incurred,
because beds are occupied by admitted inpatients. (Outpatients, on the other hand, use a
different mix of services.) Therefore, a more accurate comparison would adjust the overall total
expense using one subtotal for inpatients and another subtotal for outpatients. Let us assume,
for purposes of illustration, that the CFO of hospital 1 has determined that 70% of General
Services expense can be attributed to inpatients and that the remaining 30% can be attributed
to outpatients. Let us further assume that hospital 1’s General Services expense of $800,000 as
shown, is indeed a hospital-wide expense. The CFO would then multiply $800,000 by 70% to
arrive at $420,000, representing the inpatient portion of General Services expense.
Compare to Industry Standards
In the example just given in the paragraph above, the CFO has computed his or her own hospital’s percentage of inpatient versus outpatient utilization of General Services expense. But this
CFO may not have any way to know these equivalent percentages for hospitals 2 and 3. If this is
the case, computing the per-bed expense using overall expense, as shown in Figure 15–5, may
be the only way to show a three-hospital comparison.
The CFO, however, can use the 70% inpatient and 30% outpatient expense breakdown
for another type of comparison. It should be possible to find industry standards that break
Figure 15–6 A Comparison of Hospital One’s GS Inpatient Expenses with Industry Standards.
55%
60%
65%
70%
50%
75%
GS Inpatient Expense %
Hospital 1
70%
GS Inpatient Expense %
Industry Standard
60%
Uses of Comparative Data 167
out inpatient versus outpatient expense percentages. The use of industry standards is of
particular use for decision making because it
positions the particular organization within a
large grouping of facilities that provide a similar set of services.
Healthcare organizations are particularly well
suited to use industry standards because both the
federal and state governments release a wealth
of public information and statistics regarding the provision of health care. Figure 15–6
illustrates the CFO’s graph using such a standard. (The figures shown are for illustration
only and do not reflect an actual standard.)
MAKING DATA COMPARABLE
This section discusses annualizing partialyear expenses, along with using inflation factors, standardized measures, and currency
measures. The manager needs to know how
to make data comparable as a basis for properly preparing and/or reviewing budgets and
reports.
Annualizing
Because comparability requires consistency,
the manager needs to know how to annualize
partial-year expenses. Table 15–2 sets out the
actual 10-month expenses for the operating
room. But these expenses are going to be
compared against a 12-month budget. What
to do? The actual 10-month expenses are converted, or annualized, to a 12-month basis, as
shown in the second column of Table 15–2.
These computations were performed on a
computer spreadsheet; however, the calculation
is as follows. Using the first line as an example,
$50,431 is 10-months worth of expenses; therefore, 1 month’s expense is one-tenth of $50,431,
or $5,043. To annualize for 12-months worth
of expenses, the 10-month total of $50,431 is
increased by 2 more months at $5,043 apiece
($50,431 plus $5,043 for month 11, plus
another $5,043 for month 12, equals $60,517,
the annualized 12-month figure for the year).
Table 15–2 Annualizing Operating Room PartialYear Expenses
Expenses
Actual Annualized
Account 10 Month 12 Month
Social Security 50,431 60,517
Pension 17,229 20,675
Health Insurance 7,018 8,422
Child Care 3,803 4,564
Patient Accounting 129,463 155,356
Admitting 91,878 110,254
Medical Records 76,432 91,718
Dietary 22,938 27,526
Medical Waste 1,981 2,377
Sterile Procedures 65,600 78,720
Laundry 33,911 40,693
Depreciation—
Equipment 72,815 87,378
Depreciation—
Building 34,481 41,377
Amortization—
Interest (4,849) (5,819)
Insurance 3,513 4,216
Administration 48,305 57,966
Medical Staff 1,435 1,722
Community
Relations 41,511 49,813
Materials
Management 53,811 64,573
Human Resources 25,888 31,066
Nursing
Administration 68,726 82,471
Data Processing 14,846 17,815
Fiscal 14,750 17,700
Telephone 2,366 2,839
Utilities 22,005 26,406
Plant 64,664 77,597
Environmental
Services 27,395 32,874
Safety 1,680 2,016
Quality
Management 8,347 10,016
Medical Staff 7,870 9,444
Continuous Quality
Improvement 4,079 4,895
EE Health 474 569
Total Allocated 1,014,796 1,217,756
All Other Expenses 1,009,673 1,211,608
Total Expense 2,024,469 2,429,364
Reproduced with the permission of Wolters Kluwer Law & Business
from J.J. Baker, Activity-Based Costing and Activity-Based Management for Health Care, p. 190, © 1998, Aspen Publishers, Inc.
168 Chapter 15 Using Comparative Data
Inflation Factors
Inflation means “an increase in the volume of money and credit relative to available goods and
services resulting in a continuing rise in the general price level.”1 An inflation factor is used to
compute the effect of inflation.
Let’s assume that hospital 1’s General Services expenses for year 1 were $800,000, versus
$900,000 for year 2. We can assume that these amounts reflect actual dollars expended in each
year. But let us also now assume that inflation caused these expenses to rise by 5% in year 2. If
the Chief Financial Officer (CFO) decides to take such inflation into account, a government
source will be available to provide the appropriate inflation rate. (The 5% in our example is for
illustration only and does not reflect an actual rate.)
The inflation factor for this example is expressed as a factor of 1.05 (1.00 plus 5% [expressed
as .05] equals 1.05). The CFO might apply the inflation factor to year 1 in order to give it a
spending power basis equivalent to that of year 2. (Applying an inflation factor for a two-year
comparison is not usually the case, but let us assume the CFO has a good reason for doing so
in this case.) The computation would thus be $800,000 year 1 expense times the 1.05 inflation
factor equals an inflation-adjusted year 1 expense figure of $840,000.
However, if the CFO wants to apply an inflation factor to a whole series of years, he or she
must account for the cumulative effect over time. An example appears in Table l5–3. We assume
a base of $500,000 and an annual inflation rate of 10%. The inflation factor for the first year is
10%, converted to 1.10, just as in the previous example, and $500,000 multiplied by 1.10 equals
$550,000 in nominal dollars.
Beyond the first year, however, we must determine the cumulative inflation factor. For this purpose we turn to the Compound Interest Table. It shows “The Future Amount of $1.00,” and appears
in Appendix B of the chapter about time value of money. “The Future Amount of $1.00” table has
years down the left side (vertical) and percentages across the top (horizontal). We find the 10%
column and read down it for years one, two, three, and so on.
As shown in Table 15–3.2, the factor for year 2 is 1.210, for year 3 is 1.331, and so on. We carry
those factors to column C of Table 15–3.1. Now we multiply the $500,000 in column B times the
factor for each year to arrive at the cumulative inflated amount in column D. Thus $500,000 times
the year 2 factor of 1.210 equals $605,000, and so on.
Currency Measures
Monetary unit measurement, and the related currency measures and currency conversions, are
typically beyond most manager’s responsibilities. Nevertheless, it is important for the manager to
understand that consistency in applying such measures and conversions will be a significant factor
in expressing financial results of companies that have global operations.
Therefore, for comparative purposes we must determine if all the information being prepared or under review is measured by the same monetary unit. A few foreign currency examples
are illustrated in Exhibit 15–1. Currencies are typically converted for financial reporting purposes using the U.S.-dollar foreign exchange rates as of a certain date.
Exchange rates may be expressed in two ways: “in U.S. dollars” or “per U.S. dollars.” For
example, assume the euro is trading at 1.3333 in U.S. dollars and at 0.7500 per U.S. dollars.
That means if you were spending your U.S. dollar in, say, France (part of the “euro area”), it
would take a third as much (1.33) in your dollars to buy products priced in euros. If your French
friend, on the other hand, was spending euros for products priced in U.S. dollars, he or she
Making Data Comparable 169
Exhibit 15–1 Foreign Currency Examples
Country (or Area) Currency
Canada Canadian dollar
China Yuan
Euro Area Euro
Japan Yen
Mexico Peso
United Kingdom Pound
Table 15–3 Applying a Cumulative Inflation Factor
Table 15–3.1
SOURCE OF FACTOR IN COLUMN C BELOW:
From the Compound Interest Look-Up Table
“The Future Amount of $1.00” (Appendix 13-B)
Year Factors as shown at 10%
1 1.100
2 1.210
3 1.331
4 1.464
Table 15–3.2
(A) (B) (C) (D)
Real Cumulative Nominal
Year Dollars Inflation Factor* Dollars**
1 $500,000 (1.10)1 5 1.100 $550,000
2 500,000 (1.10) 2 5 1.210 605,000
3 500,000 (1.10) 3 5 1.331 665,500
4 500,000 (1.10)4 5 1.464 732,050
*Assume an annual inflation rate of 10%. Thus 1.00 + 0.10 = the 1.10 factor in Column C.
**Column D “Nominal Dollars” equals Column B times Column C.
could buy one-quarter more for his or her money (because the U.S. dollar would be worth only
three quarters [0.7500] of the euro at that particular exchange rate).
Standardized Measures
A final word about standardized measures. Standardized measures aid comparability. They
especially assist in performance measurement. Types of standardized measures include the typical hospital per-bed measure along with work load measures.
170 Chapter 15 Using Comparative Data
There is, of course, a whole array of uses for standardized measures. Managed care plans, for
example, may use a standard set of measures that are applied to every physician who contracts with
the plan. Each physician then receives a report from the plan that illustrates his or her performance.
Finally, electronic medical records (as further discussed in following chapters) depend upon
standardized input. The input into various fields is standardized (and thus made comparable)
by the very nature of the electronic system design.
CONSTRUCTING CHARTS TO SHOW THE DATA
Managers use charts to explain their projects and to report their results. Thus constructing
accurate and effective charts is a valuable skill.
Types of Charts
There are four basic chart styles as follows:
• Column chart
• Pie chart
• Bar chart
• Line chart
The column chart’s data is presented in vertical columns. The pie chart is typically circular
(like a pie, thus its name). The bar chart presents data in horizontal bars. The line chart generally uses multiple lines that track along a grid. Figures 15-7, 15-8, and 15-9 illustrate examples of
the pie chart, bar chart, and line chart respectively.
Distribution of DRG 0xx Cases by Physician
Quarter Ending 12/31/xx
MD1
MD 23 cases 5
25 cases
MD2
62 cases
MD3
12 cases
MD4
14 cases
Figure 15–7 Distribution of DRG 0xx Cases by Physician.
Modified from R. Hankins & J.J. Baker, Management Accounting for Health Care Organizations (Sudbury, MA: Jones &
Bartlett 2004). p. 375.
Constructing Charts to Show the Data 171
9,000
8,000
7,000
6,000
5,000
Cost (in $) 4,000
3,000
2,000
1,000
0
MD 1 MD 2
Med/Surg cost ICCU cost Ancillary cost Total cost
Physician
MD 3 M MD 4 D 5
Cost per Case by Physician for DRG 0xx
Quarter Ending 12/31/xx
Figure 15–8 Cost per Case by Physician for DRG 0xx.
Modified from R. Hankins & J.J. Baker, Management Accounting for Health Care Organizations (Sudbury, MA: Jones &
Bartlett 2004). p. 376.
Chart Content and Format
Constructing the chart means answering a series of questions about content and format, as
follows:
• What is the subject of the chart?
• What are the specific elements to be included?
• What type of chart will best serve my purpose?
• Is the information accurate and consistent?
• If applicable, is the information comparable?
• What are the dimensions of the chart?
• If applicable, what is the span between high and low?
Chart Templates
A variety of chart templates are now available online. They are generally found within office
suite programs. Each template typically offers a drop-down menu for specifics of the format and
a second drop-down menu for the chart’s data input. Electronic templates also provide quick
and easy color choices for your chart presentation. You can experiment with various colors to
reach the best combination for your project.
172 Chapter 15 Using Comparative Data
To summarize, the chart you construct can be simple or elaborate. It can be black and white
or it can be multi-colored. But whatever its style, your chart must contain accurate and comparable data.
INFORMATION CHECKPOINT
What is needed? Example of a detailed comparative budget review (comparing
budget to actual).
Where is it found? With the supervisor responsible for the budget.
How is it used? To find whether data are stated in comparable terms between
actual amounts and budget amounts.
KEY TERMS
Annualize
Inflation Factor
Monetary Unit
9,000
8,000
7,000
6,000
5,000
Cost (in $) 4,000
3,000
2,000
1,000
0
MD 1 MD 2
Total cost Average cost for DRG 0xx—all physicians
Physician
MD 3 M MD 4 D 5
Cost per Case by Physician for DRG 0xx
Quarter Ending 12/31/xx
Figure 15–9 Total Cost per Case by Physician for DRG 0xx.
Modified from R. Hankins & J.J. Baker, Management Accounting for Health Care Organizations (Sudbury, MA: Jones &
Bartlett 2004). p. 377.
Key Terms 173
DISCUSSION QUESTIONS
1. Do you believe your organization uses a flexible or static budget? Why do you
think so?
2. If you reviewed a budget at your workplace, do you think the major increases and
decreases could be explained? If so, why? If not, why not?
3. Have you ever in the course of your work reviewed a report that had been annualized? If
so, did you agree with how it appeared to be annualized?
4. Were you also able to see the assumptions used to annualize? If so, were you able to recalculate the results using the same assumptions?
5. Have you ever in the course of your work reviewed a financial report that applied inflation factors? If so, were you able to see the assumptions used to apply the factors? If not,
why not? Please describe.
NOTE
1. Merriam Webster’s Collegiate Dictionary, 10th ed., s.v. “Inflation.”
174 Chapter 15 Using Comparative Data
© LFor/Shutterstock
Construct and
Evaluate Budgets
PART
VI

Progress Notes
© LFor/Shutterstock
Operating Budgets
OVERVIEW
A budget is an organization-wide instrument. The
organization’s objectives define the specific activities to be
performed, how they will be assembled, and the particular
levels of operation, whereas the organization’s performance standards or norms set out the anticipated levels
of individual performance. The budget is the instrument
through which activities are quantified in financial terms.
Objectives for the Budgeting Process
A healthcare standard view of budgeting is illustrated by the
American Hospital Association’s (AHA’s) objectives for the
budgeting process:
1. To provide a written expression, in quantitative
terms, of a hospital’s policies and plans.
2. To provide a basis for the evaluation of financial performance in accordance with a hospital’s policies and
plans.
3. To provide a useful tool for the control of costs.
4. To create cost awareness throughout the organization.1
Operating Budgets Versus Capital Expenditure
Budgets
Operating budgets generally deal with actual short-term
revenues and expenses necessary to operate the facility. The
usual period covered is the next year (a 12-month period).
Capital expenditure budgets, on the other hand, may cover
the next year as well, but are linked into a more futuristic
view. Thus, capital expenditure budgets may cover a 5- or
even a 10-year period.
After completing this chapter,
you should be able to
1. Understand the difference
between operating budgets
and capital expenditure
budgets.
2. Understand what budget
expenses will most likely be
identifiable versus allocated
expenses.
3. Understand how to build an
operating budget.
4. Understand the difference
between static and flexible
budgets.
177
16
CHAPTER
BUDGET VIEWPOINTS
Responsibility Centers
In a responsibility center the manager is responsible for a particular set of activities. (We have
discussed responsibility centers in a previous chapter.) In the context of operating budgets there
are two common types of responsibility centers: cost centers and profit centers. As shown in
Figure 16–1, in cost centers the manager is responsible for controlling costs. In profit centers the
manager is responsible for both costs and revenues. Thus, we expect that a cost center operating
budget will show costs only, while a profit center budget should show both revenues and costs.
Transactions Outside the Operating Budget
Certain transactions are outside the operating budget, as shown in Figure 16–2. For example,
many grants received by healthcare organizations are restricted funds. The monies in a
restricted fund are not to be commingled with general operations monies. Also, a restricted
fund generally requires altogether separate accounting and reporting.
Foundation transactions are also outside the operating budget. Foundations are legally separate organizations that require separate accounting and reporting of their funds. Therefore, we
would not expect any of their costs to be included in operations.
Figure 16–1 Two Common Budget Responsibility Centers.
Common Types of Budget Responsibility Centers
Cost
Centers
Manager
responsible for
controlling costs
Manager
responsible for
both costs
and revenue
Profit
Centers
Figure 16–2 Transactions Outside the Operating Budget.
Transactions outside the Operating Budget
Grants
received
by the
organization
Restricted funds
require separate
accounting
Legally separate
organization requires
separate accounting
Foundation
transactions
178 Chapter 16 Operating Budgets
BUDGET BASICS: A REVIEW
A brief review of budget basics is advisable as we move into constructing an operating budget.
Identifiable Versus Allocated Budget Costs
Within a departmental budget, certain costs will be specifically identifiable while others will be
allocated instead, as shown in Figure 16–3:
• Direct patient care and supporting patient care should be mostly identifiable.
• General and administrative expense and patient-related expense will probably be mostly
allocated costs.
• Financial-related expense, such as interest expense, may not be included at all in the manager’s budget.
Fixed Versus Variable Costs
You will recall that fixed costs do not change in total,
even though volume rises or falls (within a wide range).
Variable costs, however, rise or fall in proportion to a
change (a rise or fall) in volume. You will further recall
that volume, in the case of healthcare organizations,
generally means number of procedures (outpatient
services) or number of patient days (inpatient services)
or perhaps, prescriptions filled (pharmacy services).
Figure 16–4 illustrates this principle, while Exhibit 16–1
provides examples of fixed and variable cost categories that would typically be found within an operating
budget.
Figure 16–3 Identified Versus Allocated Costs.
Departmental Operating Budget
General &
Administrative
Expense
Patient
Related
Expense
Mostly
allocated
costs
Financial
Related
Expense
May not
be
included
Direct
Patient Care
Supporting
Patient Care
Mostly
identifiable
costs
Figure 16–4 Fixed Versus Variable Costs.
Fixed Cost
Does not
change even
though
volume rises
or falls within
a wide range
Variable Cost
Rises or falls
in proportion
to a rise or
fall in
volume*
*Examples of volume: Number of procedures or patient days
Budget Basics: A Review 179
BUILDING AN OPERATING BUDGET: PREPARATION
Appropriate preparation is an important stage in building an operating budget. It is often
difficult for the manager to allow adequate time for budget preparation, because this effort
is above and beyond his or her daily responsibilities. Understanding the usual stages, or
sequence, of budget construction as listed here assists in predicting how much time will be
required.
Construction Stages
Operating budget construction stages include the following:
• Plan
• Gather information
• Prepare input
• Construct and submit draft version of budget
• Make required revisions to draft
• Present preliminary budget
• Make required revisions to preliminary budget
• Submit final budget
Input includes both assumptions and calculations; required revisions to the draft version
would occur after upper-level management has reviewed the draft. Additional revisions will typically be required after the preliminary budget has been presented. (The preliminary budget
almost never becomes the final version without some degree of revision.)
Construction Elements
What will your budget look like? Will it follow guidelines from last year, or will it take on a new
form? What will be expected of you, the manager? Understanding the budget construction elements will help you create a budget that is a useful tool.
Exhibit 16–1 Fixed and Variable Cost Examples
Operating Expenses Fixed Variable
Labor
Gross Salaries X
Employers’ Payroll Taxes X
Other Employee Benefits X
Part-Time Temporary Contract Labor X
Other Expenses
Drugs and Medical Supplies X
Rent X
Insurance X
Five-Year Equipment Lease X
180 Chapter 16 Operating Budgets
As part of the preparation process, you should determine the following:
• Format to be used
• Budget scope
• Available resources
• Levels of review
• Time frame
As to format, will templates be available for use? And if so, will they be required? As to budget
scope, will your budget become a segment only, to be combined and consolidated in a later
stage? If this is so, you may lose some of your line items as you lose control of the final product.
Necessary resources made available to you could include, for example, special data processing
runs or extra staff assistance to locate required information. The levels of review, along with how
many versions of the budget will be required, depend upon the structure and expectations of
the particular healthcare organization. And the time frame should be adequate.
BUILDING AN OPERATING BUDGET: CONSTRUCTION
Budget information sources, assumptions, and computations are all vital to proper operating
budget construction.
Budget Information Sources
Three primary sources of operating budget information are illustrated in Figure 16–5. They
include the Operating Revenue Forecast and the Staffing Plan or Forecast, along with a plan
or forecast of other operating expenses. As Figure 16–1 illustrated earlier in this chapter, the
manager who is responsible for both costs and revenues would require the revenue forecast. If,
however, the manager is responsible only for costs (and not for revenues), the revenue forecast
would not become part of his or her responsibility.
When the preliminary operating budget is under construction, the capacity-level checkpoints (discussed in a previous chapter) should also be taken into consideration. (This step may
be undertaken at a different level and thus may not be your own responsibility.)
Figure 16–5 Operating Budget Inputs.
Capacity Level Checkpoints
Other Operating Expenses
Staffing Plan or Forecast
Operating Revenue Forecast
Operating
Expenditures
Plan
Preliminary
Operating
Budget
Budget Assumptions and Computations
Budget assumptions and computations are somewhat intertwined.
Building an Operating Budget: Construction 181
Assumptions
Building a budget means making a series of
assumptions. The budget process should
begin with a review of strategy and objectives.
Forecasting workload is a critical part of
building a budget. The workload should tie
into expected volume for the new budget
period. Good information is necessary to forecast workload. For example, Table 16–1 presents total nursing hours by unit. But there is
not enough detail in this report to use because
it does not indicate, among other things,
hours by type of staff and/or staff level. Sufficient information at the proper level of detail
is essential in creating a budget.
Another critical assumption in building a budget is whether special projects are going to use
resources during the new budget period. Still another factor to consider is whether operations
are going to be placed under some type of unusual or inconvenient circumstances during the
new budget period. A good example would be renovation of the work area.
Computations
Computations should be supported by their assumptions and should be replicable; that
is, another individual should be able to reproduce your computations when using the same
assumptions. Computations must also be comparable; that is, the same type of computation
must be used by each unit or each department. Thus, when the departmental budgets are combined, they will all be stated on the same basis.
An example of computations that must be comparable is contained in Figure 16–6. Recall
information about preparation of the Staffing Forecast (an input to the operating budget),
which has been described in the preceding chapter about staffing. Now costs must be attached
to the forecast for budget purposes. As shown in Figure 16–6, the forecast should first contain annual FTEs and Total Paid Days Required. When cost is attached to the cost of Annual
Paid Days Required, that cost should include Gross Salaries and Employee Benefit Costs. If
Table 16–1 Nursing Hours Report
Unit Nursing Hours
No. Description Regular Overtime
620 S-MED-SURG DIV 5 72,509 6,042
630 N-MED-SURG DIV B 40,248 3,354
640 N-MED SURG DIV D 42,182 3,515
645 N-INTENSIVE CARE
UNIT 55,952 4,663
655 S-INTENSIVE CARE
UNIT 52,000 4,333
660 S-SURG ICU 21,840 1,820
665 S-STEPDOWN 52,208 4,351
Figure 16–6 Staffing Money in the Operating Budget.
Staffing
Forecast
Staffing Money
in the Operating
Budget
Attach Cost of
Number of Annual
Paid Days
Required
Includes
annualized
FTEs and
total paid
days per year
Includes Gross
Salaries +
Employee
Benefit Costs
=
182 Chapter 16 Operating Budgets
one department defines total employee benefit cost one way and another department defines
it more broadly, then the resulting combined budget’s staffing dollars will not have been computed on a comparable basis. That budget will be flawed.
Finalize and Implement the Budget
The final budget is approved for use after multiple reviews and adjustments of the preliminary
budget drafts. The final step is then to implement the new budget. It is important to explain the
contents to all involved personnel. It may also be necessary to provide training for new report
formats or similar issues.
WORKING WITH STATIC BUDGETS AND FLEXIBLE BUDGETS
Both static budgets and flexible budgets can be useful tools if wielded by a manager who understands both their strengths and their weaknesses.
Definitions and Uses
Definitions and uses of the static budget and the flexible budget are included in this section.
Static Budget
A static budget is essentially based on a single level of operations. After a static budget has been
approved and finalized, that single level of operations (volume) is never adjusted. Budgets are
measured by how they differ from actual results. Thus, a variance is the difference between
an actual result and a budgeted amount when the budgeted amount is a financial variable
reported by the accounting system. The variance may or may not be a standard amount, and it
may or may not be a benchmark amount.2
The computation of a static budget variance only requires one calculation, as follows:
Actual 2 Static Budget = Static Budget
Results Amount Variance
The basic thing to understand is that static budgeted expense amounts never change, when
volume actually changes during the year. In the case of health care, we can use patient days as
an example of level of volume, or output. Assume that the budget anticipated 400,000 patient
days this year (patient days equating to output of service delivery; thus, 400,000 output units).
Further assume that the revenue was budgeted for the expected 400,000 patient days and that
the expenses were also budgeted at an appropriate level for the expected 400,000 patient days.
Now assume that only 360,000, or 90%, of the patient days are going to actually be achieved for
the year. The budgeted revenues and expenses still reflect the original expectation of 400,000
patient days. This example is a static budget; it is geared toward only one level of activity, and the
original level of activity remains constant or static.
Static budgets may be used to plan. When utilized in this way, these budget figures represent
a goal for the budget period. Table 16–2 illustrates this concept. The table shows a goal of 100
Working with Static Budgets and Flexible Budgets 183
procedures to be performed during the budget period, along with the revenues and expenses
that support that goal.
Flexible Budget
A flexible budget is one that is created using budgeted revenue and/or budgeted cost amounts.
A flexible budget is adjusted, or flexed, to the actual level of output achieved (or perhaps
expected to be achieved) during the budget period.3 A flexible budget thus looks toward a
range of activity or volume (versus only one level in the static budget).
Flexible budgets became important to health care when diagnosis-related groups (DRGs)
were established in hospitals in the 1980s. The development of a flexible budget requires more
time and effort than does the development of a static budget. If the organization is budgeting
with workload standards, for example, the static budget projects expenses at a single normative level of workload activity, whereas the flexible budget projects expenses at various levels of
workload activity.4
The concept of the flexible budget addresses workloads, control, and planning. The budget checklists contained in Appendix 16–A are especially applicable to the flexible budget
approach.
To build a flexible budget that looks toward a range of volume, or activity, instead of a single
static amount, one must first determine the relevant range of volume, or activity:
• Thus, the outer limits of fluctuations are determined by defining the relevant range.
• Next, one must analyze the patterns of the costs expected to occur during the budget
period.
• Third, one must separate the costs by behavior (fixed or variable).
Finally, one can prepare the flexible budget—a budget capable of projecting what costs will be
incurred at different levels of volume, or activity.
Flexible budgets can readily be used to review the prior performance of the unit, the
department, or the organization. When utilized for this purpose, these budget figures will typically include the volume range (for example, a range of number of procedures or number of
patient days) discussed above. Table 16–3 illustrates this concept. The table shows a volume range
of 50, 100, and 150 procedures to be performed during the budget period, along with the perprocedure assumptions for revenues and variable expense plus the total fixed expenses that
would accompany these procedures.
Table 16–2 Static Budget: Can Be Used to Plan (a Goal)
Static Budget
Assumptions per Static Budget
Procedure Totals
# Procedures Performed 100
Net Revenue ($200 @) $200 per procedure = $20,000
Expenses [various] 15,000
Operating Income $5,000
Note: Dollar amounts shown for illustration only.
184 Chapter 16 Operating Budgets
Examples
Examples of both static budgets and flexible budgets appear in this section.
Static Budget Example
A static budget example for an open imaging center appears in Table 16–4. The net revenue is
computed using a dollar amount per procedure ($400) multiplied by the budgeted total number of procedures performed (1,000 procedures). The total expenses are derived from a variety
of sources.
Flexible Budget Example
A flexible budget example for an infusion center located within a physician practice appears
in Table 16–5. The table shows a volume range of 64, 80, and 96 procedures to be performed
Table 16–3 Flexible Budget—Used to Review Prior Performance
(1) (2) (3) (4)
Flexible Budget
Assumptions per Range of #s of Procedures
Procedure (Volume Range)
# Procedures Performed 50 100 150
Net Revenue $200 per procedure = $10,000 $20,000 $30,000
Variable Expense $150 per procedure = 7,500 15,000 22,500
Fixed Expense [fixed total amount] 1,500 1,500 1,500
Total Expense $9,000 $17,500 $24,000
Operating Income $1,000 $3,500 $6,000
Note: Dollar amounts shown for illustration only.
Table 16–4 Static Budget Example for an Open Imaging Center
Static Budget
Assumptions per Static Budget
Procedure Totals
# Procedures Performed 1,000
Net Revenue $400 per procedure = $400,000
Expenses
Salaries & Employee Benefits [various] $150,000
Supplies [various] 25,000
Insurance—General [various] 5,000
Insurance—Malpractice [various] 10,000
Depreciation—Building [various] 50,000
Depreciation—Equipment [various] 100,000
Total Expenses $340,000
Operating Income $60,000
Note: Dollar amounts shown for illustration only.
Working with Static Budgets and Flexible Budgets 185
during the budget period, along with the per-procedure assumptions for revenues and variable
expense, plus the total fixed expenses that would accompany these procedures.
BUDGET CONSTRUCTION SUMMARY
There is no one right way to prepare an operating budget. The budget construction depends
on factors such as the organizational structure, the reporting system, the manager’s scope of
responsibility and controllable costs, and so on. Exhibit 16–2 sets out a series of questions and
steps to undertake when commencing to build a budget.
It is also important to note that the budget for operations is usually part of an overall, or comprehensive, financial budget. Responsibility for the comprehensive financial budget always rests
with upper-level financial officers of the organization and is beyond the scope of this chapter.
BUDGET REVIEW
The questions discussed in constructing a budget also serve to evaluate an existing budget. Issues
of valid and replicable assumptions and comparability are especially essential. Comparative
Exhibit 16–2 Checklist for Building a Budget
1. What is the proposed volume for the new budget period?
2. What is the appropriate inflow (revenues) and outflow (cost of services delivered)
relationship?
3. What will the appropriate dollar cost be?
(Note: this question requires a series of assumptions about the nature of the operation for the new budget period.)
3a. Forecast service-related workload.
3b. Forecast non-service-related workload.
3c. Forecast special project workload if applicable.
3d. Coordinate assumptions for proportionate share of interdepartmental projects.
4. Will additional resources be available?
5. Will this budget accomplish the appropriate managerial objectives for the organization?
Table 16–5 Flexible Budget Example for Infusion Center Within a Physician Practice
(1) (2) (3) (4)
Flexible Budget
Assumptions per Range of #s of Infusions
Procedure (Volume Range)
# Procedures Performed 64 80 96
Net Revenue $2,250 per infusion = $144,000 $180,000 $216,000
Variable Expense $1,500 per infusion = 96,000 120,000 144,000
Fixed Expense [fixed total amount] 40,000 40,000 40,000
Total Expense $136,000 $160,000 $184,000
Operating Income $8,000 $20,000 $32,000
Note: Dollar amounts shown for illustration only.
186 Chapter 16 Operating Budgets
INFORMATION CHECKPOINT
What is needed? Example of variance analysis performed on a budget.
Where is it found? Probably with the supervisor who is responsible for the
budget.
How is it used? To see what type of budget it is and to see how it is constructed.
KEY TERMS
Capital Expenditures Budget
Flexible Budget
Operating Budget
Responsibility Center
Static Budget
DISCUSSION QUESTIONS
1. Do you believe your organization uses one or more operating budgets? Why do you
think so?
2. Do you believe your organization uses a flexible or a static budget? Why do you
think so?
Exhibit 16–3 Checklist for Reviewing a Budget
1. Is this budget static (not adjusted for volume) or flexible (adjusted for volume
during the year)?
2. Are the figures designated as fixed or variable?
3. Is the budget for a defined unit of authority?
4. Are the line items within the budget all expenses (and revenues, if applicable) that
are controllable by the manager?
5. Is the format of the budget comparable with that of previous periods so that several
reports over time can be compared if so desired?
6. Are actual and budget for the same period?
7. Are the figures annualized?
8. Test one line-item calculation. Is the math for the dollar difference computed correctly? Is the percentage properly computed based on a percentage of the budget
figure?
analysis, as examined in the preceding chapter, is an important skill to acquire. Exhibit 16–3
sets out a series of questions and steps to undertake when commencing to review and evaluate
a budget.
Discussion Questions 187
3. If you reviewed a budget at your workplace, do you think the major increases and
decreases could be explained?
4. If so, why? If not, why not?
NOTES
1. W. O. Cleverly, Essentials of Health Care Finance, 4th ed. (Gaithersburg, MD: Aspen Publishers, Inc., 1997).
2. C. Horngren et al., Cost Accounting: A Managerial Emphasis, 9th ed. (Englewood Cliffs, NJ:
Prentice Hall, 1998), 227.
3. Ibid., 228.
4. J. R. Pearson et al., “The Flexible Budget Process—A Tool for Cost Containment,” A. J. C.
P., 84, no. 2 (1985): 202–208.
188 Chapter 16 Operating Budgets
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BACKGROUND
This section provides background on how the budget uses diagnosis-related groups (DRGs) and
relative value units (RVUs).
Diagnosis-Related Groups
Diagnosis-related groups (DRGs) were developed in the early 1970s by Yale University to
describe all types of patient care provided in an acute care hospital.1 They form a patient classification system that can be used for several purposes, including planning and budgeting. This
system is an efficient way to measure case mix and it facilitates comparisons with other hospitals.
Specifically, price-per-case or episodes-of-care reimbursement is intended to represent the
resource intensity of hospital care utilized by patients who are classified in the specific DRG.
Thus, the case-mix methodology utilized to assign inpatients to DRGs assumes that the resources
used during their hospital stay will vary directly with length of stay.2 As a reimbursement system,
the DRG assignment ultimately determines the payment level that the hospital will receive. Yet
DRG reimbursement adds to the complexity of preparing an annual budget because the volume and mix of patients to be treated during the rate year is not always clear.
Relative Value Units
Relative Value Units (RVUs) are central to creating the DRG budget for respiratory care. They are
used to measure resource consumption as a method of budgeting or the resources consumed by
each product. RVUs are mistakenly thought to measure productivity. Every physician within a practice consumes resources, and RVUs therefore measure their resource consumption. RVUs may
also be thought of as a measurement of time and effort put in by a physician. Therefore, the value
of RVUs is in costing or accurately measuring consumption of resources.
How This Budget Uses DRGs and RVUs
The patient classification system of DRGs is used in this case to classify patients as to their overall
diagnosis grouping (thus DRG 190-192 for COPD, as below). Treatments are administered in
APPENDIX
16-A Creating a DRG
Budget for Respiratory
Care: The Resource
Consumption
Approach
189
the hospital’s outpatient Respiratory Care Department. Therefore, ICD-10-CM codes (International Classification of Diseases, 10th Revision, Clinical Modifications) are used to identify
their actual diagnosis for treatment within the department (thus ICD-10-CM J44.1 = chronic
bronchitis and J44.2 = emphysema as below).
In computing projected expenses, RVUs provide the number of minutes-per-treatment and
the computation method required in order to measure resource consumption. (Thus, volume
for each treatment is converted into RVUs by using minutes-per-treatment.) Departmental
expense totals can then be converted to expense per RVU for three categories: labor, supplies,
and overhead. (Gross revenues for this budget are computed using established charges as below.
Gross revenues are then adjusted by a percentage [“rate”] for each type of payer.)
A DRG BUDGET FOR RESPIRATORY CARE
The hospital’s outpatient Respiratory Care Department has been reorganized in response to the
increased incidence of DRG 190-192: Chronic Obstructive Pulmonary Disease (COPD). COPD
is a progressive disease without a cure, so that the staff’s main function will be to manage symptoms. COPD ICD-10 codes include J44.1 for chronic bronchitis and J44.2 for emphysema. This
year there were 620 admissions to the department. Treatments ranged from medication administration (65%), which takes 10 minutes; oxygen therapy (24%), which takes 30 minutes; and
bronchodilator administration (11%), which takes 15 minutes per treatment. The charges established by the Controller in consultation with the Chief Financial Officer are $61 per medication
administration, $310 per oxygen therapy treatment, and $85 per bronchodilator application.
Step 1: Project Volumes
(a) Calculate the current volume for each treatment.
Treatment Admissions Volume
Medication Administration 620 × .65 403
Oxygen Therapy 620 × .24 149
Bronchodilators 620 × .11 68
Total 620
(b) Convert the current volumes to RVUs.
Treatment Minutes Minutes/GCD* RVUs/Procedure Volume Total RVUs
Medication Administration 10 10/5 2 403 806
Oxygen Therapy 30 30/5 6 149 894
Bronchodilators 15 15/5 3 68 204
Total 620 1,904
*GCD = Greatest Common Denominator (equals 5)
(c) Calculate the projected volume for each treatment
With the expectation of a 6.2% increase in DRG 190-192 for the following year (620 × .062), the
department can anticipate an increase of 38 admissions, or 658 total.
190 Chapter 16 Operating Budgets
Treatment Admissions Volume
Medication Administration 658 × .65 428
Oxygen Therapy 658 × .24 158
Bronchodilators 658 × .11 72
Total 658
(d) Convert the projected volumes to RVUs
Treatment Minutes Minutes/GCD RVUs/Procedure Volume Total RVUs
Medication Administration 10 10/5 2 428 856
Oxygen Therapy 30 30/5 6 158 948
Bronchodilators 15 15/5 3 72 216
Total 658 2,020
Step 2: Convert Projected Volumes into Projected Revenues
Calculate the projected gross and net revenues by payer; in this example, COPD generally has
been an affliction of the elderly, so we are very interested in the projected and gross revenues
by Medicare, which covers 82% of our patients. (Note: Medicaid covers 13% of patients, and
self-pay patients equal 5%.)
Medicare
Treatment Projected Charge Projected Volume % Gross Revenue Rate* Net Revenue
Medication Admin. 61 428 .82 21,409 .80 17,127
Oxygen Therapy 310 158 .82 40,164 .80 32,131
Bronchodilators 85 72 .82 5,018 .80 4,014
Total 658 66,591 53,272
Note that Projected Charge, Gross Revenue, and Net Revenue are expressed in dollars.
*The DRG rate is 80% of charges.
Medicaid
Treatment Projected Charge Projected Volume % Gross Revenue Rate* Net Revenue
Medication Admin. 61 428 .13 3,394 .83 2,817
Oxygen Therapy 310 158 .13 6,367 .83 5,285
Bronchodilators 85 72 .13 796 .83 661
Total 658 10,557 8,763
Note that Projected Charge, Gross Revenue, and Net Revenue are expressed in dollars.
*The DRG rate is 83% of charges.
A DRG Budget for Respiratory Care 191
Self Pay
Treatment Projected Charge Projected Volume % Gross Revenue Rate* Net Revenue
Medication Admin. 61 428 .05 1,305 .93 1,214
Oxygen Therapy 310 158 .05 2,449 .93 2,278
Bronchodilators 85 72 .05 306 .93 285
Total 658 4,060 3,777
Note that Projected Charge, Gross Revenue, and Net Revenue are expressed in dollars.
*The Self-Pay rate is 93% because 7% don’t pay their bills.
Projected total revenue = $65,812 (53,272 + 8,763 + 3,777 = 65,812)
Step 3: Convert Projected Volumes into Projected Expenses
(a) Calculate current expenses per RVU
DRG 190-192 accounts for 35% of labor, supply, and overhead departmental expenses. The
OPD Respiratory Care Department’s labor expenses are $179,385, supply expenses are
$135,670, and overhead expenses are $286,770.
$179,383 × .35 = 62,784/1,904* = $32.97 labor expense/RVU
$135,670 × .35 = 47,485/1,904 = $24.94 supply expense/RVU
$286,770 × .35 = 100,370/1,904 = $52.72 overhead expense/RVU
(*1904 = Total RVUs)
(b) Calculate projected expenses per RVU for next year
Labor expenses are projected to increase 3% = 32.97 + .99 = 33.96
Supply expenses are projected to increase 5% = 24.94 + 1.25 = 26.19
Overhead expenses are not expected to increase = 52.72 + 0 = 52.72
Total $112.87
(c) Calculate projected expenses per treatment
Treatment Projected RVUs Projected Expense/RVU Total Projected Expense
Medication Admin. 856 $112.87 $96,617
Oxygen Therapy 948 112.87 107,001
Bronchodilators 216 112.87 24,380
Total 2020 $227,998
Step 4: Determine Profit/Loss
Net Revenues $65,812
Projected Expenses 227,998
Loss $162,186
192 Chapter 16 Operating Budgets
Next Steps
In the context of the hospital’s overall financial well being, the projected loss is untenable.
What strategies can help to mitigate the impact? Can expenses be reduced? Can revenue collection strategies be enhanced by adding more profitable treatments? Is the staffing level
optimal? Can we continue the service at a loss by having other profitable services subsidizing
Respiratory Care?
NOTES
1. J. A. Bielby, “Evolution of DRGs (2010 update),” Journal of the American Health Information Management Association, April 2010, http://library.ahima.org/doc?oid=106590#
.V7txWq46HE8
2. P. L. Grimaldi and J. A. Richardson, Diagnosis Related Groups: A Practitioner’s Guide
(Chicago: Pluribus Press, 1983).
Notes 193

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THE COMPARATIVE REPORT TO REVIEW
The following report provides figures for the Memorial Hospital’s Operating Room and Recovery Room.
Memorial Hospital Operating Budget
For the Fiscal Year October 1, 20xx to September 30, 20xx
Operating Room
Account # Item Actual Budget Variance %Variance
1010-020 RN Salaries 470,640 470,640 (10,930) (2.3)
1010-030 LPN Salaries 44,685 44,685 (3,451) (7.8)
1010-040 Other Nursing Salaries 68,390 56,937 11,453 20.1
1010-200 OR Supplies-Req. 54,350 57,162 (2,812) (4.9)
1010-220 Supplies-Direct Purchase 3,833 3,540 293 8.3
1010-221 Instruments 50,727 52,310 (1,583) (3.0)
1010-245 Uniform Expense 628 410 218 53.2
1010-605 Periodicals & Books 670 750 (80) (10.7)
1010-610 Employee Education 4,720 4,192 528 12.6
1010-620 Maintenance 6,387 5,940 447 7.6
1010-730 Purchased Maintenance 9,366 8,550 816 9.5
1010-740 Purchased Service 864 864 0 —
Recovery Room
1012-020 RN Salaries 173,527 174,807 (1,280) (0.7)%
1012-040 Other Nursing Salaries 26,155 21,617 4,538 21.0
1012-200 Recovery Room Supplies-Req. 10,114 12,375 (2,261) (18.3)
1012-213 Minor Equipment 422 422 0 —
1012-220 Supplies-Direct Purchase 482 295 187 63.4
1012-610 Employee Education 125 63 62 98.4
1012-620 Maintenance 1,037 758 279 36.8
1012-730 Purchased Maintenance 438 310 128 41.3
Note: Actual, Budget, and Variance are reported in dollars. Data in parentheses () represent negative values.
APPENDIX
16-B Reviewing a
Comparative Operating Budget Report
195
CHECKLIST QUESTIONS AND ANSWERS FOR THE COMPARATIVE BUDGET
REVIEW
1. Q. Is this budget static (not adjusted for volume) or flexible (adjusted for volume during
the year?
A. This budget should be flexible insofar as surgical volume is characterized by variation
because of elective surgery versus unplanned (emergency) surgery.
2. Q. Are the figures designated as fixed or variable?
A. The figures should be designated as fixed and variable (see Variance column).
3. Q. Is the budget for a defined unit of authority?
A. The budgets are for two interrelated units of authority: the operating and recovery
rooms, which fall under the aegis of the Department of Surgery.
4. Q. Are the line items within the budget all expenses (and revenues, if applicable) that
are controllable by the manager?
A. The line items are not all controllable by the manager; see Other Nursing Salaries,
Supplies, and Maintenance data, for example.
5. Q. Is the format of the budget comparable with that of previous periods so that several
reports over time can be compared if so desired?
A. The format is comparable. For example, one may compare fiscal year 2018 with 2017
and 2016.
6. Q. Are the actual and budget for the same period?
A. The actual and budget are for the same period.
7. Q. Are the figures annualized?
A. The figures are annualized.
8. Q. Test one line-item calculation. Is the math for the dollar difference computed correctly? Is the percentage properly computed based on a percentage of the budget
figure?
A. The calculations are properly computed. Note, for example, “Other Nursing Salaries”
in the operating room. The comparison of Actual versus Budget produces a variance
that is the most obvious and of the greatest magnitude and significance given the
importance of that line item. As a manager, you have to ask: What are the possible
causes of the variation?
Higher-than-budgeted Other Nursing Salaries may be comprised of per diems,
nurses’ aides, and certified nurse anesthetists (CNAs), the negative variance of which
may be attributed to a higher-than-normal absentee rate (nurse burnout) and/or
excessive demand.
9. Q. How are the “percent variance” figures calculated?
A. Using Account #1010-020, Operating Room RN Nursing Salaries, the variance of
($10,930) is divided by the budgeted amount of $470,640, resulting in a +2.3% variance expressed as a percent.
Likewise, for Account #1010-040, Other Nursing Salaries, the variance of $11,453
is divided by the budgeted amount of $56,937, resulting in a 220.1% variance
expressed as a percent.
196 Chapter 16 Operating Budgets
Progress Notes
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Capital
Expenditure
Budgets
OVERVIEW
Capital expenditures involve the acquisition of assets
that are long lasting, such as equipment, buildings, and
land. Therefore, capital expenditure budgets are usually
intended to plan, monitor, and control long-term financial issues. Decisions must be made about the future use of
funds in order to complete these types of budgets.
Operations budgets, on the other hand, generally deal
with actual short-term revenues and expenses necessary to
operate the facility. For example, the Great Shores Health
System’s operations budgets may usually be created to cover
the next year only (a 12-month period), while Great Shores1
capital expenditure budgets may be created to cover a
5-year span (a 60-month period) or even a 10-year span.
It is also important to note that the budget for capital
expenditures is usually part of an overall, or comprehensive, financial budget. Responsibility for the comprehensive financial budget always rests with upper-level financial
officers of the organization and is beyond the scope of this
chapter.
CREATING THE CAPITAL EXPENDITURE
BUDGET
The capital expenditure budget, which may sometimes
be identified by another name, such as “capital spending
plan,” usually consists of two parts. The first part of the budget represents spending for capital assets that have already
been acquired and are in place. This spending protects an
existing asset; you are essentially spending in order to protect that which you already have. The second part of the
budget represents spending for new capital assets. In this
After completing this chapter,
you should be able to
1. Recognize the reason that a
capital expenditure budget is
necessary.
2. Review the cash flow and the
startup cost concept.
3. Understand differences
between cash flow reporting
methods.
4. Recognize types of capital
expenditure budget
proposals.
5. Understand about evaluating
capital expenditure
proposals.
197
17
CHAPTER
case, you will be expending capital funds to acquire new assets such as equipment, buildings,
and land.
The “existing asset” part of the budget forces planning questions about whether existing
equipment and buildings should be kept in their present condition (which can involve repair
and maintenance expenses), renovated, or replaced. Renovating equipment or buildings
implies a large expenditure that would be capitalized. (To be capitalized means the expenditure would be placed on the balance sheet as an additional capital cost that is recognized as an
asset.)
The “new capital asset” part of the budget forces more planning questions. In this case, the
questions are about new assets. The reasons for new asset spending may involve the following:
• Expansion of capacity in a department or program
• Creation of a new facility, department, or program
• New equipment to improve productivity
• New equipment or space to comply with federal or state requirements
It should also be noted that acquiring new assets results in additional capital costs that will be
placed on the balance sheet as assets. For more information, refer to the chapter about assets,
liabilities, and net worth.
BUDGET CONSTRUCTION TOOLS
How the capital expenditure budget is constructed may be predetermined by requirements of
the organization. Your facility or practice may have a template that must be used. This takes the
decision out of your hands. Otherwise, you will have to decide which tool will be most effective
to build your capital expenditure budget.
One important tool is net cash flow reporting. The concept of cash flow analysis, usually an
important part of the capital expenditure budget, is described later. But how will the cash flow
be reported? Four methods are discussed in this section.
Cash Flow Concept
As its title implies, a cash flow analysis illustrates how the project’s cash is expected to move over
a period of time. Many analyses concentrate only on the cash expenditure for the equipment.
(This is, after all, a “capital expenditure” budget.) Other analyses, however, will also take revenue earned into account.
In any case, it is always important to report the net cash flow. While most line items will
usually be expenditures, called cash outflow, sometimes there will also be cash receipts, called
cash inflow. For example, if a new piece of equipment will replace an old one, and the old
replaced equipment will be sold for cash, the cash received from the sale will represent a cash
receipt.
Cash flow must also be reported as cumulative. This means the accumulated effect of
cash inflows and cash outflows must be added and/or subtracted to show the overall net
accumulated result. In our example mentioned previously: where the old equipment might
be sold, the cumulative cash flow is illustrated in Table 17–1. As you can see, the initial
expenditure or cash spent (outflow) is decreased by the cash received (inflow) to produce a
net cumulative result.
198 Chapter 17 Capital Expenditure Budgets
Cash Flow Reporting Methods
Cash flow is typically reported using one of four methods. They include the following:
• Payback method
• Accounting rate of return
• Net present value
• Internal rate of return
A previous chapter of this book has explained and illustrated each of the four methods.
Their advantages and disadvantages, for purposes of capital expenditure budgeting, are summarized later.
Payback Method
The payback method is based on cash flow. This method recognizes the cash flows that are
necessary to recover the initial cash invested. The payback method is advantageous because it is
easy to understand and highlights risks. However, it does not take either profitability or the time
value of money into account.
Accounting Rate of Return
The accounting rate of return is based on profitability. However, it does not take the time value
of money into account.
Net Present Value
Net present value, or NPV, is a discounted cash flow method. It is based on cash flows in that it
takes all the cash (incoming and outgoing) into account over the life of the equipment (or, if
applicable, over the life of the relevant project). Although the NPV is based on cash flows, it also
takes profitability and the time value of money into account.
Internal Rate of Return
Internal rate of return, or IRR, is also a discounted cash flow method that takes all incoming
and outgoing cash into account over the life of the equipment (or the project). It also takes
profitability and the time value of money into account.
The use of net present value, the internal rate of return, and so forth, is the vocabulary
of capital budgeting. It is also an important part of the language of finance. Therefore, it is
important to understand the differences between the four methods. Review the chapter about
the time value of money for more detail. Appendix 17-A at the end of this chapter presents a
step-by-step method for net present value computation that assists in this understanding.
Table 17–1 lllustration of Cumulative Cash Flow
Line Cash Spent Cash Received Cumulative
Number (Outflow) (Inflow) Cash Flow
1 Buy new equipment (50,000) — (50,000)
2 Sell old equipment that is being
replaced — +6,000 (44,000)
Budget Construction Tools 199
Budget Inputs
Capital expenditure budget inputs may have to be taken into consideration if the operating
budget requires additional capital equipment or space renovations. Figure 17–1 illustrates these
potential inputs.
Startup Cost Concept
If the proposal for capital expenditures incorporates operational expenses, the concept of
startup costs must also be taken into consideration. In these cases, management believes the
cost of starting up a new service line or a new program should be included as part of the original
investment. Although such operational costs do not fall into a strict definition of capital expenditure budgeting, the requirement is common enough to warrant discussion.
FUNDING REQUESTS
This section discusses the process of requesting capital expenditure funds and the types of proposals that might be submitted for consideration.
The Process of Requesting Capital Expenditure Funds
Different departments or divisions often have to compete for capital expenditure funding. The
hospital’s radiology department director may want new equipment, but so does the surgery
department director, and so on. The various requests for funding are often collected and subjected to a review process in order to make decisions about where, and to whom, the available
capital expenditure funds will go. While the upper levels of management make overall decisions
about future use of funds, the departmental funding requests represent the first step in the
overall process.
The process involved for capital expenditure funding requests varies according to the organization. Size plays a part. Due to its sheer size, we would expect a giant hospital to have a more
Figure 17–1 Capital Expenditures Budget Inputs.
Additional
Equipment
Required
Additional
Space or
Renovation of
Existing Space
Required
Operating Revenue Forecast
&
Staffing Plan
&
Capacity Level Checkpoint
No
Estimated
Capital Money
Required
Capital
Expenditures
Plan
Preliminary
Capital
Expenditures
Budget
Estimated
Capital Money
Required
Yes
No Yes
200 Chapter 17 Capital Expenditure Budgets
complex process than, say, a two-physician practice. The corporate culture of the organization
plays a part, too. Some organizations are extremely structured, while others are more flexible in
their management principles. And in some facilities, politics may also play a part in the process
of making and reviewing funding requests.
Types of Capital Expenditure Proposals
The type of proposal affects its size and scope. Proposal types commonly include the following
types of requests:
• Acquiring new equipment
• Upgrading existing equipment
• Replacing existing equipment with new equipment
• Funding new programs
• Funding expansion of existing programs
• Acquiring capital assets for future use
Certain of these types may sometimes be paired as either/or choices in capital expenditure
proposals. All six types of proposals are discussed in this section.
Acquiring New Equipment
The reason why new equipment is needed must be clearly stated. The acquisition cost must be a
reasonable figure that contains all appropriate specifications. The number of years of useful life
that can be reasonably expected from the equipment is also an important assumption.
Upgrading Existing Equipment
The reason why an upgrade is necessary must be clearly stated. What is the impact? What will
the outcomes be from the upgrade? The upgrade costs must be a reasonable figure that also
contains all appropriate specifications. Will the upgrade extend the useful life of the equipment? If so, by how long?
Replacing Existing Equipment with New Equipment
The rationale for replacing existing equipment with new equipment must be clearly stated.
Often a comparison may be made between upgrading and replacement in order to make a more
compelling argument. The usual arguments in these comparisons revolve around improvements in technology in the new equipment that are more advanced than available upgrades to
the old equipment. A favorite argument in favor of the new equipment is increased productivity
and/or outcomes.
Funding New Programs
A proposal for new program capital expenditures must take startup costs into account. This type
of proposal will generally be more extensive than a straightforward equipment replacement
proposal because it involves a new venture without a previous history or proven outcomes.
Funding Expansion of Existing Programs
A proposal for expansion of an existing program is generally easier to prepare than a proposal
for a new program. You will have statistics available from the existing program with which to
Funding Requests 201
make your arguments. In addition, any startup costs should be negligible for the existing program. The most difficult selling point may be comparison with other departments’ funding
requests.
Acquiring Capital Assets for Future Use
This type of proposal may be the most difficult to accomplish. Capital expenditures for future
long-term use are often postponed by decision makers in cash-strapped organizations who
must first fulfill immediate demands for funding. Consider, for example, a metropolitan hospital that is hemmed in on all sides by privately owned property. The hospital will clearly need
expansion space in the future. An adjacent privately owned property comes on the market at
a price less than its appraised value. Even though the expansion is not scheduled until several
years in the future, it would be wise to seriously consider this acquisition of a capital asset for
future use.
EVALUATING CAPITAL EXPENDITURE PROPOSALS
Management planning must involve the allocation of available financial resources for projects
that promise to reap returns in the future. This applies to both for-profit and not-for-profit
organizations.
Hard Choices: Rationing Available Capital
Most businesses, including those providing healthcare services and products, have only a limited amount of capital available for purposes of capital expenditure. It usually becomes necessary, then, to ration the available capital funds. Different organizations approach the rationing
process in different ways. However, most organizations will consider the following factors in
some fashion or other:
• Necessity for the request
• Cost of capital to the organization
• Return that could be realized on alternative investments
These three factors will probably be considered in a descending sequence of decision making. The overriding question is necessity. Necessity for the request pertains to the criticality of
the need. What are the basic reasons for contemplating the capital expenditure? Are these reasons necessary? If so, how necessary?
While necessity is an overarching consideration, the cost of capital to the organization for
the proposed capital expenditure is a computation of the sort we have previously discussed in
this section. Although the answer to “what is the cost of capital” is provided in the form of a
computation, the amount of the answer depends on the method selected to illustrate this cost.
The third element in management’s decision-making sequence is what return could be realized on alternative investments of the available capital. This concept is known as “opportunity
cost.” The term is appropriate. Assume a rationing situation where unlimited funds are not
available. Thus, when a choice is made to expend funds on capital project A, an opportunity is
lost to expend those same funds on project B or project C. The choice of A thus costs the opportunity to gain benefits from B or C.
202 Chapter 17 Capital Expenditure Budgets
To summarize, the decision makers must apply judgment in making all these choices. Thus, the
rationing of available capital becomes somewhat of a management art as well as a science.
The Review and Evaluation Process
The degree of attention paid to evaluation and the level of management responsible for making
the decisions may be dictated by the overall availability of capital funding and by the amount of
funds requested. Evaluation of capital expenditure budget proposals may be objective or subjective. An impartial review process is most desirable.
An objective method usually involves scoring and/or ranking the competing proposals. In
scoring, the basic approach generally focuses on a single proposal and evaluates it on a fixed
set of criteria. In ranking, the proposal is compared with other proposals and ranked in accordance with a looser set of criteria.
The objective review and evaluation may actually first involve scoring to eliminate the very
low-scoring proposals. The remaining higher scoring proposals may then be ranked in accordance with still another set of criteria.
The criteria may, in turn, contain quantitative items such as outcomes and/or productivity
and may also contain qualitative items such as whether the proposal is in accordance with the
organization’s core mission.
Finally, some authorities believe the source of financing the project (whether it is internal or
external, for example) should not be relevant to the investment decision. Real-world management, however, has a different view. How the project will be financed may be their first question
in the review and evaluation process.
INFORMATION CHECKPOINT
What is needed? An example of an entire capital expenditure budget or a capital
expenditure proposal for a particular project or a specific
piece of equipment.
Where is it found? Probably with your manager or the director of your department
or, depending on the dollar amount proposed, perhaps
with someone in the finance department.
How is it used? The use would probably be one time. Can you tell if this is so?
KEY TERMS
Accounting Rate of Return
Capital Budget
Capitalized Asset
Cash Flow Analysis
Cumulative Cash Flow
Internal Rate of Return
Net Present Value
Key Terms 203
Operations Budget
Opportunity Cost
Payback Method
Unadjusted Rate of Return
DISCUSSION QUESTIONS
1. Have you ever been involved in helping to create any part of a capital expenditure
budget?
2. If so, which type of proposal was it? Was the proposal successful?
3. Do you recall whether any of the four cash flow reporting methods were used? If so,
which one? Do you now think that was the best choice for the particular proposal?
4. If you were assigned to prepare a capital expenditure budget request, what two people
would you most want to have on your team? Why? How would you expect to use them?
NOTE
1. S. A. Finkler, “Flexible Budget Variance Analysis Extended to Patient Acuity and DRGs,”
Health Care Management Review, 10, no. 4 (1985): 21–34.
204 Chapter 17 Capital Expenditure Budgets
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A Further
Discussion of
Capital Budgeting
Methods
17-A
This appendix presents a further discussion of the four methods of capital budgeting computations presented in this chapter.
ASSUMPTIONS
Item: Assume the purchase of a new piece of laboratory equipment is proposed.
Cost: The laboratory equipment will cost $70,000.
Useful life: It will last five years.
Remaining value (salvage value): The lab equipment will be sold for $10,000 (its salvage value)
at the end of the five years.
Cost of capital: The estimated cost of capital for the hospital is 10%.
Cash flow: The addition of this new piece of equipment is expected to generate additional revenue. In fact, the increase of revenue over expenses is expected to amount to $20,000 per year
for the five years. The cash flow is therefore expected to be as follows: Year 0 5 ($70,000); year
1 5 $20,000; year 2 5 $20,000; year 3 5 $20,000; year 4 5 $20,000; year 5 5 $20,000. Note that
year 0 is a negative figure and years 1 through 5 are positive figures.
PAYBACK METHOD
The payback method calculates how many periods are needed to recover the equipment’s initial investment of $70,000. In this case, the periods to be counted are years; thus, there are five
years, or five periods as shown in Table 17-A–1.
The investment of $70,000 is recovered
halfway between year 3 and year 4, when the
remaining balance to be recovered equals
zero. Therefore, the payback period is three
and one-half years, expressed as 3.5 years.
Commentary: The payback method recognizes the cash flows that are necessary to
recover the initial cash invested. The payback
method is advantageous because it is easy to
APPENDIX
Table 17-A–1 Payback Method Input
Year Cash Flow Balance
0 (70,000) (70,000)
1 20,000 (50,000)
2 20,000 (30,000)
3 20,000 (10,000)
4 20,000 10,000
5 20,000 30,000
205
understand and highlights risks. However, it does not take either profitability or the time value
of money into account.
UNADJUSTED RATE OF RETURN (AKA ACCOUNTANT’S RATE OF RETURN)
The unadjusted, or accountant’s, rate of return is based on averages. The average
accounting income is divided by the average level of investment to arrive at the accounting
rate of return. Step 1 computes the average accounting income, Step 2 computes the average
level of investment, and Step 3 then calculates the accounting rate of return.
Step 1: In this example, the average accounting income is calculated by deducting depreciation
(a non-cash amount) from the annual cash flow.
Step 1.1: First, we must calculate the annual depreciation amount. In this example the
depreciation is computed on a straight-line basis, which means the total amount of depreciation will equal the equipment’s cost minus its salvage value.
The equipment’s cost is $70,000 and its salvage value at the end of its five-year life is estimated
to be $10,000. Therefore, the total amount to be depreciated is the difference, or $60,000. To
arrive at annual depreciation, the $60,000 is divided by the number of years of useful life, which
is five years in this example. Therefore, the annual amount of depreciation is $60,000 divided
by five years, or $12,000 per year.
Step 1.2: Next, we must use the depreciation amount to calculate the accounting income per
year. In this example, the accounting income represents the cash flow per year of $20,000 as
previously computed less the depreciation expense per year of $12,000. The remaining balance
net of depreciation is $8,000 as shown in Table 17-A–2.
Step 2: In this example, the average level of investment is determined by calculating the average
investment represented by the equipment. We determine the average investment by computing
its midpoint as follows:
Step 2.1: Determine the total investment by adding the initial investment of $70,000 and the salvage value of $10,000, for a total of $80,000.
Step 2.2: Now divide the total investment of $80,000 by 2. The answer of $40,000 indicates the
midpoint of the investment and is considered the average investment over the five-year period
of its useful life.
Step 3: The unadjusted or accounting rate of return is now calculated by dividing the average
income (Step 1) by the average investment (Step 2). In this example, the unadjusted or accounting rate of return amounts to $80,000 average
income divided by $40,000 average investment,
or a 20% rate of return.
Commentary: While the accounting rate of
return is based on profitability, it does not
take the time value of money into account.
That is why it is known as the “unadjusted”
rate of return. This method is used by many
capital expenditure budget decision makers.
Table 17-A–2 Accounting Income Input
Less Balance Net of
Year Cash Flow Depreciation Depreciation
1 20,000 12,000 8,000
2 20,000 12,000 8,000
3 20,000 12,000 8,000
4 20,000 12,000 8,000
5 20,000 12,000 8,000
206 Chapter 17 Capital Expenditure Budgets
NET PRESENT VALUE
Net present value, or NPV, is a discounted cash flow method. It is based on cash flows in that
it takes all the cash (incoming and outgoing) into account over the life of the equipment.
Table 17-A–3 shows the individual steps involved in the computation as follows:
Step 1: Enter the net cash flow on the table. (For this example, the net cash flow has already
been calculated; see the middle column of Table 17-A–1. Also enter the salvage value.)
Step 2: Determine the cost of capital (which is 10% in this example). Look up the present value factor for 10% for each period. Also, include the present value factor for the salvage value.
Step 3: Multiply the present value factor for each period times the period’s net cash flow.
Step 4: Compute the net present value by first adding the present value answers for each operating period (Years 1 through 5 plus the salvage value) and then by subtracting the initial cash
expenditure of $70,000 in Year 0 from the sum of the present value computations. In this example, $70,000 is subtracted from a total of $81,980 to arrive at the net present value of $11,980 as
shown in Table 17-A–3.
Commentary: Net present value takes all the cash (incoming and outgoing) into account over
the life of the equipment. Even though the net present value is based on cash flow, it also takes
profitability and the time value of money into account.
INTERNAL RATE OF RETURN
Internal rate of return, or IRR, computes the actual rate of return that is expected, or assumed,
from an investment. The internal rate of return reflects the discount rate at which the investment’s net present value equals zero.
The IRR computation will be compared against the cost of capital. In our example the cost of
capital is 10%, as set out in our initial assumptions.
The IRR seeks the rate of return that allows the net present value of the project to equal zero.
The IRR expresses the rate of return that the organization can expect to earn when investing in
the equipment (or the project, as the case may be).
The actual rate of return is determined by trial and error. The authorities say to “guess” and
work forward from your initial guess. An easier method to arrive at IRR is to use a business calculator or a computer program and let it perform the computation for you. It is cumbersome,
but possible, to arrive at the appropriate IRR by hand. An example follows.
Table 17-A–3 Net Present Value Computations
Salvage
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Value
Net Cash Flow (70,000) 20,000 20,000 20,000 20,000 20,000 10,000
Present value factor
(10% cost of capital) n/a 0.909 0.826 0.751 0.683 0.620 0.620
Present value answers (70,000) 18,180 16,520 15,020 13,660 12,400 6,200
Net present value = 11,980
Internal Rate of Return 207
This example solves for an initial investment of $70,000 and a positive cash flow of $20,000
per year for five years. Because the annual amount of $20,000 is the same for each of the five
years, we can use the “Present Value of an Annuity of $1” presented in Appendix 13-C for this
purpose.
The computation is approached in two steps as follows:
Step 1: Initial investment ($70,000) divided by the annual net cash inflow ($20,000) equals
the annuity present value (PV) factor for five periods. We compute 70,000 divided by 20,000
and arrive at a PV factor of 3.5.
Step 2: Now we refer to Appendix 13-C, the “Present Value of an Annuity of $1.” We look
across the “5” row (because that is the number of periods in our example). We are looking for
the column that most closely resembles our PV factor of 3.5. On our table we find 3.605 in the
12% column and 3.433 in the 14% column. Obviously 3.5 will fall somewhere between these
amounts. To find what 15% would be, we add the 3.605 to the 3.433 and divide by 2. The answer
is 3.519 (3.605 1 3.433 5 7.038; 7.038 divided by 2 5 3.519). Thus we have found, by trial and
error, that the rate of return in our example is approximately 15%.
As we have previously stated, an easier method to arrive at IRR is to use a business calculator
or a computer program and let it perform the computation for you. The business calculator or
computer program will quickly give you a precise answer.
Many capital expenditure budget proposals also compare the rate of return to the
organization’s cost of capital. In our example, the cost of capital is 10%, so the 15% IRR is
clearly greater.
Commentary: Internal rate of return is also a discounted cash flow method that takes all incoming and outgoing cash into account over the life of the equipment (or the project). It, too, takes
profitability and the time value of money into account.
208 Chapter 17 Capital Expenditure Budgets
© LFor/Shutterstock
Tools to Plan,
Monitor, and
Control Financial
Status
PART
VII

Progress Notes
© LFor/Shutterstock
Variance Analysis and Sensitivity Analysis
VARIANCE ANALYSIS OVERVIEW
A variance is, basically, the difference between standard
and actual prices and quantities. Variance analysis analyzes
these differences. This discussion assumes a flexible budget prepared in accordance with the steps described in the
chapters about budgeting.
Flexible budgeting variance analysis was conceived by
industry and subsequently discovered by health care. It provides a method to get more information about the composition of departmental expenses.
THREE TYPES OF FLEXIBLE BUDGET
VARIANCE
The method subdivides total variance into three types.
Volume Variance
The volume variance is the portion of the overall variance
caused by a difference between the expected workload
and the actual workload and is calculated as the difference
between the total budgeted cost based on a predetermined,
expected workload level and the amount that would have
been budgeted had the actual workload been known in
advance.1
Quantity (or Use) Variance
The quantity variance is also known as the use variance or
the efficiency variance. It is the portion of the overall variance that is caused by a difference between the budgeted
and actual quantity of input needed per unit of output, and
After completing this chapter,
you should be able to
1. Understand the three types of
flexible budget variance.
2. Perform budget variance.
3. Compute a contribution
margin.
4. Perform sensitivity analysis.
211
18
CHAPTER
is calculated as the difference between the actual quantity of inputs used per unit of output
multiplied by the actual output level and the budgeted unit price.
Price (or Spending) Variance
The price variance is also known as the spending or rate variance. This variance is the portion
of the overall variance caused by a difference between the actual and expected price of an input
and is calculated as the difference between the actual and budgeted unit price, or hourly rate,
multiplied by the actual quantity of goods, or labor, consumed per unit of output, and by the
actual output level.
TWO-VARIANCE ANALYSIS AND THREE-VARIANCE ANALYSIS COMPARED
Variance analysis can be performed as a two- or a three-variance analysis. (There is also a fivevariance analysis that is beyond the scope of this discussion.) The two-variance analysis involves
the volume variance as compared with budgeted costs (defined as standard hours for actual
production). The three-variance analysis involves the three types of variances defined above.
Figure 18–1 illustrates these elements.
Composition Compared
The makeup of the two-variance analysis is compared with the three-variance analysis in
Figure 18–2. As is shown, two elements (A and B) remain the same in both methods. The third
element (C) is a single amount in the two-variance method but splits into two amounts (C-1 and
C-2) in the three-variance method.
Computation Compared
Actual computation is illustrated in Figure 18–3 for two-variance analysis and Figure 18–4
for three-variance analysis. The A, B, C, C-1, and C-2 designations are carried forward from
Figure 18–2. In Figure 18–3, the two-variance calculation is illustrated, and a proof total
computation is supplied at the bottom of the illustration. In Figure 18–4, the three-variance
Figure 18–1 Elements of Variance Analysis.
Elements of
Three-Variance Analysis
1 Volume Variance
(Activity Variance)
2 Quantity Variance
(Use Variance, Efficiency
Variance)
3 Price Variance
(Spending Variance, Rate Variance)
Elements of
Two-Variance Analysis
1 Volume Variance
(Activity Variance)
2 Budget Variance
212 Chapter 18 Variance Analysis and Sensitivity Analysis
calculation is likewise illustrated, and a proof total computation is also supplied at the bottom
of the illustration. This set of three illustrations deserves study. If the manager understands the
concept presented here, then he or she understands the theory of variance analysis.
Different Names for the Three Variable Cost Elements
Another oddity in variance analysis that contributes to confusion is this: all three variable cost
elements—that is, direct materials, direct labor, and variable overhead—can have a price variance and a quantity variance computed. But the variance is not known by the same name in all
instances. Exhibit 18–1 sets out the different names. Even though the names differ, the calculation for all three is the same. Note, too, that variance analysis is primarily a matter of input–output
analysis. The inputs represent actual quantities of direct materials, direct labor, and variable
overhead used. The outputs represent the services or products delivered (e.g., produced) for
Figure 18–2 Composition of Two- and Three-Variance Analysis.
Composition of
Two-Variance Analysis
A = Actual Cost Incurred
B = Applied Cost
C = Budgeted Costs
(computed as standard hours
for actual production)
Composition of
Three-Variance Analysis
A = Actual Cost Incurred
B = Applied Cost
C-1 = Budgeted Costs
(computed as actual hours
for actual production)
C-2 = Budgeted Costs
(computed as standard
hours for actual production)
Figure 18–3 A Calculation of Two-Variance Analysis.
#1 A Actual Cost Incurred less C Budgeted Costs (computed as
standard hours for actual production)
#2 B Applied Cost less C Budgeted Costs (computed as
standard hours for actual production)
Total
Variance
(equals
both, either
combined
or netted)
Variance
Note: To obtain proof total, perform the following calculation:
A, Actual Cost Incurred, less B, Applied Cost = Total Variance
Two-Variance Analysis and Three-Variance Analysis Compared 213
the applicable time period, expressed in terms of standard quantity (in the case of materials) or
of standard hours (in the case of labor). In other words, the standard quantity or standard hours
equates to what should have been used (the standard) rather than what was actually used. This
is an important point to remember.
THREE EXAMPLES OF VARIANCE ANALYSIS
This section provides three useful examples of variance analysis. The Hospital Rehab Services
example is a flexible budget with all the variances expressed in Therapy Minutes (TMs). (Therapy
Minutes thus serve as uniform units of measure regarding rehab services.) One of the two examples that follow it is a static budget variance analysis, and the other is a flexible budget example—
both are carried forward from examples originating in the chapter about operating budgets.
Example 1: Hospital Rehab Services Variance Analysis
An example of variance analysis in a hospital system is given in Exhibit 18–2. It deals with price or
spending variance and quantity or use variance. The price variance is expressed in Therapy Minutes (TMs). The quantity variance is broken out into four subtypes—physical, occupation, speech,
Exhibit 18–1 Different Names for Materials, Labor, and Overhead Variances
Price or Spending Variance = Materials Price Variance [for direct materials]
Price or Spending Variance = Labor Rate Variance [for direct labor]
Price or Spending Variance = Overhead Spending Variance [for variable overhead]
Figure 18–4 Calculation of Three-Variance Analysis.
#1 A Actual Cost Incurred less C-1 Budgeted Costs
(computed as actual
hours for actual production)
#2 B Applied Cost less C-2 Budgeted Costs
(computed as standard
hours for actual production)
#3 C-1 Budgeted Costs
(computed as actual
hours for actual production)
less C-2 Budgeted Costs
(computed as standard
hours for actual production)
Total
Variance
(equals
both, either
combined
or netted)
Variance
Note: To obtain proof total, perform the following calculation:
A, Actual Cost Incurred, less B, Applied Cost = Total Variance
214 Chapter 18 Variance Analysis and Sensitivity Analysis
and recreational therapy—all of which are expressed in Therapy Minutes. Finally, it is assumed
that the budgeted activity level is equal to the standard activity level for purposes of this example.
The flexible budget calculation ($990,000) is based on actual quantity. When the $990,000
is compared with the actual cost of $920,000 for this activity center, a favorable price variance
of $70,000 is realized. When the $990,000 is compared with the budgeted cost of $937,500 for
this activity center, an unfavorable quantity variance of ($52,500) is realized. Exhibit 18–2 also
illustrates the computation of a net proof total amounting to $17,500.
Example 2: Static Budget Variance Analysis for an Open Imaging Center
An example of static budget variance analysis for an open imaging center is given in Table 18–1.
As shown, the static budget’s number of procedures performed totaled 1,000, while the actual
number totaled 1,100. The revenue per procedure is $400 for both budget and actual. The net
revenue variance is favorable in the amount of $40,000 ($440,000 less $400,000).
Exhibit 18–2 Variance Analysis for Hospital Rehab Services
Actual Cost _________ $920,000 (1)
[(3) 330,000 TM 3 (5) $2.79 per TM]
Flexible Budget _________ $990,000
(w/actual quantity as basis)
[(3) 330,000 TM 3 (6) $3.00 per TM]
Budgeted Cost ______ $937,500 (2)
[(4) 312,500 TM 3 (6) $3.00 per TM]
Price
Variance
$70,000
(favorable)
Quantity
Variance
($52,500)
(unfavorable)
KEY TO ASSUMPTIONS
Division: Rehab Services
(Physical, Occupational, Speech, and Recreational Therapy)
Cost Driver: Therapy Minutes (TM)
Overhead
Cost divided by # Therapy Minutes
(Activity Level) equals Cost per
Therapy Minute
Actual (1) $920,000 (3) 330,000 (5) $2.79
Budgeted (2) $937,500 (4) 312,500 (6) $3.00
Computation Proof Totals
Budgeted Cost $937,500 less Actual Cost $920,000 5 1$17,500
versus
Favorable Price Variance $70,000 less Unfavorable Quantity Variance ($52,500) 5 1$17,500
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Three Examples of Variance Analysis 215
The salaries and employee benefits expense line item exceeded budget by an unfavorable
balance of $20,000. Likewise, the supplies expense line item exceeded budget by an unfavorable balance of $15,000. The remaining expenses did not vary; thus the total expense variance
is an unfavorable $35,000. The operating income variance equals a favorable $5,000 (the net
difference between $40,000 favorable and $35,000 unfavorable).
Example 3: Flexible Budget Variance Analysis for an Infusion Center Within
a Physician Practice
An example of flexible budget variance using different terminology is given for an infusion
center within a physician practice in Table 18–2. Assumptions for revenue, variable expense,
and fixed expense are set out below the table itself. An explanation of the computations in
Table 18–2 follows.
As to Line 1, Number of Procedures:
Line 1 presents the number of planned procedures (80) and the number of actual procedures
(96). Thus the procedures sales volume difference is 16 (96 less 80), and is favorable.
As to Line 2, Net Revenue:
1. Eighty planned budget procedures at $2,250 revenue apiece totals line 2 column E
$180,000, while 96 actual procedures at $2,250 apiece totals line 2 column C $216,000.
2. The sales volume difference in column D totals $36,000 ($216,000 less $180,000).
3. To prove this figure, multiply the excess 16 procedures at the top of column D times
$2,250 apiece equals the $36,000.
As to Line 3, Variable Expense:
1. The budgeted variable expense for drugs was $1,500 per procedure. Thus, 80 planned
budget procedures times $1,500 drug expense apiece totals line 3 column E $120,000.
Table 18–1 Static Budget Variance Analysis for an Open Imaging Center
Actual Static Static Budget
Amounts Incurred Budget Totals Variance
# Procedures Performed 1,100 1,000 —
Net Revenue ($400/procedure) $440,000 $400,000 $40,000 F
Expenses
Salaries & Employee Benefits $170,000 $150,000 $20,000 U
Supplies 40,000 25,000 15,000 U
Insurance—General 5,000 5,000 -0-
Insurance—Malpractice 10,000 10,000 -0-
Depreciation—Building 50,000 50,000 -0-
Depreciation—Equipment 100,000 100,000 -0-
Total Expenses $375,000 $340,000 $35,000 U
Operating Income $65,000 $60,000 $5,000 F
Key: “F” = “Favorable” variance, while “U” = “Unfavorable” variance.
Note: Dollar amounts shown for illustration only.
216 Chapter 18 Variance Analysis and Sensitivity Analysis
The 96 actual procedures times the planned budget expense of $1,500 apiece totals line
3 column C $144,000. The 96 actual procedures times the actual increased variable drug
expense of $1,575 apiece totals line 3 column A $151,200.
2. The total variable expense difference is $31,200 (line 3 column A $151,200 less line 3
column E $120,000).
3. Of this difference, the sales volume difference is line 3 column D $25,200. It is represented by the 16 extra procedures (96 minus 80 equals the 16 extra) times the $1,575
actual variable expense ($1,575 times 16 equals $25,200).
4. The remaining difference is line 3 column B $6,000. It is represented by the rise in expense
attributed to the 80 planned budget procedures, or line 3 column B 80 procedures times
$75 apiece (the difference between $1,500 and $1,575) equals $6,000. Note that line 3
column B accounts for only the rise in expense for the planned procedures (80), while
line 3 column D accounts for the entire variable expense for the increase in sales volume
of the extra 16 procedures.
5. Proof total is as follows: the column B $6,000 and the column D $25,200 equals the entire
variable expense difference of $31,200 ($151,200 less $120,000 equals $31,200).
As to Line 4, Fixed Expense:
1. The entire $4,000 increase in line 4 fixed expense is attributed to the flexible budget variance, as it does not relate to sales volume.
2. The $4,000 excess expense is an unfavorable variance.
Table 18–2 Flexible Budget Variance Analysis for Infusion Center Within a Physician Practice
(A) (B) (C) (D) (E)
Static
Actual Flexible Flexible Sales Planning
Amounts at Budget Budget for Volume (Master)
Actual Prices Variance Actual Volume Variance Budget
# Procedures
1 Performed 96 — 96 16 F 80
2 Net Revenue $216,000 — $216,000 $36,000 F $180,000
3 Variable Expense $151,200 $6,000 U $144,000 $25,200 U 120,000
4 Fixed Expense 44,000 4,000 U 40,000 — 40,000
5 Total Expense $195,200 $10,000 U $184,000 $25,200 U $160,000
6 Operating Income $20,800 $10,000 U $32,000 $10,800 F $20,000
Flexible Budget Sales Volume
Variance = $11,200 U Variance = $12,000 F
Static Budget Variance = $800 F
Assumptions:
Revenue per procedure = $2,250 per static budget and per actual amounts (no increase).
Variable expense (drugs) = $1,500 per static budget; increase to $1,575 actual amounts.
Fixed expense = $40,000 total per static budget; increase in total to $44,000.
Key: “F” = “Favorable” variance, while “U” = “Unfavorable” variance.
Note: Dollar amounts shown for illustration only.
Three Examples of Variance Analysis 217
As to Line 5, Total Expense:
Total expenses on line 5 represents, of course, the total of variable and fixed expenses.
As to Line 6, Operating Income:
1. The entire operating income variance amounts to a favorable $800 (line 6 column E
static budget of $20,000 minus line 6 column A actual of $20,800 equals $800). The $800
represents the Static Budget Variance.
2. The Flexible Budget Variance equals an unfavorable $11,200 (line 6 column C $32,000
flexible budget for actual volume minus line 6 column A actual $20,800 equals the unfavorable variance of $11,200).
3. The Sales Volume Variance equals a favorable $12,000 (line 6 column C $32,000 less line
6 column E $20,000 equals the favorable variance of $12,000).
4. Proof total is as follows: favorable $12,000 variance less unfavorable variance $11,200
equals the overall static budget variance of $800.
SUMMARY
In closing, when should variances be investigated? Variances will fluctuate within some type of
normal range. The trick is to separate normal randomness from those factors requiring correction. The manager would be well advised to calculate the cost–benefit of performing a variance
analysis before commencing the analysis.
SENSITIVITY ANALYSIS OVERVIEW
Sensitivity analysis is a “what if” proposition. It answers questions about what may happen if
major assumptions change or if certain predicted events do not occur. The “what if” feature
allows the manager to plan for a variety of possibilities in different scenarios.
Forecasts almost always should be subjected to sensitivity analysis. As previously defined, a
forecast is a view of the organization’s future events. Because the future cannot be predicted
with absolute precision, forecasts will always contain a degree of uncertainty. Thus “what if”
analyses become important to the manager’s decision making. For example, “What will the
radiology department’s operating income be if the department’s revenue is 10% greater than
expected?” Or, conversely, “What will the radiology department’s operating income be if the
department’s revenue is 10% less than expected?”
A common example of sensitivity analysis is computing three levels of forecast revenue:
the basic, or most likely level, which is the planned goal; a high (best case) level; and a
low (worst case) level. A chart illustrating this three-level concept for revenue appears in
Figure 18–5.
SENSITIVITY ANALYSIS TOOLS
Manager’s tools involving sensitivity analysis that are described in this section include the contribution margin and the contribution income statement; target operating income using the
contribution margin method; and finding the break-even point using the contribution margin
method.
218 Chapter 18 Variance Analysis and Sensitivity Analysis
Contribution Margin and the Contribution
Income Statement
The contribution income statement specifically
identifies the contribution margin within the
income statement format. You will recall that the
contribution margin is the difference between revenue and variable costs. The remaining difference
is available for fixed costs and operating income.
For example, assume 100 units are sold at
$50 each for a total of $5,000 revenue. Further,
assume variable costs amount to $30 per unit. One
hundred units have been sold, so variable costs
amount to $3,000 (100 times $30/unit 5 $3,000).
The contribution margin equals $2,000 ($5,000
revenue less $3,000 variable costs). (For a further discussion of the contribution margin, refer
to the chapter about cost behavior and break-even analysis.) Now further assume that fixed
costs in this example amount to $1,200. Therefore, the operating income will amount to $800
($2,000 contribution margin less $1,200 equals $800). The format of a contribution margin
income statement will appear as follows:
Revenue $5,000
Variable costs 3,000
Contribution margin $2,000
Fixed costs 1,200
Operating income $800
Target Operating Income Using the Contribution Margin Method
A target operating income computation allows the manager to determine how many units
must be sold in order to yield a particular operating income. We will describe the contribution
margin method of computing target operating income. This method is particularly useful to
the manager because it is easily understood and can be applied in many circumstances. The
formula for the contribution margin method of determining target operating income is as
follows:
N 5 Fixed Costs 1 Target Operating Income
Contribution Margin per Unit
The necessary inputs for this formula include the following:
• Desired (target) operating income amount
• Unit price for sales
• Variable cost per unit
• Total fixed cost
Figure 18–5 Three-Level Revenue Forecast
(Sensitivity Analysis).
Time
Revenue (in dollars)
High Forecast
Basic Forecast
Low Forecast
Sensitivity Analysis Tools 219
Let us consider an example:
• Desired (target) operating income amount 5 $1,600
• Unit price for sales 5 $100
• Variable cost per unit 5 $60
• Total fixed cost 5 $2,000
The contribution margin per unit therefore amounts to $40 ($100 sales price per unit less
$60 variable cost per unit), and the formula will appear as follows:
N 5 $2,000 1 $1,600
$40
$40N 5 $3,600
N 5 $3,600 divided by $40 5 90 units
Therefore: 90 units times $100 unit price for sales 5 $9,000 required revenue.
We can then create a contribution income statement to prove the formula results, as follows:
Revenue $100/unit 3 90 units 5 $9,000
Variable costs $60/unit 3 90 units 5 5,400
Contribution margin $3,600
Fixed costs 2,000
Desired (target) operating income 5 $1,600
In summary, note that this formula is one type of cost-volume-profit (CVP) equation. (For a
further discussion of the CVP concept, refer to the chapter about cost behavior and break-even
analysis.)
Worksheet Example
Julie Smith is the Metropolis Health System’s Director of Community Relations. She has been
informed that the Health System will participate in the first area Wellness Gala, to be held at the
city convention center. The gala is an annual fundraising event in which a variety of nonprofit
organizations each have an opportunity to earn dollars for their cause. Individuals attending the
gala will be prepared to, and are expected to, purchase items from the various booths. Julie’s
boss wants their proceeds to go to the Health System’s auxiliary.
It is now Julie’s responsibility to make the financial arrangements and to coordinate the
Health System’s participation in the event. Last year the booth expense was $1,000, and
Julie uses this figure as her assumption of fixed cost for the coming year’s event. She finds
a local vendor who assembles unique gift baskets. Her wholesale cost per basket will be $30
apiece, if she can place the order within 10 days (otherwise, the cost rises after the 10 days
expires).
Julie believes the gift baskets will sell at the gala for a sales price of $50 apiece. She prepares
a worksheet to determine what dollar amount of sales would be required to earn three ranges
of operating income: $5,000, $6,250, and $7,500. Exhibit 18–3 illustrates Julie’s worksheet. Line
220 Chapter 18 Variance Analysis and Sensitivity Analysis
number 1 contains her first set of assumptions: $1,000 fixed cost for the booth rental and $30
variable cost for each basket.
The convention center representative now e-mails Julie with news: due to a recent renovation of the convention center, booth rental fees have increased. It will cost Julie $1,500 for the
booth. She then adds line 2 to her worksheet with a second set of assumptions: $1,500 fixed
cost for the booth rental and the same $30 variable cost for each basket. She is now prepared to
discuss her findings with her boss.
Break-Even Point Using the Contribution Margin Method
You will recall that the break-even point is the point at which operating revenues and costs
equal each other and operating income is zero. There is a graph method to illustrate the breakeven point (which was previously discussed in the chapter about cost behavior and break-even
analysis). In this sensitivity analysis section, we will describe another method to determine the
break-even point. It is called the “contribution margin method.” The advantage of this method
is its transparency. The manager can easily explain his or her results, because the computations
can be easily seen and understood.
It is understood that operating income is zero at the break-even point. It follows, then, that
the number of units at break-even point can be computed. The formula is as follows:
Break-Even Number of Units 5 Fixed Costs
Contribution Margin per Unit
To compute the contribution margin per unit, subtract the variable costs per unit from the
sales price per unit. In the Target Operating Income formula inputs as previously described,
the sales price per unit was $100 and the variable costs per unit were $60. Thus the contribution
margin per unit is $40 ($100 less $60 equals $40).
Using the same inputs, our break-even formula will now appear as follows:
Break-Even Number of Units 5 $2,000
$40
Thus the break-even number of units will equal $2,000 divided by $40 5 50 units.
Exhibit 18–3 Target Operating Income Worksheet
(A) (B) (C)
Variable At $50 Sales Price per Unit,
Fixed Cost $$ Sales Required to
Cost per Unit Earn Operating Income of:
(1) $1,000 $30 $5,000 $6,250 $7,500
(2) $1,500 $30 $6,250 $7,500 $8,750
Sensitivity Analysis Tools 221
We can create a contribution income statement to prove this formula’s results, as follows:
Revenue $100/unit 3 50 units 5 $5,000
Variable costs $60/unit 3 50 units 5 3,000
Contribution margin $2,000
Fixed costs 2,000
Operating income at break even 5 $-0-
SUMMARY
Sensitivity analysis, in its various forms, is a useful and flexible tool for planning purposes.
INFORMATION CHECKPOINT
What is needed? Example of variance analysis performed on a budget.
Where is it found? Possibly with the supervisor responsible for the budget. More
likely, it will be found in the office of the strategic planner or
financial analyst charged with actually performing the analysis.
How is it used? To find where and how variances have occurred during the
budget period, in order to manage better in the future.
KEY TERMS
Contribution Income Statement
Contribution Margin
Target Operating Income
Three-Variance Method
Two-Variance Method
Variance Analysis
DISCUSSION QUESTIONS
1. Do you believe variance analysis (or a better variance analysis) would be a good idea at
your workplace? If so, why? If not, why not?
2. Are any of the reports you receive in the course of your work ever in a format that includes
a contribution margin? If so, what were the circumstances?
3. Have you ever had to compute target operating income? If so, what were the
circumstances?
NOTE
1. S. A. Finkler, “Flexible Budget Variance Analysis Extended to Patient Acuity and DRGs,”
Health Care Management Review, 10, no. 4 (1985): 21–34.
222 Chapter 18 Variance Analysis and Sensitivity Analysis
Progress Notes
© LFor/Shutterstock
Estimates,
Benchmarking, and Other
Measurement Tools
ESTIMATES OVERVIEW
According to the dictionary, to estimate “… implies a judgment, considered or casual, that precedes or takes the place
of actual measuring or counting or testing out.”1
Such estimates may be of the following:
• amount
• value
• size
The first question should be, “Is it capable of being estimated?” Relying on estimates for input to reports (financial
statements, forecasts, budgets, internal monthly statements,
etc.) means sacrificing some degree of accuracy.
COMMON USES OF ESTIMATES
Using estimates often involves trade-offs, such as gaining a
quick answer that is less accurate. Four common uses of estimates are described here.
Timeliness Considerations
Deadlines may dictate the use of estimates because there
is no time allowed to develop more accurate figures. Some
managers call these “quick and dirty” results. The quick
and dirty estimates may then be followed at a later date by a
more detailed report.
Cost/Benefit Considerations
Estimates may be purposely used instead of a more formal
forecasting process discussed in a preceding chapter. Situations do arise where an estimate is adequate. The manager
After completing this chapter,
you should be able to
1. Understand four common
uses of estimates.
2. Estimate ending inventory.
3. Understand the concept of
financial benchmarking.
4. Understand the use of the
Pareto rule.
5. Compute quartiles for
measurement purposes.
223
19
CHAPTER
may decide upon using estimates instead of proceeding with the more formal forecasting process. After assessing the effort and time involved to gather and prepare a forecast, the manager
will be making a cost–benefit decision; that is, the cost (of forecasting) equivalent to the benefit
(of the more precise information)? Or will estimates adequately serve the purpose? Of course,
this manager’s decision will depend upon the intended purpose.
Lack of Data
Estimates may also be used out of necessity when there is not enough information available to
prepare a full forecast. In this case, there is no choice but to use estimates as an alternative.
Internal Monthly Statements
Estimates may be commonly used in the preparation of short-term financial statements. For
example, the monthly statements that managers receive often contain a number of estimated
figures that are derived from various ratios and percentages. These estimates will probably have
a historical basis because they are typically based on the organization’s prior years’ operating
history. Thus, if bad debts for the last two years averaged 2%, the monthly statements for the
current year may estimate bad debts at the same 2%.
EXAMPLE: ESTIMATING THE ENDING PHARMACY INVENTORY
Certain healthcare organizations (or departments) require accounting for inventory. The most
common example in health care, of course, is the pharmacy. Internal monthly statements of the
pharmacy are not usually expected to reflect the results of an actual physical inventory (unless
your organization has an electronic inventory program—and that is another story). So what to
do? Figure 19–1 illustrates the solution.
The computations contained in Figure 19–1 are described as follows:
1. We first add net drug purchases for the period to the beginning drug inventory, thus arriving at the cost of goods (drugs) available for sale. So far, the steps are the same and the
Figure 19–1 Estimating the Ending Pharmacy Inventory.
Beginning
Drug
Inventory
Net
Drug
Purchases
Estimated
Cost of Goods
(Drugs) Sold
Estimated Ending
Drug
Inventory
Cost of Goods
(Drugs)
Available
for Sale
$$ Sales × Estimated % Cost of Goods Sold = Estimated $$ Cost of Goods Sold
Inventory
Recorded
Purchases
Recorded
Calculated
Estimated
Cost of
Goods Sold
(% of Sales)
Calculated
Estimate
+ = = _
224 Chapter 19 Estimates, Benchmarking, and Other Measurement Tools
result would be the same as that in a preceding chapter, where Figure 9–1 illustrated how
to record inventory.
2. But now we will compute an estimated cost of goods (drugs) sold. To do this:
First, find the amount of net sales (sales after allowances, discounts, rebates, etc.) for
the period.
Then find the percent of net sales that represents cost of goods (drugs) sold in a prior
period. This percentage figure is your estimated assumption and it will probably come
from the last year’s financial report. (For example, $1,000,000 net sales and $800,000 cost
of goods [drugs] sold equals 80% cost of goods sold [drugs] for last year. The 80% is your
estimated assumption for this calculation.)
Apply this estimated assumption to the net sales for the period. (For example, if the
month’s drug sales amounted to $70,000, multiply the $70,000 by 80% to arrive at $56,000
for the estimated cost of goods [drugs] sold this month.)
3. Finally, we will compute the estimated ending drug inventory. We subtract the cost of
goods (drugs) sold (per Step 2 above) from the cost of goods (drugs) available for sale
(per Step 1 above) to arrive at the “Estimated Ending Drug Inventory” for the monthly
internal report.
EXAMPLE: ESTIMATED ECONOMIC IMPACT OF A NEW SPECIALTY
IN A PHYSICIAN PRACTICE
Estimates can be extremely general, or they can reflect considerable judgment, with line-item
detail that has been well thought out. Figure 19–2 illustrates an example of a general estimate
and its subsequent impact.
In this case we have a four-doctor physician practice. The four MDs decide to bring another
doctor into the practice. He is a pulmonary specialist. The county is growing rapidly, economically
Figure 19–2 Estimated Economic Impact of a New Specialist in a Physician Practice.
Estimated
Direct
Nursing Costs
Add one
half-time RN
10% overall
increase
Estimated
Administrative
Indirect Costs
Negative Impact
of
Unrecognized Indirect Costs
Administration
Coder training (new codes)
New super-bill setup
Medical transcription training
Billing training (new codes)
Front office:
Increased patient intake
New Pulmonary Specialist in a Physician Practice
Example: Estimated Economic Impact of a New Specialty in a Physician Practice 225
speaking, and the local hospital has just expanded. The doctors determine there is a sufficient
demand within this growing area to support the services of a pulmonary specialist. They want him
to join their practice, even though they have not previously had such a specialty within this practice.
One morning, the senior doctor asks the practice manager to estimate the expense involved
in adding the pulmonary specialist to the practice. He wants the report for their four o’clock
meeting that afternoon. They must make a decision quickly because the specialist has had
another offer.
The practice manager is trying to close the books for the month, but makes some time to
produce an estimate. The doctors already know the amount that the specialist wants as a guaranteed salary for the first year, and they have already projected what revenue he should produce
for the first year. There is an empty office available that was acquired in the initial lease for purposes of future expansion. Thus, the practice manager needs to estimate the impact on basic
practice operational costs. His “quick and dirty” estimate is in two parts.
Part 1: Add one half-time RN for direct support. Assume existing nursing staff can take up
any slack.
Part 2: Assume an overall 10% increase in practice administration operating costs. He has no
specific basis for the 10% estimate. Instead, he knows that labor is the greatest part of practice
administration costs. As a result of his “back of the envelope” calculation he thinks that administrative staff is not overworked at present and can handle tasks imposed by an additional physician. Since he disregards adding any administrative staff, he feels estimating an overall 10%
increase for administrative expenses of the practice is adequate.
Three months after the pulmonary specialist has arrived and joined the practice, the senior
doctor meets with the practice manager to complain. Operational costs to absorb the new specialist have far exceeded the original estimate. The doctors want an explanation from the practice manager for their meeting the next afternoon.
The practice manager realizes that his estimate did not allow for start-up costs. He composes
a memo explaining that the administrative expenses were impacted by start-up costs such as
coder training for the new pulmonary codes, the consultants’ fees for the new super-bill setup
in the office software, training about pulmonary services for the medical records transcriptionist, and training for the office biller regarding the new codes. He also notes the front office
problems arising from increased patient intake, which had been underestimated. The original
estimates and the negative impact of unrecognized indirect costs are illustrated in Figure 19–2.
OTHER ESTIMATES
Other commonly used computations are actually estimates. The weighted average inventory
method is a good example. Weighted average cost is determined by dividing the cost of goods
available for sale by the number of units available as described in the preceding chapter about
inventory. The resulting average cost of inventory is in fact an estimate.
IMPORTANCE OF A VARIETY OF PERFORMANCE MEASURES
If operations are to be managed most effectively, a variety of performance measures must be in
place for the organization. Generally, a broad variety of such measures are available, and different organizations tend to lean toward using one type over another. One healthcare organization, for example, may rely heavily on one type of measure, whereas another organization may
226 Chapter 19 Estimates, Benchmarking, and Other Measurement Tools
rely on a very different measurement profile. Generally speaking, a wider variety of performance
measures are evident in organizations that have adopted total quality improvement (TQI).
ADJUSTED PERFORMANCE MEASURES OVER TIME
We have previously discussed how measures over time are very effective when evaluating the use of
money. The example given in Figure 19–3 now combines these measures over time with a two-part
case mix adjustment. (Case mix adjustment refers to adjusting for the acuity level of the patient. It
may also refer to the level of resources required to provide care for the patient with the acuity level.)
In this case, the desired measure is cost per discharge. The vertical axis is cost in dollars. The horizontal axis is time, a five-year span in this case. Two lines are plotted: the first is unadjusted for case
mix, and the second is case mix adjusted. The unadjusted line rises over the five-year period. However, when the case mix adjustment is taken into account, the plotted line flattens out over time.
BENCHMARKING
Benchmarking is the continuous process of measuring products, services, and activities against
the best levels of performance. These best levels may be found inside the organization or outside it. Benchmarks are used to measure performance gaps.
There are three types of benchmarks:
1. A financial variable reported in an accounting system
2. A financial variable not reported in an accounting system
3. A nonfinancial variable
How to Benchmark
The benchmarking method is predicated on the assumption that an exemplary process, similar to the process being examined, can be identified and examined to establish criteria for
Figure 19–3 Adjusted Performance Measures over Time.
6,000
5,000
4,000
3,000
2,000
1,000
0
Year 1 Year 2 Year 3 Year 4 Year 5
Case Mix Adjusted
Unadjusted for Case Mix
Cost per Discharge
Cost ($)
Benchmarking 227
excellence. Benchmarking can be accomplished in one of several ways, including (1) studying
the methods and end results of your prime competitors, (2) examining the analogous process
of noncompetitors with a world-class reputation, or (3) analyzing processes within your own
organization (or health system) that are worthy of being emulated. In any of these three cases,
the necessary analysis will rely on one or both of the following methods: parametric analysis or
process analysis. In parametric analysis, the characteristics or attributes of similar services or
products are examined. In process analysis, the process that serves as a standard for comparison
is examined in detail to learn how and why it performs the way it does.
Benchmarking is used for opportunity assessment. Opportunity assessment, used for strategic planning and for process engineering, provides information about the way things should or
possibly could be. Benchmarking is a primary information-gathering approach for opportunity
assessment when it is used in this way.
Benchmarking in Health Care
Financial benchmarking compares financial measures among benchmarking groups. This is
the most common type of “peer group” healthcare benchmarking in use. An example of a
healthcare financial benchmarking report is provided in Table 19–1. The computation of ratios
included in this report has been discussed in preceding chapters. The computation of quartiles
is described later in this chapter.
Statistical benchmarking is a related method of benchmarking. In this case, the statistics of
utilization and service delivery, on which inflow and outflow are based, are compared with those
of certain other hospitals.
Table 19–1 Financial Benchmark Example
Indicator Total Upper Quartile Mid Quartile Low Quartile
No. of hospitals 500.0 105.0 305.0 90.0
Total margin (%) 4.1 11.0 4.5 –6.0
Occupancy (%) 64.5 65.7 64.0 56.1
Deductions from GPR (%) 29.0 28.5 29.2 31.3
Medicare (%GPR) 53.0 55.1 52.2 50.4
Medicaid (%GPR) 10.0 8.4 9.7 13.7
Self pay (%GPR) 7.0 8.5 7.1 6.4
Managed care plans (%GPR)* 16.0 13.0 17.0 17.5
Other third party (%GPR) 14.0 15.0 14.0 12.0
Outpatient revenue (%GPR) 22.0 25.0 21.8 17.7
No. of days in accounts receivable 75.0 70.0 74.0 80.0
Cash flow as a percentage of total debt 30.0 60.0 27.0 –0.5
Long-term debt as a percentage of
total assets 35.0 26.0 36.0 42.0
Change in admissions (2003–2007, %) –7.0 –3.7 –6.3 –15.8
Change in inpatient days (2003–2007, %) –6.0 –1.8 –6.5 –11.1
*Note: Managed care plans other than Title XVIII or Title XIX. All amounts are fictitious.
Reproduced with the permission of Wolters Kluwer Law & Business from J.J. Baker, Activity-Based Costing and Activity-Based Management for Health Care, p. 140, © 1998, Aspen Publishers, Inc.
228 Chapter 19 Estimates, Benchmarking, and Other Measurement Tools
In summary, benchmarking is a comparative method that allows an overview of the individual
organization’s indicators. Objective measurement criteria are always required for best practices
purposes.
ECONOMIC MEASURES
Other performance measures may be made outside the actual confines of the facility. A good
example of a widespread performance measure would be the role of community hospitals in
the performance of local economies. Nonprofit organizations in particular are concerned
about their ability to measure such performance. This case study gives a specific direction for
such measurement efforts.
MEASUREMENT TOOLS
Pareto Analysis
Creating benchmarks, especially in an organization committed to continuous quality
improvement, ultimately leads managers to explore how to improve some step in a process.
Pareto analysis is an analytical tool that employs the Pareto principle and helps in this exploration. Pareto was a 19th-century economist who was a pioneer in applying mathematics to economic theory. His Pareto principle states that 80% of an organization’s problems, for example,
are caused by 20% of the possible causes: thus the “80/20 Rule.”
The usual way to display a Pareto analysis is through the construction of a Pareto diagram. A
Pareto diagram displays the important causes of variation, as reflected in data collected on the
causes of such variation. Figure 19–4 presents an example of a Pareto diagram. This example
reinforces the idea behind the Pareto analysis: that the majority of problems are due to a small
number of identifiable causes.
The chief financial officer of XYZZ Hospital believes that the billing and collection
department is inefficient—or, to be more specific, that the process is probably inefficient. An
activity analysis is conducted. It shows that billing personnel are spending too much time on
unproductive work. This Pareto diagram displays the activities involved in resubmitting denied
bills. (Resubmitting denied bills is an inefficient and nonproductive activity, as we have discussed in a preceding chapter.)
Constructing a Pareto diagram is really simple. The first step is to prepare a table that shows
the activities recorded, the number of times the activities were observed, and the percentage
of the total number of times represented by each count. In Figure 19–4, the total number of
times these activities were observed is 43. The number of times that processing denied bills for
resubmission (coded as PDB) was observed is 22. Thus, 100 (22/43) 5 51%. Similar calculations complete the table. The table of observations is shown in its entirety within the figure.
The Pareto diagram has two vertical axes, the left one corresponding to the “No.” column in
the table, the right one corresponding to the “%” column in the table. On the horizontal axis, the
activities are listed, creating bases of equal length for the rectangles shown in the diagram. The
activities are listed in decreasing order of occurrence. Constructing the diagram in this manner
means that the most frequently observed activity lies on the left extreme of the diagram and the
least frequently observed activity on the right extreme. The heights of the rectangles are drawn to
show the frequencies of the activities, and then the sides of the rectangle are drawn.
Measurement Tools 229
Figure 19–4 Pareto Analysis of Billing Department Data.
40
30
20
10
0
PDB RWS LD CD
Number
Activity No. %
PDB 22 51
RWS 10 23
LD 6 14
CD 5 12
43 100%
Key to Activity Codes
PDB = Process Denied Bills
RWS = Review with Supervisor
LD = Locate Documentation
CD = Copy Documentation
100%
51%
The next step is to locate the cumulative percentage of the activities, using the right-hand
axis. The cumulative percent for the first rectangle, labeled PDB, is 51%. (The calculation of the
51% was previously explained.) For the second rectangle from the left, labeled RWS, the cumulative percentage is 51 1 23 5 74%. The 74% is plotted over the right-hand side of the rectangle
labeled RWS. The next cumulative percentage, for the third rectangle from the left, labeled LD, is
51 1 23 1 14 5 88%. The 88% is plotted over the right-hand side of the rectangle labeled LD. The
last cumulative percentage is, of course, 100% (51 1 23 1 14 1 12 5 100%), and it is plotted over
the right-hand side of the last rectangle on the right, labeled CD.
Now draw straight lines between the plotted cumulative percentages as shown in Figure 19–4.
The next step is to label the axes and add a title to the diagram. In Figure 19–4, the tallest rectangle could be lightly shaded to highlight the most frequent activity, suggesting the one that
may deserve first priority in problem solving.
In general, the activities requiring priority attention—the “vital few”—will appear on the left
of the diagram where the slope of the curve is steepest. Pareto diagrams are often constructed
before and after improvement efforts for comparative purposes. When comparing before and
after, if the improvement measures are effective, either the order of the bars will change or the
curve will be much flatter.
In conclusion, note that many authorities recommend that Pareto analysis take the costs of the
activities into account. The concern is that a very frequent problem may nevertheless imply less
overall cost than a relatively rare but disastrous problem. Also, before basing a Pareto analysis on
frequencies, as this example does, the analyst needs to decide that the seriousness of the problem
is roughly proportional to the frequency. If seriousness fails to satisfy this criterion, then activities
should be measured in some other way. Figure 19–4 underlines the importance of judging the
relevance of the measurements used in a Pareto analysis.
230 Chapter 19 Estimates, Benchmarking, and Other Measurement Tools
Quartile Computation
Reporting by quartiles is an effective way to show ranges of either financial or statistical results.
Quartiles represent a distribution into four classes, each of which contains one-quarter
of the whole. Each of the four classes is a quartile. Quartile computation is not very complicated, although several steps are involved. We can use the outpatient revenue line item in
Table 19–1 to illustrate the computation of quartile data. (Outpatient revenue, expressed
as a percentage of all revenue, is found on the tenth line down from the top in Table 19–1.)
We see from the first line that 500 hospitals were in the group used for benchmarking. The
median is found for the outpatient revenue of the entire group of hospitals. (Most computer
spreadsheet programs offer median computation as an available function.) Then each hospital’s revenue is identified as a percentage of this median. These percentages are arrayed.
In the case of this report, cutoffs were then made to arrange the arrayed percentages into
three groups. The percentages that were between 0 and 25% were designated as the lowquartile group. The percentages that were between 75 and 100% were designated as the
upper-quartile group. The percentages that were between 25 and 75% were designated as the
mid-quartile group.
The average (also known as the arithmetic mean) of each quartile group is then presented
in this report. Thus, the outpatient revenue (expressed as a percentage of gross revenue) for
the upper-quartile group in the report is 25.0; for the mid-quartile group, 21.8; and for the lowquartile group, 17.7. (A grand total of the entire 500 hospitals is also computed and presented
in the left-hand column; the grand total amounts to 22%.) In summary, quartiles are based on
a quantitative method of computation and are an effective way to illustrate a variety of performance measures.
INFORMATION CHECKPOINT
What is needed? An example of estimates, either used in some way in your
work, or published.
Where is it found? In your own files or from a public source.
How is it used? Use the example to examine how the estimate was determined, if possible.
KEY TERMS
Benchmarking
Case Mix Adjusted
Estimates
Pareto Analysis
Performance
Performance Measures
Quartiles
Key Terms 231
DISCUSSION QUESTIONS
1. Have you, in the course of your work, had to estimate items for reports? If so, what type of
items? How did you go about estimating?
2. Does your organization use measurements such as the case mix adjustment over time? If
not, do you believe they should? Why?
3. Does your organization use financial benchmarking? Would you use it if you had a chance
to do so? Why?
NOTE
1. Merriam Webster’s Collegiate Dictionary, 10th ed., s.v. “Estimate.”
232 Chapter 19 Estimates, Benchmarking, and Other Measurement Tools
Progress Notes
© LFor/Shutterstock
CHAPTER
Understanding the
Impact of Data
Analytics and Big
Data
INTRODUCTION
This chapter focuses upon the fast-moving field of data analytics and its impact upon the healthcare industry.
DEFINING DATA ANALYTICS
This section defines data analytics and big data.
What Is Data Analytics?
Data analytics represents the process of examining big data
to uncover hidden patterns, unknown correlations, and
other useful information that can be used to make better
decisions.1
What Are Healthcare Analytics?
Data analytics applied to the healthcare industry is referred
to as healthcare analytics. In addition to helping reveal
and understand historical data patterns, healthcare analytics enables new approaches toward strategic forecasting,
environmental analyses, competitor assessments, needs
assessments, patient-centered care, and improving market
knowledge about population health.
What Is Big Data?
Big data refers to large data sets that an organization
analyzes for patterns or trends.2 In other words, big data
enhances data analytics by applying more sophisticated
analysis techniques, by using new tools, and by sharing
expanded data sets that go beyond traditional claims data
and are obtained from multiple sources.3
After completing this chapter,
you should be able to
1. Define data analytics.
2. Describe healthcare
analytics.
3. Define big data and data
mining.
4. Recognize the differences
among retrospective,
predictive, and prospective
analytics.
5. Understand the impact of
healthcare analytics.
233
20
CHAPTER
Why Is Big Data Different?
Big data typically refers to volumes of data so large that traditional health information technologies and systems can no longer manage or process the information. Also characteristic of big
data is the speed at which data is created and must be processed, as well as the array of different
data sources and formats.
How Is Data Volume Measured?
The basic unit of data measure is the byte, and larger measures are generally expressed in ascending order, beginning with the byte. Thus, 1024 bytes equal one kilobyte (KB); 1024 kilobytes equal
one gigabyte (GB); 1024 gigabytes equals one terabyte (TB); and 1024 terabytes equal one petabyte (PB). The volume measures actually continue upward, as 1024 petabytes equal one exabyte
and so on through zettabytes and even yottabytes. Exhibit 20–1 illustrates these data measure units.
We need to know data volume amounts in order to allow for adequate data storage. While
gigabytes used to be adequate, terabytes are fast becoming the standard for data storage. Such
storage needs will only continue to grow. Consider, for example, Kaiser Permanente: This
health network, with over 9 million members, is believed to have between 26.5 and 44 petabytes
of data from electronic health records (EHRs). (And the data include images and annotations
along with figures.).4 To put such volume into perspective, using a byte converter app we find
that one terabyte equals 1,099,511,627,776 bytes.5 Can you imagine how many bytes are in just
one petabyte? (And KP has not just one, but 44 petabytes.)
However, health care should focus on the relevance of the data rather than the volume of
data collected. Using the data to help reduce costs and improve patient care should be of paramount importance.
What Is Big Data in the Healthcare Industry?
Healthcare industry data are of many types and are derived from many sources. A sampling of
these sources includes the following:
• Physicians’ written notes and prescriptions
• Medical imaging
• Laboratory data
• Pharmacy data
• Insurance and other administrative data
• Patient data in electronic patient
records
• Machine-generated and/or sensor
data, such as from monitoring vital
signs
• Social media posts (Twitter feeds,
blogs, and status updates on
Facebook)
• Website pages
• Information that is non-patient specific (emergency care data, news
feeds, and medical journal articles)6
Really Big Data, Illustrated
1024 Bytes 5 One Kilobyte (KB)
1024 Kilobytes 5 One Megabyte (MB)
1024 Megabytes 5 One Gigabyte (GB)
1024 Gigabytes 5 One Terabyte (TB)
1024 Terabytes 5 One Petabyte (PB)
1024 Petabytes 5 One Exabyte (EB)
Exhibit 20–1 Data Volume Measures
234 Chapter 20 Understanding the Impact of Data Analytics and Big Data
This totality of data related to patient health care and well being make up big data in the healthcare industry. Their appropriate use should lead to better-informed decisions.
TWO BASIC APPROACHES TO DATA ANALYTICS
This section explains two basic approaches to data analytics.
The Retrospective Analytics Approach
Retrospective Analytics identifies trends and problems. It looks at what has already happened
(past actions) and draws empirical conclusions. Thus, retrospective analytics, sometimes called
descriptive analytics, deals with historical information.
The retrospective-analytics approach can readily remove variations and standardize care. It
can be extremely effective in dealing with healthcare tasks such as inventory control or staffing
or billing.7
The Predictive Analytics Approach
The term often refers to the use of predictive analytics (sometimes used interchangeably with
data analytics) or other advanced methods to extract value from data. It does not tell you what
will happen in the future. Instead, it analyses the probability of what is likely to happen in the
future. We can think of the predictive approach as looking forward, while the retrospective
approach looks back. Figure 20–1 illustrates these approaches.
Working with many sets of data enables views of the organization’s operations that are not
possible when examining one set of data at a time. Such analysts are seeking relationships that
exist in the data. Analyzing data sets or using data analytics helps to find relationships that exist
in the data. Finding relationships such as new correlations and business trends, in turn, may
lead to opportunities to improve care, reduce costs, and improve operational performance.
Prospective Analytics: A Subset of Predictive Analytics
Prospective analytics is a decision-making tool that can deliver value by providing evidencebased solutions. The following example highlights the differences among retrospective, predictive, and prospective analytics.
Every year on Amateur Rodeo Night, this particular Emergency Department would get many
more patients—mostly orthopedic patients. Retrospective analytics allowed the hospital to see
Figure 20–1 Two Basic Approaches to Data Analytics.
Data Analytics Approaches
Retrospective Predictive
Two Basic Approaches to Data Analytics 235
how many patients were treated on Rodeo Saturday night compared to the previous 20 or 30
Saturday nights. In other words, retrospective analytics identified the ED’s problem.
Predictive analytics told the hospital what the likelihood was that it would need an increase in
certain services that would be relevant to these emergency room injuries. (Needing, for example, more X-rays, operating rooms, staff, etc.). In other words, predictive analytics anticipated
the problem and allowed future planning.
If, however, prospective analytics had been performed, the hospital could have seen how to
specifically adjust resources for the overload. For example, if the X-ray suites were all full, the
analytics would suggest which cases could have portable X-rays brought to bedside instead of
using the suites. In other words, prospective analytics would have provided possible solutions
to the problem that had been identified by retrospective analytics and anticipated by predictive
analytics.
DATA ANALYTICS AND HEALTHCARE ANALYTICS SERVE MANY PURPOSES
This section provides examples of how data analytics can be used.
Using Predictive Analytics to Answer a Patient Population Question
From a demographic perspective, predictive analytics can help answer a primary question: Who
are the most likely candidates for health services? For example, one hospital learned that their
self-pay population was split equally among men and women, with their ages falling mostly
between 18 and 26 years old, which led to bad debt problems as well as patients who were less
compliant with their care than other age groups. The hospital addressed the issue starting with
incentives to reduce bad debt and putting a program in place in which the patients agreed to
be compliant with their care if the provider helped them pay the cost of their prescriptions.7-8
Using Predictive Analytics in the Human Resources Department
An emerging domain for the application of big data is human resources. The practice of “people analytics” is already transforming how employers hire, fire, and promote.9 The application of predictive analytics to people’s careers is illustrated by the following example. In 2010,
Xerox switched to an online evaluation for job applicants that incorporated personality testing,
cognitive-skill assessment, and multiple-choice questions about how the applicant would handle
specific scenarios that he or she might encounter on the job. An algorithm (a process or set of
rules used in calculations) behind the evaluation analyzed the responses, along with factual
information gleaned from the candidate’s application—as used in conjunction with in-person
interviews.
Using a Combination of Retrospective and Prospective Data Analytics
For example, the use of analytics has allowed hospitals to correlate the patient risk of readmission with the actual readmission rate, the total cost of readmission encounters, and the clinical
drivers of readmissions. Analytics can also provide a financial model that calculates the overall
impact of readmission rate reductions on reimbursement, cost, and value-based purchasing
payments.10
236 Chapter 20 Understanding the Impact of Data Analytics and Big Data
Using a Sophisticated Analytics Approach to Combat Prescription Drug Fraud
Express Scripts, a national pharmacy benefit management organization, has created the
Express Scripts Fraud, Waste, & Abuse Team. The team uses “…industry-leading, proprietary
data analytics to uncover patterns of potential fraud or abuse, and scans for behavioral red
flags to identify when someone is involved in wrongdoing.”11 The proprietary data analytics
are combined with Express Script’s Health Decision Science platform (behavioral sciences,
clinical specialization, and actionable data) to identify 290 potential indicators of pharmacy
fraud.12
One case uncovered by the team involved a husband and wife. Over just eight months,
the wife obtained over 2,800 tablets from 8 physicians and 5 pharmacies, while the husband
obtained almost 4,000 tablets from 9 physicians and 12 pharmacies. The tablets included oxycodone, Endocet, and hydrocodone.13 The team member goes on to say “…upon contacting
several of the physicians we found that in several instances, the couple had signed agreements
that prohibited obtaining narcotics from other doctors. However, none of the physicians was
aware of the couple’s visits to the others.”14
DATA MINING
This section defines data mining and provides examples of its use.
What Is Data Mining?
The big data “revolution” encompasses yet another semantic variant: Data Mining. This is a
process used by organizations to turn raw data into useful information.
How Is Data Mining Used?
By using software to look for patterns in large batches of data, healthcare organizations can
learn more about their customers, develop effective marketing strategies, increase utilization,
and decrease costs. Data mining depends on effective data collection and working with many
sets of data in what is often called a data warehouse.
A Hospital’s Clinical Research Example of Data Mining
A noteworthy application of data mining to clinical medicine is occurring at Memorial-Sloan
Kettering (MSK) Cancer Center in New York City. MSK scientists leverage the massive amount
of data produced by tumor sequencing to learn more about the biology of cancer.15 They use
that leverage to take the genetic discoveries made through analysis and use them to produce
more-precise and cost-effective treatments for people with cancer more quickly.
Another Hospital’s Patient Safety Research Example of Data Mining
In yet another example, Boston Children’s Hospital has teamed with the nonprofit, federally
funded MITRE Corporation research center to tackle patient safety issues.16 In harnessing big
data to boost patient safety, they are pulling data together from multiple sources—electronic
health records, safety event reports, physiologic monitors, etc.—to gain insights into what may
have caused patient harm.
Data Mining 237
Developing a Protocol Through Data Mining
Using a combination of clinical experience and big data analytics research, The University of
Michigan Health System developed a protocol for the administration of blood transfusions.17
Associating Clinical Data with Cost Data
In another example illustrating the potential of big data, California-based Kaiser Permanente
generated a key data set by associating clinical data with cost data. The result of this important
analysis led to the discovery of adverse drug effects from Vioxx, an anti-inflammatory drug,
which led to its withdrawal from the market.18
IMPACTS OF HEALTHCARE ANALYTICS
The impact of healthcare analytics reaches across the entire industry. Three examples of such
impacts follow.
Corporate Acquisition
Noteworthy regarding the growth in the data analytics and cloud computing business is IBM’s recent
acquisition of Truven Health Analytics for $2.6 billion. The magnitude of the purchase is reflected
in the enhanced capabilities of the company’s Watson Health Unit, which is a digital repository of
health-related information for approximately 300 million patients. Truven’s contribution is to add
patient-related payment information to a database that already includes data from patients’ electronic medical records and medical imaging software.19 The ultimate goal is to have Watson’s artificial intelligence software assist physicians and administrators in improving care and curbing costs.
The Big Data Revolution
Big data creates opportunities and challenges. It’s revolutionary insofar that it gives healthcare
professionals the ability to use the data to solve problems much more quickly and in new ways
to gain greater business insight. It is a disruptive change for healthcare organizations in that it
requires new business models.20
New tools and statistical techniques are used to extract meaningful information from what
was unstructured data. An algorithm, or set of rules or processes, governs the greatly enhanced
speed with which problems are solved. The potential benefits in the realm of public health and
medicine are being defined in real time.
Collaborative Efforts
By necessity, the generation and utilization of big data in health care involves collaboration
between organizations. Optum Labs, a collaborative research and innovation center, has been
instrumental in integrating data, generating new knowledge, and translating knowledge into
practice. This has necessitated a shift in current patient care practices. Optum’s efforts have
focused on enabling physicians to utilize big data to improve the care of patients with comorbidities or chronic illnesses.21 A challenge for Optum amidst their collaborative efforts is to
assure an appropriate level of privacy regarding patient information.
238 Chapter 20 Understanding the Impact of Data Analytics and Big Data
Conclusion
Thus, analytics provide the data to reshape healthcare environments in the transition from
fee-for-service to value-based reimbursement, and in so doing can help by strategically targeting patients who need preventive care. The upshot is more effective patient-volume
forecasting.
Other impacts that result from enhanced data analytics and related data sharing include
better coordination of patient care, better use of available resources, better claims and benefit
management, and improved prevention of fraud and abuse.
CHALLENGES FOR HEALTHCARE ANALYTICS
The human resources challenge in the use of big data is well illustrated by AT&T’s Vision 2020
Plan. The essence of the challenge is to retrain its 280,000 employees to enable them to learn
coding skills and make quick business decisions based upon huge volumes of data that are all
sorted through software managed in the cloud.22 In an effort to keep up with competitors such
as Google and Amazon, AT&T executives are urging staff to spend 5–10 hours a week in online
learning relative to cloud computing. The company is willing to fund a good part of that training. The new systems facilitate collecting more data, quickly analyze information about what
people and things are doing, and react.
An ongoing challenge in the use of data analytics is to weigh progress versus privacy: Balancing the promise of big data with consumer privacy and security is an essential consideration.
Along with rising digital expectations of practitioners and patients, healthcare IT executives
know they face strict requirements related to patient privacy and data protection, leaving them
to ponder how to transform their infrastructures and keep data secure.
INFORMATION CHECKPOINT
What is needed? Find a document or report that shows it has applied data
analytics.
Where is it found? Perhaps in the IT department or in a manager’s office.
How is it used? Its use depends on the item you find. It could be used for
planning, for reference, for budgeting, or for training
purposes.
KEY TERMS
Big Data
Data Analytics
Data Mining
Healthcare Analytics
Predictive Analytics
Prospective Analytics
Retrospective Analytics
Key Terms 239
DISCUSSION QUESTIONS
1. Is your organization using big data resources to address clinical and/or administrative
issues? If so, for what purposes have they been utilized?
2. Have you or your area of work been involved in using big data and data analytics to
uncover and examine patterns or trends? Please describe.
3. Consider your organization and the context in which it operates. What would be your
recommendations for using big data?
NOTES
1. SAS, “Big Data Analytics,” www.sas.com/en_us/insights/analytics/big-data-analytics
.html (accessed November 15, 2015).
2. Z. Budryk, “5 Health IT Terms Every Hospital CEO Must Know” (June 24, 2015). www
.fiercehealthcare.com/healthcare/5-health-it-terms-every-hospital-ceo-must-know
(accessed September 17, 2016).
3. D. Hillblom, A. Schueth, S. M. Robertson, L. Topor, and G. Low, “The Impact of Information Technology on Managed Care Pharmacy: Today and Tomorrow,” Journal of Managed Care & Specialty Pharmacy, 20 (2014): 1076.
4. Institute for Health Technology Transformation (IHTT), “Transforming Health Care
Through Big Data: Strategies for Leveraging Big Data in the Health Care Industry,” 2013,
http://c4fd63cb482ce6861463-bc6183f1c18e748a49b87a25911a0555.r93.cf2.rackcdn
.com/iHT2_BigData_2013.pdf
5. What’s a Byte? http://www.whatsabyte.com/P1/byteconverter_App.htm (accessed February 17, 2016).
6. W. Raghupathi and V. Raghupathi, “Big Data Analytics in Healthcare: Promise and
Potential,” Health Information Science and Systems, 2 (2014): 3, http://www.hissjournal
.com/content/2/1/3
7. A. Bickmore, “Prospective Analytics: The Next Thing in Healthcare Analytics,”
www.healthcatalyst.com/using-prospective-analytics-to-improve-outcomes (accessed
February 17, 2016).
8. Healthcare Finance News, June 6, 2015.
9. D. Peck, “They’re Watching You at Work: What Happens When Big Data Meets Human
Resources?” The Atlantic, December 2013.
10. http://www.mentorhealth.com/control/category/~category_id=W_
HOSPITAL/~status=live (accessed December 16, 2016).
11. Express Scripts, “INFOGRAPHIC: Prescription Drug Fraud and Abuse,”
http://lab.express-scripts.com/insights/drug-safety-and-abuse/infographicprescription-drug-fraud-and-abuse (accessed February 16, 2016).
12. Ibid.
13. Express Scripts, “Rx Addiction: One Family’s 7,000 Pills,” http://lab.express-scrpts
.com/insights/drug-safety-and-abuse/rx-addiction-one-faily’s-7000-pills/ (accessed
February 16, 2016).
240 Chapter 20 Understanding the Impact of Data Analytics and Big Data
14. Ibid.
15. E. Kiesler, “Tumor Sequencing Test Brings Personalized Treatment Options to More
Patients,” Memorial Sloan Kettering Cancer Center News, June 12, 2014, https://www
.mskcc.org/blog/new-tumor-sequencing-test-will-bring-personalized-options-morepatients (accessed February 2015).
16. M. Stempniak, “Big Data Applied to Patient Safety in Children’s Hospitals,”
Hospitals and Health Networks, July 14, 2015, http://www.hhnmag.com/articles
/3335-big-data-applied-to-patient-safety-in-children-s-hospitals
17. Institute for Health Technology Transformation, “Transforming Health Care Through
Big Data: Strategies for Leveraging Big Data in the Health Care Industry,” http://c4fd63cb482ce6861463-bc6183f1c18e748a49b87a25911a0555.r93.cf2.rackcdn.com/iHT2_
BigData_2013.pdf
18. Ibid.
19. S. Lohr, “IBM Buys Truven for $ 2.6 Billion, Adding to Trove of Patient Data,” New York
Times, February 18, 2016, http://www.nytimes.com/2016/02/19/technology/ibm-buystruven-adding-to-growing-trove-of-patient-data-at-watson-health.html
20. J. Shaw, “Why ‘Big Data’ Is a Big Deal,” Harvard Magazine, March–April 2014, http://
harvardmagazine.com/2014/03/why-big-data-is-a-big-deal
21. N. D. Shah and J. Pathak, “Why Health Care May Finally Be Ready for Big Data,”
Harvard Business Review, December 3, 2014, https://hbr.org/2014/12/why-healthcare-may-finally-be-ready-for-big-data
22. Q. Hardy, “AT&T’s New Line: Adapt, or Else,” New York Times, December 16, 2016, www
.nytimes.com/2016/02/14/technology/gearing-up-for-the-cloud-att-tells-its-workersadapt-or-else.html?_r=0
Notes 241

PART
© LFor/Shutterstock
Financial Terms,
Costs, and Choices
VIII

Progress Notes
© LFor/Shutterstock
245
21
CHAPTER
INVESTMENT OVERVIEW
The language of investment is an integral part of the finance
world. Being knowledgeable about the meaning that lies
behind investment terms allows you a wider view of finance
transactions. This chapter concerns a selection of common investment terms. We will briefly explore investment
terminology and related meanings for cash equivalents,
long-term investments in bonds, investments in stocks, and
company ownership (public or private) in the context of
investing, along with investment indicators.
Investments should be recorded as either current assets
or long-term assets on the balance sheet of the organization. You will recall from a previous chapter that current
assets involve cash and cash equivalents, along with shortterm securities (those that will mature in one year or less).
These items should all appear as current assets on the balance sheet. Long-term investments, on the other hand,
involve longer-term securities that will mature in more than
one year. These investments should appear as long-term
items on the balance sheet.
CASH EQUIVALENTS
Cash equivalents are termed liquid assets; that is, they can
be liquidated and turned into cash on short notice when
needed. Healthcare organizations need to keep operating monies on hand. But it is not usually practical to hold
those monies in a non-interest-bearing checking account.
Instead, the chief financial officer will probably decide to
temporarily place the monies in some type of liquid asset
(a cash equivalent) in order to earn a little interest.
Actual cash includes not just currency (the dollar bills
in your wallet), but also monies held in bank checking
After completing this chapter,
you should be able to
1. Define cash equivalents.
2. Understand what the FDIC
does and does not insure.
3. Understand the difference
between municipal bonds
and mortgage bonds.
4. Understand the difference
between privately held
companies and public
companies.
5. Define Gross Domestic
Product (GDP).
6. Understand the difference
between deciles and
quartiles.
7. Describe the differences
among mean, median,
and mode.
Understanding
Investment and
Statistical Terms Used
in Finance
accounts and savings accounts, plus coins, checks, and money orders. Cash equivalents include
the following:
• Certificates of deposit (CDs) from banks
• Government securities (including both Treasury bills and Treasury notes)
• Money market funds
All of these short-term investments should be not only very liquid, but low risk. (A prudent chief
financial officer should, of course, seek low-risk investments.)
Certificates of deposit can be purchased for various short periods of time (30 days, 60 days,
90 days, etc.). The certificates earn interest and can be withdrawn (cashed) after the short
period, or term, expires, without paying a penalty.
Government securities that rank as cash equivalents include both Treasury bills and Treasury
notes. Treasury bills are typically issued with maturities of 3, 6, or 12 months. There is a minimum dollar amount to purchase. A Treasury bill pays the full amount invested if redeemed at
maturity. If the bill is redeemed prior to maturity, however, the amount received may be either
higher or lower than your cost, depending upon the current market.
Treasury notes are typically issued with longer maturities—years instead of months. The
shortest maturity period for a Treasury note is one year. A one-year note would be classified as
short-term and could be recorded as a current asset.
Money market funds are supposed to invest in conservative instruments such as commercial
bank CDs and Treasury bills. A money market fund should invest in an assortment of such conservative instruments. Portfolio managers, who are expected to manage responsibly and thus
select only low-risk investments, manage these funds. Money market funds are somewhat of a
hybrid, as these funds typically allow check-writing privileges. Thus, the investor is able to withdraw funds by writing what is actually a draft against the fund, although most everyone thinks
of this draft as a check.
GOVERNMENTAL GUARANTOR: THE FDIC
In the United States, the Federal Deposit Insurance Corporation (FDIC) “preserves and promotes public confidence in the U.S. financial system by insuring deposits in banks and thrift
institutions … by identifying and monitoring and addressing risks to the deposit insurance funds;
and by limiting the effect on the economy and the financial system when a bank or thrift institution fails.”1 The FDIC insured deposits in banks and thrift institutions for at least $250,000
through December 31, 2009. However, this was supposed to be a temporary increase and the
FDIC deposit insurance was supposed to be restored to its usual limit of $100,000 after that date.
Savings, checking, and other deposit accounts are combined to reach the deposit insurance limit.
“Deposits held in different categories of ownership—such as single or joint accounts—may be
separately insured. Also, the FDIC generally provides separate coverage for retirement accounts,
such as individual retirement accounts (IRAs) and Keoghs.”2 It is important to note that not all
institutions—and thus not all funds—are insured by the FDIC. Exhibit 21–1 sets out these facts.
LONG-TERM INVESTMENTS IN BONDS
A bond is a long-term debt instrument under which a borrower agrees to make payments of
interest and principal on particular dates to the holder of the debt (the bond). We have titled
246 Chapter 21 Understanding Investment and Statistical Terms
this section “long-term investments in bonds,” but in actuality the bondholder is a creditor,
because bonds are liabilities to the issuing company.
Because these are long-term contracts, bonds typically mature in 20 to 30 years, although
there are exceptions. In general, interest is paid throughout the term, or life, of the bonds, and
the principal is paid at maturity. (Although there are exceptions to this rule of thumb, too.)
Three types of bonds are discussed below.
Municipal Bonds
Municipal bonds are long-term obligations that are typically used to finance capital projects.
Municipal bonds are issued by states and also by political subdivisions. The political subdivision
might be, for example, a county, a bridge authority, or the authority for a toll road project.
General Obligation Bonds
General obligation bonds are backed, or secured, by the “full faith and credit” of the municipality that issues them. This means the bonds are backed by the full taxing authority of the municipality that issues them.
Revenue Bonds
Revenue bonds, as their name implies, are backed, or secured, by revenues of their particular
project. Eligible healthcare organizations that are not-for-profit can sometimes issue revenue
bonds through a local healthcare financing authority.
Mortgage Bonds
Mortgage bonds, as their name implies, are backed, or secured, by certain real property. When
first mortgage bonds are issued, this means the first mortgage bondholders have first claim to
the real property that has been pledged to secure the mortgage. If second mortgage bonds are
also issued, this means the second mortgage bondholders will not have a claim against the real
property until the claims of the first mortgage bondholders have been paid.
Exhibit 21–1 The FDIC: Insured or Not Insured?
FDIC-Insured
• Checking Accounts (including money market deposit accounts)
• Savings Accounts (including passbook accounts)
• Certificates of Deposit
Not FDIC-Insured
•  Investments in mutual funds (stock, bond, or money market mutual funds),
whether purchased from a bank, brokerage, or dealer
• Annuities (underwritten by insurance companies, but sold at some banks)
•  Stocks, bonds, Treasury securities or other investment products, whether purchased
through a bank or a broker/dealer
Reproduced from the Federal Deposit Insurance Corporation. “The FDIC: Insured or Not Insured?: A Guide to What Is and Is Not Protected” (April 2011).
Long-Term Investments in Bonds 247
Debentures
Debentures are bonds that are unsecured. Instead of being backed by real property, debentures
are backed by revenues that the issuing organization can earn. Unlike bondholders, holders of
debentures are unsecured. Subordinated debentures are even further unsecured, in that these
debentures cannot be paid until any and all debt obligations that are senior to the subordinated
debentures have been paid.
INVESTMENTS IN STOCKS
Stocks represent equity, or net worth, in a company. This is in contrast to bonds. Generally speaking,
a bondholder is a creditor, because bonds are liabilities to the issuing company. On the other hand,
an individual or organization that buys stock in that company becomes an investor, not a creditor.
Common Stock
A purchaser of common stock expects to receive a portion of net income of the company who issues
the stock. The proportionate share of net income will be paid out as a dividend. (Note that start-up
companies that do not pay dividends are not part of this discussion about investments in stocks.)
Preferred Stock
Preferred stock, as its name implies, has preference over common stock in certain issues such as
payment of dividends. In actual fact, preferred stock is a type of hybrid, in that it generally has
a fixed-rate dividend payment, much like a bond’s interest payment. But like common stock, it
also expects to receive a portion of net income of the company who issues the stock, up to the
amount of the fixed-rate dividend payment. (Also note that the preferred stock dividends are
paid before the common stock dividends.)
Convertible preferred stock is a type of preferred stock that can be exchanged for common shares. The exchange is usually at a particular time and price, and the exchange ratio of
preferred-to-common is also stipulated.
Stock Warrants
Stock warrants allow the owner of the warrant to purchase additional shares of stock in the
company, generally at a particular price and prior to an expiration date. Warrants do not pay
dividends. They are often part of the compensation package awarded to executives.
PRIVATELY HELD COMPANIES VERSUS PUBLIC COMPANIES
Whether a stock is listed on a stock exchange or not is a function of ownership and size of the
organization. These distinctions are described here.
Privately Held Companies
A small company with common stock that is not traded is known as a “privately held” company.
Its stock is termed “closely held” stock.
248 Chapter 21 Understanding Investment and Statistical Terms
Public Companies
Companies with publicly owned common stock are known as “public companies.” The stocks of
many larger public companies may be listed on one of several stock exchanges. Stock exchanges
exist to trade the stock of publicly held companies. At the time of this writing, besides multiple regional exchanges such as the Chicago Stock Exchange, there is the American Stock
Exchange, known as AMEX, along with the New York Stock Exchange, known as the NYSE.
(At the time of this writing it is probable that the New York Stock Exchange will be acquired by
the Intercontinental Exchange [ICE]. If so, the NYSE acronym may be changed to reflect the
new ownership.)3
Smaller public companies, however, may not be listed on a stock exchange. The stock of
these companies is considered to be unlisted; instead, their stock is traded “over the counter,”
or OTC. The National Association of Securities Dealers (NASD) oversees this market. The OTC
stock market uses a computerized trading network called NASDAQ, which stands for the “NASD
Automated Quotation system.”
Published stock tables typically reflect the composite regular trading on the stock exchanges
as of closing. A stock table will generally contain four columns: the first column is an abbreviation of the public company’s name, the second column is the company’s symbol (an alpha
symbol), the third column is the stock’s price as of closing for that day, and the fourth column is
the net change of the stock price when compared to close of the previous day. Using healthcare
organizations as examples, Johnson & Johnson’s symbol is “JNJ,” while Humana, Inc.’s symbol
is “HUM.”
Governmental Agency as Overseer
At the time of this writing, the overseer of the stock market in the United States is the U.S. Securities and Exchange Commission (SEC). (It is possible that in the future the SEC may be reorganized as a somewhat different entity with somewhat different responsibilities.) The mission of
the SEC is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”4 The SEC oversees “the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. Here, the
SEC is concerned primarily with promoting the disclosure of important market-related information, maintaining fair dealing, and protecting against fraud.”5
INVESTMENT INDICATORS
The annual rate of inflation (or deflation) is a typical investment indicator, as is the gross
domestic product measure. Both are discussed here.
Inflation Versus Deflation
Inflation means “an increase in the volume of money and credit relative to available goods and
services resulting in a continuing rise in the general price level.”6
“Indexed to inflation” means these monies will rise in accordance with an inflationary
increase. For example, Social Security payments are indexed to inflation. Excessive inflation is
feared because it reduces or devalues the spending power of the dollars you possess.
Investment Indicators 249
Deflation, on the other hand, means “a contraction in the volume of available money and
credit that results in a general decline in prices.”7 Deflation is feared because the contraction
in volume of available money and credit generally results in a fall in prices that limits and/or
reduces the country’s economic activity.
Gross Domestic Product (GDP)
The GDP measures “the output of goods and services produced by labor and property located
in the United States.”8 Investors watch the GDP because this measure is considered to be the
“gold standard” measure of the country’s overall economic fitness. The Bureau of Economic
Analysis (BEA), located within the U.S. Department of Commerce, releases quarterly estimates
of the GDP. The BEA is also responsible for the price index for gross domestic purchases. The
price index measures “prices paid by U.S. residents,”9 and is also released on a quarterly basis.
STATISTICS OVERVIEW
This overview provides an introduction to statistics, along with a discussion of mathematics
versus statistics.
Introduction
This section contains general definitions of statistical and other terms that may commonly be
used within the finance department. It is important to understand that our usage of statistical
terms in the world of healthcare finance is a specialized view. (For instance, in the case of one
example, we are concerned with how statistical analysis is used to score performance measures.)
In other words, we need enough information to understand the general process and what the
terms mean in general usage. As such, the following definitions are not technical, but instead
are intentionally generalized.
The Field of Mathematics Versus the Discipline of Statistics
The field of mathematics is broad and varied. The National Council of Teachers of Mathematics
(NCTM) has developed a set of mathematical standards for teaching and learning mathematics. These
standards are important because they help to understand the breadth and depth of mathematics.
The NCTM has set two categories of standards: thinking math and content math. Thinking
math standards are problem solving, communication, reasoning, and connections. Content
math standards are statistics and probability, fractions and decimals, estimation, number sense,
geometry and spatial sense, measurement, and patterns and relationships.10 As you can see, the
field of mathematics includes, among other disciplines, those of statistics and probability as well
as that of basic arithmetic.
• Statistics is the branch of mathematics that deals with collecting, summarizing, and analyzing numerical data, along with estimating probability and interpreting analytical results.
• Arithmetic, on the other hand, is the branch of mathematics that covers the basic functions of multiplication, division, addition, subtraction, and so on.
250 Chapter 21 Understanding Investment and Statistical Terms
In other words, statistics often provides sophisticated analytical results, while arithmetic provides the results of basic calculations.
COMMONLY USED STATISTICAL AND OTHER MATHEMATICAL TERMS
This section includes a variety of mathematical terms that are commonly used in finance
departments.
Mean, Median, and Mode
Mean, median, and mode are basic statistical concepts, but they are often confused for one
another. The following descriptions are intended to clarify the differences among them.
In order to begin our description of mean, median, and mode, first imagine a set of numbers that are arranged, or ranked, in order. They can be arranged either from the highest to
the lowest, or vice versa. Now visualize this set of numbers as they apply to the following three
descriptions.
Mean: The mean is the average of numbers, or values. To obtain the average, all the values are
added together to obtain the total. Then the total is divided by the number of line items to
obtain the average, or mean. This method is known as the “arithmetic mean” and is the most
commonly used. (Two other analytical methods, known as the geometric mean and the harmonic mean, are obtained through statistical formulas.)
Median: The median occupies a position in a ranked series of values (numbers) in which the
same number of values appear above the median as appear below it. Or, to put it another way,
there are an equal number of values (numbers) above and below the median. (In a situation
where there is no one middle number [as in the case of an even number of values], the median
instead is the average of the two middle numbers within the ranked series of values.)
Mode: The mode is the number, or value, that appears for the most times (is the most frequent)
within a series of numbers or values.
Illustrating the Difference
We show these differences in Table 21–1. Here you see a series of physicians’ scores. Their
scores represent a set of numbers, ranked from high to low as previously described. Within the
table you can see the mean, the median, and the mode each indicated within the ranked data
set of scores.
Other Statistical Analysis Terms
These descriptions pertain to other types of statistical analysis terminology.
Algorithm: A problem-solving, step-by-step process, or a set of formulas used in calculations, particularly in computer programs.
Domain: A subgroup of a whole group that is of particular interest for research or for measurement purposes. For example, the domain of safety is one subgroup of an entire patient care
grouping.
Commonly Used Statistical and Other Mathematical Terms 251
Measure: A unit of analysis, such as a measurement standard.
Measurement: The process of assigning numbers to something, such as to variables. (In other
words, measurement is how we get the numbers we analyze using statistical methods.)
Standard Deviation: Measures the average amount that a set of data within a distribution may
deviate from the mean. The further apart the values are, the larger the standard deviation will
be. A formula is used to compute the standard deviation (SD).
Standardized Measure or Scale: A statistical method that can compare data measured on different scales or instruments. (For example, the method of comparison could be a score or a
percentage.)
Statistically Significant: In general terms, a result or relationship is found to be reliable, and
thus statistically significant, if it is either bigger or smaller than if the equivalent result could be
attributed to chance alone. In other words, the finding is a result that is not merely attributable
to random chance alone.
Variable: A finding or quantity that can vary, or is apt to vary. Examples of variables include just
about anything that is capable of being measured. (Note that a constant is the opposite of a variable, because it does not vary [and thus is constant].)
Variance: The difference between a standard value and an actual value. The difference is typically arrived at through statistical analysis.
Terms About Distributions
These descriptions pertain to distribution terms, such as those used to explain scoring
methodology.
Frequency Distribution: A count of how many times (how frequently) a number appears in a group
of numbers.
Physicians’ CPIA Scores
Physician
#
Score
(in points)
1 55
2 50
3 50 Mode (The most common score)
4 50
5 45 Median (The middle score)
6 35
7 30
8 25
9 20
Total 360 divided by 9 = 40 è Mean (The average score)
Modified from W. Vogt, Dictionary of Statistics & Methodology, p. 178.
r
Table 21–1 Illustration of Mean, Median, and Mode
252 Chapter 21 Understanding Investment and Statistical Terms
Decile: A distribution into 10 classes, each of which contains one-tenth of the whole; any one of
the 10 classes is a decile.
Quartile: A distribution into four classes, each of which contains one-quarter of the whole; any
one of the four classes is a quartile.
Terms Used in Mathematical (Arithmetic) Computations
These descriptions pertain to computation terms, such as those sometimes used to explain
reporting-measures methods.
Decimal: The decimal system subdivides into tenth or hundredth units. A decimal point number
is typically expressed with a decimal point to show units that have a value of less than one. For
example, one dollar is equal to 100 cents. Thus, 30 cents can be expressed as a decimal (0.30)
because it has a value (30) that is less than the 100 cents that represents 1. Thus, the 30 that is
shown to the right of the decimal point has a value of less than 1 (1 dollar, in this example).
Fraction: Indicates both part of a whole (the numerator, which is the top part) and the entire
whole (the denominator, which is the total number of parts to be divided). For example, 30
cents can be written as a fraction (30/100) because the numerator is the part (30) and the
denominator is the whole (100 cents, or 1 dollar).
Numerator: The top part of a fraction. The numerator indicates the portion of the total under
consideration. See also Denominator.
Denominator: The bottom part of a fraction. The denominator indicates all the values under
consideration. See also Numerator.
Percent (Percentage): Typically 1 part or unit in every 100 parts or units. For example, 50% means
50 parts per 100.
Terms About Data
These descriptions pertain to data. Note that the word “data” is plural. (This means that we
should say “The data are showing” instead of “The data is showing.”)
Data: The factual information being analyzed. This information is typically used to measure
and/or calculate, although it may also be used for reasoning and/or discussion.
Data Base (also Database): A particular set of computerized data organized in a manner designed
for efficient retrieval.
Data Entry: The process of recording data, generally by electronic means.
Data Mining: A process used by organizations to turn raw data into useful information.
Data Processing: Generally speaking, taking raw data and converting it into a form that can be
readily used by computer software (processing). The processing can take place in magnetic,
optical, or mechanical form.
Data Set: A group of data (a set) gathered together for a like purpose.
Data Standardization: The process that converts data into a standard, such as the creation of
standard scores.
Big Data: Large data sets that are analyzed for patterns or trends.
Commonly Used Statistical and Other Mathematical Terms 253
Terms About Time Measurements
These descriptions pertain to terms about time measurements.
Period: A unit of time.
Baseline Period: A unit of time (period) used as a basis for comparison.
Base Year: A 12-month unit of time (year) used as a basis for comparison.
Performance Period: A unit of time during which performance is measured.
Illustrating Analytical Results
Graphics summarize and assist in interpreting statistical results. In fact, “graphing is another
way to show and see information mathematically.”11 There are multiple types of graphics available for this task. The most common types include the following:
Pie Chart: Presents data as portions of a circle
Bar chart: Presents data as horizontal bars
Line chart: Presents data as multiple lines that track along a grid
Column chart or table: Presents data as columns
Scatterplot: Shows the relationship between two data sets via a graph that plots points along both
the horizontal and vertical axes
Venn diagram: Shows the relationships between data points as a series of overlapping circles
Illustrated examples of a pie chart, bar chart, and line chart are found in the chapter, “Using
Comparative Data.”
To summarize, we may not tend to design a graphic for its particular use. Instead we may rely
on two or three formats that are used over and over. However, we should try to design a graphic
that communicates results that are often complex in a precise, clear and efficient manner.12
INFORMATION CHECKPOINT
What is needed? A copy of the Wall Street Journal.
Where is it found? At a newsstand or possibly within the offices of your own
organization.
How is it used? Locate the “Stock Tables” section of the Journal. Review the column headings in the tables and locate the names of various
stock exchanges that are included in the findings.
KEY TERMS
Common Stock
Debentures
Decile
Deflation
Denominator
Federal Deposit Insurance
Corporation (FDIC)
254 Chapter 21 Understanding Investment and Statistical Terms
Gross Domestic Product
(GDP)
Inflation
Mean
Median
Mode
Money Market Funds
Municipal Bonds
Numerator
Quartile
Preferred Stock
Securities and Exchange
Commission (SEC)
Stock Warrants
DISCUSSION QUESTIONS
1. Do you know if your own monies on deposit are FDIC insured? If you do not know, how
would you go about finding out?
2. Do you know of a healthcare company whose stock is publicly held? If you do not know,
how would you go about finding out?
3. Do you know if any healthcare company that you have worked for (now or previously)
had issued revenue bonds that were purchased by investors? If you do not know, how
would you go about finding out?
4. Do you agree with the distinction between thinking math and content math? What
type(s) of mathematics have you ever studied?
NOTES
1. Federal Deposit Insurance Corporation, “Who Is the FDIC?” Federal Deposit Insurance
Corporation, http://www.fdic.gov/about/index.html
2. Ibid.
3. Wall Street Journal Opinion, “ICE Buys NYSE,” Wall Street Journal, December 21, 2012,
A18.
4. U.S. Securities and Exchange Commission, “The Investor’s Advocate: How the SEC
Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation.” Last
modified June 10, 2013, www.sec.gov/about/whatwedo.shtml
5. Ibid.
6. Merriam Webster’s Collegiate Dictionary, 10th ed., s.v. “Inflation.”
7. Ibid., “Deflation.”
8. U.S. Department of Commerce, Bureau of Economic Analysis (BEA). News Release: Gross
Domestic Product: Fourth Quarter 2008 (Final), http://bea.gov/newsreleases/national
/gdp/gdpnewsrelease.htm
9. Ibid.
10. “What Is Mathematics?” p. 1, www.2.ed.gov/pubs/EarlyMath/whatis.html (accessed July
12, 2016).
11. Ibid., p. 7.
12. R. Hawkins and J. J. Baker. Management Accounting for Health Care Organizations: Tools and
Techniques for Decision Support. (Boston: Jones & Bartlett Publishers, 2004). p. 376.
Notes 255

Progress Notes
© LFor/Shutterstock
Business Loans and
Financing Costs
Business loans, as the term implies, represent debts
incurred to assist in running a business. Whether to take on
debt and how much to take on are common and necessary
parts of financial planning. This type of planning involves
the organization’s capital structure, as discussed in the following section.
OVERVIEW OF CAPITAL STRUCTURE
“Capital” represents the financial resources of the organization and is generally considered to be a combination of
debt and equity.
“Capital structure” means the proportion of debt versus
equity within the organization. The phrase “capital structure”
actually refers to the debt–equity relationship. For example,
if a physician practice partnership owed $500,000 in debt and
also had $500,000 in partner’s equity, the partnership capital
structure, or debt–equity relationship, would be 50–50.
Different industries typically have different debt–
equity relationships. In the case of health care, the chief
financial officer of the organization is usually responsible
for guiding decisions about the proportion of debt. The
chief financial officer will take into account various sources
of capital, as discussed in the next section.
SOURCES OF CAPITAL
Sources of capital traditionally include four methods of
obtaining funds:
• Borrowing from a lending institution
• Borrowing from investors
• Retaining the excess of revenues over expenses
• Selling an additional interest in the organization
After completing this chapter,
you should be able to
1. Understand what capital
structure means.
2. Recognize four sources of
capital.
3. Explain an amortization
schedule.
4. Understand loan costs.
257
22
CHAPTER
Borrowing from a lending institution is generally classified by the length of the loan. Shortterm borrowing is commonly expected to be repaid within a 12-month period. Long-term borrowing is usually to finance land, buildings, and/or equipment. Long-term borrowing for these
purposes is usually accomplished by obtaining a mortgage from the lending institution.
Borrowing from investors assumes the organization is big enough and has the proper legal
structure to do so. A common example of borrowing from investors is that of selling bonds.
Bonds represent the company’s promise to pay at a future date. When bonds are sold, the purchaser expects to receive a certain amount of annual interest and also expects that the bonds
will be redeemed on a certain date, several years in the future.
Retaining the excess of revenues over expenses represents retaining operating profits to a
proprietary, or for-profit, company. (Of course this assumes there is an excess of funds to retain.)
A not-for-profit organization may be bound by legal limitations on the retention of its funds.
However, the not-for-profit organization can also sometimes rely on a different income stream.
Church-affiliated not-for-profits, for example, may be able to solicit donations. This example
represents a unique method of raising capital.
Selling an additional interest in the organization depends on its legal structure. Typically, this
method involves a for-profit corporation selling additional shares of common stock to raise funds.
Not-for-profit organizations are bound by legal limitations and may not be able to follow this route.
THE COSTS OF FINANCING
Financing costs typically involve interest expense and usually also involve loan costs, as described
in this section.
Interest Expense
Payments on a business loan typically consist of two parts: principal and interest expense. The
principal portion of the loan payment reduces the loan itself, while the rest of the payment is
made up of interest on the remaining balance due on the loan.
The amount of principal and the amount of interest contained in each payment are
illustrated in an “amortization schedule.” For example, assume the purchase of equipment for
$60,000. Monthly payments will be made over a 3-year period, and the annual, or per-year, interest rate will be 12%. The first 6 months of the amortization schedule for this loan is illustrated in
Table 22–1. The entire 36-month amortization schedule is found in Appendix 22-A at the end
of this chapter.
The interest expense for each monthly payment is computed on the principal balance
remaining after the principal portion of the previous payment has been subtracted. The
“Remaining Principal Balance” column shows the declining balance of the principal. Now refer
to the “Remaining Principal Balance” column and compare it with the “Interest Expense Portion of Payment” column. Remember that the 12% annual interest rate in this example amounts
to 1% per month. You can see how 10% of $60,000.00 amounts to a $600.00 interest payment
for month 1; 10% of $58,607.14 amounts to a $586.07 interest payment for month 2; and so on.
The remainder of the payment amount—after interest expense—is then deducted from the
principal amount due, as shown in Table 22–1. Thus, of the $1,992.86 monthly payment 1, if
$600.00 is interest, then $1,392.86 is the principal portion, and of the $1,992.86 monthly payment 2, if $586.07 is interest, then $1,406.79 is the principal portion, and so on.
258 Chapter 22 Business Loans and Financing Costs
Not all amortization schedules are set up in the same configuration. The columns that are
shown can vary. For example, the entire 36-month amortization schedule for the Table 22–1
loan is contained in Appendix 22-A. Refer to this appendix to see how the columns are different
from Table 22–1. While the basic information necessary for computation is shown, the layout of
the schedule is different.
Loan Costs
The term “loan costs” covers expenses necessary to close the loan. Loan closing costs generally
include some expenses that would be reported in the current year and some other expenses
that should be spread over several years.
Suppose, for example, the Great Lakes Home Health Agency bought a tract of land
for expansion purposes. The home health agency paid a 20% down payment and obtained
mortgage financing from a local bank for the remainder of the purchase price. When
the loan was closed, meaning the transaction was completed, the statement that lists closing
costs included prorated real estate taxes and “points” on the loan. Points represent a certain
percentage of the loan amount paid, in this case to the bank, to cover costs of the financing.
The prorated real estate taxes represent an expense to be reported in the current year by
the HHA. The points, however, would be spread over several years. How would this multipleyear reporting be handled? The total would first be placed on the balance sheet as an amount
not yet recognized as expense. Each year a certain portion of that amount would be charged
to current operations as an “amortized expense.” Amortization expense is a noncash expense
that is assigned to multiple reporting periods. It works much the same way as depreciation
expense.
MANAGEMENT CONSIDERATIONS ABOUT REAL ESTATE FINANCING
Real estate financing typically occurs in the form of real estate mortgages. Management must
take several important considerations into account when contemplating a real estate purchase
that involves a mortgage. These considerations include the following:
• What would the return on investment (ROI) be for this purchase?
• What is the cost of money (i.e., the interest rate) for this mortgage?
• What would the return of capital (equity) computation amount to?
• What is the liquidity prospect (i.e., the ability to sell this property)?
Payment Total Principal Interest Expense Portion Remaining
Number Payment Portion of Payment of Payment Principal Balance
Beginning balance = $60,000.00
1 $1,992.86 $1,392.86 $600.00 $58,607.14
2 1,992.86 1,406.79 586.07 57,200.35
3 1,992.86 1,435.07 572.00 55,779.49
4 1,992.86 1,449.42 557.79 54,344.42
5 1,992.86 1,463.91 543.44 52,895.00
6 1,992.86 1,478.55 528.95 51,431.09
Table 22–1 Loan Amortization Schedule
Management Considerations About Real Estate Financing 259
• What is the potential risk factor (if any) involved in the purchase and/or the mortgage
financing?
• Is there an income tax factor to be considered? If so, what is the impact?
Repayment of a mortgage is typically a long-term liability, and this fact is yet another element
in management’s decision-making process.
MANAGEMENT DECISIONS ABOUT BUSINESS LOANS
Decisions concerning how to obtain capital are an important part of financial management decision making. The chapter on capital expenditures budgets discussed how new capital often has to
be rationed within an organization. Repaying long-term loan obligations will impact the facility’s
cash flow for years to come, and decisions to undertake a large debt load should not be made
lightly. Therefore, most institutions and/or companies have put a formal approval process into
place that generally begins with the chief financial officer and his or her staff and progresses
upward all the way to board of trustees’ approval, depending on the amount of the debt proposed.
Because of the implications, management decisions about business loans are often interwoven with strategic planning.
INFORMATION CHECKPOINT
What is needed? An example of the details of a loan.
Where is it found? In the department responsible for the organization’s finances.
How is it used? Loan information is used by your financial decision makers.
KEY TERMS
Amortization Schedule
Bonds
Capital
Capital Structure
Equity Ratio
Loan Costs
Long-Term Borrowing
Short-Term Borrowing
DISCUSSION QUESTIONS
1. Have you ever been informed of details about business loans in your unit or division?
2. If so, did you receive the information in the context of a new project (a new business loan
that was made for purposes of the new project)?
3. Do the operating reports you receive contain information about loan costs, such as interest expense?
4. If so, do you think the interest expense seems reasonable for the operation? Why?
260 Chapter 22 Business Loans and Financing Costs
© LFor/Shutterstock
Principal borrowed: $60,000.00
Annual payments: 12
Total payments: 36
Annual interest rate: 12.00%
Periodic interest rate: 1.0000%
Regular payment amount: $1,992.86*
Final balloon payment: $0.00
The following results are estimates that do not account for values being rounded to the nearest
cent. See the amortization schedule for more accurate values.
Total repaid: $71,742.96**
Total interest paid: $11,742.96
Interest as percentage of principal: 19.572%
*
Take any line item on the next page. If you add the amount in the principal column and the amount in the interest
column together, the total will amount a payment of $1,992.86.
**($60,000 principal plus $11,742.96 equals $71,742.96.)
261
Sample Amortization
Schedule 22-A
APPENDIX
Payment Cumulative Cumulative Principal
Number Principal Interest Principal Interest Balance
1 $1,392.86 $600.00 $1,392.86 $600.00 $58,607.14
2 $1,406.79 $586.07 $2,799.65 $1,186.07 $57,200.35
3 $1,420.86 $572.00 $4,220.51 $1,758.07 $55,779.49
4 $1,435.07 $557.79 $5,655.58 $2,315.86 $54,344.42
5 $1,449.42 $543.44 $7,105.00 $2,859.30 $52,895.00
6 $1,463.91 $528.95 $8,568.91 $3,388.25 $51,431.09
7 $1,478.55 $514.31 $10,047.46 $3,902.56 $49,952.54
8 $1,493.33 $499.53 $11,540.79 $4,402.09 $48,459.21
9 $1,508.27 $484.59 $13,049.06 $4,886.68 $46,950.94
10 $1,523.35 $469.51 $14,572.41 $5,356.19 $45,427.59
11 $1,538.58 $454.28 $16,110.99 $5,810.47 $43,889.01
12 $1,553.97 $438.89 $17,664.96 $6,249.36 $42,335.04
13 $1,569.51 $423.35 $19,234.47 $6,672.71 $40,765.53
14 $1,585.20 $407.66 $20,819.67 $7,080.37 $39,180.33
15 $1,601.06 $391.80 $22,420.73 $7,472.17 $37,579.27
16 $1,617.07 $375.79 $24,037.80 $7,847.96 $35,962.20
17 $1,633.24 $359.62 $25,671.04 $8,207.58 $34,328.96
18 $1,649.57 $343.29 $27,320.61 $8,550.87 $32,679.39
19 $1,666.07 $326.79 $28,986.68 $8,877.66 $31,013.32
20 $1,682.73 $310.13 $30,669.41 $9,187.79 $29,330.59
21 $1,699.55 $293.31 $32,368.96 $9,481.10 $27,631.04
22 $1,716.55 $276.31 $34,085.51 $9,757.41 $25,914.49
23 $1,733.72 $259.14 $35,819.23 $10,016.55 $24,180.77
24 $1,751.05 $241.81 $37,570.28 $10,258.36 $22,429.72
25 $1,768.56 $224.30 $39,338.84 $10,482.66 $20,661.16
26 $1,786.25 $206.61 $41,125.09 $10,689.27 $18,874.91
27 $1,804.11 $188.75 $42,929.20 $10,878.02 $17,070.80
28 $1,822.15 $170.71 $44,751.35 $11,048.73 $15,248.65
29 $1,840.37 $152.49 $46,591.72 $11,201.22 $13,408.28
30 $1,858.78 $134.08 $48,450.50 $11,335.30 $11,549.50
31 $1,877.37 $115.49 $50,327.87 $11,450.79 $9,672.13
32 $1,896.14 $96.72 $52,224.01 $11,547.51 $7,775.99
33 $1,915.10 $77.76 $54,139.11 $11,625.27 $5,860.89
34 $1,934.25 $58.61 $56,073.36 $11,683.88 $3,926.64
35 $1,953.59 $39.27 $58,026.95 $11,723.15 $1,973.05
36 *$1,973.05 $19.73 $60,000.00 $11,742.88 $0.00
*The final payment has been adjusted to account for payments having been rounded to the nearest cent.
Table 22-A–1 36-Month Sample Amortization Schedule
262 Chapter 22 Business Loans and Financing Costs
263
Progress Notes
© LFor/Shutterstock
23
CHAPTER
Choices: Owning
Versus Leasing Equipment
After completing this chapter,
you should be able to
1. Understand what purchasing
equipment involves.
2. Understand what leasing
equipment involves.
3. Recognize a for-profit
organization.
4. Recognize a not-for-profit
organization.
PURCHASING EQUIPMENT
Purchasing equipment means taking title to, or assuming
ownership of, the item. In this case, the asset representing
the equipment is recorded on the organization’s balance
sheet. The purchase could take place by paying cash from
the organization’s cash reserves, or the organization could
finance all or part of the purchase. If financing occurs, the
resulting liability is also recorded on the balance sheet.
LEASING EQUIPMENT
When is a lease not a lease? When it is a lease-purchase, also
known as a financial lease. This is a very real question that
affects business decisions. The financial lease is described
in the next section, and it is followed by a description of the
operating lease.
Financial Lease
The lease-purchase is a formal agreement that may be
called a lease, but it is really a contract to purchase. This
contract-to-purchase transaction is also called a financial
lease. The important difference is this: the equipment must
be recorded on the books of the organization as a purchase.
This process is called “capitalizing” the lease.
A financial lease is considered a contract to purchase.
Generally speaking, a lease must be capitalized and thus
placed on the balance sheet as an asset, with a corresponding
liability, if the lease contract meets any one of the following
criteria:
1. The lessee can buy the asset at the end of the lease
term for a bargain price.
2. The lease transfers ownership to the lessee before the lease expires.
3. The lease lasts for 75% or more of the asset’s estimated useful life.
4. The present value of the lease payments is 90% or more of the asset’s value.
Operating Lease
The cost of an operating lease is considered an operating expense. It does not have to be capitalized and placed on the balance sheet because it does not meet the criteria just described.
An operating lease is treated as an expense of current operations. This is in contrast to the
financial lease just described that is treated as an asset and a liability. A payment on an operating
lease becomes an operating expense within the time period when the payment is made.
BUY-OR-LEASE MANAGEMENT DECISIONS
Leasing is an alternative to other means of financing. When analyzing lease-versus-purchase
decisions, it is usually assumed that the money to purchase the equipment will be borrowed. In
some cases, however, this is not true. The organization might decide to use cash from its own
funds to make the purchase. This decision would, of course, change certain assumptions in the
comparative analysis.
Another differential in comparative analysis concerns service agreements. Sometimes the
service contracts or service agreements (to service and/or repair the equipment) are made
a part of the lease agreement. This feature would need to be deleted from the total agreement before the comparison between leasing and purchasing can occur. Why? Because the
service agreement would be an expense, regardless of whether the equipment would be leased
or purchased.
An Example
The question for our example is whether a clinic should purchase or lease equipment. We
examine two clinics: Northside Clinic, a for-profit corporation, and Southside Clinic, a not-forprofit corporation.
For both Northside and Southside, assume that the equipment’s cost will be $50,000 if it is
purchased. Likewise, assume for both Northside and Southside that if the equipment is leased,
the lease will amount to $11,000 per year for five years.
We also need to make assumptions about depreciation expense for the purchased equipment. We further assume straight-line depreciation in the amount of $10,000 for years
2 through 4. For the initial year of acquisition (year 0), we assume the half-year method
of depreciation, whereby the amount will be one-half of $10,000, or $5,000. We will further assume the purchased equipment will be sold for its salvage value of 10%, or $5,000,
on the first day of year 5. (Therefore, the full amount of [prior] year 4’s depreciation can
be taken.)
The difference between the for-profit Northside and the not-for-profit Southside is that the
for-profit is subject to income tax. We assume the federal and state income taxes will amount to
a total of 25%. Thus, the depreciation taken as an expense results in a tax savings amounting to
one-quarter of the total expense in each year. The depreciation expense and its equivalent tax
264 Chapter 23 Choices: Owning Versus Leasing Equipment
savings are shown by year in Table 23–1. Also, the same rationale is applicable for the leasing
expense in the for-profit organization.
In the following section, we compare two financial situations that affect the way the analysis
is performed: a for-profit, or proprietary, clinic and a not-for-profit clinic. For purposes of this
analysis, what is the major difference? As we have previously stated, the for-profit practice realizes tax savings on expense items such as depreciation. The not-for-profit clinic does not realize
such tax savings because it does not pay taxes. Consequently, one analysis later here (the forprofit) includes the effect of tax savings on depreciation, and the other analysis (the not-forprofit) does not.
Computing the Comparative Net Cash Flow Effects of Owning Versus Leasing
This description results in computation of the net cash flow for owned equipment versus leased
equipment in a for-profit organization compared with that of a not-for-profit organization.
Table 23–2–A.1 and Table 23–2–A.2 first illustrate the comparative net cash flow effects of owning versus leasing in a for-profit organization. Table 23–2–A.1 illustrates the cost of owning. The
equipment purchase price of $50,000 in year 0 (line 1) and the salvage value of $5,000 in year 5
Table 23–1 Depreciation Expense Computation
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Depreciation expense $5,000 $10,000 $10,000 $10,000 $10,000 —
Depreciation expense tax savings $1,250 $2,500 $2,500 $2,500 $2,500 —
Table 23–2–A.1 Cost of Owning—Northside Clinic (For-Profit)—Comparative Cash Flow
Line
Number Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
1 Equipment purchase price ($50,000)
2 Depreciation expense
tax savings $1,250 $2,500 $2,500 $2,500 $2,500 —
3 Salvage value — — — — — $5,000
4 Net cash flow ($48,750) $2,500 $2,500 $2,500 $2,500 $5,000
Table 23–2–A.2 Cost of Leasing—Northside Clinic (For-Profit)—Comparative Cash Flow
Line
Number Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
5 Equipment lease (rental)
payments ($11,000) ($11,000) ($11,000) ($11,000) ($11,000) —
6 Lease expense tax
savings $2,750 $2,750 $2,750 $2,750 $2,750 —
7 Net cash flow ($8,250) ($8,250) ($8,250) ($8,250) ($8,250) —
Buy-or-Lease Management Decisions 265
Table 23–2–B.1 Cost of Owning—Southside Clinic (Not-for-Profit)—Comparative Cash Flow
Line
Number Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
8 Equipment purchase price ($50,000)
9 Depreciation expense
tax savings n/a n/a n/a n/a n/a —
10 Salvage value — — — — — $5,000
11 Net cash flow ($50,000) — — — — $5,000
Table 23–2–B.2 Cost of Leasing—Southside Clinic (Not-for-Profit)—Comparative Cash Flow
Line
Number Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
12 Equipment lease (rental)
payments ($11,000) ($11,000) ($11,000) ($11,000) ($11,000) —
13 Lease expense tax
savings n/a n/a n/a n/a n/a —
14 Net cash flow ($11,000) ($11,000) ($11,000) ($11,000) ($11,000) —
(line 3) are shown. The for-profit’s net cash flow is also affected by tax savings from depreciation expense, as was previously explained and as is shown on line 2. The resulting net cash flow
by year is shown on line 4.
Table 23–2–A.2 illustrates the cost of leasing in the for-profit organization. The equipment
lease or rental payments are shown on line 5. The for-profit’s net cash flow is affected by tax savings from the lease payments, as is shown on line 6. The resulting net cash flow by year is shown
on line 7.
Table 23–2–B.1 and Table 23–2–B.2 now illustrate the comparative net cash flow effects of
owning versus leasing for the not-for-profit organization. Table 23–2–B.1 illustrates the cost
of owning. The equipment purchase price of $50,000 in year 0 (line 8) and the salvage value of
$5,000 in year 5 (line 10) are shown. The not-for-profit’s net cash flow is not affected by tax savings from depreciation expense because it is exempt from such income taxes. Therefore, the
depreciation expense tax savings entry on line 9 is shown as not applicable, or “n/a.” The resulting net cash flow by year is then shown on line 11.
Table 23–2–B.2 illustrates the cost of leasing in the not-for-profit organization. The equipment lease or rental payments are shown on line 12. The not-for-profit’s net cash flow is not
affected by tax savings from the lease payments because it is exempt from such income taxes.
Therefore, the lease expense tax savings entry on line 13 is shown as not applicable, or “n/a.”
The resulting net cash flow by year is then shown on line 14.
Computing the Comparative Present Value Cost of Owning Versus Cost of Leasing
This continuing description results in computation of the present value cost of owning versus leasing equipment in a for-profit organization compared with that of a not-for-profit
organization.
266 Chapter 23 Choices: Owning Versus Leasing Equipment
Table 23–2–C.1 and Table 23–2–C.2 now illustrate the present value cost of owning versus
leasing for the for-profit organization. Table 23–2–C.1 first carries forward (on line 15) the net
cash flow computed on line 4. Line 16 then shows the present value factor for each year at 8%,
which is the assumed cost of capital in this example. Line 17 contains the present value answers,
which result from multiplying line 15 times line 16. The overall present value cost of owning
(derived by adding all items on line 17) is shown on line 18.
Table 23–2–C.2 illustrates the present value cost of leasing in the for-profit organization.
Table 23–2–C.2 first carries forward (on line 19) the net cash flow computed on line 7. Line 20
then shows the present value factor for each year at 8%, which is the assumed cost of capital in
this example. Line 21 contains the present value answers, which result from multiplying line 19
times line 20. The overall present value cost of owning (derived by adding all items on line 21)
is shown on line 22.
Finally, Table 23–2–C.3 compares the for-profit organization’s cost of owning to its cost of
leasing. In the case of the for-profit, the net advantage is to leasing by a net amount of $1,489.
The tables now illustrate the present value cost of owning versus leasing for the not-for-profit
organization. Table 23–2–D.1 illustrates the present value cost of owning. It first carries forward
(on line 24) the net cash flow computed on line 11. Line 25 then shows the present value factor
for each year at 8%, which is the assumed cost of capital in this example. Line 26 contains the
present value answers, which result from multiplying line 24 times line 25. The overall present
value cost of owning (derived by adding all items on line 26) is shown on line 27.
Table 23–2–C.1 Cost of Owning—Northside Clinic (For-Profit)—Comparative Present Value
Line For-Profit
Number Cost of Owning Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
15 Net cash flow (from line 4) ($48,750) $2,500 $2,500 $2,500 $2,500 $5,000
16 Present value factor (at 8%) n/a 0.926 0.857 0.794 0.735 0.681
17 Present value answers = ($48,750) $2,315 $2,143 $1,985 $1,838 $3,405
18 Present value cost of owning = ($37,064)
Table 23–2–C.2 Cost of Leasing—Northside Clinic (For-Profit)—Comparative Present Value
Line For-Profit
Number Cost of Leasing Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
19 Net cash flow (from line 7) ($8,250) ($8,250) ($8,250) ($8,250) ($8,250) —
20 Present value factor (at 8%) n/a 0.926 0.857 0.794 0.735 —
21 Present value answers 5 ($8,250) ($7,640) ($7,070) ($6,551) ($6,064) —
22 Present value cost of leasing 5 ($35,575)
Table 23–2–C.3 Comparison of Costs—Northside Clinic (For-Profit)
Line Number Computation of Difference
23 Net advantage to leasing = $1,489 (37,064) (line 18) less (35,575) (line 22) equals 1,489
Buy-or-Lease Management Decisions 267
Table 23–2–D.2 illustrates the present value cost of leasing in the not-for-profit organization. It
first carries forward (on line 28) the net cash flow computed on line 14. Line 29 then shows the
present value factor for each year at 8%, which is the assumed cost of capital in this example. Line
30 contains the present value answers, which result from multiplying line 28 times line 29. The
overall present value cost of owning (derived by adding all items on line 30) is shown on line 31.
Finally, Table 23–2–D.3 compares the not-for-profit organization’s cost of owning to its cost
of leasing. In the case of the not-for-profit, the net advantage is to owning by a net amount of
$676. It might be noted that the net difference of $676 is so small that it might be disregarded
and considered as a nearly neutral comparison between the two methods of financing.
In summary, the tax effect on cash flow of for-profit versus not-for-profit will generally (but
not always) be taken into account in comparative proposals for funding.
ACCOUNTING PRINCIPLES REGARDING LEASES
As previously explained, financial statements used for external purposes in the United States
must follow generally accepted accounting principles, or GAAP. The treatment of equipment
leases for such accounting purposes would, of course, fall under GAAP, and the technical
aspects of such reporting are beyond the scope of this text. Be aware, however, that sometime
in the near future, U.S. publicly held companies may be required to adopt certain international
accounting standards as produced by the International Accounting Standards Board (IASB).1
The treatment of leases is a particular issue within these potential adoption requirements and
is, of course, beyond the scope of this text.
Table 23–2–D.3 Comparison of Costs—Southside Clinic (Not-for-Profit)
Line Number Computation of Difference
32 Net Advantage to Owning = $676 (47,271) (line 31) less (46,595) (line 27) equals 676
Table 23–2–D.2 Cost of Leasing—Southside Clinic (Not-for-Profit)—Comparative Present Value
Line Not-for-Profit
Number Cost of Leasing Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
28 Net cash flow (from line 14) ($11,000) ($11,000) ($11,000) ($11,000) ($11,000) —
29 Present value factor (at 8%) n/a 0.926 0.857 0.794 0.735
30 Present value answer = ($11,000) ($10,186) ($9,427) ($8,573) ($8,085) —
31 Present value cost of leasing = ($47,271)
Table 23–2–D.1 Cost of Owning—Southside Clinic (Not-for-Profit)—Comparative Present Value
Line Not-for-Profit
Number Cost of Owning Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
24 Net cash flow (from line 11) ($50,000) — — — — $5,000
25 Present value factor (at 8%) n/a — — — 0.681
26 Present value answer = ($50,000) — — — — $3,405
27 Present value cost of owning = ($46,595)
268 Chapter 23 Choices: Owning Versus Leasing Equipment
INFORMATION CHECKPOINT
What is needed? An example of a buy-or-lease management decision analysis.
Where is it found? Probably with your manager or your departmental director.
How is it used? Study the way the analysis is laid out and the method of comparison used.
KEY TERMS
Buy-or-Lease Decisions
Depreciation
Equipment Purchase
Financial Lease
For-Profit Organization
Lease-Purchase
Not-for-Profit Organization
Operating Lease
Present Value
DISCUSSION QUESTIONS
1. In the examples given in the chapter, there is not much monetary difference between
owning versus leasing. In these circumstances, which method would you recommend?
Why?
2. Have you ever been involved in a lease-or-buy decision in business? In your personal life?
3. If so, was the decision made in a formal reporting format, or as an informal decision?
4. Do you think this was the best way to make the decision? If not, what would you change?
Why?
NOTE
1. K. Tysiac, “Still in Flux: Future of IFRS in U.S. Remains Unclear After SEC report,”
Journal of Accountancy, p.4 (September 2012). www.journalofaccountancy.com/Issues
/2012/Sep/20126059.htm
Note 269

PART
© LFor/Shutterstock
Strategic Planning:
A Powerful Tool
IX

273
Progress Notes
© LFor/Shutterstock
Strategic Planning
and the Healthcare
Financial Manager
MAJOR COMPONENTS OF THE
STRATEGIC PLAN: OVERVIEW
This chapter will cover the six major components of planning and their process flows, along with various examples
of mission, value, and vision statement types. A federal governmental agency planning example will be presented. The
chapter also discusses strategic planning tools, including
situational analysis and financial projections.
INTRODUCTION
Strategic planning is vital for any organization. There are multiple approaches to accomplish such planning, and there is
often confusion about the terminology used in these different
approaches. In this section we will describe the typical components of strategic planning. We will also discuss the confusion
about differences in approach and related terminology.
SIX MAJOR COMPONENTS
The ultimate result of strategic planning is an actual plan,
presented in report form. The major components of a strategic plan include the following:
• Mission Statement
• Vision Statement
• Organizational Values
• Goals
• Objectives
• Action Plans and/or Performance Plans and/or
Initiatives
These components are illustrated in Figure 24–1 and are
further described as follows.
After completing this chapter,
you should be able to
1. Describe the six major
components of strategic
planning.
2. Understand the purpose
and relationship between
mission, vision, and value
statements.
3. Describe the strategic planning
cycle and its process flow.
4. Understand why the
governmental planning
requirements are important.
5. Identify the four components
of a SWOT analysis.
6. Recognize the difference
between a financial forecast
and a financial projection.
24
CHAPTER
Mission Statement
The mission statement explains the purpose of the organization. In other words, it explains
“what we are now.” Generally speaking, the mission statement will cover a near-future period,
usually three to five years.
Vision Statement
The vision statement explains “what we want to be” or perhaps “what we aspire to be.” It is a
look further into the future, perhaps 10 years from now. Not all organizations publicize a vision
statement.
Organizational Values
Values express the philosophy of the organization. There seems to be two approaches to
expressing values: either they are summarized into just a few meaningful phrases or they are
quite lengthy and “wordy.”
Goals
A goal is “…a statement of aim or purpose included in a strategic plan.”1 Goals support the
mission statement. While strategic goals are necessarily broad in nature, nevertheless each goal
Figure 24–1 The Six Major Components of Strategic Planning.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Mission
Statement
Vision
Statement
Values
Goals
Objectives
Action
Plans
274 Chapter 24 Strategic Planning and the Healthcare Financial Manager
should tie directly into an element of the mission statement. Every goal should be considered
an outcome that can be accomplished in the future.
Objectives
A strategic objective further defines intended outcomes in order to achieve a goal. Each objective must support—and thus tie directly into—a particular strategic goal. There are typically
several objectives associated with each goal.
Action Plans
An Action Plan is a detailed plan of operations that shows how one part of a particular objective
will be accomplished. It supports a subcomponent of the overall objective. It is a short-term plan
that provides details (actions) about how a specific area of a particular objective will be carried
out. Action plans are often called by other names, such as “Operational Plans,” “Performance
Plans” or “Initiatives.” They may also be called “Targets.”
VARIED APPROACHES TO STRATEGIC PLANNING
How strategic planning is approached may be affected by the organization type and/or the
program or project type.
Governmental Versus Nongovernmental
Governmental entities are guided by regulatory restrictions. Among these restrictions are federal regulations that mandate strategic planning. These regulations apply to federal governmental organizations and specify the format, contents, and timing of the required strategic
plans. On the other hand, nongovernmental entities are not covered under these mandated
requirements.
For-Profit Versus Not-For-Profit
A for-profit company is in business to make a profit (supposedly, anyway) and is answerable to its
owners. Its owner may be shareholders (for corporations) or partners (for partnerships) or possibly sole proprietors. This company’s mission will generally be proprietary in nature.
A not-for-profit organization, on the other hand, is expected to have a mission that is broadly
charitable in nature. It is typically answerable to the stakeholders who are impacted in one way
or another by its mission.
Specific Programs or Projects
In some cases the type of program or project or initiative will define the basic approach to
strategic planning. Funding sources and/or regulations may also make such demands. For
example, in some states construction of healthcare facilities is controlled by a regulatory Certificate of Need process. In these states, then, strategic planning for a new facility would be
Varied Approaches to Strategic Planning 275
a specific project. The outcome would be uncertain—because there is competition, success
would be unknown—so the project would be specially treated within the plan.
EXAMPLES OF MISSION, VISION, AND VALUE STATEMENTS
This section introduces various types of mission, vision, and value statements. The organization
and the length of statements can vary. Their terminology and their emphasis can also vary. One
set of examples that follow recognizes a special status or focus, another recognizes a financial
emphasis, and a third shows how the message is relayed.
RECOGNIZING A SPECIAL STATUS OR FOCUS WITHIN THE STATEMENTS
The following five examples each recognize a special status or focus within the statements.
Recognizing Non-Profit Status: Sutter Health
Sutter Health is a network of doctors and hospitals located in Northern California. Sutter’s mission statement specifically points out its not-for-profit commitment.
Mission
We enhance the well-being of people in the communities we serve through a not-for-profit commitment to compassion and excellence in healthcare services.
Vision
Sutter Health leads the transformation of health care to achieve the highest levels of quality,
access and affordability.
Values
• Excellence and Quality
• Innovation
• Affordability
• Teamwork
• Compassion and Caring
• Community
• Honesty and Integrity2
[Note: Sutter’s values are arranged in a circular graphic, with “Honesty & Integrity’’ in the middle of the
circle.]
Recognizing For-Profit Status: Tenet Healthcare Corporation
Tenet Healthcare Corporation is a publicly held corporation that is listed on the New York
Stock Exchange (NYSE:THC). As a for-profit corporation operating a healthcare delivery system, Tenet specifically mentions providing a return to its shareholders.
276 Chapter 24 Strategic Planning and the Healthcare Financial Manager
Mission
At Tenet, our business is health care. Our mission is to improve the quality of life of every
patient who enters our doors. Our approach makes us unique and defines our future.
Values
As we seek to improve the quality of our patients’ lives, to serve our communities, to provide an
exceptional environment for our employees and affiliated physicians, and to provide an attractive return to our shareholders, we are guided by five core values.3
Recognizing Hospital Taxing-District Status: Parkland Hospital
Parkland Hospital is the tax-supported hospital serving Dallas County, Texas. As such, Parkland
first states its mandate from the taxpayers.
Mandate
To furnish medical aid and hospital care to indigent and needy persons residing in the hospital
district.
Mission
Dedicated to the health and well-being of individuals and communities entrusted to our care.
Vision
By our actions, we will define the standards of excellence for public academic health systems.
Guiding Principles
Our values and principles reflect our shared responsibility to achieve healthcare excellence for
our patients and communities.4
Recognizing the Vision and Intent of Their Founders: Mayo Clinic
The Mayo Clinic, a large nonprofit organization with a long history, provides medical care,
research, and education at locations including the Midwest, Arizona, and Florida. The Mayo
Clinic is research oriented and is known for treating difficult cases.
Mission
To inspire hope and contribute to health and well-being by providing the best care to every
patient through integrated clinical practice, education, and research.
Primary Value
The needs of the patient come first.
Value Statements
These values, which guide Mayo Clinic’s mission to this day, are an expression of the vision and
intent of our founders, the original Mayo physicians and the Sisters of Saint Francis.5
Recognizing a Special Status or Focus Within the Statements 277
Recognizing Patient and Community Commitment: Regions Hospital
Regions Hospital is a private not-for-profit hospital in St. Paul, Minnesota, that is over 100 years
old. Regions’ commitment to both patients and community is very clear.
Mission
Our mission is to improve the health of our patients and community by providing high quality
health care, which meets the needs of all people.
Vision
Our vision is to be the patient-centered hospital of choice of our community.6
FINANCIAL EMPHASIS WITHIN THE STATEMENTS
This section presents two examples of financial emphasis within the statements, as follows.
A Foundation’s Financial Responsibility: Saint Barnabas Medical
Center Foundation
A healthcare foundation typically exists to receive and manage charitable gifts. This foundation
exists to support a specific hospital: Saint Barnabas Medical Center, a major teaching hospital
located in Livingston, New Jersey.
Mission
The Saint Barnabas Medical Center Foundation is a charitable organization dedicated to
nurturing philanthropic support for the programs and services of Saint Barnabas Medical
Center.
These programs provide the communities we serve with the highest quality, most compassionate health care. To accomplish our mission, the Foundation will:
• Ensure that charitable gifts are used effectively, responsibly, and as directed by the
donor; and
• Carefully manage the endowed funds entrusted to us.7
A Medical Practice Network Emphasizes Financial Structure: Texas Oncology
Texas Oncology specializes in oncology patients through a network of physicians that covers the state of Texas. This organization places its vision first and mission second, as follows.
Note also that evidence-based, or scientific, care is contained within the mission statement.
Vision
To be the first choice for cancer care.
Mission
To provide excellent, evidence-based care for each patient we serve, while advancing cancer care
for tomorrow.
278 Chapter 24 Strategic Planning and the Healthcare Financial Manager
Texas Oncology has three Core Values, consisting of Patient Care, Culture, and Business.
The Business Core Value is of particular interest to us. At the time of this writing, it reads as follows: Business—Our practice values professional management that:
• Promotes convenient access at rural and urban sites.
• Provides leadership in efficient care delivery and improves all aspects of cancer care.
• Provides a financial structure to expand services to our patients.
• Is competitive in all aspects of our business.8
These values clearly recognize the fact that an organization must have the financial structure
and resources to endure and to succeed.
RELAYING THE MESSAGE
The results of strategic planning as expressed in the mission statement, vision, and values are of
little use unless people know about them and what they say. This section focuses upon relaying
that message.
Introducing the Message
This section presents three examples of introducing the message within the statements, as
follows.
An Overall Title for the Message: Aetna Insurance Company
Aetna is a national insurance company over 150 years old that offers health insurance plans.
This company has wrapped their mission, values, and goals together under one overall title
called The Aetna Way, as follows:
Our company’s mission, values and goals are expressed through The Aetna Way. The Aetna
Way, comprising the elements below, encompasses our shared sense of purpose and provides
clarity as we pursue our operational and strategic goals.9
Emphasizing Areas of Focus: American Medical Association
The American Medical Association (AMA) is, according to its website, “…the largest physician
organization in the nation.”10 It provides a wide variety of resources and support for its members.
The AMA has created a five-year strategic plan, “…which aims to ensure that enhancements
to health care in the United States are physician-led, advance the physician-patient relationship,
and ensure that health care costs can be prudently managed.”11
This plan places emphasis on three particular “core areas of focus,” which include the
following:
• Improving health outcomes
• Accelerating change in medical education
• Enhancing physician satisfaction and practice sustainability by shaping delivery and payment models12
The plan was posted electronically, and an AMA member could click on any of the three focus
areas to read more. The AMA also provided a members-only feedback form in order to receive
input.
Relaying the Message 279
Explaining the Terms: Good Samaritan Society
The Good Samaritan Society is the largest not-for-profit provider of senior care and services in
the United States.
There is an important paragraph that appears before Good Samaritan’s Strategic statements.
That paragraph explains the purpose of each term contained with the statements, as follows:
• Our Mission states why the Society exists.
• Our Vision defines the desired outcome of our work.
• Our Strategic Direction defines where we want to be as an organization.
• And our Hallmark Values and related Core Principles identify the values that we strive to
integrate into all aspects of our work.13
Mission Expressed as a Motto
Mottos are an effective way to communicate the organization’s mission. However, composing
such a short piece is much more difficult than it seems at first. Two examples follow.
A Six-Word Motto: Good Samaritan Society
The Good Samaritan Society has also created a pithy concise motto consisting of only six words.
Grounded in Mission
Centered in Values14
A Three-Phrase Motto: Providence Healthcare Network
Providence Healthcare Network is a member of Ascension Health, “…the nation’s largest Catholic and largest nonprofit health system.”
A mission of compassion.
Compassion is perfected by excellence.
Because excellence goes beyond the will to help others by providing the determination and
tools to succeed where the heart takes you.15
The Message Available as Website Downloads
Website downloads make the information available to anyone who has access to a computer.
This section presents two examples of making the message available as a website download.
Downloadable Summaries from Duke Medicine
The umbrella term “Duke Medicine” actually covers three components—the Duke University
Health System, the Duke University School of Medicine, and the Duke University School of Nursing, all based in the Raleigh-Durham, North Carolina area. Duke Medicine has created both a mission and a vision that encompasses all these components. Then each component also has its own
strategic plan that feeds in turn into the combined plan.
At the time of this writing an overview of these plans was available in booklet form. The
booklet, entitled “Thinking Big” could be downloaded from the Duke Medicine website as a
280 Chapter 24 Strategic Planning and the Healthcare Financial Manager
PDF file.16 Summaries of each strategic plan could also be downloaded. Thus Duke provides
transparency and useful summaries in a readily accessible electronic format.
Downloadable Visuals from Johns Hopkins Medicine
Johns Hopkins also uses a single name—John Hopkins Medicine—for its overall medical
enterprise. This enterprise, based in Baltimore, Maryland, includes the Johns Hopkins Health
System along with the John Hopkins University School of Medicine.
Johns Hopkins Medicine has created a mission, vision, and core values for the entire enterprise. At the time of this writing it was possible to download and print out the Johns Hopkins
Medicine mission, vision, and core values in one of three ways:
• A Wall-Mounted Poster (large)—24” 3 36”
• A Framed Desk-top Poster (small)—8” 3 10”
• A Pocket Card—2.5” 3 3.5”17
Thus the message is definitely relayed, and in three possible forms, for three different display
purposes. It keeps the message visible as a reminder.
THE STRATEGIC PLANNING CYCLE AND ITS PROCESS FLOW
The basic elements of strategic planning can be visualized as a series of process flows. Thus by
visualizing the process involved, the planning function can be broken into its various manageable components.
PROCESS FLOW FOR CREATING GOALS, OBJECTIVES,
AND ACTION PLANS
Figure 24–2 illustrates these initial three components of the strategic plan.
Establishing Goals
You will recall that a goal is a statement of aim or purpose. In order to establish such a goal, it is
important to define how it will accomplish a particular segment of the mission statement. Establishing the actual goal involves the following:
• Define the goal.
• Determine that there is a clear and distinct connection to the mission statement.
• Decide how long it will take to accomplish this goal; that is, will it take one year, two years,
three years?
• Compose and condense final wording of the goal to properly express it in a concise
manner.
Broad Goals Become Narrower Objectives
A strategic objective further defines a particular strategic goal. Thus a single broad goal is segmented into several narrower and more defined objectives, as illustrated in Figure 24–2.
Process Flow for Creating Goals, Objectives, and Action Plans 281
Narrower Objectives Become Detailed Action Plans
You will also recall that an action plan provides a detailed plan of operations that shows how to
achieve one part of a particular objective. Thus a single defined objective is segmented into a
number of even more detailed action plans. This step shows how part of the objective will actually be accomplished. The action plan’s relationship to objectives and to goals is also illustrated
in Figure 24–2.
PROCESS FLOW FOR CREATING ACTION PLANS AND THEIR
PERFORMANCE MEASURES
Figure 24–3 illustrates the multiple performance measures that make each action plan operational.
The Action Plan Must Relate to Its Objective
As previously discussed, an action plan should always directly relate to the relevant component of its specific strategic objective. Details will be organized into subcomponents
as necessary and, as its title implies, the action plan will demonstrate how actions will be
accomplished.
Detailed Action Plans Will Contain Multiple Performance Measures
So how will the action plan demonstrate that its actions will be accomplished? The required
actions, or operations, will be linked to a series of performance measures, as illustrated in
Figure 24–3. The performance measures provide accountability.
When these measures are properly designed, performance can be reported as outcomes.
This achieves desired accountability and one cycle of the planning process flow is thus
complete.
Figure 24–2 Process Flow for Creating Goals, Objectives, and Action Plans.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Goal
Objective
# 1
Action Plan (A)
Action Plan (B)
Objective
# 2
Action Plan (D)
Action Plan (C)
282 Chapter 24 Strategic Planning and the Healthcare Financial Manager
Figure 24–3 Process Flow for Creating Action Plans and Their Performance Measures.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Performance Measure 7
Performance Measure 6
Performance Measure 9
Performance Measure 8
Performance Measure 10
Action Plan (C)
Action Plan (D)
Action Plan (A) Performance Measure 2
Performance Measure 1
Performance Measure 3
Performance Measure 4
Performance Measure 5
Action Plan (B)
THE PLANNING CYCLE OVER TIME
We visualize the ideal strategic planning cycle itself as a never-ending process. In other words,
a completed plan is not set in stone, never to change. Instead, there should be a “refresh and
renew” approach to such planning. Incidentally, planning cycle segments may be called by different names, but they are still in a cycle. Look past the names to see the “skeleton” of the overall process.
Goals, Objectives, and Action Plans Interact and Repeat
The interaction of goals, objectives, and action plans should take feedback into account. This
feedback should be obtained as is appropriate from all levels of management within the organization. However, internal managers are not the only stakeholders involved with the strategic plan.
The Planning Cycle Over Time 283
Planning Revisions and Updates Are Necessary
The capability for planning revisions and updates should ideally be built into the plan itself. Unanticipated events can occur—both internally and externally—that require major revisions if the plan
is to be kept operational. Updates, on the other hand, are to be expected and allowance should be
made for them in order to keep the plan.
Stakeholders Provide Input Within the Cycle
Stakeholders can be both internal and external. In order to maintain a manageable planning
cycle, questions need to be answered. For example, how many external stakeholders need input
into the plan? Who, specifically are they? How will they provide this input?
Likewise, how many internal stakeholders need to provide input and/or feedback to the
plan? Who, specifically, are they? What departments or divisions do they represent within the
organization? Is this representation a good balance? And how will they provide this input?
Programming and Budgets Support the Planning Cycle
It makes sense that planning should be supported by budgets and the related funding. It is also
logical that programming should in turn support these budgets. We can then ask: “What goal
and what objective does this particular program and this budget support?”
Financial Aspects of the Plan
A plan must, above all, be operational. And to be operational, it must have financial support. How
will this financial support be provided? Will another division or project be cut in order for this to
happen? Can the consequences be predicted? If so, what will they be?
Related Timeframes
Necessary timeframes are appropriate for the particular portion of strategic planning. For
example, the plan itself typically covers a period of 4 to 5 years. If there is a vision statement, it
should be much further into the future, perhaps out to 10 years. Yet the managers’ accountability should be at least annually, and in fact may be quarterly.
MANAGERS’ RESPONSIBILITIES
Responsibility for the various segments can be assigned. The manager’s responsibility will generally rest in one of three management areas as follows.
Planning
The manager may contribute to planning by gathering data or by analyzing the data to provide specific information that is desired and necessary for the plan. In other words, the manager is participating in the planning function by doing his/her part in the preliminary segment of the process.
Decision Making
The manager may or may not be able to participate in the actual decision making for the plan,
depending upon his/her staff level within the organization. However, he/she may be assigned
284 Chapter 24 Strategic Planning and the Healthcare Financial Manager
to work on a planning committee or a task force that contributes directly to the decision makers
in the organization. This type of assignment is an important responsibility.
Providing Accountability
The manager can definitely contribute in suggesting criteria for performance measures. The
action plan will require performance measures in order to provide the necessary accountability.
And the manager is the best person to understand what measures are needed within his/her
department or division.
A well-designed planning process will also include milestones. The milestones signify the
completion of plan segments within a designated timeframe for completion of the entire plan.
The manager can and should be responsible for assisting in reaching certain milestones on
a timely basis. This function (one hospital CEO called it “ramrodding”) is another type of
accountability responsibility.
FEDERAL GOVERNMENTAL AGENCIES MUST PREPARE STRATEGIC PLANS
Agencies in the federal government are required by law to prepare strategic plans. They are also
required by law to provide reports on performance that tie to the strategic plans. This section
explains the importance of the federal planning cycle and describes its planning and performance requirements. It also provides an example of an agency strategic planning cycle.
WHY ARE FEDERAL PLANNING REQUIREMENTS IMPORTANT TO US?
The federal government’s planning requirements are important to us because they provide guidance in the form of well-thought-out and time-tested regulated concepts and a framework for
strategic planning.
INTRODUCTION: REQUIREMENTS, PLANS, AND PERFORMANCE
Legislative requirements for strategic planning and related performance reporting are
discussed as follows.
Legislative Requirements: Overview
Congress has enacted a law that provided for the establishment of strategic planning and
performance measurement in the federal government. This law, known as the Government
Performance and Results Act (GPRA) of 1993, required each agency of the federal government to prepare a strategic plan for program activities. These strategic plans were then to
be submitted to Congress and to the Director of the Office of Management and Budget
(OMB).18
Legislative Requirements for Strategic Planning
Each agency’s strategic plan must contain the following:
• A comprehensive mission statement
• General goals and objectives for major functions and operations
Introduction: Requirements, Plans, and Performance 285
• A description of how these goals and objectives are to be achieved
• Key factors external to the agency and beyond its control that might significantly
affect achieving these goals and objectives19
Strategic Plan Timeframes
The original 1993 Act required that the strategic plan cover a period of not less than five years
forward from the fiscal year in which it would be submitted. (You will recall that the federal government’s fiscal year is not a calendar year. Instead it begins on October 1st and ends on September
30th.) In addition the plan was to be updated and revised at least every three years.20
The plan’s timeframe has been subsequently revised to four years by the GPRA Modernization Act of 2010. At the time of this writing, the specific requirement is as follows: “…The plan
shall cover a period of not less than four years following the fiscal year in which the plan is
submitted.”21
Plans’ Impacts on Budgets and Funding
Governmental managers must reconcile their budget requests with their applicable part of the
strategic plan. The projects for which they are responsible can’t (usually) be funded if they are
not approved in the budget.
A common problem involves maintaining a project’s carry forward over sequential annual
budgets. In other words, a multi-year project will need to be recognized for funding in each
annual budget as the project progresses. This can be a real problem, considering the multiple levels of bureaucracy within the government that hinder the approval process.
We can also turn the concept of “impact” around the other way. Instead of asking
“What is the impact of the plan on budgets and funding,” we can ask the opposite questions.
They include, “Does the intent of the plan actually get funded? And stay funded?”
How Agency Strategic Plans Are Tied to Performance
This section describes performance reporting requirements for federal agencies.
Legislative Requirements for Performance Reporting
The 1993 Act actually had three elements: besides requiring strategic plans that covered multiple years, it also required that performance plans and program performance reports be submitted. These requirements actually make the strategic plan itself operational because they hold
the agencies accountable.
Agency Performance Plans Are Required
The GPRA Modernization Act of 2010 legislation requires the agency performance plans to be
submitted annually. The performance plans are to be posted on the Agency’s website.22
Agency Performance Reports Are Also Required
The Agency is also required to prepare an update report that compares actual performance achieved with performance goals as established in the performance plan. This
report is also to be posted on the Agency’s website.23
286 Chapter 24 Strategic Planning and the Healthcare Financial Manager
Unmet Goals May Require a Performance Improvement Plan
Each fiscal year the Office of Management and Budget (OMB) is supposed to determine
whether the Agency has met the performance goals and objectives of the performance
plan. The OMB produces a review report. If goals are not met according to the OMB
report, the Agency must then prepare and submit a Performance Improvement Plan to
increase program effectiveness for each unmet goal. The plan must include measurable
milestones.24
Strategic Mission Statements: Two Federal Departmental Examples
Two departmental examples of governmental strategic mission statement appear in this section.
The first example belongs to the Department of Health and Human Services (HHS). This mission statement is of interest because the Centers for Medicare and Medicaid Services (CMS) is
an agency within the HHS department. The Medicare and Medicaid programs administered by
CMS are frequent subjects of interest in this book.
The second example belongs to the Department of Veterans Affairs (VA). We include this
example as background information because the VA’s Office of Information Technology is
the subject of the governmental planning cycle example that appears in the next section of
this chapter. Note the necessarily broad wording within both of these departmental mission
statements.
Department of Health and Human Services (HHS)
The Department of Health and Human Services (HHS) is “…the United States government’s
principal agency for protecting the health of all Americans and providing essential human services, especially for those who are least able to help themselves.”25
There are more than 300 programs within HHS, including both the Medicare and the Medicaid programs.
Department of Health and Human Services (HHS) Mission Statement
The mission of the U.S. Department of Health and Human Services (HHS) is to enhance the
health and well-being of Americans by providing for effective health and human services and
by fostering sound, sustained advances in the sciences underlying medicine, public health, and
social services.
HHS accomplishes its mission through several hundred programs and initiatives that cover a
wide spectrum of activities, serving the American public at every stage of life.26
Department of Veterans Affairs (VA)
The Department of Veterans Affairs (VA) oversees benefits and services, including health care,
for the nation’s veterans. There are three VA sub-agencies within the Department as follows.
The Veterans Health Administration (VHA) manages veterans’ health care and services. The
Veterans Benefits Administration (VBA) manages veterans’ benefits, including life insurance
and pensions. The National Cemetery Administration (NCA) oversees both burials and memorials for veterans.27
Introduction: Requirements, Plans, and Performance 287
Department of Veterans Affairs (VA) Mission Statement
“Our mission at VA is to serve Veterans by increasing their access to our benefits and services,
to provide them the highest quality of health care available, and to control costs to the best of
our abilities.”28
AN EXAMPLE: THE VA OFFICE OF INFORMATION TECHNOLOGY IT
STRATEGIC PLANNING CYCLE
This section contains a governmental planning cycle example. Elements of the cycle are then
defined and discussed. The section concludes with a summary of management responsibilities.
INTRODUCTION
You will recall that federal planning requirements are especially important to us because these
requirements provide guidance through a time-tested and regulated framework for strategic
planning. We are about to provide a real-life illustration of the planning cycle.
We present the illustrated cycle as an excellent example of the planning process. This example is drawn from a VA Directive concerning strategic planning. The entire scope of the Directive’s requirements is, of course, well beyond the scope of this text. We have had to generalize
the required process in order to provide this example. In generalizing, we are forced to disregard additional explanations, terminology, and background details contained in the Directive.
Please refer to it as a source for further details.
The elements within this VA illustrated example include components that we have described
earlier in this chapter. The components include the following:
• Set Broad Goals and Narrower Objectives for Programs
• Set Performance Measures to Achieve the Goals and the Objectives
• Determine External Key Factors That Are Significant
• Prepare Annual Performance Plan
• Prepare Periodic Performance Reports
• Revise and Update as Needed
THE VA OFFICE OF INFORMATION TECHNOLOGY IT STRATEGIC
PLANNING CYCLE: AN EXAMPLE
Figure 24–4 illustrates the planning cycle in accordance with VA Directive 6052. The Directive’s
version used here is dated 2009. While there will inevitably be future updates and revisions, this
example of the planning cycle process serves our purpose very well.29
THE VA PLANNING CYCLE’S PROCESS FLOW
Figure 24–4 shows the overall VA Strategic Plan and Goals at the top of the visual. This overall
plan and its goals then flow to four “administrative strategic plans.” The four plans include one
apiece for the three subagencies (VHA, VBA, and NCA), plus a fourth plan for the VA Staff
Office.
288 Chapter 24 Strategic Planning and the Healthcare Financial Manager
Figure 24–4 VA Office of Information Technology IT Strategic Planning Cycle.
Reproduced from the Department of Veterans Affairs. VA Directive 6052 Appendix A (April 23, 2009).
Legislative
Changes
5-Year Planning
Cycle
3-Year Planning
Cycle
(Base/YR+1/
Target)
Annual End of
Fiscal Year
VHA
Strategic Plans
VBA
Strategic Plans
NCA
Strategic Plans
VA Staff Office
Strategic Plans
VA Strategic Plan and Goals
VA Key Business Priorities/Goals/Objectives
IT Strategic Plan
(IT Goals/Objectives/Strategies)
IT Performance Plans (Measures)
IT Management Accountability Report
EA/Multiyear
Programming/IT
Capability (BRM)
Budget
Program/Operational Plans
DAS/DCIOs/Executive Directors
IT Directors and Managers
Tactical Plans
Each of the four plans flow to, and relate to, VA key business priorities, goals, and objects.
The Information Technology (IT) Strategic Plan contains IT goals, objectives, and strategies.
Its multi-year planning cycle (shown on Figure 24–4 as a five-year cycle) flows back in and out of
the four Administrative Strategic Plans, as indicated by the two-way arrows.
The VA Planning Cycle’s Process Flow 289
Program and Operational Plans that support the IT Strategic Plan are the responsibility of
the Deputy Assistant Secretary (DAS), the Deputy Chief Information Officers (DCIOs) and the
Executive Directors. These plans are shown on a three-year planning cycle.
IT Performance Plans and their related Performance Measures are an outgrowth of the Program
and Operational Plans. They are on a shorter cycle that we interpret as the base year plus one target.
The Tactical Plans that will carry out the Performance Plans are the responsibility of the IT
Directors and Managers. Finally, an IT Management Accountability Report is required annually
at the end of each fiscal year.
The Legislative Changes (an external factor that influences the process) are shown in a box on
the left-hand side of the visual. Their influence feeds into and impacts the overall process.
Finally, the box on the dotted line to the left reads “EA/Multiyear Programming/IT
Capability (BRM) Budget.” We understand this is a budget that contains multi-year programming. We further understand it references IT Capability. The remaining portion of the acronym references the “One VA EA Business Reference Model,” or BRM. The BRM was developed
in part to provide a common set of process definitions. It thus assists in making “…the complex
integration between business processes transparent.”30
PLANNING CYCLE DEFINITIONS FOR THIS EXAMPLE
The following definitions are contained in the Office of Information Technology IT Planning
Directive. While they are specific to the Directive’s purpose, they provide greater depth to an
overall understanding of the illustrated cycle and its process flow.
Strategic Planning
Strategic planning is a continuous process by which IT determines direction and operational
focus over the next three to five years consistent with priorities established by the Secretary of
Veterans Affairs as expressed in the Departmental Strategic Plan. There is one IT Strategic Plan;
however, strategic planning involves all parts of VA Administrations and Staff Offices.
IT Mission
A mission statement is brief, defines the basic purpose of the organization, and corresponds
directly with the organization’s core programs and activities. An organization’s program goals
should flow from the mission statement. The mission defines the approach and means IT will
take to fulfill the mission of VA as a whole.
IT Vision
The vision defines the ideal state for IT. (It is) what an organization desires to accomplish in
the future.
IT Strategic Goals
A goal is a statement of aim or purpose included in a strategic plan (required under GPRA).
The strategic goal defines how an agency will carry out a major segment of its mission over a
290 Chapter 24 Strategic Planning and the Healthcare Financial Manager
period of time. The goal is expressed in a manner that allows a future assessment to be made of
whether the goal was or is being achieved. Most strategic goals will be outcomes and are longterm in nature. IT goals define the forward-thinking and transformational outcomes IT pursues
to achieve its mission over a period of time.
IT Strategic Objectives
Strategic objectives are strategy components or continuous improvement activities that are
needed to create value for the customers. IT objectives further define intended program outcomes to achieve IT goals.
Program Plans
A program plan consists of planned activities or related projects managed in a coordinated way to include an element of ongoing work products or projects. A program plan is
designed to accomplish a predetermined objective or set of objectives.
Operational Plans
An operational plan is a detailed action plan to accomplish the specific objectives. The plan is a
derivative of the strategic plan describing short-term business strategies, showing how the strategic plan will be put into operation and serving as a basis for an annual operating budget. An
operational plan may comprise a three-year rolling plan to be completed by a small subgroup of
people with expertise and/or a stake relating to a major goal.
Performance Measures
Performance measures are valid and reliable metrics for evaluating the extent to which goals
and objectives are achieved. The measures should be SMART (Specific, Measurable, Achievable, Results-oriented, Time-limited).
IT Management Accountability Report
The IT management accountability report (IT MAR) is an annual report that provides OI&T
performance information (i.e., strategic goals, objectives, fiscal year performance goals, and
outcomes). The IT MAR is a management tool that will provide a basis for assessing the organization’s effectiveness.
Environmental Scan: Feedback and Assessment
An environment scan is an ongoing internal and external customer feedback and assessment process conducted at all levels of the organization for use in developing vision, goals, and objectives.31
MANAGEMENT RESPONSIBILITIES WITHIN THE PLANNING CYCLE
This section concludes with a generalized view of planning responsibilities by three levels of
management. Figure 24–5 illustrates the three levels. Any planning cycle should reflect these
levels, as does the previous example.
Management Responsibilities Within the Planning Cycle 291
Upper-Level Responsibilities
Top-level management represents those individuals at the top of the organization chart.
These upper-level individuals should provide overall direction for the organization’s mission,
vision, and strategic framework. They should be responsible for policymaking and supervisory guidance issues.
Mid-Level Responsibilities
Mid-level individuals are basically accountable to those above, while they operate in a supervisory mode to those below them in the organization chart. Mid-level management should
typically provide the strategies to accomplish goals, performance measures, and operational
plans.
Managerial-Level Responsibilities
The managers, meanwhile, are accountable to all those above them on the organization chart.
The managerial level should typically develop the subordinate plans that will align with midlevel operational plans. Other responsibilities include managing the activities that are designed
to meet strategic goals, initiatives, and performance targets.
TOOLS FOR STRATEGIC PLANNING: SITUATIONAL ANALYSIS
AND FINANCIAL PROJECTIONS
Situational analysis and feasibility studies are discussed in this section, with an emphasis on their
roles in strategic planning.
Figure 24–5 Primary Planning Responsibilities by Management Levels.
Top Level
Mid-Level
Managerial Level
Provides mission, vision, strategic
framework, policy, and guidance
Provides strategies to accomplish
goals, performance measures, and
operational plans
Develops subordinate plans to align
with mid-level operational plans and
manages the activities designed to
meet strategic goals, initiatives, and
performance targets
292 Chapter 24 Strategic Planning and the Healthcare Financial Manager
SITUATIONAL ANALYSIS
This section defines situational analysis (SWOT) and discusses its components.
Definition
A situational analysis does two things. It reviews the organization’s internal operations for
strengths and weaknesses and it explores the organization’s external environment for opportunities and threats. (Thus SWOT: strengths-weaknesses-opportunities-threats.) A situational analysis
allows management to, literally, analyze the organization’s situation.
SWOT Analysis as a Strategic Tool
A SWOT analysis, properly performed, can be an excellent strategic tool. The four components
of a SWOT analysis include the following:
• Strengths
• Weaknesses
• Opportunities
• Threats
The basic SWOT analysis format is illustrated in Figure 24–6. Here we see that the “Strengths”
and “Weaknesses” sectors of the matrix are labeled “Internal,” while the “Opportunities” and
“Threats” sectors are labeled “External.”
Figure 24–6 Basic SWOT Analysis Format.
Internal
External
Strengths Weaknesses
Opportunities Threats
Sample SWOT Worksheets Are Contained in Appendix 24-A
Appendix 24-A contains Sample SWOT Worksheets. The worksheets and their supplemental
Question Guides concern Electronic Health Records (EHR) adoption and implementation.
These worksheets can, however, be easily adopted for other purposes.
Appendix 24-A contains three “Internal Worksheets” for analyzing strengths and weaknesses,
and an “External Worksheet” for analyzing external opportunities and threats. Supplemental
Question Guides are also included for each worksheet. A Scoring Summary Sheet is included
to complete the analysis.
Sequential Steps in the SWOT Analysis Project
The following steps pertain to both the internal and external components of the analysis:
1. First, decide if the sample worksheets and the supplemental question guides need to be
customized; if so, do so.
Situational Analysis 293
2. Gather necessary information.
3. Fill in the worksheets, utilizing the question guides as needed.
4. Reach agreement, or consensus, on the final score for each line item on the
worksheets.
5. Summarize the scores.
6. Enter the final net scores on the Scoring Summary Sheet.
7. Report the results.
Commencing the SWOT Analysis Project Process
In order to commence the SWOT analysis project’s process, a number of decisions must be
made. They include the following:
1. What type of task force or committee does the project need?
2. Who will be appointed to this task force?
3. What types of data/information should be gathered for this project?
4. Who will gather the information that is needed?
5. Will the scoring process be subjective or objective? (This may depend on the amount and
type of available data.)
6. Will the same task force members that are involved in recording the worksheet information also be involved in the scoring process, or will a separate group be appointed to carry
out the scoring function?
7. Who prepares the final report?
8. Who receives the report?
9. Who is responsible for taking appropriate action after the analysis and its report are
completed?
Conclusion
Situational analysis is particularly appropriate for the analysis of electronic records implementation because such implementation requires the collaboration of multiple knowledge areas. A
meeting of the minds can better occur with the discipline that a situational analysis can impose.
It is a powerful tool when properly applied.
We should also acknowledge that there are a variety of approaches to performing a situational analysis, and this brief discussion features only a single approach. No matter what
approach is utilized, the results of the situational analysis are what count.
FINANCIAL PROJECTIONS FOR STRATEGIC PLANNING
The type of financial projection that we discuss is this section is produced internally. These projections are intended for internal use during the planning process, and are thus not intended
for any use outside the organization.
Definition
Projections are views into the future. We “project” future events, projects, or operations using a
set of presumed, or hypothetical, assumptions.
294 Chapter 24 Strategic Planning and the Healthcare Financial Manager
Projections are different than forecasts, although both are considered to be “prospective”
(thus “future”) financial statements. Forecasts are based on assumptions that are expected to
exist, and that reflect actions that are expected to occur.32
Projections, on the other hand, are often prepared to answer a “what-if” question, such as
“what if…this service/program/initiative were to be adopted?” In these “what-if” situations
several projections may be prepared, each based on a different set of hypothetical assumptions
and each reflecting the actions that might occur, based on such assumptions.33
Build a Planner’s Projection
An eight-step process for building a financial projection to be used internally for planning purposes is described as follows. The process is also illustrated in Figure 24–7.
Determine the Future Timeframe
What should the future start and end dates be for this projection? Is the time period to be covered long enough? Or is it too long for reasonable assumptions to be made?
Determine the Focus
Focus on what the plan (or planner) needs to know in order to go forward. Let that focus determine
the direction your search for information will take. (Also note that sometimes a different agenda
can redirect the focus.)
Gather Enough Information
You will need enough information to make informed decisions about your projection. The
range of subjects may vary, but the information should be as up-to-date as possible.
Make Reasonable Assumptions
By “reasonable assumptions” we mean no wildly unattainable assumptions. For example, in most
instances “we will increase revenue by 200% in the
fourth quarter of next year” is an assumption that
will not be accomplished thus is not reasonable.
Document the Assumptions
Assumptions used for the projection are key to
its success. Documenting the assumptions is an
indication of a well-constructed projection. The
documentation adds validity to the final product. It also provides a record of the overall process of information-gathering that underlies the
assumptions themselves.
Prepare the Projected Statements
Projected financial statements are then assembled using the documented assumptions. In
accountant’s terminology this is known as “compiling” the projections.
Figure 24–7 Build a Planner’s Financial Projection.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
1) Determine the future time frame
2) Determine the focus
3) Gather enough information
4) Make reasonable assumptions
5) Document the assumptions
6) Prepare the projected statements
7) Review for reasonableness
8) Create alternative scenarios
Financial Projections for Strategic Planning 295
Review for Reasonableness
For example, ask: “Is this assumption reasonable for an organization of my type and size?” This
type of review may be subjective, but it is a logical part of the process. Appropriate members
of the organization may also perform a review in order to highlight any weak spots within the
assumptions.
Create Alternative Scenarios
It is often helpful to produce multiple versions of the projections (“Model A,” “Model B,” etc.).
In this case, certain key assumptions are changed for each model. Thus the “what if” question is
answered in several different ways.
Financial Projections as Strategic Tools
These internal planning projects may be used to better make informed decisions. If properly
constructed, they can provide information that is laid out in a logical format, supported by
assumptions that are properly explained for the knowledgeable reader. To summarize, projections can be an important tool to inform and support the planning process.
CASE STUDY: STRATEGIC FINANCIAL PLANNING IN LONG-TERM CARE
Chapter 32, “Case Study: Strategic Financial Planning in Long-Term Care” later in this volume
involves a case study about strategic financial planning in long-term care. The case study is
authored by Dr. Neil R. Dworkin, Emeritus Associate Professor of Management at Western Connecticut State University. His case study merits your close attention, as it will utilize planning
concepts that have been discussed within this chapter.
APPENDIX 24-A: SAMPLE SWOT WORKSHEETS AND QUESTION GUIDES
Appendix 24-A contains four Sample SWOT Worksheets (three internal and one external) concerning EHR adoption and implementation, along with a Scoring Summary Sheet.
A Question Guide is also included for each Worksheet. Electronic medical records adoption
is a good subject for situational analysis. The sample worksheets in this Appendix can assist in
beginning such a project.
INFORMATION CHECKPOINT
What is needed? A “set” of an organization’s mission statement, vision statement, and values.
Where is it found? In the planning and policy division or within the administration office.
How is it used? These documents are used to guide the organization.
296 Chapter 24 Strategic Planning and the Healthcare Financial Manager
KEY TERMS
Action Plan
Financial Forecast
Financial Projection
Goal
Innovation
Mission Statement
Situational Analysis
Strategic Objective
SWOT Analysis
Values Statement
Vision Statement
DISCUSSION QUESTIONS
1. Do you know if your organization has a mission statement and a vision statement? If so,
how are they communicated? Are they printed, posted on a website, or available in some
other format? Please describe.
2. Have you ever been involved in a strategic planning session? If so, please describe
how the group and the session were structured (but without revealing proprietary
information).
3. Have you ever been involved in (or have observed) the process of a situational analysis
(SWOT)? If so, please describe how the group went about performing the analysis (but
again without revealing proprietary information).
NOTES
1. Department of Veterans Affairs (VA), VA Directive 6052 Appendix A (April 23, 2009).
2. Sutter Health, www.sutterhealth.org/about/mission (accessed May 31, 2012).
3. Tenet Health, www.tenethealth.com/about/pages/missionandvalues.aspx (accessed
July 30, 2012).
4. Parkland, www.parklandhospital.com/whoweare/mission_vision.html (accessed
June 7, 2012).
5. Mayo Clinic, www.mayoclinic.org/about/missionvalues.html (accessed July 30, 2012).
6. Regions Hospital, www.regionshospital.com/rh/about/index.html (accessed May 31,
2012).
7. Saint Barnabas Medical Center, www.saintbarnabasfoundation.org/about/mission.html
(accessed July 30, 2012).
8. Texas Oncology, www.texasoncology.com/about-txo/vision-mission-history.aspx
(accessed December 3, 2012).
9. Aetna, www.aetna.com/about-aetna-insurance/aetna-corporate-profile/aetna_mission
_statement (accessed July 30, 2012).
10. AMA Press Release November 26, 2012, www.ama-assn.org (accessed January 16, 2013).
11. American Medical Association, www.ama-assn.org/ana/pub/about-ama/strategic-focus
.page? (accessed October 17, 2012).
12. Ibid.
Notes 297
13. Good Samaritan Society, www.good-sam.com/index.php/about_us/ (accessed July 30,
2012).
14. Ibid.
15. Providence Healthcare Network, http://www.providence.net/about/ (accessed January
16, 2013).
16. Duke Health, www.dukemedicine.org/AboutUs (accessed July 30, 2012).
17. John Hopkins Medicine, www.hopkinsmedicine.org/se/util/display_mod.cfm?
MODULE=/se-server/mod/mod (accessed July 30, 2012).
18. Public Law 103-62. 103 P.L. 62; 107 Stat. 285—Section 3(a), The language of the Act
says “every agency,” but in fact certain Executive agencies were excluded, including the
Central Intelligence Agency, the General Accounting Office, the Panama Canal Commission, the United States Postal Service, and the Postal Rate Commission. [See 103 P.L.
62 Section 3(f).]
19. P.L. 62—Section 3(a) (1), (2), (3), (5).
20. P.L. 62—Section 3(a) (6b).
21. P.L. 111-352 Section 2(b).
22. Ibid. Section 3(b)(1).
23. Ibid. Section 4(b).
24. Ibid. Section 4(g).
25. U.S. Department of Health & Human Services (HHS), HHS Agencies & Offices,
http://www.hhs.gov/about/whatwedo.html (accessed December 4, 2012).
26. U.S. Department of Health & Human Services (HHS), HHS Strategic Plan, http://www
.hhs.gov/secretary/about/introduction.html (accessed May 25, 2012).
27. Administrative Law Review, www.administrativelawreview.org/publicresources/
index.php?option=com_content&view=article&id=21&Itemid=28 (accessed
February 2, 2013).
28. Department of Veterans Affairs, Strategic Plan: Refresh, FY 2011–2015, http://www
.amvets.org/pdfs/legislative_pdfs/2012/VA-Strategic-Plan-Refresh-FY-2011-2015
.pdf (accessed November 21, 2016).
29. Department of Veterans Affairs (VA), “VA Directive 6052, Information Technology Strategic Planning” (April 23, 2009), http://www.itstrategy.oit.va.gov/docs/directive_6052
.pdf, p. 6 (accessed December 4, 2012).
30. M Powered Strategies, www.mpoweredstrategies.com/news/2011/12/one-va-ea-businessreference-model/ (accessed February 2, 2013).
31. Ibid.
32. American Institute of Certified Public Accountants (AICPA), “Financial Forecasts
and Projections” AT Section 301 (c)(d), http://www.aicpa.org/Research/Standards
/AuditAttest/DownloadableDocuments/AT-00301.pdf
33. Ibid. AT Section 301 (d)(f).
298 Chapter 24 Strategic Planning and the Healthcare Financial Manager
© LFor/Shutterstock
The following Sample SWOT Worksheets and their supplemental Question Guides concern
Electronic Health Records (EHR) adoption and implementation. However, the worksheets and
question guides can be readily adapted for other purposes.
INTRODUCTION
Situational analysis explores an organization’s internal operation for strengths and weakness
and observes the organization’s external environment for opportunities and threats. The analysis process is often called “SWOT,” for strengths-weaknesses-opportunities-threats. To be effective, the analysis must be objective and realistic.
Electronic medical records adoption is a good subject for situational analysis. The sample
worksheets in this Appendix provide assistance in commencing such a project.
This Appendix contains four Sample SWOT Worksheets (three internal and one external)
concerning EHR adoption and implementation, along with a Scoring Summary Sheet. A Question Guide is also included for each Worksheet. The Guides are intended to commence the
process of analysis. Other questions may be added to customize the analysis for a particular
process, situation, or department.
SCORING SUMMARY SHEET FOR EHR ADOPTION AND IMPLEMENTATION
Exhibit 24-A–1 collects and summarizes the SWOT analysis scores. Both the internal and
external worksheets are to be scored for each item appearing on that particular worksheet.
The scores range from 1 to 5, as follows: 1 = very good; 2 = good; 3 = fair; 4 = poor; and
5 = very poor. These scores are then summarized and the final net score is entered on the
Exhibit 24-A–1.
THREE INTERNAL WORKSHEETS FOR STRENGTHS AND WEAKNESSES
Three internal worksheets present the results of the SWOT strengths and weaknesses internal analysis. These worksheets represent four important subjects that are relevant to EHR.
The first two worksheets concern staff members involved in some capacity with EHR. The third
worksheet addresses both technology and capital funding. These subjects are, of course, separate
from the staffing issues. Each worksheet is described below.
Sample SWOT
Worksheets and
Question Guides 24-A
APPENDIX
299
INTERNAL WORKSHEET FOR EHR INFORMATION
TECHNOLOGY (IT) STAFF
Exhibit 24-A–2 specifically addresses the information technology staffing. These staff members
are the ones who must make electronic health records implementation work. The responsible
staff are divided into three levels, depending upon the type of work they are expected to perform. The three levels represent “IT operations staff,” who are the most directly involved; the
“hands-on managers,” who manage the operations staff day-to-day; and the “upper-level supervisory IT management,” who manage from afar, but who are responsible for results.
Question Guide for EHR Information Technology Staff
Exhibit 24-A–3 contains 10 questions about IT staff. The questions are to be answered as is
appropriate for the various staff levels described in the preceding paragraph.
1 2 3 4 5
INTERNAL STRENGTHS SCORES
IT Department Staff □ □ □ □ □
Financial, Clinical, and Administrative Staff □ □ □ □ □
EHR Technology □ □ □ □ □
Capital Funding □ □ □ □ □
INTERNAL WEAKNESSES SCORES
IT Department Staff □ □ □ □ □
Financial, Clinical, and Administrative Staff □ □ □ □ □
EHR Technology □ □ □ □ □
Capital Funding □ □ □ □ □
EXTERNAL OPPORTUNITIES SCORES
Government □ □ □ □ □
Economy □ □ □ □ □
Competition □ □ □ □ □
Other Funding Sources □ □ □ □ □
EXTERNAL THREATS SCORES
Government □ □ □ □ □
Economy □ □ □ □ □
Competition □ □ □ □ □
Other Funding Sources □ □ □ □ □
Score 1 to 5 with 1 being very good and 5 being very poor
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Exhibit 24-A–1 SWOT Scoring Summary Sheet for EHR Adoption and Implementation
300 Chapter 24 Strategic Planning and the Healthcare Financial Manager
IT OPERATIONS STAFF (for each type of position listed)
Overall Computer Skills
Strengths ____________________________________________________________________
Weaknesses __________________________________________________________________
Specific EHR Skills
Strengths ____________________________________________________________________
Weaknesses __________________________________________________________________
Staffing Capacity
Strengths ____________________________________________________________________
Weaknesses __________________________________________________________________
HANDS-ON IT MANAGERS
Background and Experience
Strengths ____________________________________________________________________
Weaknesses __________________________________________________________________
EHR Proficiency and Support
Strengths ____________________________________________________________________
Weaknesses __________________________________________________________________
Coverage (Man Hours Available)
Strengths ____________________________________________________________________
Weaknesses __________________________________________________________________
UPPER-LEVEL SUPERVISORY IT MANAGEMENT
Background and Experience
Strengths ____________________________________________________________________
Weaknesses __________________________________________________________________
EHR Proficiency and Support
Strengths ____________________________________________________________________
Weaknesses __________________________________________________________________
Coverage (Man Hours Available)
Strengths ____________________________________________________________________
Weaknesses __________________________________________________________________
Attach sheets to document the additional information used for this analysis.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Exhibit 24-A–2 EHR Internal Operations Analysis: Worksheet for Information
Technology (IT) Department Staff
Internal Worksheet for EHR Information Technology (IT) Staff 301
INTERNAL WORKSHEET FOR OTHER STAFF INVOLVED IN EHR
Exhibit 24-A–4 addresses responsible staff in three other departments of the organization.
These staff members are the ones who must make electronic health records implementation work within their own departments. The responsible staff members in each of these
three departments (financial, clinical, and administrative) are again divided into three levels,
depending upon the type of work they are expected to perform. The three levels represent
“Staff responsible for some aspect of EHR,” who are the most directly involved; the “handson managers,” who are responsible for some aspect of EHR; and the “upper-level supervisory
management,” who manage from afar, but who are responsible for results.
Question Guide for Financial, Clinical, and Administrative Staff
Exhibit 24-A–5 contains 14 questions about relevant staff members within these three departments. This guide and its accompanying worksheet would, of course, be reproduced with as
many copies as would be necessary in order to answer these questions for each department.
INTERNAL WORKSHEET FOR TECHNOLOGY AND CAPITAL FUNDING
Exhibit 24-A–6 addresses two subjects: computer technology and capital funding resources. The
computer technology section concerns hardware, software, space requirements, and vendors.
The section is then divided into two parts: one for overall computer systems and one for specific
EHR computer resources.
Staff questions (Answer the questions about IT staff as appropriate for the various
staff levels: IT operations staff, hands-on IT managers, and upper-level supervisory
IT management.)
□ Possess advanced computer operations concepts?
□ Possess basic computer operations concepts?
□ Understand EHR technical computer applications in depth?
□ Understand basic EHR technical computer applications?
□ Understand the concept of EHR calculations?
□ Cooperate/support multidisciplinary EHR adoption and implementation
efforts?
□ Resist/ignore EHR process and procedures?
□ Sufficient IT staffing for EHR implementation?
□ Sufficient IT staffing for EHR ongoing support?
□ Acceptable productivity for EHR implementation?
Attach sheets to document the additional information used for this analysis.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Exhibit 24-A–3 Question Guide for EHR Internal Operations Analysis: Information Technology (IT) Department Staff
302 Chapter 24 Strategic Planning and the Healthcare Financial Manager
STAFF RESPONSIBLE FOR SOME ASPECT OF EHR
Overall Computer Skills
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Specific EHR Skills
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Staffing Capacity
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
HANDS-ON MANAGERS RESPONSIBLE FOR SOME ASPECT OF EHR
Background and Experience
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
EHR Proficiency and Support
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Coverage (Man Hours Available)
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
UPPER-LEVEL SUPERVISORY MANAGEMENT RESPONSIBLE FOR SOME
ASPECT OF EHR
Background and Experience
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
EHR Proficiency and Support
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Coverage (Man Hours Available)
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Attach sheets to document the additional information used for this analysis.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Exhibit 24-A–4 Worksheet for EHR Internal Operations Analysis: Financial, Clinical, and
Administrative Staff
Internal Worksheet for Technology and Capital Funding 303
The capital funding section of the worksheet addresses both short-term and long-term funding resources. The short-term funding requirement concerns EHR transition cash flow. The
long-term funding requirement concerns what fixed capital may be specified for EHR implementation. Both are important to success.
Question Guide for Technology and Capital Funding Resources
Exhibit 24-A–7 contains eight questions about computer systems and four questions about capital funding resources. Additional customized questions may supplement this initial guide’s
content.
EXTERNAL WORKSHEET FOR OPPORTUNITIES AND THREATS
Exhibit 24-A–8 addresses four external environment subjects, including Government, Economy,
Competition, and Funding Sources Other than Patient Revenue. Other subjects may, of course,
be added as desired.
Staff questions (Answer the questions about staff as appropriate for the various financial, clinical, and administrative staff levels: workers; hands-on managers, and upperlevel supervisory management.)
□ Possess advanced financial management concepts?
□ Possess basic financial management concepts?
□ Possess advanced clinical management concepts?
□ Possess basic clinical management concepts?
□ Understand EHR technical applications in depth from the financial view?
□ Understand basic EHR technical applications from the financial view?
□ Understand EHR technical applications in depth from the clinical view?
□ Understand basic EHR technical applications from the clinical view?
□ Understand the concept of EHR calculations?
□ Cooperate/support multidisciplinary EHR adoption and implementation
efforts?
□ Resist/ignore EHR process and procedures?
□ Sufficient relevant staffing for EHR implementation?
□ Sufficient relevant staffing for EHR ongoing support?
□ Acceptable productivity for EHR implementation?
Attach sheets to document the additional information used for this analysis.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Exhibit 24-A–5 Question Guide for EHR Internal Operations Analysis: Financial, Clinical, and
Administrative Staff
304 Chapter 24 Strategic Planning and the Healthcare Financial Manager
OVERALL COMPUTER SYSTEMS
Hardware and Software
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Space Requirements
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Vendor Contractual Agreements (if applicable)
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Vendor Performance (if applicable)
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
SPECIFIC EHR COMPUTER RESOURCES
Hardware and Software
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Additional Space Requirements (if applicable)
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Vendor Contractual Agreements (if applicable)
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Vendor Performance (if applicable)
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
CAPITAL FUNDING
Short-Term EHR Transition Cash Flow Requirements
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Long-term Fixed Capital Specified for EHR Implementation
Strengths ____________________________________________________________________________
Weaknesses __________________________________________________________________________
Attach sheets to document the additional information used for this analysis.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Exhibit 24-A–6 Worksheet for EHR Internal Operations Analysis: Resources Other than Staff
External Worksheet for Opportunities and Threats 305
Question Guide for EHR External Environment Analysis
Exhibit 24-A–9 contains a total of 22 questions about various components of the external environment. This guide may also be augmented with customized questions that relate to issues
within the specific organization under analysis.
OVERALL COMPUTER SYSTEMS
□ Sufficient equipment (hardware and software) for general operations?
SPECIFIC EHR COMPUTER RESOURCES
□ Sufficient equipment (hardware and software) for EHR implementation?
□ Sufficient equipment (hardware and software) for EHR ongoing support?
□ Equipment operates adequately?
□ Equipment costly to maintain? To operate?
□ If applicable, are vendor contracts costly to maintain (updates, add-ons, etc.)?
□ Does the equipment produce desired results? Timely results?
□ If applicable, does the vendor produce desired results? Timely results?
CAPITAL FUNDING
□ Have the short-term EHR transition cash flow requirements been accurately
projected?
□ Are these cash flow requirements accurately presented in the organization’s budget?
□ Are the long-term fixed capital specified for EHR implementation accurately
projected?
□ Are these long-term fixed capital requirements acknowledged in the strategic plan?
Attach sheets to document the additional information used for this analysis
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Exhibit 24-A–7 Question Guide for EHR Internal Operations Analysis: Resources Other than
Staff
306 Chapter 24 Strategic Planning and the Healthcare Financial Manager
GOVERNMENT (EHR impact for each governmental element listed)
Medicare Program
Opportunities _______________________________________________________________________
Threats _____________________________________________________________________________
Medicaid Program
Opportunities ________________________________________________________________________
Threats ______________________________________________________________________________
Regulations About Electronic Standards (Version 5010 and ongoing versions)
Opportunities ________________________________________________________________________
Threats ______________________________________________________________________________
Other Federal/State Regulations
Opportunities ________________________________________________________________________
Threats ______________________________________________________________________________
ECONOMY (as to continuing need for and impact of EHR)
Opportunities ________________________________________________________________________
Threats ______________________________________________________________________________
COMPETITION (relevant to EHR)
Opportunities ________________________________________________________________________
Threats ______________________________________________________________________________
FUNDING SOURCES OTHER THAN PATIENT REVENUE (impact, if any, on EHR)
Opportunities ________________________________________________________________________
Threats ______________________________________________________________________________
Attach sheets to document the additional information used for this analysis.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Exhibit 24-A–8 Worksheet for EHR External Environment Analysis
External Worksheet for Opportunities and Threats 307
GOVERNMENT (EHR impact for each governmental element listed)
Medicare Program
□ What EHR implementation costs are related to this program initiative?
□ What revenues from EHR governmental sources are related to this program initiative?
□ What savings in work flow or processes are related to adopting EHR?
□ Additional changes to the EHR Medicare Initiative are scheduled to occur at various
points in the future. How will these initiative changes impact the organization?
Medicaid Program
□ What EHR implementation costs are related to this program initiative?
□ What revenues from EHR governmental sources are related to this program
initiative?
□ What savings in work flow or processes are related to adopting EHR?
□ Additional changes to the EHR Medicaid Initiative are scheduled to occur at various
points in the future. How will these initiative changes impact the organization?
Regulations About Electronic Standards (Version 5010 and ongoing versions)
□ What EHR implementation costs are related to these requirements?
□ What savings in work flow or processes are related to adopting these standards?
□ Additional changes to the regulatory electronic standards are scheduled to occur at various points in the future. How will these initiative changes impact the organization?
Other Federal/State Regulations
□ What other federal and/or state regulations affect EHR implementation?
□ How do these regulations impact the organization?
ECONOMY (as to continuing need for and impact of EHR)
□ Will EHR affect continuing need for medical services? If so, how?
□ What impact is EHR implementation projected to have on the medical services economy nationally? Regionally?
COMPETITION (relevant to EHR)
□ What are your three biggest competitors?
□ How do the services they provide compare to your services?
□ What do you predict the impact of EHR adoption will be on each?
□ How have they prepared for EHR initial implementation?
□ How does their preparation and impact affect your own organization?
OTHER FUNDING SOURCES (impact, if any, on EHR)
□ Does your organization have such funding sources?
□ If so, what impact, if any, will EHR adoption have on such sources?
Attach sheets to document the additional information used for this analysis.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Exhibit 24-A–9 Question Guide for EHR External Environment Analysis
308 Chapter 24 Strategic Planning and the Healthcare Financial Manager
Progress Notes
© LFor/Shutterstock
Putting It All Together: Creating a Business
Plan That Is Strategic
OVERVIEW
A business plan is a document typically prepared in order
to obtain funding and/or financing. A traditional business
plan typically contains information about three major elements: the proposed project’s organization, marketing, and
financial aspects. However, the actual business plan is generally constructed in a series of segments, each involving a
particular type of information. The overall business plan is
built up as these individual segments are completed. The
segments are described in this chapter.
ELEMENTS OF THE BUSINESS PLAN
A traditional business plan typically contains three major
elements:
• Organization plan
• Marketing plan
• Financial plan
The organization segment should describe the management team. The marketing segment should discuss who
may use the service and/or product. The financial segment
should contain the numbers that illustrate how the project
is expected to operate over an initial period of time. We
believe that it is also important to begin the business plan
with an executive summary that outlines key points, plus a
clear and concise description of the service and/or product
that is the subject of the plan.
After completing this chapter,
you should be able to
1. Understand the construction
of a business plan.
2. Describe the organization
segment of a business plan.
3. Describe the marketing
segment of a business plan.
4. Describe the financial segment of a business plan.
309
25
CHAPTER
PREPARING TO CONSTRUCT THE BUSINESS PLAN
The planning stage will shape a business plan’s content. The initial decisions, such as those
shown in Exhibit 25–1, will determine your approach to the plan. For example, if your
organization requires a certain type of format and preexisting blank spreadsheets, many of
the initial decisions have already been made for you. Otherwise, the checklist contained in
Exhibit 25–1 will assist you in making initial decisions for the business plan’s approach.
It is important to note that the level of sophistication for the overall plan should be based on
the decision makers who will be the primary audience. Another practical consideration involves
creating a grid or matrix to assist in gathering all necessary information. The grid or matrix
could also include which individuals are responsible for helping to create or collect the required
information. Finally, it is important to create a file at the beginning of the project in which all
computations, backup information, dates, and sources are kept together in an organized fashion.
THE SERVICE OR EQUIPMENT
DESCRIPTION
The service and/or equipment description
should do a good job of describing what the
heart of the business plan is about. If the business plan is for a project or a new service line,
then this description would expand to include
the entire project or the overall service line.
Information that should always be included in
the description is contained in Exhibit 25–2.
The test of a good description is whether
an individual who has never been involved in
your planning can read the description and
understand it without additional questions
being raised.
THE ORGANIZATION SEGMENT
The organization segment should describe the
management team. But it should also describe
how the proposed service or equipment fits
into the organization. Who will be charged
with the new budget? Who will be responsible
for the controls and reporting for this proposal? It is important to provide a clear picture
that informs decision makers about how the
proposed acquisition will be managed. Basic
facts to explain are included in Exhibit 25–3.
Visual depictions of the chain of authority
and supervisory responsibilities provide helpful illustrations for this segment.
Exhibit 25–2 Basic Information for the
Service or Equipment Description
Service or Equipment Description
• What the service specifically
provides
• Why this service is different and/or
special
• What the equipment specifically
does
• Why this equipment is different
and/or special
• Required training, if applicable
• Regulatory requirements and/or
impact, if any
Courtesy of J.J. Baker and R.W. Baker, Dallas,
Texas.
Exhibit 25–1 Initial Decisions for the
Business Plan
Business Plan Initial Decisions
• Outline necessary format
• Decide on length
• Decide on level of sophistication
• Determine what information is
needed
• Determine who will provide each
piece of information
Courtesy of J.J. Baker and R.W. Baker, Dallas,
Texas.
310 Chapter 25 Putting It All Together: Creating a Business Plan
THE MARKETING SEGMENT
The marketing segment should describe the
available market, that portion of the market
your service or equipment should attract,
and that portion of the market occupied
by the competition. This segment should
achieve a balance between describing those
individuals who will be availing themselves of
the service or equipment and a description of
the competition. A description of who will be
responsible for the marketing is also valuable
information for the decision makers. Strive
for a realistic and objective appraisal of the
situation. Basic facts to include are illustrated
in Exhibit 25–4.
Of all areas of the business plan, the marketing segment is most likely to be overoptimistic in its assumptions. It is wise to be
conservative about estimations of physician
and patient acceptance and usage. And it is
equally wise to be realistic when assessing the
competition and its likely impact.
THE FINANCIAL ANALYSIS SEGMENT
The financial segment should contain the
numbers that illustrate how the project is
expected to operate over an initial period of
time. Financial plans may range from a projected period of 1 year to as much as 10 years.
A 1-year projection is often too short to show
true outcomes, whereas a 10-year projection
may be too long to meaningfully forecast.
Your organization will usually have a standard
length of time that is accepted for these projections. The standard forecasted periods for
high-tech equipment, for example, often range from 3 to 5 years. Why? Because advances in
technology may render them obsolete in 5 years or less. Therefore, the forecast is set for a realistically short time period.
The financial analysis for a business plan should contain a forecast of operations.
The forecast may be simple, such as a cash flow statement, or it may be more extensive.
A more extensive forecast would also require a balance sheet and an income statement.
The required statements and schedules will depend on two factors: the size and complexity
of the project and the usual procedure for a business plan presentation that is expected in
your organization.
Exhibit 25–3 Basic Information for the
Organization Segment
Organization Segment Information
• Physical location where service will
be provided
• Physical location of the equipment
• The department responsible for the
budget
• The division responsible for
operations
• The directly responsible supervisor
• Composition of the overall management team
Courtesy of J.J. Baker and R.W. Baker,
Dallas, Texas.
Exhibit 25–4 Basic Information for the
Marketing Segment
Marketing Segment Information
• Physicians who will use the service
or equipment
• New patients who will use the
service or equipment
• Established patients who will use the
service or equipment
• Estimated portion of the market to
be captured
• Competition and its impact
Courtesy of J.J. Baker and R.W. Baker, Dallas,
Texas.
The Financial Analysis Segment 311
The Projected Cash Flow Statement
As we have just stated, it is possible that the forecast of operations may simply consist of the cash
flow statement. In any case, the statement can be complex, with many detailed line items, or
it can be condensed. The condensed type of statement is most often found in a business plan.
Keep in mind, however, that a detailed worksheet—the source of the information on the condensed statement—may well be filed in the supporting work papers for the project. Necessary
cash flow assumptions are illustrated in Exhibit 25–5.
The Projected Income Statement
What income statement assumptions will your
business plan’s financial analysis require? The
basic assumptions for a healthcare project’s
income statement are illustrated in Exhibit 25–6.
The “revenue type” in Exhibit 25–6 refers to
whether, for example, the revenue is derived
entirely from services or whether part of the
revenue is derived from drugs and devices.
The “revenue sources” refers to how many
payers will pay for the service and/or drug
and device, and in what proportion (such
as Medicare 60%, Medicaid 15%, and commercial payers 25%). The “revenue amount”
refers to how much each payer is expected to
pay for the service and/or drug and device. The total amount of revenue can then be determined by multiplying each payer’s expected payment rate times the percentage of the total
represented by that payer.
In regard to the “expenses” in Exhibit 25–6,
the labor cost will usually be determined
by staffing assumptions. The required staffing should be set out by type of employee
and the pay rate for each type of employee.
The number of full-time equivalents (FTEs)
for each type of employee will then be
established. The FTEs will be multiplied times
the assumed pay rate to arrive at the labor cost
assumption.
“Supplies” refers to the necessary supplies required to perform the procedure or
service. “Cost of drug or device” refers to the
cost to the organization of purchasing the
drug or device (if a drug or device is necessary to the service). The labor, supplies, and
cost of drug or device are costs that can be
directly attributed to the service that is the
Exhibit 25–6 Basic Assumptions for Business
Plan Income Statement Projections
Income Statement Assumptions
• Revenue type
• Revenue source(s)
• Revenue amount
• Expenses:
• Labor
• Supplies
• Cost of drug or device
(if applicable)
• Equipment
• Space occupancy
• Overhead
Courtesy of J.J. Baker and R.W. Baker, Dallas,
Texas.
Exhibit 25–5 Basic Assumptions for Business
Plan Cash Flow Statement Projections
Cash Flow Statement Assumptions
• Number of years in the future to
forecast
• Capital asset purchase or lease
information
• Capital asset salvage value (if any)
• Cash inflow
• Cash outflow
• Cost of capital (if applicable)
Courtesy of J.J. Baker and R.W. Baker, Dallas,
Texas.
312 Chapter 25 Putting It All Together: Creating a Business Plan
subject of the business plan. Likewise, the “equipment” cost refers to the annual depreciation
expense of any equipment that is directly attributed to the service that is the subject of the
business plan.
“Space occupancy” refers to the overall cost of occupying the space required for the service
or procedure. “Space occupancy” is a catchall phrase. It includes either annual depreciation
expense (if the building is owned) or annual rent expense (if the building is leased) of the
square footage required for the service. Space occupancy also includes other related costs such
as utilities, maintenance, housekeeping, and insurance. Security might also be included in this
category. The actual forecast might group these expense items into one line item, or the forecast might show each individual expense (depreciation, housekeeping, etc.) on a separate line.
If the expenses are grouped, a footnote or a supplemental schedule should show the actual
detail that makes up the total amount.
“Overhead” refers to the remaining expenses of operation that are necessary to produce
the service but that are not directly attributable to that service. Examples of such overhead in a
physician’s office might include items such as postage and copy paper. This amount of indirect
overhead may be expressed as a percentage; for example, “overhead equals 10%.” Whether the
“space occupancy” example or the “overhead” example discussed previously here are grouped
or detailed in the forecast will probably depend on how large the amount is in relation to the
other expenses, or it might depend instead on the usual format that your organization expects
to see in a typical business plan that is presented to management.
The Projected Balance Sheet
What balance sheet assumptions will your business plan’s financial analysis require? The basic
assumptions for a healthcare project’s balance sheet are illustrated in Exhibit 25–7.
The elements of a balance sheet (assets, liabilities, and equity) are described in a previous
chapter. If a full projected set of statements is required for the business plan, the balance sheet
entries will in large part be a function of the income statement projections discussed in the
preceding section of this chapter. For example, accounts receivable would be primarily determined by the revenue assumptions, while accounts payable would be primarily determined
by the expense assumptions. Likewise, acquisition of equipment or other capital assets
will affect capital assets (property and equipment), while their funding assumptions will
affect either or both liability and equity totals
on the projected balance sheet.
THE “KNOWLEDGEABLE READER”
APPROACH TO YOUR BUSINESS
PLAN
We believe a good business plan should
answer the questions that occur to a knowledgeable reader. Thus, the information you
include in the business plan should reflect
Exhibit 25–7 Basic Assumptions for Business
Plan Balance Sheet Projections
Balance Sheet Assumptions
• Cash
• Accounts Receivable
• Inventories
• Property and Equipment
• Accounts Payable
• Accrued Current Liabilities
• Long-Term Liabilities
• Equity
Courtesy of J.J. Baker and R.W. Baker, Dallas,
Texas.
The “Knowledgeable Reader” Approach to Your Business Plan 313
the choices that you made in selecting the
assumptions for your financial analysis. For
instance, an example of considerations for
forecasting an equipment acquisition is presented in Exhibit 25–8. The content of the
final business plan should touch upon these
points in describing your assumptions that
underlie the financial analysis.
THE EXECUTIVE SUMMARY
The executive summary should contain a wellwritten and concise summary of the entire
plan. It should not be longer than two pages;
many decision makers consider one page
desirable. Some people like to write the executive summary first. They tend to use it as an
outline to guide the rest of the content. Other
people like to write the executive summary
last, when they know what all the detailed content contains. In either instance, the executive
summary should tell the entire story in a compelling manner.
ASSEMBLING THE BUSINESS PLAN
The business plan should be assembled into
a suitable report format that is determined by
many of your initial decisions, such as length
and level of sophistication. A sample format
appears in Exhibit 25–9.
If an appendix is desired, it should contain detail to support certain contents in the
main part of the business plan. In preparing
the final report, certain other logistics are
important. It is expected, for example, that
the pages should be numbered. (You might
also want to add the date in the footer and
perhaps a version number as well.) Although
the report may or may not be bound, it should
have all pages firmly secured.
PRESENTING THE BUSINESS PLAN
You may be asked to present more than once.
Sometimes you will have to prepare a short
Exhibit 25–8 Considerations for Forecasting
Equipment Acquisition
Considerations for Forecasting Equipment Acquisition
• Only one location?
• Equipment single purpose or multipurpose?
• Technology: new, middle-aged, old
(obsolete vs. untested)?
• Equipment compatibility?
• Medical supply cost?
• High or low capital investment?
• Buy new or used (refurbished)?
• Buy or lease?
• Lease for number of years or lease
on a pay-per-procedure deal?
• How much staff training is required?
• Certification required?
• Square footage required for
equipment?
• Is the required square footage
available?
• Cleaning methods and equipment
(and staff level required)?
• Repairs and maintenance expense
(high, medium, low)?
Courtesy of J.J. Baker and R.W. Baker, Dallas,
Texas.
Exhibit 25–9 Sample Format for a
Business Plan
A Sample Business Plan Format
• Title Page
• Table of Contents
• Executive Summary
• Service and/or Equipment
Description
• The Organizational Plan
• The Marketing Plan
• The Financial Plan
• Appendix (optional)
Courtesy of J.J. Baker and R.W. Baker, Dallas,
Texas.
314 Chapter 25 Putting It All Together: Creating a Business Plan
form and a long form of the plan, depending on the audience. Tips on presenting your
business plan are presented in Exhibit 25–10.
It is especially important to practice your
presentation in advance. When you leave time
for questions and for discussion, you also want
to be well prepared for anticipated questions.
By constructing a well-thought-out business
plan, you have substantially increased your
chances for a successful outcome.
STRATEGIC ASPECTS OF YOUR
BUSINESS PLAN
Your business plan must fit into your organization’s strategic plan. To begin to do so, you
might answer the following questions:
• How does my business plan fit into
the overall strategic plan (the “master
plan”) for my organization?
• How does my business plan specifically
fit into my department or division’s segment of the organization’s overall strategic plan/master plan?
• Does the proposed timing of my business plan coincide with the strategic plan’s time
frames?
• Does the proposed funding of my business plan fit into available funding resources mentioned in the strategic plan?
• What competition will my business plan face, strategically speaking, within my organization? Does my plan provide a good defense against this competition?
• Are there external competition and/or legislative aspects mentioned in my business
plan that are also addressed within the strategic plan? If so, does my plan’s treatment of
these external aspects coordinate with that of the strategic plan? If not, have I explained
why not?
The previous chapter explored Strategic Planning in some depth. Other aspects contained
in that chapter may also be applicable to your business plan.
INFORMATION CHECKPOINT
What is needed? A sample of a business plan.
Where is it found? Probably with your manager or the departmental director.
How is it used? Study the way the business plan was distributed. Who received
it? What did they do with it? What was the result?
Exhibit 25–10 Tips on Presentation of the
Business Plan
Tips on Presenting Your Business Plan
• Determine who will be attending
ahead of time
• Determine how long you will have
for the presentation
• Be sure you have a copy for each
attendee
• Decide upon whether to use audio/
visual aids
• LCD projector and PowerPoint
slides?
• Flip chart and markers?
• Other methods?
• Practice your presentation in
advance
• Leave time for questions and for
discussion
Courtesy of J.J. Baker and R.W. Baker, Dallas,
Texas.
Information Checkpoint 315
KEY TERMS
Business Plan
Overhead
Revenue Amount
Revenue Sources
Revenue Type
Space Occupancy
Supplies
DISCUSSION QUESTIONS
1. Have you ever been involved in the creation of a business plan?
2. If so, did the plan include all three segments (organizational, marketing, and finance)? If
not, why do you think one or more of the segments was missing?
3. Have you ever attended the formal presentation of a business plan? If so, was it successful
in obtaining the desired funding?
4. Was the plan that was presented similar to what we have described in this chapter? What
would you have changed in the presentation? Why?
316 Chapter 25 Putting It All Together: Creating a Business Plan
Progress Notes
© LFor/Shutterstock
Understanding Strategic Relationships:
Health Delivery Systems, Finance, and Reimbursement
INTRODUCTION
We begin this chapter by defining three areas: health delivery systems, finance, and reimbursement. We include these
definitions in order to illustrate where finance and reimbursement fit into the overall system. We will then describe
the various strategic relationships that are involved.
By its very nature, the complexion and purpose of a
health delivery system cannot be considered separately
from the range of values and issues surrounding finance
and reimbursement, including the magnitude of government involvement. Healthcare finance is the linchpin of
the United States healthcare delivery system. While there
are some similarities to corporate finance (i.e., budgeting;
financial planning), there are major differences.
DEFINING HEALTH DELIVERY SYSTEMS
This section defines the health delivery system before
observing its strategic relationships within an overall system.
What Is a Health Delivery System?
A health delivery system typically contains different levels
of patient care and different sites of service, all operating
under one integrated system for the delivery of health care.
A more formal definition is as follows:
A delivery system which “provides or aims to
provide a coordinated continuum of services
to a defined population and are willing to be
held clinically and fiscally accountable for the
outcomes and the health status of the population served.”1
After completing this chapter,
you should be able to
1. Define health delivery
systems.
2. Define the area of healthcare
finance.
3. Understand the strategic
relationship between
healthcare delivery systems
and finance.
4. Understand the strategic
relationship between finance
and reimbursement.
5. Recognize the strategic
relationship between
third-party reimbursement
and government expenditures.
6. Recognize a new focus on
the relationship between
finance and healthcare
delivery.
317
26
CHAPTER
A successful health system that functions properly needs the six following elements:
• Trained health workers who are motivated
• A well-managed infrastructure
• A reliable supply of medicines and technologies
• Adequate funding
• Evidence-based policies
• Strong health plans, including strong updated strategic plans2
Who Are the Stakeholders in Health Delivery Systems?
Stakeholders in health delivery systems can be divided into two categories: internal and external. The internal stakeholders consist of those delivering care (clinicians), those who support
the care deliverers (administrators), and those receiving care (the patients).
External stakeholders are varied and numerous. Their motivations may vary, but their interests still center upon the delivery of care within the internal system. Figure 26–1 illustrates 12
different types of external stakeholders. They include the following:
• Insurance providers
• Government providers
• Government policy makers
• Government overseers
• The pharmaceutical industry
• The medical device industry
• Other health industry suppliers
• Professional organizations
• Educators
Figure 26–1 Stakeholders in Health Delivery Systems. Government Providers
Professional
Organizations
Government
Overseers
Insurance
Providers
Pharmaceutical
Industry
Other Health
Industry Suppliers
Consumers
Government
Policy Makers
Caregivers
Investors
Educators
Medical Device
Industry
Internal Healthcare
Delivery: Clinicians,
Administrators &
Patients
318 Chapter 26 Understanding Strategic Relationships
• Investors
• Caregivers
• Consumers
Insurance company providers include such organizations as Aetna, United Health, etc. Government providers include federal agencies such as Medicare, Medicaid, and TRICARE, along
with state agencies. Government policy makers include Congress and many supporting federal agencies such as the Office of Management and Budget (OMB), while individual states
also determine relevant health policy. Other government agencies oversee various elements
of our public health; they include the Centers for Disease Control and Prevention (CDC), the
National Institute of Health (NIH), and various others.
Health care is a huge industry in the United States. Figure 26–1 highlights three types of
industry: pharmaceutical, medical device, and all other health industry suppliers. The “all
other” includes both services and supplies, as varied as computer services to food and cleaning
supplies.
Numerous professional organizations provide support for both clinicians and administrators; examples include the American Hospital Association (AHA) and the American Medical
Association (AMA), though there are many more and they play an important supporting role.
Academia is a stakeholder for its educational role in both medical schools and business schools.
Investors play an important stakeholder role, as they provide funding. Caregivers have a personal interest in the health delivery system. And consumers are stakeholders because they are
impacted by rising costs of the healthcare industry as a whole.
DEFINING THE AREA OF HEALTHCARE FINANCE
This section defines the area of healthcare finance within the overall system.
What Are the Responsibilities Associated with Finance?
There are four major responsibilities typically associated with healthcare finance. They include:
• Planning
• Controlling
• Organizing and directing
• Decision making3
One of our colleagues, a nurse, talks about the area of healthcare finance as “a method of getting money in and out of the business.” It is not a bad description, because the Finance Department
is primarily responsible for achieving the most beneficial financial outcome for the organization.
What Are the Duties Associated with Finance?
The duties associated with healthcare finance revolve around the successful management of
planning, controlling, organizing and directing, and decision making. Specific duties for a
financial officer will depend upon the type of organizational structure where he or she works.
For example, is the organization large and consolidated, with a head office? If so, some (or
all) of the planning and decision making around planning will probably be handled in the
Defining the Area of Healthcare Finance 319
head office. The onsite financial officer’s duties will then center mostly upon operational matters such as controlling and organizing and directing. Such a large organization may have a
treasurer in addition to a chief financial officer. Or is the organization smaller, without a head
office? If so,the financial officer may have to direct all financial matters. He or she would have to
direct planning and related decision making in addition to the day-to-day operational matters.
The individual performing these duties may have one of several different job titles. A description of three such titles follows.
Chief Financial Officer: Responsible for operations (administrative, financial, and risk management), including both financial and operational strategies; determining the metrics that
are related to the strategies; and developing and monitoring internal control systems.4
Controller: Responsible for the organization’s accounting functions; includes producing accurate financial reports that adhere to appropriate standards, maintaining the accounting
system, and overseeing controls and budgets.5
Treasurer: Responsible for a higher level of the organization’s financial activities, mainly
centering upon financial liquidity, investments, and risk management.6
DEFINING THE AREA OF HEALTHCARE REIMBURSEMENT
This section defines the area of healthcare reimbursement within the overall system. The term
“reimbursement” basically means a method of paying (reimbursing) a healthcare provider for
services or procedures provided. Payment is made upon receipt of a claim (bill) from the service provider. This claim typically contains codes for specific procedures and services that tie to
relevant payment amounts. Payment of the claim may be made by a third-party payer or by the
patient directly.7
What Are the Responsibilities Associated with Reimbursement?
Simply put, there are three major responsibilities associated with reimbursement:
• Prepare correct and complete claims
• Get these claims to the correct payer(s) in a timely manner
• Collect the proper payment that is due in a timely manner
In addition, the reimbursement personnel are responsible for carrying out any directives
received from the Finance Department, including those of strategic planning.
What Are the Duties Associated with Reimbursement?
Reimbursement duties within the system may be split up into different positions. For example,
the following job titles may typically be responsible for these duties. (Note: other job titles also
exist that describe these same duties.)
• Data entry clerk: Enters codes and insurance information
• Medical coder: Enters service and procedure codes onto a claim
• Medical biller: Verifies the patient’s insurance coverage; prepares the bill (claim form);
reviews unpaid claims and/or appeals those that are denied
320 Chapter 26 Understanding Strategic Relationships
• Billing supervisor or coordinator: Oversees scheduling, monitoring, and training of
personnel
• Medical claims specialist or examiner: Reviews samples of claims for accuracy; documents
information for legal actions; provides legal support when required (this position functions outside the regular day-to-day operations and may work directly from the Finance
Department)
Other reimbursement duties involve management of monies received (or not received).
Incoming payments of claims must be reconciled and matched to the organization’s records of
billings. And nonpayments (past-due bills) must have collection efforts made. These payment
duties are typically handled by different personnel.
It is also possible that the billing and collection duties may be performed by an outside contractor. One specialist physician that we know uses such an outside contractor.
Both medical information and billing information can now be generated in real time. For
example, the doctor may have a data entry person right in the exam room with him. (Sometimes this is a nurse who has many other duties as well, but other doctors may use a “scribe”
whose only job is the data entry.) The doctor dictates medical notes as he performs his examination and the assistant enters the information into the computer. At the end of the visit, he
refers to his super bill.(The super bill is a customized form that contains procedure and diagnosis codes specific to a particular practice and/or specialty. A super bill allows information to
be recorded quickly and efficiently). He calls off the codes to be billed for this examination,
including any lab work ordered, etc. The data entry assistant also enters this coding information
into the computer. The billing codes are then transmitted electronically, either to the internal
billing department or to the outside billing service. And if transmitted externally, the outside
billing service is then typically responsible for all billing and collection—for a fee, of course.
While the above encapsulates the essence of healthcare reimbursement, two caveats are
worth mentioning. When healthcare reimbursement involves a third party, consumers may be
largely unconcerned with the costs of their care, knowing that their bills are paid by another
party. Moreover, third-party transactions may also remove providers from concerns about the
cost of care, as they may not need to confront a patient covered by insurance with the actual
charges, no matter how high. One may assume that these third-party concerns should be mitigated by the further implementation of value-based purchasing.
STRATEGIC RELATIONSHIP BETWEEN THE HEALTHCARE DELIVERY
SYSTEM AND FINANCE
This section discusses strategic relationships and their impacts across the system.
Relationship Cause-and-Effect: An Example
This relationship can be described as a circular cause-and-effect. That is, finance department
actions often affect the overall delivery system, and the overall delivery system in turn often
affects the finance department. We illustrate this cause-and-effect with an example. In this
example, particular elements of the overall delivery system will affect the strategic positioning
of the finance department.
Value-based programs are an important current trend in payment for U.S. healthcare services. Briefly, the programs rely upon digitally recorded performance measures, including
Strategic Relationship Between the Healthcare Delivery System and Finance 321
certain quality measures, to reflect value provided by the system. That value is then basically
rewarded by a bonus payment or penalized by a negative payment.
It follows, then, that accurate and timely recording of such quality measures will ultimately affect
total payments, which will affect the finance department’s financial strategic planning. But the
finance department has no control over how (or when) these measures are recorded. They happen
elsewhere within the system. This strategic relationship is illustrated step-by-step in Figure 26–2.
Note that the information generated in this example is used both internally and externally.
Steps are as follows:
Step 1: A medical service is performed by a clinician. This professional is assigned to a
medical department somewhere within the system.
Step 2: The data generated from this service is recorded within an electronic health record
(EHR). It includes the service itself plus specific quality information (quality measures).
Step 3.1: The data is reported in two parts. First, the medical service portion is transmitted to the Reimbursement Division, who then bills the third-party payer.
Figure 26–2 The Strategic Relationship of Value-Based Programs, Quality Measures, Finance, and
Reimbursement.
To Reimbursement Division
who bills the third-party payer
To third-party payer
From third-party payer
Of the Finance Department
By the Finance Department &
the Reimbursement Division
Medical Services Data
Quality Measures
For Value & Performance
As shown by data analytics
Data Analyzed
Data Reported
Outcome of Analysis
Becomes Actionable
Results in Pay for
Performance
(with Bonus/Penalty)
Payment Impacts Revenues,
Budgets, & Forecasts
Affects Strategic Positioning
By clinician assigned to a
medical department Medical Service Performed
Data Generated From service performed
Data Recorded By digital means to an EHR
322 Chapter 26 Understanding Strategic Relationships
Step 3.2: In the second part of this step, the quality measures portion of the data is
transmitted to the third-party payer, who accumulates it for future analysis.
Step 4: At a future point in time, the third-party payer analyzes the accumulated quality
measure data.
Step 5: The outcome of this analysis becomes actionable by the payer, as shown by the
data analytics.
Step 6: The resulting action is a pay-for-performance bonus or penalty from the
third-party payer.
Step 7: This payment result impacts the finance department’s revenues, budgets, and
forecasts.
Step 8: The resulting financial impact affects strategic positioning by the finance
department.
The resulting financial impact also, of course, impacts the financial position of the overall
system. Thus, the strategic relationship of the entire system versus the finance department is
cause-and-effect. Accurate reporting of good quality measures by an entirely separate department trickles down to affect dollars received (or not received), which in turn affects both the
finance department and the entire system.
Strategic Analysis Relationships Within the System
The previous example illustrated a relationship that resulted in payment impacts from a payer
outside the health delivery system itself. However, the same data can and should be analyzed for
internal strategic uses. Figure 26–3 illustrates this type of analysis as follows:
a. The medical service data is generated and recorded via EHRs, using software installed by
the organization.
b. The accumulated data is analyzed for value-based purposes. This analysis may be performed internally by the IT department or by an outside contractor.
c. The outcome of such analysis, as shown by data analytics, becomes actionable. This is an
internal analysis, generated for internal use.
d. The strategic action plan is then revised. Revisions are undertaken by the personnel who
are responsible for strategic planning within the system.
e. Strategic positioning results from plan revisions.
Such analysis highlights strategic relationships between and among the various departments
within the system. While the positioning in this example may be most likely to affect the Finance
Department and its Reimbursement Division, as shown, that might not always be the case. The
result of the internal strategic analysis may reveal faults in the process and workflow at the
clinical level. Strategic relationships should then be activated to remedy the faults, wherever
they may lie.
THE STRATEGIC RELATIONSHIP BETWEEN FINANCE AND
REIMBURSEMENT
At first glance, the strategic relationship between finance and reimbursement seems like a oneway street. That is, finance personnel provide the lead in strategy and reimbursement personnel
must follow.
The Strategic Relationship Between Finance and Reimbursement 323
However, what happens if the reimbursement division fails in its responsibilities? Answer:
Cash flow for the organization is reduced. (And, in some cases, the reduction in cash flow
can be significant.) In this case, finance must react to the reimbursement situation instead of
providing the lead. Finance personnel will have to find funding to make up the cash shortfall.
Strategic planning must be revised while remedial action is taken.
Inasmuch as the Chief Financial Officer (or Vice President of Finance in a larger organization) is responsible for all finance activities within the organization, it is incumbent upon that
person to raise the necessary funds and to ensure that those funds are effectively used. Specific applications may include the acquisition of capital, cash and debt management, and lease
financing among strategic alternatives.
It is worth noting that some things are beyond the organization’s control. A case-in-point
is the Centers for Medicare and Medicaid Services’ (CMS’s) Readmission Reduction Program. Penalties are levied against hospitals for excessive readmissions within 30 days of
discharge.8
Figure 26–3 Internal Strategic Analysis for Value-Based Programs.
Affects Strategic
Positioning
By The Finance
Department &
The Reimbursement
Division
Overall
Medical Service
Data Generated
& Recorded
Via EHRs and
software installed by
the organization
Data Analyzed
For
Value-Based Purposes
By ITT department or
outside contractor
Outcome of Analysis
Becomes Actionable
For Internal Use
As shown by data
analytics
Strategic Action Plan
Is
Revised
By the personnel
responsible for
strategic planning
324 Chapter 26 Understanding Strategic Relationships
THIRD-PARTY REIMBURSEMENT AND GOVERNMENT EXPENDITURES:
ANOTHER STRATEGIC RELATIONSHIP
This section discusses third-party reimbursement and government expenditure relationships.
Reliance on Third-Party Reimbursement
Reliance on third-party reimbursement sets healthcare finance apart from its corporate brethren. It plays the dominant role in the configuration of finance flow in the healthcare industry.
Without third-party reimbursement, inclusive of private insurance carriers, healthcare finance
and the delivery system that it supports would take on a very different complexion, one that
would not be sustainable.
Reimbursement Methods Have Evolved
Historically, different methods of reimbursement have had attendant risks and incentives associated with them. They have gone through an evolution of sorts, beginning with the retrospective cost-based or cost-plus method, moving on to charge-based methods (using negotiated rates
that sometimes reflect discounts), and evolving into the prospective payment system that pays
a predetermined, fixed amount.9 (The retrospective system pays after the service is provided,
while the prospective payment system pays before the service is provided.) These three types of
reimbursement mechanisms are indicative of a fee-for-service framework.
Two additional types of reimbursement that are relevant to the interplay between health
delivery systems and finance are capitation and pay-for-performance (P4P). In the former, the
provider is typically paid a fixed per-member-per-month payment for each covered participant.
This payment is to cover all medical services that have been contracted for the period.10 In P4P,
providers receive payment incentives when they meet specific performance measures that show
they are delivering high-quality, efficient care. Thus, pay-for-performance is also referred to as
value-based purchasing (VBP), in that it “…connects reimbursement to the quality of patient
care rather than just the quantity of services received.”11
Government Support in Healthcare Spending
The magnitude of government support, of which third-party reimbursement is a central feature, is illustrated by the following data. Healthcare spending in the United States grew 5.3% in
2014, reaching $3 trillion or $9,523 per person. As a share of the nation’s Gross Domestic Product (GDP), health spending accounted for 17.5%, up from 17.3% in 2013.12 See Figure 26–4 for
a visual representation of these data.
The CMS predicts annual healthcare costs will be $4.64 trillion by 2020, which would be
nearly 20% of the U.S. GDP. Moreover, Medicare’s major role in the health delivery system is
illustrated by its accounting for 20% of total health spending in 2014, the majority of which
was spent on hospital care (27%) and physician services (23%).13 In fiscal year 2014, Medicaid accounted for 16% of national health expenditures, comprised of acute care (68.2%),
long-term care (28.1%), and Disproportionate Share Hospital (DSH) payments (3.7%).14
Figure 26–5 illustrates these health-spending percentages.
Third-Party Reimbursement and Government Expenditures: Another Strategic Relationship 325
In the latter context, federal law requires that state Medicaid programs make DSH payments to qualifying hospitals that serve a larger number of Medicaid and uninsured individuals. Although there has been a noticeable slowing in the rate of increase in annual healthcare
expenditures, the largest spending increase in 2014 was registered for prescription drugs
(12.2%, compared to 2.4% growth in 2013).15
Figure 26–5 Medicare and Medicaid Spending for Fiscal Year 2014.
Data from CMS. NHE 2014 Highlights.
4%
28%
68%
Medicaid Spending
Physician
Services
23%
Hospital
Care
27%
All other
services
50%
Medicare Spending
Disproportionate Share Hospitals
Long-Term Care
Acute Care
Medicaid
16%
Medicare
20% All other
payors
64%
Figure 26–4 Total U.S. Healthcare Spending for Fiscal Year 2014.
Data from CMS. NHE Fact Sheet (12-03-15).
326 Chapter 26 Understanding Strategic Relationships
A NEW FOCUS ON THE RELATIONSHIP BETWEEN FINANCE AND
HEALTHCARE DELIVERY
This section describes a new relationship focus.
Trending Forward Toward the Future
Medicare and Medicaid just turned 50. No statutes have had more of an impact on American
health care and well-being. That said, it should be noted that the Affordable Care Act, signed
into law in March 2010, created new areas of focus between the relationship of finance to delivery. It is the largest change in healthcare financing and accessibility to health care since 1965.
CMS unveiled its Accountable Care Organization (ACO) program in 2012. The ACO model
stresses primary care coordination, primarily for the chronically ill, and beneficiary engagement opportunities, as well as advancing the managed care concept by rewarding providers for
measurably improving care quality and efficiency rather than simply for saving money.16 The
groups of providers who are integral to ACOs come together voluntarily. Recent revisions are
designed to test whether stronger incentives can improve outcomes and cut costs for Medicare
beneficiaries. As of July 2015, there were over 750 ACOs.17
The New Finance–Delivery Link Is a Challenge
As such, this new focus on the finance–delivery link reflects the ongoing challenge for healthcare leaders to integrate clinical and business data. It’s the shift to value-based care that is making this integration an imperative. An important part of this shift entails at-risk payments, such
as those that characterize the aforementioned ACOs, both upside risk (sharing in savings) and
downside risk (reimbursement penalties).18 The presence of risk causes providers, such as physician organizations, to increase their dependence on analytics modules. We need to know the
cost of care if we’re going to be at risk.
REIMBURSEMENT AND PHYSICIANS: AN ONGOING STRATEGIC
CHALLENGE
This section discusses a particularly important strategic challenge.
The Sustainable Growth Rate and Physician Reimbursement
Healthcare finance and reimbursement is anathema to many physicians. Aspects of Medicare
illustrate the complexity that many physicians contend with. An ongoing feature of the program
has been the Sustainable Growth Rate (SGR), which was used by CMS to control growth in
Medicare physician service expenditures. Generally, this was a method to ensure that the yearly
increase in expense per Medicare beneficiary did not exceed the growth in the GDP.19
On March 1 of each year, the physician fee schedule was updated accordingly. This has been
euphemistically known as a “doc fix.” Physician groups, including the AMA and the American
Osteopathic Association (AOA) have lobbied for a permanent reform to the SGR so that physician payment rates are not subject to annual cuts; a permanent doc fix.
Reimbursement and Physicians: An Ongoing Strategic Challenge 327
The SGR Has Been Replaced
A 1.5% or less annual update in payment rates has been common over the last 10 years.20 Predictably, these low increases in Medicare payments have consequences: while fewer physicians
may take on new Medicare patients, other physicians may withdraw entirely from the program.
On April 14, 2015, Congress ended the doc fix by passing the Medicare Access and Children’s
Health Insurance Program (CHIP) Reauthorization Act (MACRA). This Act put an end to the
SGR physician payment formula. Providers would have seen Medicare reimbursement rates drop
by 21% starting on April 15, 2015, had this legislation not been enacted. The Act establishes an
automatic 0.5% raise annually in provider reimbursement rates from 2015 through 2019.21
The New Performance-for-Payment Reimbursement Method Presents Different
Physician Challenges
From 2019 on, payments to providers are adjusted based on performance under a two-part
Quality Payment Program (QPP). The QPP thus includes certain payment adjustments under
the Merit-Based Incentive Payment System (MIPS). The program also provides certain payment
adjustments for “Advanced” Alternative Payment Model (APM) entities. What QPP underscores, potentially further vexing physicians, is CMS’s objective to tie the majority of reimbursement to quality outcomes and increased beneficiary access to quality care.
The program may also present practice management challenges to providers and their business partners. For example, starting in 2019, MIPS mandates negative payment adjustments
for providers who fall below certain performance thresholds. By 2022, some providers may see
payments cut by up to 9%. (For more detail about QPP, see the chapter entitled “New Payment
Methods and Measures: MIPS & APMs for Eligible Professionals.”)
Physician Leadership Is Needed
Concurrent with the change to value-based payment and the resulting value-focused organization should be a shift in leadership roles that involves more physicians. Physicians should
be employed as leaders. They have unique insight into the needs of the patient population.
Their knowledge of optimal patient outcomes and how to achieve them are critical to effectively
adopting to the new reimbursement climate based on value. Building an effective “Physician
Enterprise” wherein new management structures are physician directed and led requires that
the resulting organization be both flexible and transparent enough to achieve both cost reduction and better outcomes.22
In conclusion, CMS’s attempt to remake the nation’s heathcare finance system based upon
value-based payments is a “sea change”. Strategic relationships are very much affected by this
sea change. Recognizing the importance of such change and how it impacts various areas of the
organization is an important step in revising the strategic plan.
INFORMATION CHECKPOINT
What is needed? A description of your organization’s health delivery system,
finance department, or reimbursement division.
328 Chapter 26 Understanding Strategic Relationships
Where is it found? This information may be present on your organization’s website or within a brochure prepared for the public. In the
case of the health delivery system, it may even be found
within a PowerPoint presentation, but be careful about
proprietary use if that is the case.
How is it used? Use will depend upon the item you find. Typically, it could be
used for marketing, for training, or even for recruitment
purposes.
KEY TERMS
Capitation
Electronic Health Record
Finance
Gross Domestic Product
(GDP)
Health Delivery System
Information Technology
(IT)
Pay-for-Performance (P4P)
Reimbursement
Super Bill
Stakeholder
Sustainable Growth Rate
(SGR)
OTHER ACRONYMS
ACO: Accountable Care Organization
AHA: American Hospital Association
AMA: American Medical Association
AOA: American Osteopathic Association
APM: Alternative Payment Model
CDC: Centers for Disease Control and Prevention
CHIP: Children’s Health Insurance Program
MACRA: Medicare Access and CHIP Reauthorization Act
MIPS: Merit-Based Incentive Payment System
NIH: National Institutes of Health
OMB: Office of Management and Budget
QPP: Quality Payment Program
WHO: World Health Organization
DISCUSSION QUESTIONS
1. If you work in a healthcare organization, do you know how your finance operation is
organized? Please describe.
2. Discuss the essence of the relationship between the healthcare delivery system and thirdparty reimbursement.
3. Do you think that the transition from fee-for-service payment to value-based payment is
feasible?
4. If you work in a healthcare organization, what percentage of your revenue is derived from
third-party reimbursement?
Discussion Questions 329
NOTES
1. F. Lega, “Organizational Design for Health Integrated Delivery Systems: Theory and Practice,” Health Policy, 81 (2007): 258–279.
2. World Health Organization (WHO), “Health Systems Service Delivery,” www.who.int
/healthsystems/topics/delivery/en/, accessed December 15, 2016.
3. Note that these areas of responsibility are more fully discussed under “The Elements of
Financial Management” in the introductory chapter of this text.)
4. Accounting Tools, “Chief Financial Officer (CFO) Job Description,” www.accountingtools
.com/job-description-cfo, accessed March 1, 2016.
5. Ibid.
6. Ibid.
7. Note: The term “reimbursement” implies that a claim is being paid, or reimbursed, for
services already rendered. We now have prospective reimbursement whereby payment
may be made for services that will be rendered in the future. Nevertheless, “reimbursement” is still being used as a descriptive term even though the payment method may be
prospective.
8. CMS, Hospital Readmissions Reduction Program, www.medicare.gov/hospitalcompare
/readmission-reduction-program.html, accessed September 17, 2016.
9. Health Care Financing & Organization (HCFO) & Robert Wood Johnson
Foundation (RWJF), “Learning from Medicare: Prospective Payment,” May
2011; also: CMS, “Hospital Value-Based Purchasing,” www.cms.gov/Medicare
/Quality-Initiatives-Patient-Assessment-Instruments/hospital-value-based-purchasing/,
accessed June 28, 2016.
10. J. McCally, Capitation for Physicians (Chicago: Irwin Professional Publishing, 1996), 176.
11. HCFO & RWJF, “Learning from Medicare.”
12. CMS, “National Health Expenditures 2014 Highlights,” https://www.cms.gov/research
-statistics-data-and-systems/statistics-trends-and-reports/nationalhealthexpenddata
/downloads/highlights.pdf, accessed February 7, 2016.
13. Ibid.
14. Ibid.
15. Ibid.
16. H. Larkin, “ACO or No?” Hospitals & Health Networks, 88, no. 5 (2014): 26–31.
17. S. Shortell, “The Next Frontier: Creating Accountable Communities for Health,” Hospitals & Health Networks, 89, no. 7 (2015): 12.
18. M. Zeis, “The Certainty of Analytics,” HealthLeaders, 18, no. 3 (2015): 32–36.
19. CMS, “Estimated Sustainable Growth Rate and Conversion Factor, for Medicare Payments to Physicians in 2015,” p. 1, www.cms.gov/medicare/medicare-fee-for-servicepayment/sustainablegratesconfact/downloads/sgr2015.pdf, accessed September 17,
2016.
20. Ibid., Table 6, p. 8.
21. Medicare Access and CHIP Reauthorization Act of 2015, Pub. L. No. 114-10 (2015).
22. P. Betbeze, “Building an Effective Physician Enterprise,” HealthLeaders, 18, no. 3 (2015):
38–42.
330 Chapter 26 Understanding Strategic Relationships
PART
© LFor/Shutterstock
Information
Technology as
a Financial and
Strategic Tool
X

Progress Notes
© LFor/Shutterstock
Understanding ValueBased Health Care
and Its Financial and
Digital Outcomes
THE VALUE-BASED CONCEPT: INTRODUCTION
To many financial managers, the term “value-based” has
come to mean a combination of both quality and cost. If
you are shopping, whether for a box of cereal or a car, you
will probably consider this combination. In the case of lowcost items, like the cereal, you might first consider quality
(taste and so on) and then its cost; with larger purchases,
such as a car, you may consider the cost first and then its
quality. Either way, both cost and quality will usually enter
into your equation.
Healthcare organizations have used a variety of methods
to determine cost and to measure the quality of care delivery over the years. However, in the past few years, the concept of value-based health care has come about. A primary
feature of a “value-based” approach is to recognize both
quality and cost, just as you might in your personal life.
Meanwhile, in today’s healthcare world, the term “valuebased” actually has come to have multiple definitions. The
particular definition depends upon the particular focus.
For purposes of healthcare finance, value-based concepts
can be, and are, applied to value-based purchasing (as with
your car and the cereal), payment adjustments, pricing,
strategy, and patient care. When we speak of value-based
healthcare financial management, we may be referring to
different aspects of all these concepts. We can even view the
broad span of value-based population health and the role
that financial management can play.
This chapter, therefore, addresses different facets of
the value-based concept in healthcare finance and related
financial management. We have divided the chapter into
several parts, and each part builds upon your understanding
After completing this chapter,
you should be able to
1. Describe value-based
progress and programs in
the private and public sector.
2. Distinguish among different
types of value-based
education efforts.
3. Understand the basics of
value-based legislative
reform.
4. Describe quality
measurement in the public
and private sectors.
5. Recognize various possible
digital outcomes.
6. Identify types of financial
outcomes.
7. Describe elements of
strategic planning in the
public and private sectors.
333
27
CHAPTER
of the value-based concept. The remainder of the chapter will discuss the following value-based
health concepts:
• Progress in the private sector
• Progress in the public sector
• Education efforts
• Legislative reform
• Quality measurement concept
• Public reporting efforts
• Financial and digital outcomes
• Strategic planning approaches
VALUE-BASED PROGRESS IN THE PRIVATE SECTOR
Leaders in innovation within the private sector have adopted a variety of value and quality efforts.
This section discusses value-based progress in implementing, research, and collaboration.
Implementing Value-Based Approaches
Two examples appear below.
An Organizational System Approach
The Mayo Clinic’s “Value Creation System” and Office of Value Creation are the direct result
of this improvement strategy. The Office of Value Creation was originally tasked with owning
the various value-based projects. As time went on, however, responsibility and accountability
for quality and value efforts shifted to operational levels. This left the Office of Value Creation
available to monitor quality and value within the organization. Thus, Mayo’s system has been in
place long enough that progress has moved to a second, higher value-based level.1
A Data-Driven Approach
The Geisinger Health System has implemented an approach to health care that is data driven.
As a Wall Street Journal article commented, Geisinger’s “…decades of investment in technology
and integration have made it a pioneer in the use of electronic medical records and other
data.”2 And that is a true statement: Geisinger is indeed a pioneer. The system utilizes datadriven management and achieves value through standardization and care coordination.
Value-Based Research Centers
Two examples appear below.
A Center for Value-Based Care Research
The Cleveland Clinic supports its own Center for Value-Based Care Research. The Center’s
researchers focus on not only identifying high-value health care, but also disseminating the
information obtained. That focus is reflected in the Center’s mission statement: “to make
quality healthcare possible for all Americans by conducting research to identify value in
healthcare.”3
334 Chapter 27 Understanding Value-Based Health Care
A Comparative Effectiveness Research Center
The Brigham and Women’s Hospital has established its own Patient-Centered Comparative
Effectiveness Research Center (PCERC). As its name suggests, the Center focuses upon comparative effective research (CER) and patient-centered outcomes research (PCOR) at the hospital.
This Center provides value in that it studies both the comparable effectiveness of treatment
options for individual patients and the outcomes of healthcare practices. The Center’s overall
approach is to improve the quality of health care.4
Value-Based Collaboration and Affiliation
A definite effort toward both collaboration and affiliation among organizations is underway.
Two examples follow.
The High Value Healthcare Collaborative
This collaboration actually began in late 2010 with four organizations: the Mayo Clinic, Denver
Health, Intermountain Healthcare, and the Dartmouth Institute for Health Policy and Clinical
Practice (TDI). The group wanted to achieve high value by improving health care and lowering
costs. They also wanted to “move best practices out to the national provider community.”5 Since
its formation, the collaborative has expanded to almost 20 health systems.
Network Affiliations
The National Comprehensive Cancer Network (NCCN) is a “not-for-profit alliance of 27 of the
world’s leading cancer centers devoted to patient care, research and education.” The NCCN is
dedicated to “improving the quality, effectiveness and efficiency of cancer care so that patients
can live better lives.”6 Network membership such as this is a type of affiliation that can provide
significant value-based benefits, especially in the areas of evidence-based treatment and quality
of care.
VALUE-BASED PROGRESS IN THE PUBLIC SECTOR
At the time of writing, the Centers for Medicare and Medicaid Services (CMS) have a total of
seven value-based programs (VBPs): Five programs are already implemented and two are in the
planning and development stages. The
seven programs are illustrated in Exhibit
27–1. These programs tie payment to
value (thus “value-based”). They represent an important trend, because they
are part of the movement toward paying
for quality of patient care.7
These VBPs are important because
they have aided in showing the way
toward value. Their structure has
provided an important foundation
to build upon. In other words, they
helped to make today’s rapid changes
possible.
1. Hospital Value-Based Purchasing
(HVBP)
2. Hospital Readmission Reduction (HRR)
3. Hospital Acquired Conditions (HAC)
4. Physician Value-Based Modifier (PVBM)
5. Skilled Nursing Facility Value-Based
Program (SNFVBP)
6. Home Health Value-Based Program
(HHVBP)
7. End-Stage Renal Disease (ESRD)
Quality Initiative
Exhibit 27–1 Seven Federal Value-Based Programs
Value-Based Progress in the Public Sector 335
Three Hospital Value-Based Programs
Three hospital programs are among the first value-based programs to be implemented by CMS.
A brief description of each follows.
Hospital Value-Based Purchasing Program
This program provides incentive payments for acute care hospitals. The payment adjustments
are based on quality of care, and are part of the Inpatient Prospective Payment System (IPPS).
In other words, the hospital value-based purchasing (HVBP) program links payment to performance. The performance measures are adjusted (and typically increased) yearly. CMS has set a
timeline for these adjustments that runs out to the year 2022.8
Hospital Readmission Reduction Program
The hospital readmission reduction (HRR) program provides incentive payments in order to
reduce hospital readmissions, which are costly and may be unnecessary. Reductions may be
accomplished in two ways: improving the coordination of transitions of care to other care settings
and improving the quality of care provided.9
Hospital Acquired Conditions Program
This program works in reverse: It reduces payments instead of making incentive payments. In this
case, those hospitals whose patients get the most hospital-acquired conditions are penalized. In
other words, the hospitals that rank worst in hospital acquired conditions (HACs) are the ones
that have their payments reduced.10
Four Other Value-Based Programs
These four programs cover multiple care settings, as described below.
Physician Value-Based Modifier Program
This program for physicians is also one of the original value-based programs to be implemented by CMS. The program payments began in 2015 and have been paid to ever-expanding
groups of physicians over 2016 and 2017. The program expands to include other clinicians
in 2018.
As the title implies, when an eligible claim is submitted, the payment is adjusted, or modified,
based on particular quality and cost measures performance. In other words, when the modifier
is applied to payment, it rewards both lower costs and higher quality performance. (Note that
the Physician Value-Based Modifier (PVBM) Program is also known as the Value-Modifier [VM]
Program.)11
Skilled Nursing Facility Value-Based Program
This program provides incentive payments to skilled nursing facilities (SNFs). The payments
reward SNFs based on the quality of care provided. In other words, payment is received for quality of care, not quantity of care. At the time of this writing, the skilled nursing facility value-based
program (SNFVBP) continues to develop. This development is expected to progress in stages.12
However, the IMPACT Act is moving post-acute care facilities (PACs) toward standardization
and interoperability. This legislation, which includes SNFs, may affect certain aspects of the SNF
value-based program due to standardization efforts.
336 Chapter 27 Understanding Value-Based Health Care
Home Health Value-Based Program
This program was first implemented on January 1, 2016, as a home health value-based program
(HHVBP) model in nine states. Payment for those participating in the model is based on quality
performance. In an interesting concept, the participating home health agencies (HHAs) will
compete on value in order to receive quality performance incentive payments.
At the time of this writing, the HHVBP continues to develop. This development is expected
to progress in stages.13 However, as with SNFs, the HHA value-based program may be impacted
by legislative efforts toward standardization and interoperability.
End-Stage Renal Disease Quality Initiative Program
The End-Stage Renal Disease (ESRD) Quality Initiative Program is a disease-specific program.
It concerns outpatient dialysis or ESRD facilities , and it too was one of the original programs to
be implemented by CMS. This program provides incentive payments for better quality of care,
and it also reduces payments to those facilities that do not meet particular standards of performance. In other words, this program also links payment to performance.14
Value-Based Payments
The traditional method to pay for service delivery is by volume. Instead, CMS is now beginning to pay for value and quality. For example, CMS announced two related goals for Medicare
fee-for-service payments, as follows.
Payment Goal One
“Thirty percent of Medicare payments are tied to quality or value through alternative payment
models…by the end of 2016, and 50% [will be] by the end of 2018.”15 (The various types of alternative payment models are described elsewhere in this chapter.) According to CMS estimates,
this aggressive 2016 timeline was actually exceeded.16
Payment Goal Two
Eighty-five percent of all traditional Medicare fee-for-service payments have been tied to quality
or value by the end of 2016, and 90% will be by the end of 2018. This goal was accomplished
through certain CMS programs, including the HVBP and the HRRP.17 (These programs are also
described elsewhere in this chapter.)
VALUE-BASED EDUCATION EFFORTS
The following examples illustrate just a few value-based education efforts. Note the digital
impact of each, as all these examples are obtained online.
A Certificate in the Fundamentals of Value-Based Health Care
The Dartmouth Institute for Health Policy and Clinical Practice (TDI) offers the TDI Certificate in the Fundamentals of Value-Based Health Care. To obtain the certificate, students
must take six sequential online courses that center upon understanding and navigating highvalue patient-centered healthcare delivery. Value-based improvement is measured by achieving
Value-Based Education Efforts 337
outcomes that are not only better, but are achieved with the same or lower costs. And that
improvement should be “…both scientifically and ethically sound and sustainable.”18
An Online Course That Earns Continuing Education Credit
The Center for Continuing Education at Cleveland Clinic provides online courses that earn
continuing education credits for healthcare professionals. One topic provided is entitled,
“Value-Based Health Care”; this particular online course is included in the Disease Management Clinical Decisions series and is in the form of an interactive case study.19
Education Directed to Patients and Their Families
The Patient and Family Health Education Center at Cleveland Clinic provides information on a
variety of healthcare topics. One topic is “Value-Based Care.” The patient-directed information
includes defining value-based care and explaining how such care reduces costs.20
Governmental Education for Professionals
CMS provides healthcare professional education products through the Medicare Learning Network, or MLN.21 The MLN offers a wide variety of topics, many as either electronic downloads
or print versions. Some provide continuing education credits as well. At this point in time,
value-based information is most commonly found within quality measurement and/or regulatory payment updates.
VALUE-BASED LEGISLATIVE REFORM
Legislation is moving toward even more value-based programs. These programs accomplish
their aims through both reporting and payments.
How Value-Based Reporting and Payments Came About: The Legislative Background
The following summary of legislative progress helps you to see the step-by-step progress toward
value-based reform.
Initial “Digitizing” Steps
The early efforts toward “digitizing” health care covered a period of several years. One of the
more important developments during this time was requiring Medicare providers to submit
their claims for payment electronically. We consider this the first real step toward “digitizing,” as
every Chief Financial Officer wants to get claims paid, and a the conversion to electronic claim
forms was thus established throughout the country.
HITECH Legislative Funding
The Health Information Technology for Economic and Clinical Health (HITECH) Act was part
of the American Recovery and Reinvestment Act that was signed into law on February 17, 2009.
The HITECH Act promoted the adoption and use of health information technology (HIT)
338 Chapter 27 Understanding Value-Based Health Care
and electronic health records (EHRs) through payment incentives. CMS described these EHR
Incentive Programs in a single sentence: “The Medicare and Medicaid EHR Incentive Programs
provide incentive payments to eligible professionals, eligible hospitals and critical access hospitals (CAHs) as they adopt, implement, upgrade or demonstrate meaningful use of certified
EHR technology.”22
The HITECH Act’s legislative funding provided approximately $17 billion in incentives for
hospitals and physicians. This law will impact future healthcare information management for
many years to come (up to 2021 in the case of one program).
Value-Based Legislative Reform: The MACRA Act
A further legislative reform to the Medicare payment structure is now in place through the
Medicare Access and CHIP Reauthorization Act of 2015 (MACRA). This Act is briefly described
below. Note that the Act ends a method of payment to physicians that has been in place since
the beginning of the Medicare program in the 1960s. This is truly a reform.
More Value-Based Legislative Reform: The IMPACT Act
Yet another legislative reform is now in place through the Improving Medicare Post-Acute Care
Transformation (IMPACT) Act of 2014. This Act is also briefly described below. Note that, for
the first time, interoperability will be required between and among the four types of post-acute
facilities. This is another true reform.
Quick Facts About Physicians and the MACRA Act, MIPS, and APMs
MACRA reforms Medicare payments to physicians and certain clinicians via the following:
• Repealing the Sustainable Growth Rate (SCR) method of payment
• Replacing the SGR method with a new payment framework that emphasizes “giving better
care, not just more care”
• Combining existing quality reporting programs into the single new payment framework.23
For the first two years, the individuals affected by the MACRA Act include physicians, physician assistants, nurse practitioners, clinical nurse specialists, and certified registered nurse anesthetists. Groups that include these eligible professionals are also included. In a second phase
(from the third year onward), the Secretary can add more eligible professionals such as social
workers, certified audiologists, and others.
The MACRA reforms help CMS to move toward the value-based goal of paying for both value
and for better care. Physicians and other eligible professionals (EPs) can choose one of two
quality programs: either the Merit-Based Incentive Payment System (MIPS) or the Alternative
Payment Models (APMs). Both MIPS and APMs will go into effect over a period from mid-2015
through 2021 and beyond.24
What Is MIPS?
This new value-based program combines certain parts of existing quality reporting programs.
The programs involved include certain sections of the Physician Quality Reporting System
(PQRS), the Value Modifier (VM; also known as the Value-based Payment Modifier), and the
Medicare Electronic Health Record (EHR) incentive program. (These stand-alone programs
will be sunsetted, or ended, when they are combined into the new value-based program.)
Value-Based Legislative Reform 339
Physicians and other eligible professionals will be measured in four areas. These performance areas include quality, resource use, meaningful use of certified EHR technology, and
clinical practice improvement. (The first three areas come from the existing quality reporting
programs, but the clinical practice improvement area is new.)
The MIPS payment method includes an automatic base increase for the period 2015 through
2019, followed by an additional increase applied from 2026 onward. These EPs are also at risk
for positive or negative performance adjustments to their payments beginning in 2019.
What Are APMs?
APMs provide new methods of payment from Medicare to physicians and other eligible professionals. The MACRA Act considers the following entities to be APMs that are generally eligible
for incentive payments:
• CMS Innovation Center Models
• Shared Savings Program Tracks
• Certain statutorily required demonstrations25
Specific types of entities within these general categories are then set out annually in a rule
published by CMS. These “Advanced APMs” are considered to be advanced because they accept
financial risk along with rewards (the rewards being the incentive payments).
The APM payment methods include a lump-sum incentive payment for some participating
providers for the period 2019 to 2024. In addition, beginning in 2026, some providers can
receive higher annual payments. In the future we can expect increased transparency of such
physician-focused payment models (PFPMs). We can also anticipate the development of additional PFPMs as time goes on.
Other Provisions of the Act
Other provisions of the Act are detailed elsewhere, as the additional provisions are beyond the
scope of this particular chapter.
Meaningful Use Is Not Dead, But Is Evolving
Meaningful use still exists. At a healthcare conference in the spring of 2016, CMS acting
Administrator, Andy Slavitt, said that “the meaningful use program, as it has existed, will now be
effectively over and will be replaced with something better.”26 However, various media sources
reported only that meaningful use was dead, which is incorrect.27 What Slavitt meant was that
meaningful use is being incorporated into the MACRA Act’s programs. Thus, meaningful use
still exists, but its role has evolved. To see more about how this change has come about, see
Appendix 28-A.
Quick Facts About Post-Acute Care and the IMPACT Act
The IMPACT Act of 2014 requires that standardized patient assessment data be reported by
four types of post-acute care facilities, including SNFs, HHAs, inpatient rehabilitation facilities
(IRFs), and long-term care hospitals (LTCHs). Note that hospice, another type of post-acute
care facility, is not included in these requirements.
340 Chapter 27 Understanding Value-Based Health Care
Data Interoperability
The Act specifies that “certain data elements must be standardized and interoperable to allow
for the exchange and use of data among these PAC and other providers.”28 This will facilitate
coordinated care and will “improve the long-term outcomes of beneficiaries receiving postacute services across different care settings.”29 (Standardized data ensure that wording is comparable for purposes of assessment and scoring. Interoperability makes transmitting data across
different systems possible.)
Transparency and Public Reporting
Transparency and public reporting is another important element in the IMPACT Act. The Act
stipulates that there must be public reporting of PAC provider performance on both valuebased aspects: quality measures and resource use.30
Other Provisions of the Act
Other provisions of the Act are detailed elsewhere. However, note that the Act also provided
funding for much greater specificity in the reporting of nurse staffing.
QUALITY MEASUREMENT: THE CONCEPT
As one of the two foundations of value-based care, quality must be able to be studied and quantified. (The other value-based foundation is cost.) Note that types of quality measures can vary, as
discussed within this section. Also note that developing quality measures is not just the first step
in the process, but is an ongoing project. We hope that, in the future, public/private alignment
will become commonplace.
Quality Measures in the Private Sector
This section discusses measures use linked to payment in a large alternative payment model and
quality measures as used by an accrediting organization.
The California-Based Integrated Healthcare Association
The integrated healthcare association (IHA), working with health plans and physician organizations, launched a statewide pay-for-performance initiative over 15 years ago. This alternative
payment model is based upon four elements, including “a common set of measures and benchmarks, health plan incentive payments, public reporting and public recognition awards.”31
The IHA Value-Based Pay-for-Performance (P4P) program measures quality, cost, and
resource use. The program’s common measure set is evidence based and includes four major
elements:
• Clinical quality
• Patient experience
• Meaningful use of HIT
• Resource use and total cost of care
To put the size of this program into perspective, participation in the Value-Based P4P includes
“10 health plans and 200 California physician organizations with 35,000 physicians caring for
Quality Measurement: The Concept 341
9 million Californians enrolled in commercial health maintenance organization (HMO) and
point of service (POS) products.”32
The National Committee for Quality Assurance
The National Committee for Quality Assurance (NCQA) is a private 501(c)3 not-for-profit organization that accredits health plans and that provides annual statistics about the quality of care
delivered by these plans. The Committee has developed quality standards and performance
measures for an array of healthcare organizations.
According to the NCQA website:
• Health plans earning NCQA accreditation at the present time must address
an array of more than 60 standards, and reports on their performance are
required in over 40 areas.
• Health plans are accredited in every state, the District of Columbia and Puerto
Rico.
• These plans cover 109 million Americans.
• That figure accounts for 70.5% of all Americans in health plans.33
Quality Measures in the Public Sector
Value and quality are often intertwined when discussing value-based efforts. Certain quality
measures have already been established for specific providers. These measures must first be
recorded by the provider and then transmitted as appropriate. Within the public sector, CMS
has a number of such quality reporting programs in place as follows.
Quality Reporting Programs
Examples of CMS Quality Reporting Programs are listed below. Note that additional programs
may be developed in the near future. It is also expected that existing programs will be revised
and refined, also in the near future.
Existing programs at the time of this writing include the following:
• Hospital Inpatient Quality Reporting (HIQR) Program
• Hospital Outpatient Quality Reporting (HOQR) Program
• Physician Quality Reporting System (PQRS)
• Long-Term Care Hospital (LTCH) Quality Reporting Program (QRP)
• Inpatient Rehabilitation Facility (IRF) Quality Reporting Program (QRP)
• Home Health Quality Reporting Program (HHQRP)
• Hospice Quality Reporting Program (HQRP).34
We understand that upgrading efforts are ongoing for these reporting programs. Such upgrades
include greater transparency and ease of access.
Challenges in Quality Measure Implementation
The staff at CMS has identified a number of challenges that may occur in quality measure
implementation from their viewpoint. This useful list of challenges can be divided into three
segments as follows:
342 Chapter 27 Understanding Value-Based Health Care
Issues related to patients and providers
Engaging patients in the measure development process
Reducing provider burden
Issues related to shortening and streamlining processes
Shortening the period for measure development
Streamlining data acquisition for measure testing
Issues related to development
Developing meaningful outcome measures
Developing patient-reported outcome measures (PROMS) and appropriate use measures
Developing measures that promote shared accountability across settings and providers35
Challenges for the Manager
We cannot deny that challenges to quality measure implementation exist. The manager must
deal with a whole variety of management issues related to these measures. The manager faces
problems and challenges in both the development and implementation of quality measures. By
their very nature such measures are metrics, and metrics must involve digital changes. Examples
of the problems involved for the manager include the following:
• Hardware issues
• Software issues
• Training
• Staff stability and related turnover
• Uniform reporting during digital changes
To succeed, managers involved in measure development and implementation need support
from the highest levels within the organization. This support must include funding for both
required digital infrastructure and related staffing.
VALUE-BASED PUBLIC REPORTING IN THE PRIVATE SECTOR
Sharing information about quality reporting programs with the public is another important
method of supporting value-based efforts. In this section, we discuss three different types of
value-based public reporting.
Public Reporting by Providers and Health Plans
Two types of reporting about value-based efforts are described below. There are, of course, a
number of other existing examples.
Annual Reporting of Program Results
The California-based Integrated Healthcare Association (IHA), in association with the California
Office of the Patient Advocate (OPA), publicly reports value-based pay-for-performance results
each year. These reports allow comparison between and among various health plans and providers. The intent is to “allow health care purchasers and consumers to make informed decisions
Value-Based Public Reporting in the Private Sector 343
about providers based on value.”36 Other reporting efforts by this partnership include reports
on total cost of care performance by physician organizations and the Medical Group Medicare Report Card for “medical groups caring for seniors and people with disabilities enrolled
in Medicare Advantage health plans.”37 In addition, each year the IHA also recognizes topperforming and most-improved physician organizations. Another IHA public recognition effort
is the Excellence in Healthcare Award.38
An Overview of Annual Facts and Statistics
This type of report is typically an overview. The website containing the overview then allows
the viewer to go to specific information about items of interest, including value-based efforts
for the particular year. For example, Cleveland Clinic publishes an annual year-end “Facts +
Figures” report. The two-page report provides a snapshot of the organization. Included, for our
purposes, besides Mission, Vision, and Values, is a section titled “Quality, Safety, Transparency.”
This section mentions Quality and Patient Safety accountability that oversees improvement in
quality and safety, all data driven. It also mentions “relentless focus on monitoring, recording
and reporting quality and safety data.”39
Public Reporting of Quality and Value by Other Organizations
A variety of other organizations also provide public reporting of quality and associated value.
They include, among others, the National Quality Forum, the National Committee for Quality
Assurance, the Leapfrog Group for Patient Safety, the Informed Patient Institute, and the Commonwealth Fund.40
Public Reporting of Physician Credentials and Experience
Another type of public reporting that websites provide is background information on physician
groups and on individual doctors. To experiment, we typed our own GP’s name into Google
and seven websites came up that contained his credentials and experience.
These sites provide a type of value-based information, in that they can readily tell you, the
consumer, important facts about the healthcare professional. Most sites contain information
about specialties, experience, and credentials. You can find whether the physician has any sanctions, malpractice suits, or board actions against him or her. The site may also provide the
results of patient satisfaction surveys or reviews, and possibly a comparative rating.
VALUE-BASED PUBLIC REPORTING IN THE PUBLIC SECTOR
This type of public reporting provides another layer of value by disseminating value-based information to interested parties. Within this section, we describe both national and state reporting
examples as follows.
National Reporting Examples
Value-based quality measurement can be readily linked to public reporting. You may be familiar
with one of the CMS “Compare” websites that publishes these quality measures. A brief description of four “Compare” sites follows.
344 Chapter 27 Understanding Value-Based Health Care
Hospital Compare
The Hospital Compare website contains information about quality of care for over 4,000 hospitals in the United States.41 The site contains a profile of each hospital. Besides general facility
information and certain other measures that are reported, the particular measure of interest
to us is “Payment and Value of Care.”42 This value-based measure is in three parts: “Medicare
spending per beneficiary,” “Payment measures,” and “Value of care.” The “Value of care” part is
a combination of payment measures and quality-of-care measures.43
Physician Compare
At the time of writing, group practices are present on the “Physician Compare” CMS website.
There are plans to add individual physicians and other healthcare professionals in the future.
Also note that the site only includes those who are enrolled in the Medicare program.44 The site
contains a profile of each physician, including specialties, board certification, medical school
and residency, and other information.45
The particular item of interest to us concerns participation in quality activities. If the physician or group practice participates in one or more of four quality activities, there is a green
check mark on the profile page. (The site is careful to say, however, that “participation alone
does not mean quality care has been achieved. Showing a commitment to quality is the first step
in achieving quality care.”)46
Nursing Home Compare
According to CMS, the Nursing Home Compare website contains information about both quality of care and staffing for all 15,000-plus nursing homes in the United States that are Medicare
and Medicaid participating.47 The site provides a five-star quality rating that covers quality measures, staffing, and health inspections. Each of these three elements is given an individual rating, and the three ratings are then combined to create an overall rating. The star rating is on a
scale of 1 to 5, with 1 being the lowest and 5 being the highest score.48 (The site does point out
that there can be variation among states as to the inspection process and as to Medicaid program differences. Thus, it is best to compare facilities within a single state.)49
Home Health Compare
The Home Health Compare website contains information about the quality of care that is provided by home health agencies throughout the United States that are Medicare certified.50 The
site contains a profile of each agency, including type of ownership and services offered. The
particular items of interest to us include information about quality measures, plus a “quality
of patient care star rating.”51 The star rating is on a scale of 1 to 5, with 1 being the lowest and
5 being the highest score. Scores are based upon how the performance of a particular home
health agency compares to that of other agencies.52
A State Reporting Example
According to an article in Health Affairs, just about one-half of the states in the United States
have created some type of public reporting program.53 As you might suspect, the content of
these programs varies state by state. We provide one example, as follows.
The Utah Department of Health provides a Public Health Outcome Measures Report
(PHOM). The report includes 109 public health measures in an online format that is easy
Value-Based Public Reporting in the Public Sector 345
to use. In this case, the purpose of public reporting is to “promote an understanding of the
health status of the Utah population.”54 These measures, or indicators, are taken from another
of Utah’s websites, “Indicator-Based Information System for Public Health (IBIS-PH),” which
contains even more detail.
FINANCIAL OUTCOMES
This section discusses several types of value-based financial outcomes.
A Financial Outcome Example
Intermountain Health (IH) provides an example of documented positive financial outcomes
as follows. Intermountain Health is a Utah-based not-for-profit health system with 22 hospitals
and 185 clinics in the Intermountain Medical Group, along with health insurance plans from
SelectHealth. (Although it is not relevant to the example, IH is a pioneer in the use of telemedicine.) Intermountain piloted an integration of mental health with primary care a number of
years ago. Every primary care patient at the Intermountain Medical Group clinics receives this
screening, whether or not they are members of Intermountain’s health plan. This value-based
coordinated care model has improved outcomes for patients. Furthermore, Intermountain’s
financial outcomes are positive. Specifically, while costs per member are $22 higher up front,
per-member costs are $115 lower overall annually. The annual reduced cost is due to fewer
emergency room visits and other care.55
An Overview of Financial Outcomes as a Value-Based Business Model
The Harvard Business Review has published an article entitled “Turning Value-Based Health Care
into a Real Business Model.”56 The authors begin by saying the shift from volume-based health
care to value-based health care is inevitable. (We agree with this view.) While they discuss benefits in patient care, they also point out that sometimes short-term financial losses may be part
of this shift to a value-based approach. In some cases, of course, the short-term loss may be offset
by a long-term gain. The Intermountain example above is one of those cases.
The authors conclude that organizations’ short-term financial losses were strategic. The benefits of these value-based strategic decisions include, for example, risk-management experience.
Risk management is an integral part of many pay-for-performance alternative payment models,
and gaining such experience would be valuable. Relationship building is another strategic benefit.
Collaboration and alignment with stakeholders and physicians takes time and becomes even more
important in moving toward a population-health approach. There is also a competitive advantage.
In other words, in this value-based business model, each organization will gain competitively in
the long run. This is because it will have already embraced and adapted to a value-based financial
approach (the business model) while other organizations who have not done so will be left behind.
Large Interactive Systems Require Investment Dollars
Because of their size, large healthcare systems need large electronic health record systems. It follows
that these large electronic systems require a substantial investment. In this section, we discuss two
examples of such investments, both of which can be considered value-based financial outcomes.
346 Chapter 27 Understanding Value-Based Health Care
Duke University Health System’s Investment
North Carolina–based Duke University Health System (Duke) includes three hospitals along
with physician practices, home care, hospice care, and support services.57 In July 2012, Duke
began a multi-year information systems project to unify electronic medical records across the
health system. The new technology was to be implemented in three phases, from mid-2012 to
spring 2014.58 The project stayed on schedule; as of spring 2014, the system was operational in
all three hospitals and 223 outpatient facilities.59
The investment in this project was widely reported to be $500 million. However, when the
Duke Chief Medical Information Officer discussed related financial issues in a newspaper interview, he acknowledged $500 million as the gross cost, but also said the net cost was estimated at
approximately $300 million, as follows.
He explained that the $500 million figure represented total ownership costs over a seven-year
period. This amount included, therefore, the cost to maintain and upgrade the system over seven
years, in addition to the initial costs to acquire and begin to use the technology. He also explained
that the $500 million was the gross investment figure. If you add up all the costs to maintain
and to support the 135 applications that are being replaced, and if you then subtract that cost
from the $500 million, you wind up with a net new investment that is “a little bit more than
$300 million.”60 Finally, he also pointed out that the project should be eligible to receive tens of
millions of dollars in federal funding” that would help to partially cover costs of the investment.61
Kaiser Permanente’s Investment
California-based Kaiser Permanente (KP) is a non-profit integrated health plan that includes
38 hospitals and over 600 medical office buildings and other facilities that are located in eight
states plus the District of Columbia. The plan serves almost 10 million people.62
Kaiser Permanente claims that HealthConnect, the plan’s comprehensive electronic record,
is “one of the largest private electronic health systems in the world.”63 It took 10 years to build
and became fully operational in 2010.64
InfoWorld interviewed Philip Fasano, the Chief Information Officer of KP, about the plan’s
EHR systems. The interviewer asked how much it cost to build the system, to which Fasano
replied, “about $4 billion, a substantial amount of money, but we have 9 million members [so
it costs about $444 per member].”65 (Note that the interview occurred three years prior to the
time of this writing, so the member count is different.) The CIO went on to make another
important point: that it is necessary to continuously invest in the system during its lifetime.
DIGITAL OUTCOMES
This section discusses value-based digital outcomes that are important for physicians and for
large healthcare systems.
How Would Digital Outcomes Benefit a Physician’s Practice?
Value-based alternative payment models rely upon an array of performance measures that are
reported electronically. The electronic submissions represent the record of the provider’s performance. Thus, appropriate data collection and submission represents the positive digital outcome that should result in payment advantages.
Digital Outcomes 347
For example, physicians and other eligible professionals are in the midst of transition to
value-based payment models due to MACRA. This transition relies heavily upon electronic submission of performance data, which provides certain benefits. Specifically, the physicians who
use certified EHRs and/or qualified clinical data registries (QCDRs) should benefit in two ways:
• Reduce data collection and the associated reporting burden
• Support timely performance
Figure 27–1 illustrates these points.
What Are Value-Based Digital Outcome Examples in Large Healthcare Systems?
This section provides outcome examples for two large systems.
Duke University Health System
Duke University Health System’s (Duke’s) information system project cost has been discussed in the preceding investment section. In this section, we discuss the project’s digital
outcomes.
The information system project’s purpose was to unify electronic medical records across
the system. It accomplished this purpose. Value-based outcomes include medical record
access that is both seamless and in real time. Medical information can now be exchanged
across all care settings. As the Duke press release states, quality, safety, speed, and efficiency
have all been improved with implementation of the new system. In addition, 130 old clinical information systems became obsolete and were eliminated when the new system went
online.66
The patient experience has been improved via the system’s new online tool, “Duke MyChart.”
The patient can, among other features, view and/or request appointments, view their medical
reports, request prescription refills, and send messages to healthcare providers.67
Finally, the organization’s commitment to the project is underscored by another statistic.
Duke provided 173,000 hours of training to faculty and staff in order to ensure a smooth transition. And it worked, too; the press release says neither patient care nor patient billing was significantly disrupted during the implementation process of this value-based system.68
Reduce data
collection &
reporting burden
Support timely
performance
feedback
EPs That Use
Certified EHR
Technologies and
QCDRs
Figure 27–1 MACRA Electronic Specifications Provide Benefits.
348 Chapter 27 Understanding Value-Based Health Care
Kaiser Permanente
The cost of KP’s “HealthConnect” project has been discussed in the preceding investment
section. In this section we discuss the digital outcomes for the entire KP online system. Note
that KP covers the spectrum of care, as it is both a health plan (payer) and a provider of care.
KP also has amassed a huge amount of electronic data that are being used for value-based
purposes.
For example, HealthConnect is part of KP’s online portal called “My Health Manager.” This
portal allows patients online access to such features as appointment scheduling, refills of prescriptions, messages to care providers, and so on. However, another valuable feature, called the
online Patient Action Plan (oPAP), is also available. This web-based system concerns preventive
care that is personalized for the individual patient in a health action plan. Researchers who
studied the use of this patient-enabled health management tool found improved patient outcomes for preventive care.69
Clinicians also benefit from KP HealthConnect features. They have access to information
about latest treatments and preventive care, and that access is already proving valuable. For
example, in one pilot project, this access to information helped physicians to reduce coronary
artery disease death by 76%.70
Another Outcome: Electronic Transmission Standards Must Be Updated
and Maintained
Electronic transmission standards are important because they directly impact providers, health
plans, and other stakeholders. These standards are coordinated with and are the beginning
point for certified EHR technology. Both financial and digital outcomes depend upon such
technology. Specific versions of the standards are acceptable for certified EHR technology at
different points in time. As such, it is imperative that the related standards are updated and
maintained at all times.
VALUE-BASED STRATEGIC PLANNING BY THE PRIVATE SECTOR
Leaders in the private sector already have their value-based strategic planning underway. We
provide some examples of such planning within this section. Note that while there may be different approaches, the value-based aims are similar.
Recognizing That Value-Based Care Is a Long-Term Goal
The Cleveland Clinic has integrated the value-based concept throughout its organization,
including research, education, and care delivery. Dr. Tony Cosgrove, President and CEO of
Cleveland Clinic, has written in a blog that value-based health care is a “breakthrough that
will change the face of medicine” and that “ whether providers like it or not, healthcare is
evolving from a proficiency-based art to a data-driven science.”71 Finally, one of the Cleveland
Clinic’s web pages summarizes the organization’s strategic positioning: “[T]he ideal result
is fewer readmissions, less frequent hospitalization and trips to the ER. Value-based care is a
long-term goal.”72
Value-Based Strategic Planning by the Private Sector 349
Taking a Patient-Centered View of Value
At the Mayo Clinic, it seems obvious that the Office of Value Creation must play an important
role in value-based strategic planning. However, this Office does not operate within a silo. One
of the “Quality at Mayo Clinic Update: How the Mayo Value Creation System Is Improving
Patient Care” publications a few years ago makes this clear.
It says the organization, at that time, was working to define value, and the Office of Value
Creation, the Value Program in the Center for the Science of Healthcare Delivery, Government
Affairs, and Contracting were all working together toward this effort. Strategically speaking, “at
this point, we are trying to take a patient-centered view of value at the levels of the care pyramid.”73 (And their concept at that point in time was a care “pyramid” consisting of complex
care, intermediate care, and population health, with value definitions and detail for each level.)
There is no doubt that this strategic approach has further evolved over time.
Focusing Upon Population Health as a Value-Based Strategy
Dartmouth-Hitchcock describes a focus upon population health that is strategic. This organization believes in the achievement of a sustainable health system. To quote one comment, “we
believe the focus of organizations such as D-H should no longer be just on treating illness. We
have an obligation to ensure health.”74
Dartmouth-Hitchcock is a leader in value-based alternative-payment models that are risk
based. This organization clearly believes that the incentives under such models will “move to
keeping defined populations health as a way of controlling costs. Defined populations under
new payment models are those ‘attributed’ to us because we are the entity responsible for their
health and health care costs.”75
VALUE-BASED STRATEGIC PLANNING BY THE PUBLIC SECTOR
A “national quality strategy” exists and this strategy guides planning throughout the U.S. Department of Health and Human Services (DHHS). The value-based and quality programs that are
discussed within this chapter are an important part of CMS planning. Thus, because CMS is a part
of DHHS, these value-based and quality issues are tied into national quality strategy as well. This
section illustrates how CMS has fit its quality strategy goals into the national quality priorities.
National Quality Strategy
The National Quality Strategy (NQS) is led by the Agency for Healthcare Research and Quality
(AHRQ) on behalf of the U.S. DHHS.76 The NQS structure is summarized below.
Three Aims and Six Priorities
To summarize, the NQS is structured with three aims and six priorities. The three overarching
aims are as follows:
• Better care
• Healthy people/healthy communities
• Affordable care77
350 Chapter 27 Understanding Value-Based Health Care
Details about the six priorities for NQS are discussed in the following section, especially as to
how they interrelate to the CMS quality strategy.
Nine Strategic Levers
The NQS also created nine “levers.” Used in this sense, the term “levers” may be core business
functions, resources, and/or actions, any of which may be activated in order to align to the quality strategy. These strategic alignment elements are as follows:
• Measurement and feedback
• Payment
• Health information technology
• Innovation and diffusion
• Public reporting
• Learning and technical assistance
• Certification, accreditation, and regulation
• Consumer incentives and benefit designs
• Workforce development
The strategic levers are also summarized in Exhibit 27–2.
The Agency has included a phrase for each lever, as follows, to better describe how the levers
work should work. Table 27–1 illustrates the appropriate phrase for each of the nine levers.78
Why Are the NQS Levers Important?
The levers are important because they show how all aspects of value-based and quality programs
fit into the national strategic plan. We can recognize one or more of these nine levers in each of
the private and public sector value-based efforts that are discussed within this chapter.
How Do CMS Quality Strategy and Goals Fit into the National Strategy?
CMS quality strategy coordinates with the national quality strategy’s priorities. In other words,
the CMS strategy fits into the national
strategy because CMS has adopted the
NQS priorities as the six CMS goals. A
description of this sequence follows.
National Quality Strategy Priorities Are
Converted into Domains
In order to implement these priorities,
they are converted into domains. Six
domains represent the priorities of the
NQS. These domains, as described in the
CMS Quality Strategy, are as follows:79
• Efficiency and Cost Reduction
Domain
• Care Coordination Domain
Nine levers that can be activated for
strategic alignment:
1. Measurement & feedback
2. Payment
3. Health information technology
4. Innovation & diffusion
5. Public reporting
6. Learning & technical assistance
7. Certification, accreditation, & regulation
8. Consumer incentives & benefit designs
9. Workforce development
Exhibit 27–2 Nine Strategic Levers
Value-Based Strategic Planning by the Public Sector 351
The Lever How It Should Work
Measurement and Feedback Provide performance feedback to plans and providers to improve care
Payment Reward and incentivize providers to deliver highquality, patient-centered care
Health Information Technology Improve communication, transparency, and efficiency for better coordinated health and health care
Innovation and Diffusion Foster innovation in healthcare quality improvement and facilitate rapid adoption within and across
organizations and communities
Public Reporting Compare treatment results, costs, and patient experience for consumers
Learning and Technical Assistance Foster learning environments that offer training,
resources, tools, and guidance to help organizations achieve quality improvement goals
Certification, Accreditation, and Regulation Adopt or adhere to approaches to meet safety and
quality standards
Consumer Incentives and Benefit Designs Help consumers adopt health behaviors and make
informed decisions
Workforce Development Investing in people to prepare the next generation
of healthcare professionals and support lifelong
learning for providers
Reproduced from The National Quality Strategy: Fact Sheet, AHRQ Publication No. 14-M006-EF, www.ahrq.gov/workingforquality/nqs
/nqsfactsheet.htm
Table 27–1 How the Strategic Levers Should Work
• Clinical Quality of Care Domain
• Safety Domain
• Person and Caregiver Centered Experience and Outcomes Domain
• Population and Community Health Domain
Detail for each of these domains is contained in Table 27–2.
Strategic Goals for Quality
This section discusses various national and agency aspects of strategic goals.
Linking National and CMS Strategies
To take this coordination a step further, CMS has adopted the domains just described as its
“framework for measurement.” This methodology is important because it links NQS strategy—
and resulting domains—directly and efficiently to CMS strategic goals and their measurement.
Thus, each National Quality Priority Domain as just described is linked to a specific CMS Quality Strategy Goal. In other words, six national domains equal six CMS goals. Details for each of
these CMS goals are contained in Table 27–3.
352 Chapter 27 Understanding Value-Based Health Care
National Priority Domains Details
Efficiency & Cost Reduction Cost
Efficiency
Appropriateness
Care Coordination Patient and family activation
Infrastructure and processes for care coordination
Impact of care coordination
Clinical Quality of Care Care type (preventive, acute, post-acute, chronic)
Conditions
Subpopulations
Safety All-cause harm
HACs
HAIs
Unnecessary care
Medication safety
Person and Caregiver Centered Experience
and Outcomes
Patient experience
Caregiver experience
Preference and goal-oriented care
Population and Community Health Health behaviors
Access
Physical and social environment
Health status
Table 27–2 National Quality Strategy Priorities Are Converted to Domains
Table 27–3 National Quality Strategy Domains Are Linked to CMS Quality Strategy Goals
National Priority Domains CMS Goals
Efficiency & Cost Reduction Make care affordable
Care Coordination Promote effective communication & coordination
of care
Clinical Quality of Care Promote effective prevention & treatment of
chronic disease
Safety Make care safer by reducing harm caused while
care is delivered
Person and Caregiver Centered Experience and
Outcomes
Help patients & their families be involved as
partners in their care
Population and Community Health Work with communities to help people live
healthily
More About CMS Strategic Quality Measure Development
This chapter provides an overview of NQS Priorities and Domains. The national priorities
are converted into six national domains (see Table 27–2). This chapter also shows how these
Value-Based Strategic Planning by the Public Sector 353
domains can then be linked to CMS goals (see Table 27–3). (Note that CMS goals are part
of CMS’s own quality strategy.) (Also note that Exhibits 27–1 and Table 27–1 in this chapter
address another aspect of strategic planning. These two exhibits describe “levers” that can be
activated to better achieve important strategic alignment.)
CONCLUSION: THE FUTURE
This section contains a brief look into the future.
Required Implementation Changes Still to Come
Future legislative and regulatory changes will certainly occur. Some are predictable at this time,
while others are not. At the time of writing, for example, we cannot reasonably predict the
direction that multiple value-based alternative payment models may take. Likewise, we cannot
predict the outcome over the next few years of the current multiple challenges to other aspects
of healthcare legislation.
Leadership: The Essential Ingredient
One thing is clear, however. If an organization is to meet its value-based goals, leadership
support and encouragement is essential. This quote sums it up very well: “[T]he investment
required is as much in leadership as in dollars.”80
The “Glide Path”
In conclusion, we expect interpretations of the various value-based and health information
technology strategic priorities, along with their supporting rules and regulations, to emerge
over a considerable period of years. A formidable base of knowledge has been laid as a foundation for these directions. One official, who must have had an aviation background, was reported
to have said we were now on the “glide path” to success in the area of health information technology, meaning that the sailing (or flying) would be smooth from now on. We hope he was
correct.
INFORMATION CHECKPOINT
What is needed? A descriptive document about value-based health care.
Where is it found? In the planning office or in the financial division; possibly on
the organization’s website. (But be careful not to borrow
proprietary information that belongs to the organization.)
How is it used? Its use depends upon the item you have found. Potential uses
include strategic planning or an analysis of potential financial impacts. Other uses could be for informational or
educational purposes.
354 Chapter 27 Understanding Value-Based Health Care
KEY TERMS
Alternative Payment Model
(APM)
Electronic Health Record
(EHR)
Eligible Professional (EP)
IMPACT Act
MACRA
Meaningful Use (MU)
Merit-Based Incentive
Payment System (MIPS)
Value-Based Program
(VBP)
Value Modifier (VM)
OTHER ACRONYMS
ESRD-QIP: End-Stage Renal Disease Quality Initiative Program
HAC: Hospital Acquired Conditions Program
HIQRP: Hospital Inpatient Quality Reporting Program
HHQRP: Home Health Quality Reporting Program
HHVBP: Home Health Value-Based Program
HOQR: Hospital Outpatient Quality Reporting Program
HQRP: Hospice Quality Reporting Program
HRR: Hospital Readmission Reduction Program
HVBP: Hospital Value-Based Purchasing Program
IRF-QRP: Inpatient Rehabilitation Facility Quality Reporting Program
LTCH-QRP: Long-Term Care Hospital Quality Reporting Program
PQRS: Physician Quality Reporting System
PVBM: Physician Value-Based Modified Program
SNFVBP: Skilled Nursing Facility Value-Based Program
DISCUSSION QUESTIONS
1. Using your organization as a point-of-reference, how would you define “value-based
care”?
2. If senior management appointed you to chair a committee to adopt such a concept,
whom would you include?
3. How would you describe a patient-centered view of value?
4. Identify the essential elements of a National Quality Strategy. Describe how they are
interrelated.
5. Describe the recent key elements to legislative reform of the Medicare payment structure.
6. Why are value-based digital outcomes important for healthcare providers?
NOTES
1. Mayo Clinic, “Quality at Mayo Clinic: 2013 Update: How the Mayo Value Creation System Is Improving Patient Care,” publication # MC6312-33rev0413, www.mayo.edu/pmts
/mc6300-mc6399/mc6312-33.pdf, accessed April 14, 2016.
Notes 355
2. C. Weaver, “A Health-Care Model in Coal Country,” The Wall Street Journal, September
27, 2015.
3. Cleveland Clinic, “Center for Value-Based Care Research,” https://my.clevelandclinic
.org/services/medicine-institute/research/Center-for-Value-Based-Care-Research,
accessed April 14, 2016.
4. Brigham and Women’s Hospital, “Patient-Centered Comparative Effectiveness Research
Center,” www.brighamandwomens.org/research/centers/pcerc/default.aspx, accessed
April 14, 2016.
5. Dartmouth-Hitchcock, “Our Collaborations,” www.dartmouth-hitchcock.org/about
_dh/what_is_population_health.html, accessed April 14, 2016.
6. National Comprehensive Cancer Network, “About NCCN,” www.nccn.org/about
/default.aspx, accessed April 14, 2016.
7. Centers for Medicare and Medicaid Services [CMS], “CMS’ Value-Based Programs,”
https://www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments
/Value-Based-Programs/Value-Based-Programs.html
8. CMS, “Hospital Value-Based Purchasing,” last modified October 30, 2015, https://www
.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/hospital-value
-based-purchasing/index.html?redirect=/Hospital-Value-Based-Purchasing/
9. CMS, “Readmissions Reduction Program (HRRP),” last modified April 18, 2016,
https://www.cms.gov/medicare/medicare-fee-for-service-payment/acuteinpatientpps
/readmissions-reduction-program.html
10. CMS, “Hospital-Acquired Condition (HAC) Reduction Program,” www.cms.gov/Medicare
/Quality-Initiatives-Patient-Assessment-Instruments/Value-Based-Programs/HAC
/Hospital-Acquired-Conditions
11. CMS, “The Value Modifier (VM) Program,” https://www.cms.gov/Medicare/Quality
-Initiatives-Patient-Assessment-Instruments/Value-Based-Programs/VMP/Value
-Modifier-VM-or-PVBM.html
12. CMS, “The Skilled Nursing Facility Value-Based Purchasing Program (SNFVBP),”
https://www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments
/Value-Based-Programs/Other-VBPs/SNF-VBP.html
13. CMS, “The Home Health Value-Based Purchasing (HHVBP) Model,” https://www
.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/Value-Based
-Programs/Other-VBPs/HHVBP.html
14. CMS, “End-Stage Renal Disease (ESRD) Quality Incentive Program (QIP),” https://
www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/Value
-Based-Programs/Other-VBPs/ESRD-QIP.html
15. CMS, “What Are the Value-Based Programs?” www.cms.gov/Medicare/Quality
-Initiatives-Patient-Assessment-Instruments/Value-Based-Programs/MACRA-MIPS
-and-APMs
16. U.S. Department of Health and Human Services, “HHS Reaches Goal of Tying 30 Percent of Medicare Payments to Quality Ahead of Schedule, March 2016, www.hhs.gov
/about/news/2016/03/03/hhs-reaches-goal-tying-30-percent-medicare-payments-quality
-ahead-schedule.html
17. Ibid.
18. The Dartmouth Institute, “The TDI Certificate in the Fundamentals of Value-Based
Health Care,” accessed April 14, 2016, www.tdiprofessionaleducation.org/tdi-certificate
-program.html
356 Chapter 27 Understanding Value-Based Health Care
19. Cleveland Clinic Center for Continuing Education, “Disease Management Clinical
Decisions: Value-Based Health Care,” www.clevelandclinicmeded.com/online/casebased
/decisionmaking/value-based-care, accessed April 14, 2016.
20. Cleveland Clinic Patient and Family Health Education Center, “Diseases and Conditions: Value-Based Care,” https://my.clevelandclinic.org/health/diseases_conditions
/hic-value-based-care, accessed April 14, 2016.
21. MLN Homepage, Centers for Medicare and Medicaid Services, www.cms.gov/outreach
-and-education/medicare-learning-network-min/mingeninfo/index.html, accessed
September 17, 2016.
22. CMS, “EHR Incentive Programs: Getting Started,” www.cms.gov/Regulations-and-Guidance
/Legislation/EHRIncentivePrograms/Getting-Started.html
23. CMS, “What Are the Value-Based Programs?”
24. Ibid.
25. P.L. 114-10 (April 16, 2015) 129 STAT 121
26. B. Ahier, “Meaningful Use Isn’t Quite Dead Yet,” March 1, 2016, www.healthdata
management.com/opinion/meaningful-use-isnt-quite-dead-yet
27. Ibid.
28. CMS, “IMPACT Act Spotlights and Announcements,” last modified August 31, 2016, https://
www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/Post-Acute
-Care-Quality-Initiatives/IMPACT-Act-of-2014/Spotlights-and-Announcements-.html
29. Ibid.
30. P.L. 113-185 Sec. 2(g)(1) (October 6, 2014).
31. Integrated Healthcare Association, “Fact Sheet: Value Based Pay for Performance in California,” September 2015, www.iha.org/sites/default/files/resources/vbp4-fact-sheet
-final-20150925.pdf
32. Ibid.
33. National Committee for Quality Assurance, “About NCQA,” www.ncqa.org/about-ncqa,
accessed May 18, 2016.
34. 80 Federal Register (FR) 22067 (April 20, 2015).
35. Adapted from CMS, “CMS Quality Measure Development Plan (MDP),” December 18,
2015, page 8.
36. Integrated Healthcare Association, “Fact Sheet: Total Cost of Care,” April 2015, www.iha
.org/sites/default/files/resources/fact-sheet-total-cost-of-care-2015.pdf
37. Integrated Healthcare Association, “Results and Public Reporting,” accessed May 9,
2016, www.iha.org/our-work/accountability/value-based-p4p/results-public-reporting
38. Integrated Healthcare Association, “Fact Sheet: Total Cost of Care.”
39. Cleveland Clinic, “Facts + Figures: 2015 Year-End,” updated March 16, 2016, https://
newsroom.clevelandclinic.org/wp-content/uploads/sites/4/2016/4/16-CCC-332-Facts
-and-Figures_04.01.2016.pdf
40. Health Affairs, “Health Policy Briefs: Public Reporting on Quality and Costs,” March 8,
2012, www.healthaffairs.org/healthpolicybriefs/brief.php?brief_id=65
41. Medicare.gov, “What is Hospital Compare?” www.medicare.gov/hospitalcompare
/About/What-Is-HOS.html, accessed May 10, 2016.
42. Medicare.gov, “What Information Can I Get About Hospitals?” www.medicare.gov
/hospitalcompare/About/Hospital-Info.html, accessed May 10, 2016.
43. Ibid.
Notes 357
44. Medicare.gov, “About Physician Compare,” www.medicare.gov/physiciancompare
/staticpages/aboutphysiciancompare/about.html, accessed May 10, 2016.
45. Medicare.gov, “Information Available on Physician Compare,” www.medicare.gov
/physiciancompare/staticpages/aboutphysiciancompare/informationavailable,
accessed May 10, 2016.
46. Medicare.gov, “About the Data,” www.medicare.gov/physiciancompare/staticpages/data
/aboutthedata.html, accessed May 10, 2016.
47. Medicare.gov, “What is Nursing Home Compare?” www.medicare.gov/nursinghomecompare
/About/What-Is-NHC.html, accessed May 10, 2016.
48. Medicare.gov, “What are the 5-Star Quality Ratings?” www.medicare.gov/Nursing
HomeCompare/About/Ratings.html, accessed May 10, 2016.
49. Medicare.gov, “Strengths and Limitations,” www.medicare.gov/NursingHomeCompare
/About/Strengths-and-Limitations.html, accessed May 10, 2016.
50. Medicare.gov, “What is Home Health Compare?” www.medicare.gov/homehealthcompare
/About/What-Is-HHC.html, accessed May 10, 2016.
51. Medicare.gov, “What Information Can I Get About Home Health Agencies?” www.medicare
.gov/HomeHealthCompare/About/What-Information-Is-Available.html, accessed May
10, 2016.
52. Medicare.gov, “Quality of Patient Care Star Ratings,” www.medicare.gov
/HomeHealthCompare/About/Patient-Care-Star-Ratings.html, accessed May 10, 2016.
53. Health Affairs, “Health Policy Briefs: Public Reporting on Quality and Costs,”
www.healthaffairs.org/healthpolicybriefs/brief.php?brief_id=65, accessed March 8,
2012.
54. Utah Department of Health, “Public Health Outcome Measures Report,” April 2014,
http://ibis.health.utah.gov/phom/Introduction.html
55. L. S. Kaiser and T. H. Lee, “Turning Value-Based Health Care into a Real Business
Model,” Harvard Business Review, October 8, 2015, https://hbr.org/2015/10/turning
-value-based-health-care-into-a-real-business-model
56. Ibid.
57. Duke University Health System, “Duke Human Resources: About Duke University
Health System,” https://www.hr.duke.edu/jobs/duke_durham/duhs.php, accessed
May 10, 2016.
58. Duke University Health System, “Duke Starts to Transfer to Digital Electronic Health
Records,” www.wral.com/lifestyles/goaskmom/blogpost/11364264/?comment_order
=forward, accessed September 17, 2016.
59. Duke University Health System, “Duke Medicine Completes Implementation of Electronic
Health Records Across All Outpatient Facilities and Duke University Hospital,” http://
corporate.dukemedicine.org/news_and_publications/news_office/news/duke-medicine
-completes-implementation-of-electronic-health-records-across-all-outpatient-facilities
-and-duke-university-hospital/view, accessed May 18, 2016.
60. D. Ranii, “Duke Kicks Off Digital Health Records Plan,” www.ecu.edu/cs-admin/news
/clips/upload/071812.pdf, accessed September 17, 2016.
61. Ibid.
62. Kaiser Permanente, “Who We Are,” www.kaiserpermanentejobs.org/who-we-are.aspx,
accessed May 19, 2016.
358 Chapter 27 Understanding Value-Based Health Care
63. Kaiser Permanente, “About Us: Connectivity,” https://share.kaiserpermanente.org
/total-health/connectivity/, accessed May 19, 2016.
64. InfoWorld, “How Kaiser Bet $4 Billion On Electronic Health Records—And Won,” May
2, 2013, http://www.infoworld.com/article/2614353/ehr/how-kaiser-bet–4-billion-on
-electronic-health-records—-and-won.html
65. Ibid.
66. Duke University Health System, “Duke Medicine Completes Implementation.”
67. Duke University Health System, “Duke’s New Medical Records System Improves Patient
Experience,” http://corporate.dukemedicine.org/news_and_publications/news
_office/news/duke-s-new-medical-records-system-improves-patient-abilities-and-access
-to-providers, accessed May 19, 2016.
68. Duke University Health System, “Duke Medicine Completes Implementation.”
69. Kaiser Permanente, “Patient Access to Online Health Action Plans Enhances Rate of
Preventive Care,” https://share.kaiserpermanente.org/article/patient-access-to-online
-health-action-plans-enhances-rate-of-preventive-care/, accessed May 19, 2016.
70. Kaiser Permanente, “About Us: Connectivity.”
71. Z. Budryk, “How Value-Based Care Will Change Healthcare,” September 26, 2013,
http://www.fiercehealthcare.com/healthcare/how-value-based-care-will-change
-healthcare/
72. Cleveland Clinic, “Diseases and Conditions: Value-Based Care.”
73. Mayo Clinic, “Quality at Mayo Clinic.”
74. Dartmouth-Hitchcock, “What Is Population Health?” www.dartmouth-hitchcock.org
/about_dh/what_is_population_health.html, accessed April 14, 2016.
75. Ibid.
76. U.S. Department of Health and Human Services, “The National Quality Strategy:
Fact Sheet,” last updated September 2014, www.ahrq.gov/workingforquality/nqs
/nqsfactsheet.htm
77. Ibid.
78. Ibid.
79. 80 FR 68667 (November 5, 2015).
80. L. S. Kaiser and T. H. Lee, “Turning Value-Based Health Care into a Real Business
Model.”
Notes 359

361
Progress Notes
© LFor/Shutterstock
New Payment Methods and Measures:
MIPS and APMs for Eligible Professionals
INTRODUCTION
This chapter explores how new payment methods and quality measures work for physicians and other eligible professionals. The chapter has several parts, as follows, and each
part contributes to an understanding of the choices among
MIPS, APMs, and the related measures that determine their
payment. Chapter parts include the following:
• Overview of MACRA and the payment choices that
must be made
• Choice #1 is for MIPS incentives: how this choice is
structured, who is eligible for MIPS, and facts about
payment and reporting
• Details of the MIPS scoring process and how the
scores become payment adjustments for the individual practitioner
• Details about the MIPS performance categories, how
the related quality measures are created, and their
timelines
• Choice #2 is for APM incentives: how this choice is
structured, the various APM models, and facts about
payment and reporting
• Details about the Advanced APM participation
requirements and scoring standards
In conclusion, two reference sections are included: one for
the three incentive programs as they existed before MIPS
and one for existing alternative payment models.
This chapter should be read in conjunction with the
preceding chapter, “Understanding Value-Based Health
Care and Its Financial and Digital Outcomes.” While this
chapter describes how MIPS and APMs work, the preceding
chapter provides a view of the healthcare industry’s overall
After completing this chapter,
you should be able to
1. Distinguish between the two
pay-for-performance choices
in the Quality Payment
Program.
2. Recognize the three existing
incentive programs that were
combined into MIPS.
3. Identify the four MIPS
performance categories.
4. Describe how the MIPS
Composite Performance Score
uses weighted averages.
5. Identify the Advanced APM
“significant participation”
requirements.
6. Understand the Scoring
Standards for APMs.
7. Discuss the framework for
MACRA Quality Measurement.
28
CHAPTER
value-based effort, along with the legislative sequence that came before the MACRA requirements. (See the section entitled “Value-Based Legislative Reform” in the preceding chapter.)
LEGISLATIVE REFORM AND MACRA: AN OVERVIEW
This section provides an overview of legislative reform as it pertains to MACRA.
The Legislative Act
The Medicare Access and CHIP Reauthorization Act of 2015 (MACRA) was signed into law on
April 16, 2015. The law is grouped into categories, and each category is identified by a title number and heading. This chapter concerns new pay-for-performance incentives (MIPS and APMs)
for physicians and other eligible professionals, which is located under Title I.1
The Repeal of SGR
Repeal of the Sustainable Growth Rate, or SGR, is a true legislative reform. The short history of
SGR that follows explains why reform was necessary.
The SGR was a formula used to calculate Medicare payments to physicians. Each year, the
formula compared increases or decreases in physician spending to increases or decreases in the
gross domestic product (GDP). If the GDP increase exceeded the increase in physician spending, then the physicians’ base rate payment amount would increase. However, if the physicians’
spending increase exceeded the increase in the GDP, then the physicians’ base rate payment
amount would decrease.
An abbreviated SGR timeline looks like this:
1997: The SGR formula came into existence.
2002: The formula results in a 4.8% cut in the Medicare base payment rate (a wake-up call).
2003: A law blocking the formula’s cuts was passed.
2004–2005: Congress passes annual “fixes” that disregard the formula’s cuts.
2006: Another law was passed that made the annual cuts cumulative.
2009–2010: Congress passes annual “fixes” that disregard the cumulative cuts.
2015: The SGR formula is repealed by law.2
The problem with cumulative annual cuts is the resulting excessive reduction in base payment rates. This meant, for example, if last year’s blocked cut was 4% and this year’s cut was 5%,
then the pay cut would now amount to a cumulative total cut of 9%, and so on, year after year.
Basically, at this point the SGR formula was broken. It was not sustainable. And to repeal it
and replace the long-standing SGR formula with an entirely different approach to physician
payment, as MACRA does, is true legislative reform.
New Pay-for-Performance Incentives (MIPS and APMs)
MACRA provides new physician pay-for-performance incentives that replace the repealed
SGR formula. There are two methods, or types, of participation. The first type of
362 Chapter 28 New Payment Methods and Measures
participation is in the new Merit-Based Incentive Payment System, or MIPS. The second type
allows incentive payments when requirements are met to be a qualifying participant in an
Advanced Alternative Payment Model (APM).3 The two payment methods and their related
performance measures and/or requirements are described in the following sections of this
chapter.
Other Provisions of the Act
As previously explained, subjects covered by this law are grouped into categories, and each
category is identified by a title number and heading. Four other categories, and titles, are
included in the Act. Title II concerns “extenders”; in other words, a series of programs and
other funding efforts receive an extension within this title. Title III concerns an extension, or
reauthorization, of the Children’s Health Insurance Program (CHIP). (You will notice that
CHIP is in the title of the law.) Title IV concerns offsets; these include certain limitations,
updates and adjustments. The final Title V is labelled as “miscellaneous” and covers an array of
other various subjects.4
PAYMENT CHOICES: MIPS VERSUS APMs
MACRA provides for two value-based pay-for-performance initiatives: MIPS and APMs. The
new name for this overall payment approach is the Quality Payment Program. In other words,
the Quality Payment Program includes both MIPS and APM types of incentive payments.
Because MACRA provides two choices for payment, eligible professionals must generally opt for
one or the other of these choices. Figure 28–1 illustrates the two choices. Note that the start date
(“Year 1”) for both MIPS and APM incentive payments is 2019.
MIPS INCENTIVES
This section describes the MIPS payment structure and those eligible professionals who may be
included and/or excluded from this initiative.
Figure 28–1 Physicians Can Choose One of Two Pay-for-Performance Incentive Tracks.
Track # 1
Merit-Based Incentive
Payment System
(MIPS)
Track #2
Alternative Payment
Models (APM)
Beginning
In
Year 1
MIPS Incentives 363
MIPS Payment Structure
The MIPS payment structure consists of modified inputs from three existing programs, plus one
new category. The three existing incentive programs whose modified measures are combined
into MIPS inputs are described below. The fourth, new MIPS category is called Clinical Practice
Improvement Activities. It is further described later in this chapter. Figure 28–2 illustrates the
four elements that provide inputs for the MIPS payment structure as of 2019.
Three Existing Incentive Programs Are Combined into MIPS
Many modified features of three existing incentive programs are combined into MIPS. They
include the: Physician Quality Reporting System (PQRS) program, the Value Modifier program,
and the Meaningful Use and Electronic Health Records Initiative.
These Three Programs End as Stand-Alones as MIPS Begins
At the time of this writing, payments will end in 2018 for these three programs. In other words,
these programs became obsolete because the new Quality Payment Program (including both
MIPS and APMs) takes over. Figure 28–3 illustrates the changeover.
The payment penalties associated with the three existing incentive programs will also disappear as features of the programs are rolled into the MIPS payment structure. Figure 28–4
illustrates the dissolution of such penalties.
Figure 28–2 Four Pay-for-Performance Inputs Are Combined into MIPS.
Physician
Quality
Reporting
System
(PQRS)
Physician
Value-Based
Payment
Modifier
(VBPM)
Meaningful Use
Electronic
Health
Records
(MU/EHR)
Clinical
Practice
Improvement
Activities
As of 2019
Inputs Combined Into The
Merit-Based Incentive
Payment System
(MIPS)
Existing New
364 Chapter 28 New Payment Methods and Measures
Eligible Professionals for MIPS
This section describes both eligible professionals included and excluded from MIPS as follows.
Note that the Centers for Medicare and Medicaid Services (CMS) have chosen to use the term
“eligible clinicians” instead of “eligible professionals.” The description below uses the legislative
term “eligible professionals.”
Figure 28–3 Three Incentive Program Payments End as MIPS Is Established in 2019.
Three Incentive Payments End
PQRS
VM
Meaningful
Use of EHR
MIPS Payment Is
Established
in
2019
Figure 28–4 Some Payment Penalties Disappear at the End of 2018.
Some Payment Penalties
Disappear at the end of 2018
2% Penalty for failure
to report PQRS quality
measures ends
3% Penalty for failure to
meet EHR meaningful use
requirements ends
Certain penalties
(“negative modifiers”)
associated with ValueBased Modifier end
MIPS Incentives 365
Eligible Professionals Categories Subject to MIPS Will Increase
Five categories of eligible professionals (EPs) are
subject to MIPS for the first two payment years.
As of the third year, however, the Secretary has
the right to add other types of eligible professionals, and eight more professional categories
have been suggested for addition in the third
year. Exhibit 28–1 lists the five EPs types included
in years one and two, plus the eight types that
have been suggested beginning in year three.
Who May Be Excluded from MIPS?
As discussed previously, physicians and certain other eligible professionals have a choice
between two payment methods; either MIPS or
APMs. Therefore, certain eligible professionals who chose the APM methods may also be
excluded from MIPS. In addition, some professionals will fall below the low-volume threshold
and will be excluded. (The low-volume threshold
is discussed in more detail in a following section
of this chapter.) Finally, an eligible professional
who is in the first year of participation in Medicare may be excluded from MIPS. Exhibit 28–2
illustrates some reasons for exclusion.
HOW ARE MIPS PHYSICIANS
AND OTHER ELIGIBLE
PROFESSIONALS PAID?
This section summarizes performance scores
and payment adjustments.
EPs Are Scored on Performance
Eligible professionals for MIPS are scored
on performance. Their performance will be
rated on a scale that ranges from maximum
positive to neutral to maximum negative.
Summary of MIPS Payment Adjustments
and Their Timelines
MIPS EPs receive an automatic base increase
of 0.5% from 2015 through 2019. At the time
Exhibit 28–1 MIPS Eligible Professionals
Inclusion Varies by Timeline
Definitely Included
For Years One & Two (2019 & 2020)*
• Physician
• Physician assistant
• Nurse practitioner
• Clinical nurse specialist
• Certified registered nurse
anesthetist
• Groups that include such professionals
Possibly Included
From the third year onward (2021)*
• The Secretary can add other EPs
such as:
• Physical therapists
• Occupational therapists
• Certified audiologists
• Clinical psychologists
• Speech-language pathologists
• Clinical social workers
• Nurse midwives
• Dietitians or nutrition professionals
*Timeline may change
SSA Section 1848 (g)(1)(c)(i)
Exhibit 28–2 Professionals Who May Be
Excluded from MIPS
An eligible professional may be
excluded from MIPS if he or she:
• Is a qualifying APM participant
• Is a partial-qualifying APM
participant
• Is below the low-volume threshold
for the performance period
• Is in the first year of Medicare
participation
SSA Section 1848 (g)(1)(c )(ii)
366 Chapter 28 New Payment Methods and Measures
of this writing there is zero automatic base increase from 2020 through 2025, with a 0.25%
increase applied from 2026 onward.
These EPs are then at risk for performance adjustments to their payments beginning in 2019.
These payments are budget neutral. That means the total dollars paid out to successful providers will equal total dollars that reduce payments to unsuccessful providers. Thus, the budget
neutral payments range from 4% maximum and minimum in 2019 increasingly upward to 9%
maximum and minimum in 2025. The payment percentage amounts by year are illustrated
in Figure 28–5.
MACRA also allows an extra bonus for exceptional performance. The bonus amount of $500
million dollars is exempt from budget neutrality and can be paid out over the first five years of the
program. Participants become eligible for the bonus based on increases in their MIPS performance
scores. (The scoring increase for exceptional performance is topped at an additional 10%.)5
MIPS COMPOSITE PERFORMANCE SCORE
This section provides an overview of the MIPS composite performance score.
Payment Adjustment Is Determined by Four Performance Categories Within the
Composite Performance Score
The MIPS composite performance score (CPS) consists of four parts. Each part is a separate
performance category within the composite score. (Note that some of their descriptive titles
have changed, as indicated.)
• Quality
• Advancing Care Information (a.k.a. Meaningful Use of Electronic Health Records)
• Clinical Practice Improvement Activities
• Cost (a.k.a. Resource Use)
Each part (category) of the score is discussed in more detail in the following sections.
Figure 28–5 MIPS Payment Adjustments and Timelines.
Modified from CMS, “Path to Value: The Medicare Access & CHIP Reauthorization Act of 2015,” p. 9 and p. 18.
MIPS Payment Adjustment Timelines
MIPS 2015–2018* 2019 2020 2021 2022–2024 2025 2026 & Onward
(1) Automatic** Base Increase 0.5% 0.5% 0.0% 0.0% 0.0% 0.0% 0.25%
PLUS (2) Three Levels of
Performance Adjustments at RISK
Maximum Positive Adjustment*** +4% +5% +7% +9% +9%
Neutral Adjustment 0.0% 0.0% 0.0% 0.0% 0.0%
Maximum Negative Adjustment*** –4% –5% –7% –9% –9%
*Note: PQRS, VM, and EHR remain in effect for the period 2015 to 2018.
**Automatic annual base conversion factor increase of 0.5% also in effect for period 2015–2018.
***Annual totals must be budget neutral.
MIPS Composite Performance Score 367
The payment adjustment illustrated in Figure 28–5 begins with the clinician’s (or group’s)
CPS. The CPS is a unified scoring system that converts measures and/or activities into points,
allows partial credit, and provides advance information about what is needed for top-performance scoring.
MIPS Scoring Uses Weighted Averages
MIPS scoring uses weighted averages within the CPS that will change the performance
categories weighting from year to year. Figure 28–6 illustrates these changes. The figure
shows how the distribution of weighted averages may shift from 2019 to 2021. In other words,
the two years in this illustration show a different set of weighted averages among the four
categories.
MIPS PERFORMANCE CATEGORIES
Each performance category is made up of a series of individual measures. The clinician chooses,
within limits, which measures to report within each category. A brief summary about each category follows. The four categories are also illustrated in Figure 28–7.
Quality
This category contains streamlined measures from the PQRS and the Quality portion of the
Value Modifier (VM) program. Required reporting for this category consists of six measures,
rather than the nine measures previously required by PQRS. There is also more emphasis on
outcome measurement. The Year 1 proposed weight of 50% subsequently became 60%.
As initially proposed, the eligible clinicians (EPs) or groups are allowed to choose the six
measures that best reflect their practice. There are certain limitations to this choice. Of the six,
one has to be either an outcome or a high-quality measure, and another has to be a crosscutting measure. (A crosscutting measure is one that can be applied across a number of providers
and/or specialties; thus, these measures “cut across.”) There is another available choice for
specialists: they can choose a set of measures related to their particular specialty.6
Figure 28–6 Weighted Averages for the MIPS Score Measures as Initially Proposed.
50%
25%
15%
10%
30%
15% 25%
30%
2019
Quality
Meaningful EHR Use*
Clinical Improvement
Resource Use
2021
Quality
Meaningful EHR Use*
Clinical Improvement
Resource Use
*As modified: now known as “Advancing Care Information”
368 Chapter 28 New Payment Methods and Measures
Advancing Care Information (also known as Meaningful Use of Electronic Health
Records)
Meaningful use has gained a new name: Advancing Care Information (ACI). The ACI measures,
originally derived from the Meaningful Use EHR program, have been modified and streamlined
for use within MIPS. Quarterly reporting has been eliminated, as has the “all-or-nothing” threshold measurement of electronic health record (EHR) technology. Redundant measures and two
objectives have been eliminated to reduce the reporting burden. The Year 1 weight is 25%.
For purposes of MIPS reporting, eligible clinicians or groups can choose measures that are
most important within their practice. These customized choices will represent key measures
of interoperability and information exchange. Flexible scoring has been implemented for all
measures. The flexibility will help to promote care coordination. Thus better care coordination
should result in better patient outcomes.7
Clinical Practice Improvement Activities (CPIA)
The new Clinical Practice Improvement performance category contains six types of activities
proposed for Year 1:
• Expanded Practice Access
• Population Management
Figure 28–7 MIPS Performance Categories.
Quality
Streamlined measures
from PQRS & Quality
portion of VM
Cost*
Replaces cost portion of
Value Modifier Program
Advancing Care
Information**
Streamlined measures
from Meaningful Use
EHR Program
Clinical Practice
Improvement
Activities
New category with 6
activities & 90 options
*Cost a.k.a. Resource Use
**Advancing Care Information a.k.a. Meaningful Use
MIPS Performance Categories 369
• Care Coordination
• Beneficiary Engagement
• Patient Safety and Practice Access
• Participation in an APM
The Year 1 weight is 15%.
The CMS proposed rule sets out measures of more than 90 activities within this category.
Eligible clinicians or groups can choose six measures among these that best reflect goals for the
practice. (At least one activity must be chosen in order to avoid a zero score.)8
Cost (also known as Resource Use)
The cost category will assess all the applicable resource use measures that are applicable to the
particular clinician or group. This category replaces the cost portion of the Value Modifier
program. Over 40 episode-specific measures have been added in order to address specialty concerns. Year 1 weight proposed at 10% subsequently became zero.
The eligible clinician or group does not have to report measures for this category. Instead,
CMS performs the calculation. To do so, CMS will compare resource use across practices that
involve similar care episodes and similar clinical condition groups.9
HOW MIPS SCORING WORKS
The clinician’s (or group’s) chosen measures, as reported, are accumulated into annual totals.
The clinician’s totals from each category’s measures as reported are converted into points.
How Do Points Earned Become Percentage Scores?
The next step is for points earned to become percentage scores. You will recall that there
are weighted averages within the composite performance score. Figure 28–6 illustrates these
weights for both 2019, which is Year 1 for the Quality Payment Program and MIPS, and for 2021.
Accordingly, the Year 1 maximum score possible for each performance category will equal
that category’s weight within the overall score (the Composite Performance Score). The Year 1
maximum percentage scores are therefore proposed as follows:
Quality = 50%, subsequently changed to 60%.
Advancing Care Information = 25%
Clinical Practice Improvement Activities = 15%
Cost = 10%, subsequently changed to zero.
(Note that these percentages are as shown in Figure 28–6.)
Points are turned into percentage scores in this manner. First, the clinician earns points
by reporting his or her chosen measures for the first three performance categories listed
previously. (You will recall that the “Cost” category does not require the reporting of measures
because it is calculated by CMS from claims and volume information.)
There are a certain number of points needed to reach the maximum score for each of the
first three performance categories listed above. An example follows.
370 Chapter 28 New Payment Methods and Measures
Quality = 80 to 90 points (depending on group size)
Advancing Care Information = 100 points
Clinical Practice Improvement Activities = 60 points
Table 28–1 illustrates the Year 1 proposed percentages and total points as just discussed.
Dr. Brown’s Scores: An Example
The points earned by an individual (or a group) are mathematically converted into the relevant
percentage. For example, Dr. Brown’s practice earns all 60 points in the Clinical Practice Improvement Activities category, so that portion of his weighted composite performance score will be
the full 15%. But due to office staff errors, some measures for the Advancing Care Information
(a.k.a. Meaningful Use) category were not properly reported for part of the performance period.
As a result, Dr. Brown’s practice only earned 50 points, or one-half, of the 100 points that are
needed in order to reach the maximum score. Therefore, his percentage score for this category
will be 12.5%, or one-half of the 25% maximum possible score. (Refer to the left-hand column
in Table 28–1 to further understand the maximum possible scores as expressed in percentages.)
All told, Dr. Brown’s four performance category percentage scores looked like this:
Quality = 37.5%
Advancing Care Information = 12.5%
Clinical Practice Improvement Activities = 15.0%
Cost = 8.0%
The four performance category composite scores would then be converted into a total composite score using the weighted averages as shown in Figure 28–6. How Dr. Brown’s scores affect
his payment adjustment is the subject of the next section.
How Do Scores Become Payment Adjustments?
This section discusses the overall process of computing scores and converting them into payment adjustments.
Table 28–1 MIPS Scoring by Performance Category: An Example
MIPS Performance Category Maximum Possible Score
(stated as a percentage)
Total Points Needed to Reach
the Maximum Score
Quality 50 80 to 90*
Advancing Care Information
(a.k.a. Meaningful Use) 25 100
Clinical Practice Improvement
Activities 15 60
Cost (a.k.a. Resource Use) 10
CMS calculates average score
of all resource measures that
can be attributed
*Depending on group size.
Modified from CMS Quality Program Executive Summary Table 1, p. 10 (May 2016).
How MIPS Scoring Works 371
Measures Are Submitted During the Performance Period
First, the physician (or group) records and submits selected measures during the performance
period. (We have already discussed how each practice can choose measures to report within
the four performance categories. More detail about performance periods appears in a following section.) After all these data are collected, properly reported measures are analyzed and
outcomes are calculated. The resulting computations are then converted into scores and the
scores, in turn, are converted into payment adjustments. An overview of this process follows.
(While the following section provides a general descriptive overview, the actual computations
are quite sophisticated and are beyond the scope of this text.)
Five Steps from Measures to MIPS Payment Adjustment
This section provides a general overview of five steps that would generally convert submitted
measures into MIPS payment adjustments. For purposes of our description, we will assume that
Analyst Jane works for CMS and is going to perform all five steps. (This is not realistic, of course,
as individual teams of analysts would be segmenting the process into individual team responsibilities.) We will also assume that Dr. Brown’s individual composite score is the end result of this
example.
Step 1: First, Analyst Jane and her team will analyze the submitted measures from all over
the country. These represent measures for the Quality, Advancing Care Information, and Clinical Practice Improvement Activities performance categories as submitted during the performance period. The national analysis will, of course, include Dr. Brown’s submitted measures
for the performance period. (The team will also compute relevant benchmarks for comparative
purposes.)
Step 2: Analyst Jane and her team will compute costs and certain other outcomes from CMS
data sources. These calculated outcomes primarily represent the Resource Use (Cost) performance category. (Note that some of these computations may be based on the prior year’s data
rather than performance period data.)
Step 3: Analyst Jane and her team will have already standardized the data from the four performance categories and will have performed a series of statistical analyses. Now they compute
the national means and medians. They divide the results of this analysis into quartiles. Using
the quartile results, they apply standard deviation computations to divide their analysis into
three national tiers. The three tiers are labelled as high, average, and low.
Step 4: Next, Analyst Jane does two things. First, she finds the individual physician or group’s
composite, or multiple-part, performance score. In our example, that would be Dr. Brown’s
composite performance score. Then, she assigns the doctor’s score to one of the three national
tiers. The doctor’s score will thus fall into a high, average, or low tier.
Step 5: Now that Analyst Jane knows which tier Dr. Brown’s score is in, she will compute
the doctor’s payment adjustment. (Her computation must also take budget neutrality into
account.) This payment adjustment will have one of three possible outcomes: it will result in a
positive, neutral, or negative payment adjustment for Dr. Brown.10
Figure 28–8 illustrates the five-step process just described. Note that this process would be
repeated each time a performance period ends. (Note also that the exact process will probably
be modified over time.)
At the time of this writing we understand that first, an eligible MIPS participant should
be able to view preliminary results, and second, that there may be certain appeal rights
established.
372 Chapter 28 New Payment Methods and Measures
MIPS REQUIRED REPORTING AFFECTS PAYMENT
This section discusses required reporting and the related performance periods.
Required Reporting
Reporting on required measures is important because the reported measures directly impact
future payment adjustment amounts. Complete reporting—that is, reporting on every measure
that is has been previously selected—is necessary in order for the measures to be recognized
when they are submitted. In other words, an incomplete set of measures may not be counted.
Accuracy in recording is equally important, of course.
What Is a Performance Period?
A performance period is a designated time span that is used to capture data. The data that are
captured measure how well that facility or professional or group is performing. At the time of
this writing, for example, the MIPS program performance period covers a one-year period, and
that period is a calendar year.11
How Does Performance Period Reporting Affect Payments?
This section discusses the reporting and scoring timeline along with feedback opportunities.
Timeline
The measures reported during a performance period are analyzed to help determine a payment adjustment that is based on quality and value performance. CMS has provided an example of the timeline for the first performance period under MIPS as follows.
The first MIPS performance period, for example, is calendar year 2017. CMS uses the following year (2018 in this example) for analysis and scoring of the data collected in the prior
year. Then the next year (2019 in this example) is when the first MIPS payment adjustments are
made. In other words, the performance period reporting made two years ago directly affects the
payment adjustments received in a current year.12
Feedback
CMS is expected to provide feedback to the physicians and groups who are MIPS participants.
At the time of this writing, the first feedback was anticipated in the middle of the performance
Figure 28–8 How MIPS Scoring Works: An Overview.
Find the individual
physician or group
composite scores
Compute the individual
physician or group
payment adjustment
Assign the score
to
High-Avg-Low
tiers
Results in
Positive
Neutral
Negative
Payment adjustment
Results in
High-Avg-Low
tiers
Analyze submitted
measures
Calculate
outcomes and costs
Find the national
means & quartiles
MIPS Required Reporting Affects Payment 373
period year. (This would give an opportunity for adjustments to the participant’s reporting process.) The second feedback was then anticipated in the middle of the analysis-and-scoring year
(the year in between the performance period and the payment-adjustment year).
Sunsetting Existing Programs
In discussing timelines, it is important to understand that previously existing incentive programs remain in existence for the period 2015 through 2018. During that four-year period,
providers are still being paid under these programs. (The three programs include the PQRS,
the Value-Modifier, and the Meaningful Use of EHR.)
DATA SUBMISSION
This section describes the allowable options proposed for submitting required data.
Individual Reporting
Individuals can choose among various options for data submission. The four performance categories differ somewhat in available options. These differences are described as follows.
Quality Performance Category Options
Data submission choices include submission through EHRs or through a Qualified Registry
or Qualified Clinical Data Registry (QCDR). Claims submitted by providers are also part of
quality data submission, as are administrative claims. (“Administrative claims” means CMS
will perform any needed computations, and no special submission is required from the
participant.)
Advancing Care Information (ACI) Performance Category Options
Submission choices for ACI include through EHRs, a Qualified Registry, or a QCDR. Attestation
is another available choice for this category. Administrative claims are also part of the process,
but, again, no special submission is required.
Clinical Practice Improvement Activities (CPIA) Options
Submission choices for CPIA also include through EHRs, a Qualified Registry, a QCDR, or
through attestation. Once again, administrative claims are part of the process but no action is
required on the part of the participant.
Resource Use (Cost) Performance Category Options
The Resource Use category entirely uses the administrative claims computation process, so no
action at all is required by the participant.13
Group Reporting
Groups have a couple of additional options. In the case of the Quality Performance category,
groups may also choose the CAHPS for MIPS Survey option. Groups of 25 or more may use the
CMS Web Interface when submitting data for the Quality, ACI, and CPIA categories.14
374 Chapter 28 New Payment Methods and Measures
Reporting by Intermediaries
CMS has proposed to allow certain intermediaries to submit performance category data on behalf
of eligible clinicians. At the time of this writing, the allowable intermediaries include health information technology (HIT) vendors who obtain their data from the eligible clinicians’ certified
EHR technology, CMS-approved (certified) survey vendors, Qualified Registries and QCDRs.15
APM INCENTIVES—(CHOICE #2)
These alternative payment models, or APMs, represent innovations in how to compensate physicians and other eligible professionals.
Advanced APMs According to MACRA
MACRA considers the following to be Advanced APMs:
• CMS Innovation Center Models under section 1115A (other than a healthcare innovation
award)
• The Shared Savings Program
• A demonstration under section 1866C
• Demonstrations required by Federal law
These APMs are considered “advanced” because the participants accept risks along with rewards
(the rewards being the incentive payments). To be eligible for such payment, particular criteria
about EHR usage and reporting of quality measures must be met.16
Eligible Advanced APMs Proposed for Year 1
CMS proposes specific criteria for Advanced APMs through rulemaking. These criteria fit within
MACRA’s description of entities as listed above. At the time of writing, the eligible Advanced
APMs proposed for Year 1 are as follows:
• Comprehensive Primary Care Plus (CPC+)
• Medical Shares Savings Programs—Tracks 2 and 3
• Next Generation ACO Model
• Comprehensive End-Stage Renal Disease Care (CEC) Model
• Oncology Care Model
It is important to note that the Comprehensive End-Stage Renal Disease Care Model is a
large dialysis organization arrangement. Likewise, the Oncology Care Model is a two-sided risk
arrangement. Figure 28–9 summarizes these models. It is also important to note that some
changes to the types of Year 1 proposed models may occur before actual implementation.
The eligibility for Advanced APMs will be reviewed annually. Thus, while these models are
proposed for Year 1, we are still at the beginning of this transition to value-based performance
payment models. As such, we can expect a series of modifications, expansions, and revisions
as time goes on. We can therefore expect that the choices among future multiple payment
approaches will increase. We can also expect increased transparency through public reporting
as these models develop and mature.17
APM Incentives—(Choice #2) 375
Other Payer Advanced APMs: An Upcoming Option
Another interesting option is expected to be in effect for payment in 2021. (If so, this means the
relevant performance-reporting period may be two years prior, or 2019.) This proposed option is
another type of APM, called Other Payer Advanced APMs. As the name suggests, data from payers
other than Medicare could be taken into account when determining a provider’s participation
status. These other payers could be either private insurers or particular state Medicaid programs.
Participation requirements for these Other Payer Advanced APMs would be as follows:
• Use certified EHR technology.
• Provide payment based on quality measures that are comparable to measures in the MIPS
quality performance category.
• Bear more than a nominal amount of risk for monetary losses (or be a particular comparable type of Medicaid Medical Home Model.)18
ELIGIBLE PROFESSIONALS WITHIN APMs
Eligible Professionals for APMs fall into one of two categories: Qualifying (QEPs or QPs) and
Partial Qualifying (PQEPs). This distinction is important because APM payment adjustments
and their related timelines vary between QEPs and PQEPs. Also, note that MACRA refers to Eligible Professionals. However, CMS proposes to use a different term within its rule making. The
equivalent CMS term is “Eligible Clinicians.”
Qualifying Eligible Professionals (a.k.a. Qualifying Eligible Clinicians) Defined
Qualifying eligible professionals (QEPs) meet all thresholds (as defined in the scoring section
of this chapter) and are at risk. “At risk” means financially at risk. In other words, the eligible
professional/clinician will bear some financial burden based on performance.
Partial Qualifying Eligible Professionals (a.k.a. Partial Qualifying Eligible Clinicians)
Defined
Partial qualifying eligible professionals (PQEPs) meet slightly reduced thresholds and are at
risk. They also bear some financial burden based on their performance.
Figure 28–9 Advanced Alternative Payment Models (APMs) as Proposed for Year 1.
*Other models may subsequently be included.
**A large dialysis organization arrangement.
***A two-sided risk arrangement.
Advanced Alternative Payment Models (APMs)
As Proposed for Year 1*
Comprehensive
Primary Care
Plus
Medical Shared
Savings
Program-Track 2
Medical Shared
Savings
Program-Track 3
Next
Generation
ACO Model
Comprehensive
End Stage Renal
Disease Care
Model**
Oncology
Care
Model***
376 Chapter 28 New Payment Methods and Measures
The Pathway Toward Becoming a Qualifying APM Participant (QP)
It is important to understand that the EPs/ECs within an Advanced APM entity may collectively
meet the necessary threshold for participation. In other words, everyone who is eligible within
a particular Advanced APM may receive the same score and thus the same payment adjustment. This is a key distinction that can easily be overlooked or misunderstood. The sequence of
progression, or pathway, for eligible clinicians toward becoming a Qualifying APM Participant
(QP) is illustrated in Figure 28–10.
19
Four Steps to Find if the Eligible Clinician Will Become a Qualifying APM
Participant
CMS has published four steps that illustrate whether or not an eligible clinician within an
Advanced APM will become a QP. (Remember that these clinicians will be collectively meeting
the necessary thresholds.) The four steps are as follows:
1. QP determinations are made at the Advanced APM Entity level.
2. CMS calculates a Threshold Score for each Advanced APM Entity.
3. The Threshold Score for each method is compared to the corresponding QP threshold.
4. All the eligible clinicians in the Advanced APM Entity become QPs for the payment year.20
Figure 28–10 Qualifying APM Participant (QP) Pathway.
Modified from 81 Federal Register 28295 Figure B (May 9, 2016).
APM meets advanced AMP criteria
APM entity participates in advanced APM
Eligible clinicians advanced entity collectively meet
QP threshold of participation
Alternative Payment Model (APM)
Advanced APM
Advanced APM Entity
Qualifying APM Participant (QP)
Eligible Professionals Within APMs 377
The result: If the threshold scores for the Advanced APM Entity are above the appropriate
threshold, then all the eligible clinicians in the Advanced APM Entity will become QPs for that
particular payment year. However, if the threshold scores for the Advanced APM Entity are
below the corresponding QP threshold, then none of the eligible clinicians will become QPs for
that payment year. In other words, the determination is all or nothing at the time of this writing.
It is also important to understand that the threshold scores are derived each year from a calendar year performance period. The performance period will be two years prior to the payment
year, and is thus aligned with the MIPS performance period.21
HOW ARE ADVANCED APM EPs PAID?
This section discusses payment adjustments and timelines. Note that the following comments
about payment refer to scoring thresholds. A description of such thresholds appears in the scoring section of this chapter.
Qualifying Eligible Professionals (QEPs) Payments
This section describes payment details for QEPs.
Incentive Payments 2019 Through 2024
If QEPs meet their thresholds, they receive an annual lump sum incentive payment of 5.0%
from 2019 through 2024. These QEPs will also be excluded from MIPS adjustments. At the
time of this writing, beginning in 2026, qualifying participants may receive higher fee schedule
updates.22 A timeline payment summary appears later in this section.
QEP Incentive Payment Base Period Versus QP Performance Period
It is important to understand the difference between base period and performance periods for
Advanced APM Qualifying Professionals/Clinicians. The performance period will be two years
prior to the payment year, as previously discussed, and is aligned with MIPS performance periods.
The incentive payment base period is for a different purpose. It is used to calculate how much the
5% incentive lump sum will be. To do so, the relevant payments for services are added up; then 5%
of that figure equals the 5% incentive lump sum to be received. (The relevant payments to be added
up are based on “the estimated aggregate payments for professional services furnished the year
prior to the payment year…e.g. the 2019 APM Incentive Payment will be based on 2018 services.”23
This cycle is repeated each year. For example, as CMS explains it, the first cycle would be as follows: 2017 = QP Performance Period; 2018 = Incentive Payment Base Period (to calculate the 5%);
2019 = Payment Year. Then the second cycle starts. It would be: 2018 = QP Performance Period;
2019 = Incentive Payment Base Period; 2020 = Payment Year. And the cycle would keep repeating for the duration of the 5% incentive payments.24
Partial Qualifying Eligible Professionals (PQEPs) Payments
This section describes payment details for PQEPs.
Some eligible professionals/clinicians may be participating in an Advanced APM that does
not meet the standard threshold as previously described. Instead, this Advanced APM meets a
378 Chapter 28 New Payment Methods and Measures
slightly reduced threshold. Therefore, these eligible professionals/clinicians are considered to
be Partial Qualifying Eligible Professionals/Clinicians, or PQEPs.
The PQEPs receive no lump sum incentive payment. They can either choose to participate
in MIPS, or they can choose to opt out of MIPS. If they choose to participate in MIPS, they will
receive favorable weights in the MIPS scoring. If they choose to opt out instead, they will be held
harmless. In other words, they would receive no favorable payment adjustment, but neither
would they be subject to a MIPS negative adjustment.25
Summary of APM Payment Adjustments and Their Timelines
In discussing timelines, it is important to understand that any previously existing payment methods remain in existence for the period 2015 through 2018. In other words, during that four-year
period, providers are still being paid under these methods.
At the time of this writing, the APM payment adjustments are scheduled to commence in
2019. As previously discussed, these APM payment adjustments are based upon the results of
reporting for a performance period two years prior to 2019. Thus, measures reported in 2017
represent the performance period for Year 1 (2019) APM incentive payments. Table 28–2
summarizes both the payment information and the timelines as discussed.
What Is the “Intermediate Option” for Payment Adjustment Choices?
“Intermediate Option” is the term for flexibility of choice between the MIPS and APM tracks.
First, as we have previously described, partially qualifying EPs can choose whether or not they
want to receive the MIPS payment adjustment. Second, the APM/MIPS participants would get
credit toward their score within the category of Clinical Practice Improvement Activities. CMS
has proposed aligning MIPS standards and APM standards in order to “make it easy for clinicians to move between them.”26
Table 28–2 APM Payment Adjustments and Timelines (as Proposed)
APMs
Payment Adjustments 2015–2018* 2019 2020 2021 2022–
2024 2025 2026 Onward
Qualifying EPs (QEPs; meet
all thresholds and are at risk)
Annual Lump Sum Payment
5.0%
Higher fee
schedule
updates starting
in 2026
Partial Qualifying EPs
(PQEPs; meet slightly
reduced thresholds
and are at risk)
No lump sum payment; can choose to participate
in MIPS OR No lump sum paid; can opt out of
MIPS and be held harmless
To be determined
*Note: PQRS, VM & EHR remain in effect for the period 2015 to 2018.
Modified from CMS, “Path to Value: The Medicare Access & CHIP Reauthorization Act of 2015,” p. 18.
How Are Advanced APM EPs Paid? 379
HOW SIGNIFICANT PARTICIPATION WORKS
This section discusses Advanced APM participation requirements.
What Is Significant Participation in an Advanced APM?
Significant participation is expressed in terms of ever-increasing percentages. In other words, participation must be met in each applicable payment year in either of the following two ways: percentage of payments through an Advanced APM or percentage of patients through an Advanced APM.
At the time of this writing, participation percentages for APM payments range from 25% to
75% over a six-to-seven year period. Likewise, participation percentages for APM patients range
from 20% to 50% over the same six-to-seven year period. Table 28–3 illustrates the progression
of these timelines.
Will These Requirements Change Over Time?
It is to be expected that specific requirements will be edited and perhaps modified as time goes
on. In addition, “CMS will continue to modify models in coming years to help them qualify as
Advanced APMs.”27
ADVANCED APM PARTICIPATION STANDARDS
This section discusses participation standards that are applicable to Advanced APMs.
Participation Standards for Advanced APMs
The initial proposed standards for Advanced APMs include three particular areas, as follows.
Financial Risk
The financial risk standards involve the level of financial risk. If financial risk requirements are not
met, then CMS could take action in several ways. Possible CMS actions include requiring repayment, withholding current payments due, or reducing future rates to equal the required repayment
penalty. In other words, the APM would lose money. (Of course, if the APM exceeds the standards,
it should gain, because it would receive incentive payments.) The proposed initial financial risk
standards must be met in three ways, including total risk, marginal risk, and a minimum loss rate.
Table 28–3 Advanced APMs: Required Participation by Year (as Proposed)
Payment Years
Required participation through an
Advanced APM*
2017 2018 2019 2020 2021 2022 & Later
Percentage of payments 25% 25% 50% 50% 75% 75%
OR
Percentage of patients 20% 20% 35% 35% 50% 50%
*Requirements for percentage of significant participation, by year.
Modified from CMS Quality Payment Program Overview Fact Sheet Table 1, p. 5 (October 14, 2016).
380 Chapter 28 New Payment Methods and Measures
Comparable Measures
This standard requires that the APM measures be comparable to MIPS measures within
the quality performance category. As you will recall, to be comparable the measures must always
be valid and reliable. They must also be evidence-based and at least one of the measures must be
an outcome measure (assuming there is an appropriate measure available).
Certified EHR Technology (as Proposed)
This standard requires that in the first year of the performance period, 50% of the APM clinicians must use certified EHR technology. And for the second year of the performance period 75
percent of the APM clinicians must use certified EHR technology.28
Required Reporting for the First Year
CMS has proposed that all EPs will be reporting through MIPS for the first year. This requirement is imposed because they want to determine whether the particular EP (or group) can
actually meet the Advanced APM requirements.
Accurate and complete reporting of measures is always important. However, complete
reporting is especially important when the provider is attempting to qualify for participation as
an Advanced APM. Overall scoring standards for APMs are the subject of the following section.
SCORING STANDARD FOR APMs
The APM scoring standard implements uniformity across the various types of APMs. Goals
include reducing reporting burdens while maintaining the goals and objectives of the individual APM entity. (Meeting the requirements for this standard can also be viewed as a necessary
first step toward becoming an Advanced APM.)
Criteria for Eligibility
Eligibility criteria for APM entity scoring standards include the following:
• The APM participates in an agreement with CMS.
• The APM bases its payment incentives on performance, using quality and cost-utilization
measures.
• The APM includes at least one eligible MIPS clinician on a CMS participation list.
(Note that the eligible clinician’s name must be on an APM participation list by the end of the MIPS
performance year. If not, the clinician has to report under standard MIPS methods instead.)29
Types of APM Entities That Qualify
At the time of this writing, the following types of APM entities qualified for the APM scoring
standard:
• Comprehensive Primary Care Plus (CPC+)
• Medical Shares Savings Programs (all tracks)
• Next Generation ACO Model
• Comprehensive End-Stage Renal Disease Care (CEC) Model
Scoring Standard for APMs 381
• Oncology Care Model (OCM)
• All other APMs that meet the criteria for the scoring standard
The Standard Aggregates Scores
Under the standard, all MIPS scores for eligible clinicians are combined, or aggregated;
weighted; and averaged to arrive at a single score at the level of the APM entity. This means
that all the eligible clinicians within that APM will receive the exact same MIPS composite performance score. The standard has streamlined both reporting and scoring. Also, wherever possible, the scoring standard uses performance measures that are related to that APM.
Performance scores under the standard use the same performance categories as does MIPS.
At the time of this writing, it appears that the Resource Use category will usually be not applicable and thus will not contribute to the score. The remaining three categories (Quality, ACI,
and CPIA) will be weighted when computing the final composite score. However, the weights
may vary according to the type of APM entity.
CREATING PHYSICIAN-FOCUSED PAYMENT MODELS (PFPMS)
This section focuses upon how more physician-focused payment models may be created.
Legislative Intent
The underlying legislative intent is to encourage the creation of physician-focused payment
models (PFPMs) as per the following quotation. Alternative Payment Models “provide incentive payments for certain eligible professionals (EPs) who participate in APMs, by exempting
EPs from the MIPS if they are qualifying APM participants, and by encouraging the creation of
physician-focused payment models (PFPMs).”30
A New Committee
The overall phrase used to describe these models is “physician-focused payment models”
or PFPMs. A new committee will have the responsibility for reviewing and assessing possible new models. Its title is the “Physician Focused Payment Model Technical Advisory
Committee.”31
BUILDING THE MEASUREMENT DEVELOPMENT PLAN FOR MIPS AND APMs:
DEVELOPING NEW QUALITY MEASURES
Measuring quality and value are important for MIPS and APMs because quality and value
are the foundation of the new payment system for EPs. Since MIPS measures are more fully
developed than those of APMs, there are differences between MIPS and APMs as to their implementation timelines. MIPS measures are more developed and are ready for the first stages of
implementation. APMs, on the other hand, are taking longer in the initial stages of development. Our focus on measuring quality and value centers upon MIPS for that reason.
382 Chapter 28 New Payment Methods and Measures
What Is the Measure Development Plan (MDP)?
The Measure Development Plan (MDP) has been created in response to a MACRA requirement. The law requires that a draft plan for the development of quality measures be developed
and posted on the CMS.gov website.32 A final plan is then posted at a later date. The final plan
is supposed to take comments regarding the draft plan into consideration. The plan’s full title is
“CMS Quality Measure Development Plan: Supporting the Transition to the Merit-based Incentive Payment System (MIPS) and Alternative Payment Models (APMs) (Draft).”33 Introductory
commentary states that the law provides
both a mandate and an opportunity for the Centers for Medicare & Medicaid Services
(CMS) to leverage quality measure development as a key driver to further the aims of
the CMS Quality Strategy:
• Better Care,
• Smarter Spending, and
• Healthier People.34
The purpose of the MDP is twofold: “to meet the requirements of the statute and serve as a
strategic framework for the future of clinician quality measure development to support MIPS
and APMs.”35
Creating New Quality Measures for MIPS
New quality measures are an important part of the MIPS payment structure. The basic sequence
for creating these new measures is as follows:
• First, start with existing measures. These are contained in the PQRS, in the VM program,
and in the Meaningful Use (MU) requirements of the Medicare EHR Incentive Program.
• Next, align and harmonize these measures. In other words, the existing measures may be
combined, expanded, and/or enhanced.
• Then add new measures. New measures will be needed to fill gaps. A process is in place
to identify these “identified measure and performance gaps.”36 When adding the new
measures, stakeholder comments may be considered. (Such comments may be gathered
in response to a published Request for Information, or RFI.) In addition, measures that
private payers are using may be considered.
New MIPS quality measures will result from this process. Figure 28–11 illustrates the process just
described. Note also that any quality measures developed for APMs must be comparable.
TIMELINES FOR DEVELOPING QUALITY MEASURES
This section discusses various measure development timelines.
Timelines Initially Set by MACRA
MACRA called for the initial draft Measure Development Plan (MDP) to be published as of
January 1, 2016. A comment period followed. Then the final MDP was published in May 2016.
Timelines for Developing Quality Measures 383
The Act further called for updates to the MDP to be published annually or otherwise as appropriate.37 Thus we expect to see annual updates, as required, published on a regular annual
schedule. Any updates that might be otherwise appropriate, of course, are unpredictable.
Procedural Timelines
CMS has another set of procedural timelines to comply with. A final rule about quality measure
development will be published each year by CMS no later than the first of November.38 Within
the regulatory rule-making process, a Call for Measures will be published in the first half of each
year. This allows stakeholders to submit their input. After the Call for Measures ends in June
of each year, a proposed rule will most probably be published with a multi-month comment
period. Only then will the final rule be ready to be published on the first of November.
A FRAMEWORK FOR MACRA QUALITY MEASUREMENT
This section discusses quality measurement concerning a framework for measurement along
with related priorities and domains.
Required Priorities and Domains for Quality Measures Development
MACRA sets out specific requirements for development of quality measures as follows.
MACRA-Required Priorities for Types of Measures
The Measure Development Plan (MDP) required by MACRA has been described in a previous
section of this chapter. MACRA further requires that the Measure Development Plan take four
priorities into account when creating the quality measures. The four priorities are as follows:
Figure 28–11 Building the MDP for MIPS and APMs: Creating New Quality Measures.
I. Building the MDP for MIPS
II. Quality measures to be developed for APMs must be comparable
Start with
• PQRS
• VM
• Meaningful
Use of EHR
Align &
Harmonize
these Measures
Add New Measures
• Utilize RFI
comments
• Consider
Pr
Measur
ivate Payer
es
New MIPS
Quality
Measures
• Combine
• Expand
• Enhance
+ =
384 Chapter 28 New Payment Methods and Measures
• Outcome measures (including patient reported outcome and functional status measures)
• Patient experience measures
• Care coordination measures
• Measures of appropriate use of services (including measures of over use)39
Figure 28–12 illustrates this requirement.
MACRA-Identified Quality Domains
MACRA also sets out specific quality domains for use in quality measure development. MACRA
says “the term quality domains means at least the following domains” and five domains are then
listed as follows.
• Clinical care
• Safety
• Care coordination
• Patient and caregiver experience
• Population health and prevention40
• An additional sixth quality domainis under consideration by CMS. It is: efficiency and
reduction
(Note that this addition is permissible, as the legislative wording is “…at least the following….”)
Figure 28–13 illustrates these requirements. The addition of an efficiency and reduction
domain is especially logical, because it ties into the National Quality Strategy (NQS) domains.
In other words, with this addition, these six domains mirror the six NQS domains that are the
subject of the next section in this chapter.
A Framework for Quality Measurement
CMS has published a Framework for MACRA quality measurement that is linked to NQS domains.
The framework is mapped to the six National Quality Strategy (NQS) domains as follows. Note
that the details following each domain’s title are a part of CMS’s framework. (Note also that
some domain titles vary slightly as they are expanded from the NQS titles as listed above.)
Figure 28–12 Four Priorities for Types of Quality Measures as Identified by MACRA.
Data from MACRA Section 102(1)(D)(4-16-15).
Priorities for Types of Measures as Identified by MACRA
Outcome Care
Coordination
Patient
Experience
Appropriate
Use of
Services
A Framework for MACRA Quality Measurement 385
Clinical Quality of Care
• Care type (preventive, acute, post-acute, chronic)
• Conditions
• Subpopulations
Safety
• All-cause harm
• Hospital-acquired conditions (HACs)
• Hospital-associated infections (HAIs)
• Unnecessary care
• Medication safety
Care Coordination
• Patient and family activation
• Infrastructure and processes for care coordination
• Impact of care coordination
Person- and Caregiver-Centered Experience and Outcomes
• Patient experience
• Caregiver experience
• Preference- and goal-oriented care
Population and Community Health
• Health behaviors
• Access
• Physical and social environment
• Health status
Efficiency and Cost Reduction
• Cost
• Efficiency
• Appropriateness41
Figure 28–13 Six Quality Domains for Quality Measures Development.
Data from SSA Section 1848 (s)(1)(D).
Clinical
Care Safety
Care
Coordination
Patient &
Caregiver
Experience
Population
Health &
Prevention
Efficiency
& Cost
Reduction
Also
considered by
CMS
Quality Domains Identified by MACRA
386 Chapter 28 New Payment Methods and Measures
We have illustrated this linkage in Figure 28–14. CMS has published two more comments concerning the framework:
• Measures should be patient-centered and outcome-oriented whenever possible.
• Measure concepts in each of the six domains that are common across providers and settings can form a core set of measures.42
Other Measure Development Considerations
Other measure development considerations include the following:
• Coordinate across various measure developers.
• Consider how clinical practice guidelines and best practices can be used in the measures.
• Use an evidence-based approach for certain measures where relevant.
It is also important to realize that measures will be reassessed and revised over time. We
can therefore expect that more future efforts toward standardization and ease of use for all
measures.
More About National Quality Strategy’s Priorities and Domains
This chapter uses a four-part sequence to show how CMS develops quality measures.
First, the Measure Development Plan for MIPS is described. (See Figure 28–11.) Second,
the priorities for quality measures that are identified (and thus required) by MACRA are
described. (See Figure 28–12.) Third, the quality domains that are identified (and thus
required) by MACRA legislation are described. (See Figure 28–13.) And fourth, this chapter
then shows how the CMS framework for measurement ties back into the six NQS domains.
(See Figure 28–14.)
Figure 28–14 CMS Framework for Measurement Mapped to National Quality Strategy Domains.
Modified from 80 FR 68668 (November 5, 2015).
Person &
Caregiver Centered
Experience &
Outcomes
Care
Coordination
Clinical Quality
Of Care
Safety
Population
&
Community Health
Efficiency & Cost
Reduction
A Framework for MACRA Quality Measurement 387
CONCLUSION: BENEFITS AND COSTS OF THE QUALITY PAYMENT
PROGRAM
Implementing the Quality Payment Program results in both benefits and costs.
Benefits and Costs
One benefit of the new MIPS program is an increase in the attention to quality of care. The
measures’ metrics provide information that may be used for internal comparative performance
purposes. Another benefit concerns the program feedback about cost of care. The cost of care
as computed by CMS may provide financial information based on a national benchmark. Comparing this national baseline financial information to the provider’s own costs, also as computed
by CMS, may be especially valuable for future financial planning.
Costs of program participation include costs of new software plus potential hardware
upgrades. Staff training is essential and is of course another cost. The potential time lag in cash
flow at the point of implementation should also be recognized.
Public reporting can be considered either a benefit or a cost. This depends upon the organization’s public image and the results that are posted within the public reporting venue.
Ingredients for Success
Success of this value-based program begins with proper measure choices and continues with
measure development and implementation. Proper implementation first means the right
choices. Another crucial element is sufficient training of a focused staff who understands the
implications.
Success Also Depends Upon the Use of Qualified Electronic Transmission
Standards
Success also depends upon complying with all digital requirements involving use of qualified electronic transmission standards. Funding must be made available for sufficient hardware and software, along with proper training of staff. Timely updates on software and
staff training are essential. In addition, an electronic disaster plan should be in effect and
up-to-date.
Organizational Implications
Leadership must be responsible for seeing that quality and financial incentives align properly.
Such alignment could well result in a move away from so-called “silo,” or vertical, departmental responsibilities. Assigning responsibilities differently (not departmentally) could potentially
result in horizontal networks of responsibility that are organized around patient groups with
similar needs.
Finally the organization’s leadership must recognize that the digital age has arrived. It is
here, and the inevitable change that it brings must be recognized and dealt with in order to
achieve success.
388 Chapter 28 New Payment Methods and Measures
THREE INCENTIVE PROGRAMS AS THEY EXISTED BEFORE MIPS:
A REFERENCE
This information is provided to serve as a bridge between what came before MIPS and what has
followed. It can be used for both comparative and reference purposes.
Physician Quality Reporting System (PQRS)
The Physician Quality Reporting System (PQRS) is a quality reporting program concerning covered professional services within the Medicare Part B Physician Fee Schedule (MPFS).43 PQRS
applies to both individual EPs and group practices and is intended to improve the quality of
care provided to patients. CMS considered the following factors as the minimum when EPs are
selecting measures for reporting. The minimum factors include:
• Clinical conditions usually treated
• Types of care typically provided (e.g., preventive, chronic, acute)
• Settings where care is usually delivered (e.g., office, emergency department [ED], surgical
suite)
• Quality improvement goals for 2016
• Other quality reporting programs in use or being considered44
Practitioners can see, after the fact, how often they met a particular quality measure and thus
can assess their overall quality performance.
Beginning in 2015, the program applied a negative payment adjustment to certain individual
EPs and PQRS group practices. Those practitioners received negative payment adjustments
because they did not satisfactorily report data on quality measures for the relevant performance
period. Each year’s results stand alone, so a negative adjustment in one year does not necessarily mean a negative result for the following year. In other words, reporting satisfactorily for the
2016 performance period year would avoid a negative payment adjustment in the 2018 PQRS
program year. Finally, for those who might be wondering, PQRS originally had another name:
It was previously known as the Physician Quality Reporting Initiative.
Value-Based Payment Modifier (Value Modifier)
The Value-Based Payment Modifier, or Value Modifier (VM), provides a budget-neutral
payment adjustment to a physician (or group) based upon “the quality of care compared
to the cost of care furnished to Medicare fee-for-service beneficiaries during a performance
period.”45
The VM uses a two-part composite score. The quality composite score is primarily calculated
from submitted PQRS data. (The quality score also includes three outcome measures that are
calculated by CMS from Medicare claims data.)46 The cost composite score includes performance cost measures and is calculated by CMS by primarily using claims data. The cost measures, also calculated by CMS, include six performance cost measures.
The VM provides eligible practitioners with a positive, neutral, or negative payment adjustment. It is important to note that the VM adjustment is separate from the PQRS as described
previously. However, the quality measures for the two programs have been aligned. The VM was
Three Incentive Programs as They Existed Before MIPS: A Reference 389
phased in; it first applied to groups of 100 or more eligible professionals. By 2016, the VM was
applicable to groups of 10 or more eligible professionals.47
Meaningful Use (MU) and the Electronic Health Records (EHR) Incentive Program
The EHR Incentive Programs were first implemented in 2011. The program was designed to
encourage providers to “adopt, implement, upgrade and demonstrate meaningful use of certified EHR technology.”48 Medicare EHR incentive program payments to eligible professionals,
eligible hospitals, and critical access hospitals have come to an end. Meaningful use, as defined
above, was still required, however, and at the time of this writing negative payment adjustments
have been imposed for non-use through 2018. (Note, however, that Medicaid incentive program payment adjustment continues until 2021.)
Meaningful use is determined by reporting upon certain objectives and measures. Within the
Medicare program, implementation progresses in three stages: Stage 1, Stage 2 (now Modified
Stage 2), and Stage 3. (The numerous Medicaid program variations are beyond the scope of
this book.) At first, the Medicare EHR Incentive Program required choices among “core” and
“menu” objectives and measures. However, as of 2016, the program has been streamlined. All
providers are now required to attest to a single set of objectives and measures.49 The streamlining also means that the number of objectives has been reduced.
Meaningful Use measures have been modified and incorporated into the new Quality Payment
Program (MIPS and APMs), a Medicare program that is presently scheduled to commence payment in 2019. And MU has gained a new name within the Quality Payment Program. It becomes
“Advancing Care Information” instead. For more details about the current status of Meaningful
Use in its new Advancing Care Information form, see Appendix 28-A at the end of this chapter.
ALTERNATIVE PAYMENT MODELS: A REFERENCE
This information is provided to serve as a bridge between existing APM models and those models that qualify for incentive payments as Advanced APMs. In other words, these models were in
operation before new Quality Payment Program criteria were set. We intend this information to
be used for both comparative and reference purposes.
A brief description of various models follows. (A full discussion of such models is beyond the
scope of this text.)
Accountable Care Organizations (ACOs)
The Medicare program offers various ACO programs, as follows.50
Medicare Shared Savings Program
Under this program, hospitals, eligible providers, and suppliers can come together in a Shared
Savings Program ACO. The program was created to “facilitate coordination and cooperation
among providers to improve the quality of care for Medicare Fee-For-Service (FFS) beneficiaries and reduce unnecessary costs.”51 The ACO that meets performance standards and lowers
the growth in costs will be rewarded. Note also that data about the shared savings program
ACOs is made public.52
390 Chapter 28 New Payment Methods and Measures
Advance Payment ACO Model
This interesting model came about through input from stakeholders. There was concern that
smaller ACO groups would not be able to pay for the necessary investment in infrastructure
and staff. (This investment would be required in order to achieve the desired care coordination.) Therefore, this Advance Payment ACO model is intended to assist rural providers and
physician-based groups by providing cash up front. This cash is not a grant or a gift; instead it is
cash advanced from the shared savings that the ACO group is expected to earn.53
Furthermore, the advance payment design recognizes that there are both fixed start-up costs
and variable start-up costs. For that reason, according to CMS, each of these ACOs will receive
the following three types of advance payments. Note that two are upfront, one fixed and one
variable, while the third payment is monthly. The ACO will receive:
• An upfront, fixed advance payment
• An upfront, variable advance payment that is based on beneficiary numbers
• A monthly variable advance amount that is based on the size of the ACO54
Pioneer ACO Model
This model is intended for a more sophisticated group of organization and providers who
are experienced in care coordination. In other words, they do not have a learning curve.
Two design elements are especially interesting in this model. First, these groups are expected
to move more quickly from the shared savings plan into a population-based payment model.
That expectation is due to their prior experience. While the model is flexible, generally speaking, participants in the initial two years are held to a higher level of both shared savings and risk
than those participants in the “regular” shared savings plan.55
The second interesting element is that this model is supposed to work in cooperation with
private payers. It does that by “aligning provider incentives, which will improve quality and
health outcomes for patients across the ACO, and achieve cost savings for Medicare, employers
and patients.56 (Note that at the time of this writing, this model was closed to new applicants.)
Patient-Centered Medical Homes
The easy-to-use phrase “patient-centered medical homes” actually refers to a CMS demonstration project with a long title. The demonstration’s formal name is “The Federally Qualified
Health Center Advanced Primary Care Practice, or FQHC APCP. It has a three-year life, unless it
is subsequently extended and/or expanded. As the title suggests, only federally qualified health
centers (FQHCs) can participate, and there is a strict set of criteria, terms, and conditions. Once
accepted into the demonstration, each FQHC receives a monthly management fee for each
applicable eligible Medicare beneficiary. The fee is paid quarterly and payment is automatic.57
Four Bundled Payment Models
The Bundled Payments for Care Improvement (BPCI) Initiative presently covers four care models. Payment is linked, or bundled, for multiple services that occur during a patient’s episode
of care. Organizations agree to episode-of-care payments that include both performance and
financial accountability.58 A brief comment about each of the four care models follows.
Alternative Payment Models: A Reference 391
For Model #1, the episode of care equals the inpatient stay in an acute care hospital. Payment
to the hospital is discounted from the usual Inpatient Prospective Payment System and payment
to physicians is made separately under the Medicare Physician Fee Schedule.
Model #2 takes a different approach, as its payment is retrospectively bundled. The episode
of care includes the inpatient stay, plus the post-acute care, plus all related services for are bundled for a period of up to 90 days after discharge from the hospital. The retrospective bundled
payment adjustment is made after comparison to the target price, and such payment adjustment can either be positive or negative.
Model #3 is also retrospectively bundled and the episode of care is designated, or triggered,
by a hospital stay. However, unlike the previous model, in this case the episode of care concerns
only post-acute care provided to the patient. Once again, the retrospective bundled payment
adjustment is made after comparison to a target price, and such payment adjustment can either
be positive or negative.
Model #4 differs from that of Model #1. In this case one bundled payment is made to the
hospital. This payment covers all the episode-of-care services, including those of the physicians.
The hospital then pays the physicians and other professionals, using part of the bundled payment that it has received for this episode of care. (For those who are wondering, to complete
the entire cycle the physicians must send a “no-pay” claim form to Medicare that sets out what
services they performed.)59
Other New APM Models
Other new APM models will be developed in the near future. At the time of this writing, CMS
has recently issued a “RFI” or Request for Information that seeks input about possible new
physician-focused payment models or PFPMs.60
INFORMATION CHECKPOINT
What is needed? Some description of the MACRA legislation, the Quality Payment Program, and/or MIPS and APMs.
Where is it found? A newsletter or a training announcement or a planning committee report.
How is it used? The use depends upon the particular item. Typical uses would
be for general information or for training or planning
purposes.
KEY TERMS
Accountable Care
Organizations (ACOs)
Alternative Payment Model
(APM)
Bundled Payment
Composite Performance
Score
Eligible Professional (EP)
(a.k.a. Eligible Clinician)
MACRA
Meaningful Use (MU)
Measure Development Plan
(MDP)
Merit-Based Incentive
Payment System (MIPS)
392 Chapter 28 New Payment Methods and Measures
Partial Qualifying Eligible
Professional (PQEP)
Patient-Centered Medical
Homes
Performance Period
Physician-Focused Payment
Models (PFPMs)
Qualifying Eligible
Professionals (QEPs)
Sustainable Growth Rate
(SGR)
Value-Based Program
DISCUSSION QUESTIONS
1. Describe how the Merit-Based Incentive Payment System (MIPS) and the Advanced Alternative Payment Model (APM) are illustrative of “pay-for-performance.”
2. Put on your physician’s hat. How would you determine which of the two incentive payment programs to participate in?
3. How did the Sustainable Growth Rate (SGR) work, and why was it ultimately repealed?
NOTES
1. 80 Federal Register 59102 (October 1, 2015).
2. B. Wynne, “May the Era of Medicare’s Doc Fix (1997–2015) Rest in Peace. Now
What?” Health Affairs Blog, April 14, 2015, Healthaffairs.org/blog/2015/04/14
/may-the-era-of-medicares-doc-fix-1997-2015-rest-in-peace-now-what; also M. A. Carey,
“Congress Is Poised To Change Medicare Payment Policy. What Does That Mean
For Patients And Doctors?” Kaiser Health News, January 16, 2014, Khn.org/news
/congress-doc-fix-sustainable-growth-rate-sgr-legislation
3. Centers for Medicare and Medicaid Services (CMS), “Proposed Policy, Payment, and
Quality Provisions Changes to the Medicare Physician Fee Schedule for Calendar Year
2016,” July 8, 2015, www.cms.gov/newsroom/mediareleasedatabase/fact-sheets/2015
-fact-sheets-items/2015-07-08.html
4. 80 FR 59102 (October 1, 2015).
5. CMS, “Fact Sheet: Quality Payment Program Executive Summary,” p. 5, https://www
.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/Value-Based
-Programs/MACRA-MIPS-and-APMs/NPRM-QPP-Fact-Sheet.pdf, accessed May 23,
2016.
6. CMS, “The Medicare Access and CHIP Reauthorization Act of 2015: Quality Payment
Program,” https://www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment
-Instruments/Value-Based-Programs/MACRA-MIPS-and-APMs/Quality-Payment
-Program/MACRA-NPRM-Slides.pdf, accessed June 6, 2016.
7. Ibid.
8. Ibid.
9. Ibid.
10. The computation steps overview as described was generalized from the composite score
steps used to calculate the 2016 Value Modifier. CMS, “CMS Fact Sheet: Computation of
the 2016 Value Modifier,” September 2015, www.cms.gov/Medicare/Medicare-Fee-for
-Service-Payment/PhysicianFeedbackProgram/downloads/2016-VM-Fact-Sheet.pdf
Notes 393
11. CMS, “Hospital Value-Based Purchasing,” September 2015, www.cms.gov/Outreach-and
-Education/Medicare-Learning-Network-MLN/MLNProducts/downloads/Hospital
_VBPurchasing_Fact_Sheet_ICN907664.pdf
12. CMS, “MIPS: Advancing Care Information Performance Category,” p. 41, www.cms.
gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/Value-BasedPrograms/MACRA-MIPS-and-APSs/Advancing-Care-Information-Presentation.pdf,
accessed June 7, 2016.
13. CMS, “MACRA: Quality Payment Program,” pp. 39–40.
14. Ibid.
15. 81 FR 28280 (May 9, 2016).
16. P.L. 114-10-(April 16, 2015) 129 STAT.121.
17. MACRA, “Delivery System Reform, Medicare Payment Reform: What’s the Quality
Payment Program?” https://www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/Value-Based-Programs/MACRA-MIPS-and-APMs/MACRA-MIPSand-APMs.html, accessed March 17, 2016.
18. 81 FR 28165 (May 9, 2016).
19. Ibid., 28295.
20. CMS, “MACRA: Quality Payment Program,” pp. 63 and 68.
21. Ibid.
22. Ibid., pp. 70–71, and CMS. Qualifying Eligible Professionals (QEPs) Payments, www
.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/Value-Based
-Programs/MACRA-MIPS-and-APMs, accessed March 17, 2016.
23. CMS, “MACRA: Quality Payment Program,” pp. 70–71.
24. Ibid.
25. Ibid., p. 86.
26. CMS, “Fact Sheet: Quality Payment Program ES,” p. 4.
27. Ibid., p. 3.
28. Ibid., p. 11.
29. CMS, “MACRA: Quality Payment Program,” pp. 87–92.
30. 80 Federal Register (FR) 63485 (October 20, 2015).
31. P.L. 114-10 (April 16, 2015) 129 STAT. 115.
32. P.L. 114-10 Sec 102 (April 16, 2015).
33. CMS, “CMS Quality Measure Development Plan: Supporting the Transition to the Meritbased Incentive Payment System (MIPS) and Alternative Payment Models (APMs).”
(Baltimore, MD: Author, 2015), https://www.cms.gov/Medicare/Quality-Initiatives
-Patient-Assessment-Instruments/Value-Based-Programs/MACRA-MIPS-and-APMs
/Final-MDP.pdf
34. Ibid., p. 3; also, CMS, “CMS Quality Strategy 2016,” (Baltimore, MD: Author, 2015).
35. Ibid., p. 3.
36. Ibid., p. 4.
37. Sec 1848(s)(1)(A).
38. Ibid.
39. MACRA Sec.102(1)(D).
40. MACRA Sec. 102(1)(B).
41. 80 FR 68668 (November 5, 2015).
42. Ibid.
394 Chapter 28 New Payment Methods and Measures
43. CMS, “Physician Quality Reporting System,” last modified August 8, 2016, www.cms.gov
/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/PQRS
44. CMS, “Measures Codes,” last modified August 31, 2016, www.cms.gov/medicare/quality
-initiatives-patient-assessment-instruments/pqrs/measurescodes.html
45. CMS, “CMS Fact Sheet: Computation of the 2016 Value Modifier,” September 2015, www
.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/PhysicianFeedbackProgram
/downloads/2016-VM-Fact-Sheet.pdf
46. https://www.cms.gov/Medicare-Fee-for-Service-Payment/PhysicianFeedbackProgram
/ValueBasedPaymentModifier.html
47. CMS, “Value-Based Payment Modifier,” accessed January 20, 2016, www.cms.gov
/Medicare/Medicare-Fee-for-Service-Payment/PhysicianFeedbackProgram
/valuebasedpaymentmodifier.html
48. CMS, “Medicare and Medicaid EHR Incentive Program Basics,” last modified January
12, 2016), https://www.cms.gov/regulations-and-guidance/legislation/ehrincentive
programs/basics.html
49. CMS, “2016 Program Requirements,” https://www.cms.gov/Regulations-and-Guidance/Legislation/EHRIncentivePrograms/2016ProgramRequirements.html, accessed
June 9, 2016.
50. CMS, “Accountable Care Organizations (ACOs),” last modified January 6, 2015, www.cms
.gov/Medicare/Medicare-Fee-for-Service-Payment/ACO/index.html
51. CMS, “Shared Savings Program,” http://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/sharedsavingsprogram/index.html?redirect=/SharedSavingsProgram,
accessed September 19, 2016.
52. Ibid., pp. 1–2.
53. CMS, “Advance Payment ACO Model,” pp. 1–2, last modified February 19, 2016, https://
innovation.cms.gov/initiatives/Advance-Payment-ACO-Model
54. Ibid., p. 2
55. CMS, “Pioneer ACO Model,” https://innovation.cms.gov/initiatives/Pioneer-ACOModel/, accessed April 6, 2016.
56. Ibid., p. 1
57. CMS, “Federally Qualified Health Center Advanced Primary Care Practice (FQHC
APCP) Demonstration Fact Sheet,” www.cms.gov/Medicare/Demonstration-Projects/
DemoProjectsEvalRpts/downloads/fqhc_fact_sheet.pdf, accessed April 6, 2016.
58. CMS, “Bundled Payments for Care Improvement (BPCI) Initiative: General Information,” p. 1, https://innovation.cms.gov/initiatives/bundled-payments, accessed April 6,
2016.
59. Ibid., pp. 2–3.
60. CMS, MACRA RFI (CMS-3321-NC), http://www.innovation.cms.gov/Files/x/macra-faq
.pdf, accessed June 30, 2016.
Notes 395

© LFor/Shutterstock
HOW MEANINGFUL USE HAS EVOLVED
This section provides background information that leads to a better understanding of the
current program.
Meaningful Use’s New Name Applies to Physicians and Other Eligible Professionals
As we have learned, in the accompanying chapter, “Meaningful Use of Certified Electronic
Health Records (EHRs)” has a new name. It is now known as Advancing Care Information
(ACI). It is important to understand that the new name applies to usage by physicians and other
eligible professionals.
ACI is now one component in the Merit-Based Incentive Payment System (MIPS). And MIPS
is one of two methods contained in the overall Quality Payment Program. The legislation that
created the new incentive program is known as the Medicare Access and CHIP Reauthorization Act of 2015 (MACRA). This Act applies to physicians and other eligible professionals. The
accompanying chapter to this Appendix describes details of the Quality Payment Program,
including both MIPS and Advanced Alternative Payment Methods (APMs). (For simplicity purposes, in the remainder of this Appendix, when we say “physicians,” we actually mean “physicians and other eligible professionals.”)
Physicians and Hospitals Have Different Meaningful Use Programs
Meaningful Use (MU) programs are in place for physicians and for hospitals. Separate incentive programs have been implemented for physicians and for hospitals. A very brief background
summary follows.
Hospitals Retain the “Meaningful Use” Name for Now
The hospital Medicare program incentive payments spanned a four-year period. Then, beginning in fiscal year 2015, eligible hospitals that were not meaningful users of certified EHR technology became subject to payment adjustments.1 In other words, negative payment adjustments
(reductions) now apply if eligible hospitals are not meaningful users.
Meaningful Use: Modified and Streamlined with a
New Name
28-A
APPENDIX
397
Do not be confused by different terminology. At the time of this writing, hospitals still use the
term “meaningful use” (although it is possible that may change in the near future). At present,
the new name “Advancing Care Information” only applies to the physician and other eligible
professionals. However, the hospital’s meaningful use program has also been streamlined. Its
measures are undergoing an alignment process that is beyond the scope of this text.
Physicians Use the New ACI Name Upon Quality Payment Program Implementation
The original Medicare program incentive payments for physicians spanned a similar period.
Then, beginning in calendar year 2015, eligible physicians who were not meaningful users of
certified EHR technology also became subject to payment adjustments.2 In other words, physicians were also subject to negative payment adjustments (reductions) if they were not meaningful users. They remained subject to these reductions until MACRA’s Quality Payment Program
(QPP) was implemented.
Meaningful Use had to Be Demonstrated Every Year
The Centers for Medicare and Medicaid Services (CMS) made it clear that meaningful use had
to be demonstrated every year as follows. “EPs must demonstrate meaningful use every year
in order to avoid Medicare payment adjustments. For example, an eligible professional that
demonstrates meaningful use for the first time in 2013 will avoid the payment adjustment in
calendar year (CY) 2015, but will need to demonstrate meaningful use again in 2014 in order to
avoid the payment adjustment in CY 2016.”3
Reporting Periods for MU Used to Vary by Type of Provider
The typical reporting period covers 12 months. However, the beginning month and the ending month will vary between two types of providers. (At the time of this writing, the difference
still existed.) The physician and eligible professional reporting period is a CY. A CY runs like
the calendar does, from January 1 to December 31. The hospital reporting period, on the
other hand, is a fiscal year (FY). Specifically, it is the federal fiscal year. This reporting period
runs from October 1 of one year to September 30 of the following year.
However, as of 2016, MU reporting for hospitals was also converted to a CY.4 This change
means comparison of like data is easier because the reporting periods match.
CHANGES TO ALLOWABLE MU STAGES
This section discusses allowable MU stages plus a modification of one stage.
MU Has Progressed Stage by Stage
This section provides background information about the stages of meaningful use.
Three Original Stages of Meaningful Use
The original meaningful use programs progressed in three stages:
398 Chapter 28 New Payment Methods and Measures
• Stage 1, which included data capture and sharing
• Stage 2, which included advanced clinical processes
• Stage 3, which included improved outcomes
Figure 28-A–1 illustrates this progression.
Stages Progressed Through a Rolling Implementation
The program allowed a rolling implementation. Under this concept, eligible providers had a
choice as to what year they would enter the program. Note that while numerous other changes
to MU have occurred, at the time of this writing providers may still choose which year to enter
the program.
Stage 2 Was Modified
Meaningful use stages have been streamlined when preparing for use as ACI in the QPP. In
another process, however, Stage 2 Meaningful Use previously underwent a series of changes to
make MU more user-friendly. Therefore, the Stage 2 MU in use until QPP implementation has
been termed Modified Stage 2.
Allowable Stages of Meaningful Use in the First Year
In 2015 or 2016, a provider demonstrating meaningful use for the first time was allowed to use
Modified Stage 2. In 2017 or 2018, the provider demonstrating meaningful use for the first time
was allowed to use either Modified Stage 2 or Stage 3. By 2018, everyone is scheduled to use
Stage 3. In other words, only one single version of meaningful use (Stage 3) will be allowable.5
The end to multiple stages also ended the necessity for rolling implementation. These
changes then allowed a smooth progression to the streamlined MU that became ACI within the
QPP. Table 28-A–1 illustrates allowable implementation by year from 2015 through 2019 and
into the future.
Figure 28-A–1 Three Initial Stages of Meaningful Use.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Stage 1
Improved outcomes
Stage 2
Stage 3
Data capturing &
sharing
Advanced clinical
procedures
Changes to Allowable MU Stages 399
CHANGES TO MEANINGFUL USE REQUIREMENTS
Prior to ACI, new participation requirements were put into place for the period 2015 to 2017.
Objectives and measures were simplified at the same time.
New Participation Requirements Began
New Medicare participation requirements were put into place for the period 2015 to 2017. The
CMS focus for both Modified Stage 2 and Stage 3 was as follows:
• Advanced use of certified EHR technology to support health information exchange and
interoperability
• Advanced quality measurement
• Maximized clinical effectiveness and efficiencies6
Objectives and Measures Were Simplified
For the period 2015 to 2017, all providers use one single set of objectives and measures. This
change simplifies the original “core and menu” structure that was previously in effect. For this
period, the number of objectives was also reduced. Hospital objectives were reduced to nine
while eligible professional objectives were reduced to 10.7.
Some providers were also able to claim certain “alternate exclusions.” One example of an
alternate exclusion is as follows. A provider who was scheduled to be in either Stage 1 or Stage 2
First year demonstrating
meaningful use
Stage of Meaningful Use
2015 2016 2017 2018 2019 & Future Years +
2015 Modified
Stage 2
Modified
Stage 2
Modified
Stage 2
or
Stage 3
Stage 3 Stage 3
2016 n/a Modified
Stage 2
Modified
Stage 2
or
Stage 3
Stage 3 Stage 3
2017 n/a n/a Modified
Stage 2
or
Stage 3
Stage 3 Stage 3
2018 n/a n/a n/a Stage 3 Stage 3
2019 & Future Years
2019+
n/a n/a n/a n/a Stage 3
Modified from CMS “Table: Stage of Meaningful Use Criteria by First Year” EHR Incentive Programs (4-14-2016).
Table 28-A–1 Meaningful Use Stages by First Year
400 Chapter 28 New Payment Methods and Measures
in 2016 may be allowed to claim an alternate exclusion for certain Public Health Reporting
measures. This exclusion may be allowable if it requires “acquisition of additional technologies
that they did not previously have or did not previously intend to include in their activities for
meaningful use.”8 In other words, alternate exclusions are short-term aids that help the transition of MU stage implementation.
CONCLUSION: ADVANCING CARE INFORMATION BECOMES THE NEW
MEANINGFUL USE
This section clarifies certain aspects of the transition from MU to ACI.
The Methodology Still Uses Objectives and Measures
A number of changes have been made to MU as it became ACI. However, the basic measurement structure remains. This means objectives and measures are still in use within the new
advancing care information.
Three Types of ACI Measures
Each ACI objective is accomplished by meeting a particular set of measures that belong to that
specific objective. At the time of this writing, there are three types of such measures as described
below.
System-Based Measures
System-based measures ask three questions, as follows:
• What function of our certified EHR technology system must be enabled?
• Do we meet the required threshold?
• Are we excluded from the measure?
Action-Based Measures
Action-based measures also ask three questions, as follows:
• What actions must we take?
• Do we meet the required threshold?
• Are we excluded from the measure?
Percentage-Based Measures
Percentage-based measures ask four questions, as follows:
• What makes up the denominator?
• What makes up the numerator?
• Do we meet the required threshold?
• Are we excluded from the measure?
Figure 28-A–2 further illustrates this concept.
Conclusion: Advancing Care Information Becomes the New Meaningful Use 401
Computing a Percentage-Based Measurement
ACI objectives may often use the percentage-based measures as described above. Therefore,
managers need an understanding of how these measures are calculated. This section first discusses numerators and denominators, and then provides a six-step computation method.
Numerators and Denominators
To compute a percentage, you must first calculate a fraction, as illustrated in the six-step method
that follows. A fraction has two parts: the numerator is the top number and the denominator is
the bottom number. The line between the two parts signifies the division function. The denominator indicates the total number of parts available to be divided and the numerator indicates
the number of parts of the denominator that are taken.
Why Is This Subject Important?
CMS has provided specifications for computing measures. Each specification for a percentagebased measure sets out what the composition of the denominator should be and what the composition of the numerator should be. Therefore, it is important to understand the consequences
of selecting a denominator and the consequences of what the numerator will be. We understand
that electronic software will actually perform the calculations, but managers should know how the
method works in order to better understand the results produced for their organization.
A Six-Step Computation Method
It works this way:
Step 1: Determine your denominator.
Step 2: Determine your numerator.
Step 3: Calculate the fraction (including the decimal).
Step 4: Convert the fraction to a percentage.
Step 5: Refer to the threshold percentage that is set for this particular measure.
Step 6: Compare your percentage to the threshold percentage; it must meet the threshold in order to count. (That is, it must meet a minimum level.)
Action-Based
Measures
System-Based
Measures
Percentage-Based
Measures
What function of our
certified EHR technology
system must be enabled?
Do we meet the required
threshold?
Are we excluded from the
measure?
What actions must we take?
Do we meet the required
threshold?
Are we excluded from the
measure?
What makes up the denominator?
What makes up the numerator?
Do we meet the required threshold?
Are we excluded from the measure?
Figure 28-A–2 Three Types of Meaningful Use Measures.
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
402 Chapter 28 New Payment Methods and Measures
For additional detail about the six steps, see the Supplemental Materials section entitled
“The Mechanics of Percentage Computation.”
Exceptions
Be aware that certain exceptions exist for particular measures. These exceptions don’t have to
be included in the numerator or denominator, so they won’t count against you.
Summary
In summary, the Advancing Care Information performance category has a mix of new and older
items. The overall ACI concept is working toward a more user-friendly method.
ACRONYMS
ACI = Advancing Care Information
APM = Alternative Payment Model
CHIP = Children’s Health Insurance Program
CY = Calendar Year
EHR = Electronic Health Record
FY = Fiscal Year
MACRA = Medicare Access and CHIP Reauthorization Act of 2015
MIPS = Merit-Based Incentive Payment System
MU = Meaningful Use
QPP = Quality Payment Program
NOTES
1. CMS, MLN #904626, p. 1.
2. ARRA Division B. Title IV Section 4101 (HITECH Act).
3. CMS, “Understanding 2018 Medicare Quality Program Payment Adjustments
(v1.03/1/2016),” p. 3, March 2016, www.cms.gov/Medicare/Quality-Initiatives-Patient
-Assessment-Instruments/PQRS/Downloads/Understand2018MedicarePayAdjs.pdf
4. CMS, “Medicare and Medicaid EHR Incentive Program Basics,” last modified January 12,
2016, www.cms.gov/regulations-and-guidance/legislation/ehrincentiveprograms/basics.html
5. CMS, “Stage of Meaningful Use Criteria by First Year: EHR Incentive Programs,” April 14, 2016.
6. CMS, “Medicare and Medicaid EHR Incentive Program Basics.”
7. CMS, “2016 Program Requirements,” www.cms.gov/Regulations-and-Guidance/Legislation
/EHRIncentivePrograms/2016ProgramRequirements.html, accessed June 9, 2016.
8. Ibid.
Notes 403

405
Progress Notes
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Standardizing
Measures and
Payment in PostAcute Care: New
Requirements
THE IMPACT ACT: NEW DIRECTIONS FOR
POST-ACUTE CARE
This section focuses upon provisions of the IMPACT Act
legislation, along with legislative intent.
Legislative Provisions
The Improving Medicare Post-Acute Care Transformation
(IMPACT) Act of 2014 was signed into law on October 6,
2014. Major provisions of the Act are discussed as follows.
Purposes of the IMPACT Act
The IMPACT Act describes five particular purposes for the
legislation as follows:
• Enable comparable data and quality across post-acute
care (PAC) settings
• Improve Medicare beneficiary outcomes
• Facilitate coordinated care by allowing provider access
to longitudinal information
• Improve hospital discharge planning
• Provide data for research1
The purposes actually reach beyond the post-acute settings; see, for example, “Improve hospital discharge planning,” and “Provide data for research,” which implies future
results of such research that may stretch into many years.
Exhibit 29–1 illustrates this aspect of the legislation.
Requirement of the IMPACT Act: Standardizing Measures
The Act requires the reporting of standardized patient
assessment data and standardized quality measure data.
The Act further requires that the standardized data be
After completing this chapter,
you should be able to
1. Identify five purposes of the
IMPACT Act.
2. Identify four types of
facilities affected by the
IMPACT Act.
3. Understand three reasons
for focusing attention on
post-acute care (PAC)
settings.
4. Understand the concept of a
core set of measures within
domains.
5. Describe standardized data.
6. Define interoperability.
29
CHAPTER
interoperable. Such standardized data
enables electronic-related uniformity,
exchangeability, and comparability across
PAC settings. (See the section about standardized data and interoperability later in
this chapter for further details.)
Standardized assessment data allows
additional cross-setting outcomes. Such outcomes include the following:
• Quality care
• Improved outcomes
• Coordinated care
• Improved discharge planning2
Table 29–1 lists both electronic-related and
other benefits.
Moving Toward Creating a Uniform PAC Payment System
The Act proposes a uniform payment system to be created across the four post-acute care settings listed below. At the time of this writing, the proposed system is termed a “Proposed Alternative Post-Acute Care Payment Model.”
Other Provisions of the Act
Implementing verifiable and auditable data collection about staffing in skilled nursing facilities
(SNFs) has been funded in the amount of $11 million. Facilities are required to “electronically
submit…direct care staffing information, including information for agency and contract staff,
based on payroll and other verifiable and auditable data in a uniform format,” which may then
be audited in order to verify staffing information.3 (See the “Regulations” section in the preceding chapter entitled “Staffing: Methods, Operations and Regulations” for specific details.)
Among other provisions, hospice facilities are to be inspected every three years.4 In addition, both hospitals and PAC providers are affected by regulations to be promulgated about the
discharge planning process.5
Facilities Affected by the IMPACT Act
This legislation concerns four different care settings that provide care after acute care treatment
(thus “post-” or “after-” acute care). The four care
settings include the following:
• Skilled nursing facilities (SNFs)
• Home health agencies (HHAs)
• Inpatient rehabilitation facilities (IRFs)
• Long-term care hospitals (LTCHs)
Exhibit 29–2 illustrates the care settings that are
impacted.
Exhibit 29–1 Five IMPACT Act Purposes
Purposes of the IMPACT Act include
• Enable comparable data & quality across
PAC settings
• Improve Medicare beneficiary outcomes
• Facilitate coordinated care by allowing provider access to longitudinal
information
• Improve hospital discharge planning
• Provide data for research
Modified from CMS, “The IMPACT Act
of 2014 and Data Standardization,” MLN
Connects, p. 5 (October 21, 2015).
Electronic-Related All Other
• Data element
uniformity
• Exchangeability
of data
• Comparing data
& quality across
all PAC settings
• Quality care &
improved
outcomes
• Coordinated care
• Improved
discharge
planning
Modified from CMS, “The IMPACT Act of 2014 and Data
Standardization,” MLN Connects, p. 4 (October 21, 2015).
Table 29–1 IMPACT Act Requirements
406 Chapter 29 Standardizing Measures and Payment in Post-Acute Care
WHY FOCUS ATTENTION ON POST-ACUTE CARE?
The Centers for Medicare and Medicaid Services (CMS) point out three valid reasons for turning attention to these post-acute care facilities. The reasons, illustrated in Exhibit 29–3 include
the following:
• Escalating PAC costs
• PAC data standards and/or data interoperability are lacking
• Meeting the goal of setting payment rates by individual patient characteristics instead of
by care setting6
Note also that physicians and other eligible professionals are not part of this legislation. Hospitals, however, are somewhat affected due to coordination of discharge planning requirements.
Control Escalating PAC Costs
The costs are substantial. As illustrated in Table 29–2, Medicare spending amounted to $58.9
billion in 2014 across the four types of facilities.7 These costs are projected to continue to
increase.
(The authors will mention that fraud also plays some part in inflating these costs, particularly
in HHAs, but chasing fraud is the responsibility of another division of CMS [Fraud & Abuse
Enforcement for Program Integrity] and is
well beyond the scope of this text.)
Set Data Standards and Ensure Digital
Interoperability
Value-based programs need accountability in
order to work, and that accountability results
from recording standard measures. Setting
uniform standards across all four care settings
allows accountability. Ensuring that digital
information can be transmitted across these
settings (interoperability) is another key element of such standardization.
Skilled
Nursing
Facilities
(SNFs)
Home
Health
Agencies
(HHAs)
Inpatient
Rehabilitation
Facilities
(IRFs)
Long-Term
Care
Hospitals
(LTCHs)
Physicians and other eligible professionals are not part of this legislation.
Exhibit 29–2 Facilities Affected by the IMPACT Act
Exhibit 29–3 Three Reasons to Focus
Attention on Post-Acute Care
• Escalating PAC costs
• PAC data standards and/or
interoperability are lacking
• Goal of setting payment rates by
individual patient characteristics
instead of the care setting (i.e.,
alternative PAC payment model)
Modified from CMS, “The IMPACT Act
of 2014 and Data Standardization,” MLN
Connects, p. 5 (October 21, 2015).
Why Focus Attention on Post-Acute Care? 407
Create an Alternative Post-Acute Care Payment Model
Setting payment rates by individual patient characteristics is an important goal. This goal can
be accomplished by creating an alternative post-acute care payment model that reaches across
the four care settings. As Table 29–2 illustrates, almost 29,000 facilities and almost 5.6 million
beneficiaries could be affected by creating such a “cross-setting model.”
A NEW ALTERNATIVE PAYMENT MODEL FOR FOUR CARE SETTINGS
This section discusses three aspects of the new PAC alternative payment model.
The New Alternative Model Would Combine Four Care Settings into One Payment
The new Alternative Post-Acute Care Payment Model proposes to primarily do two things. First,
the model would establish a universal PAC payment system. In other words, payment across the
four care settings would be unified. Second, the model would eliminate the present payment
methods for the four care settings, because these methods would all be replaced by the new
unified model.
Exhibit 29–4 illustrates the primary features of the new method. To summarize, the alternative model would set payment rates in accordance with characteristics of individual patients,
instead of in accordance with the type of care setting.
Why the New Payment Model Is Possible
The new model is possible because each of
the four affected care settings has some type
of patient assessment instrument: SNFs use
the Minimum Data Set (MDS), HHAs use
the Outcome and Assessment Information
Set (OASIS), IRFs use the IRF-Patient Assessment Instrument (PAI), and LTCHs use the
Continuity Assessment Record and Evaluation (CARE). Therefore, if major information
exists in some form on each type of assessment,
then standardizing the data makes the new
Exhibit 29–4 Proposed Alternative PAC
Payment Model
• Establish a unified PAC payment
system
• Set payment rates according to
characteristics of individuals
• Eliminate present payment tied to
PAC care setting
Provider Facilities Beneficiaries Medicare Spending
(in Billions)
Nursing Homes 15,000 1.7 Million $28.7
Home Health Agencies (HHAs) 12,311 3.4 Million 18.0
Inpatient Rehabilitation Facilities (IRFs) 1,166 373K 6.7
Long-Term Care Hospitals (LTCHs) 420 124K 5.5
Modified from: www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments.html
Table 29–2 Post-Acute Care Statistics
408 Chapter 29 Standardizing Measures and Payment in Post-Acute Care
model possible. This is because, of course, standardization then allows “cross-setting” across the
four care settings.
The SNFs and HHAs have by far the most assessment instrument annual submissions. At
the time of this writing, 2014 information reported 35 million OASIS (HHA) submissions and
20 million MDS (SNF) submissions. The combined 55 million submissions from these two
care settings far overshadow numbers from the remaining two care settings. Their combined
total of 568,000 (492,000 PAI [IRF] and 76,000 CARE [LTCH] amounted to just about one
percent of the 55 million from the combined SNFs and HHAs.8 Figure 29–1 illustrates this
information.
First Steps: Implementing Uniform Measures in Three Phases
This PAC reform depends upon uniform measures across four care settings. Phase I covers specifications of applicable measures, followed by data collection and analysis of the uniform measures.
In Phase II, providers among the four
care settings receive confidential
feedback. The feedback reveals how
they have performed on the uniform
measures they reported. In Phase III,
public reporting is implemented.
This reporting makes performance
by provider open information to
the public. (Note also that providers
may receive preview reports before
their information is made public.)
Figure 29–2 illustrates these phases.9
Figure 29–1 Post-Acute Care (PAC) Assessment Instrument Submissions.
Data from www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments.html
Skilled
Nursing
Facilities
Minimum
Data
Set
(MDS)
MDS
Submissions =
20 Million
Home
Health
Agencies
Outcomes &
Assessment
Information
Set
(OASIS)
OASIS
Submissions =
35 Million
Inpatient
Rehabilitation
Facilities
IRF-Patient
Assessment
Instrument
(PAI)
PAI
Submissions =
492 Thousand
Long-Term
Care
Hospital
Continuity
Assessment
Record &
Evaluation
(CARE)
CARE
Submissions =
76 Thousand
Figure 29–2 PAC Measurement Implementation Phases.
Phase I
Measure Specifications
Data Collection
Data Analysis Phase II
Confidential
feedback to PAC
providers about
performance on the
measures
Phase III
Public reporting
of PAC providers
performance on
the measures
A New Alternative Payment Model for Four Care Settings 409
STANDARDIZED DATA AND INTEROPERABILITY: THE KEYS TO PAC REFORM
This section discusses standardization and interoperability.
Why Does the IMPACT Act Require Standardized Data?
Legislative reform has now introduced “cross-setting” to post-acute care. At the time
of this writing, each type of post-acute facility has its own set of assessment information.
(The SNFs have the MDS, the HHAs have OASIS, and so on.) This “silo” of electronic data
does not, and typically cannot, cross over into a different type of facility. In “cross-setting,”
those information barriers are eliminated. Information can readily flow back and forth
throughout the four types of post-acute facilities—the government term for this easy flow is
“interoperability.”
The cross-setting concept runs throughout the IMPACT Act as described within this chapter.
In other words, standardized data enables electronic-related uniformity, exchangeability, and
comparability across the various post-acute care settings. (See the section about standardized
data and interoperability later in this chapter for further details.)
Table 29–1 previously listed three electronic-related elements that are enabled by standardizing assessment data. They include the following: Data element uniformity; exchangeability of
data; comparing data and quality across all PAC settings. Note that all these requirements are
possible because of today’s digital technology status in health care. The adoption of electronic
health records (EHR) nationwide was the key that allows today’s improvements to recording
and submitting electronic data.
What Is Standardized Data?
This section defines standardized data and provides two examples.
Standardized Data Defined
To standardize is to make uniform. In this case, standardized data are data that are both uniform and comparable. For example, each of the four types of PAC facilities has some type of
assessment instrument that they are already using. Certain data elements from each of these
assessment instruments have been selected to be standardized. These uniformly reported items
will then be precisely comparable across each type of facility.
One Example
The example used in one CMS training session was “eating.” All four instruments had some type
of “eating” assessment item, but the wording was different for each.10 Standardized data would
make sure that the wording (and intent of the assessment) is the same for each.
Another Example
“Mobility” is another example used in the training session. Of all 17 mobility items listed, 8,
or just over half, were present on the instruments for SNFs, IRFs, and LTCHs.11 Even though
individual wording may be different from assessment to assessment, the opportunity for standardization is present.
410 Chapter 29 Standardizing Measures and Payment in Post-Acute Care
What Is Interoperability?
This section defines and discusses the concept of interoperability.
Interoperability Defined
In this case, interoperability means the ability to operate or, actually, to transmit across the data
systems used by the various types of PAC facilities. Thus certain elements of a skilled nursing
home’s data should be in a standard format that is comparable to the standard format for those
elements that rest in, say, a home health agency.
The Key to Achieving Outcomes
The IMPACT Act requires that such data be interoperable because we need for such data to
be transmitted back and forth across the various care settings. This interoperability, along with
standardization, are the keys to achieving the anticipated outcomes.
STANDARDIZING ASSESSMENT AND MEASURE DOMAINS FOR PAC PROVIDERS
This section discusses various aspects of measurement criteria.
Background
The CMS has evolved a framework for measurement that serves as a basic structure for measurement criteria. The criteria within this framework can be applied to measurements required
within the IMPACT Act legislation, as follows.
Types of measures utilized for the PAC reform should have two basic characteristics: all
adopted measures should be patient-centered and outcome-oriented.12 Note that an outcomeoriented measure should be used whenever possible. Therefore, not every measure will or can
be measuring outcomes as such.
The Concept: A Core Set of Measures
The CMS measurement framework hinges upon domains. Certain domains can be commonly
identified across the four PAC settings and their respective providers. Thus it is possible to
create a core set of measures framed within these domains. This point is especially important
because it is a basic concept that underlies the PAC reform approach.
Note that the IMPACT Act specifically identifies assessment and
measure domains that are required
under this law. Therefore, it is especially important to recognize them
and their underlying concept.
Figure 29–3 illustrates both measure
types discussed above along with the
“core set” concept. A discussion of
required domains for both assessments and measures follows.
Figure 29–3 Two Structural Elements in the CMS Framework
for Measurement.
Adapted from 80 FR 68668 (November 5, 2015).
Measures should be
patient-centered
&
Outcome-oriented
whenever possible
Measure concepts in
each of the domains that
are common across
providers & settings can
form a core set of
measures
Standardizing Assessment and Measure Domains for PAC Providers 411
Assessment Domains That Must Be
Standardized
The IMPACT Act specifies five assessment
domains that must be standardized. They include
the following:
• Functional status
• Cognitive function and mental status
• Special services, treatments, and interventions
• Medical conditions and comorbidities
• Impairments13
Note that additional domains may be added, but
these five are the original basic requirements.
Exhibit 29–5 illustrates this information.
Measure Domains That Must Be Standardized
The IMPACT Act also specifies eight measure domains that must be standardized. These eight
domains can be divided into three groups, generally based on intent behind the information to
be gained. Refer to Exhibit 29–6 to find descriptive phrases for each domain.
The first and largest group of measure domains
consists of patient care information. These general types of care information are as follows:
• Various functional status and cognitive function measures for the individual patient
• Skin integrity, etc., typically centering upon
pressure ulcers and/or their prevention
• Reconciliation of the patient’s various
medications
• Number of major falls the patient has
experienced
The second group of measure domains consists of information about a patient moving
between care settings and/or being discharged
from care, including:
• Information transfer and care preferences
as an individual patient moves from one
care setting to another
• Information about the individual patient
being discharged from any care setting (i.e.,
“into the community”)
• Information about hospital readmission
rates (in particular, readmissions that may
be preventable)14
Exhibit 29–5 Five PAC Standardized
Assessment Domains
• Functional status
• Cognitive function & mental status
• Special services, treatments &
interventions
• Medical conditions & comorbidities
• Impairments
Modified from CMS, “IMPACT Act of
2014 and Data Standardization,” MLN
Connects, pp. 33–37 (October 21, 2015).
Exhibit 29–6 Eight PAC Standardized
Measure Domains
1. Functional status, cognitive function, & changes in function & cognitive function
2. Skin integrity & changes in skin
integrity
3. Medication reconciliation
4. Incidence of major falls
5. Transfer of health information &
care preferences when an individual transitions
6. Resource use measures, including
estimated Medicare spending per
beneficiary
7. Discharge to community
8. All-condition risk-adjusted potentially preventable hospital readmission rates
Modified from CMS, “IMPACT Act of
2014 and Data Standardization,” MLN
Connects, pp. 33–37 (October 21, 2015).
412 Chapter 29 Standardizing Measures and Payment in Post-Acute Care
The final “group” is actually a single item that represents measures about resource use. Resource
use is typically a value-based measure. As such, the grouping is expected to utilize estimated
Medicare spending per beneficiary. Certain methodology adjustments for resource use may be
aligned as necessary, including spending per beneficiary and time period(s), plus geographic
and other relevant adjustments.15
The reporting of these quality measures is to occur “through the use of a PAC assessment
instrument.” Therefore, the relevant assessment instruments are to be modified “as necessary”
to enable their use for such reporting.16
ELECTRONIC REPORTING TIMELINES FOR PAC PROVIDERS
This section discusses timeline requirements.
Time Required for Measure Development
CMS estimates that developing these quality measures will take six months to two years. The
development process includes public and stakeholder input along with guidance from the
Measure Applications Partnership (MAP).17 It is therefore possible that some timelines may be
revised. (The Measure Application Partnership is a multi-stakeholder partnership that guides
the selection of performance measures for federal health programs.)18
PAC Provider Timelines
At the time of this writing, certain standardized assessment domains will be implemented for
SNF, IRF, and LTCH providers as of October 1, 2018, and for HHAs as of January 1, 2019. There
is variation among the four providers as to the specific domain items they must initially report as
of these dates. (For more information about these domains, see the section entitled “Standardizing Assessment and Measure Domains for PAC Providers,” discussed previously.)
It is important to understand that SNF and LTCH providers should already have begun
reporting certain quality and resource use measures two years earlier as part of their new valuebased programs. Thus the SNF and LTCH providers may simply be adding new measures as
required on October 1, 2018. This contrasts with IRF providers, who will be reporting their
required measures for the first time as of October 1, 2018, and with HHA providers, who will be
reporting their required measures for the first time as of January 1, 2019.
Payment Penalty for SNFs
Beginning in fiscal year 2018, SNF payment rates may be reduced if applicable data is not submitted. The payment rate reduction amounts to two percentage points.19
PAC Action Requirements
The most important action requirements for PAC providers are submission dates. According
to CMS, “providers must submit standardized assessment data through PAC assessment instruments under applicable reporting provisions. The data must be submitted with respect to admission and discharge for each patient, or more frequently as required.”20
Electronic Reporting Timelines for PAC Providers 413
Also, at the time of this writing, IMPACTrequired measures must begin to be submitted
no later than October 1, 2018 for SNF, IRF, and
LTCH providers. IMPACT-required measures for
HHAs must begin to be submitted no later than
January 1, 2019.21 These dates are illustrated in
Exhibit 29–7.
PUBLIC REPORTING: IMPACT ACT
REQUIREMENTS
The IMPACT Act requires public reporting of
PAC provider performance, including both quality measures and resource use measures.
Timeline for Public Reporting of Quality Measures
Note that public reporting includes not only reporting the measures themselves, but also
includes the provider who is associated with those measures. The relevant data and information
are to be made publicly available no later than two years after the measure’s application date.22
Opportunity to Review
The Act stipulates that providers have the opportunity to review data and information that is
to be made public. Thus the provider has the opportunity to both review and to submit corrections prior to any public reporting of the data.23
Required Improvements to the 5-Star Rating System
CMS has implemented certain improvements to the Nursing Home Compare website’s 5-Star
Rating System. This federal website provides information about every nursing home that participates in Medicare and/or Medicaid. Nursing Home Compare rates facilities using the 5-Star Rating System. Each facility is rated on a five-point scale for each of three domains (health survey,
nurse staffing, and quality measures), plus a composite scale that combines the ratings for the
three domains.24
Several revisions are directly tied to the Act, such as using payroll-based staffing reports and
providing additional quality measures. A related improvement is a revised scoring methodology
for the 5-Star Rating System that will take advantage of the data and information received from
the payroll-based reporting and additional new quality measures.25
Two additional improvements are as follows. First, CMS and states have implemented focused
survey inspections nationwide in order to verify staffing and quality measure information. Second, CMS has strengthened the requirements that states must maintain a user-friendly website
and complete nursing home inspections in a timely manner so the current survey information
can be included in the 5-Star Rating System.26
Exhibit 29– 7 Action Requirements for
PAC Providers
• Submit patient-specific standardized assessment data
• Submit through the appropriate
assessment instrument (MDS, etc.)
• Begin to use standardized data no
later than:
October 1, 2018, SNF, IRF, LTCH
January 1, 2019, HHA
Modified from CMS, “IMPACT Act of
2014 and Data Standardization,” MLN
Connects, p. 33 (October 21, 2015)
414 Chapter 29 Standardizing Measures and Payment in Post-Acute Care
IMPACT ACT BENEFITS AND COSTS: A SUMMARY
This section discusses the Act’s benefits, costs, and challenges.
Benefits
The IMPACT Act’s benefits center upon requirements for quality improvement and a focus
upon future payment reform. Quality improvement benefits include the following:
• Facilitate coordinated care among PACs
• Achieve improved outcomes
• Allow overall quality comparisons
• Allow “patient-centeredness”
Payment reform is anticipated through the creation of one or more Alternative Post-Acute Care
Payment models. This type of model is based upon the individual patient’s care and outcomes
instead of the facility-based payment system now in place. Thus this quality- and value-based
type of payment system has the potential to become a significant benefit for post-acute care.
Costs
PAC providers will encounter transitional costs, including the following:
• Required changes to hardware and software
• Related staff training
• Potential disruption of cash flow
• Planning costs for leadership
Most of the required changes are phased in over time, so certain implementation costs may also
be phased in instead of occurring all at once.
Challenges
The Act’s requirements face a challenge in implementing interoperability. A couple of years
ago, the Office of the National Coordinator for Health Information Technology (ONC) made
its annual report to Congress and noted that national interoperability had increased, but widespread interoperability remained a challenge.
The challenge included unchanged provider practice patterns and a lack of standardization
among EHRs.27 We believe the IMPACT Act’s requirements address both of these challenges as
related to post-acute care providers.
MEETING STRATEGIC GOALS
This section briefly discusses goals and their underlying strategy.
Background
The CMS goals for quality strategy are to support the three aims of National Quality Strategy
(NQS). These three aims can be summarized as “better health; better healthcare; lower costs.”28
Meeting Strategic Goals 415
The three NQS aims are converted into six NQS priorities. CMS, in turn, has adopted these
priorities as strategic goals for quality. (The CMS goals appear below.)
The CMS Quality Strategy Goals
As described above, CMS has adopted a (slightly revised) version of the NQS priorities as its
quality strategy goals. The CMS goals appear as follows. (The NQS domain phrase for each
follows in parentheses.)29
• Promote effective communication and coordination of care (Care Coordination)
• Promote effective prevention and treatment (Clinical Quality of Care)
• Make care affordable (Efficiency and Cost Reduction)
• Strengthen person and family engagement (Person- and Caregiver-Centered Experience
and Outcomes)
• Make care safer (Safety)
• Work with communities to promote best practices of healthy living (Population/Community Health)30
More about goals and the National Quality Strategy can be found in the chapter entitled
“Understanding Value-Based Health Care and Its Financial and Digital Outcomes.”
Other Initiatives: Toward a Common Goal
Certain other initiatives are working toward the common goal of quality- and value-based
patient care. For example, HHA regulations have been modernized “for the first time since
1989, with a focus on patient-centered, well-coordinated care.”31 Modernized improvements
include requirements for a data-driven quality assessment, along with a performance improvement (QAPI) program.
The Road Map to Interoperability
The ONC is “the principal federal entity charged with coordination of nationwide efforts to
implement and use the most advanced health information technology and the electronic
exchange of health information.”32 It has created a 10-year Road Map to Interoperability that
outlines goals for both governance and certification standards. It calls for consistency at federal,
state, and private levels—an “unprecedented collaboration.”33 If such widespread interoperability can be accomplished, then technology could seamlessly support patients’ health. The
IMPACT Act is an important step toward that goal of seamless digital technology.
CONCLUSION: INNOVATION IN THE DIGITAL AGE
This section discusses the process of innovation, leadership and the future.
Innovation Defined
Innovation may be defined as “the introduction of something new; a new idea, method, or
device,” while “to innovate” is defined as “to effect a change in; to make changes.”34 In light of
416 Chapter 29 Standardizing Measures and Payment in Post-Acute Care
this, the scope of reforms proposed for PAC settings, along with the digital conversions involved,
would certainly qualify as innovations.
How do leaders of an organization approach an innovative project? E. M. Rogers, a communication and innovation researcher, comments upon reaction to an innovation as follows:
An innovation presents an individual or an organization with a new alternative or alternatives, with new means of solving problems. But the probabilities of the new alternatives
being superior to previous practice are not exactly known by the individual problem
solvers. Thus, they are motivated to seek further information about the innovation to
cope with the uncertainty that it creates.35
We visualize this type of information-seeking information approach as a sequential decision
process, as discussed in the following section.
The Process of Leadership Decisions Affects Innovation
Leadership decisions are often made in a series of stages. Figure 29–4 illustrates three decision stages
that may lead to adoption, for example, of a particular approach to PAC reform digital choices.
The three-stage decision process includes the following:
1. Gathers information: This stage seeks enough information to attain knowledge.
2. Forms an opinion: This stage uses the knowledge gained to reach an understanding that
leads to forming an opinion.
3. Makes a decision: This stage uses the opinion that has been formed to make a decision.
The last stage, “Makes a decision,” should result in one of two outcomes: The decision will
either be positive (Yes: will adopt and implement) or negative (No: will not adopt). (There
could be a third possible outcome on that last stage. R. W. once briefly worked with a boss who
would never say “yes” or “no”; instead, his decision would be “Take no action either way.”) We should
also note that a negative decision might not always be final, as it might be reversed at a later date.
Bringing About Innovation
How can a manager help to bring about an innovative concept such as the legislative reforms
that are the subject of this chapter? He or she can help first to understand and then to diffuse.
Figure 29–4 Process Flow: Leadership Decision Stages.
*Negative decisions may not be final.
Gathers Information
Forms an Opinion
Makes a Decision
Yes: Will Adopt & Implement
No: Will Not Adopt*
Conclusion: Innovation in the Digital Age 417
Understanding the Required Framework
You as a manager can gather information and use it to understand the required framework. If
requested, you can also actually assist in gathering information to provide to your upper-level
management.
Diffusing the Information
You as a manager can also help to establish understanding about the innovative concept
throughout your part of the organization. This could be by specific assignment or through
informal information sharing. In either case, you would be assisting by helping to diffuse the
information through individuals who need to know.
Management and the Impact of Leadership Changes
Two types of change in leadership may well impact the strategy and progress of healthcare technology management.
Leadership Change Within a Healthcare Organization
It seems obvious to say that leadership change within a healthcare organization may well result
in a change in strategic direction. Still, this is often the case. Consequently, certain resources
and/or initiatives may now receive more support, while some other resources and/or initiatives
may have their funds and staffing cut, or even eliminated. It is important for a manger to be
aware of this possibility, and be ready to defend his/her projects with current, well-organized
information.
Leadership Change Within Legislative Bodies
Leadership change within legislative bodies can have a similar impact on projects in progress.
This is especially true when it comes to funding, both current and future.
THE FUTURE: CHANGE IS INEVITABLE
The rate of change has accelerated in the digital age of health care. The IMPACT Act’s reform
legislation resonates across these four provider settings and beyond. It sets an interoperable
quality- and vision-based vision of reform. While change is inevitable, it seems these PAC provider changes are in step with future patient-centered goals.
INFORMATION CHECKPOINT
What is needed? Information about the new requirements affecting post-acute
care facilities.
Where is it found? Newsletters, blogs, or training materials
How is it used? In general, to better inform healthcare providers. If your organization is a SNF, HHA, IRF, or LTCH, to educate staff
about these required changes that are in progress.
418 Chapter 29 Standardizing Measures and Payment in Post-Acute Care
KEY TERMS
Cross-Setting
Electronic Health Record (EHR)
Interoperability
IMPACT Act
Post-Acute Care (PAC)
Standardized Data
Value-Based Program
OTHER ACRONYMS
CARE = Continuity Assessment Record and Instrument
HHA = Home Health Agency
IRF = Inpatient Rehabilitation Facility
LTCH = Long-Term Care Hospital
MDS = Minimum Data Set
MAP = Measure Applications Partnership
NQS = National Quality Strategy
OASIS = Outcome and Assessment Information Set
ONC = Office of the National Coordinator for Health Information Technology
PAI = Patient Assessment Instrument
QAPI = Quality Assurance Performance Improvement
SNF = Skilled Nursing Facility
DISCUSSION QUESTIONS
1. Are you familiar with a post-acute care facility?
2. If so, how do you think these legislative requirements have affected that facility?
3. Do you think the requirements to standardize data and achieve interoperability are a
good idea?
NOTES
1. P. L. 113-185 Sec. 2(a); also Centers for Medicare and Medicaid Services (CMS), “The
IMPACT Act of 2014 and Data Standardization,” MLN Connects (October 21, 2015), p. 5.
2. “The IMPACT Act of 2014 and Data Standardization,” p. 4.
3. 80 Federal Register 46462 (August 4, 2015).
4. P. L. 113-185 Sec. 3(a)(1-2).
5. SSA Title XVIII Sec. 1899B (i)(1-3).
6. “The IMPACT Act of 2014 and Data Standardization,” p. 5.
Notes 419
7. Ibid., p. 6.
8. Ibid., p. 6.
9. Sec. 1899B (e)(1)(A-C).
10. “The IMPACT Act of 2014 and Data Standardization,” p. 10.
11. Ibid.
12. 80 FR 68668 (November 5, 2015).
13. Sec. 1899B (b)(1)(B).
14. Sec. 1899B (c)(1)(A-E).
15. Sec. 1899B (d)(2)(A-C).
16. Sec. 1899B (c)(2)(A).
17. “The IMPACT Act of 2014 and Data Standardization,” p. 37.
18. National Quality Forum, “Measure Applications Partnership,” www.qualityforum.org
/setting_priorities/partnership/measure_applications_partnership.aspx
19. Sec. 1888 (e)(6)(A)(i).
20. “The IMPACT Act of 2014 and Data Standardization,” p. 33.
21. Ibid.
22. Sec. 1899B (g)(1-4).
23. Ibid.
24. CMS, “Fact Sheet: Nursing Home Compare Five-Star Quality Rating System,” www.cms
.gov/medicare/provider-enrollment-and-certification/certificationandcomplianc
/downloads/consumerfactsheet.pdf, accessed July 8, 2016.
25. CMS.gov, “CMS Announces Two Medicare Quality Improvement Initiatives,” October
6, 2014, www.cms.gov/Newsroom/MediaReleaseDatabase/Press-releases/2014
-items/2014-10-06.html
26. Ibid.
27. D. Bowman, “ONC Interoperability Road Map Draft,” p. 2, October 14, 2014, www
.fiercehealthit.com/story/onc-interoperabiliity-road-map-draft-outlines-governance
-certification-stand/2014-10-14
28. “The IMPACT Act of 2014 and Data Standardization,” p. 18.
29. 80 FR 68668 (November 5, 2015).
30. “The IMPACT Act of 2014 and Data Standardization,” p. 19.
31. “CMS Announces Two Medicare Quality Improvement Initiatives,” p. 2.
32. HealthIT.gov, “Newsroom: About ONC,” www.healthit.gov/newsroom/about-onc,
accessed July 7, 2016.
33. “ONC Interoperability Road Map Draft,” p. 1.
34. Merriam Webster’s Collegiate Dictionary, 10th ed., s.v. “Innovation.”
35. E. M. Rogers, Diffusion of Innovations, 4th ed., (New York: The Free Press, 1995), xvii.
420 Chapter 29 Standardizing Measures and Payment in Post-Acute Care
CHAPTER
ICD-10 E-RECORDS OVERVIEW AND IMPACT
This chapter provides an ICD-10 overview and describes the
ICD-10 electronic records impact.
OVERVIEW OF THE ICD-10 CODING SYSTEM
The International Classification of Diseases, 10th Revision
(ICD-10) is designed to “promote international comparability in the processing classification and presentation
of mortality statistics.”1 The ICD is the international standard diagnostic classification for all general epidemiological issues, many health management purposes, and
clinical use.2
This classification system has been developed by collaboration among the World Health Organization (WHO) and
10 international centers. Other countries that have already
adopted ICD-10 include Australia, Canada, France, Germany, and the United Kingdom.3
ICD-10-CM AND ICD-10-PCS CODES
The National Center for Health Statistics (NCHS) is 1 of
the 10 international centers collaborating with the WHO
in the development and revisions of the ICD. The NCHS
is an agency within the Centers for Disease Control and
Prevention (CDC). As such, NCHS is the federal agency
that is responsible for use of the ICD-10 in the United
States.
WHO owns the ICD-10 copyright and has “authorized
the development of an adaptation of ICD-10 for use in the
United States for U.S. government purposes.”4 The NCHS,
under the CDC, has developed a clinical modification of
421
Progress Notes
© LFor/Shutterstock
30
CHAPTER
After completing this chapter,
you should be able to
1. Understand the six benefits
of transitioning to ICD-10.
2. Understand why the change to
ICD-10 codes is a technology
problem.
3. Identify the three types of
ICD-10 implementation costs.
4. Understand how KPIs are used.
5. Describe ICD-10 KPIs’ essential indicators.
6. Understand why situational
analysis is particularly appropriate for electronic records implementation such as ICD-10.
7. Identify the four components
of a SWOT analysis.
ICD-10 Implementation
Continues: Finance and
Strategic Challenges
for the Manager
the ICD-10, termed “ICD-10-CM.” The
ICD-10-CM replaces the ICD-9-CM.
The ICD-10-CM diagnosis classification
system has been developed for use in all
types of healthcare treatment settings in
the United States.5
Meanwhile, the Centers for Medicare
and Medicaid Services (CMS) has developed a procedure classification system,
termed the “ICD-10-PCS.” The ICD10-PCS is for use in inpatient hospital
settings only within the United States.6
(Note this difference: ICD-10-CM is for
use in all types of healthcare treatment
settings, while ICD-10-PCS is for use in
inpatient hospital settings only.)
Final Revised ICD-10 Compliance Date
CMS has extended the deadline for ICD-10 compliance by one year. Thus the compliance date
for ICD-10-CM and ICD-10-PCS is now October 1, 2015, instead of October 1, 2014, as reflected
in Figure 30–1. CMS officials believe this extension “…will give covered entities the additional
time needed to synchronize system and business process preparation and changeover to the
updated medical data code sets.”7
Providers and Suppliers Impacted by the ICD-10 Transition
The change from ICD-9 to ICD-10 has a ripple effect that impacts nearly every corner of the
healthcare industry in the United States. The companies and organizations impacted by the
ICD-10 transition include inpatient providers, outpatient providers, and an array of other support services and suppliers.
Figure 30–2 illustrates the entities that are affected by the ICD-10 transition. Inpatient providers impacted include both hospitals and nursing facilities. Outpatient providers include, at a
minimum, physician offices, outpatient care centers, medical diagnostic and imaging services,
home health services, other ambulatory care services, and durable medical equipment providers. Support services and suppliers include health insurance carriers and third-party administrators, along with the vendors who provide computer system design and related services.8 Note
that pharmacies (both chain and independent pharmacies) are substantially impacted by the
required electronic transaction standards updates for pharmacies, while ICD-10 adoption is
generally more of a peripheral issue for pharmacies.
E-RECORD STANDARDS AND THE ICD-10 TRANSITION
This section discusses Version 5010 of electronic record standards and provides an example of
standards use.
Figure 30–1 ICD-10 Revised Final Compliance Date.
ICD-10-CM
and
ICD-10-PCS
Revised Final
Compliance Date
October 1, 2015
422 Chapter 30 ICD-10 Implementation Continues
Version 5010 of Standards and the ICD-10 Transition
Version 5010 of electronic transmission standards includes infrastructure changes that were
necessary in order to prepare for the adoption of ICD-10 codes. A whole array of sequential
rules and regulations has evolved over the last two decades to create these electronic transaction
standards and to require their adoption—a full description of such rules and regulations is well
beyond the scope of this text.9
Example of Standards Use
However, two particular items are of interest to us in the context of the ICD-10 transition:
1. It was necessary to update many electronic transaction standards in order to accommodate the new ICD-10 codes. The groups, or sets, of codes (termed “standard medical data
code sets”)10 to be used in those electronic transactions also had to be updated. (Note
that at the time of this writing, the current standard to be adopted is Version 5010, although new versions will inevitably be introduced in the near future.)11
2. When the Centers for Medicare and Medicaid Services (CMS) staff compute transition
costs, they divide some of these costs between the updating of transaction standards such
as Version 5010 (which they argue would have to occur anyway) versus the cost of adopting and implementing the ICD-10 codes. We will be referring to this cost-splitting in a
later discussion of implementation costs.
ICD-10 BENEFITS AND COSTS
The ICD-10 transition process will require management decisions that take both costs and benefits into account. A brief summary follows.
Inpatient Providers
• Hospitals
• Nursing Facilities
Others
• Health Insurance Carriers &
Third-Party Administrators
• Computer System Design &
Related Services
Outpatient Providers
• Physician Offices
• Outpatient Care Centers
• Medical Diagnostic &
Imaging Services
• Home Health Services
• Other Ambulatory Care Services
• Durable Medical Equipment
Figure 30–2 Inpatient and Outpatient Providers and Suppliers Impacted by the ICD-10 Transition.
Reproduced from 74 Federal Register 3357 (January 16, 2009).
ICD-10 Benefits and Costs 423
Benefits
Management will need to account for what their own organization will realize in conversion savings as benefits. CMS identified six benefits of transitioning to ICD-10:
• More accurate payments for new procedures
• Fewer rejected claims
• Fewer improper claims
• Improved disease management
• Better understanding of health conditions and healthcare outcomes
• Harmonization of disease monitoring and reporting worldwide12
In regard to recognition of other benefits, see our comment about cost-splitting in a previous paragraph, as the same concept applies to splitting benefits. Thus, the systems conversion
to Version 5010 also recognizes three types of benefits, including operational savings (better
standards), cost savings (increase in electronic claims transactions), and operational savings
(increase in use of auxiliary transactions).13
Managers should also decide what potential governmental financial assistance might be
available to their own organization. The ICD-10 conversion is, of course, part (but not all) of
this adoption process. It is therefore logical for management to consider part of the financial
incentives offered as relating to this system conversion when analyzing benefits. The ARRA legislation described in previous chapters provides financial incentives for the timely adoption of
electronic health records.
Costs
Management must make decisions about major costs incurred in the ICD-10 transition, including direct adoption costs and cash flow disruption costs. Some costs will be one-time costs, while
other costs will become recurring costs, and this factor must also be considered in the decisionmaking process.14
Three Types of ICD-10 Adoption Costs
CMS acknowledges that transition costs from ICD-9-CM to ICD-10 code sets are unavoidable
and are incurred in addition to the Version 5010 standards conversion costs.15 Three recognized types of ICD-10 adoption costs include the following:
1. System changes
2. Training costs
3. Productivity losses
CMS believes that large providers and institutions will most likely need to make system
changes and software upgrades. However, CMS also believes small providers may only need
software upgrades.16 This belief is based upon findings that the majority of small providers have
simplistic systems.17
Details about training costs and productivity losses are addressed within this chapter. As a
final note, also see our comment about cost-splitting in a prior paragraph. Thus, systems conversion to Version 5010 recognizes two similar types of cost: system implementation costs and
transition costs.18
424 Chapter 30 ICD-10 Implementation Continues
Cash Flow Disruption Costs
Code set transition has a learning curve for all users. Thus it is to be expected that a greater
proportion of claims will be rejected during this learning curve. Rejected claims lead to cash
flow disruption, and should be taken into
account when decisions are made about
implementation costs and benefits.
If certain contracts contain stipulations
as to ICD-9 codes, these contracts may have
to be renegotiated. The much greater specificity of the ICD-10 codes may make such
renegotiation necessary in certain cases,
and cash flow from contracts may be disrupted in the interim.
ICD-10 IMPLEMENTATION:
SYSTEMS AFFECTED AND
TECHNOLOGY ISSUES
ICD-10 implementation affects numerous
computerized systems and creates complex technology issues, as discussed in the
following sections.
Systems and Applications Affected by
the ICD-10 Change
The ICD-10 technology changes that we
will discuss in the following section impact
a broad variety of systems and applications. It is important for the manager to
fully understand the breadth and depth
of change that is required by the technological transition from ICD-9 to ICD-10.
Figure 30–3 illustrates the types of systems
and applications that must change.
Twenty-five different examples of various systems and applications are contained
in Figure 30–3, divided into three categories as follows:
1. Necessary revisions to vendor software and systems
2. Systems used to model or calculate
that are impacted
3. Specifications that will need to be
revised19
Figure 30–3 Systems and Applications Affected
by the ICD-10 Change.
Reproduced from 74 Federal Register 3357 (January
16, 2009).
Ambulatory systems
Billing systems
Patient accounting systems
Physician office systems
Practice management systems
Quality measurement systems
Emergency department software
Contract management programs
Reimbursement modeling programs
Financial functions such as:
Code assignment
Medical records abstraction
Claims submission
Other nancial functions
Acuity systems
Decision support systems and content
Patient care systems
Patient risk systems
Staffing needs systems
Selection criteria within electronic medical
records
Presentation of clinical content for support of
plans of care
Necessary Revisions to Vendor
Software and Systems for Transition
from ICD-9 to ICD-10 include:
Systems used to model or calculate are
also impacted by the use of ICD-10
code sets:
Specifications that will need to be revised
for ICD-10 use include specifications for:
Data le extracts
Reporting programs and external interfaces
Analytic software that performs business analysis
Analytic software that provides decision support
analytics for nancial and clinical management
Business rules guided by patient condition or
procedure
ICD-10 Implementation: Systems Affected and Technology Issues 425
UNDERSTAND TECHNOLOGY ISSUES AND PROBLEMS
Examining the details of ICD-10 code set changes will help you more fully understand the technological problems that management will face in this transition. The scope of change is illustrated in the next three exhibits.
Comparison of ICD-9-CM and ICD-10-CM Diagnosis Codes
There were approximately 13,000 ICD-9-CM diagnosis codes; now ICD-10-CM has approximately 68,000 diagnosis codes, more than a 500% increase. ICD-9-CM diagnosis codes
had three to five characters in length, while ICD-10-CM’s characters are three to seven
characters in length. This generally means input fields have to be lengthened in order to
accommodate seven characters. In addition, ICD-9-CM’s first digit may be alpha (E or V)
or numeric, and digits two to five are numeric, while ICD-10-CM’s first digit is alpha, digits two and three are numeric, and digits four to seven are either alpha or numeric. This
change means reprogramming will be required for many applications. Exhibit 30–1 sets
ICD-9-CM Diagnosis Codes ICD-10-CM Diagnosis Codes
3–5 characters in length
Approximately 13,000 codes
First digit may be alpha (E or V) or numeric; digits 2–5 are numeric
Limited space for adding new codes
Lacks detail
Lacks laterality
Difficult to analyze data due to nonspecific
codes
Codes are nonspecific and do not adequately define diagnoses needed for medical
research
Does not support interoperability because
it is not used by other countries
3–7 characters in length
Approximately 68,000 available codes
Digit 1 is alpha; digits 2 and 3 are numeric;
digits 4–7 are alpha or numeric
Flexible for adding new codes
Very specific
Has laterality
Specificity improves coding accuracy and
richness of data for analysis
Detail improves the accuracy of data used
for medical research
Supports interoperability and the exchange
of health data between other countries and
the United States
Reproduced from 73 Federal Register 49803 (August 22, 2008).
Exhibit 30–1 Comparison of ICD-9-CM and ICD-10-CM Diagnosis Codes
426 Chapter 30 ICD-10 Implementation Continues
Reproduced from 73 Federal Register 49803 (August 22, 2008).
out a comparison of ICD-9-CM versus ICD-10-CM diagnosis codes. The exhibit includes six
benefits of the new code set in addition to the three differentials previously discussed in
this paragraph.20
Comparison of ICD-9-CM and ICD-10-PCS Procedure Codes
There were approximately 3,000 ICD-9-CM procedure codes; now ICD-10-PCS has approximately 87,000 available procedure codes, or 29 times as many available codes. ICD-9-CM
procedure codes had three to four numbers in length, while ICD-10-CPS’s characters are
alpha-numeric and seven characters in length. This generally means input fields have to be
lengthened in order to accommodate seven characters and possibly reprogrammed to accept
alpha characters. Exhibit 30–2 sets out a comparison of ICD-9-CM versus ICD-10-PCS procedure
codes. The exhibit includes seven benefits of the new code set in addition to the two differentials previously discussed in this paragraph.21
Exhibit 30–2 Comparison of ICD-9-CM and ICD-10-PCS Procedure Codes
ICD-9-CM Procedure Codes ICD-10-PCS Procedure Codes
3–4 numbers in length
Approximately 3,000 codes
Based upon outdated technology
Limited space for adding new codes
Lacks detail
Lacks laterality
Generic terms for body parts
Lacks description of methodology and
approach for procedures
Limits DRG assignment
Lacks precision to adequately define
procedures
7 alpha-numeric characters in length
Approximately 87,000 available codes
Reflects current usage of medical terminology and devices
Flexible for adding new codes
Very specific
Has laterality
Detailed descriptions for body parts
Provides detailed descriptions of
methodology and approach for
procedures
Allows DRG definitions to better recognize new technologies and devices
Precisely defines procedures with detail
regarding body part, approach, any device used, and qualifying information
Understand Technology Issues and Problems 427
AN EXAMPLE: COMPARISON OF OLD AND NEW ANGIOPLASTY CODES
Exhibit 30–3 sets out one example of the proliferation of codes. In the ICD-9-CM, angioplasty
had one code (39.50). In the ICD-10-PCS, angioplasty has 1,170 codes.22 The Wall Street Journal
even used this example in a headline: “Why We Need 1,170 Angioplasty Codes.”23 (The original
1,170 codes have subsequently been reduced to 874, as shown in Exhibit 30–3.)
ICD-10 IMPLEMENTATION: TRAINING AND LOST PRODUCTIVITY COSTS
This section describes training and lost productivity costs for the ICD-10 transition. Also see this
chapter’s Appendix, entitled “ICD-10 Conversion Costs for a Midwestern Community Hospital.”
WHO GETS TRAINED ON ICD-10?
CMS identified three types of individuals who would require varying levels of training on ICD10. These included coders, code users, and physicians.
Coders
It is vital that coders receive adequate training on the ICD-10 coding changes. CMS, therefore,
estimated training costs for both full-time and part-time coders. In producing cost estimates,
Reproduced from CMS. “ICD-10-CM/PCS: The Next Generation of Coding,” ICN #901044
(June 2015).
Exhibit 30–3 Comparison of Old and New Angioplasty Codes
Old Code:
ICD-9-CM
Angioplasty
1 code (39.50)
New Code:
ICD-10-PCS
Angioplasty Codes
854 codes
Specifying body part, approach, and device, including:
047K04Z Dilation of right femoral artery with drug-eluting intraluminal device, open
approach
047K0DZ Dilation of right femoral artery with intraluminal device, open approach
047K0ZZ Dilation of right femoral artery, open approach
047K34Z Dilation of right femoral artery with drug-eluting intraluminal device, percutaneous approach
047K3DZ Dilation of right femoral artery with intraluminal device, percutaneous
approach
428 Chapter 30 ICD-10 Implementation Continues
CMS assumed that full-time coders were primarily dedicated to hospital inpatient coding
and that part-time coders worked in outpatient ambulatory settings. The difference is based
on the job setting for a reason. CMS further assumed that all coders will need to learn ICD10-CM, while the coders who work in the hospital inpatient job setting will also need to learn
ICD-10-PCS.24
Code Users
CMS refers to the American Health Information Management Association (AHIMA) definition
of code users as “anyone who needs to have some level of understanding of the coding system,
because they review coded data, rely on reports that contain coded data, etc., but are not people
who actually assign codes.”25 These users can be people who are outside of healthcare facilities:
individuals such as researchers, consultants, or auditors, for example. Or these users might
actually be inside the healthcare facility but are not coders. Such facility users might include
upper-level management, business office and accounting personnel, clinicians and clinical
departments, or corporate compliance personnel.26
Physicians
CMS believed that the majority of physicians did not work with codes and thus would not need
training. The initial assumption was that only 1 in 10 physicians would require such knowledge.
(CMS also believed that physicians would probably obtain the needed training through continuing professional education courses that they would attend anyway.)27
COSTS OF TRAINING
ICD-10 training costs were estimated for each category described above: coders, code users, and
physicians.
Coder Training Costs
CMS initially assumed the following:
1. There were 50,000 full-time hospital coders that would need 40 hours of training per
coder on ICD-10-CM and ICD-10-PCS. The 40 hours of training was estimated to cost
$2,750, including lost work time of $2,200, plus $550 for the expenses of training, for a
total of $2,750 per coder.
2. Training of full-time coders would start the year before ICD-10 implementation. It was
further assumed that 15% of training costs would be expended in this initial year, 75%
would be expended in the year of implementation, and the remaining 10% would be
expended in the year after implementation.
3. There were approximately 179,000 part-time coders who would require training only
on ICD-10-CM (and not on ICD-10-PCS). The part-time coders’ training expense would
amount to $110 for the expenses of training, plus $440 for lost work time, for a total of
$550.28
Costs of Training 429
Code Users Training Costs
CMS estimated there were approximately 250,000 code users, of which 150,000 would work
directly with codes. Each code user was estimated to need eight hours of training at $31.50 per
hour or approximately $250 apiece.29
Physician Training Costs
CMS estimated there were approximately 1.5 million physicians in the United States, of which
1 in 10 would require training. Each physician was estimated to need four hours of training at
$137 per hour or approximately $548 apiece.30
COSTS OF LOST PRODUCTIVITY
CMS used a productivity loss definition as follows: “The cost resulting from a slow-down in
coding bills and claims because of the need to learn the new coding systems.”31 Thus, the productivity loss slowdown reflects the extra staff hours that are needed to code the same number
of claims per hour as prior to the ICD-10 conversion. (For instance, Jane normally codes x
claims per hour; during the first month learning the new system, she slows down to xx claims
per hour.)
CMS estimated that inpatient coders would incur productivity losses for the first six months
after ICD-10 implementation; they further estimated that productivity would increase (and
losses thus decrease) month by month over the initial six-month period until by the end of six
months, productivity has returned to its former level. It was estimated that inpatient coders
would take an extra 1.7 minutes per inpatient claim in the first month. At $50 per hour, 1.7
minutes equates to $1.41 per claim.32 ($50.00 per hour divided by 60 minutes equals $0.8333
per minute times 1.7 minutes equals $1.41 per claim.)
CMS assumed the same six-month productivity loss period for outpatient coders. CMS further
assumed that outpatient claims require much less time to code. In fact, the initial assumption
was that outpatient claims would take one-hundredth of the time for a hospital inpatient claim.
Thus, one-hundredth of the inpatient 1.7 minute productivity loss equals 0.017 minutes. At the
same $50 per hour, one-hundredth of the $1.41 inpatient loss equals 0.014 per claim, or about
1.5 cents.33 (To compute one-hundredth of $1.41, move the decimal to the left two places. Thus
$1.41 becomes $0.014.) The reasoning for this small amount of coding time per claim is that
physician offices “may use preprinted forms or touch-screens that require virtually no time to
code.”34
INTRODUCTION: ABOUT ICD-10 KEY PERFORMANCE INDICATORS
This section defines Key Performance Indicators (KPIs) for ICD-10 transition and maintenance.
What Are ICD-10 Key Performance Indicators (KPIs)?
As the name suggests, these indicators reveal problems regarding ICD-10 implementation and
maintenance. The problems may affect productivity and/or cash flow.35
430 Chapter 30 ICD-10 Implementation Continues
How Are ICD-10 KPIs Used?
The ICD-10 KPIs are typically used for two purposes. The KPIs will track your progress in
transitioning, maintaining, and updating ICD-10 within your organization. KPIs will also provide
opportunities for improvement. Typical improvements include system revisions and/or enhancements, plus specialized staff training to improve productivity lapses.36
KEY PERFORMANCE INDICATORS TO ASSESS ICD-10 PROGRESS
The following KPIs are grouped into six categories. The first two categories contain “essential
indicators” that any organization should be able to generate.37
Four Essential Indicators About Claims
These four indicators should be available to you as they should be tracked by all healthcare
organizations as key information regarding claim submission and payment:
Days to Final Bill: The number of days from time of service until the provider generates
and submits claims.
Days to Payment: The number of days from the time the claim is submitted until the provider is paid.
Claims Acceptance/Rejection Rates: The percentage of claims that are accepted or
rejected during payer “front-end” edits. Front-end edits are those a payer performs before
the claim is entered into the payer’s adjudication system.
Claims Denial Rate: The percentage of claims accepted into the payer’s adjudication system that are denied.
Two Essential Indicators About Payment and Reimbursement Rates
These KPIs can give a picture of both payment amounts received per service and the rate of
reimbursement against amounts billed.
Payment Amounts: Payment amounts that your organization receives for specific services,
especially high-volume and resource-intensive services.
Reimbursement Rate: Cents on the dollar that your organization receives on claims versus
the amount billed on those claims.
Four Coder Productivity Indicators
Productivity is measured by various methods as follows:
Coder Productivity: The number of medical records coded per hour. This indicator
should be reviewed separately for each coder.
Volume of Coder Questions: The number of records that coders returned to clinicians
with requests for more documentation needed in order to support proper code selection.
Again, reviewing this indicator separately for each coder may reveal whether a problem exists with the individual coder or with the particular professional or department generating
the source records.
Key Performance Indicators to Assess ICD-10 Progress 431
Requests for Additional Information: The number of requests from payers asking for additional information required to process claims. Reviewing this indicator separately by payer
may highlight specific coding issues.
Daily Charges/Claims: The number of charges or claims submitted per day. This is a pure
productivity indicator for the department.
Three Internal Error Indicators
These indicators concern the individuals or departments that generate the initial information
that coders use:
Incomplete or Missing Charges: The number of incomplete or missing charges, analyzed
either by the week or the month. Again, separate reviews of particular departments will
highlight problems to be solved.
Incomplete or Missing Diagnosis Codes: The number of incomplete or missing ICD-10
diagnosis codes on orders. If ICD-10 implementation is running smoothly, this indicator
should almost be zero. Problems, on the other hand, could either be with individuals generating the information or possibly with the software they may be using.
Use of Unspecified Codes: The volume and frequency of unspecified code use. The use
of unspecified codes may be perceived as a timesaving maneuver, but it should be tracked
and corrected. Unspecified codes cause revenue losses.
Four External Error Indicators
These indicators concern actions by entities outside your own organization:
Clearinghouse Edits: This indicator can be approached in two ways. First, obtain and review the number and content of edits that are required by clearinghouses. Second, obtain
and review the number of claims either accepted or rejected by clearinghouses.
Payer Edits: The number and reason for edits required by payers.
Return to Provider (RTP)/Fiscal Intermediary Shared System (FISS) Volumes: The number of rejections in the RTP/FISS volumes.
Medical Necessity Pass Rate: The rate of acceptance (or rejection) of claims with medical
necessity content.
A Positive Usage Indicator
This indicator reveals best practices within the coding field:
Use of ICD-10 Codes on Prior Authorizations and Referrals: The number of orders and
referrals that include ICD-10 codes.
USING KPIs TO TRACK ICD-10 IMPLEMENTATION PROGRESS
The first step in assessing ICD-10 implementation is to choose the particular KPIs that you
intend to use. You may choose from the KPIs listed in Exhibit 30–4. Your next steps are as
follows.38
432 Chapter 30 ICD-10 Implementation Continues
Establish Baselines
It is necessary to establish baselines, or points of comparison, for each of your chosen
indicators.
These baselines should be pre-implementation—that is, from a period shortly before your organization implemented ICD-10 codes. If so, you will be able to compare pre- and post-implementation
results for your assessment purposes.
Track Your Chosen Indicators
To properly assess KPIs, it is desirable to track your chosen indicators on a periodic pre-set
schedule. The schedule should be reasonable as to the timing of assessment dates. For example,
should assessments occur on a monthly, quarterly, or semi-annual basis?
Compare Against Baselines
Comparison of pre–ICD-10 implementation versus post–ICD-10 implementation is a most
useful process. However, early transition results compared to later transition results are also
helpful. In that case, you might find significant improvement in some areas and virtually no
improvement in other areas.
Modified from CMS, “ICD-10: Next Steps for Providers—Assessment & Maintenance Toolkit.”
Exhibit 30–4 Checklist for Assessing ICD-10 Progress: Key Performance Indicators
• Number of days to final bill
• Number of days to payment
• Claims acceptance/rejection rates
• Claims denial rate
• Payment amounts
• Reimbursement rate
• Coder productivity
• Volume of coder questions
• Payer requests for additional information
• Daily charges/claims
• Incomplete or missing charges
• Incomplete or missing diagnosis codes
• Use of unspecified codes
• Clearinghouse edits
• Payer edits
• RTP/FISS volumes
• Medical necessity pass rate
• Use of ICD-10 codes on prior authorizations & referrals
Using KPIs to Track ICD-10 Implementation Progress 433
Review Results
Some revisions may be desirable after tracking has been in place for several cycles. You may find
that you are able to break results into smaller segments for more detailed results. For example,
you may decide to keep separate track of authorization denials versus coding denials. Detail
about reviewing such results appears in the following section.
REVIEWING KPI RESULTS
This section discusses the review of performance indicator results. Sometimes such reviews are
called “troubleshooting,” which is a good term to describe this process.
Review “Essential Indicator” Results for Claims and Payment
Taken together, the four essential indicators about claims and the two essential indicators about
payment and reimbursement provide a snapshot of your ICD-10 implementation progress.
When these six performance indicators from your baseline pre-implementation are compared
to results post-implementation, problem areas that require action will be highlighted.
It is also good practice to compare indicators such as “Days to Final Bill” and “Days to Payment” against national or regional standards. If your organization is part of a multi-facility system, it is also a good practice to compare facility-specific results within the system.
Review Coder Productivity and Internal Error Indicator Results
The four coder productivity indicators allow an overview of the internal department or division
responsible for coding. If your organization uses an outside billing service, then the important
indicator would be “Requests for Additional Information.” The outside billing service’s requests
for more information would be coming back to somewhere in your organization and would
indicate an existing problem.
The three internal error indicators relate to places and people within the organization other
than coders. If a claim has incomplete or missing charges and/or diagnosis codes, then the coders
obviously cannot complete the claim and submit it for payment. In other words, the problem exists
elsewhere. Segmenting this review by departments would assist in highlighting the problem area(s).
Review External Error Indicator Results
Claims are sent back by either payers or clearinghouses for further edits. These indicator results
may be a people issue or a computer system issue. In either case, the result is unpaid claims and
the reasons need to be addressed.
Other claims may be rejected. The results for this indicator have financial impact regarding cash
flow. Segmenting the review by department is a good method to explore the reasons for such rejections.
Allow For Feedback
Try to provide a formal system for feedback regarding performance indicator results. One
proven method is to create one single “issues list” that resides in one single location. Responsibility for providing the related feedback must then be formally designated.
434 Chapter 30 ICD-10 Implementation Continues
CREATING ACTION PLANS TO DEAL WITH PROBLEMS
The KPIs are likely to reveal a series of different problems that will vary in their severity. Thus it makes sense to create a set of action plans that are designed to deal with this
variety.
What Is an Action Plan?
An action plan consists of a series of steps (actions) that are intended to bring about change of
some sort. Each step should be able to answer the following questions:
• What actions or changes will occur?
• Who will carry out these actions or changes?
• When will they take place, and for how long?
• What resources (such as funding and staff) are needed to carry out the actions or
changes?
• How will information regarding the actions or changes be communicated (who should
know what)?39
What Makes a Good Action Plan?
To be successful, your action plan needs to be complete, clear, and current. “Complete” means
that the plan lists all the relevant action steps required to accomplish desired actions or changes.
“Clear” means that the plan clearly answers the “who, when, what, and communication”questions.
“Current” concerns whether the plan actually contains current work.40 In other words, has the
plan anticipated and addressed recently emerging issues, or is it already behind the times by the
time it is released?
BUILDING SPECIFIC ACTION PLANS TO CORRECT DEFICIENCIES
This section outlines a selection of issues that could become part of specific action plans. The
issues are divided between internal and external matters as follows.41
Internal Coding and Systems Action Plan Issues
Action plans typically point toward solutions. Different KPIs are designed to measure performance in different areas that impact productivity, payment, and cash flow. The following issues
all require some type of solution.
Isolate Internal Coding Problems
• What codes are causing the most difficulty? What is the particular difficulty, and where
within the organization does it originate?
• Who selects diagnosis codes, and who makes sure the codes adhere to guidelines (clinicians, billers, certified coders, others)?
• Would chart audits support selection of a particular ICD-10 code?
• When KPIs expose coding productivity issues, who specifically is responsible for seeing
to supplemental training and subsequent tracking to assess any improvements? If such
improvements are not forthcoming, what is the next step?
Building Specific Action Plans to Correct Deficiencies 435
Isolate Internal Systems Problems
• Are certain system deficiencies regarding the ICD-9/ICD-10 transition not yet corrected?
• Are adjustments for annual ICD-10 updates not yet in place and are overdue?
• Have all systems implemented all available upgrades?
• Are there departmental “silo” issues (i.e., do IT [informational technology] supervisors
and coding supervisors ever communicate)?
External Coding and Payer Action Plan Issues
Action plans provide structure while working to resolve issues with your payers and your external systems vendors. Producing the relevant data from your KPI process will serve to reinforce
the concerns that you are expressing.
Isolate External Coding and Payer Problems
• Is code selection driven by vendor templates? If so, is this acceptable? Can it be changed?
If not, why not? Who is responsible for finding out?
• Is the external systems vendor slow to install coding updates to your system? If so, who is
responsible for pressuring the vendor to comply? What is the plan if such efforts fail?
• IfKPIs expose a consistent claims edit and/or rejection problem with a particular payer, who is
specifically responsible for addressing/solving issues with this payer? Under what time frame?
• If KPIs expose consistently slow payments from a particular payer, who is responsible for
researching and resolving the issue? If such efforts fail, what is the next step?
Isolate External Systems Problems
• If KPIs expose productivity problems due to an outside systems vendor, is that vendor responsive to your organization’s problems? If not, why not?
• Do contractual obligations with the system vendor hinder making changes? Is there a reasonable solution? Who is responsible for negotiating such a solution?
• Does the outside systems vendor provide experienced professionals to work with your
staff, or is your organization a training ground for all the vendor’s new employees? Is this
a problem significant enough to justify inclusion in an action plan?
Untangling Internal Versus External Performance Problems: An Example
It is sometimes difficult to determine whether the root cause of a performance problem is
within or outside the organization. An example follows.
This example centers upon the KPI for claims acceptance/rejection rates. For instance, certain problem areas can be isolated by computing the number of days in your accounts receivable for each payer. Problem areas can best be revealed by tracking the age of claims for each
payer in 30-day intervals. Thus, how many of payer #1’s claims are 0–30 days old? What about
31–60 days old? Or 61–90 days old? Or, even worse, 91–120 or 121-plus days old? What about
payer #2? And so on.
In our experience, receiving payment for claims that are older than 90 days is questionable; these old claims should be red flags in your assessment. If you break down your aging
assessment by payer, the culprits’ red flags should be very evident. It may be that these old
436 Chapter 30 ICD-10 Implementation Continues
claims sitting in your accounts receivable are claims rejected by your payer. On the one hand,
does this payer have an extraordinary number of rejected claims, and if so, why? On the other
hand, within the internal department, who is responsible for responding to rejected claims by
revising and refiling? (Or has the date for doing so on many of the old claims already passed
you by?)
Another possibility is that the old claims residing in your accounts receivable are actually
denied claims. Again, does the payer have an extraordinary number of denied claims, and if
so, why? Or, within the internal departments, who is responsible for pursuing secondary payers? Why haven’t they been doing so? Or are the claims so old that payment from anyone is not
viable? If so, they should be written off the books as bad debts.
Understanding the Lines of Authority
As in the preceding example, it is helpful to clearly understand the lines of authority concerned
with your issues. In other words, what department, office, division, or individual is in charge
of the procedures that you are attempting to revise? What is the chance that this department,
office, division, or individual will cooperate? It is likely that some member of the task force or
one of your supervisors should be able to help define the applicable lines of authority that are
relevant.
ICD-10 IMPLEMENTATION: SITUATIONAL ANALYSIS
System implementation on this scale requires multiple planning cycles. Recommendations for
implementation planning that include situational analysis are described as follows.
IMPLEMENTATION PLANNING RECOMMENDATIONS
CMS recommends that healthcare organizations plan for implementation of ICD-10-CM/PCS
by developing a three-step organizational plan that includes the following:
• Step 1: Situational Analysis
• Step 2: Strategic Implementation/Organizing
• Step 3: Planning for Strategic Control42
Figure 30–4 illustrates these steps. We believe that development of a timeline and a map of
individual responsibilities should also be an important part of this planning process, as follows:
1. Situational Analysis: Situational analysis is defined and discussed in the following section.
2. Strategic Implementation and Organizing: The strategic implementation and organizing
planning step includes acquiring the resources to implement the plan and evaluating
the financial impact of the plan. In actual fact, these two steps should be reversed, as the
scope of the financial impact should be considered before resources are acquired.
3. Planning for Strategic Control: Developing objectives should, of course, be the first step
in planning for strategic control. The remaining planning recommendations are action
steps. They include planning measurement tools, evaluation strategies, and actions to
implement.43
Implementation Planning Recommendations 437
SITUATIONAL ANALYSIS RECOMMENDATIONS
This section provides background plus recommendations for an ICD-10 situational analysis.
Background
You will recall that situational analysis does two things. It reviews the organization’s internal operations for strengths and weaknesses and it explores the organization’s external environment
for opportunities and threats. Thus it is called “SWOT,” for strengths-weaknesses-opportunities
-threats.
Situational analysis is particularly appropriate for the analysis of electronic records
systems implementation such as ICD-10 because such implementation requires the collaboration of multiple knowledge areas. A meeting of the minds can better occur with the discipline that a situational analysis can impose. As we have previously said, it is a powerful tool
when properly applied.
CMS Recommendations for ICD-10 Adoption
CMS recommends six steps for an ICD-10 adoption situational analysis. We believe the six
steps should be divided into two parts. The first part contains strategic steps that must be
addressed at the beginning of the project. The second part of the analysis contains developmental steps that we believe can only be properly accomplished after the strategic steps
have been completed. (That said, however, we must also acknowledge that sometimes immovable deadlines and/or lack of sufficient planning resources do not allow the ideal two-part
process.) Figure 30–5 illustrates the CMS situational analysis recommendations for ICD-10
adoption.
Figure 30–4 System Implementation Planning Recommendations.
Adapted from the Centers for Medicare and Medicaid Services, “ICD-10 Clinical Modification/Procedure Coding
System.” ICN #901044 (October 2008).
See
Figure 26–5
• Acquire resources
to implement
• Evaluate financial
impact
Situational
Analysis
Strategic
Implementation/
Organizing
Planning for
Strategic
Control
• Develop objectives
• Plan measurement tools
• Plan evaluation strategies
• Plan actions to implement
438 Chapter 30 ICD-10 Implementation Continues
Strategic Steps
The strategic steps that CMS recommends include three steps, as follows:
1. Stakeholders: Step 1 is to identify stakeholders. This traditional first step is an important
beginning point for the analysis. The array of stakeholders will vary depending upon the
size and nature of the healthcare organization. Payers should always be one of the stakeholders. Regulatory agencies may also be recognized as stakeholders.
2. Impacts: Step 2 involves assessing the impact of the ICD-10 transition. Impacts on all aspects
of the organization should be recognized. As with stakeholders, the transition’s impact will
also vary significantly depending upon the size and type of healthcare organization.
3. Strategies and Goals: Step 3 involves formulating strategies and identifying goals. The
larger the organization the more likely there will be competing strategies and goals. Compromises may have to be negotiated. Tight deadlines and/or lack of planning resources
may work to shortchange this component of the situational analysis.44
Developmental Steps
The developmental steps that CMS recommends also include three steps, discussed as follows.
Note that different knowledge areas are required for these different steps.
Figure 30–5 Situational Analysis Recommendations.
Adapted from the Centers for Medicare and Medicaid Services. “ICD-10 Clinical Modification/Procedure Coding System.”
ICN #901044 (October 2008).
Identify
stakeholders
Assess
impact
Formulate
strategies
and
identify
goals
Develop education/
training plans for
employees at all levels
Plan for
documentation
changes
Develop information
systems/technology
systems change
implementation plan
that includes testing
and “go live” date
Situational Analysis Recommendations 439
1. Training Plans: Training plans must be developed for employees at all levels. The cost of training for ICD-10-CM/PCS implementation is discussed and illustrated earlier in this chapter.
2. Systems Change Implementation Plan: Information systems and/or technology systems
“change implementation plans” must be developed. These plans must include timelines
and individual responsibilities. The timelines should leave sufficient time for testing. (Insufficient testing time is a common pitfall.) A “go live” date is another important part of this
plan. If hardware and/or software vendors are involved in a facility’s implementation plan,
all timelines and the final “go live” date must also be coordinated closely with the vendor.
3. Documentation Change Plan: The documentation change plan will hopefully cover
all areas of the organization where documents exist that will reflect ICD-10-CM/PCS
changes. A document inventory is the ideal beginning point for a documentation change
plan. The inventory allows for a full and complete change plan, but lack of resources
often means completing the full document inventory is not possible.45
COMMENCING AN INFORMATION TECHNOLOGY SWOT MATRIX FOR ICD-10
This section discusses building a situational analysis matrix. The example used involves ICD10 adoption as the project under consideration and information technology as the division or
department involved in the project.
Background
Building a SWOT matrix can be an important strategic process. Each of the four components of
a SWOT (strengths, weaknesses, opportunities, and threats) was discussed in a previous chapter
about strategic planning. The SWOT analysis matrix containing all four components was also
presented in that chapter. You will recall that the “Strengths” and “Weaknesses” sectors of the
matrix were labeled “Internal,” while the “Opportunities” and “Threats” sectors were labeled
“External.” We will use this format in the following section.
Building the Matrix
As to the internal components, the SWOT team or task force needs to evaluate resources and
thus identify those that should belong in the strengths and weaknesses sectors of the SWOT
matrix. For example, for an IT analysis such as the ICD-10 adoption issue, the team might enter
“Financial Resources” as a main heading and “Capital Resources Available” as one of the Financial Resources subheadings in the strengths and weaknesses categories.
The team might also enter “Information Technology” as a main heading. Because this is an
IT project, some of the subheadings in the strengths and weaknesses categories might include
the following:
• IT Hardware Resources
• IT Software Resources
• IT Storage Capacity
• IT Staffing Capacity
• IT Staffing Knowledge Levels
Understand that the SWOT matrix is built as these resources are evaluated. As to the external
components, the SWOT team or task force would likewise evaluate the external opportunities
440 Chapter 30 ICD-10 Implementation Continues
and threats as a parallel exercise. In an IT analysis such as the ICD-10 adoption issue, the team
might logically enter the government’s incentive payment as an external opportunity (potential
dollars received) and an external threat (compliance requirements to be met).
The basic SWOT matrix in its present stage is illustrated in Figure 30–6. For further information about building a situational analysis, see the SWOT Worksheets and related Question
Guides that appear as an Appendix to the Strategic Planning chapter.
SUMMARY
The four-part SWOT matrix is built as the key internal resources, both strengths and weaknesses, are evaluated, and the key external opportunities and threats are identified and evaluated. We can tie the CMS recommendations in the preceding section to the process of building
a SWOT matrix as follows. Identifying stakeholders and commencing to assess impacts of the
ICD-10 adoption are considered part of building the SWOT matrix. Formulating strategies and
identifying goals would most likely come after building the initial matrix, because these actions
would be influenced and should naturally carry forward from the evaluations performed as part
of the SWOT matrix-building process. Finally, the remaining three developmental steps, each of
which involves creating a plan, should all come as final steps in the situational analysis process.
As we have previously mentioned, there are a variety of approaches to performing a situational analysis, and this brief discussion features only the single approach as recommended
by CMS. The important point is this: no matter what approach is utilized, a situational analysis is an important planning tool.
INFORMATION CHECKPOINT
What is needed? An ICD-10 newsletter or course announcement or an ICD-10
training manual.
Where is it found? Within your place of work or posted on the website of an industry
trade organization.
How is it used? It is used for the purpose of ICD-10 training.
KEY TERMS
Code Users
ICD-10 Codes
Key Performance Indicator (KPI)
Situational Analysis
SWOT Analysis
Version 5010 of Standards
Figure 30–6 Basic Information Technology SWOT Analysis Format.
Internal re IT
External re IT
IT Strengths
IT Opportunities IT Threats
IT Weaknesses
Key Terms 441
DISCUSSION QUESTIONS
1. Do you believe your place of work (the organization) has been affected by the ICD-10
transition? If so, how has your organization been affected? If not, why not?
2. Has your own area of work been involved in the transition to ICD-10? If so, are you aware
of how your organization managed the transition? (Through task force, planning committees, etc.)
3. Do you think using KPIs is a good idea? Does your organization use these types of indicators? If so, please describe.
NOTES
1. National Center for Health Statistics, International Classification of Diseases, Tenth Revision
(ICD-10), www.cdc.gov/nchs/about/major/dvs/icd10des.htm
2. World Health Organization, Classifications, www.who.int/classifications/icd/en/
3. Centers for Medicare and Medicaid Services (CMS), “ICD-10 Clinical Modification
/Procedure Coding System Fact Sheet.” www.cms.hhs.gov/MLNProducts/downloads
/ICD-10factsheet2008.pdf
4. National Center for Health Statistics (NCHS), About the International Classification
of Diseases, Tenth Revision, Clinical Modification (ICD-10-CM), www.cdc.gov/nchs/icd
/icd10cm.htm
5. CMS, “ICD-10-CM-PCS Fact Sheet.”
6. Ibid.
7. 77 Federal Register (FR) 54665 (September 5, 2012).
8. 74 Federal Register (FR) 3357 (January 16, 2009).
9. CMS, “New Health Care Electronic Transactions Standards Versions 5010, D.0, and 3.0,”
Medicare Learning Network Fact Sheet ICN #903192 (January 2010).
10. 74 Federal Register (FR) 3328 (January 16, 2009).
11. 73 Federal Register (FR) 49745 (August 22, 2008).
12. 73 Federal Register (FR) 49821 (August 22, 2008).
13. Ibid., 49769.
14. Ibid., 49811.
15. Ibid., 49813.
16. Ibid., 49818.
17. Ibid., 49829.
18. Ibid., 49769.
19. 74 Federal Register (FR) 3348-9 (January 16, 2009).
20. 73 Federal Register (FR) 49803 (August 22, 2008).
21. Ibid.
22. CMS, “ICD-10-CM-PCS Fact Sheet.”
23. J. Zhang, “Why We Need 1,170 Angioplasty Codes,” Wall Street Journal, November 11, 2008.
24. 73 Federal Register (FR) 49814-5 (August 22, 2008).
442 Chapter 30 ICD-10 Implementation Continues
25. Ibid., 49815-6.
26. Ibid., 49815.
27. Ibid., 49816.
28. Ibid., 49815.
29. Ibid., 49816 and 74 Federal Register (FR) 3346-7 (January 16, 2009).
30. Ibid., 49816.
31. M. Libicki and I. Brahmakulam, The Costs and Benefits of Moving to the ICD-10 Code
Sets (Santa Monica, CA: RAND Corporation, 2004), 10, http://www.rand.org/pubs
/technical_reports/2004/RAND_TR132.pdf
32. 73 Federal Register (FR) 49816 (August 22, 2008) and 74 Federal Register (FR) 3346-7
(January 16, 2009).
33. 73 Federal Register (FR) 49817 (August 22, 2008).
34. Ibid., 49816-7.
35. CMS, “ICD-10 KPIs at a Glance,” March 9, 2016, www.cms.gov/Medicare/Coding/ICD10
/Downloads/ICD10KPIs20160309.pdf
36. CMS, “ICD-10 Next Steps for Providers: Assessment & Maintenance Toolkit,” February 26,
2016, https://www.cms.gov/Medicare/Coding/ICD10/Downloads/ICD10NextStepsTool
kit20160226.pdf
37. Certain KPI information within this section may be modified and/or condensed from
“ICD-10 Next Steps…Assessment & Maintenance Toolkit.”
38. Ibid.
39. Work Group for Community Health and Development at the University of Kansas,
“Developing an Action Plan,” http://ctb.ku.edu/table-of-contents/structure/strategic
-planning/develop-action-plans/main, accessed July 14, 2016.
40. Ibid.
41. Some concepts within this section may be modified and/or condensed from “ICD-10
Next Steps.”
42. CMS, “ICD-10-CM-PCS Fact Sheet.”
43. Ibid.
44. Ibid.
45. Ibid.
Notes 443

© LFor/Shutterstock
ICD-10 Conversion
Costs for a
Midwestern
Community Hospital
30-A
APPENDIX
AUTHORS’ NOTE
This CMS example illustrates the computation of hospital training costs and productivity loss
costs and estimates a cost for system changes and upgrades in order to arrive at a total hospital
ICD-10 conversion cost. We have numbered the paragraphs for easy reference. (And FYI, when
the scenario below says “we” it means CMS, not the authors.)
INTRODUCTION
To further illustrate the computation of hospital ICD-10 conversion costs, CMS staff developed
a scenario for a typical community hospital in the Midwest.1 The material presented in the
appendix was published in the proposed rule as an example of costs that might be incurred by
a hospital. The data were drawn from the American Hospital Directory, available at www.AHD
.com. While based on an actual hospital in a Midwestern state, the data have been altered to
make calculations simpler.
THE SCENARIO
1. The hospital has 100 beds, 4,000 discharges annually, and gross revenues of $200 million.
Using the factors presented in the impact analysis, we estimated training costs (including
the cost of the actual training as well as lost time away from the job), productivity loss for
the first six months resulting from becoming familiar with the diagnostic and procedure
codes, and the cost of system changes.
2. For our scenario, we assumed that the hospital employs three full-time coders who will
require eight hours of training at $500 per coder for $1,500 ($500 times 3). While they
are in training, the hospital will have to substitute other staff, either by hiring temporary
coders if possible, or by shifting staff. The estimated cost at $50 per hour is $1,200 (8
hours times 3 staff times $50 per hour).
3. In estimating the productivity loss, we are only looking at the initial six months after
implementation. Therefore, we divided the annual number of discharges of 4,000 by 2
to equal 2,000. We assume that three-quarters of the discharges are surgical, giving us
1,500 discharges requiring use of PCS codes. Dividing this by six months yields an average
monthly discharge rate of 250.
445
4. We performed a similar calculation for outpatient claims. Of the 13,000 outpatient
claims, the monthly average is 1,083 (we do not distinguish between medical and surgical
outpatient claims).
5. Applying the 1.7 extra minutes per discharge, we estimated it would take an extra 425
minutes (1.7 times 250) to code the discharges in the first month. At $50 per hour, the
cost per minute is $0.83 ($50 divided by 60 minutes) and the cost per claim is $1.41
($0.83 times 1.7). For the first month, the productivity loss for inpatient coding is $353
($1.41 times 250). Assuming for simplicity’s sake that the resumption of productivity over
the six-month period would increase in a straight line, we divide the $353 by six to come
up with $59. We reduce the productivity loss by this amount each month through the
sixth month. The total loss for the six-month period is $1,233.
6. We apply the same method to determine the outpatient productivity loss. Based on our
assumption that outpatient claims will require one-hundredth of the time for hospital
inpatient claims, when applying the 0.17 extra minutes per claim, we estimate it would
take an extra 18.41 minutes (0.017 times 1,083) to code the discharges in the first month.
At $50 per hour, the cost per minute is $0.83 ($50 divided by 60 minutes) and the cost per
claim is $0.14 ($0.83 times 0.017). For the first month, the productivity loss for outpatient
coding is $15.28 ($0.014 times 1,083). Assuming for simplicity sake that the resumption
of productivity over the six-month period would increase in a straight line, we divide the
$15.28 by six, coming up with $2.55. We reduce the productivity loss by this amount each
month through the sixth month. Thus the total loss for the first six months will equal $53.
7. In estimating the cost of system changes and software upgrades, we deliberately chose a
value that we think overstates the cost. We assumed that the hospital will have to spend
$300,000 on its data infrastructure to accommodate the new codes. Summing the training costs, productivity losses, and system upgrades, we estimate the total cost to the hospital will equal approximately $303,990. Finally, in order to determine the percentage of
the hospital’s revenue that would be diverted to funding the conversion to the ICD-10, we
compared the estimated cost associated with the conversion to ICD-10 to the total hospital revenue of $200 million. The costs amount to 0.15% of the hospital’s annual revenues.
8. We note that although the impact in our scenario of 0.15% is significantly larger than
the estimated impact of 0.03% for inpatient facilities (set out in the rule), it is still significantly below the threshold the Department considers a significant economic impact.
We are of the opinion that, for most providers and suppliers, payers, and computer firms
involved in facilitating the transition, the costs will be relatively small.
NOTE
1. 73 Federal Register 49830 (August 22, 2008).
446 Chapter 30 ICD-10 Implementation Continues
PART
© LFor/Shutterstock
Case Studies
XI

© LFor/Shutterstock
449
THE OFFER: “SELL YOUR PRACTICE TO US”
This case study explores a doctor’s dilemma: Should he sell his practice? Dr. John Matthews, a
cardiac surgeon, has been approached by the administrator of Clinton Memorial Hospital to
ascertain his level of interest in selling his practice. Dr. Matthews has admitting privileges at
the hospital. He has been reading about the Feds’ speeding up plans for value‐based payments,
wherein half of provider payments in five years will be linked to quality of care. In essence, the
intent according to DHHS (U.S. Department of Health & Human Services) officials is to cut
down on the volume of unnecessary procedures while improving patient outcomes.
Dr. Matthews understands that a complex time lies ahead. As the shift from volume to value
gains momentum, both Clinton Memorial and his own practice will need to move quickly to understand the likely trajectory in their markets, to identify their desired role, and to make the significant structural and operational changes needed to succeed in the changing business model.
SEEKING TO UNDERSTAND HEALTHCARE FINANCE REFORM
While still considering the hospital’s entreaty, Dr. Matthews feels that he needs to learn more
about these concepts that constitute healthcare finance reform. At hospital medical staff meetings, accountable care organizations (ACOs) and bundled payments are frequently on the
agenda. In general, Dr. Matthews has been able to ascertain that providers are wary of jumping
head first into risk‐sharing payment models, or risk contracting based on quality and cost.
Dr. Patrick Conway, Chief Medical Officer for the Centers for Medicare and Medicaid Services
(CMS), said that through its Medicare Shared Savings Program (MSSP), 50% of all fee‐for‐service
payments to providers will be tied to quality incentives (hitting quality metrics) through alternative
payment models—particularly ACOs and bundled payments, which are also expected to slow the
growth of healthcare costs. As the name implies, MSSP providers share in the savings through a
percentage of funds that goes back to the ACO.
ACOs are provider groups that accept responsibility for the cost and quality of care delivered
to a specific population of patients cared for by the groups’ clinicians. Under these risk- and
value‐based payment models that reward achieving cost and outcomes of care, provider organizations have incentives to keep people well.1 The organizations also provide data to be used in
assessing their performance on cost and quality criteria.2
31
CHAPTER
Case Study: The Doctor’s Dilemma
A bundled payment is a single payment to providers and/or healthcare facilities for all services to treat a given condition or provide a given treatment. Payments are made to the providers on the basis of expected costs for clinically defined episodes that may involve several
practitioner types, settings of care, and services or procedures over time. When designed to improve value, bundled payments should include clear quality metrics focused on desired clinical
outcomes that providers must achieve to maximize their payment.3 These payments are perhaps
even more key to reforming healthcare finance because they address specific issues of care and
quality directly and could be more quickly adopted than ACOs.
RESEARCHING ACQUISITION VIEWPOINTS AND INDUSTRY TRENDS
Having achieved a better understanding of contemporary healthcare finance, Dr. Matthews
turned his attention back to the acquisition question. Interestingly, Clinton Memorial’s inquiry
comes amidst a trend that, at first, found the acquisition rate of hospitals acquiring medical
groups slowing in the past few years, with the apex having already occurred in 2011.4
A Negative View
The budgets of many of these same hospitals that once prioritized physician practice acquisitions are now in the red, causing administrators to rethink their practice acquisition strategies. A
2013 report from the Medical Group Management Association calculated a median loss for employing a physician to be $176,463.5 This has led analysts such as Moody’s to predict a pullback
on physician practice acquisitions as costs continue to outpace revenue. In fact, Moody’s identified physician employment as one of the largest expenses impacting hospitals’ margin pressure.
Hospitals acquire physician practices in order to expand their networks, which they hope
will in turn boost their revenues. However, in doing so, they also incur the costs associated
with physician/employee salaries, benefits, office space, and necessary upgrades to IT infrastructures.
A Positive View
The above notwithstanding, the emerging macro view suggests something quite different. Provider mergers and acquisitions in the first three quarters of 2014 were up a robust 13.4% over
the same period in 2013 according to Modern Healthcare’s Merger and Acquisition Report.6
This suggests that mergers, acquisitions, and partnerships will continue apace as healthcare
reform reshapes the industry.
In fact, an outsize example of this trend is Baylor Healthcare System’s recent merger with
Scott & White Healthcare, a move that resulted in Texas’s largest nonprofit healthcare provider. The merger produced a system that includes 48 hospitals, more than 40,000 employees,
and more than $9 billion in assets.7
Another Industry Trend
Moreover, consolidation in the health industry is also occurring among insurers, with Anthem
poised to acquire rival Cigna, and Aetna and Humana agreeing to a $37 billion marriage.8 It
should be noted, however, that regulators are not standing by idly.
450 Chapter 31 Case Study: The Doctor’s Dilemma
The Federal Trade Commission is planning to block a merger between two large Illinois
hospital groups, Advocate Health Care and North-Shore University Health System. Should the
merger be approved, it would create a 16-hospital system that would dominate the North Shore
area of Chicago.9
CONSIDERING OTHER PHYSICIANS’ REACTIONS
Dr. Matthews also wants to know what other physicians think about practice acquisitions. He
approaches the question from two directions, as follows.
What Others Who Sold May Have Believed
Amidst these complex trends, Dr. Matthews knows that many physicians who choose to sell
their practices to a hospital or hospital system believe that doing so will allow them to spend
more time with their patients. While it may appear that they have more regular hours and thus
encounter fewer administrative hassles, they also end up feeling less productive because they
lose the ability to have final say on their schedules. Instead, hospital administrators become the
individuals in charge of setting doctors’ office and on‐call hours.
How Colleagues of His Who Sold Have Reacted
At this juncture, Dr. Matthews deemed it wise to call recently acquired physician colleagues to
monitor how they reacted to the transition. He also knows there is a need for evidence‐based
management and business practice information that help physicians to better understand the
business aspects of their practice.
WHAT WILL DR. MATTHEWS DECIDE?
We cannot predict the doctor’s decision, because we do not have enough information about his
practice’s situation. But we can pose a question: Are doctors happier now, or are cost‐cutting
measures causing them to miss the autonomy of being a private-practice owner? And one thing
is clear: Healthcare organizations must do better in incorporating change management and
cultural integration into their merger and acquisition strategy.
NOTES
1. S. M. Shortell, “Creating Accountable Communities for Health,” H&HN: American Hospital Association, July 2015.
2. S. M. Shortell, L. P. Casalino, and E. S. Fisher, “How the Centers for Medicare and Medicaid Innovation Should Test Accountable Care Organizations,” Health Affairs, 29, no. 7
(2010): 1293–1298.
3. S. Delbanco, “The Payment Reform Landscape: Bundled Payment,” Health Affairs Blog,
July 2, 2014.
4. D. Doyle, “Why the Hospital Buying Spree May Be Coming to an End,” Physician’s Practice,
March 29, 2014, www.physcianspractice.com
Notes 451
5. Medical Group Management Association, “MGMA Data Drive Cost and Revenue 2013,”
www.mgma.com, 2013.
6. B. Kutscher, “Expect More Not-for-Profit Hospital Mergers and Acquisitions,” October
21, 2014, www.modernhealthcare.com/article/2014102/NEWS/31029964
7. G. Jacobson, “Baylor Health Care System, Scott & White Complete Their Merger,” Dallas
Morning News, Section D-1, March 2, 2016.
8. M. McArdle, “Supersizing the Health Industry,” The Week, August 7, 2015.
9. R. Abelson, “Regulators Tamp Down on Mergers of Hospital,” New York Times, December 19,
2015.
452 Chapter 31 Case Study: The Doctor’s Dilemma
32
CHAPTER
Case Study: Strategic
Financial Planning
in Long-Term Care
Neil R. Dworkin, PhD
© LFor/Shutterstock
453
BACKGROUND
John Maxwell, CEO of Seabury Nursing Center, a not-for-profit long-term care organization
located in suburban Connecticut, had just emerged from a board of directors meeting. He was
contemplating the instructions he had received from the board’s executive committee to assess
the financial feasibility of adding a home care program to the Center’s array of services.
Seabury’s current services consist of two levels of inpatient care, chronic care, and subacute
units, and a senior citizens’ apartment complex financed in part by the Federal Department
of Housing and Urban Development. In keeping with its mission, Seabury has a reputation of
providing personalized, high-quality, and compassionate care across all levels of its continuum.
The CEO and his executive team agreed to meet the following week to plan the next steps.
FRAMEWORK OF THE BOARD’S MANDATE
At its last retreat, the board made clear that, reimbursement and payment systems
notwithstanding, Seabury must establish realistic and achievable financial plans that are consistent with their strategic plans. Accordingly, three points relative to integrating strategic planning and financial planning should hold sway:
1. Both are the primary responsibility of the board
2. Strategic planning should precede financial planning
3. The board should play an active role in the financial planning process
Ultimately, every important investment decision involves three general principles:
1. Does it make sense financially?
2. Does it make sense operationally?
3. Does it make sense politically?
The board’s interest in a possible home initiative was guided by these stipulations, particularly as they relate to Seabury’s growth rate in assets and profitability objectives. As a result of the
financial downturn, the organization is experiencing declining inpatient volumes, a deteriorat-
ing payer mix, and a higher cost of capital, all of which have the potential to weaken its liquidity
position.
Taking the strategic service line path to a home care program would be less capital intensive
and should appeal broadly to the significant baby boomer population residing in its service
area, whose preference would undoubtedly be to be treated in their homes.
INDUSTRY PROFILE
When John Maxwell convened his executive team the following week, he had already decided to
present an overview of the home health industry as gleaned by Seabury’s Planning Department.
He prefaced his comments by drawing on recent research by the federal Agency for Healthcare
Research and Quality that detailed why home health care in the 21st century is different from
that which has existed in the past. He cited four reasons:
1. We’re living longer and more of us want to “age in place” with dignity.
2. We have more chronic, complex conditions.
3. We’re leaving the hospital earlier and thus need more intensive care.
4. Sophisticated medical technology has moved into our homes. Devices that were used only
in medical offices are now in our living rooms and bedrooms. For example, home caregivers regularly manage dialysis treatments, infuse strong medications via central lines,
and use computer-based equipment to monitor the health of loved ones.1
The CEO presented a profile of national home care data as compiled by the National Association
for Home Care and Hospice as follows:
• Approximately 12 million people in the United States require some form of home
health care.
• More than 33,000 home healthcare providers exist today.
• Almost two-thirds (63.8%) of home healthcare recipients are women.
• More than two-thirds (69.1%) of home healthcare recipients are over age 65.
• Conditions requiring home health care most frequently include diabetes, heart ­failure,
chronic ulcer of the skin, osteoarthritis, and hypertension.
• Medicare is the largest single payer of home care services. In 2009, Medicare spending was
approximately 41% of the total home healthcare and hospice expenditure.2
According to the U.S. Census Bureau, he continued, in 2010 Connecticut’s population was
3,574,097 of which 14.4% were age 65 or older.3
A Visiting Nurse Association (VNA) analysis of revenue by payer source in the state indicated that 60% of revenue was derived from Medicare.4
FEASIBILITY DETERMINATION
The CEO went on to explain that the feasibility determination would be based on initially setting the home care program’s capacity at 50 clients because that was the minimum required
for Certificate-of-Need (CON) approval in Connecticut. He distributed a model developed by
healthcare finance expert William O. Cleverly (Figure 32–1), which presents the logic behind
the integration of strategic and financial planning.
In essence, he said, financial planning is influenced by the definition of programs and services in consort with the mission and goals. The next step entails financial feasibility of the
454 Chapter 32 Case Study: Strategic Financial Planning in Long-Term Care
proposed homecare program. Among the components that should be considered in determining financial feasibility are the following:
• The configuration and cost of staff
• The prevailing Medicare and Medicaid reimbursement rates
• A projection of visit frequency by provider category based on the most prevalent
clinical conditions
• The physical location of the program and its attendant costs (e.g., rent, new ­construction)
• A projection of cash flows
Direct care staff associated with the home care program includes:
• Medical Social Worker (MSW)
• Physical Therapist (PT)
• Home Health Aide (HHA)
Figure 32–1 Integration of Strategic and Financial Planning.
Reproduced from W. O. Cleverley, Essentials of Health Care Finance, 7th ed. (Sudbury, MA: Jones & Bartlett), 289.
Strategic
planning
Strategic
planning
Mission
goals
Programming
Desired
programs/
services
Financial
feasibility
Approved
programs/
services
Management
control
Financial
planning Yes
No
Feasibility Determination 455
• Registered Nurse (RN)
• Registered Dietitian (RD)
Maxwell indicated that it would be useful to create a scenario depicting a home health visit
abstract incorporating prevailing Medicare and Medicaid reimbursement rates for a 70-yearold male with heart failure and no comorbidities in order to gain traction and project potential
cash flow. As previously noted, heart failure is a condition frequently requiring home healthcare services. Productivity in the home is typically based on the average number of visits per day
by provider category. The visit scenario is depicted in Table 32–1.
Table 32–1 A Home Health Visit Scenario
Once the board decides to move ahead with the home care program and it is approved by
the state, implementation and ongoing operations becomes a management control issue (see
the Cleverly model in Figure 32–1). The CEO refers to a proposed table of organization as
illustrated in Figure 32–2.
Given the paucity of other home care programs in its service area, Maxwell knows that Seabury is likely to be accorded a green light.
As he and his team reflect on this, the looming question will be where will the clients come
from? He knows that likely referral sources will include Seabury’s subacute inpatient population and residents from its senior citizens’ apartment complex who are “aging in place.”
Other likely sources will be recently discharged patients from the region’s two community hospitals, both bereft of home care programs. A premium will be placed on effective case management, and direct marketing to the community will also be necessary.
456 Chapter 32 Case Study: Strategic Financial Planning in Long-Term Care
Services Visit Frequency Payer Rate Rate x 4.2* Medicare
Cost
Medicaid
Cost
Nursing (RN) 2x/month, every
other week
Mc $ 166.83 $ 700.69 $ 700.69
Medical Social
Worker (MSW)
Visits wkly
for 4 wks
MA $ 119.51 $ 501.94 $ 501.94
Physical
Therapist (PT)
3x wkly
for 2 wks
Mc $ 103.22 $ 433.52 $ 433.52
Home Health
Aide (HHA)
Visits 4hrs
MWF wkly
for 60 days
Mc $ 25.00 $ 1,260.00 $ 1,260.00
Registered
Dietitian (RD)
3x wkly
for 1 wk
MA $ 103.16 $ 309.48
Mc = Medicare
MA = Medicaid
*4.2 = The state’s formula for the #wks/per month
Total monthly Medicaid budget = $826.95
Total monthly Medicare budget = $2,394.21
NOTES
1. U.S. Department of Health and Human Services, “Human Factors Challenges in Home
Health Care,” Research Activities, no. 376 (December 2011).
2. National Association for Home Care and Hospice, Basic Statistics about Home Care (Updated 2010).
3. Department of Commerce, U.S. Census Bureau, 2010 Demographic Profile.
4. Visiting Nurse Association, VNA Healthcare Annual Report (Hartford, CT: Hartford Healthcare, 2012).
Notes 457
Figure 32–2 Seabury Nursing Center’s Home Healthcare-Related Organization Chart.
President & CEO
Director of Senior
Citizen Housing
Director of Home
Care Services
Director of Inpatient
Services
Chief Operating
Officer

459
© LFor/Shutterstock
BACKGROUND
1. The Hospital System
Metropolis Health System (MHS) offers comprehensive healthcare services. It is a midsize taxing district hospital. Although MHS has the power to raise revenues through taxes,
it has not done so for the past seven years.
2. The Area
MHS is located in the town of Metropolis, which has a population of 50,000. The town has
a small college and a modest number of environmentally clean industries.
3. MHS Services
MHS has taken significant steps to reduce hospital stays. It has developed a comprehensive array of services that are accessible, cost-effective, and responsive to the community’s
needs. These services are wellness oriented in that they strive for prevention rather than
treatment. As a result of these steps, inpatient visits have increased overall by only 1,000
per year since 2010 whereas outpatient/same-day surgery visits have had an increase of
over 50,000 per year.
A number of programmatic, service, and facility enhancements support this major transition in the community’s institutional health care. They are geared to provide the quality,
convenience, affordability, and personal care that best suit the health needs of the people
whom MHS serves.
• Rehabilitation and Wellness Center—for outpatient physical therapy and return-towork services, plus cardiac and pulmonary rehabilitation, to get people back to a normal way of living.
• Home Health Services—bringing skilled care, therapy, and medical social services into
the home; a comfortable and affordable alternative in longer-term care.
• Same-Day Surgery (SDS)—eliminating the need for an overnight stay. Since 2010
same-day surgery procedures have doubled at MHS.
• Skilled Nursing Facility—inpatient service to assist patients in returning more fully to
an independent lifestyle.
Case Study: Metropolis
Health System 33
CHAPTER
• Community Health and Wellness—community health outreach programs that provide educational seminars on a variety of health issues, a diabetes education center,
support services for patients with cancer, health awareness events, and a women’s
health resource center.
• Occupational Health Services—helping to reduce workplace injury costs at over 100
area businesses through consultation on injury avoidance and work-specific rehabilitation services.
• Recovery Services—offering mental health services, including substance abuse programs and support groups, along with individual and family counseling.
4. MHS’s Plant
The central building for the hospital is in the center of a two-square-block area. A physicians’ office building is to the west. Two administrative offices, converted from former
residences, are on one corner. The new ambulatory center, completed two years ago,
has an L shape and sits on one corner of the western block. A laundry and maintenance
building sits on the extreme back of the property. A four-story parking garage is located
on the eastern back corner. An employee parking lot sits beside the laundry and maintenance building. Visitor parking lots fill the front eastern portion of the property. A
helipad is on the extreme western edge of the property behind the physicians’ office
building.
5. MHS Board of Trustees
Eight local community leaders who bring diverse skills to the board govern MHS. The
trustees generously volunteer their time to plan the strategic direction of MHS, thus
ensuring the system’s ability to provide quality comprehensive health care to the
community.
6. MHS Management
A chief executive officer manages MHS. Seven senior vice presidents report to the CEO.
MHS is organized into 23 major responsibility centers.
7. MHS Employees
All 500 team members employed by MHS are integral to achieving the high standards for
which the system strives. The quality improvement program, reviewed and reestablished
in 2010, is aimed at meeting client needs sooner, better, and more cost-effectively. Participants in the program are from all areas of the system.
8. MHS Physicians
The MHS medical staff is a key part of MHS’s ability to provide excellence in health care.
Over 75 physicians cover more than 30 medical specialties. The high quality of their training and their commitment to the practice of medicine are great assets to the health of the
community.
The physicians are very much a part of MHS’s drive for continual improvement on the
quality of healthcare services offered in the community. MHS brings in medical experts
from around the country to provide training in new techniques, made possible by MHS’s
technologic advancements. MHS also ensures that physicians are offered seminars, symposiums, and continuing education programs that permit them to remain current with
changes in the medical field.
460 Chapter 33 Case Study: Metropolis Health System
The medical staff’s quality improvement program has begun a care path initiative to
track effective means for diagnosis, treatment, and follow-up. This initiative will help
avoid unnecessary or duplicate use of expensive medications or technologies.
9. MHS Foundation
Metropolis Health Foundation is presently being created to serve as the philanthropic
arm of MHS. It will operate in a separate corporation governed by a board of 12 community leaders and supported by a 15-member special events board. The mission of the
foundation will be to secure financial and nonfinancial support for realizing the MHS
vision of providing comprehensive health care for the community.
Funds donated by individuals, businesses, foundations, and organizations will be designated for a variety of purposes at MHS, including the operation of specific departments,
community outreach programs, continuing education for employees, endowment, equipment, and capital improvements.
10. MHS Volunteer Auxiliary
There are 500 volunteers who provide over 60,000 hours of service to MHS each year.
These men and women assist in virtually every part of the system’s operations. They also
conduct community programs on behalf of MHS.
The auxiliary funds its programs and makes financial contributions to MHS through
money it raises on renting televisions and vending gifts and other items at the hospital.
In the past, its donations to MHS have generally been designated for medical equipment
purchases. The auxiliary has given $250,000 over the last five years.
11. Planning the Future for MHS
The MHS has identified five areas of desired service and programmatic enhancement in
its five-year strategic plan:
I. Ambulatory Services
II. Physical Medicine and Rehabilitative Services
III. Cardiovascular Services
IV. Oncology Services
V. Community Health Services
MHS has set out to answer the most critical health needs that are specific to its community. Over the next five years, the MHS strategic plan will continue a tradition of quality,
community-oriented health care to meet future demands.
12. Financing the Future
MHS has established a corporate depreciation fund. The fund’s purpose is to ease the
financial burden of replacing fixed assets. Presently, it has almost $2 million for needed
equipment and renovations.
MHS CASE STUDY
Financial Statements
• Balance Sheet (Exhibit 33–1)
• Statement of Revenue and Expense (Exhibit 33–2)
MHS Case Study 461
• Statement of Cash Flows (Exhibit 33–3)
• Statement of Changes in Fund Balance (Exhibit 33–4)
• Schedule of Property, Plant, and Equipment (Exhibit 33–5)
• Schedule of Patient Revenue (Exhibit 33–6)
• Schedule of Operating Expenses (Exhibit 33–7)
Exhibit 33–1 Balance Sheet
Metropolis Health System
Balance Sheet
March 31, 2
Assets
Current Assets
Cash and Cash Equivalents $1,150,000
Assets Whose Use Is Limited 825,000
Patient Accounts Receivable 7,400,000
(Net of $1,300,000 Allowance
for Bad Debts)
Other Receivables 150,000
Inventories 900,000
Prepaid Expenses 200,000
Total Current Assets 10,625,000
Assets Whose Use Is Limited
Corporate Funded
Depreciation 1,950,000
Held by Trustee Under Bond
Indenture Agreement 1,425,000
Total Assets Whose Use Is
Limited 3,375,000
Less Current Portion (825,000)
Net Assets Whose Use Is
Limited 2,550,000
Property, Plant, and
Equipment, Net 19,300,000
Other Assets 325,000
Total Assets $32,800,000
Liabilities and Fund Balance
Current Liabilities
Current Maturities of Long-Term
Debt $525,000
Accounts Payable and Accrued
Expenses 4,900,000
Bond Interest Payable 300,000
Reimbursement Settlement
Payable 100,000
Total Current Liabilities 5,825,000
Long-Term Debt 6,000,000
Less Current Portion of
Long-Term Debt (525,000)
Net Long-Term Debt 5,475,000
Total Liabilities 11,300,000
Fund Balances
General Fund 21,500,000
Total Fund Balances 21,500,000
Total Liabilities and Fund
Balances $32,800,000
462 Chapter 33 Case Study: Metropolis Health System
Metropolis Health System
Statement of Revenue and Expense
for the Year Ended March 31, 2
Revenue
Net patient service revenue $34,000,000
Other revenue 1,100,000
Total Operating Revenue $35,100,000
Expenses
Nursing services $5,025,000
Other professional services 13,100,000
General services 3,200,000
Support services 8,300,000
Depreciation 1,900,000
Amortization 50,000
Interest 325,000
Provision for doubtful accounts 1,500,000
Total Expenses 33,400,000
Income from Operations $1,700,000
Nonoperating Gains (Losses)
Unrestricted gifts and memorials $20,000
Interest income 80,000
Nonoperating Gains, Net 100,000
Revenue and Gains in Excess of Expenses and Losses $1,800,000
Exhibit 33–2 Statement of Revenue and Expense
Statistics and Organizational Structure
• Hospital Statistical Data (Exhibit 33–8)
• MHS Nursing Practice and Administration Organization Chart (Figure 33–1)
• MHS Executive-Level Organization Chart (Figure 33–2)
MHS Case Study 463
Metropolis Health System
Statement of Cash Flows
for the Year Ended March 31, 2
Statement of Cash Flows
Operating Activities
Income from operations $1,700,000
Adjustments to reconcile income from operations
to net cash flows from operating activities
Depreciation and amortization 1,950,000
Changes in asset and liability accounts
Patient accounts receivable 250,000
Other receivables (50,000)
Inventories (50,000)
Prepaid expenses and other assets (50,000)
Accounts payable and accrued expenses (400,000)
Reduction of bond interest payable (25,000)
Estimated third-party payer settlements (75,000)
Interest income received 80,000
Unrestricted gifts and memorials received 20,000
Net cash flow from operating activities $3,350,000
Cash Flows from Capital and Related Financing Activities
Repayment of long-term obligations (500,000)
Cash Flows from Investing Activities
Purchase of assets whose use is limited (100,000)
Equipment purchases and building improvements (2,000,000)
Net Increase (Decrease) in Cash and Cash Equivalents $750,000
Cash and Cash Equivalents, Beginning of Year 400,000
Cash and Cash Equivalents, End of Year $1,150,000
Exhibit 33–3 Statement of Cash Flows
464 Chapter 33 Case Study: Metropolis Health System
Metropolis Health System
Statement of Changes in Fund Balance
for the Year Ended March 31, 2
General Fund Balance April 1, 2____ $19,700,000
Revenue and Gains in Excess of Expenses and Losses 1,800,000
General Fund Balance March 31, 2____ $21,500,000
Exhibit 33–4 Statement of Changes in Fund Balance
Exhibit 33–5 Schedule of Property, Plant, and Equipment
Metropolis Health System
Schedule of Property, Plant, and Equipment
for the Year Ended March 31, 2
Buildings and Improvements $14,700,000
Land Improvements 1,100,000
Equipment 28,900,000
Total $44,700,000
Less Accumulated Depreciation (26,100,000)
Net Depreciable Assets $18,600,000
Land 480,000
Construction in Progress 220,000
Net Property, Plant, and Equipment $19,300,000
MHS Case Study 465
Exhibit 33–6 Schedule of Patient Revenue
Metropolis Health System
Schedule of Patient Revenue
for the Year Ended March 31, 2
Patient Services Revenue
Routine revenue $9,850,000
Laboratory 7,375,000
Radiology and CT scanner 5,825,000
OB–nursery 450,000
Pharmacy 3,175,000
Emergency service 2,200,000
Medical and surgical supply and IV 5,050,000
Operating rooms 5,250,000
Anesthesiology 1,600,000
Respiratory therapy 900,000
Physical therapy 1,475,000
EKG and EEG 1,050,000
Ambulance service 900,000
Oxygen 575,000
Home health and hospice 1,675,000
Substance abuse 375,000
Other 775,000
Subtotal $48,500,000
Less allowances and charity care (14,500,000)
Net Patient Service Revenue $34,000,000
466 Chapter 33 Case Study: Metropolis Health System
Exhibit 33–7 Schedule of Operating Expenses
Metropolis Health System
Schedule of Operating Expenses
for the Year Ended March 31, 2
Nursing Services
Routine Medical/Surgical $3,880,000
Operating Room 300,000
Intensive Care Units 395,000
OB–Nursery 150,000
Other 300,000
Total $5,025,000
Other Professional Services
Laboratory $2,375,000
Radiology and CT Scanner 1,700,000
Pharmacy 1,375,000
Emergency Service 950,000
Medical and Surgical Supply 1,800,000
Operating Rooms and
Anesthesia 1,525,000
Respiratory Therapy 525,000
Physical Therapy 700,000
EKG and EEG 185,000
Ambulance Service 80,000
Substance Abuse 460,000
Home Health and Hospice 1,295,000
Other 130,000
Total $13,100,000
General Services
Dietary $1,055,000
Maintenance 1,000,000
Laundry 295,000
Housekeeping 470,000
Security 50,000
Medical Records 330,000
Total $3,200,000
Support Services
General $4,600,000
Insurance 240,000
Payroll Taxes 1,130,000
Employee Welfare 1,900,000
Other 430,000
Total $8,300,000
Depreciation 1,900,000
Amortization 50,000
Interest Expense 325,000
Provision for Doubtful
Accounts 1,500,000
Total Operating Expenses $33,400,000
MHS Case Study 467
Metropolis Health System
Schedule of Hospital Statistics
for the Year Ended March 31, 2
Inpatient Indicators:
Patient Days
Medical and surgical 13,650
Obstetrics 1,080
Skilled nursing unit 4,500
Admissions
Adult acute care 3,610
Newborn 315
Skilled nursing unit 440
Discharges
Adult acute care 3,580
Newborn 315
Skilled nursing unit 445
Average Length of Stay (in days) 4.1
Departmental Volume Indicators:
Respiratory therapy treatments 51,480
Physical therapy treatments 34,050
Laboratory workload units
(in thousands) 2,750
EKGs 8,900
CT scans 2,780
MRI scans 910
Emergency room visits 11,820
Ambulance trips 2,320
Home health visits 14,950
Approximate number of employees
(FTE) 510
Exhibit 33–8 Hospital Statistical Data
Figure 33–1 MHS Nursing Practice and Administration Organization Chart.
Courtesy of Resource Group, Ltd., Dallas, Texas.
468 Chapter 33 Case Study: Metropolis Health System
Women’s
Health
Pediatric
Nursing
Ambulatory
Nursing
Medical
Surgical
Emergency
Nursing
TQI
Education
Recruitment
Support
Finance
Information
Systems
Support
Director
of
Nurses
MRI
Dialysis
Oncology
Cardiac Rehab
Medical
Surgical
Emergency
OB/GYN
Health
&
Development
Children’s Medicine
Pediatric Medicine
Figure 33–2 MHS Executive-Level Organization Chart.
Courtesy of Resource Group, Ltd., Dallas, Texas.
MHS Case Study 469
Metropolis
Health System
President/CEO
Sr. Vice President
Service Delivery
Operations/COO
Inpatient
Operations
Ambulatory
Operations
Other
Operations
Operations
TQI
Sr. Vice President
Human Resources
Human Resources
Operations
HR Planning
& Placement
Learning
Services
Sr. Vice President
Medical Management
Physician
Benefits
Physician
Recruitment
Integration
Sr. Vice President
General Counsel
Legal
Affairs
Risk
Management
Sr. Vice President
Human Affairs
Community
Outreach
Community
Health Council
Community
Health Improvement
Programs
Sr. Vice President
Information Systems/CIO
Info Systems
Operations
Data
Management
Info Systems
Development
Sr. Vice President
Finance/CFO
Central
Business Office
Finance
Insurance
Managed Care
Real Estate
Facilities/Development
Physician
TQI

471
© LFor/Shutterstock
Metropolis Health System
Balance Sheet
March 31, 20X3 and 20X2
Assets
Current Assets
Cash and cash equivalents $1,150,000 $400,000
Assets whose use is limited 825,000 825,000
Patient accounts receivable 8,700,000 8,950,000
Less allowance for bad debts (1,300,000) (1,300,000)
Other receivables 150,000 100,000
Inventories of supplies 900,000 850,000
Prepaid expenses 200,000 150,000
Total Current Assets 10,625,000 9,975,000
Assets Whose Use Is Limited
Corporate funded depreciation 1,950,000 1,800,000
Under bond indenture agreements—
held by trustee 1,425,000 1,475,000
Total Assets Whose Use Is Limited 3,375,000 3,275,000
Less Current Portion (825,000) (825,000)
Net Assets Whose Use Is Limited 2,550,000 2,450,000
Property, Plant, and Equipment, Net 19,300,000 19,200,000
Other Assets 325,000 375,000
Total Assets $32,800,000 $32,000,000
Metropolis Health
System’s Financial Statements and
Excerpts from Notes
33-A
APPENDIX
Metropolis Health System
Balance Sheet
March 31, 20X3 and 20X2
Liabilities and Fund Balance
Current Liabilities
Current maturities of long-term debt $525,000 $500,000
Accounts payable and accrued expenses 4,900,000 5,300,000
Bond interest payable 300,000 325,000
Reimbursement settlement payable 100,000 175,000
Total Current Liabilities 5,825,000 6,300,000
Long-Term Debt 6,000,000 6,500,000
Less Current Portion of Long-Term Debt (525,000) (500,000)
Net Long-Term Debt 5,475,000 6,000,000
Total Liabilities 11,300,000 12,300,000
Fund Balances
General Fund 21,500,000 19,700,000
Total Fund Balances 21,500,000 19,700,000
Total Liabilities and Fund Balances $32,800,000 $32,000,000
472 Chapter 33 Case Study: Metropolis Health System
Metropolis Health System
Statement of Revenue and Expenses
for the Years Ended March 31, 20X3 and 20X2
Revenue
Net patient service revenue $34,000,000 $33,600,000
Other revenue 1,100,000 1,000,000
Total Operating Revenue 35,100,000 34,600,000
Expenses
Nursing services 5,025,000 5,450,000
Other professional services 13,100,000 12,950,000
General services 3,200,000 3,220,000
Support services 8,300,000 8,340,000
Depreciation 1,900,000 1,800,000
Amortization 50,000 50,000
Interest 325,000 350,000
Provision for doubtful accounts 1,500,000 1,600,000
Total Expenses 33,400,000 33,760,000
Income from Operations 1,700,000 840,000
Nonoperating Gains (Losses)
Unrestricted gifts and memorials 20,000 70,000
Interest income 80,000 40,000
Nonoperating Gains, Net 100,000 110,000
Revenue and Gains in Excess of
Expenses and Losses $1,800,000 $950,000
Metropolis Health System’s Financial Statements 473
Metropolis Health System
Statement of Changes in Fund Balance
for the Years Ended March 31, 20X3 and 20X2
General Fund Balance April 1st $19,700,000 $18,750,000
Revenue and Gains in Excess of
Expenses and Losses 1,800,000 950,000
General Fund Balance March 31st $21,500,000 $19,700,000
Metropolis Health System
Schedule of Property, Plant, and Equipment
for the Years Ended March 31, 20X3 and 20X2
Buildings and Improvements $14,700,000 $14,000,000
Land Improvements 1,100,000 1,100,000
Equipment 28,900,000 27,600,000
Total 44,700,000 42,700,000
Less Accumulated Depreciation (26,100,000) (24,200,000)
Net Depreciable Assets 18,600,000 18,500,000
Land 480,000 480,000
Construction in Progress 220,000 220,000
Net Property, Plant, and Equipment $19,300,000 $19,200,000
474 Chapter 33 Case Study: Metropolis Health System
Metropolis Health System
Schedule of Patient Revenue
for the Years Ended March 31, 20X3 and 20X2
Patient Services Revenue
Routine revenue $9,850,000 $9,750,000
Laboratory 7,375,000 7,300,000
Radiology and CT scanner 5,825,000 5,760,000
OB–nursery 450,000 445,000
Pharmacy 3,175,000 3,140,000
Emergency service 2,200,000 2,180,000
Medical and surgical supply and IV 5,050,000 5,000,000
Operating rooms 5,250,000 5,200,000
Anesthesiology 1,600,000 1,580,000
Respiratory therapy 900,000 890,000
Physical therapy 1,475,000 1,460,000
EKG and EEG 1,050,000 1,040,000
Ambulance services 900,000 890,000
Oxygen 575,000 570,000
Home health and hospice 1,675,000 1,660,000
Substance abuse 375,000 370,000
Other 775,000 765,000
Subtotal 48,500,000 48,000,000
Less Allowances and Charity Care 14,500,000 14,400,000
Net Patient Service Revenue $34,000,000 $33,600,000
Metropolis Health System’s Financial Statements 475
Metropolis Health System
Schedule of Operating Expenses
for the Years Ended March 31, 20X3 and 20X2
Nursing Services
Routine Medical/Surgical $3,880,000 $4,200,000
Operating Room 300,000 325,000
Intensive Care Units 395,000 430,000
OB–Nursery 150,000 165,000
Other 300,000 330,000
Total $5,025,000 $5,450,000
Other Professional Services
Laboratory $2,375,000 $2,350,000
Radiology and CT Scanner 1,700,000 1,680,000
Pharmacy 1,375,000 1,360,000
Emergency Service 950,000 930,000
Medical and Surgical Supply 1,800,000 1,780,000
Operating Rooms and Anesthesia 1,525,000 1,515,000
Respiratory Therapy 525,000 530,000
Physical Therapy 700,000 695,000
EKG and EEG 185,000 180,000
Ambulance Services 80,000 80,000
Substance Abuse 460,000 450,000
Home Health and Hospice 1,295,000 1,280,000
Other 130,000 120,000
Total $13,100,000 $12,950,000
General Services
Dietary $1,055,000 $1,060,000
Maintenance 1,000,000 1,010,000
Laundry 295,000 300,000
Housekeeping 470,000 475,000
Security 50,000 50,000
Medical Records 330,000 325,000
Total $3,200,000 $3,220,000
Support Services
General $4,600,000 $4,540,000
Insurance 240,000 235,000
Payroll Taxes 1,130,000 1,180,000
Employee Welfare 1,900,000 1,950,000
Other 430,000 435,000
Total $8,300,000 $8,340,000
Depreciation $1,900,000 $1,800,000
Amortization 50,000 50,000
476 Chapter 33 Case Study: Metropolis Health System
EXCERPTS FROM METROPOLIS HEALTH SYSTEM NOTES TO FINANCIAL
STATEMENTS
Note 1—Nature of Operations and Summary of Significant Accounting Policies
General
Metropolis Hospital System (Hospital) currently operates as a general acute care hospital. The
hospital is a municipal corporation and body politic created under the hospital district laws of
the state.
Cash and Cash Equivalents
For purposes of reporting cash flows, the hospital considers all liquid investments with an original maturity of three months or less to be cash equivalents.
Inventory
Inventory consists of supplies used for patients and is stated as the lower of cost or market. Cost
is determined on the basis of most recent purchase price.
Investments
Investments, consisting primarily of debt securities, are carried at market value. Realized and
unrealized gains and losses are reflected in the statement of revenue and expenses. Investment
income from general fund investments is reported as nonoperating gains.
Income Taxes
As a municipal corporation of the state, the hospital is exempt from federal and state income
taxes under Section 115 of the Internal Revenue Code.
Property, Plant, and Equipment
Expenditures for property, plant, and equipment, and items that substantially increase the useful lives of existing assets are capitalized at cost. The hospital provides for depreciation on the
straight-line method at rates designed to depreciate the costs of assets over estimated useful
lives as follows:
Years
Equipment 5 to 20
Land Improvements 20 to 25
Buildings and Improvements 40
Funded Depreciation
The hospital’s Board of Directors has adopted the policy of designating certain funds that are
to be used to fund depreciation for the purpose of improvement, replacement, or expansion
of plant assets.
Interest Expense 325,000 350,000
Provision for Doubtful Accounts 1,500,000 1,600,000
Total Operating Expenses $33,400,000 $33,760,000
Excerpts from Metropolis Health System Notes to Financial Statements 477
Unamortized Debt Issue Costs
Revenue bond issue costs have been deferred and are being amortized.
Revenue and Gains in Excess of Expenses and Losses
The statement of revenue and expenses includes revenue and gains in excess of expenses and
losses. Changes in unrestricted net assets that are excluded from excess of revenue over expenses, consistent with industry practice, would include such items as contributions of longlived assets (including assets acquired using contributions that by donor restriction were to be
used for the purposes of acquiring such assets) and extraordinary gains and losses. Such items
are not present on the current financial statements.
Net Patient Service Revenue
Net patient service revenue is reported as the estimated net realizable amounts from patients,
third-party payers, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payers. Retroactive adjustments are
accrued on an estimated basis in the period the related services are rendered and adjusted in
future periods as final settlements are determined.
Contractual Agreements with Third-Party Payers
The hospital has contractual agreements with third-party payers, primarily the Medicare and
Medicaid programs. The Medicare program reimburses the hospital for inpatient services under
the Prospective Payment System, which provides for payment at predetermined amounts based
on the discharge diagnosis. The contractual agreement with the Medicaid program provides for
reimbursement based upon rates established by the state, subject to state appropriations. The
difference between established customary charge rates and reimbursement is accounted for as
a contractual allowance.
Gifts and Bequests
Unrestricted gifts and bequests are recorded on the accrual basis as nonoperating gains.
Donated Services
No amounts have been reflected in the financial statements for donated services. The hospital
pays for most services requiring specific expertise. However, many individuals volunteer their
time and perform a variety of tasks that help the hospital with specific assistance programs and
various committee assignments.
Note 2—Cash and Investments
Statutes require that all deposits of the hospital be secured by federal depository insurance or
be fully collateralized by the banking institution in authorized investments. Authorized investments include those guaranteed by the full faith and credit of the United States of America as
to principal and interest; or in bonds, notes, debentures, or other similar obligations of the
United States of America or its agencies; in interest-bearing savings accounts or interest-bearing
certificates of deposit; or in certain money market mutual funds.
478 Chapter 33 Case Study: Metropolis Health System
At March 31, 20X3, the carrying amount and bank balance of the hospital’s deposits with
financial institutions were $190,000 and $227,000, respectively. The difference between the carrying amount and the bank balance primarily represents checks outstanding at March 31, 20X3.
All deposits are fully insured by the Federal Deposit Insurance Corporation or collateralized
with securities held in the hospital’s name by the hospital agent.
Carrying Amount
20X3 20X2
U.S. Government Securities or
U.S. Government Agency Securities $4,325,000 $3,575,000
Total Investments 4,325,000 3,575,000
Petty Cash 3,000 3,000
Deposits 190,000 93,000
Accrued Interest 7,000 4,000
Total 4,525,000 3,675,000
Consisting of
Cash and Cash Equivalents—General Fund 1,150,000 400,000
Assets Whose Use Is Limited
Corporate Funded Depreciation 1,950,000 1,800,000
Held by Trustee Under Bond Indenture Agreements 1,425,000 1,475,000
Total $4,525,000 $3,675,000
Note 3—Charity Care
The hospital voluntarily provides free care to patients who lack financial resources and are
deemed to be medically indigent. Such care is in compliance with the hospital’s mission. Because the hospital does not pursue collection of amounts determined to qualify as charity care,
they are not reported as revenue.
The hospital maintains records to identify and monitor the level of charity care it provides.
These records include the amount of charges forgone for services and supplies furnished under
its charity care policy. During the years ended March 31, 20X3 and 20X2, such charges forgone
totaled $395,000 and $375,000, respectively.
Note 4—Net Patient Service Revenue
The hospital provides healthcare services through its inpatient and outpatient care facilities.
The mix of receivables from patients and third-party payers at March 31, 20X3 and 20X2, is as
follows:
20X3 20X2
Medicare 30.0% 28.5%
Medicaid 15.0 16.0
Patients 13.0 12.5
Other third-party payers 42.0 43.0
Total 100.0% 100.0%
Excerpts from Metropolis Health System Notes to Financial Statements 479
The hospital has agreements with third-party payers that provide for payments to the hospital at amounts different from its established rates. Contractual adjustments under third-party
reimbursement programs represent the difference between the hospital’s established rates for
services and amounts paid by third-party payers. A summary of the payment arrangements with
major third-party payers follows.
Medicare
Inpatient acute care rendered to Medicare program beneficiaries is paid at prospectively
determined rates-per-discharge. These rates vary according to a patient classification system that
is based on clinical, diagnostic, and other factors. Inpatient nonacute care services and certain
outpatient services are paid based upon either a cost reimbursement method, established fee
screens, or a combination thereof. The hospital is reimbursed for cost reimbursable items at a
tentative rate with final settlement determination after submission of annual cost reports by the
hospital and audits by the Medicare fiscal intermediary. At the current year end, all Medicare
settlements for the previous two years are subject to audit and retroactive adjustments.
Medicaid
Inpatient services rendered to Medicaid program beneficiaries are reimbursed at prospectively
determined rates-per-day. Outpatient services rendered to Medicaid program beneficiaries are
reimbursed at prospectively determined rates-per-visit.
Blue Cross
Inpatient services rendered to Blue Cross subscribers are reimbursed under a cost reimbursement
methodology. The hospital is reimbursed at a tentative rate with final settlement determined after
submission of annual cost reports by the hospital and audits by Blue Cross. The Blue Cross cost
report for the prior year end is subject to audit and retroactive adjustment.
The hospital has also entered into payment agreements with certain commercial insurance
carriers, health maintenance organizations, and preferred provider organizations. The bases
for payment under these agreements include discounts from established charges and prospectively determined daily rates.
Gross patient service revenue for services rendered by the hospital under the Medicare, Medicaid, and Blue Cross payment agreements for the years ended March 31, 20X3 and 20X2, is
approximately as follows:
20X3 20X2
Amount % Amount %
Medicare $20,850,000 43.0 $19,900,000 42.0
Medicaid 10,190,000 21.0 10,200,000 21.5
All other payers 17,460,000 36.0 17,300,000 36.5
$48,500,000 100.0 $47,400,000 100.0
Note 5—Property, Plant, and Equipment
The hospital’s property, plant, and equipment at March 31, 20X3 and 20X2, are as follows:
480 Chapter 33 Case Study: Metropolis Health System
20X3 20X2
Buildings and improvements $14,700,000 $14,000,000
Land improvements 1,100,000 1,100,000
Equipment 28,900,000 27,600,000
Total $44,700,000 $42,700,000
Accumulated depreciation (26,100,000) (24,200,000)
Net Depreciable Assets $18,600,000 $18,500,000
Land 480,000 480,000
Construction in progress 220,000 220,000
Net Property, Plant, Equipment $19,300,000 $19,200,000
Construction in progress, which involves a renovation project, has not progressed in the
last 12-month period because of a zoning dispute. The project will not require significant
outlay to reach completion, as anticipated additional expenditures are currently estimated at
$100,000.
Note 6—Long-Term Debt
Long-term debt consists of the following:
Hospital Facility Revenue Bonds (Series 1995) at varying
interest rates from 4.5% to 5.5%, depending on date of
maturity through 2020. 20X3 20X2
$6,000,000 $6,500,000
The future maturities of long-term debt are as follows:
Years Ending March 31
20X2 $ 475,000
20X3 500,000
20X4 525,000
20X5 550,000
20X6 575,000
20X7 600,000
Thereafter 3,750,000
Under the terms of the trust indenture the following funds (held by the trustee) were
established: an interest fund, a bond sinking fund, and a debt service reserve fund.
Interest Fund
The hospital deposits (monthly) into the interest fund an amount equal to one-sixth of the next
semi-annual interest payment due on the bonds.
Bond Sinking Fund
The hospital deposits (monthly) into the bond sinking fund an amount equal to
one-twelfth of the principal due on the next July 1.
Excerpts from Metropolis Health System Notes to Financial Statements 481
Debt Service Reserve Fund
The debt service reserve fund must be maintained at an amount equal to 10% of the aggregate
principal amount of all bonds then outstanding. It is to be used to make up any deficiencies in
the interest fund and bond sinking fund.
Assets held by the trustee under the trust indenture at March 31, 20X3 and 20X2, are
as follows:
20X3 20X2
Interest Fund $ 300,000 $ 325,000
Bond Sinking Fund 525,000 500,000
Debt Service Reserve 600,000 650,000
Total $1,425,000 $1,475,000
Note 7—Commitments
At March 31, 20X3, the hospital had commitments outstanding for a renovation project at the
hospital of approximately $100,000. Construction in progress on the renovation has not progressed in the last 12-month period because of a zoning dispute. Upon resolution of the dispute, remaining construction costs will be funded from corporate funded depreciation cash
reserves.
482 Chapter 33 Case Study: Metropolis Health System
483
© LFor/Shutterstock
Sample General Hospital is another facility within the Metropolis Health System. Sample General Hospital has recently been acquired by Metropolis. It is a 100-bed hospital that has been losing money steadily over the last several years. The new chief financial officer (CFO) has decided
to use benchmarking as an aid to turn around Sample’s financial situation. Benchmarking will
illustrate where the hospital stands in relationship to its peer group.
The CFO orders two benchmarking reports: one for the hospitals that are 100 beds or less
and one for all hospitals, no matter the size. The 100-beds-or-less report will allow direct comparability for Sample, while the all-hospital report will give a universal or overall view of Sample’s
standing. Both reports appear at the end of this case study. Exhibit 33-B–1 is the benchmark
data report for Sample General Hospital compared with hospitals less than 100 beds, whereas
Exhibit 33-B–2 is the benchmark data report for Sample General Hospital compared with all
hospitals.
When the reports arrive, the CFO writes a description of how the data are arranged so that
his managers will better understand the information presented. His description includes the
following points:
1. The percentile rankings are intended to present the hospital’s performance ranked
against all other performers in the comparison group. Whether the hospital’s actual performance is good or bad depends on the statistic being evaluated.
2. The first column, labeled “Annual Average Year 1,” provides a historical trend of actual
performance of the hospital in the previous year. It is provided for reference only so that
the reader can see the trend over time.
3. The column labeled “Q1 Year 2” represents the first quarter of the current year. These are
the most recent data that this service has been provided for Sample General Hospital and
are the data used in the comparison columns that follow.
4. The column labeled “50th %ile” represents the 50th percentile of all of the hospitals in the
comparison group that supplied data for the individual line item.
5. The “Variance” column compares the data from Q1 Year 2 of Sample General Hospital
with the 50th percentile information from the entire comparison group.
6. The column labeled “%ile Range” indicates where Sample General Hospital’s individual
score fell within a percentile range.
Comparative Analysis
Using Financial Ratios and
Benchmarking Helps Turn
Around a Hospital in the
Metropolis Health System
33-B
APPENDIX
Benchmark Data Report
Sample General Hospital
Compared to Hospitals of Less Than 100 Beds
Current Quarter Benchmark
Annual Average Q1 %ile
Year 1 Year 2 50%ile Variance Range
Severity/Length of Stay
Average Length of Stay 3.80 3.91 4.06 –0.15 35–40
Case Mix Index (All Patients) 1.02 1.04 1.04 0.005 50–55
Case Mix Index (Medicare) 1.24 1.26 1.19 0.07 80–85
Productivity/Labor Utilization
FTE per Adjusted Occupied Bed 5.11 4.68 4.44 0.24 60–65
Paid Hours per Adjusted Patient Day 29.12 26.67 25.3 1.37 60–65
Paid Hours per Adjusted Discharge 110.53 104.19 109.5 –5.32 35–40
Salary Cost per Adjusted Discharge $2,638 $2,510 $2,510 $0 50–55
Costs & Charges
Cost per Adjusted Patient Day $1,704 $1,608 $1,448 $161 70–75
Cost per Adjusted Discharge $6,467 $6,282 $5,909 $373 55–60
Cost per CMI (All Pat.) Adj. Discharge $6,328 $6,041 $5,837 $204 50–55
Cost per CMI (All Pat.) Adjusted
Patient Day $1,667 $1,546 $1,408 $139 60–65
Supply Cost per Adjusted Discharge $1,046 $968 $867 $101 60–65
Supply Cost per CMI (All Pat.) Adj.
Discharge $1,024 $931 $829 $102 60–65
Gross Charges per Adjusted Discharge $12,987 $14,155 $12,536 $1,620 60–65
Deductions Percentage 0.40% 58.46% 51.04% 7.42% 60–65
Net Charges per Adjusted Discharge $6,112 $5,880 $5,929 ($49) 45–50
Net Charges per Adjusted Patient Day $1,610 $1,505 $1,424 $82 60–65
Utilization
Average Daily Census 43.15 46.36 37.69 8.67 65–70
Occupancy Percentage 41.09% 46.36% 57.66% –11.30% 10–15
Outpatient Charges Percentage 53.15% 54.02% 50.14% 3.88% 55–60
Beds in Use 100 100 66 34 90–95
Adjusted Occupied Beds 92.2 100.82 72.05 28.76 75–80
Total Patient Days Excluding Newborns 3,936 4,172 3,392 780 65–70
Total Discharges Excluding Newborns 1,036 1,068 751 317 80–85
Newborn Days as a % of Total Patient
Days 6.95% 5.40% 4.61% 0.79% 60–65
Exhibit 33-B–1 Hospital Statistical Data
484 Chapter 33 Case Study: Metropolis Health System
Financial Performance—Profitability Ratios
Operating Margin –2.26 –3.18 1.95 –5.13 15–20
Profit Margin –2.26 –3.18 2.06 –5.24 20–25
Return on Total Assets
(Annualized) (%) –2.37% –3.58% 1.22% –4.80% 20–25
Return on Equity (Annualized) (%) –6.56% –11.19% 4.61% –15.80% 15–20
Financial Performance—Liquidity Ratios
Current Ratio 1.28 1.19 1.9 –0.71 15–20
Quick Ratio 0.54 0.56 1.56 –0.99 15–20
Net Days in Patient AR (Days) 50.73 49 51.86 –2.86 40–45
Financial Performance—Leverage and Solvency Ratios
Total Asset Turnover—Annualized 1.07 1.13 0.99 0.14 65–70
Current Asset Turnover—Annualized 3.21 3.65 3.57 0.08 50–55
Equity Financing 0.38 0.32 0.47 –0.15 25–30
Long-Term Debt to Equity 0.77 0.85 0.56 0.28 70–75
Current Quarter Benchmark
Annual Average Q1 %ile
Year 1 Year 2 50%ile Variance Range
Exhibit 33-B–1 Hospital Statistical Data (continued)
For example, review the average length of stay information for hospitals less than 100 beds in
Exhibit 33-B–1. For the Q1 Year 2, Sample General Hospital has a length of stay of 3.91 versus a
benchmark comparison number of 4.06, a favorable performance against the 50th percentile
by 0.15 (the 20.15 indicates an amount under the 50th percentile that, in the case of average
length of stay, would be favorable). This performance places the hospital’s score in the 35th to
40th percentile of all respondents.
As the CFO already knows, Sample General Hospital is in trouble. In most cases, the facility is
either at or below (worse than) the 50th percentile information. Most of the labor productivity
measures are in the 60th to 65th percentile range, with the cost information in the same relative
range. This indicates that Sample is spending more than the peer group for labor and supplies.
The utilization statistics also present a dismal picture.
Each statistic has to be evaluated against what it means to the institution before a conclusion
can be drawn. For example, the occupancy percentage for Sample is 46.36% versus the 50th
percentile of 57.66%. This places Sample in the 10th to 15th percentile range for the comparison group of hospitals less than 100 beds. In terms of utilization, the CFO knows that a facility
should be in the 80th to 85th percentile range to use all of its assets effectively.
What other statistics should the CFO review to assure that a higher occupancy percentage is
beneficial to the hospital? The answer is average length of stay. Sample General Hospital has a
length of stay of 3.91 (as discussed earlier), which is favorable compared with the peer group,
but an occupancy rate that is 11.30% below the 50th percentile for the peer group of hospitals
less than 100 beds. If these two statistics are observed in combination, one could say that Sample
efficiently manages its patients, but just does not have enough of them.
Comparative Analysis Using Financial Ratios and Benchmarking 485
Benchmark Data Report
Sample General Hospital
Compared to All Hospitals
Current Quarter Benchmark
Annual Average Q1 %ile
Year 1 Year 2 50%ile Variance Range
Severity/Length of Stay
Average Length of Stay 3.80 3.91 4.81 –0.91 10–15
Case Mix Index (All Patients) 1.02 1.04 1.14 –0.103 25–30
Case Mix Index (Medicare) 1.24 1.26 1.38 –0.118 30–35

Productivity/Labor Utilization
FTE per Adjusted Occupied Bed 5.11 4.68 4.87 –0.19 40–45
Paid Hours per Adjusted Patient Day 29.12 26.67 27.77 –1.1 40–45
Paid Hours per Adjusted Discharge 110.53 104.19 134.6 –30.41 10–15
Salary Cost per Adjusted Discharge $2,638 $2,510 $2,927 ($417) 25–30
Costs & Charges
Cost per Adjusted Patient Day $1,704 $1,608 $1,530 $78 60–65
Cost per Adjusted Discharge $6,467 $6,282 $7,284 ($1,001) 30–35
Cost per CMI (All Pat.) Adj. Discharge $6,328 $6,041 $6,115 ($74) 45–50
Cost per CMI (All Pat.) Adjusted
Patient Day $1,667 $1,546 $1,268 $278 80–85
Supply Cost per Adjusted Discharge $1,046 $968 $1,250 ($282) 25–30
Supply Cost per CMI (All Pat.)
Adj. Discharge $1,024 $931 $1,069 ($138) 30–35
Gross Charges per Adjusted
Discharge $12,987 $14,155 $17,196 ($3,041) 35–40
Deductions Percentage 0.40% 58.46% 56.31% 2.15% 55–60
Net Charges per Adjusted Discharge $6,112 $5,880 $7,419 ($1,539) 20–25
Net Charges per Adjusted Patient Day $1,610 $1,505 $1,529 ($24) 45–50
Utilization
Average Daily Census 43.15 46.36 142.98 –96.62 15–20
Occupancy Percentage 41.09% 46.36% 69.38% –23.02% < 5
Outpatient Charges Percentage 53.15% 54.02% 39.64% 14.38% 85–90
Beds in Use 100 100 206 –106 20–25
Adjusted Occupied Beds 92.2 100.82 225.9 –125.09 15–20
Total Patient Days Excluding Newborns 3,936 4,172 12,868 –8,696 15–20
Total Discharges Excluding Newborns 1,036 1,068 2,506 –1,438 20–25
Newborn Days as a % of Total
Patient Days 6.95% 5.40% 4.52% 0.87% 60–65
Exhibit 33-B–2 Hospital Statistical Data
486 Chapter 33 Case Study: Metropolis Health System
Financial Performance—Profitability Ratios
Operating Margin –2.26 –3.18 4.45 –7.63 10–15
Profit Margin –2.26 –3.18 4.66 –7.84 10–15
Return on Total Assets
(Annualized) (%) –2.37% –3.58% 4.04% –7.62% 10–15
Return on Equity (Annualized) (%) –6.56% –11.19% 8.46% –19.65% 5–10
Financial Performance—Liquidity Ratios
Current Ratio 1.28 1.19 2.2 –1 10–15
Quick Ratio 0.54 0.56 1.74 –1.18 5–10
Net Days in Patient AR (Days) 50.73 49 55.76 –6.77 25–30
Financial Performance—Leverage and
Solvency Ratios
Total Asset Turnover—Annualized 1.07 1.13 0.93 0.2 70–75
Current Asset Turnover—Annualized 3.21 3.65 3.48 0.18 50–55
Equity Financing 0.38 0.32 0.5 –0.18 20–25
Long-Term Debt to Equity 0.77 0.85 0.59 0.26 65–70
Current Quarter Benchmark
Annual Average Q1 %ile
Year 1 Year 2 50%ile Variance Range
Exhibit 33-B–2 Hospital Statistical Data (continued)
Other statistics bear the same message. The hospital is not profitable, and much of the problem is because the cost of running the institution exceeds the availability of patients to pay the
bills. In other words, all institutions have core staffing requirements, and within a certain range
of volume, most costs are fixed. Sample has 100 beds in use while the 50th percentile for its
peer group shows 66 beds in use. Sample’s plant is too big for its patient volume. These circumstances can mean the hospital is heading for disaster.
So what happened to Sample General Hospital? As you can surmise from the data, the previous year (labeled “Year 1” on Exhibits 33-B–1 and 33-B–2) was not favorable. Three years previous, the institution was losing money at a rate of over $1 million per month. The next two years
showed improvement (even though the data still show concern), and the improvement trend
continued through the year labeled “Year 2” on Exhibits 33-B–1 and 33-B–2. By using benchmarking data (and a lot of other analysis), management was able to determine and address many
issues that forced this facility to perform below market averages. By improving quality, managing
costs, and controlling productivity, the hospital was able to stabilize its financial position. In addition, with creative management and attention to both clinical quality and customer service, the
occupancy percentage rose to above the 50th percentile. Finally, the operating margin improved
dramatically. In the first quarter of year 2, the margin was minus 3.18. By the end of year 3, results
showed a positive margin of greater than 2.5%, a dramatic turnaround. Benchmarking assisted
in this turnaround by showing management where the need for improvement was greatest.
Comparative Analysis Using Financial Ratios and Benchmarking 487

489
© LFor/Shutterstock
Proposal to Add a
Retail Pharmacy to a Hospital in the Metropolis Health System
Sample General Hospital belongs to the Metropolis Health System. The new chief financial
officer (CFO) at Sample Hospital has been attempting to find new sources of badly needed
revenue for the facility. Consequently, the CFO is preparing a proposal to add a retail pharmacy within the hospital itself. If the proposal is accepted, this would generate a new revenue
stream. The CFO has prepared four exhibits, all of which appear at the end of this case study.
Exhibit 33-C–1, a three-year retail pharmacy profitability analysis, is the primary document. It is
supported by Exhibit 33-C–2, the retail pharmacy proposal assumptions. The profitability analysis is further supported by Exhibit 33-C–3, a year 1 monthly income statement detail. Finally,
Exhibit 33-C–4 presents the supporting year 1 monthly cash flow detail and assumptions.
When the controller reviewed the exhibits, she asked how the working capital of $49,789
was derived. The CFO explained that it represents 3 months of departmental expense. He also
explained that the cost of drugs purchased for the first 60 days was offset by these purchases’
accounts payable cycle, so the net effect was 0. In essence, the vendors were financing the drug
purchases. Thus, the working capital reconciled as follows:
Working Capital
Cost of drugs (2 months) $303,400
Vendor financing (accounts payable) ($303,400)
Departmental expense (3 months) $49,789
Total Working Capital Required $49,789
The controller also noticed on Exhibit 33-C–4 that the cost of renovations to the building
is estimated at $80,000 and equipment purchases are estimated at $50,000 for a total capital
expenditure of $130,000. The building renovations are depreciated on a straight-line basis over
a useful life of 15 years, whereas the equipment purchases are depreciated on a straight-line
basis over a useful life of 5 years. The required capital is proposed to be obtained from hospital
sources, and no borrowing would be necessary. In addition, the total capital expenditure is projected to be retrieved through operating cash flows before the end of year 1.
33-C
APPENDIX
Exhibit 33-C–1 Sample General Hospital 3-Year Retail Pharmacy Profitability Analysis
Year 1 Year 2 Year 3
Rx Sales 2,587,613 2,692,152 2,828,375
Cost of Goods Sold 2,047,950 2,088,909 2,151,576
Gross Margin 539,663 603,243 676,799
GM % 20.9% 22.4% 23.9%
Expenses
Salaries and Wages 192,000 197,760 203,693
Benefits 38,400 39,552 40,739
Materials and Supplies 12,000 14,400 17,280
Contract Services and Fees 14,400 17,280 20,736
Depreciation and Amortization 15,333 15,333 15,333
Interest — — —
Provision for Bad Debts 25,876 26,922 28,284
Misc. Expenses 3,600 4,320 5,184
Total Expense 301,609 315,567 331,248
Net Income 238,053 287,676 345,550
Operating Margin 9.2% 10.7% 12.2%
Cash Flow
Year 1 Year 2 Year 3
Sources
Net Income 238,053 287,676 345,550
Depreciation 15,333 15,333 15,333
Borrowing — — —
Total Sources 253,386 303,010 360,884
Uses
Capital Purchasing 130,000 — —
Working Capital 49,789 — —
Total Uses 179,789 — —
Cash at Beginning of Period — 73,597 376,607
Net Cash Activities 73,597 303,010 360,884
Cash at Ending of Period 73,597 376,607 737,490
Volume
Year 1 Year 2 Year 3
Number of Prescriptions Sold 55,350 56,457 58,151
Courtesy of Resource Group, Ltd., Dallas, Texas.
490 Chapter 33 Case Study: Metropolis Health System
Exhibit 33-C–2 Sample General Hospital Retail Pharmacy Proposal Assumptions
Prescriptions
1. Annual Prescription Estimates—Rate of Growth/Capture Per Day Annual
Year 1 225 55,350
Year 2 2.0% 230 56,457
Year 3 3.0% 236 58,151
2. Average Net Revenue per Prescription—Yearly Increases
Year 1 $ 46.75
Year 2 2.0% $ 47.69
Year 3 2.0% $ 48.64
3. Bad Debt Percentage 1.0%
4. Average Cost per Prescription—Yearly Increases
Year 1 $ 37.00
Year 2 3.0% $ 38.11
Year 3 3.0% $ 39.25
5. Inflation Rates—Per Year
Salary and Wages 3.0%
Other Than Prescriptions 2.0%
Benefits as a % of Salaries 20.0%
6. Initial Capital Requirements
Building 80,000
Equipment 50,000
Working Capital 49,789
Total 179,789
Year 1 Year 2 Year 3
Gross Margin 539,663 603,243 676,799
Net Income before Taxes 238,053 287,676 345,550
Year 1 Year 2 Year 3
Beginning Cash Balance — 73,597 376,607
Net Cash Activity 73,597 303,010 360,884
Ending Cash Balance 73,597 376,607 737,490
Courtesy of Resource Group, Ltd., Dallas, Texas.
Proposal to Add a Retail Pharmacy to a Hospital in the Metropolis Health System 491
Exhibit 33-C–3 Sample General Hospital Retail Pharmacy Proposal Year 1 Monthly Income Statement Detail
Return on Investment Analysis Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12
Average Rx Sales Price $47 $47 $47 $47 $47 $47 $47 $47 $47 $47 $47 $47
Average Rx Cost $37 $37 $37 $37 $37 $37 $37 $37 $37 $37 $37 $37
Gross Margin 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21%
Scripts per Day 225 225 225 225 225 225 225 225 225 225 225 225
7.4% 7.4% 7.4% 7.8% 7.8% 8.3% 8.3% 8.7% 9.1% 9.3% 9.3% 9.3%
Business Days in the Month 20.5 20.5 20.5 20.5 20.5 20.5 20.5 20.5 20.5 20.5 20.5 20.5
Monthly Scripts 4,100 4,100 4,100 4,305 4,305 4,612.5 4,612.5 4,817.5 5,022.5 5,125 5,125 5,125
Rx Sales $191,675 $191,675 $191,675 $201,259 $201,259 $215,634 $215,634 $225,218 $234,802 $239,594 $239,594 $239,594
COG Sold $151,700 $151,700 $151,700 $159,285 $159,285 $170,663 $170,663 $178,248 $185,833 $189,625 $189,625 $189,625
Gross Margin $39,975 $39,975 $39,975 $41,974 $41,974 $44,972 $44,972 $46,971 $48,969 $49,969 $49,969 $49,969
GM % 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21% 21%
Expenses
Salaries and Wages $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000 $16,000
Benefits $3,200 $3,200 $3,200 $3,200 $3,200 $3,200 $3,200 $3,200 $3,200 $3,200 $3,200 $3,200
Materials and Supplies $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000
Contract Services and Fees $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200
Depreciation and Amortization $1,278 $1,278 $1,278 $1,278 $1,278 $1,278 $1,278 $1,278 $1,278 $1,278 $1,278 $1,278
Interest $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0
Provision for Bad Debts $1,917 $1,917 $1,917 $2,013 $2,013 $2,156 $2,156 $2,252 $2,348 $2,396 $2,396 $2,396
Misc. Expenses $300 $300 $300 $300 $300 $300 $300 $300 $300 $300 $300 $300
Total Expenses $24,895 $24,895 $24,895 $24,991 $24,991 $25,134 $25,134 $25,230 $25,326 $25,374 $25,374 $25,374
Net Income $15,080 $15,080 $15,080 $16,983 $16,983 $19,838 $19,838 $21,740 $23,643 $24,595 $24,595 $24,595
Accumulated Profits $15,080 $30,161 $45,241 $62,224 $79,207 $99,045 $118,882 $140,623 $164,266 $188,861 $213,456 $238,050
Courtesy of Resource Group, Ltd., Dallas, Texas.
Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 Month 10 Month 11 Month 12
Depreciation Years
Renovations 15 80,000 444 444 444 444 444 444 444 444 444 444 444 444
Equipment 5 50,000 833 833 833 833 833 833 833 833 833 833 833 833
Total Depreciation 130,000 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278
Cash Flow
Beginning Balance $0 ($163,431) ($147,073) ($130,714) ($112,453) ($94,192) ($73,076) ($51,961) ($28,942) ($4,021) $21,852 $47,725
Sources
Net Income $15,080 $15,080 $15,080 $16,983 $16,983 $19,838 $19,838 $21,741 $23,644 $24,595 $24,595 $24,595
Depreciation 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278 1,278
Borrowing 0 0 0 0 0 0 0 0 0 0 0 0
Total Sources $16,358 $16,358 $16,358 $18,261 $18,261 $21,116 $21,116 $23,018 $24,921 $25,873 $25,873 $25,873
Uses
Capital Purchasing 130,000 0 0 0 0 0 0 0 0 0 0 0
Working Capital 49,789 0 0 0 0 0 0 0 0 0 0 0
Total Uses 179,789 0 0 0 0 0 0 0 0 0 0 0
Net Cash Activities ($163,431) $16,358 $16,358 $18,261 $18,261 $21,116 $21,116 $23,018 $24,921 $25,873 $25,873 $25,873
Ending Balance ($163,431) ($147,073) ($130,714) ($112,453) ($94,192) ($73,076) ($51,961) ($28,942) ($4,021) $21,852 $47,725 $73,597
Exhibit 33-C–4 Sample General Hospital Retail Pharmacy Proposal Year 1 Monthly Cash Flow Detail and Assumptions
Courtesy of Resource Group, Ltd., Dallas, Texas.
494 Chapter 33 Case Study: Metropolis Health System
So how was the proposal received by the hospital’s board of trustees? They first asked for a
small market study to test the amount of prescription sales projected within the proposal. When
the market study results came back positive, the board approved the project, and renovations
are about to commence.
© LFor/Shutterstock
PART
XII
Mini-Case Studies

CONFRONTING THE OPERATIONAL PROBLEM
The Women, Infants, and Children (WIC) Program, a federal program managed by the county
boards of health, provides a mandated health service under strict federal guidelines to women
and young children. In this chapter, we analyze how a WIC clinic, located in the Atlanta metropolitan area, can serve its clientele more efficiently in an environment of constraints. We focus
on achieving shorter waiting times for WIC clients through better management of the flow
of clients through the clinic. We apply the peak-load framework from economics to this basic
operations research problem.
THE ENVIRONMENT
The WIC program provides nutrition counseling, limited physical examinations, and food
vouchers for low-income pregnant women and for children with nutritional deficiencies who
are five years old or less. WIC represents just one part of the integrated services provided to
women and children by the county clinic. Other services include inoculations, medical visits
with the nurse, and a variety of social services. Providing more than one health service at the
county clinic is advantageous because it reinforces good health practices, provides intervention
where necessary, and is convenient for the clients. However, it also complicates the management of service provision and makes it more difficult to improve the delivery of WIC’s services.
To participate in the WIC program, a certification of income and health status is required.
The first step for a client is to schedule an appointment for certification with a clinic nurse.
Once certified, the client is immediately eligible to receive food vouchers and can return to
the clinic to pick up her vouchers for up to a year without revisiting a nurse. Vouchers may
also be picked up when a client comes to the clinic for nutritional classes, which are required
periodically.
From the providers’ point of view, several activities directly related to the WIC program are managed simultaneously. They include the scheduling of appointments for
certification, meeting previously scheduled certification appointments by the nurses,
accommodating unscheduled clients who walk in seeking certification, and distributing food
*B. A. Brotman, M. Bumgarner, and P. Prime, “Client Flow through the Women, Infants, and Children
Public Health Program,” Journal of Health Care Finance 25, no. 1 (1998): 72–77.
© LFor/Shutterstock
497
34
Mini-Case Study 1 CHAPTER
The Economic Significance
of Resource Misallocation:
Client Flow Through the
Women, Infants, and Children
Public Health Program*
Billie Ann Brotman, Mary Bumgarner,
and Penelope Prime
vouchers to eligible clients. (Eligible clients include those certified by the county clinic as well
as those who have been certified by Kennestone Hospital and Home Visits, and Child Health.)
In principle, the appointment system is designed to regulate these activities. In practice,
several factors, none of which are within the control of the clinic staff, undermine it. First,
because clients come to the clinic for other services as well, they often are delayed for their WIC
appointments. Second, of those that make appointments, 40 to 50% of them do not keep them
because they either arrive late or simply do not come. Understanding the obstacles many of the
clients face when arranging work schedules, getting transportation to the clinic, and arranging
for child care, the clinic’s management has instituted a policy of waiting 20 minutes for a client
to arrive before rescheduling the appointment. Third, walk-ins are common and, according to
federal guidelines, must be accommodated. In addition, the clinic has difficulty retaining qualified staff, and its physical space is limited. The end result is that women and children are often
in the clinic for hours, are uncomfortable, and are unable to adequately care for their children
during this time.
THE PEAK-LOAD PROBLEM
The economic problem faced by the clinic is one of demand exceeding capacity, leading to
excessive wait times for the clinic’s patrons as well as inefficient use of clinic nurses and clerks.
The problem arises because the clinic’s services are beneficial to the health of expectant mothers and children, and are provided without fee to the patient. Without a price mechanism to
ration demand, quantity demanded exceeds quantity supplied. This problem is not uncommon. It is encountered often in the public or quasi-public sector, when the price of the good or
service does not adequately reflect the benefits of the good or service as perceived by the public.
In this case, the problem of disequilibrium between demand and supply is exacerbated by
the fact that demand for the clinic’s services is unpredictable. Clients often do not keep their
appointments or arrive at unscheduled times. As a result, appointments may go unfilled, or two
or more clients may seek the same appointment time.
On the supply side, capacity constraints, coupled with a persistent lack of sufficient numbers
of experienced clerks and nurses, hamper the clinic’s ability to respond to unexpected demand
shifts. Moreover, due to employee turnover experienced by the clinic, few employees become sufficiently skilled to work as part-time clerks during periods of peak demand.
The economic significance of the problem is one of resource misallocation. In this case,
too many resources are employed in the production of WIC services. The market solution is
to increase the price of the service, thereby matching demand with capacity. But because that
option is not available, efficiently managing demand and supply is necessary if the amount of
resources used in providing WIC services is to be reduced.
Federal guidelines for the WIC program leave little maneuvering room to improve the delivery of services. For example, the clinic cannot refuse to see unscheduled walk-ins, all clients
must see a nurse for certification, all clients must attend nutrition classes, and vouchers must be
closely monitored. Based on the data and information provided by the clinic, we determined
that the fundamental cause of the queuing problem was the time spent by clients waiting to see
clerks and nurses. Our hypothesis is that the flow of traffic through the clinic can be managed
more efficiently by changing the current policy of waiting 20 minutes before filling a broken
appointment with a “walk-in,” to a new policy of filling the appointment immediately.
498 Chapter 34 Mini-Case Study 1
METHOD
We began by collecting information on the average daily client volume, the pattern of client
flow through various services, the waiting points and times, and services rendered to the clients.
The data were collected by clinic personnel, recorded in a chart throughout the day in periodic intervals, and included nine items:
1. Number of clerks available
2. Number of nurses available
3. Waiting time to see clerks for walk-ins and appointments
4. Waiting time to see nurses for walk-ins and appointments
5. Total time in the clinic for walk-ins and appointments
6. Waiting time to get vouchers
7. Number of nutrition classes
8. Number of appointments met
9. Number of appointments missed
The actual flow of traffic through the clinic is depicted in Figure 34–1.
Clients visit the clinic to keep an appointment with the nurse, attend a nutrition class, or as
an unscheduled walk-in. All clients first see a clerk to arrange for their records to be pulled.
They then check in and wait to be called to their class or appointment. At the completion of the
appointment, they see a clerk to pick up vouchers. Vouchers are also distributed at the end of
the nutrition classes.
The General Purpose Simulation System for personal computer model simulates the average
flow of traffic through the clinic. Estimation of traffic flow through the clinic is initiated when the
client signs in and continues as the client meets with the clerks and the nurses. The model estimates the average amount of time a client spends in the clinic as well as average waiting times at
each station. Clerk and nurse utilization rates are also generated assuming a variety of staffing levels. For comparison purposes, each version of the model is run with a 20-minute time lag before a
late appointment is filled and then run with a 1-minute lag.
Six versions of the model are estimated using different combinations of numbers
of clerks and nurses. Model A assumes that the clinic is staffed with three nurses and
three clerks, Model B with two clerks and three nurses, and Model C with two clerks and
two nurses.
RESULTS
Models A, B, and C present the results of all the computer simulations.
Model A: Three Nurses and Three Clerks
A comparison of the results generated changing a 20-minute wait to a 1-minute wait show that
reducing the time before an appointment is filled results in the following:
1. A decrease in the total time in the clinic for the client from 3 hours and 16 minutes to
1 hour and 11 minutes
Results 499
2. A decrease in the time spent waiting for the clerk from 1 hour and 9 minutes to
approximately 3 minutes
3. An increase in time spent waiting for a nurse from 3 minutes to 10 minutes
500 Chapter 34 Mini-Case Study 1
Figure 34–1 Traffic Flow.
Republished with permission of Wolters Kluwer Law & Business, from Brotman et al. Client Flow through the Women,
Infants, and Children Public Health Program, Journal of Health Care Finance 25, no. 1 (1998): 72–77.
Enter Clinic
Walk to WIC
Wait for Clerk
Pull # Check In Check In Check In
Wait Wait Wait Wait
To Clerk To Clerk Called for
Nutrition Class To Clerk
Pick Up Vouchers Wait Attend Class Wait
Leave Building To RN Wait To RN
Wait Pick Up Vouchers
Pick Up Vouchers Pick Up Vouchers
Wait
To Clerk Leave Building
Leave Building Leave Building
To Clerk
Appointments
Walk-In Class
4. A decrease in the utilization of clerks from 91.6% to 53.2%
5. An increase in the utilization of nurses from 46.7% to 61.2%
Model B: Three Nurses and Two Clerks
1. A decrease in the total time in the clinic for the client from 3 hours and 13 minutes to
1 hour and 27 minutes
2. A decrease in the time spent waiting for the clerk from 1 hour and 19 minutes to
approximately 1 minute
3. An increase in time spent waiting for a nurse from 8 minutes to 43 minutes
4. A decrease in the utilization of clerks from 91.6% to 46.8%
5. An increase in the utilization of nurses from 51.2% to 73.3%
Model C: Two Nurses and Two Clerks
1. A decrease in the total time in the clinic for the client from 1 hour and 50 minutes to
1 hour and 9 minutes
2. A decrease in the time spent waiting for the clerk from 19 minutes to less than 1 minute
3. A decrease in time spent waiting for a nurse from 18 minutes to 13 minutes
4. A decrease in the utilization of clerks from 76.6% to 30.3%
5. A decrease in the utilization of nurses from 64.6% to 53.7%
In all three versions of the model that were estimated, the results of the simulations reveal
that reducing the time before a late appointment is filled significantly decreases the time spent
in the clinic by the client, on average, for all clients. Furthermore, the time spent waiting for
both clerks and nurses decreases, the utilization of the clerks decreases, and the utilization of
the nurses increases in two of the three estimations.
Greater decreases in waiting time occur when the clinic is staffed with three nurses and either
three or two clerks. Smaller decreases occur when only two nurses and two clerks are available.
This suggests that the clinic has little to no scheduling flexibility on days when it is understaffed,
and a policy of filling late appointments immediately should be particularly beneficial.
The utilization of clerks and the time spent waiting for a clerk decreases in all three models
when appointments are filled within one minute, and in every case but one, the utilization rate
of nurses increases when appointments are filled immediately. This suggests that the flow of
clients through the clinic is improved by filling appointments quickly. Utilization rates of nurses
decreases only when the clinic is staffed with three nurses and three clerks. One explanation for
this result is that the clinic is overstaffed with this combination of nurses and clerks. A supporting piece of evidence for this conclusion is that the change in rates of utilization for both nurses
and clerks is the smallest when three of each are employed.
Another implication of these results is that if the clinic does not implement the expedited
scheduling policy, it makes little difference to time spent in the clinic whether it is staffed with
two nurses and two clerks or three nurses and two clerks. Both scenarios result in clients spending approximately 3.25 hours in the clinic. With the 20-minute wait before rescheduling, the
clinic must be staffed with three nurses and three clerks if the time spent in the clinic by the
client is to fall below 2 hours.
Results 501
In summary, our results suggest that following a policy of immediately rescheduling missed
appointments reduces the misallocation of resources employed in the clinic and thus permits
the clinic to respond to its clients’ needs more efficiently. Although this approach cannot duplicate the increase in efficiency that could be realized through the use of a price mechanism, it
does improve the overall welfare of the clinic’s clients. Filling appointments immediately results
in shorter wait times for all clients, so no client is made worse off by the new policy. Moreover, as
the patients realize that timeliness is important, more will arrive on time, further increasing the
clinic’s ability to monitor demand and provide services for its clients.
502 Chapter 34 Mini-Case Study 1
© LFor/Shutterstock
Mini-Case Study 2
Technology in Health Care:
Automating Admissions
Processes*
Eric Christ
Alexander Bain was a clever fellow. He invented the electric clock and the first electric printing
telegraph. He also invented the fax machine, the device that many long-term care providers rely
on for patient referral and admissions communications. That was in 1843.
That’s right, the technology at the core of the referral and admissions process for many continuing care providers is more than 150 years old.
Needless to say, a lot has changed since then. Providers can benefit from these changes by
looking at their patient intake processes and considering ways to use the Internet and other
technological advances to automate and accelerate admissions and referral management.
ASSESS ADMISSIONS PROCESS
The first step for providers who are considering improved tools for patient intake is to assess
current processes. Here are some good questions to start with:
• How many referrals are received per day or per month?
• How many sources (hospitals, physicians, liaisons, other long-term care providers) send
referrals?
• How many pages of documents are associated with each referral?
• How are patient review and approval tasks assigned and tracked?
• How are referral and intake activities collected and reported?
Many providers do not realize what vast mountains of paper they manage. Results from a
2007 survey of about 400 skilled nursing facilities and home health agencies indicate the average provider receives 4 referrals per day, each with 22 pages of related documents. That’s 1,460
referrals and 32,120 pages of documents per year—an 8-foot stack of paper for the average
provider to process, review, and manage.
In a study conducted by a Canadian health policy organization, nursing facility admissions
processes were found to involve 160 steps, including 69 handling steps, 36 forms to complete, 4
family trips to the facility that involved 53 steps and 5 staff members, and 9 forms.
*E. Christ, “Technology in Health Care: Automating Admissions Processes,” Provider Magazine (Oct.
2008): 81–84. Reprinted with permission from Provider Magazine.
503
35
CHAPTER
AREAS TO AUTOMATE
Clearly, providers have many opportunities to streamline the admissions process. For example,
there are typically four to five steps between an initial inquiry and a response to the referral
source, after which insurance must be verified before a final decision to admit is made.
Once a provider has identified the steps in its admissions process, it can evaluate ways to
apply messaging, management, and workflow technologies that can improve admissions in
the following areas: fax and document management, communications, referral tracking and
approval, and reporting.
FAX AND DOCUMENT MANAGEMENT
“Any solution that doesn’t address the fax challenges will typically fall short,” says Felicia Wilson,
a licensed nursing facility administrator and director of the human services program at Shorter
College in Rome, Georgia. “Experience has shown that providers must take steps to minimize receipt and management of faxed paper documents to make referral management more efficient.”
Providers also may not realize how frequently fax errors occur that could delay or block
inbound referrals. Typically, about 8% of outbound faxes do not reach their intended
destination on the first try.
One option for providers is to convert faxed documents into an electronic format. Fax servers can provide this capability at a reasonable cost.
Providers may also benefit from software that helps organize and manage those electronic
documents, which helps facilitate a smooth transition away from paper-filing processes.
It is important to note that providers should not let discussions about waiting for universal
healthcare data standards for electronic medical records sidetrack attempts to automate. Just
storing and managing documents in a common electronic document format, such as the ubiquitous PDF, is a huge incremental improvement over paper filing.
COMMUNICATION IS IMPORTANT
Both internal and external communications are critical to a responsive, efficient admissions
team. In the May 2008 Provider cover story, Donna Shaw, administrator of Woodbine Rehabilitation Health Care in Alexandria, Virginia, summed up the critical need for responsive
communications with referral sources: “Relationships with social workers and discharge
planners at the hospitals are key,” she said. “In an effort to move patients out quickly, hospitals are now expediting their placing process, which, in many cases, means a patient is
referred to the facility that has the first available bed.”
That urgency means providers cannot afford to miss calls or play phone tag with referral
sources. Messaging and alerting systems can help providers know immediately when a referral
comes in and send automated e-mails or faxes back to the referral source to update the status.
There are also emerging technologies to instantly confirm patient information, such as insurance verification—a step that typically requires multiple phone calls and can delay an admissions decision.
Some hospitals have adopted e-referral solutions that facilitate faster exchange of referral
communications. These e-referrals still represent a small percentage of inbound referrals,
however—about 6% according to the 2007 admissions survey. About 80% of new referral inquiries still arrive by fax or phone.
504 Chapter 35 Mini-Case Study 2
Providers should adopt tools and processes to effectively manage all inbound referrals, from
all sources or methods, and communicate instantly with those referral sources.
REFERRAL TRACKING AND APPROVAL
Referral tracking and approval often remains a decidedly low-tech operation. A hospital or
other source faxes in a referral request. The intake coordinator receives the fax, captures it in
a handwritten log book or spreadsheet, makes copies of the paper documents, and distributes
them to the appropriate clinical and management staff for review, with sticky notes affixed providing further instructions.
While this process may ultimately work, it is slow and inefficient. It also does not provide any
mechanism for viewing the status of multiple active referral cases.
Some providers have adopted workflow automation software that can enable the admissions
team to do several things:
• Notify staff when a new referral arrives
• Set review tasks for multiple staff members
• Capture and share notes related to the referrals
• Provide a quick update of referral status
“In an area where every second counts, workflow automation can make the difference between
winning or losing a qualified patient referral,” says Wilson.
ANALYZING REFERRAL ACTIVITY
Admissions staff often must report referral activity to management weekly or even daily. Much
like the typical referral review process, this effort usually involves manually capturing information from multiple sources and compiling it into a written report or spreadsheet.
These manual processes make it extremely difficult to analyze referral activity, capacities,
and win-loss data and create a particular challenge for multi-location providers that seek to view
and analyze referral activity across all locations. They struggle to identify and deliver the services
that are most in demand, prioritize and measure marketing programs, and keep admissions at
peak levels.
One of the greatest advantages of automating admissions and referral processes is the
enhanced ability to see and analyze referral activity. If a provider adopts a system that helps
manage referral documents and workflows, by nature, that system will be capturing information that can help the provider make more informed decisions related to the admissions
process.
There are several things a provider can expect to get a better view of with an automated system, including wins and losses; referral sources, types, and methods; reasons for decline; referral status and performance across locations; and acceptance rates.
Any provider considering solutions for automating admissions should evaluate up front what
data it wants to report.
HOURS SAVED
One six-location skilled nursing provider implemented a web automation solution for
centralized admissions and has seen the potential for tremendous gains in responsiveness and
Hours Saved 505
efficiency. An analysis that examined the time the provider spent on daily referral management
processes revealed that the provider will save an estimated 1,175 hours, or 29.5 work weeks per
year, by expediting referral review and communications processes.
This helps the provider meet goals to improve responsiveness to referral sources and maintain a competitive advantage in its marketplace.
The good news for providers seeking similar results is that many of the associated technologies are fairly simple, such as fax servers, e-mail messaging and alerting tools, and electronic
document formats.
Providers may also benefit from web-based subscription solutions. Accessing a program
through a web portal that is utilized as a monthly or annual subscription can eliminate upfront
investments, such as software and hardware, as well as the need to install upgrades.
Providers simply need to assess their current admission processes and identify and apply the
right mix to make admissions faster, smarter, and more effective.
506 Chapter 35 Mini-Case Study 2
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507
Checklists
1. Is this budget static (not adjusted for volume) or flexible (adjusted for volume during
the year)?
2. Are the figures designated as fixed or variable?
3. Is the budget for a defined unit of authority?
4. Are the line items within the budget all expenses (and revenues, if applicable) that are
controllable by the manager?
5. Is the format of the budget comparable with that of previous periods so that several
reports over time can be compared if so desired?
6. Are actual and budget for the same period?
7. Are the figures annualized?
8. Test one line-item calculation. Is the math for the dollar difference computed
correctly? Is the percentage properly computed based on a percentage of the budget
figure?
Checklist A-1 Reviewing a Budget
A
APPENDIX
1. What is the proposed volume for the new budget period?
2. What is the appropriate inflow (revenues) and outflow (cost of services delivered) relationship?
3. What will the appropriate dollar cost be?
(Note: this question requires a series of assumptions about the nature of the operation
for the new budget period.)
3a. Forecast service-related workload.
3b. Forecast non-service-related workload.
3c. Forecast special project workload if applicable.
3d. Coordinate assumptions for proportionate share of interdepartmental projects.
4. Will additional resources be available?
5. Will this budget accomplish the appropriate managerial objectives for the
organization?
Checklist A-2 Building a Budget
1. What is the date on the balance sheet?
2. Are there large discrepancies in balances between the prior year and the current year?
3. Did total assets increase over the prior year?
4. Did current assets increase, decrease, or stay about the same?
5. Did current liabilities increase, decrease, or stay about the same?
6. Did land, plant, and equipment increase or decrease significantly over the prior year?
7. Did long-term debt increase or decrease significantly over the prior year?
Courtesy of J.J. Baker and R.W. Baker, Dallas, Texas.
Checklist A-3 Balance Sheet Review
508 Appendix A Checklists
1. What is the period reported on the statement of revenue and expense?
2. Is it one year or a shorter period? If it is a shorter period, why is that?
3. Are there large discrepancies in balances between the prior year operations and the
current year operations?
4. Did total operating revenue increase over the prior year?
5. Did total operating expenses increase, decrease, or stay about the same? Is any particular line item unusually large or small?
6. Did income from operations increase, decrease, or stay about the same?
7. Are there unusual nonoperating gains or losses?
8. Did the current year result in an excess of revenue over expense? Is it as much as that
of the prior year?
9. Did long-term debt increase or decrease significantly over the prior year?
Checklist A-4 Review of the Statement of Revenue and Expense
• Only one location?
• Equipment—single purpose or multi-purpose?
• Technology—new, middle-aged, old (obsolete vs. untested)?
• Equipment compatibility
• Medical supply cost
• High or low capital investment?
• Buy new or used (refurbished)?
• Buy or lease?
• Lease for a number of years or lease on a pay-per-procedure deal?
• How much staff training is required?
• Certification required?
• Square footage required for equipment?
• Is the required square footage available?
• Cleaning methods and equipment (and staff level required)?
• Repairs and maintenance expense (high, medium, low)?
Checklist A-5 Considerations for Forecasting Equipment Acquisition
Checklists 509
Modified from CMS, “ICD-10: Next Steps for Providers—Assessment & Maintenance Toolkit.”
• Number of days to final bill
• Number of days to payment
• Claims acceptance/rejection rates
• Claims denial rate
• Payment amounts
• Reimbursement rate
• Coder productivity
• Volume of coder questions
• Payer requests for additional information
• Daily charges/claims
• Incomplete or missing charges
• Incomplete or missing diagnosis codes
• Use of unspecified codes
• Clearinghouse edits
• Payer edits
• RTP/FISS volumes
• Medical necessity pass rate
• Use of ICD-10 codes on prior authorizations and referrals
Checklist A-6 Checklist for Assessing ICD-10 Progress: Key Performance Indicators
510 Appendix A Checklists
Progress Notes
© LFor/Shutterstock
Glossary
Accountable Care Organization (ACO): An organization consisting of a group of providers who
have joined together voluntarily to provide coordinated, quality care to patients.
Alternative Payment Model (APM): Provides new methods of payment by Medicare for physicians and other eligible professionals (a.k.a. eligible clinicians).
Accounting Rate of Return: See Unadjusted Rate of Return.
Accounting System: Records the evidence that some event has occurred in the healthcare
financial system.
Accrual Basis Accounting: Revenue is recorded when it is earned, not when payment is received.
Expenses are recorded when they are incurred, not when they are paid. The opposite of
accrual basis is cash basis accounting.
Action Plan: A detailed plan of operations that shows how one part of a particular objective will
be accomplished.
Annualize: To convert data to an annual (12-month) period.
Assets: The net value of what an organization owns.
Balance Sheet: One of the four basic financial statements. Generally speaking, the balance
sheet records what an organization owns, what it owes, and what it is worth at a particular
point in time.
Base Year: A 12-month unit of time (one year) used as a basis for comparison.
Baseline Period: A unit of time (period) used as a basis for comparison.
Benchmarking: The continuous process of measuring products, services, and activities against
the best levels of performance. Best levels may be found inside or outside of the organization.
Big Data: A very large data set that is typically used for analysis to reveal patterns and/or trends.
Book Value: The book value (also known as net book value) of a fixed asset is a balance sheet
figure that represents the remaining undepreciated portion of the fixed asset cost.
Break-Even Point: The point when the contribution margin (i.e., net revenues less variable
costs) equals the fixed costs.
511
Budget: The organization-wide instrument through which activities are quantified in financial
terms.
Business Plan: A document that is typically prepared in order to obtain funding and/or financing.
Capital: Represents the financial resources of the organization. Generally considered to be a
combination of debt and equity.
Capital Expenditure Budget: A budget usually intended to plan, monitor, and control longterm financial issues.
Capital Structure: Means the proportion of debt versus equity within the organization. The
phrase “capital structure” actually refers to the debt–equity relationship.
Case Mix Adjusted: A performance measure that has been adjusted for the acuity level of the
patient and, presumably, the resource level required to provide care.
Cash Basis Accounting: A transaction does not enter the books until cash is either received or
paid out. The opposite of cash basis is accrual basis accounting.
Cash Flow Analysis: This type of analysis illustrates how the project’s cash is expected to move
over a period of time.
Certificate of Need (CON) Program: A program to control excess capacity in the form of facility overbuilding.
Certified EHR Technology: An electronic health record (EHR) that has been specially certified for use in the EHR Incentive Programs.
Chart of Accounts: Maps out account titles in a uniform manner through a method of numeric
coding.
Code Users: Any individual who needs to have some level of understanding of the coding system, but does not actually assign codes.
Common Sizing: A process of converting dollar amounts to percentages to put information on
the same relative basis. Also known as vertical analysis.
Common Stock: Stocks represent equity, or net worth, in a company. Common stock typically
pays a proportionate share of net income out as a dividend to its investors.
Composite Performance Score: See also Composite Score.
Composite Score: An overall score assembled from multiple scores, or parts.
Contribution Income Statement: Specifically identifies the contribution margin within the
income statement format.
Contribution Margin: Called this because it contributes to fixed costs and to profits. Computed
as net revenues less variable costs.
Controllable Expenses: Subject to a manager’s own decision making and thus “controllable.”
Controlling: Making sure that each area of the organization is following the plans that have
been established.
512 Glossary
Core Objectives: EHR Incentive Program criteria that is necessary to achieve meaningful use.
Core objectives are mandatory; thus the provider must meet all applicable core objectives.
See also Menu Objective.
Cost: The amount of cash expended (or property transferred, services performed, or liability
incurred) in consideration of goods or services received or to be received.
Cost-Profit-Volume: A method of illustrating the break-even point, whereby the three elements
of cost, profit, and volume are accounted for within the computation.
Cost Object: Any unit for which a separate cost measurement is desired.
Critical Access Hospitals (CAHs): Certain rural providers qualify as CAHs under the Medicare
program. These eligible CAHs are a separate provider type and are reimbursed using a
separate payment method.
Cross-cutting (measure): A measure that crosses among different types of facilities (thus “cuts
across”).
Cross-setting: Allowing information to flow back and forth among different types of facilities
(thus “across-settings”).
Cumulative Cash Flow: The accumulated effect of cash inflows and cash outflows are added
and/or subtracted to show the overall net accumulated result.
Current Ratio: A liquidity ratio considered to be a measure of short-term debt-paying ability.
Computed by dividing current assets by current liabilities.
Data: Factual information typically used to measure and/or calculate, although data may also
be used for reasoning and/or discussion.
Data Analytics: The process of mining data to discover patterns, correlations, and other related
information, primarily in order to make better decisions.
Database (also Data Base): A particular set of computerized data organized in a manner
designed for efficient retrieval.
Data Mining: The process used by organizations to turn raw data into useful information.
Data Set: A group of data (a set) gathered together for a like purpose.
Days Cash on Hand Ratio: A liquidity ratio that indicates the number of days of operating
expenses represented in the amount of unrestricted cash on hand. Computed by dividing
unrestricted cash and cash equivalents by the cash operating expenses divided by number
of days in the period.
Days Receivables Ratio: A liquidity ratio that represents the number of days in receivables.
Computed by dividing net receivables by net credit revenues divided by number of days in
the period.
Debentures: Bonds that are unsecured. Debentures are backed by revenues that the issuing
organization can earn.
Glossary 513
Debt Service Coverage Ratio: A solvency ratio universally used in credit analysis to measure ability
to pay debt service. Computed by dividing change in unrestricted net assets (net income) plus
interest, depreciation, and amortization by maximum annual debt service.
Decile: A distribution into 10 classes, each of which contains one-tenth of the whole; any one
of the 10 classes is a decile.
Decision Making: Making choices among available alternatives.
Deflation: A contraction in the volume of available money and credit that results in a general
decline in prices.
Denominator: The bottom part of a fraction. The denominator indicates the total number of
parts available to be divided. See also Numerator.
Depreciation: Depreciation expense spreads, or allocates, the cost of a fixed asset over the useful life of that asset.
Diagnoses: A common method of grouping healthcare expenses for purposes of planning and
control. Such a grouping may be by major diagnostic categories or by diagnosis-related
groups.
Digital Media: Information that may be stored digitally, such as in a computer or mobile device,
or online.
Direct Costs: These costs are incurred for the sole benefit of a particular operating unit. They
can therefore be specifically associated with a particular unit or department or patient.
Laboratory tests are an example of a direct cost.
Discounted Fee-for-Service: The provider of services is paid according to an agreed-upon
contracted discount and after the service is delivered.
Dispenser: Either a person or other legal entity who provides drug products for human use on
prescription in the course of professional practice, and who is licensed, registered, or otherwise permitted by the jurisdiction in which the person practices, or the entity is located, to
do so.
Electronic Data Interchange: The electronic transfer of information such as electronic media
claims. The transfer is made in a standard format between trading partners.
Electronic Health Record (EHR): A health-related electronic record of an individual that
includes patient demographic and clinical information and that has the capacity to provide
clinical decision support, support physician order entry, capture and query quality information, and exchange and integrate electronic health information. It is possible for this digital
record to contain information about a patient’s total health status across all providers. See
also Electronic Medical Record (EMR).
Electronic Medical Record (EMR): The digital version of the traditional paper chart as
recorded by a single provider. See also Electronic Health Record (EHR).
Electronic Prescribing (E-Prescribing): Transmitting a prescription or prescription-related
information using electronic media between a prescriber, dispenser, PBM, or health plan.
514 Glossary
The transmission may be either direct or through an intermediary, including an e-prescribing
network.
Electronic Transaction Standards: Standards that are adopted and used to facilitate the electronic transmission of healthcare information and related business transactions.
Eligible Clinician: Another term for Eligible Professional.
Eligible Professional: In this context, physicians, practitioners, and other professionals who are
eligible for payment in certain incentive programs.
Equity: Claims held by the owners of the business because they have invested in the business;
what the business is worth on paper, net of liabilities.
Estimates: A judgment that takes the place of actual measurement.
Expenses: Actual or expected cash outflows incurred in the course of doing business. Expenses
are the costs that relate to the earning of revenue. An example is salary expense for labor performed.
Expired Costs: Costs that are used up in the current period and are matched against current
revenues.
Fee-for-Service: The provider of services is paid according to the service performed and after
the service is delivered.
FIFO: The First-In, First-Out inventory costing method recognizes the first costs placed into
inventory as the first costs moved out into cost of goods sold when a sale occurs.
Financial Accounting: Is generally for outside, or third-party, use and thus emphasizes external
reporting.
Financial Forecast: “Forecasted” prospective financial statements. Forecasts are based on
assumptions that are expected to exist, and that reflect actions that are expected to occur.
Financial Lease: A formal agreement that may be called a lease but is actually a contract to purchase. This type of lease must meet certain criteria.
Financial Projection: “Projected” prospective financial statements that are often prepared to
answer “what-if” questions. The statements “project” a view of future events, projects, or
operations using a set of presumed, or hypothetical, assumptions.
Fixed Costs: Those costs that do not vary in total when activity levels or volume of operations
change. Rent expense is an example of fixed cost.
Flexible Budget: A budget based on a range of activity or volume. The flexible budget is
adjusted, or flexed (thus “flexible”) to the actual level of output achieved or expected to be
achieved during the budget period.
Forecasts: Information used for purposes of planning for the future. Forecasts can be short,
intermediate, or long range.
For-Profit Organization: A proprietary organization that is generally subject to income tax.
Glossary 515
Full-Time Equivalent (FTE): A measure to express the equivalent of an employee (annualized)
or a position (staffed) for the full time required.
Fund Balance: The difference between net assets and net liabilities; a term generally used by
not-for-profit organizations.
General Ledger: A document in which all transactions for the period reside.
General Services Expenses: This type of expense provides services necessary to maintain the
patient, but the service is not directly related to patient care. Examples of general services
expenses are laundry and dietary.
Goal: A statement of aim or purpose that is part of a strategic plan.
Gross Domestic Product (GDP): A measure of the output of goods and services produced by
labor and property located in the United States. The Bureau of Economic Analysis (BEA) is
responsible for releasing quarterly estimates of the GDP.
Healthcare Analytics: Data analytics applied to the healthcare industry.
Health Delivery System: A health system containing varying levels of care and multiple sites of
service that deliver care under one integrated system.
Health Information Exchange (HIE): The electronic movement, or transmission, of healthrelated information between and among organizations using nationally recognized standards.
Health Information Technology (HIT): Technology that is designed for, or supports use by,
healthcare entities or patients. Includes hardware, software, integrated technologies or
related licenses, intellectual property, upgrades, or packaged solutions.
Horizontal Analysis: The process of comparing and analyzing figures over several time periods.
Also known as trend analysis.
ICD-10 Codes: The International Classification of Diseases (ICD) is the international standard
for diagnostic disease classifications. ICD-10 indicates the tenth revision.
IMPACT Act: A legislative act that requires standardized patient assessment data be reported
by four types of post-acute care facilities. Its full name is the “Improving Medicare PostAcute Care Transformation Act of 2014.”
Indirect Cost: These costs are incurred on behalf of the overall operation and therefore cannot
be associated with the provision of specific health services. The finance office is an example
of an indirect cost. Also known as joint costs.
Inflation: An increase in the volume of money and credit relative to available goods and services resulting in a continuing rise in the general price level.
Information System: Gathers the evidence that some event has occurred in the healthcare
financial system.
Information Technology (IT): Computer and telecommunications technology that organizes,
processes, stores, retrieves, secures, and transmits information.
516 Glossary
Innovation: An idea, practice, or object that is perceived as new.
Internal Rate of Return: A return on investment method, defined as the rate of interest that
discounts future net inflows (from the proposed investment) down to the amount invested.
Interoperability: The ability to operate, or transmit, across data systems used by different types
of facilities.
Inventory: All the items (“goods”) that an organization has for sale in the normal course of its
business.
Inventory Turnover: A ratio that shows how fast inventory is sold, or “turns over.”
Joint Costs: These costs are incurred on behalf of the overall operation and therefore cannot
be associated with the provision of specific health services. The finance office is a typical
example of a joint cost. Also known as indirect cost.
Liabilities: What the organization owes.
Liabilities to Fund Balance Ratio: A solvency ratio used as a quick indicator of debt load. Computed by dividing total liabilities by unrestricted net assets. Also known as Debt to Net
Worth Ratio.
LIFO: The Last-In, First-Out inventory costing method recognizes the latest, or last, costs
placed into inventory as the first costs moved out into cost of goods sold when a sale
occurs.
Liquidity Ratios: Ratios that reflect the ability of the organization to meet its current obligations. Liquidity ratios are measures of short-term sufficiency.
Loan Costs: Those costs necessary to close a loan.
MACRA: A legislative act that reformed Medicare payment to physicians and certain eligible
professionals (a.k.a. eligible clinicians). Its full name is the “Medicare Access and CHIP
Reauthorization Act of 2015.”
Managed Care: A means of providing healthcare services within a network of healthcare
providers. The central concept is coordination of all healthcare services for an individual.
Managerial Accounting: Is generally for inside, or internal, use and thus emphasizes information useful for managerial employees.
Mean: An average of numbers or values.
Meaningful Use: Providers must show that they are “meaningfully using” their certified EHR
technology by meeting thresholds, or minimums, for certain program objectives.
Meaningful User: To be a meaningful user of electronic health records, the provider must be
using EHR in a meaningful manner, be connected in a way that allows electronic exchange
of health information, and be reporting on measures using EHR.
Measure Development Plan (MDP): A plan to develop quality measures that support the transition to new payment methods for physicians and certain other professionals.
Glossary 517
Median: The median occupies a position in a ranked series of values (numbers) in which the
same number of values appears above the median as appear below it (or, in the case of an
even number of values, the average of the two middle-ranked values).
Medicaid Program: A federal and state matching entitlement program intended to provide
medical assistance to eligible needy individuals and families. The program was established
under Title XIX of the Social Security Act.
Medicare Program: A federal health insurance program for the aged (and, in certain instances,
for the disabled) intended to complement other federal benefits. The program was established under Title XVIII of the Social Security Act.
Menu Objective: EHR Incentive Program criteria that is necessary to achieve meaningful use.
Menu objectives provide a choice; thus the provider must meet a certain number of applicable menu objectives, but not all of them. See also Core Objectives.
Merit-Based Incentive Program (MIPS): A value-based program that combines certain parts of
existing quality reporting programs for physicians and certain eligible professionals (a.k.a.
eligible clinicians).
Mission Statement: A Mission Statement explains the purpose of the organization. It explains
“what we are now.”
Mixed Cost: Those costs that contain an element of variable cost and an element of fixed cost.
Mode: The number or value that appears the most frequently within a series of numbers or
values.
Monetary Unit: A measure of units of currency, such as the dollar. Monetary units should be
comparable when reporting financial results.
Mortgage Bonds: Bonds that are backed, or secured, by certain real property.
Municipal Bonds: Long-term obligations that are typically used to finance capital projects.
Net Worth: See Equity.
Noncontrollable Expenses: Outside the manager’s power to make decisions, and thus “noncontrollable.”
Nonproductive Time: Paid-for time when the employee is not on duty—that is, not producing.
Paid-for vacation days and holidays are examples of nonproductive time.
Nonprofit Organization: Indicates the taxable status of the organization. A nonprofit (or voluntary) organization is exempt from paying income taxes.
Not-for-Profit Organization: See Nonprofit Organization.
Numerator: The top part of a fraction. The numerator indicates the total number of parts of
the denominator taken. See also Denominator.
Operating Budget: A budget that generally deals with actual short-term revenues and expenses
necessary to operate the facility.
518 Glossary
Operating Lease: A lease that is considered an operating expense and thus is treated as an
expense of current operations. This type of lease does not meet the criteria to be treated as
a financial lease.
Operating Margin: A profitability ratio generally expressed as a percentage, the operating margin is a multipurpose measure. It is used for a number of managerial purposes and also
sometimes enters into credit analysis. Computed by dividing operating income (loss) by
total operating revenues.
Operations Expenses: This type of expense provides service directly related to patient care.
Examples of operations expenses are radiology expense and drug expense.
Organization Chart: Indicates the formal lines of communication and reporting and how
responsibility is assigned to managers.
Organizational Values: Organizational values express the philosophy of the organization, most
often expressed in a Values Statement.
Organizing: Deciding how to use the resources of the organization to most effectively carry out
the plans that have been established.
Original Records: Provide evidence that some event has occurred in the healthcare financial system.
Overhead: Refers to the remaining expenses of operation that are necessary to produce the
service but that are not directly attributable to that service.
Pareto Analysis: An analytical tool employing the Pareto principle, also known as the 80/20
rule. The Pareto principle states that 80% of an organization’s problems are caused by 20%
of the possible causes.
Patient Engagement: A patient who is an active partner in his or her own health care.
Patient Mix: A term indicating the mix of payers; thus, whether the individual is a Medicare
patient, a Medicaid patient, a patient covered by private insurance, or a private pay patient
varies the patient mix proportions. Patient mix information allows estimated payment levels to be associated with the service utilization assumptions.
Pay-for-Performance (P4P): Providers receive payment incentives when meeting performance
measures that show they are delivering and promoting improvements in high-quality, efficient care.
Payback Period: The length of time required for the cash coming in from an investment to
equal the amount of cash originally spent when the investment was acquired.
Payer Mix: The proportion of revenues realized from different types of payers. A measure often
included in the profile of a healthcare organization.
Payment Adjustment: Term used for the downward adjustment of a provider’s payment. A payment adjustment is usually viewed as a penalty.
Performance Measures: Measures that compare and quantify performance. Performance measures may be financial, nonfinancial, or a combination of both types.
Glossary 519
Performance Period: A unit of time during which performance is measured.
Period Cost: For purposes of healthcare businesses, period cost is necessary to support the
existence of the organization itself, rather than actual delivery of a service. Period costs
are matched with revenue on the basis of the period during which the cost is incurred. The
term originated with the manufacturing industry.
Planning: Identifying objectives of the organization and identifying the steps required to
accomplish the objectives.
Population Health: Health care concerned with the outcomes of an entire population instead
of a single patient.
Predictive Analytics: An advanced analytical method used to extract value from data.
Preferred Stock: Stock that has preference over common stock in certain issues such as payment of dividends.
Prescriber: A physician, dentist, or other person who issues prescriptions for drugs for human
use, and who is licensed, registered, or otherwise permitted by the United States or the
jurisdiction in which he or she practices to do so.
Present Value Analysis: A concept based on the time value of money. The value of a dollar today
is more than the value of a dollar in the future.
Private Sector Organizations: Those organizations that are not part of the government.
Procedures: A common method of grouping healthcare expenses for purposes of planning
and control. Such a grouping will generally be by Current Procedural Terminology (or
CPT) codes, which list descriptive terms and identifying codes for medical services and
procedures performed.
Product Cost: For the purposes of healthcare businesses, product cost is necessary to actually
deliver the service. The term originated with the manufacturing industry.
Productive Time: Equates to the employee’s net hours on duty when performing the functions
in his or her job description.
Profit Center: Makes a manager responsible for both the revenue/volume (inflow) side and
the expense (outflow) side of a department, division, unit, or program. Also known as a
responsibility center.
Profitability Ratios: Ratios that reflect the ability of the organization to operate with an excess
of operating revenue over operating expense.
Profit-Oriented Organization: Indicates the taxable status of the organization. A profitoriented (or proprietary) organization is responsible for paying income taxes.
Profit-Volume (PV) Ratio: The contribution margin (i.e., net revenues less variable costs)
expressed as a percentage of net revenue.
Proprietary Organization: Indicates the taxable status of the organization. A proprietary (or
profit-oriented) organization is responsible for paying income taxes.
520 Glossary
Prospective Analytics: A subset of predictive analytics that is used as a decision-making tool.
Quartile: A distribution into four classes, each of which contains one-quarter of the whole; any
one of the four classes is a quartile.
Quick Ratio: A liquidity ratio considered the most severe test of short-term debt-paying ability
(even more severe than the current ratio). Computed by dividing cash and cash equivalents
plus net receivables by current liabilities. Also known as the acid-test ratio.
Reimbursement: A method of paying (reimbursing) a healthcare provider for services or procedures provided.
Reporting System: Produces reports of an event’s effect in the healthcare financial system.
Responsibility Centers: Makes a manager responsible for both the revenue/volume (inflow)
side and the expense (outflow) side of a department, division, unit, or program. Also
known as a profit center.
Retrospective Analytics: Identifies trends and problems by looking at historical information
and drawing empirical conclusions.
Return on Total Assets: A profitability ratio generally expressed as a percentage, this is a broad
measure of profitability in common use. Computed by dividing earnings before interest and
taxes, or EBIT, by total assets. This ratio is known by its acronym, EBIT, in credit analysis circles.
Revenue: Actual or expected cash inflows due to the organization’s major business. Revenues
are amounts earned in the course of doing business. In the case of health care, revenues are
mostly earned by rendering services to patients.
Revenue Amount: Refers to how much each payer is expected to pay for the service and/or
drug or device.
Revenue Sources: Refers to how many payers will pay for the service and/or drug and device,
and in what proportion.
Revenue Type: A designation as to whether, for example, revenue is derived entirely from services or whether part of the revenue is derived from drugs and devices.
Salvage Value: Also known as residual value or scrap value, represents any expected cash value
of the asset at the end of its useful life.
Semifixed Costs: Those costs that stay fixed for a time when activity levels or volume of operations change; rises will occur, but not in direct proportion.
Semivariable Costs: Those costs that vary when activity levels or volume of operations change,
but not in direct proportion. A supervisor’s salary is an example of a semivariable cost.
Situational Analysis: Management tool that reviews, assesses, and analyzes the organization’s
internal operations for strengths and weaknesses and the organization’s external environment for opportunities and threats.
Social Media: Online technology and content whose original purpose was that of enhancing social communication and collaboration. Current examples of social media include
Facebook and Twitter.
Glossary 521
Solvency Ratios: Ratios that reflect the ability of the organization to pay the annual interest and
principal obligations on its long-term debt. These ratios determine ability to “be solvent.”
Space Occupancy: Within the context of a forecast or projection, refers to the overall cost
of occupying the space required for the service or procedure. Considered to be an
indirect cost.
Staffing: A term that means the assigning of staff to fill scheduled positions.
Stakeholder: A person or entity that has an interest in a service, program, and/or outcome.
Standardized Data: Data that are both uniform and comparable.
Statement of Cash Flows: One of the four basic financial statements, this statement reports the
current period cash flow by taking the accrual basis statements and converting them to an
effective cash flow. This is accomplished by a series of reconciling adjustments that account
for the noncash amounts.
Statement of Fund Balance/Net Worth: One of the four basic financial statements, this statement reports the excess of revenue over expenses (or vice versa) for the period as the
excess flows into equity (or reduces equity, in the case of a loss for the period).
Statement of Revenue and Expense: One of the four basic financial statements, this statement
reports the inflow of revenue and the outflow of expense over a stated period of time. The
net result is also reported, either as excess of revenue over expense or, in the case of a loss
for the period, excess of expense over revenue.
Static Budget: A budget based on a single level of operations, or volume. After it is approved
and finalized, the single level of operations (volume) is never adjusted; thus, the budget is
“static” or unchanging.
Stock Warrants: Warrants allow the owner of the warrant to purchase additional shares of stock
in the company, generally at a particular price and prior to an expiration date.
Strategic Objective: A strategic objective further defines intended outcomes in order to achieve
a goal.
Structured Data: Data that adheres to standards that allow patient information to be easily
retrieved and transferred.
Subsidiary Journals: Documents that contain specific sets of transactions and that support the
general ledger.
Subsidiary Reports: Reports that support, and thus are subsidiary to, the four major financial
statements.
Supplies: Within the context of a forecast or projection, refers to the necessary supplies that
are required to perform a procedure or service. Considered to be a direct expense.
Support Services Expenses: This type of expense provides support to both general services
expenses and to operations expenses. It is necessary for support, but it is neither directly
related to patient care nor is it a service necessary to maintain the patient. Examples of
support services are insurance and payroll taxes.
522 Glossary
Sustainable Growth Rate (SGR): A method to ensure that the yearly increase in expense per
Medicare beneficiary does not exceed the growth in the GDP.
SWOT Analysis: Acronym for a method of situational analysis assessing an organization’s
strengths-weaknesses-opportunities-threats; thus “SWOT.”
Target Operating Income: Allows the manager to determine, or target, how many units must be
sold in order to yield a particular operating income.
Three-Variance Method: A method of variance analysis that compares volume variance to use
(or quantity) variance and to spending (or price) variance.
Threshold: A minimum number, or percentage, to be met.
Time Value of Money: The present value concept, which is that the value of a dollar today is
more than the value of a dollar in the future.
Trend Analysis: The process of comparing and analyzing figures over several time periods. Also
known as horizontal analysis.
Trial Balance: A document used to balance the general ledger accounts and to produce financial statements.
Two-Variance Method: A method of variance analysis that compares volume variance to budgeted
costs (defined as standard hours for actual production)—thus the “two-variance” method.
Unadjusted Rate of Return: An unsophisticated return on investment method, the answer for
which is an estimate containing no precision.
Unexpired Costs: Costs that are not yet used up and will be matched against future revenues.
Useful Life: The useful life of a fixed asset determines the period over which the fixed asset’s
cost will be spread.
Value-Based Concept: In finance, a combination of cost and quality. Value-based concepts may
be applied to purchasing, payment, pricing, strategy, and/or patient care.
Values Statement: See Organizational Values.
Variable Costs: Those costs that vary in direct proportion to changes in activity levels of volume
of operations. Food for meal preparation is an example of variable cost.
Variance Analysis: A variance is the difference between standard and actual prices and quantities. Variance analysis analyzes these differences.
Version 5010 of Transmission Standards: The current version of electronic transmission standards at the time of this writing. See Electronic Transmission Standards.
Vertical Analysis: A process of converting dollar amounts to percentages to put information on
the same relative basis. Also known as common sizing.
Vision Statement: The Vision Statement explains “what we want to be.” It is a look further into
the future.
Voluntary Organization: Indicates the taxable status of the organization. A voluntary (or
nonprofit) organization is exempt from paying income taxes.
Glossary 523

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The following examples and exercises include examples, practice exercises, and assignment
exercises. Solutions to the practice exercises are found at the end of this section. Exercises are
designated by chapter number.
EXAMPLES AND EXERCISES
CHAPTER 1
Assignment Exercise 1–1
Review the chapter text about types of organizations and examine the list in Exhibit 1–1.
Required
1. Obtain listings of healthcare organizations from the yellow pages of a telephone book.
2. Set up a worksheet listing the classifications of organizations found in Exhibit 1–1.
3. Enter the organizations you found in the yellow pages onto the worksheet.
4. For each organization indicate the type of organization.
5. If some cannot be identified by type, comment on what you would expect them to be; that
is, proprietary, voluntary, or government owned.
Assignment Exercise 1–2
Review the chapter text about organization charts. Also examine the organization charts
appearing in Figures 1–2 and 1–3.
Required
1. Refer to the Metropolis Health System (MHS) case study appearing in Chapter 33 and
read about the various types of services offered by MHS.
2. The MHS organization chart has seven major areas of responsibility, each headed by
a senior vice president. Select one of the seven areas and design additional levels of
detail that indicate the managers. If you have considerable detail you may choose one
Examples and
Exercises,
Supplemental
Materials, and
Solutions
525
department (such as ambulatory operations) instead of the entire area of responsibility
for that senior vice president.
3. Do you believe your design of the detailed organization chart indicates centralized or
decentralized lines of authority for decision making? Can you explain your approach in
one to two sentences?
CHAPTER 2
Assignment Exercise 2–1: Health System Flowsheets
Review the chapter text about information flow and Figures 2–2 and 2–3.
Required
1. Find an information flowsheet from a healthcare organization. It can be from a published source or from an actual organization.
2. Based on this flowsheet, comment on what the structure of the organization’s information system appears to be.
3. If you were a manager (at this organization), would you want to change the structure?
If so, why? If not, why not?
Assignment Exercise 2–2: Chart of Accounts
Review the chapter text about the chart of accounts and how it is a map of the company
elements. Also review Exhibits 2–1, 2–2, and 2–3.
Required
1. Find an excerpt from a healthcare organization’s chart of accounts. It can be from a published source or from an actual organization.
2. Based on this chart of accounts excerpt, comment on what the structure of the organization’s reporting system appears to be.
3. If you were a manager (at this organization), would you want to change the system? If so,
why? If not, why not?
CHAPTER 3
Assignment Exercise 3–1
Review the chapter text concerning the engaged patient.
Required
1. Find a source that discusses one of the patient engagement digital impact areas mentioned in the chapter text (patient portals, telemedicine, remote monitoring, etc.).
2. Based on the source that you find, comment on how effective you believe this type of
patient engagement would be.
526 Examples and Exercises, Supplemental Materials, and Solutions
3. Would you want to use this type of patient engagement digital connection in your organization? If so, why? If not, why not?
Assignment 3–2
Review the chapter text concerning population health.
Required
1. Find a source of information from a healthcare organization that claims to be addressing
population health.
2. Review the organization’s information and answer the following: Does it define the population? Does it describe the care the population is receiving? Does it describe the delivery
system that is providing this care?
3. Can you tell from this information whether there is a gap between the care required for
this population and the care that is provided? If so, what do you think could be done to
bridge this gap?
CHAPTER 4
Example 4A: Assets and Liabilities
Study the chapter text concerning examples of assets and liabilities. Is the difference between
short-term and long-term assets and liabilities clear to you?
Practice Exercise 4–I
Place an “X” in the appropriate classification for each balance sheet item listed below.
Short-Term
Asset
Long-Term
Asset
Short-Term
Liability
Long-Term
Liability
Payroll taxes due
Accounts receivable
Land
Mortgage payable
(noncurrent)
Buildings
Note payable
(due in 24 months)
Inventory
Accounts payable
Cash on hand
Chapter 4 527
Assignment Exercise 4–1: Balance Sheet
Locate a healthcare-related balance sheet. The source of the balance sheet can be internal
(within a healthcare facility of some type) or external (from a published article or from a company’s annual report, for example). Write your impressions and/or comments about the assets,
liabilities, and net worth found on your balance sheet. Would you have preferred more detail in
this statement? If so, why?
Assignment Exercise 4–2: Balance Sheet
Locate a second healthcare-related balance sheet. Again, the source of the balance sheet can be
either internal or external. Compare the balance sheet you acquired for Assignment Exercise 4-1
with the second balance sheet you have now obtained. What is the same? What is different?
Which one do you find more informative? Why?
CHAPTER 5
Example 5A: Contractual Allowances
Contractual allowances represent the difference between the full established rate and the
agreed-upon contractual rate that will be paid. An example was given in the text of Chapter 5 by
which the hospital’s full established rate for a certain procedure is $100, but Giant Health Plan
has negotiated a managed care contract whereby the plan pays only $90 for that procedure. The
contractual allowance is $10 ($100 less $90 = $10). Assume instead that Near-By Health Plan has
negotiated its own managed care contract whereby this plan pays $95 for that procedure. In this
case the contractual allowance is $5 ($100 less $95 = $5).
Assignment Exercise 5–1: Contractual Allowances
Physician office revenue for visit code 99214 has a full established rate of $72.00. Of 10 different
payers, there are 9 different contracted rates, as follows:
Payer Contracted Rate (in dollars)
FHP 35.70
HPHP 58.85
MC 54.90
UND 60.40
CCN 70.20
MO 70.75
CGN 10.00
PRU 54.90
PHCS 50.00
ANA 45.00
Rates for illustration only.
528 Examples and Exercises, Supplemental Materials, and Solutions
Required
1. Set up a worksheet with four columns: Payer, Full Rate, Contracted Rate, and Contractual
Allowance.
2. For each payer, enter the full rate and the contracted rate.
3. For each payer, compute the contractual allowance.
The first payer has been computed below:
Payer Full Rate (less)
Contracted
Rate (equals)
Contractual
Allowance
FHP $72.00 $35.70 $36.30
Example 5B: Revenue Sources and Grouping Revenue
Sources of healthcare revenue are often grouped by payer. Thus, services might be grouped as
follows:
Revenue from the Medicare Program (payer = Medicare)
Revenue from the Medicaid Program (payer = Medicaid)
Revenue from Blue Cross Blue Shield (payer = Commercial Insurance)
or
Revenue from Blue Cross Blue Shield (payer = Managed Care Contract)
Assignment Exercise 5–2: Revenue Sources and Grouping Revenue
The Metropolis Health System (MHS) has revenue sources from operations, donations, and
interest income. The revenue from operations is primarily received for services. MHS groups
its revenue first by cost center. Within each cost center the services revenue is then grouped by
payer.
Required
1. Set up a worksheet with individual columns across the top for six revenue sources (payers): Medicare, Medicaid, Other Public Programs, Patients, Commercial Insurance, and
Managed Care Contracts.
2. Certain situations concerning the Intensive Care Unit and the Laboratory are described
below.
Set up six vertical line items on your worksheet, numbered 1 through 6. Six situations
are described below. For each of the six situations, indicate its number (1 through 6) and
enter the appropriate cost center (either Intensive Care Unit or Laboratory). Then place
an X in the column(s) that represents the correct revenue source(s) for the item. The six
situations are as follows:
(1) ICU stay billed to employee’s insurance program.
(2) Lab test paid for by an individual.
(3) Pathology work performed for the state.
(4) ICU stay billed to member’s health plan.
Chapter 5 529
(5) ICU stay billed for Medicare beneficiary.
(6) Series of allergy tests run for eligible Medicaid beneficiary.
Headings for your worksheet:
Other Public Commercial Managed
Medicare Medicaid Programs Patients Insurance Care Contracts
(1)
(2)
(3)
(4)
(5)
(6)
CHAPTER 6
Example 6A: Grouping Expenses by Cost Center
Cost centers are one method of grouping expenses. For example, a nursing home may consider
the Admitting department as a cost center. In that case the expenses grouped under the Admitting department cost center may include:
• Administrative and Clerical Salaries
• Admitting Supplies
• Dues
• Periodicals and Books
• Employee Education
• Purchased Maintenance
Practice Exercise 6–I: Grouping Expenses by Cost Center
The Metropolis Health System groups expenses for the Intensive Care Unit into its own cost
center. Laboratory expenses and Laundry expenses are likewise grouped into their own cost
centers.
Required
1. Set up a worksheet with individual columns across the top for the three cost centers:
Intensive Care Unit, Laboratory, and Laundry.
2. Indicate the appropriate cost center for each of the following expenses:
• Drugs Requisitioned
• Pathology Supplies
• Detergents and Bleach
• Nursing Salaries
• Clerical Salaries
• Uniforms (for Laundry Aides)
• Repairs (parts for microscopes)
(Hint: One of the expenses will apply to more than one cost center.)
530 Examples and Exercises, Supplemental Materials, and Solutions
Headings for your worksheet:
Intensive Care Unit Laboratory Laundry
Assignment Exercise 6–1: Grouping Expenses by Cost Center
The Metropolis Health System’s Rehabilitation and Wellness Center offers outpatient therapy
and return-to-work services plus cardiac and pulmonary rehabilitation to get people back to a
normal way of living. The Rehabilitation and Wellness Center expenses include the following:
• Nursing Salaries
• Physical Therapist Salaries
• Occupational Therapist Salaries
• Cardiac Rehab Salaries
• Pulmonary Rehab Salaries
• Patient Education Coordinator Salary
• Nursing Supplies
• Physical Therapist Supplies
• Occupational Therapist Supplies
• Cardiac Rehab Supplies
• Pulmonary Rehab Supplies
• Training Supplies
• Clerical Office Supplies
• Employee Education
Required
1. Decide how many cost centers should be used for the above expenses at the Rehabilitation and Wellness Center.
2. Set up a worksheet with individual columns across the top for the cost centers you have
chosen.
3. For each of the expenses listed above, indicate to which of your cost centers it should be
assigned.
Example 6B
Study the chapter text concerning grouping expenses by diagnoses and procedures. Refer to
Exhibits 6–3 and 6–4 (about major diagnostic categories), Exhibit 6–5 (about DRGs and MDCs),
and Table 6–1 (about procedure codes) for examples of different ways to group expenses by
diagnoses and procedures.
Assignment Exercise 6–2
Required
Find a listing of expenses by diagnosis or by procedure. The source of the list can be internal
(within a healthcare facility of some type) or external (such as a published article, report, or
Chapter 6 531
survey). Comment upon whether you believe the expense grouping used is appropriate. Would
you have grouped the expenses in another way?
CHAPTER 7
Example 7A: Direct and Indirect Costs
Review the chapter text regarding direct and indirect costs. In particular, review the example
of ambulance direct costs (Exhibit 7–1) and indirect costs (Exhibit 7–2). Remember that
indirect costs are shared and are sometimes called joint costs or common costs. Because such
costs are shared they must be allocated. Also, remember that one test of a direct cost is to
ask: “If the operating unit (such as a department) did not exist, would this cost not be in
existence?”
Practice Exercise 7–I: Identifying Direct and Indirect Costs
Make a worksheet with two columns: Direct Cost and Indirect Cost. Place each of the following
items in the appropriate column:
• Managed care marketing expense
• Real estate taxes
• Liability insurance
• Clinic telephone expense
• Utilities (for the entire facility)
• Emergency room medical supplies
Assignment Exercise 7–1: Allocating Indirect Costs
Study Table 7–1, Table 7–2, and review the chapter text describing how the indirect cost
is allocated. This assignment will change the allocation bases input for (A) Number of Visits
(Volume), (B) Proportion of Direct Costs, and (C) Number of Computers in Service.
Required
1. Compute the costs allocated to cost centers “Clerical Salaries,” “Administrative Salaries,”
and “Computer Services” using the new allocation bases shown below. Use worksheet #1
that replicates the set up in Table 7–2. Total the new results.
The new allocation bases are:
A 5 # Visits (Volume): PT 5 9,600; OT 5 4,000; ST 5 2,400; Total 5 16,000
(16,000 3 $3.50 5 $56,000)
B 5 Proportion of Direct Costs: PT 5 60%; OT 5 25%; ST 5 15%; Total 5 100%
(% 3 $55,000 total)
C 5 # Computers in Service: PT 5 10; OT 5 3; ST = 3; Total 5 16
(16 3 $5,000 each 5 $80,000)
2. Using worksheet #2 that replicates the set up in Table 7–1, enter the new direct cost and
the new totals for indirect costs resulting from your work. Total the new results.
532 Examples and Exercises, Supplemental Materials, and Solutions
Practice Exercise 7–II: Responsibility Centers
The Metropolis Health System has one director who supervises the areas of Security, Communications, and Ambulance Services. This director also supervises the medical records relevant to
Ambulance Services, the educational training for Security and Ambulance Services personnel,
and the human resources for Security, Communications, and Ambulance Services personnel.
Required
Of the duties and services described, all of which are supervised by one director, which areas
should be responsibility centers and which areas should be support centers? Draw them in a
visual and indicate the reporting requirements.
Assignment Exercise 7–2: Responsibility Centers
Choose among the strategic financial planning Case Study in Chapter 32, the public health
clinic Mini-Case Study in Chapter 34, or the Metropolis Health System information as contained in its Chapter 33 Case Study and the Chapter 33-A Appendix that contains its comparative financial statements. Designate the responsibility centers and the support centers for the
organization selected. Prepare a rationale for the structure you have designed.
CHAPTER 8
Example 8A: Fixed, Variable, and Semivariable Distinction
Review the chapter text for the distinction between fixed, variable, and semivariable costs. Pay
particular attention to the accompanying Figures 8–1 through 8–5.
Practice Exercise 8–I: Analyzing Mixed Costs
The Metropolis Health System (MHS) has a system-wide training course for nurse aides. The
course requires a packet of materials that MHS calls the training pack. Due to turnover and
because the course is system-wide, there is a monthly demand for new packs. In addition, the
local community college also obtains the training packs used in their credit courses from MHS.
The education coordinator needs to know how much of the cost is fixed and how much
of the cost is variable for these training packs. She decides to use the high–low method of
computation.
Required
Using the monthly utilization information presented below, find the fixed and variable portion
of costs through the high–low method.
Number of
Month Training Packs Cost
January 1,000 $ 6,200
February 200 1,820
March 250 2,350
April 400 3,440
Chapter 8 533
May 700 4,900
June 300 2,730
July 150 1,470
August 100 1,010
September 1,100 7,150
October 300 2,850
November 250 2,300
December 100 1,010
Assignment Exercise 8–1: Analyzing Mixed Costs
The education coordinator decides that the community college packs may be unduly influencing the high–low computation. She decides to rerun the results, omitting the community college volume.
Required
1. Using the monthly utilization information presented here, and omitting the community
college training packs, find the fixed and variable portion of costs through the high–low
method. Note that the college only acquires packs in three months of the year: January,
May, and September. These dates coincide with the start dates of their semesters and summer school.
2. The reason the education coordinator needs to know how much of the cost is fixed is
because she is supposed to collect the appropriate variable cost from the community college for their packs. For her purposes, which computation do you believe is better? Why?
Month
Total Number of
Training Packs Total Cost
Community
College Number
Packs
Community
College Cost
(in dollars)
January 1,000 $ 6,200 200 1,240
February 200 1,820
March 250 2,350
April 400 3,440
May 700 4,900 300 2,100
June 300 2,730
July 150 1,470
August 100 1,010
September 1,100 7,150 300 1,950
October 300 2,850
November 250 2,300
December 100 1,010
Example 8B: Contribution Margin
Computation of a contribution margin is simplified if the fixed and variable expense has already
been determined. Examine Table 8–1, which contains Operating Room fixed and variable costs.
534 Examples and Exercises, Supplemental Materials, and Solutions
We can see that the total costs are $1,217,756. Of this amount, $600,822 is designated as variable
cost and $616,934 is designated as fixed ($529,556 plus $87,378 equals $616,934). For purposes
of our example, assume the Operating Room revenue amounts to $1,260,000. The contribution
margin is computed as follows:
Amount
Revenue $1,260,000
Less Variable Cost (600,822)
Contribution Margin $659,178
Thus, $659,178 is available to contribute to fixed costs and to profit. (In this example fixed
costs amount to $616,934, so there is an amount left to contribute toward profit.)
Practice Exercise 8–II: Calculating the Contribution Margin
Greenside Clinic has revenue totaling $3,500,000. The clinic has costs totaling $3,450,000. Of
this amount, 40% is variable cost and 60% is fixed cost.
Required
Compute the contribution margin for Greenside Clinic.
Assignment Exercise 8–2: Calculating the Contribution Margin
The Mental Health program for the Community Center has just completed its fiscal year end. The
program director determines that his program has revenue for the year of $1,210,000. He believes
his variable expense amounts to $205,000 and he knows his fixed expense amounts to $1,100,000.
Required
1. Compute the contribution margin for the Community Center Mental Health Program.
2. What does the result tell you about the program?
Example 8C: Cost-Volume-Profit (CVP) Ratio and Profit-Volume (PV) Ratio
Closely review the examples of ratio calculations in the chapter text. Also note that examples
are presented in visuals as well as text.
Practice Exercise 8–3: Calculating the PV Ratio
The profit-volume (PV) ratio is also known as the contribution margin (CM) ratio. Use the same
assumptions for the Community Center Mental Health Program. In addition to the contribution margin figures already computed, now compute the PV ratio (also known as the CM ratio).
Assignment Exercise 8–3: Calculating the PV Ratio and the CVP Ratio
Use the same assumptions for the Greenside Clinic. One more assumption will be added: The
clinic had 35,000 visits.
Chapter 8 535
Required
1. In addition to the contribution margin figures already computed, now compute the PV
ratio (also known as the CM ratio).
2. Add another column to your worksheet and compute the clinic’s per-visit revenue and
costs.
3. Create a Cost-Volume-Profit chart. Refer to the chapter text along with Figure 8–6.
CHAPTER 9
Assignment Exercise 9–1: FIFO and LIFO Inventory
Study the FIFO and LIFO explanations in the chapter.
Required
1. Use the format in Exhibit 9–1 to compute the ending FIFO inventory and the cost of
goods sold, assuming $90,000 in sales; beginning inventory 500 units @ $50; purchases of
400 units @ $50; 100 units @ $65; 400 units @ $80.
a. Also compute the cost of goods sold percentage of sales.
2. Use the format in Exhibit 9–2 to compute the ending LIFO inventory and the cost of
goods sold, using same assumptions.
a. Also compute the cost of goods sold percentage of sales.
b. Comment on the difference in outcomes.
Assignment Exercise 9–2: Inventory Turnover
Study the “Calculating Inventory Turnover” portion of the chapter closely, whereby the cost of
goods sold divided by the average inventory equals the inventory turnover.
Required
Compute two inventory turnover calculations as follows:
1. Use the LIFO information in the previous assignment to first compute the average inventory and then to compute the inventory turnover.
2. Use the FIFO information in the previous assignment to first compute the average inventory and then to compute the inventory turnover.
Example 9A: Depreciation Concept
Assume that Metropolis Health System (MHS) purchased equipment for $200,000 cash on
April 1 (the first day of its fiscal year). This equipment has an expected life of 10 years. The
salvage value is 10% of cost. No equipment was traded in on this purchase.
Straight-line depreciation is a method that charges an equal amount of depreciation for each
year the asset is in service. In the case of this purchase, straight-line depreciation would amount
to $18,000 per year for 10 years. This amount is computed as follows:
Step 1. Compute the cost net of salvage or trade-in value: 200,000 less 10% salvage value or
20,000 equals 180,000.
536 Examples and Exercises, Supplemental Materials, and Solutions
Step 2. Divide the resulting figure by the expected life (also known as estimated useful life):
180,000 divided by 10 equals 18,000 depreciation per year for 10 years.
Accelerated depreciation represents methods that are speeded up, or accelerated. In other
words a greater amount of depreciation is taken earlier in the life of the asset. One example of
accelerated depreciation is the double-declining balance method. Unlike straight-line depreciation, trade-in or salvage value is not taken into account until the end of the depreciation schedule. This method uses book value, which is the net amount remaining when cumulative previous
depreciation is deducted from the asset’s cost. The computation is as follows:
Step 1. Compute the straight-line rate: 1 divided by 10 equals 10%.
Step 2. Now double the rate (as in double-declining method): 10% times 2 equals 20%.
Step 3. Compute the first year’s depreciation expense: 200,000 times 20% equals 40,000.
Step 4. Compute the carry-forward book value at the beginning of the second year: 200,000
book value beginning Year 1 less Year 1 depreciation of 40,000 equals book value at
the beginning of the second year of 160,000.
Step 5. Compute the second year’s depreciation expense: 160,000 times 20% equals 32,000.
Step 6. Compute the carry-forward book value at the beginning of the third year: 160,000
book value beginning Year 2 less Year 2 depreciation of 32,000 equals book value at
the beginning of the third year of 128,000.
—Continue until the asset’s salvage or trade-in value has been reached.
—Do not depreciate beyond the salvage or trade-in value.
Practice Exercise 9–I: Depreciation Concept
Assume that MHS purchased equipment for $600,000 cash on April 1 (the first day of its fiscal
year). This equipment has an expected life of 10 years. The salvage value is 10% of cost. No
equipment was traded in on this purchase.
Required
1. Compute the straight-line depreciation for this purchase.
2. Compute the double-declining balance depreciation for this purchase.
Assignment Exercise 9–3: Depreciation Concept
Assume that MHS purchased two additional pieces of equipment on April 1 (the first day of its
fiscal year), as follows:
1. The laboratory equipment cost $300,000 and has an expected life of 5 years. The salvage
value is 5% of cost. No equipment was traded in on this purchase.
2. The radiology equipment cost $800,000 and has an expected life of 7 years. The salvage
value is 10% of cost. No equipment was traded in on this purchase.
Required
For both pieces of equipment:
1. Compute the straight-line depreciation.
2. Compute the double-declining balance depreciation.
Chapter 9 537
Example 9B: Depreciation
This example shows straight-line depreciation computed at a five-year useful life with no salvage
value. Straight-line depreciation is the method commonly used for financing projections and
funding proposals.
Depreciation Expense Computation: Straight Line
Five-year useful life; no salvage value
Year # Annual Depreciation Remaining Balance
Beginning Balance = 60,000
1 12,000 48,000
2 12,000 36,000
3 12,000 24,000
4 12,000 12,000
5 12,000 –0
Example 9C: Depreciation
This example shows straight-line depreciation computed at a five-year useful life with a remaining salvage value of $10,000. Note the difference in annual depreciation between Example 9B
and Example 9C.
Depreciation Expense Computation: Straight Line
Five-year useful life; $10,000 salvage value
Year # Annual Depreciation Remaining Balance
Beginning Balance = 60,000
1 10,000 50,000
2 10,000 40,000
3 10,000 30,000
4 10,000 20,000
5 10,000 10,000
Example 9D: Depreciation
This example shows double-declining depreciation computed at a five-year useful life with no
salvage value. As is often the case with a five-year life, the double-declining method is used
for the first three years and the straight-line method is used for the remaining two years. The
double-declining method first computes what the straight-line percentage would be. In this
case 100% divided by five years equals 20%. The 20% is then doubled. In this case 20% times
2 equals 40%. Then the 40% is multiplied by the remaining balance to be depreciated. Thus
60,000 times 40% for year one equals 24,000 depreciation, with a remaining balance of 36,000.
538 Examples and Exercises, Supplemental Materials, and Solutions
Then 36,000 times 40% for year two equals 14,400 depreciation, and 36,000 minus 14,400
equals 21,600 remaining balance, and so on.
Now note the difference in annual depreciation between Example 9B, using straight-line
for all five years, and Example 9D, using the combined double-declining and straight-line
methods.
Depreciation Expense Computation: Double-Declining-Balance
Five-year useful life; $10,000 salvage value
Year # Annual
Depreciation
Remaining
Balance
Beginning Balance = 60,000
1 24,000* 36,000
2 14,400* 21,600
3 8,640* 12,960
4 6,480** 6,480
5 6,480** 6,480
*double-declining balance depreciation
** straight-line depreciation for remaining two years (12,960 divided by 2 = 6,480/yr)
Practice Exercise 9–II: Depreciation
Compute the straight-line depreciation for each year for equipment with a cost of $50,000, a
five-year useful life, and a $5,000 salvage value.
Assignment Exercise 9–4: Depreciation
Set up a purchase scenario of your own and compute the depreciation with and without salvage
value.
Assignment Exercise 9–5: Depreciation Computation: Units-of-Service
Study the “Units of Service” portion of the chapter closely.
Required
1. Using the format in Table 9–A-5, compute units of service depreciation using the following assumptions:
Cost to be depreciated 5 $50,000
Salvage value 5 zero
Total units of service 5 10,000
Units of service per year: Year 1 5 2,200; Year 2 5 2,100;
Year 3 5 2,300; Year 4 5 2,200; Year 5 5 200
Chapter 9 539
2. Using the same format, compute units of service depreciation using adjusted assumptions as follows:
Cost to be depreciated = $50,000
Salvage value = $5,000
Total units of service = 10,000
Units of service per year: Year 1 = 2,200; Year 2 = 2,100;
Year 3 = 2,300; Year 4 = 2,200; Year 5 = 200
CHAPTER 10
Example 10A
Review the chapter text about annualizing positions. In particular review Exhibit 10–2, which
contains the annualizing calculations.
Practice Exercise 10–I: FTEs to Annualize Staffing
The office manager for a physicians’ group affiliated with Metropolis Health System (MHS)
is working on her budget for next year. She wants to annualize her staffing plan. To do so she
needs to convert her staff’s net paid days worked to a factor. Their office is open and staffed
seven days a week, per their agreement with two managed care plans.
The office manager has the MHS worksheet, which shows 9 holidays, 7 sick days, 15 vacation
days, and 3 education days, equaling 34 paid days per year not worked. The physicians’ group
allows 8 holidays, 5 sick days, and 1 education day. An employee must work one full year to earn
5 vacation days. An employee must have worked full time for three full years before earning
10 annual vacation days. Because the turnover is so high, nobody on staff has earned more than
5 vacation days.
Required
1. Compute net paid days worked for a full-time employee in the physicians’ group.
2. Convert net paid days worked to a factor so the office manager can annualize her
staffing plan.
Assignment Exercise 10–1: FTEs to Annualize Staffing
The Metropolis Health System managers are also working on their budgets for next year.
Each manager must annualize his or her staffing plan, and thus must convert staff net paid
days worked to a factor. Each manager has the MHS worksheet, which shows 9 holidays,
7 sick days, 15 vacation days, and 3 education days, equaling 34 paid days per year not
worked.
The Laboratory is fully staffed 7 days per week and the 34 paid days per year not worked is
applicable for the lab. The Medical Records department is also fully staffed 7 days per week.
However, Medical Records is an outsourced department so the employee benefits are somewhat
different. The Medical Records employees receive 9 holidays plus 21 personal leave days, which
can be used for any purpose.
540 Examples and Exercises, Supplemental Materials, and Solutions
Required
1. Compute net paid days worked for a full-time employee in the Laboratory and in Medical
Records.
2. Convert net paid days worked to a factor for the Laboratory and for Medical Records so
these MHS managers can annualize their staffing plans.
Example 10B
Review the chapter text about staffing requirements to fill a position. In particular review
Exhibit 10–4, which contains (at the bottom of the exhibit) the staffing calculations. Remember
this method uses a basic work week as the standard.
Practice Exercise 10–II: FTEs to Fill a Position
Metropolis Health System (MHS) uses a basic work week of 40 hours throughout the system.
Thus, one full-time employee works 40 hours per week. MHS also uses a standard 24-hour
scheduling system of three 8-hour shifts. The Admissions manager needs to compute the staffing requirements to fill his departmental positions. He has more than one Admissions office
staffed within the system. The West Admissions office typically has two Admissions officers on
duty during the day shift, one Admissions officer on duty during the evening shift, and one
Admissions officer on duty during the night shift. The day shift also has one clerical person on
duty. Staffing is identical for all seven days of the week.
Required
1. Set up a staffing requirements worksheet, using the format in Exhibit 10–4.
2. Compute the number of FTEs required to fill the Admissions officer position and the
clerical position at the West Admissions office.
Assignment Exercise 10–2: FTEs to Fill a Position
Metropolis Health System (MHS) uses a basic work week of 40 hours throughout the system.
Thus, one full-time employee works 40 hours per week. MHS also uses a standard 24-hour
scheduling system of three 8-hour shifts. The Director of Nursing needs to compute the staffing
requirements to fill the Operating Room (OR) positions. Since MHS is a trauma center, the OR
is staffed 24 hours a day, 7 days a week. At present, staffing is identical for all 7 days of the week,
although the Director of Nursing is questioning the efficiency of this method.
The Operating Room department is staffed with two nursing supervisors on the day shift and
one nursing supervisor apiece on the evening and night shifts. There are two technicians on the
day shift, two technicians on the evening shift, and one technician on the night shift. There are
three RNs on the day shift, two RNs on the evening shift, and one RN plus one LPN on the night
shift. In addition, there is one aide plus one clerical worker on the day shift only.
Required
1. Set up a staffing requirements worksheet, using the format in Exhibit 10–4.
2. Compute the number of FTEs required to fill the Operating Room staffing positions.
Chapter 10 541
CHAPTER 11
Practice Exercise 11–I: Components of Balance Sheet and Statement of Net Income
Financial statements for Doctors Smith and Brown are provided here. Use the doctors’ balance
sheet, statement of revenue and expenses, and statement of capital for this assignment.
Required
Identify the following doctors’ balance sheet and statement of net income components. List the
name of each component and its amount(s) from the appropriate financial statement.
Current Liabilities
Total Assets
Income from Operations
Accumulated Depreciation
Total Operating Revenue
Current Portion of Long-Term Debt
Interest Income
Inventories
Assignment Exercise 11–1: Components of Balance Sheet and Statement
of Net Income
Refer to the Metropolis Health System (MHS) financial statements contained in Appendix 33-A.
Use the MHS comparative balance sheet, statement of revenue and expenses, and statement of
fund balance for this assignment.
Required
Identify the following MHS balance sheet components. List the name of each component and
its amount(s) from the appropriate MHS financial statement.
Current Liabilities
Total Assets
Income from Operations
Accumulated Depreciation
Total Operating Revenue
Current Portion of Long-Term Debt
Interest Income
Inventories
542 Examples and Exercises, Supplemental Materials, and Solutions
Doctors Smith and Brown:
Statement of Net Income
for the Three Months Ended March 31, 2___
Revenue
Net patient service revenue 180,000
Other revenue -0-
Total Operating Revenue 180,000
Expenses
Nursing/PA salaries 16,650
Clerical salaries 10,150
Payroll taxes/employee benefits 4,800
Medical supplies and drugs 15,000
Professional fees 3,000
Dues and publications 2,400
Janitorial service 1,200
Office supplies 1,500
Repairs and maintenance 1,200
Utilities and telephone 6,000
Depreciation 30,000
Interest 3,100
Other 5,000
Total Expenses 100,000
Income from Operations 80,000
Nonoperating Gains (Losses)
Interest Income -0-
Nonoperating Gains, Net -0-
Net Income 80,000
Chapter 11 543
Doctors Smith and Brown
Balance Sheet
March 31, 2___
Assets
Current Assets
Cash and cash equivalents 25,000
Patient accounts receivable 40,000
Inventories—supplies and drugs 5,000
Total Current Assets 70,000
Property, Plant, and Equipment
Buildings and Improvements 500,000
Equipment 800,000
Total 1,300,000
Less Accumulated Depreciation (480,000)
Net Depreciable Assets 820,000
Land 100,000
Property, Plant, and Equipment, Net 920,000
Other Assets 10,000
Total Assets 1,000,000
Liabilities and Capital
Current Liabilities
Current maturities of long-term 10,000
debt
Accounts payable and accrued 20,000
expenses
Total Current Liabilities 30,000
Long-Term Debt 180,000
Less Current Portion of Long-Term Debt (10,000)
Net Long-Term Debt 170,000
Total Liabilities 200,000
Capital 800,000
Total Liabilities and Capital 1,000,000
Doctors Smith and Brown
Statement of Changes in Capital
for the Three Months Ended March 31, 2___
Beginning Balance $720,000
Net Income 80,000
Ending Balance $800,000
544 Examples and Exercises, Supplemental Materials, and Solutions
Example 11A: Components of Balance Sheet and Income Statement
The “Accounts Receivable (net)” in Exhibit 11–1 means the accounts receivable figure of
$250,000 on the balance sheet is net of the allowance for bad debts. If the allowance for bad
debts is raised on the balance sheet, then bad debt expense (a.k.a. provision for doubtful
accounts) on the income statement (a.k.a. statement of revenue and expense) also rises. Think
of these two accounts as a pair.
Practice Exercise 11–II: Components of Balance Sheet and Income Statement
Refer to Doctors Smith and Brown’s balance sheet, where patient accounts receivable is stated
at $40,000. Do you think this figure is net of an allowance for bad debts?
Assignment Exercise 11–2: Components of Balance Sheet and Income Statement
Refer to the Metropolis Health System (MHS) balance sheet and statement of revenue and
expense in the MHS Case Study appearing in Chapter 33. Patient accounts receivable of $7,400,000
is shown as net of $1,300,000 allowance for bad debts (8,700,000 2 1,300,000 5 7,400,000).
(1) What percentage of gross accounts receivable is the allowance for bad debts? (2) If the allowance for bad debts is raised to $1,500,000, where does the extra $200,000 go?
Example 11B: Components of Balance Sheet and Income Statement
Refer to Exhibit 11–1 and Exhibit 11–2’s Westside Clinic statements. The “Property, Plant,
and Equipment (net)” total in Exhibit 11–1 means the property, plant, and equipment figure of $360,000 on the balance sheet is net of the reserve for depreciation. If the reserve for
depreciation is raised on the balance sheet, then the depreciation expense on the income
statement (a.k.a. statement of revenue and expense) also rises. Think of these two accounts
as another pair.
Practice Exercise 11–III: Components of Balance Sheet and Income Statement
Refer to Doctors Smith and Brown’s balance sheet, where buildings and equipment are both
stated as net (the $820,000 figure), but land is not. Do you recall why this is so?
Assignment Exercise 11–3: Components of Balance Sheet and Income Statement
Refer to the Metropolis Health System (MHS) balance sheet and statement of revenue and
expense in the MHS Case Study appearing in Chapter 33. Property, plant, and equipment of
$19,300,000 is shown as “net,” meaning net of the reserve for depreciation. If the $19,300,000
is reduced by $200,000 (meaning the reserve for depreciation has risen), what happens on the
income statement?
Chapter 11 545
CHAPTER 12
Example 12A
To better understand how the information for the numerator and the denominator of each
calculation is obtained, Figure 12–1 illustrates the process. This figure takes the balance sheet
and the statement of revenue and expense that were discussed in the preceding chapter and
illustrates the source of each figure in the four liquidity ratios. The multiple computations in
days cash on hand and in days receivables are further broken out into a three-step process to
better illustrate sources of information.
Practice Exercise 12–I: Liquidity Ratios
Two of the liquidity ratios are illustrated in this practice exercise. Refer to Doctors Smith and
Brown’s financial statements appearing in the preceding exercises for Chapter 11.
Required
1. Set up a worksheet for the current ratio and the quick ratio.
2. Compute the ratios for Doctors Smith and Brown.
Assignment Exercise 12–1: Liquidity Ratios
Refer to the Metropolis Health System (MHS) case study appearing in Chapter 33.
Required
1. Set up a worksheet for the liquidity ratios.
2. Compute the four liquidity ratios using the MHS financial statements appearing in
Chapter 33.
Example 12B
To better understand how the information for the numerator and the denominator of each
calculation is obtained, Figure 12–2 illustrates the process. This figure takes the balance sheet
and the statement of revenue and expense that were discussed in the preceding chapter and
illustrates the source of each figure in the two solvency ratios. Any multiple computations are
further broken out to better explain sources of information.
Practice Exercise 12–II: Solvency Ratios
Refer to Doctors Smith and Brown’s financial statements appearing in the preceding exercises
for Chapter 11.
Required
1. Set up a worksheet for the solvency ratios.
2. Compute these ratios for Doctors Smith and Brown. To do so, you will need one additional piece of information that is not present on the doctors’ statements: their maximum
annual debt service is $22,200.
546 Examples and Exercises, Supplemental Materials, and Solutions
Assignment Exercise 12–2: Solvency Ratios
Refer to the Metropolis Health System (MHS) case study appearing in Chapter 33.
Required
1. Set up a worksheet for the liquidity ratios.
2. Compute the solvency ratios using the Chapter 33 MHS financial statements.
Example 12C
To better understand how the information for the numerator and the denominator of each
calculation is obtained, study Figure 12–2. This figure takes the balance sheet and the statement
of revenue and expense that were discussed in the preceding chapter and illustrates the source
of each figure in the two profitability ratios. Any multiple computations are further broken out
to better explain sources of information.
Practice Exercise 12–III: Profitability Ratios
Refer to Doctors Smith and Brown’s financial statements appearing in the preceding exercises
for Chapter 11.
Required
1. Set up a worksheet for the profitability ratios.
2. Compute these ratios for Doctors Smith and Brown. All the necessary information is present on the doctors’ statements.
[Hint: “Operating Income (Loss)” is also known as “Income from Operations.”]
Assignment Exercise 12–3: Profitability Ratios
Refer to the Metropolis Health System (MHS) case study appearing in Chapter 33.
Required
1. Set up a worksheet for the liquidity ratios.
2. Compute the profitability ratios using the Chapter 33 MHS financial statements.
CHAPTER 13
Example 13A: Unadjusted Rate of Return
Assumptions
• Average annual net income 5 $100,000
• Original investment amount 5 $1,000,000
• Unrecovered asset cost at the end of useful life (salvage value) 5 $100,000
Chapter 13 547
Calculation using original investment amount:
$100,000
$1,000,000 5 10% Unadjusted Rate of Return
Calculation using average investment amount:
Step 1: Compute average investment amount for total unrecovered asset cost.
At beginning of estimated useful life 5 $1,000,000
At end of estimated useful life 5 $ 100,000
Sum $1,100,000
Divided by 2 5 $550,000 average investment amount
Step 2: Calculate unadjusted rate of return.
$100,000
$550,000 5 18.2% Unadjusted Rate of Return
Practice Exercise 13–I: Unadjusted Rate of Return
Assumptions
• Average annual net income 5 $100,000
• Original investment amount 5 $500,000
• Unrecovered asset cost at the end of useful life (salvage value) 5 $50,000
Required
1. Compute the unadjusted rate of return using the original investment amount.
2. Compute the unadjusted rate of return using the average investment method.
Assignment Exercise 13–1: Unadjusted Rate of Return
Metropolis Health Systems’ Laboratory Director expects to purchase a new piece of equipment.
The assumptions for the transaction are as follows:
• Average annual net income 5 $70,000
• Original investment amount 5 $410,000
• Unrecovered asset cost at the end of useful life (salvage value) 5 $41,000
Required
1. Compute the unadjusted rate of return using the original investment amount.
2. Compute the unadjusted rate of return using the average investment method.
Example 13B: Finding the Future Value (with a Compound Interest Table)
Betty Dylan is Director of Nurses at Metropolis Health System. Her oldest son will be entering
college in five years. Today Betty is trying to figure what his college fund will amount to in five
548 Examples and Exercises, Supplemental Materials, and Solutions
more years. (Hint: Compound interest means interest is not only earned on the principal, but
also is earned on the previous interest earnings that have been left in the account. Interest is
thus compounded.)
The college fund savings account presently has a balance of $9,000 and any interest earned
over the next five years will be left in the account. Betty assumes the annual interest rate will
be 6%. How much money will be in the account at the end of five more years?
Solution to Example
Step 1. Refer to the Compound Interest Table appearing in Appendix 13-B at the back of
this chapter. Reading across, or horizontally, find the 6% column. Reading down, or
vertically, find Year 5. Trace across the Year 5 line item to the 6% column. The factor
is 1.338.
Step 2. Multiply the current savings account balance of $9,000 times the factor of 1.338
to find the future value of $12,042. In five years at compound interest of 6%, the
college fund will have a balance of $12,042.
Practice Exercise 13–II: Finding the Future Value (with a Compound Interest Table)
Assume the college savings fund in the preceding example presently has a balance of $11,000
and any interest earned will be left in the account. Assume the annual interest rate will
be 7%.
Required
Compute how much money will be in the account at the end of six more years. (Use the compound interest table appearing in Appendix 13-B.)
Assignment Exercise 13–2: Finding the Future Value (with a Compound
Interest Table)
John Whitten is one of the physicians on staff at Metropolis Health System. His practice is six
years old. He has set up an office savings account to accumulate the funds to replace equipment
in his practice. Today John is trying to figure what his equipment fund will amount to in four
more years.
The equipment fund savings account presently has a balance of $63,500 and any interest
earned over the next four years will be left in the account. John assumes the annual interest rate
will be 5%. How much money will be in the account at the end of four more years?
Required
Compute how much money will be in the account at the end of four more years. (Use the compound interest table appearing in Appendix 13-B.)
Example 13C: Finding the Present Value (with a Present-Value Table)
Betty Dylan is taking an adult education night course in personal finance at the community
college. The class is presently studying retirement planning. Each student is to estimate the
Chapter 13 549
amount of funds (in addition to pension plans and social security) they believe will be needed
at retirement. Then they are to make a retirement plan.
Betty has estimated she would need $100,000 fifteen years from now. In order to complete
her assignment, she needs to know the present value of the $100,000. Betty further assumes an
interest rate of 6%.
Solution to Example
Step 1. Refer to the Present-Value Table appearing in Appendix 13-A at the back of this chapter. Reading across, or horizontally, find the 6% column. Reading down, or vertically,
find Year 15. Trace across the Year 15 line item to the 6% column. The factor is 0.4173.
Step 2. Multiply $100,000 times the factor of 0.4173 to find the present value of $41,730.
Practice Exercise 13–III: Finding the Present Value (with a Present-Value Table)
Betty isn’t finished with her assignment. Now she wants to find the present value of $150,000
accumulated fifteen years from now. She further assumes a better interest rate of 7%.
Required
Compute the present value of $150,000 accumulated fifteen years from now. Assume an interest
rate of 7%. (Use the Present-Value Table appearing in Appendix 13-A at the back of this chapter.)
Assignment Exercise 13–3: Finding the Present Value (with a Present-Value Table)
Part 1—Dr. John Whitten is still figuring out his equipment fund. According to his calculations
he needs $250,000 to be accumulated six years from now. John is now trying to find the present
value of the $250,000. He continues to assume an interest rate of 5%.
Required
Compute the present value of $250,000 accumulated fifteen years from now. Assume an interest
rate of 5%. (Use the Present-Value Table appearing in Appendix 13-A at the back of this chapter.)
Part 2—John doesn’t like the answer he gets. What if he can raise the interest rate to 7%? How
much difference would that make?
Required
Compute the present value of $250,000 accumulated fifteen years from now assuming an interest rate of 7%. Compare the difference between this amount and the present value at 5%.
Example 13D: Internal Rate of Return
Review the chapter text to follow the steps set out to compute the internal rate of return.
Practice Exercise 13–IV: Internal Rate of Return
Metropolis Health System (MHS) is considering purchasing a tractor to mow the grounds.
It would cost $16,950 and have a 10-year useful life. It will have zero salvage value at the end of
550 Examples and Exercises, Supplemental Materials, and Solutions
10 years. The head of the MHS grounds crew estimates it would save $3,000 per year. He figures
this savings because just one of the present maintenance crew would be driving the tractor,
replacing the labor of several men now using small household-type lawn mowers. Compute the
internal rate of return for this proposed acquisition.
Assignment Exercise 13–4: Computing an Internal Rate of Return
Dr. Whitten has decided to purchase equipment that has a cost of $60,000 and will produce a
pretax net cash inflow of $30,000 per year over its estimated useful life of six years. The equipment will have no salvage value and will be depreciated by the straight-line method. The tax rate
is 50%. Determine Dr. Whitten’s approximate after-tax internal rate of return.
Example 13E: Payback Period
Review the chapter text and follow the Doctor Green detailed example of payback period
computation.
Practice Exercise 13–V: Payback
The MHS Chief Financial Officer is considering a request by the Emergency Room department
for purchase of new equipment. It will cost $500,000. There is no trade-in. Its useful life would
be 10 years. This type of machine is new to the department but it is estimated that it will result
in $84,000 annual revenue and operating costs would be one-quarter of that amount. The CFO
wants to find the payback period for this piece of equipment.
Assignment Exercise 13–5: Payback Period
The MHS Chief Financial Officer is considering alternate proposals for the hospital Radiology
department. The Director of Radiology has suggested purchasing one of two pieces of equipment. Machine A costs $15,000 and Machine B costs $12,000. Both machines are estimated to
reduce radiology operating costs by $5,000 per year.
Required
Which machine should be purchased? Make your payback calculations to provide the answer.
CHAPTER 14
Example 14A: Common Sizing
Common sizing converts numbers to percentages so that comparative analysis can be performed.
Reread the chapter text about common sizing and examine the percentages shown in Table 14–1.
Practice Exercise 14–I: Common Sizing
The worksheet below shows the assets of two hospitals.
Chapter 14 551
Required
Perform common sizing for the assets of the two hospitals.
Same Year for Both Hospitals
Hospital A Hospital B
Current Assets $ 2,000,000 $ 8,000,000
Property, Plant, & Equipment 7,500,000 30,000,000
Other Assets 500,000 2,000,000
Total Assets $10,000,000 $40,000,000
Assignment Exercise 14–1: Common Sizing
Refer to the Metropolis Health System (MHS) comparative financial statements appearing in
Appendix 33-A.
Required
Common size the MHS statement of revenue and expenses.
Example 14B: Trend Analysis
Trend analysis allows comparison of figures over time. Reread the chapter text about trend
analysis and examine the difference columns shown in Table 14–3.
Practice Exercise 14–II: Trend Analysis
The worksheet below shows the assets of Hospital A over two years.
Required
Perform trend analysis for the assets of Hospital A.
Hospital A
Year 1 Year 2
Current Assets $1,600,000 $ 2,000,000
Property, Plant, & Equipment 6,000,000 7,500,000
Other Assets 400,000 500,000
Total Assets $8,000,000 $10,000,000
Assignment Exercise 14–2: Trend Analysis
Refer to the Metropolis Health System (MHS) comparative financial statements appearing in
Appendix 33-A.
Required
Perform trend analysis on the MHS statement of revenue and expenses.
552 Examples and Exercises, Supplemental Materials, and Solutions
Practice Exercise 14–III: Contractual Allowance
Assumptions:
1. Your unit’s gross charges for the period to date amount to $200,000.
2. The uniform gross charge for each procedure in your unit is $100.
3. The unit receives revenue from four major payers. For purposes of this exercise, assume
the revenue volume from each represents 25% of the total. (The equal proportion is
unrealistic, but serves the purpose for this exercise.)
4. The following contractual payment arrangements are in effect for the current period.
The percentage of the gross charge that is currently paid by each payer is as follows:
Payer 1 = 90%
Payer 2 = 80%
Payer 3 = 70%
Payer 4 = 50%
Q: How many procedures has your unit recorded for the period to date?
Q: Of these, how many procedures are attributed to each payer?
Q: How much is the net revenue per procedure for each payer, and how much is the contractual allowance per procedure for each payer?
Assignment Exercise 14–3
As a follow-up to the previous Practice Exercise, new assumptions are as follows:
1. Your unit’s gross charges for the period to date amount to $200,000.
2. The uniform gross charge for each procedure in your unit is $100.
3. The unit receives revenue from four major payers. The number of procedures performed
for the period totals 2,000. Of that total, the number of procedures per payer (stated as a
percentage) is as follows:
Payer 1 = 30%
Payer 2 = 40%
Payer 3 = 20%
Payer 4 = 10%
4. The following contractual payment arrangements are in effect for the current period. The
percentage of the gross charge that is currently paid by each payer is as follows:
Payer 1 = 80% [Medicare]
Payer 2 = 70% [Commercial managed care plans]
Payer 3 = 50% [Medicaid]
Payer 4 = 90% [Self-pay]
Q: How many procedures are attributed to each payer?
Q: How much is the net revenue per procedure for each payer, and how much is the contractual allowance per procedure for each payer?
Chapter 14 553
Q: How much is the total net revenue for each payer, and how much is the total contractual
allowance for each payer?
Assignment Exercise 14–4.1: Forecast Capacity Levels
Review the information in Exhibit 14–1. The exhibit assumes three chairs and one 40-hour RN,
for a realistic capacity level of seven patients infused per day.
Required
Prepare another Infusion Center Capacity Level Forecast as follows:
Assume the same three infusion chairs, but add another nurse for either four or six hours
per day. How would this change the daily capacity level for number of patients infused per day?
Assignment Exercise 14–4.2
Required
Prepare another Infusion Center Capacity Level Forecast as follows:
Increase the number of infusion chairs to four, and add another nurse for either four or six
hours per day. How would this change the daily capacity level for number of patients infused
per day?
CHAPTER 15
Assignment Exercise 15–1: Comparable Data in a Graph
Review Figures 15–1 through 15–5. Each of the five figures presents a graph depicting some
type of comparative data.
Required
Locate healthcare information that can reasonably be compared. (1) Prepare your comparative data. (2) Using your data, create one or more graphs similar to those found in Figures 15–1
through 15–5.
Assignment Exercise 15–2: Cumulative Inflation Factor for Comparable Data
Review Table 15–3 and the accompanying text.
Assumptions
Two hospitals report their annual projected revenue for five years to the local newspaper for
a story on the area’s future economic outlook. However, Hospital 1 has applied a cumulative
inflation factor of 5% per year while Hospital 2 has not applied any inflation factor. Thus the
information is not properly comparable.
554 Examples and Exercises, Supplemental Materials, and Solutions
Projected Revenue
Year 1 Year 2 Year 3 Year 4 Year 5
Hospital 1 $20,000,000 $22,500,000 $27,500,000 $27,500,000 $30,000,000
Hospital 2 $20,000,000 $21,000,000 $25,000,000 $24,000,000 $26,000,000
Required
Revise Hospital 2’s projections by applying a cumulative inflation factor of 5% per year.
Assignment Exercise 15–3
The head of your department is a prominent researcher. A health research foundation has
asked him travel to London to give an important speech at a conference. He will then travel
to Paris to tour a research facility before returning home. Although his travel expenses are
being funded by the foundation, he will still need to take along some personal money. Consequently, he asks you to figure the exchange rates for $500 and for $1,000 in both pounds and
euros. He explains that he is trying to judge the spending power of U.S. dollars when converted to the other currencies so he can decide how much personal money to take on the trip.
Required
Locate the current exchange rates for pounds and euros and compute the currency conversion
for $500 and for $1,000.
Assignment Exercise 15–4: The Discovery
The Chief Financial Officer at Sample General Hospital has just discovered that the hospital’s
Chief of the Medical Staff’s son Jason, a student at the local community college, is paid $100 per
week year-round for grounds maintenance at the hospital’s Outpatient Center.
The CFO, no fan of the Chief of Medical Staff, now wants you to prepare a report that compares the relative costs of lawn care at each of three locations: the hospital itself, the outpatient
center, and the hospital-affiliated nursing home down the block.
Required
Review the available information for grounds maintenance at the three facilities. Decide how to
convert this information into comparable data. Then prepare a report, based on your assumptions, that presents comparable costs of grounds care. Also provide your assessment of what the
best future course of action should be.
Relevant Information
So far you have assembled the following information. Now you need to decide how it can be
converted into comparable data.
Chapter 15 555
Introduction to the Three Facilities
Sample General Hospital is an older 100-bed hospital. The new Outpatient Center, built last
year, is across the street and the Golden Age Nursing Facility is down one block, on the corner.
All three facilities are part of the Metropolis Health System. (The Case Study about Comparative Analysis Using Financial Ratios and Benchmarking appearing in Appendix 33-B contains
some financial details about Sample Hospital.) The hospital is located in the Midwestern sunbelt; there is occasional frost in the winter but no snow.
Grounds Maintenance Tasks That Should Be Performed at All Three Sites
• Mowing and edging
• Walk sweeping
• Raking leaves
• Blowing off parking lot
• Flower bed maintenance (where necessary)
• Hedge trimming and minor tree pruning (major tree trimming is performed by a contractor on an as-needed basis and thus should be disregarded)
Figure Ex–1 provides a map that illustrates the layout of the grounds for each facility and their
proximity to each other.
Figure Ex–1 Sample Hospital Map.
Parking
Entrance
Golden Age Center
Service
Jefferson Street
Washington Street
Jackson Street
7th Avenue
8th Avenue
9th Avenue
Outpatient
Parking
Sample Hospital
Parking
Trees
556 Examples and Exercises, Supplemental Materials, and Solutions
Grounds Maintenance Arrangements for the Three Facilities
The current grounds maintenance arrangements vary among the three facilities as follows:
1. Sample General Hospital uses its Maintenance department employees for grounds care.
The hospital pays these employees $15 per hour plus 15% employee benefits; it is estimated
they spend 1,000 hours per year on grounds maintenance work. Another estimated 120 hours
per year are spent on maintaining the lawn care equipment. The employees use a riding lawn
mower, edger, and blower, all owned by the hospital. The hospital just bought a new mower for
$2,995 less a 10% discount. It is expected that the mower should last for five years.
2. The hospital’s Chief of the Medical Staff’s son Jason, a student at the local community
college, is paid $100 per week year-round for grounds maintenance at the hospital’s Outpatient Center. A friend sometimes helps, but when that happens Jason pays him out of his
weekly $100. It takes about 1.5 hours to mow, edge, and blow. Jason uses his dad’s riding
mower and blower, but Jason recently bought his own edger. Jason also buys fertilizer for the
grass twice a year.
3. The Nursing Facility contracts with a landscape service on a seasonally adjusted sliding
scale. The landscape service is paid $600 per month from April to October (mowing season);
$400 per month for February, March, and November; and $200 per month for November,
December, and January. The landscape service provides all their own equipment. They also
provide fertilizer and provide annuals to plant in the flower beds every quarter.
Sample General Hospital Property Description
The grounds to be maintained are as follows:
• The front lawn is grass in two sections on either side of the front entrance. Each section is
about 50 feet by 60 feet.
• There is a hedge along the front of the building that is about 50 feet on either side of the
front entrance.
• There are two small matching flower beds on either side of the front entrance.
• Another strip of grass alongside of the building is 30 feet by 100 feet.
• A third small strip of grass about 5 feet by 25 feet is by the Emergency entrance.
• The walkway dimensions are as follows: about 50 feet of front walk; about 30 feet of staff
entrance walk, both of which are 5 feet wide.
• The Emergency Department’s paved patient drop-off area is about 25 feet by 30 feet.
• The parking lot surface is about 200 feet by 250 feet. Along one side are overhanging trees
that drop leaves and debris and are a constant sweeping problem. These are the only trees
on the hospital site.
Outpatient Center Property Description
The grounds to be maintained are as follows:
• There is a strip of grass at the front of the building that is 12 feet wide and 65 feet long,
split in the middle by a walkway 5 feet wide.
• There is a strip of grass at the back of the building between the building and the parking
lot that is 5 feet wide and 50 feet long
• All the rest of the property is paved.
Chapter 15 557
Nursing Center Property Description
Golden Age Nursing Center occupies one whole block. The grounds have many large trees.
Flower beds have been planted around the trees as well as along the front walk and entrance.
There are also two secured patio areas at the side of the building, screened by hedges, and each
has a small bed of annuals. Because of the unique design of the building, grounds maintenance
requires considerable handwork such as edging with a weed eater.
CHAPTER 16
Example 16A: Budgeting
A static budget is based on a single level of operations that is never adjusted. Therefore, the
static budgeted expense amounts will not change, even though actual volume does change during the year.
The computation of a static budget variance only requires one calculation, as follows:
Actual Static Budget Static Budget
Results
minus
Amount equals Variance
We can set up the example in the chapter text in this format as follows:
Use patient days as an example of level of volume, or output. Assume that the budget anticipated 40,000 patient days this year at an average of $600 revenue per day, or $2,400,000. Further
assume that expenses were budgeted at $560 per patient day, or $22,400,000. The budget would
look like this:
As Budgeted
Revenue $24,000,000
Expenses 22,400,000
Excess of Revenue over Expenses $1,600,000
Now assume that only 36,000, or 90%, of the patient days are going to actually be achieved
for the year. The average revenue of $600 per day will be achieved for these 36,000 days (thus
36,000 times $600 equals $21,600,000). Further assume that, despite the best efforts of the
Chief Financial Officer, the expenses will amount to $22,000,000. The actual results would look
like this:
Actual
Revenue $21,600,000
Expenses 22,000,000
Excess of Expenses over Revenue $ (400,000)
The budgeted revenue and expenses still reflect the original expectation of 40,000 patient
days; the budget report would look like this:
558 Examples and Exercises, Supplemental Materials, and Solutions
Actual Budget
Static Budget
Variance
Revenue $21,600,000 $24,000,000 $(2,400,000)
Expenses 22,000,000 22,400,000 (400,000)
Excess of Expenses over Revenue $ (400,000) $ 1,600,000 $(2,000,000)
(Note: The negative actual result of (400,000) combined with the positive budget expectation
of 1,600,000 amounts to the negative net variance of [(2,000,000].)
This example has shown a static budget, geared toward only one level of activity and remaining constant or static.
Practice Exercise 16–I: Budgeting
Budget assumptions for this exercise include both inpatient and outpatient revenue and
expense. Assumptions are as follows:
As to the initial budget:
• The budget anticipated 30,000 inpatient days this year at an average of $650 revenue
per day.
• Inpatient expenses were budgeted at $600 per patient day.
• The budget anticipated 10,000 outpatient visits this year at an average of $400 revenue per
visit.
• Outpatient expenses were budgeted at $380 per visit.
As to the actual results:
• Assume that only 27,000, or 90%, of the inpatient days are going to actually be achieved
for the year.
• The average revenue of $650 per day will be achieved for these 270,000 inpatient days.
• The outpatient visits will actually amount to 110%, or 11,000 for the year.
• The average revenue of $400 per visit will be achieved for these 11,000 visits.
• Further assume that, due to the heroic efforts of the Chief Financial Officer, the actual
inpatient expenses will amount to $11,600,000 and the actual outpatient expenses will
amount to $4,000,000.
Required
1. Set up three worksheets that follow the format of those in Example 16A. However, in each
of your worksheets make two lines for revenue; label one as Revenue—Inpatient and the
other Revenue—Outpatient. Add a Revenue Subtotal line. Likewise, make two lines for
expense; label one as Expense—Inpatient and the other Expense— Outpatient. Add an
Expense Subtotal line.
2. Using the new assumptions, complete the first worksheet for “As Budgeted.”
3. Using the new assumptions, complete the second worksheet for “Actual.”
4. Using the new assumptions, complete the third worksheet for “Static Budget Variance.”
Chapter 16 559
Assignment Exercise 16–1: Budgeting
Select an organization: either from the Case Studies appearing in Chapters 31, 32, 33, 33-A,
33-B or 33-C or from one of the Mini-Case Studies appearing in Chapters 34 and 35.
Required
1. Using the organization selected, create a budget for the next fiscal year. Set out the details
of all assumptions you needed in order to build this budget.
2. Use the “Checklist for Building a Budget” (Exhibit 16–2) and critique your own budget.
Assignment Exercise 16–2: Budgeting
Find an existing budget from a published source. Detail should be extensive enough to present
a challenge.
Required
1. Using the existing budget, create a new budget for the next fiscal year. Set out the details
of all the assumptions you needed in order to build this budget.
2. Use the “Checklist for Building a Budget” (Exhibit 16–2) and critique your own effort.
3. Use the “Checklist for Reviewing a Budget” (Exhibit 16–3) and critique the existing
budget.
Assignment Exercise 16–3: Transactions Outside the Operating Budget
Review Figure 16–2 and the accompanying text.
Metropolis Health System (MHS) has received a wellness grant from the charitable arm of an
area electronics company. The grant will run for 24 months, beginning at the first of the next fiscal year. Two therapists and two registered nurses will each be spending half of their time working on the wellness grant. All four individuals are full-time employees of MHS. The electronics
company has only recently begun to operate the charitable organization that awarded the grant.
While they have gained all the legal approvals necessary, they have not yet provided the manuals and instructions for grant transactions that MHS usually receives when grants are awarded.
Consequently, guidance about separate accounting is not yet forthcoming from the grantor.
Required
How would you handle this issue on the MHS operating budget for next year?
Assignment Exercise 16–4: Identified Versus Allocated Costs in Budgeting
Review Figure 16–3 and the accompanying text.
Metropolis Health System is preparing for a significant upgrade in both hardware and software for its information systems. As part of the project, the Chief of Information Operations
(CIO) has indicated that the Information Systems (IS) department can change the format of
the MHS operating budgets and related reports before the operating budget is constructed
for the coming fiscal year. The Chief Financial Officer (CFO) has long wanted to modify what
costs are identified and what costs are allocated (along with the method of allocation). This is
560 Examples and Exercises, Supplemental Materials, and Solutions
a golden opportunity to do so. To gain ammunition for the change, the CFO is preparing to
conduct a survey. The survey will obtain a variety of suggestions for potential changes in allocation methods for the new operating budget report formats. You have been selected as one of the
employees who will be surveyed.
Required
You may choose your role for this assignment, as follows:
Refer to the “MHS Executive-Level Organization Chart” (appearing as Figure 33–2 in the
MHS Case Study). (1) Either (a) choose any type of patient service that would be under the
direction of the Senior Vice President of Service Delivery Operations or (b) choose any other
function shown on the organization chart. (Your function could be a whole department or a
division or unit of that department. For example, you might choose Community Outreach or
Human Resources Operations or the Emergency department, etc.) (2) Make up your own organization chart for other employee levels within the function you have chosen. (3) Now make up
another chart that indicates the operating budget costs you think would be mostly identifiable
for the department or unit or division you have chosen and what other operating budget costs
you think would be mostly allocated to it. (You may use Figure 16–3 as a rough guide, but do not
let it limit your imagination. Model the detail on your “identifiable versus allocated costs” chart
after a real department if you so choose.) Use MHS hospital statistics appearing in Exhibit 33–8
of the MHS Case Study as a basis for allocation if these statistics are helpful. If they are not,
make a note of what other statistics you would like to have.
(Note: As an alternative approach, you may choose a function from the MHS “Nursing Practice and Administration Organization Chart” appearing in Figure 33–1 of the MHS Case Study
instead of choosing from the Executive-Level Organization Chart.)
CHAPTER 17
Example 17A: Description of Capital Expenditure Proposals Scoring System
Worthwhile Hospital has a total capital expenditure budget for next year of five million dollars. Of this amount, three million is already committed as spending for capital assets that have
already been acquired and are in place. The remaining two million dollars is available for new
assets and for new projects or programs.
Worthwhile Hospital typically divides the available capital expenditure funds into monies
available for inpatient purposes and monies available for outpatient purposes. This year the
split is proposed to be 50-50.
The hospital’s CFO is also proposing that a scoring system be used to evaluate this year’s
proposals. She has set up a scoring system that allows a maximum of five points. Thus the low is
a score of one point and the high is a score of five points.
In addition to the points earned by a funding proposal, the CFO will allow one “bonus point” for
upgrading existing equipment and one “bonus point” for funding expansion of existing programs.
Practice Exercise 17–I: Capital Expenditure Proposals
Jody Smith, the director who supervises the Intensive Care Units, wants to secure as much of the
one million dollars available for inpatient purposes as is possible for the ICU. At the same time
Chapter 17 561
Ted Jones, the director who supervises the Surgery Unit, also wants to secure as much of the one
million dollars available for inpatient purposes as is possible for his Surgery Unit.
Given the CFO’s new scoring system, how should Jody go about choosing exactly what to
request?
Assignment Exercise 17–1: Capital Expenditure Proposals
Ted Jones, the Surgery Unit Director, is about to choose his strategy for creating a capital expenditure funding proposal for the coming year. Ted’s unit needs more room. The Surgery Unit
is running at over 90% capacity. In addition, a prominent cardiology surgeon on staff at the
hospital wants to create a new cardiac surgery program that would require extensive funding
for more space and for new state-of-the-art equipment. The surgeon has been campaigning with
the hospital board members.
Required
What should Ted decide to ask for? How should he go about crafting a strategy to justify his
request, given the hospital’s new scoring system?
CHAPTER 18
Example 18A: Variance Analysis
Our variance analysis example and practice exercise use the flexible budget approach. A flexible budget is one that is created using budgeted revenue and/or budgeted cost amounts. A flexible budget is adjusted, or flexed, to the actual level of output achieved (or perhaps expected to
be achieved) during the budget period. A flexible budget thus looks toward a range of activity
or volume (versus only one level in the static budget).
Examples of how the variance analysis works are contained in Figure 18–1 (the elements),
in Figure 18–2 (the composition), and in Figures 18–3 and 18–4 (the calculations). Study these
examples before undertaking the Practice Exercise.
We have restated Exhibit 18–2 in a worksheet format for purposes of this example. The new
format appears as follows. (The numbers have not changed.)
Actual Cost $920,000
Less: Flexible Budget 990,000
Price Variance (favorable) $ 70,000
Budgeted Cost $937,500
Less: Flexible Budget 990,000
Quantity Variance (unfavorable) $(52,500)
Net Variance (favorable) $ 17,500
562 Examples and Exercises, Supplemental Materials, and Solutions
Assumptions (refer to Exhibit 18–2)
Overhead
Cost divided by
# Therapy Minutes
(Activity Level) equals
Cost per
Therapy Minute
Actual (1) $920,000 (3) 330,000 (5) $2.79
Budgeted (2) $937,500 (4) 312,500 (6) $3.00
Practice Exercise 18–1
Exhibit 18–2 presents the Variance Analysis for hospital rehab services for the third quarter. For
our practice exercise we will duplicate this report for the fourth quarter. We are able to reformat
the information in Exhibit 18–2 into a worksheet as follows. The fourth quarter assumptions
appear below the worksheet.
Actual Cost
Less: Flexible Budget
Price Variance (favorable)
Budgeted Cost
Less: Flexible Budget
Quantity Variance (unfavorable)
Net Variance (unfavorable)
Assumptions
Overhead
Cost divided by
# Therapy Minutes
(Activity Level) equals
Cost per
Therapy Minute
Actual (1) $950,000 (3) 350,000 (5) $2.71
Budgeted (2) $930,000 (4) 310,000 (6) $3.00
Required
1. Set up a worksheet for the fourth quarter like that shown in Exhibit 18–2 for the third quarter.
2. Insert the Fourth Quarter Input Data (per assumptions given above) on the worksheet.
3. Complete the “Actual Cost,” “Flexible Budget,” and “Budgeted Cost” sections at the top
of the worksheet.
4. Compute the Price Variance and the Quantity Variance in the middle of the worksheet.
5. Indicate whether the Price and the Quantity Variances are favorable or unfavorable for
the fourth quarter.
Optional
Can you compute how the $950,000 actual overhead costs and the $930,000 budgeted overhead
costs were calculated?
Chapter 18 563
Assignment Exercise 18–1: Variance Analysis
Greenview Hospital operated at 120% of normal capacity in two of its departments during the
year. It operated 120% times 20,000 normal capacity direct labor nursing hours in routine services and it operated 120% times 20,000 normal capacity equipment hours in the laboratory.
The lab allocates overhead by measuring minutes and hours the equipment is used; thus equipment hours.
Assumptions
For Routine Services Nursing:
• 20,000 hours 3 120% 5 24,000 direct labor nursing hours.
• Budgeted Overhead at 24,000 hours 5 $42,000 fixed plus $6,000 variable 5 $48,000 total.
• Actual Overhead at 24,000 hours 5 $42,000 fixed plus $7,000 variable 5 $49,000 total.
• Applied Overhead for 24,000 hours at $2.35 5 $56,400.
For Laboratory:
• 20,000 hours 3 120% 5 24,000 equipment hours.
• Budgeted Overhead at 24,000 hours 5 $59,600 fixed plus $11,400 variable 5 $71,000 total.
• Actual Overhead at 24,000 hours 5 $59,600 fixed plus $11,600 variable 5 $71,200 total.
• Applied Overhead for 24,000 hours at $3.455 5 $82,920.
Required
1. Set up a worksheet for applied overhead costs and volume variance with a column for
Routine Services Nursing and a second column for Laboratory.
2. Set up a worksheet for actual overhead costs and budget variance with a column for Routine Services Nursing and a second column for Laboratory.
3. Set up a worksheet for volume variance and budget variance totaling net variance with a
column for Routine Services Nursing and a second column for Laboratory.
4. Insert input data from the Assumptions.
5. Complete computations for all three worksheets.
Example 18B
Review the “Sensitivity Analysis Overview” section and Figure 18–5 in Chapter 18.
Assignment Exercise 18–2: Three-Level Revenue Forecast
Three eye-ear-nose-and-throat physicians decide to hire an experienced audiologist in order to
add a new service line to their practice.* They ask the practice manager to prepare a three-level
volume forecast as a first step in their decision making.
Assumptions: For the base level (most likely) revenue forecast, assume $200 per procedure
times 4 procedures per day times 5 days equals 20 procedures per week times 50 weeks per year
equals 1,000 potential procedures per year.
For the best-case revenue forecast, assume an increase in volume of one procedure per day
average, for an annual increase of 250 procedures (5 days per week times 50 weeks equals 250).
(The best case is if the practice gains a particular managed care contract.)
564 Examples and Exercises, Supplemental Materials, and Solutions
For the worst case revenue forecast, assume a decrease in volume of 2 procedures per day
average, for an annual decrease of 500 procedures. (The worst case is if the practice loses a
major payer.)
*Assume audiologists were designated as “eligible for physician and other prescriber incentives.” Thus the new service line was a logical move.
Required
Using the above assumptions, prepare a three-level forecast similar to the example in Figure 18–5
and document your calculations.
Practice Exercise 18–II
Closely study the chapter text concerning target operating income.
The necessary inputs for target operating income include the following:
• Desired (target) operating income amount 5 $20,000
• Unit price for sales 5 $500
• Variable cost per unit 5 $300
• Total fixed cost 5 $10,000
Compute the required revenue to achieve the target operating income and compute a contribution income statement to prove the totals.
Assignment Exercise 18–3: Target Operating Income
Acme Medical Supply Company desires a target operating income amount of $100,000, with
assumption inputs as follows:
• Desired (target) operating income amount 5 $100,000
• Unit price for sales 5 $80
• Variable cost per unit 5 $60
• Total fixed cost 5 $60,000
Compute the required revenue to achieve the target operating income and compute a contribution income statement to prove the totals.
CHAPTER 19
Assignment Exercise 19–1: Estimate of Loss
You are the practice manager for a four-physician office. You arrive on Monday morning to find
the entire office suite flooded from overhead sprinklers that malfunctioned over the weekend.
Water stands ankle-deep everywhere. The computers are fried and the contents of all the filing cabinets are soaked. Your own office, where most of the records were stored, has the worst
damage.
The practice carries valuable papers insurance coverage for an amount up to $250,000. It is
your responsibility to prepare an estimate of the financial loss so that a claim can be filed with
Chapter 19 565
the insurance company. How would you go about it? What would your summary of the losses
look like?
Assignment Exercise 19–2: Estimate of Replacement Cost
The landlord carries contents insurance that should cover the damage to the furnishings,
equipment, and to the computers, and the insurance company adjuster will come tomorrow
to assess the furnishings and equipment damage. However, your boss is sure that the insurance
settlement will not cover replacement costs. Consequently, you have been instructed to prepare
an estimate of what has been lost and/or damaged plus an estimate of what the replacement
cost might be. How would you go about it? What would your summary of these losses look like?
Assignment Exercise 19–3: Benchmarking
Review the chapter text about benchmarking.
Required
1. Select an organization: either from the Case Studies appearing in Chapters 31, 32, 33,
33-A, 33-B or 33-C or from one of the Mini-Case Studies appearing in Chapters 34 and35.
2. Prepare a list of measures that could be benchmarked for this organization. Comment on
why these items are important for benchmarking purposes.
3. Find another example of benchmarking for a healthcare organization. The example can
be an organization report or it can be taken from a published source such as a journal
article.
Assignment Exercise 19–4: Pareto Rule
Review the chapter text about the Pareto rule and examine Figure 19–4. Note that the text says
Pareto diagrams are often drawn to reflect before and after results.
Assume that Figure 19–4 is the before diagram for the Billing department. Further assume
that the after results are as follows:
Activity Activity Code Number
Process Denied Bills PDB 12
Review with Supervisor RWS 10
Locate Documentation LD 6
Copy Documentation CD 5
33
Required
1. Redo the Pareto diagram with the after results. (Use Figure 19–4 as a guide.)
2. Comment on the before and after results for the Billing department.
Assignment Exercise 19–5: Quartiles
Review the chapter text about quartiles and study Table 19–1, which indicates results in quartiles.
566 Examples and Exercises, Supplemental Materials, and Solutions
Required
1. Locate healthcare information (such as bed days, number of visits, payment amounts,
etc.) that contains a list of no less than twelve numerical amounts.
2. Divide the list you have found into quartiles.
3. Enter your results on a worksheet with the highest quartile first and the lowest quartile
last. Include an explanation of your computations.
CHAPTER 20
Assignment 20–1
Study the chapter text that discusses retrospective versus predictive data analytics.
Required
1. Locate an article that presents a healthcare study of some sort that has used data analytics.
2. Write a review of the article. Your review should identify whether retrospective or predictive analytics have been used to obtain the study results.
3. If you had designed this study, would you have used the same type of analysis? If so,
explain why. If not, explain why not.
Assignment 20–2
Review the chapter text about big data, especially the section about big data in the healthcare
industry.
Required
1. Find a healthcare organization’s description of how it, in its organization, utilizes big data.
2. Review their description of this usage: For what purpose? Who performs the actual analysis; can you tell if the analysis is done internally or externally? Are the results current? Are
the results useful in some way, and is that usefulness described?
3. If you were employed by this organization and you had been assigned to write this description, what would you do differently? Do you think you would use the data differently? If
so, describe how. If not, explain why not.
CHAPTER 21
Assignment Exercise 21–1
Review the information about public companies and stock exchanges in the Chapter 21 text.
Required
Obtain a copy of the Wall Street Journal. Locate the “Stock Tables” section of the Journal. Review
the column headings in the tables and locate the names of various stock exchanges that are
included in the findings. See if you can find the abbreviated names and the stock exchange
symbols for healthcare companies that are publicly held.
Chapter 21 567
Alternatively, explore the websites of three or four publicly held healthcare organizations.
Somewhere on the website they should identify their stock exchange symbol. Then go onto a
web-based stock exchange listing of the market for the day, locate the symbols, and determine
their current stock prices according to the listing.
Assignment 21–2
Review the chapter text about mean, median, and mode and refer to the illustration in Table 21–1.
Required
Locate an article that reports results expressed as the mean, the median, or the mode. Can you tell
why the particular method was used to report results? (For example, why was the mean used instead
of the median?) If so, describe your conclusions. Alternatively, locate a series of numbers such as
scores and find the mean, the median, and the mode. Illustrate them as is shown in Table 21–1.
CHAPTER 22
Example 22A: Loan Amortization
This example illustrates the initial monthly payments of a loan with a principal balance of
$50,000, an interest rate of 10%, and a payment period of 3 years or 36 months.
Loan Amortization Schedule
Principal borrowed: $50,000
Total payments: 36
Annual interest rate 10.00% (monthly rate = 0.8333%)
Payment
#
Total
Payment
Principal Portion
of Payment
Interest Expense
Portion of Payment
Remaining
Principal Balance
Beginning balance 5 $50,000.00
1 $1,613.36 $1,196.69 $416.67 $48,403.31
2 1,613.36 1,206.67 406.69 47,596.64
3 1,613.36 1,216.72 396.64 46,379.92
4 1,613.36 1,226.86 386.50 45,153.06
5 1,613.36 1,237.08 376.28 43,915.98
6 1,613.36 1,247.39 365.97 42,668.58
Practice Exercise 22–I: Loan Amortization
This exercise illustrates a different principal amount than Example 22A, but computed at the
same monthly interest rate and the same number of payments.
Required
Compute the first 6 months of a loan amortization schedule with a principal balance of $60,000,
an interest rate of 10%, and a payment period of 3 years or 36 months.
568 Examples and Exercises, Supplemental Materials, and Solutions
Loan Amortization Schedule
Principal borrowed: $60,000
Total payments: 36
Annual interest rate 10.00% (monthly rate = 0.8333%)
Payment
#
Total
Payment
Principal Portion
of Payment
Interest Expense
Portion of Payment
Remaining
Principal Balance
Beginning balance 5 $60,000.00
1
2
3
4
5
6
Assignment Exercise 22–1: Financial Statement Capital Structures
Required
Find three different financial statements that have varying capital structures. Write a paragraph
about each that explains the debt–equity relationship and that computes the percentage of
debt and the percentage of equity represented.
Also note whether the percentage of annual interest on debt is revealed in the notes to the
financial statements. If so, do you believe the interest rate is fair and equitable? Why?
CHAPTER 23
Practice Exercise 23–I: Cost of Leasing
A cost of leasing table is reproduced below.
Required
Using the appropriate table from the Time Value of Money Appendices appearing as 13-A, 13-B,
and 13-C, record the present-value factor at 6% for each year and compute the present-value
cost of leasing.
Cost of Leasing: Suburban Clinic—Comparative Present Value
Not-for-Profit Cost of Leasing: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Net Cash Flow (11,000) (11,000) (11,000) (11,000) (11,000) —-
Present-value factor (at 6%)
Present-value answer 5
Present-value cost of leasing 5
Chapter 23 569
Assignment Exercise 23–1: Cost of Owning and Cost of Leasing
Cost of owning and cost of leasing tables are reproduced below.
Required
Using the appropriate table from the Chapter 13 Time Value of Money Appendices appearing
as 13-A, 13-B, and 13-C, record the present-value factor at 10% for each year and compute the
present-value cost of owning and the present value of leasing. Which alternative is more desirable at this interest rate? Do you think your answer would change if the interest rate was 6%
instead of 10%?
Cost of Owning: Anywhere Clinic—Comparative Present Value
For-Profit Cost of Owning: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Net Cash Flow (48,750) 2,500 2,500 2,500 2,500 5,000
Present-value factor
Present-value answers 5
Present-value cost of owning 5
Cost of Leasing: Anywhere Clinic—Comparative Present Value
For-Profit Cost
Line of Leasing: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
19 Net Cash Flow (8,250) (8,250) (8,250) (8,250) (8,250) —-
20 Present-value factor
21 Present-value answers 5
22 Present-value cost of leasing 5
Assignment Exercise 23–2
Great Docs, a three-physician practice with two office sites, is considering whether to buy or
lease a new computer system. Currently they own a low-tech (and low-cost) information system. The new system will have to meet all government specifications for an electronic health
record system and will also have to connect the two office sites. It will be considerably more
sophisticated than the current hardware and software and thus will require training for office
staff, clinical staff, and the physicians. Everyone agrees there will be a learning curve in order to
reach the system’s full potential.
Doctor Smith, the majority owner of the practice, wants to buy a medical records system
from Sam’s Club. He argues that the package is supposed to electronically prescribe, track
billings, set appointments, and keep records, so it should meet their needs. The cost of the
first installed system is supposed to be $25,000, plus $10,000 for each additional system. The
doctors are not sure if this means $25,000 for one office site plus $10,000 for the (connected)
second office site for a total of $35,000, or if this means $25,000 for the first installed system
plus $10,000 each for three more doctors, for a total of $55,000. There is also supposed to be
$4,000 to $5,000 in maintenance costs each year as part of the purchased package. Doctor
Smith proposes to pay 20% down and obtain a five-year installment loan from the local bank
for the remaining 80% at an interest rate of 8%.
570 Examples and Exercises, Supplemental Materials, and Solutions
Doctor Jones, the youngest of the three physicians, has been recently added to the practice. A
computer nerd, he wants to lease a complete system from the small company his college roommate began last year. While he has received a quote of $20,000 for the entire system including
first year maintenance, it does not meet the government requirements for an electronic health
record system. Consequently, the other two doctors have outvoted Doctor Jones and this system
will not be seriously considered.
Doctor Brown, the usual peace-maker between Doctor Smith and Doctor Jones, wants to
lease a system. He argues that leasing will place the responsibility for upgrades and maintenance upon the lessor company, and that removing the responsibilities of ownership is
advantageous. He has received a quote of $20,000 per year for a five-year lease that includes
hardware and software for both offices, that meets the government requirements for an electronic health record system, and that includes training, maintenance, and upgrades.
Required
Summarize the costs to the practice of owning a system (per Doctor Smith) versus leasing (per
Doctor Brown). Include a computation of comparative present value. (Refer to Assignment 23–1
for setting up a comparative present-value table.)
Assignment Exercise 23–3
Metropolis Health System has to do something about their ambulance situation. They have to
(1) buy a new ambulance, (2) lease a new one, or (3) renovate an existing ambulance that MHS
already owns. Rob Lackey, the Assistant Controller, has been asked to gather pertinent information in order to make a decision. So far Rob has found these facts:
1. It will cost at least $250,000 to purchase a new ambulance, although the cost varies widely
depending upon the quantity and sophistication of the emergency equipment contained
on the vehicle.
2. In order to renovate the existing vehicle, it will cost at least $100,000 to purchase and
install a new “box.” (In other words, a new emergency-equipped body is installed on the
existing chassis.) Rob has found this existing ambulance has an odometer reading of
80,000 miles. The vehicle will also need a new fuel pump and new tires, but he believes
these items would be recorded as repair and maintenance operating expenses and thus
would not be included in his calculations.
3. Lease terms for ambulances also vary widely, but so far Rob believes a cost of $60,000 per
year is a ballpark figure.
Required
How much more information should Rob have before he begins to make any calculations?
Make a list. Which alternative do you believe would be best? Give your reasons.
CHAPTER 24
Assignment Exercise 24–1
This group project assignment concerns situational analysis.
Chapter 24 571
Create a hypothetical organization, complete with an IT department and financial, clinical,
and administrative staff levels. This IT department is tasked with adopting and implementing
EHR.
Required
Step 1. Using your hypothetical organization’s personnel, assign a variety of scores to a Scoring Summary Sheet such as that shown in Exhibit 24–A-1 appearing in the chapter
Appendix 24-A.
Step 2. Summarize the scores and place the net scores in a SWOT matrix such as the one
shown in Figure 24–6.
Step 3. Create a report to the organization’s CEO that summarizes the (good or bad)
results.
Optional Additional Assignment
Required
Locate several healthcare organizations’ mission, value, and vision statements. Use public
sources with no privacy concerns.
Then fit the statements you have discovered into the chapter’s categories of recognizing a
special status or focus within the statements; financial emphasis within the statements; and/or
relaying the message.
CHAPTER 25
Example 25A: Assumptions
Types of assumptions required for the financial portion of a business plan typically include
answers to the following questions:
• What types of revenue?
• How many services will be offered to produce the revenue (by month)?
• How much labor will be required (FTEs)?
• What will the labor cost?
• How many and what type of supplies, drugs, and/or devices will be required to offer the
service?
• What will the supplies, drugs, and/or devices cost?
• How much space will be required?
• What will the required space occupancy cost?
• Is special equipment required?
• If so, how much will it cost?
• Is staff training required to use the special equipment?
• If so, how much time is required, and what will it cost?
Practice Exercise 25–I: Assumptions
Refer to the Case Study proposal to add a retail pharmacy appearing in Chapter 33–C.
572 Examples and Exercises, Supplemental Materials, and Solutions
Required
Identify how many of the assumption items listed in the example above can be found in the
retail pharmacy proposal worksheets.
Assignment Exercise 25–1: Business Plan
Refer to the Case Study proposal to add a retail pharmacy appearing in Chapter 33–C.
Required
Build a business plan for this proposal. Prepare the service description using your consumer
knowledge of a retail pharmacy (if necessary). Of course this retail pharmacy will be located
within the hospital, but its purpose is to dispense prescriptions to carry off-site and use at home.
Thus, it operates pretty much like the neighborhood retail pharmacy that you use yourself.
Use the information provided in the MHS Case Study appearing in Chapter 33 to prepare
the financial section of the business plan. Use your imagination to create the marketing segment and the organization segment.
CHAPTER 26
Assignment Exercise 26–1
Review the chapter text that defines a health delivery system.
Required
1. First, define a geographic area for healthcare delivery purposes. If you live in a city, it
could be your metropolitan area. If you live in a more rural area, it could be an area of so
many square miles.
2. Next, using the definition of a health delivery system within the chapter, list all the health
delivery systems that presently exist within the geographic area defined above. Make a
chart that shows the services and care settings that each system provides.
3. Research how many mergers or other types of consolidation have occurred within the
past five years that have affected the systems on your list. Have any facilities closed in your
geographic area within past five years? Are there rumors about possible future mergers?
4. Do you see a pattern of strategic plans and/or strategic thinking within your geographic
area’s health delivery system relationships? If so, please describe. If not, what are your
reasons for so believing?
Assignment Exercise 26–2
Study the chapter text concerning stakeholders in health delivery systems.
Required
1. Review the section about internal and external stakeholders and choose one example to
study. (Internal stakeholders deliver care, support the care deliverers, or receive the care,
while Figure 26–1 lists 12 different types of external stakeholders.)
Chapter 26 573
2. Research your chosen example. Write a report about what part your chosen entity plays
within the system. What strategic relationships can you identify for your research subject?
Can you make a map of those relationships?
3. How much strategic power do you think your chosen example has within the overall
internal and external players within a system? Do you think that power is increasing or
decreasing? Explain why within your report.
CHAPTER 27
Assignment Exercise 27–1
Review the chapter text about value-based financial outcomes, including examples.
Required
This assignment may be a group project. If so, divide the groups into two or more teams; each
team should choose a different example to report.
1. Choose one value-based financial outcomes example from the text, such as the documented positive financial outcomes of Intermountain Health or the investment dollars
required by Duke and Kaiser Permanente.
2. Find a similar type of value-based financial outcome as reported by some other healthcare entity. Research both information about the outcome and information about the
entity that is reporting this financial outcome.
3. Write a report about the findings of your research. Present your report to the class and
hold a Q&A session afterward.
Alternative Assignment Exercise 27–1
Review the chapter text about value-based digital outcomes, including examples.
Required
This assignment may also be a group project. If so, divide the groups into two or more teams;
each team to choose a different example to report.
1. Choose one value-based digital outcomes example from the text, such as how digital outcomes would benefit a particular organization (the example in the text was a physician
practice), or what value-based digital outcomes might be reported by a large healthcare
system (the examples in the text were Duke and Kaiser Permanente).
2. Find a similar type of value-based digital outcome as reported by some other healthcare
entity. Research both information about the outcome and information about the entity
that is reporting this digital outcome.
3. Write a report about the findings of your research. Present your report to the class and
hold a Q&A session afterward.
Assignment Exercise 27–2
Review the chapter text about value-based strategic planning.
574 Examples and Exercises, Supplemental Materials, and Solutions
Required
1. Find information about value-based strategic planning by either a private-sector or
public-sector healthcare organization.
2. See if you can determine the focus of this organization’s value-based strategic planning.
(The chapter text recognized long-term goals, patient-centered views, and a populationhealth focus; there are others as well.) Describe this focus in as much depth as is possible.
3. Do you believe this organization’s focus is appropriate for value-based planning? If so,
why? Or is it too broad, too narrow, or deficient in some other manner? If so, why?
CHAPTER 28
Assignment Exercise 28–1
Review the chapter text about physician incentives under MACRA within the chapter text. See also
the maximum incentive payments an eligible professional can receive under MIPS (Figure 28–5).
Also review those professionals who are included and excluded, per Exhibits 28–1 and 28–2.
Required
1. Locate additional information about electronic systems (or add-ons) that are being sold
to physicians based on implementation of MACRA/MIPS requirements. Attempt to
determine what the net cost of hardware, software, and installation would be for an average physician practice. Compare this cost with the payment adjustments that an eligible
physician would receive over a five-year period. Determine the approximate net technology cost to the physician after such incentive payments.
2. Also determine the cost to the physician practice if the practice does not comply and is
penalized through a negative payment adjustment over a five-year period. Compare this
negative payment adjustment against the approximate net technology cost to the physician if implementation were to occur.
3. As an extension of this assignment, you might also determine what start-up costs, other
than the technology costs, may be incurred by the physician.
Assignment Exercise 28–2
Review the entire chapter text.
Required
Assume you are an employee of a health delivery system. You are assigned to write a training
plan about MACRA, MIPS, and APMs. Training content is to be at three different levels (basic,
intermediate, advanced), depending upon who is receiving the training.
1. Decide which employees should receive which level of training, and create a list.
2. Decide what essential subjects should be included and create a basic training list.
3. Determine what additional detail should be included at the intermediate level and create
an intermediate training list.
4. Determine what extra detail should be included at the advanced level and create an
advanced training list.
Chapter 28 575
5. Determine who should serve as trainers for the different levels and create a list.
6. Assemble your lists into a draft training plan.
CHAPTER 29
Assignment Exercise 29–1
This assignment may be a group project.
Review the chapter text about standardized data and interoperability.
Assumptions
First choose one type of care setting: either a skilled nursing facility (SNF) or a home health
agency (HHA). Assume that, in the near future, this hypothetical SNF or HHA must (1) make
the necessary changes to forms, processes, and scheduling in order to implement standardized data, and (2) invest in additional electronics that are necessary to implement cross-setting
interoperability. Not all details about required changes are available at this point in time. Nevertheless, a task force has been assembled to begin planning for the transition and to produce
a draft implementation plan. You are part of the task force.
Required
1. List the organization’s departments that will be directly affected by the transition and
those that will be indirectly affected.
2. List the actions that the task force believes are essential for a successful transition.
3. Is your hypothetical SNF or HHA part of a larger health delivery system? If so, designate
responsibility for each of these actions; will the individual SNF or HHA be responsible or
will the system’s home office take responsibility?
4. What types of financial costs will be required? Can the task force predict whether such
costs will occur over time or all at once? Is there an example, such as EHR implementation, that would provide a model for this issue?
5. Produce an outline of essential subjects to be covered in the task force’s draft implementation plan.
Assignment Exercise 29–2
Review the chapter text about public reporting requirements.
Required
1. Locate the Nursing Home Compare website as described in the chapter.
2. Review how the 5-Star Rating System composite scale works.
3. Pull up the website and locate nursing homes that are in your region. How many are
listed? Review the 5-Star scores for the facilities in your region. Is there a big difference
among the scores? Describe your region’s overall scores.
4. All SNFs that accept Medicare should be represented on the website. Do you know of a
facility in your area that is not on the list? If so, can you tell why that may be?
5. Would you find the website and the 5-Star system helpful in choosing a facility for a family
member? If so, why? If not, why not?
576 Examples and Exercises, Supplemental Materials, and Solutions
CHAPTER 30
Practice Exercise 30–I
The Productivity Loss section of this chapter describes how the dollar amount of such loss
was computed after determining that it took coders an extra 1.7 minutes per claim in the first
month of ICD-10 transition.
Assume a hospital’s coders are dealing with 1,500 claims within a certain period. What would
the dollar amount of productivity loss be if the coders took an extra two minutes (instead of 1.7
minutes) per claim?
Assignment Exercise 30–1: Information About the ICD-10-CM and ICD-10-PCS
Implementation.
Required
Locate some articles and/or government websites that describe the ICD-10-CM diagnosis codes
and the ICD-10-PCS procedure codes and tools for their implementation over a period of years.
Write a summary of whether the materials you have found fully explain the bradth and depth of
the challenge for managers who must live through the implementation.
Assignment Exercise 30–2: Hospital Conversion to ICD-10
Try to locate sufficient detail about a healthcare organization – enough that you can perform
a make-believe SWOT analysis about a conversion of electronic systems to ICD-10 as required.
Write a description of theorganization’s background, including its information system. (Add
imaginary details if you need to.) This description will then lead into the ICD-10 implementation’s situation analysis. Perform the make-believe SWOT analysis using the four-part format
(internal Strengths and Weaknesses and external Opportunities and Threats).
As an alternative approach, you can use information from the Case Study about Sample General Hospital appearing in Appendix 33-B as your starting point. Use your personal experience
and observations to fill out the rest of the details you would need in order to commence a makebelieve SWOT analysis for this hospital’s ICD-10 implementation.
Assignment Exercise 30–3: Hospital Costs To Implement
Refer to the Scenario For A Midwestern Community Hospital, appearing in Appendix 30–A.
Required
Part 1—Within this scenario the productivity loss for the six-month learning period is calculated to be $1,233. Beginning with month 1 at $353 ($1.41 times 250 equals $353), compute the
cost of productivity loss for the remaining five months as explained in the scenario, to total an
overall amount of $1,233. Be prepared to show and explain your computations.
Part 2—Later in the scenario, CMS states that the hospital’s total cost amounts to $303,990.
Study the explanation and summarize the totals of each type of cost discussed. When you are
finished, your total should amount to $303,990. Be prepared to show and explain how you
arrived at this total.
Chapter 30 577
SUPPLEMENTARY MATERIALS: THE MECHANICS OF PERCENTAGE
COMPUTATIONS
The Reason for This Explanation: Author’s Note
I had just finished presenting a day-long finance seminar when the vice president of a bank who
had been attending pulled me aside. After looking around to make sure no one was listening,
he asked me to show him how to calculate a percentage.
As I didn’t know him or anyone from the town he lived and worked in, he wasn’t embarrassed
to ask me. So we believe if the vice president of a bank can ask about how to figure a percentage,
then that calculation deserves to be described within this Appendix, as follows.
The Fraction’s Parts: Numerator and Denominator
Reminder: A fraction has two parts—the numerator is the top number and the denominator is
the bottom number. Or, to be more precise, the numerator is the part of a fraction that is above
the line and signifies the number of parts of the denominator taken.
The denominator is the part of a fraction that is below the line and signifies division and that
in fractions with 1 as the numerator indicates into how many parts the unit is divided.
First Calculate the Fraction (Including the Decimal)
To calculate a fraction, the bottom number (denominator) is divided into the top number
(numerator). For example, if the numerator is 90 and the denominator is 100, divide 100
into 90. The resulting answer is 0.90. (Note that the decimal point is to the left of the 0.90
answer.)
Next Convert the Fraction to a Percentage
To obtain the percentage, we need to convert the fraction. To do so, move the decimal two
places to the right. Now the answer is 90, and the percentage answer is 90%.
Summary
We know that your computer or tablet will perform this computation automatically, but situations may still arise when you may need to calculate by hand. It’s a good thing to know.
SOLUTIONS TO PRACTICE EXERCISES
Solution to Practice Exercise 4–I
Short-term assets: cash on hand; accounts receivable; inventory
Long-term assets: land; buildings
Short-term liabilities: payroll taxes due; accounts payable
Long-term liabilities: mortgage payable (noncurrent); note payable (due in 24 months)
578 Examples and Exercises, Supplemental Materials, and Solutions
Solution to Practice Exercise 6–I
Intensive Care Unit Laboratory Laundry
Drugs requisitioned X
Pathology supplies X
Detergents and bleach X
Nursing salaries X
Clerical salaries X X X
Uniforms (for laundry aides) X
Repairs (parts for microscopes) X
Note: If no clerical salaries are assigned to Laundry, this is an acceptable alternative solution.
SOLUTION TO PRACTICE EXERCISE 7–I
Direct Cost Indirect Cost
Managed care marketing expense X
Real estate taxes X
Liability insurance X
Clinic telephone expense X
Utilities (for the entire facility) X
Emergency room medical supplies X
SOLUTION TO PRACTICE EXERCISE 7–II
In real life the solution to this exercise will depend upon factors unique to the particular organization. The following solution is a generic one.
Responsibility Center Support Center
Security X
Communications X
Ambulance services X
Medical records X
Educational resources X
Human resources X
Reporting: Each responsibility center has a manager. All report to the director.
SOLUTION TO PRACTICE EXERCISE 8–I
Step 1. Find the highest volume of 1,100 packs at a cost of $7,150 in September and the lowest volume of 100 packs at a cost of $1,010 in August.
Step 2. Compute the variable rate per pack as:
# of Packs Training Pack Cost
Highest volume 1,100 $7,150
Lowest volume 100 1,010
Difference 1,000 $6,140
Solution to Practice Exercise 8–I 579
Step 3. Divide the difference in cost ($6,140) by the difference in # of packs (1,000) to arrive at the variable cost rate:
$6,140 divided by 1,000 packs equals $6.14 per pack
Step 4. Compute the fixed overhead rate as follows:
At the highest level:
Total cost $7,150
Less: Variable portion
[1,100 packs 3 $6.14] (6,754)
Fixed Portion of Cost $ 396
At the lowest level:
Total cost $1,010
Less: Variable portion
[100 packs 3 $6.14] (614)
Fixed Portion of Cost $ 396
Proof totals: $396 fixed portion at both levels.
SOLUTION TO PRACTICE EXERCISE 8–II
Step 1. Divide costs into variable and fixed portions. In this case $3,450,000 times 40% equals
$1,380,000 variable cost and $3,450,000 times 60% equals $2,070,000 fixed cost.
Step 2. Compute the contribution margin:
Amount
Revenue $3,500,000
Less variable cost (1,380,000)
Contribution margin $2,120,000
Less fixed cost 2,070,000
Operating income $ 50,000
SOLUTION TO PRACTICE EXERCISE 8–III
Amount %
Revenue $1,210,000 100.00
Less variable cost (205,000) 16.94
Contribution margin $1,005,000 83.06 5 PV or CM Ratio
Less fixed cost (1,100,000) 90.91
Operating loss $(95,000) 7.85
SOLUTION TO PRACTICE EXERCISE 9–I
1. Straight-line depreciation would amount to $54,000 per year for 10 years. This amount is
computed as follows:
580 Examples and Exercises, Supplemental Materials, and Solutions
Step 1. Compute the cost net of salvage or trade-in value: 600,000 less 10% salvage value
or 60,000 equals 540,000.
Step 2. Divide the resulting figure by the expected life (also known as estimated useful
life): 540,000 divided by 10 equals 54,000 depreciation per year for 10 years.
2. Double-declining depreciation is computed as follows:
Step 1. Compute the straight-line rate: 1 divided by 10 equals 10%.
Step 2. Now double the rate (as in “double-declining method”): 10% times 2 equals 20%.
Step 3. Compute the first year’s depreciation expense: 600,000 times 20% = 120,000.
Step 4. Compute the carry-forward book value at the beginning of the second year:
600,000 book value beginning year 1 less year 1 depreciation of 120,000 equals
book value at beginning of the second year of 480,000.
Step 5. Compute the second year’s depreciation expense: 480,000 times 20% = 96,000.
Step 6. Compute the carry-forward book value at the beginning of the third year: 480,000
book value beginning year 2 less year 2 depreciation of 96,000 equals book value
at beginning of the third year of 384,000.
Continue until the asset’s salvage or trade-in value has been reached.
Book Value at
Beginning of Year Depreciation Expense Book Value at End of Year
600,000 600,000 3 20% 5 120,000 600,000 2 120,000 5 480,000
480,000 480,000 3 20% 5 96,000 480,000 2 96,000 5 384,000
384,000 384,000 3 20% 5 76,800 384,000 2 76,800 5 307,200
307,200 307,200 3 20% 5 61,440 307,200 2 61,440 5 245,760
245,760 245,760 3 20% 5 49,152 245,760 2 49,152 5 196,608
196,608 196,608 3 20% 5 39,322 196,608 2 39,322 5 157,286
157,286 157,286 3 20% 5 31,457 157,286 2 31,457 5 125,829
125,829 125,829 3 20% 5 25,166 125,829 2 25,166 5 100,663
100,663 100,663 3 20% 5 20,132 100,663 2 20,132 5 80,531
80,531 80,561 at 10th year 80,561 2 20,561 5 60,000
Balance remaining at end of 10th year represents the salvage or trade-in value.
Note: Under the double-declining balance method, book value never reaches zero.
Therefore, a company typically adopts the straight-line method at the point where
straight line would exceed the double-declining balance.
SOLUTION TO PRACTICE EXERCISE 9–II
Straight-line depreciation would amount to $9,000 per year for five years. This amount is computed as follows:
Step 1. Compute the cost of salvage or trade-in value: 50,000 less 10% salvage value or 5,000
equals 45,000.
Step 2. Divide the resulting figure by the expected life (also known as the estimated useful
life): 45,000 divided by 5 equals 9,000 depreciation per year for 5 years.
Solution to Practice Exercise 9–II 581
SOLUTION TO PRACTICE EXERCISE 10–I
1. Compute Net Paid Days Worked
Total days in business year 364
Less two days off per week 104
# Paid days per year 260
Less paid days not worked
Holidays 8
Sick days 5
Education day 1
Vacation days 5
19
Net paid days worked 241
2. Convert Net Paid Days Worked to a Factor
Total days in business year divided by net paid days worked equals factor
364/241 5 1.510373
SOLUTION TO PRACTICE EXERCISE 10–II
24-Hour
Shift 1 Shift 2 Shift 3 5 Scheduling
Day Evening Night Total
Position: Admissions officer 2 1 1 four 8-hour shifts
FTEs—to cover position
7 days/week equals 2.8 1.4 1.4 5.6 FTEs
Position: Clerical 1 0 0 one 8-hour shift
FTEs—to cover position
7 days/week equals 1.4 0 0 1.4 FTEs
SOLUTION TO PRACTICE EXERCISE 11–I
Current Liabilities 30,000
Total Assets 1,000,000
Income from Operations 80,000
Accumulated Depreciation 480,000
Total Operating Revenue 180,000
Current Portion of Long-Term Debt 10,000
Interest Income -0-
Inventories 5,000
SOLUTION TO PRACTICE EXERCISE 11–II
No, Doctors Smith and Brown’s patient accounts receivable does not appear to be net of an
allowance for bad debts, because we cannot find an equivalent bad debt expense on their
582 Examples and Exercises, Supplemental Materials, and Solutions
statement of net income. Do you think the doctors should have an allowance for bad debts on
their statement? Why do you think they do not?
SOLUTION TO PRACTICE EXERCISE 11–III
As mentioned in the chapter text, land is not stated at “net” because land is never depreciated.
SOLUTION TO PRACTICE EXERCISE 12–I
Current Ratio
The current ratio is represented as Current Ratio equals Current Assets divided by Current
Liabilities. This ratio is considered to be a measure of short-term debt-paying ability. However,
it must be carefully interpreted.
Current Ratio Computation
Current Assets 5 $70,000 5 2.33 to 1
Current Liabilities $30,000
Quick Ratio
The quick ratio is represented as Quick Ratio equals Cash and Short-Term Investments plus Net
Receivables, divided by Current Liabilities. This ratio is considered to be an even more severe
test of short-term debt-paying ability (even more severe than the current ratio). The quick ratio
is also known as the acid-test ratio, for obvious reasons.
Cash and Short-Term Investments 1 Net Receivables 5
$65,000 5 2.167 to 1
Current Liabilities 30,000
SOLUTION TO PRACTICE EXERCISE 12–II
Solvency Ratios
Debt Service Coverage Ratio (DSCR)
The Debt Service Coverage Ratio (DSCR) is represented as change in unrestricted net assets
(net income) plus interest, depreciation, and amortization, divided by maximum annual debt
service. This ratio is universally used in credit analysis.
Change in Unrestricted Net Assets (net income)
plus Interest, Depreciation, Amortization 5 $113,100 5 5.1
Maximum Annual Debt Service $22,200
Note: $80,000 1 $3,100 1 $30,000 5 $113,100.
Solution to Practice Exercise 12–II 583
Liabilities to Fund Balance (or Debt to Net Worth)
The liabilities to fund balance or net worth computation is represented as total liabilities divided
by unrestricted net assets (fund balances or net worth) equals total debt divided by tangible net
worth. This figure is a quick indicator of debt load.
Total Liabilities 5 $200,000 5 2.5
Unrestricted (Fund Balance) $800,000
SOLUTION TO PRACTICE EXERCISE 12–III
Profitability Ratios
Operating Margin
The operating margin, which is generally expressed as a percentage, is represented as operating
income (loss) divided by total operating revenues. This ratio is used for a number of managerial
purposes and also sometimes enters into credit analysis. It is therefore a multi-purpose measure.
Operating Income (Loss) 5 $80,000 5 44.4%
Total Operating Revenues $180,000
Return on Total Assets
The return on total assets is represented as earnings before interest and taxes (EBIT) divided by
total assets. This is a broad measure in common use.
EBIT (Earnings before Interest and Taxes) 5 $83,100 5 8.3%
Total Assets $1,000,000
Note: $80,000 1 $3,100 5 $83,100.
SOLUTION TO PRACTICE EXERCISE 13–I: UNADJUSTED RATE OF RETURN
1. Calculation using original investment amount:
$100,000
$500,000
5 20% Unadjusted Rate of Return
2. Calculation using average investment amount:
Step 1. Compute average investment amount for total unrecovered asset cost:
At beginning of estimated useful life 5 $500,000
At end of estimated useful life 5 $ 50,000
Sum $550,000
Divided by 2 5 $275,000 average investment amount
Step 2. Calculate unadjusted rate of return:
$100,000
$275,000
5 36.4% Unadjusted Rate of Return
584 Examples and Exercises, Supplemental Materials, and Solutions
SOLUTION TO PRACTICE EXERCISE 13–II: FINDING THE FUTURE VALUE
(WITH A COMPOUND INTEREST TABLE)
Step 1. Refer to the Compound Interest Table found in Appendix 13–B at the back of this
chapter. Reading across, or horizontally, find the 7% column. Reading down, or vertically, find Year 6. Trace across the Year 6 line item to the 7% column. The factor is
1.501.
Step 2. Multiply the current savings account balance of $11,000 times the factor of 1.501 to
find the future value of $16,511. In six years at compound interest of 7%, the college
fund will have a balance of $16,511.
SOLUTION TO PRACTICE EXERCISE 13–III: FINDING THE PRESENT VALUE
Step 1. Refer to the Present-Value Table appearing in Appendix 13–A at the back of this
chapter. Reading across, or horizontally, find the 7% column. Reading down, or vertically, find Year 15. Trace across the Year 15 line item to the 7% column. The factor
is 0.3624.
Step 2. Multiply $150,000 times the factor of 0.3624 to find the present value of $54,360.
SOLUTION TO PRACTICE EXERCISE 13–IV
Assemble the assumptions in an orderly manner:
Assumption 1: Initial cost of the investment = $16,950.
Assumption 2: Estimated annual net cash inflow the investment will generate = $3,000.
Assumption 3: Useful life of the asset = 10 years.
Perform calculation:
Step 1. Divide the initial cost of the investment ($16,950) by the estimated annual net
cash inflow it will generate ($3,000). The answer is a ratio amounting to 5.650.
Step 2. Now use the abbreviated look-up table for the Present Value of an Annuity of $1
appearing in Appendix 13–C. Find the line item for the number of periods that
matches the useful life of the asset (10 years in this case).
Step 3. Look across the 10-year line on the table and find the column that approximates
the ratio of 5.650 (as computed in Step 1). That column contains the interest rate
representing the rate of return. In this case the rate of return is 12%.
SOLUTION TO PRACTICE EXERCISE 13–V
Assemble assumptions in an orderly manner:
Assumption 1: Purchase price of the equipment = $500,000.
Assumption 2: Useful life of the equipment = 10 years.
Assumption 3: Revenue the machine will generate per year = $84,000.
Assumption 4: Direct operating costs associated with earning the revenue = $21,000.
Assumption 5: Depreciation expense per year (computed as purchase price per assumption
1 divided by useful life per assumption 2) = $50,000.
Solution to Practice Exercise 13–V 585
Perform computation:
Step 1. Find the machine’s expected net income after taxes:
Revenue (Assumption 3) $84,000
Less
Direct operating costs (Assumption 4) $21,000
Depreciation (Assumption 5) 50,000
71,000
Net income $13,000
Note: No income taxes for this hospital.
Step 2. Find the net annual cash inflow the machine is expected to generate (in other
words, convert the net income to a cash basis).
Net income $13,000
Add back depreciation (a noncash expenditure) 50,000
Annual net cash inflow after taxes $63,000
Step 3. Compute the payback period:
Investment 5 $500,000 Machine Cost* 5 7.9 Year Payback Period Net Annual Cash Inflow $63,000**
*Assumption 1 above.
**Per Step 2 above.
The machine will pay back its investment under these assumptions in 7.9 years.
SOLUTION TO PRACTICE EXERCISE 14–I
Common sizing for the assets of the two hospitals appears on the worksheet below. Note that
their gross numbers are very different, yet the proportionate relationships of the percentages
(20%, 75%, and 5%) are the same for both hospitals.
Same Year for Both Hospitals
Hospital A Hospital B
Current assets $ 2,000,000 20% $ 8,000,000 20%
Property, plant, and equipment 7,500,000 75% 30,000,000 75%
Other assets 500,000 5% 2,000,000 5%
Total assets $10,000,000 100% $40,000,000 100%
SOLUTION TO PRACTICE EXERCISE 14–II
Hospital A
Year 1 Year 2 Difference
Current assets $1,600,000 $ 2,000,000 $ 400,000 25%
Property, plant, and equipment 6,000,000 7,500,000 1,500,000 25%
Other assets 400,000 500,000 100,000 25%
Total assets $8,000,000 $10,000,000 $2,000,000 —
586 Examples and Exercises, Supplemental Materials, and Solutions
Note: The worksheet below shows Hospital A with both common sizing and trend analysis:
Hospital A
Year 1 Year 2 Difference
Current assets $1,600,000 20% $ 2,000,000 20% $ 400,000 25%
Property, plant, and equipment 6,000,000 75% 7,500,000 75% 1,500,000 25%
Other assets 400,000 5% 500,000 5% 100,000 25%
Total assets $8,000,000 100% $10,000,000 100% $2,000,000 —
SOLUTION TO PRACTICE EXERCISE 14–III
Q: How many procedures has your unit recorded for the period to date?
Solution: The unit has recorded 2,000 procedures ($200,000 divided by $100 apiece equals
2,000 procedures).
Q: Of these, how many procedures are attributed to each payer?
Solution: At 25% of the volume per payer, each payer accounts for 500 procedures (2,000
times 25% equals 500 procedures). Proof total: 500 procedures apiece times four payers
equals 2,000 procedures.
Q: How much is the net revenue per procedure for each payer, and how much is the contractual allowance per procedure for each payer?
Solution: The computation is as follows:
Payer # Gross Charges
% Paid by
Each Payer
Net Revenue
per Procedure
Contractual Allowance
per Procedure
1 $100.00 90% $90.00 $10.00
2 $100.00 80% $80.00 $20.00
3 $100.00 70% $70.00 $30.00
4 $100.00 50% $50.00 $50.00
SOLUTION TO PRACTICE EXERCISE 16–I
Your initial budget assumptions were as follows:
Assume the budget anticipated 30,000 inpatient days this year at an average of $650 revenue
per day, or $19,500,000. Further assume that inpatient expenses were budgeted at $600 per
patient day, or $18,000,000. Also assume the budget anticipated 10,000 outpatient visits this year
at an average of $400 revenue per visit, or $4,000,000. Further assume that outpatient expenses
were budgeted at $380 per visit, or $3,800,000. The budget worksheet would look like this:
As Budgeted
Revenue—Inpatient $19,500,000
Revenue—Outpatient 4,000,000
Subtotal $23,500,000
Expenses—Inpatient $18,000,000
Expenses—Outpatient 3,800,000
Subtotal $21,800,000
Excess of revenue over expenses $1,700,000
Solution to Practice Exercise 16–I 587
Now assume that only 27,000, or 90%, of the patient days are going to actually be achieved
for the year. The average revenue of $650 per day will be achieved for these 27,000 days (thus
27,000 times 650 equals 17,550,000). Also assume that outpatient visits will actually amount to
110%, or 11,000 for the year. The average revenue of $400 per visit will be achieved for these
11,000 visits (thus 11,000 times 400 equals 4,400,000). Further assume that, due to the heroic
efforts of the Chief Financial Officer, the actual inpatient expenses will amount to $11,600,000
and the actual outpatient expenses will amount to $4,000,000. The actual results would look
like this:
Actual
Revenue—Inpatient $17,550,000
Revenue—Outpatient 4,400,000
Subtotal $21,950,000
Expenses—Inpatient 16,100,000
Expenses—Outpatient 4,000,000
Subtotal $20,100,000
Excess of revenue over expenses $1,850,000
Since the budgeted revenues and expenses still reflect the original expectations of 30,000
inpatient days and 10,000 outpatient visits, the budget report would look like this:
Static Budget
Actual Budget Variance
Revenue—Inpatient $17,550,000 $19,500,000 $(1,950,000)
Revenue—Outpatient 4,400,000 4,000,000 400,000
Subtotal $21,950,000 $23,500,000 $(1,550,000)
Expenses—Inpatient $16,100,000 $18,000,000 $(1,900,000)
Expenses—Outpatient 4,000,000 3,800,000 200,000
Subtotal $20,100,000 $21,800,000 $(1,700,000)
Excess of revenue over
expenses $ 1,850,000 $ 1,700,000 $ 150,000
Note: The negative effect of the $1,550,000 net drop in revenue is offset by the greater effect of
the $1,700,000 net drop in expenses, resulting in a positive net effect of $150,000.
SOLUTION TO PRACTICE EXERCISE 17–I
Because there is no one right answer, students will approach this exercise in different ways.
SOLUTION TO PRACTICE EXERCISE 18–1
Required Solution to Practice Exercise 18–1
The Price Variance is $100,000 (favorable).
The Quantity Variance is $120,000 (unfavorable).
The Net Variance is $20,000 (unfavorable).
588 Examples and Exercises, Supplemental Materials, and Solutions
Actual Cost $950,000
Less: Flexible Budget 1,050,000
Price Variance (favorable) $100,000
Budgeted Cost $930,000
Less: Flexible Budget 1,050,000
Quantity Variance (unfavorable) 2$120,000
Net Variance (favorable) 2$ 20,000
Assumptions
Overhead
Cost divided by
# Therapy Minutes
(Activity Level) equals
Cost per
Therapy Minute
Actual (1) $950,000 (3) 350,000 (5) $2.71
Budgeted (2) $930,000 (4) 310,000 (6) $3.00
Optional Solution to Practice Exercise 18–I
The $950,000 actual overhead cost represents 350,000 therapy minutes times $2.71 per therapy
minute.
The $930,000 budgeted overhead cost represents 310,000 therapy minutes times $3.00 per
therapy minute.
SOLUTION TO PRACTICE EXERCISE 18–II
The required revenue to achieve a target operating income of $20,000 amounts to revenue of
$75,000.
The contribution income statement to prove the formula results is as follows:
Revenue $500/unit 3 150 units 5 $75,000
Variable costs $300/unit 3 150 units 5 45,000 _______
Contribution margin $30,000
Fixed costs 10,000 _______
Desire (Target) Operating Income 5 $20,000
SOLUTION TO PRACTICE EXERCISE 22–I
With beginning principal of $60,000, the monthly payment is $1,936.03 and the remaining principal balance at the end of six payments is $51,202.30.
Solution to Practice Exercise 22–I 589
SOLUTION TO PRACTICE EXERCISE 23–I
The present-value cost of leasing for Suburban Clinic amounts to $49,116.
SOLUTION TO PRACTICE EXERCISE 25–I
The retail pharmacy case study appearing in Chapter 33-C contains all of the assumption items
listed in Example 25A.
SOLUTION TO PRACTICE EXERCISE 26–I
$50 per hour divided by 60 minutes equals $0.8333; thus 2 minutes equals $1.6667. If a hospital’s coders are dealing with 1,500 claims, then the dollar amount of productivity loss is $2,499
(1.6667 per claim times 1,500 claims equals $2,499).
590 Examples and Exercises, Supplemental Materials, and Solutions
© LFor/Shutterstock
adoption
CMS recommendations for ICD-10
developmental steps, 439–440
strategic steps, 439
costs, ICD-10, 424, 428
ADS. See Alternative Depreciation System
Advance Payment ACO model, 391
Advanced Alternative Payment Models (APMs),
397
Accountable Care Organizations, 390–391
eligible professionals for, 376–378, 377f
four bundled payment models, 391–392
“Intermediate Option,” 379
Measure Development Plan for, 383, 384f
Other Payer, 376
participation standards for, 380–381
patient-centered medical homes, 391
pay-for-performance incentives, 362–363
payment adjustments and timelines, 379
as proposed for Year 1, 375–376, 376f
scoring standard for, 381–382
significant participation in, 380
Advanced APMs. See Advanced Alternative
Payment Models
Advancing Care Information (ACI), 369, 374
action-based measures, 401, 402f
percentage-based measures, 401–403, 402f
system-based measures, 401, 402f
The Aetna Way, 279
AHA. See American Hospital Association
algorithm, 251
allocated costs, identified vs., 179, 179f
Alternative Depreciation System (ADS), 92
Alternative Payment Models (APMs), 340
A
accelerated book depreciation methods, 90–91
account number, 15–17
Accountable Care Organizations (ACOs), 26,
327, 390–391, 449
accountant’s method, 135
accounting rate of return, 199, 206
accounting system, 11
accounting, types of, 7
accounts
chart of, 14–17
groupings of, 15
accounts payable, 35, 48
accounts receivable, 34, 39
accrual basis accounting, 123
ACI. See Advancing Care Information
acid-test ratio, 129
ACOs. See Accountable Care Organizations
action plan, strategic planning, 274f, 275
process flow for creating, 281–283, 281f,
283f
action-based measurement, of ACI, 401 402f
actual expenses, 164
administrative claims, 374
admissions
analyzing referral activity, 505
areas to automate, 504
assessing, 503
case studies, 468, 503–506
communications, 504–505
fax and document management, 504
referral tracking and approval, 505
saving time with automated, 505–506
Note: Page numbers followed with f and t refer to figures and tables.
Index
591
592 Index
baseline period, 254
BEA. See Bureau of Economic Analysis
behavioral health, 27, 44
benchmarking, 227–229
case study, 483–487
big data, 233, 253
in healthcare industry, 234–235
revolution, 238
billing department, 230f
board of trustees, 460
bond sinking fund, 481
bonds, 246–247, 258
bonds payable, 35
book depreciation, methods of computing, 90
book values, 34, 88–92
books and records, 17–18
borrowing, 258
BPCI Initiative. See Bundled Payments for Care
Improvement Initiative
break-even analysis, 65–78
break-even points, 76
contribution margin method, 221–222
BRM. See Business Reference Model
budgeted expenses, 163, 164f
budgets
assumptions and computations, 181–183,
181f, 182f, 182t
building, preparation
construction elements, 180–181
construction stages, 180
capital expenditure, 177, 197–203
checklists, 184, 186, 196
construction summary, 186
construction tools, 198–200
finalize and implement, 183
flexible, 184–186, 185t, 186t
forecasts and, 152
information sources, 181, 181f
inputs, 200
managerial accounting and, 7
objectives for, 177
operating, 177, 180–183, 181f, 182f, 182t
reviewing, 179–180, 179f, 186–187, 196
static, 183–184, 184t
viewpoints, 178, 178f
transactions outside operating budget,
178, 178f
building revenue forecast assumptions,
154–155
buildings, 34
Alternative Post-Acute Care Payment Model,
408–409, 409f
AMA. See American Medical Association
ambulance service center (ASC), 56–58, 58f
direct costs, 56–57, 56f, 56t–57t
indirect costs, 56–57, 56f, 56t–57t
ambulatory care information system, 12, 12f, 13
American Hospital Association (AHA), 177
American Medical Association (AMA), 279
American Stock Exchange (AMEX), 249
AMEX. See American Stock Exchange
amortization
expense, 259
schedules, 258, 259t
angioplasty codes, 428
annual management cycle, 18–20
annual year-end reports, 19–20
daily operating reports, 19
quarterly reports and statistics, 19
weekly operating reports, 19
annual year-end reports, 19–20
annuity, present value, 136
APMs. See Alternative Payment Models
arithmetic, 250
ASC. See ambulance service center
assets
on balance sheets, 119–120
capital, 197
description of, 33
examples, 34
fixed, and depreciation expense, 88
lease-purchase agreements, 263–264
long-term, 34, 120
short-term, 34
useful life of, 88
assisted-living services, 41
assumptions, forecasts and, 153
authority, lines of, 6, 48–49, 156, 156f
B
“back of the envelope” calculation, 226
bad debts, 39
Bain, Alexander, 503
balance sheet, 113–114
case study, 461–462
checklist for review of, 125
projections, in business plans, 313
bar chart, 254
base year, 254
Index 593
care settings
expense grouping by, 50–51
grouping by, 42
case mix adjustments, 227
case studies
admissions, 468, 503–506
balance sheets, 461–462
benchmarking, 483–487
financial ratios, 483–487
Hospital Statistical Data, 468, 484–487
market studies, 489–494
metropolis health system, 453–469
pharmacy addition, 489–494
resource misallocation, 497–502
Schedule of Operating Expenses, 467, 476
Schedule of Patient Revenue, 466, 475
Schedule of Property, Plant, and Equipment,
465, 474
solvency ratios, 485, 487
statement of revenue and expense, 463, 473
technology in healthcare, 503–506
cash
as asset, 34
concept, 123
cash basis accounting, 119
cash equivalents, 245–246
cash flow
analysis, 198
annual net cash inflow, 137–138
budgeting and, 199
concept, 198–199
cumulative, 198–199
discounted, 137
monthly detail and assumptions, 493
owning vs. leasing equipment, 265–266, 265t
payback methods, 199
reporting methods, 199
for retail pharmacies, 489–494
statement of, 123, 124
types of proposals, 201–202
cash flow disruption costs, 425
cash flow statement, 463
projections, 312
cause-and-effect relationship, 321–323
CCRC. See continuing care retirement
community
CDs. See certificates of deposit
CEC Model. See Comprehensive End Stage
Renal Disease Care Model
Center for Value-Based Care Research, 334
Bundled Payments for Care Improvement
(BPCI) Initiative, 391–392
burden approach, 104
Bureau of Economic Analysis (BEA), 250
business loans, 257–260
capital structure, 257
costs of financing, 258–259
real estate financing, 259–260
sources of capital, 257–258
business plans, 309–315
assembly of, 314
cash flow assumptions, 493
elements of, 309
executive summaries, 314
financial analysis segment, 311–313
formats, 314
“knowledgeable reader” approach,
313–314
marketing segment, 311
monthly income statements, 489, 492
organization segment, 310
planning stage, 310
presentation, 315
strategic aspects of, 315
Business Reference Model (BRM), 290
buy-or-lease management decisions, 264–268,
265t
net cash flow effects, 265, 265t
present value, 266–268, 267t–268t
C
California-Based Integrated Healthcare
Association (IHA), 341–344
California-based Kaiser Permanente, 238, 347
capacity issues, staffing and, 158
capital
asset acquisition, 201
definition, 257
sources of, 257–258
capital asset, 123
capital expenditure
budgets, 177, 197–203
evaluating proposals, 202–203
inputs, 200
spending plan, 197
Capital Stock, 35
capital structures, 257
capitalized asset, 197
capitation, 325
594 Index
coders
and ICD-10 training, 429
training costs, 429
coinsurance, 41
collaborative efforts, 238
column chart, 254
column table. See column chart
combat prescription drug fraud, 237
commercial insurers, 41
common costs, 55
common sizing, 149–150, 150t, 164, 165f
Common Sizing, Expense Information, 164
Common Sizing Liability Information, 164, 165f
common stock, 248
communication
in admissions, 504–505
financial information, 20
lines of, 7
community health programs, 460
company ownership, 245
comparability requirements
consistency, 161
comparative analysis, 149, 151, 186–187,
483–487
comparative budget review, 162–163
comparative data, 161–173
annualizing expenses, 167–168, 169t
charts, 171–173, 171f–173f
comparing to industry standards, 167, 168f
currency measures, 169–170
inflation factors, 162, 168–169, 170t
manager’s view of, 162–163
requirement, 161–162
standardized measures, 170–171
uses of, 163–167
competitors, 228
composite performance score (CPS), of MIPS,
367–368
compound interest, 136
Comprehensive End Stage Renal Disease Care
(CEC) Model, 375
Comprehensive Health Planning and Services
Act (CHP), 112–113
computing tax depreciation, 92–93
CON. See Certificate-of-Need
continuing care retirement community
(CCRC), 43
contracts, types of, 41
contractual allowances, 38–39, 39t
assumptions, 154–155
Centers for Medicare and Medicaid Services
(CMS), 373, 407, 422
“Compare” websites, 344–345
Medicare Learning Network (MLN), 338
procedural timelines, 384
quality reporting programs, 342
quality strategy, 383
quality strategy goals, 351–354, 353t
value-based programs, 335–336
Certificate-of-Need (CON), 112–113, 454
Comprehensive Health Planning and
Services Act (CHP), 112–113
health planning, 112
Hill–Burton Act, 112
program, 113
staffing, 113
certificates of deposit (CDs), 246
certified EHR technology, 381
CFO. See chief financial officer
Changes in Fund Balance, 465
charity care, 479
charity services, 39
chart of accounts, 14–17
Chart of Accounts for Hospitals (Seawell), 15
chart templates, 172
charts, types of, 171–172, 171f, 172f
Chicago Stock Exchange, 249
chief executive officer, 48
chief financial officer (CFO), 163, 168, 257,
483, 489
Children’s Health Insurance Program (CHIP),
363
CHIP. See Children’s Health Insurance Program
CHP. See Comprehensive Health Planning and
Services Act
Chronic Obstructive Pulmonary Disease
(COPD), 190
clinic balance sheet, 120, 121
clinical data, 238
Clinical Practice Improvement Activities
(CPIA), 364, 369–370, 374
clinical viewpoint, 4
closing costs, 259
cloud-based systems, 25
CMS. See Centers for Medicare and Medicaid
Services
code users
and ICD-10 training, 429
training costs, 430
coder productivity, 434
Index 595
CPIA. See Clinical Practice Improvement
Activities
CPT. See Current Procedural Terminology codes
credit losses, 39
cross-setting, Improving Medicare Post-Acute
Care Transformation Act, 410
cumulative cash flow, 198–199
currency measures, 169
current budget, current expenses to, 163–164,
165f
current liabilities, 120
Current Procedural Terminology (CPT) codes,
50
current ratio, 129, 131f
CVP ratio. See cost-volume-profit
D
daily operating reports, 13, 19
Dartmouth Institute for Health Policy and
Clinical Practice (TDI), 337
data, 253
data analytics
basic approaches, 235–236
predictive analytics approach, 235
retrospective analytics approach, 235
subset of predictive analytics, 235–236
big data, 233
data volume measures, 234
and health care analytics, 236–237
healthcare analytics, 233
healthcare industry, 234–235
data entry, 253
data mining, 237–238, 253
data processing, 253
data repository, 12
data set, 253
data sharing, 25
data standardization, 253
data volume measures, 234
database, 253
days cash on hand (DCOH), 129, 131f
days receivable, 130, 131f
DCOH. See days cash on hand
DDB method. See double-declining balance
method
debentures, 248
debt service coverage ratio (DSCR), 130, 133f
debt service reserve fund, 482
debt-equity relationships, 257
contribution income statement, and
contribution margins, 219
contribution margin method, 73
break-even point using, 221–222
contribution and income statement, 219
target operating income using,
219–220
controllable costs, 156, 156f
controllable vs. noncontrollable expenses, 156,
156f
controller’s office, 55
controlling, purpose of, 5
convertible preferred stock, 248
COPD. See Chronic Obstructive Pulmonary
Disease
corporate acquisition, 238
cost centers, 48–50
cost object, 55–56, 56f, 60
cost/benefit considerations, 223–224
cost/benefit of robot, 87
costs
behavior, 65–78
case study, 489–494
classification, 55–61, 73
definition, 47
direct and indirect, 55, 56f
expired, 47, 54
of financing, 258–259
fixed, 65–69
ICD-10 training and lost productivity costs,
428
of lost productivity, 430
of owning vs. leasing equipment, 266–268,
267t–268t
performance category. See resource use,
performance category
period, 59–61, 60f
product, 59–61, 60f
rent, 65
reports, 52–53, 53t
responsibility centers, 57–59, 58f
of sales, 59
semifixed, 65–69
semivariable, 65–69
staffing and, 107–108
of training, 429–430
unexpired, 47, 54
variable, 65–69
costs of goods sold, 82–83
cost-volume-profit (CVP) ratio, 73–74
596 Index
directing, purpose of, 5
disbursements for services, 48
discharges, case study, 468
discounted cash flow, 137
discounted fees for services, 38, 45
disease management, 44
document management, 504
donations, 41, 258
Double-Declining Balance (DDB)
method, 91
doubtful accounts, 39
DRGs. See diagnosis-related groups
DSCR. See debt service coverage ratio
Duke Medicine, 280–281
Duke MyChart, 348
Duke University Health System, unified EHR
adoption, 347–348
E
earnings, time pattern of, 137
economic measures, 229
EDI. See electronic data information
efficiency, specialization and, 3
efficiency variance, 211
EHRs. See electronic health records
electronic data information (EDI), 12–13
electronic health records (EHRs), 25–27, 322,
339–340, 348–349, 410
adoption
and implementation, 293, 299–308
incentive programs, 390
Meaningful Use of. See Advancing Care
Information
electronic inventory program, 224
electronic management, 504
electronic media, 25
electronic medical record (EMR), 25
electronic records, standardized input and,
170–171
electronic reports, forecasting, 153
electronic templates, 172
electronic transmission standards, 349
eligible professionals (EPs), 339–340, 348
for Advanced Alternative Payment Models,
378–380, 380t
for MIPS, 365–366
emergency services, 44
employee welfare cost centers, 49
EMR. See electronic medical record
debts, 39
as liabilities, 35
long-term, 120, 258, 481–482
long-term, 481–482
short-term, 258
uncollectible, 38, 39t
decentralization, 7
decile, 253
decimal, 253
decision making
about business loans, 260
budgeting and, 199
lines of authority and, 6
managers’ responsibilities, 285–286
purpose of, 5
deductibles, 41
deflation, 250
denominator, 253
Department of Health and Human Services
(HHS), 287
Department of Veterans Affairs (VA), 40, 287
office of IT strategic planning cycle, 287–288
depreciation
of assets, 34
assumptions, 264
book value of fixed asset and reserve for,
88–92
computing tax depreciation, 92–93
expenses, 123, 264–265, 265t
interrelationship of expense and reserve for,
89
methods of computing book, 90–92
overview, 88
diagnoses
expense grouping by, 49–50, 52t
hospital department codes by, 52
technology issues and problems, 426
diagnosis-related groups (DRGs)
budget uses in, 189–190
expense grouping by, 50
flexible budgets, 184, 184t, 189
hospital department codes by, 51–52
digital interoperability, post-acute care, 407, 411
digital media, 24
“digitizing” health care, 338
direct care staff, 455
direct costs, 56–57, 56t–57t
definition, 55
examples, 56–57, 56f, 56t–57t
rehab cost center examples, 56t
Index 597
F
“Facts + Figures” report, 344
FASB. See Financial Accounting Standards Board
FDIC. See Federal Deposit Insurance
Corporation
Federal Agency for Healthcare Research and
Quality, 454
Federal Department of Housing and Urban
Development, 453
Federal Deposit Insurance Corporation (FDIC),
246, 247
federal governmental agencies, 285
federal government’s planning, 285
federally qualified health centers (FQHCs), 391
feedback, 373–374
feedback, purpose of, 5
fees for services, 38, 40, 41
field of mathematics
vs. discipline of statistics, 250–251
FIFO inventory method. See First-In, First-Out
inventory method
financial accounting, 7
Financial Accounting Standards Board (FASB),
120
financial benchmarking, 228–229, 228t
financial emphasis, within statements, 278–279
financial forecast, 295
financial information, communication, 20
financial lease, 263–264
financial management systems
annual management cycle, 18–20
communicating financial information, 20
concept, 4
elements of, 5
in healthcare business, 4
history, 3
information flow, 12–14
system elements, 14–18
viewpoints, 4–5, 5f
financial planning, 453, 454, 455f
financial projection for strategic planning,
294–296, 295f
financial ratios, 483–487
financial responsibility, healthcare foundation,
278
financial risk standards, for Advanced APMs, 380
financial statements, MHS, 461–463, 477–482
financial viewpoint, 4
financially indigent patients, 39
End-Stage Renal Disease (ESRD) Quality
Initiative Program, 337
engaged patient, 23–24
EPs. See eligible professionals
equipment
acquisition, 201, 314
as asset, 34
budgeting and, 199
costs, 313
descriptions, 310
funding requests, 200–202
leasing, 263–264
financial lease, 263–264
operating lease, 264
owning vs., 263–268
purchasing, 263
replacing, 201
upgrading, 201
equity
definition, 35
revenues and, 47
e-record standards, version 5010 of standards,
423
e-referrals, 504
ESRD Quality Initiative Program. See
End-Stage Renal Disease Quality
Initiative Program
estimates, use of, 223–224
excessive inflation, 249
executive-level judgment, 153
Executive-Level Organization Chart, 469f
expansions, 198
expenses (outflow), 47–53
annualizing, 167–168, 169t
budgeted, 180
comparative analysis, 149, 151
definition, 47–48
depreciation, 264–265, 265t
general and administrative (G&A), 58–59, 58f
general services, 49–50, 54
grouping, 48–52, 52t
noncontrollable, 156, 156f
operating, 120, 122
operations, 48–49, 54
for retail pharmacies, 489–494
statement of, 120, 122
support services, 49
trend analysis, 150–151, 150t
expired costs, 47, 54
external coding, 436
598 Index
fund balance, 47
on balance sheets, 119–120
statement of changes, 122–123
fund designator, 16–17
Fundamentals of Value-Based Health Care, TDI
Certificate in, 337–338
funding requests, 200–202
G
G&A. See general and administrative expenses
GAAP. See generally accepted accounting principles
Garmin, 24
GDP. See gross domestic product
GDS. See General Depreciation System
Geisinger Health System, 334
general and administrative (G&A) expenses,
58–59, 58f
General Depreciation System (GDS), 92
general ledger, 17–18
general obligation bonds, 247
General Purpose Simulation System, 499
general services expenses, 49, 54, 168
generally accepted accounting principles
(GAAP), 120
goals, strategic planning, 274–275, 274f,
281–284, 290–291
Good Samaritan Society, 280
goods sold, inventory and costs of, 82–83
government
revenue sources, 39–40
securities, 246
Government Performance and Results Act
(GPRA) of 1993, 285
government support, in healthcare spending,
325–326, 326f
governmental vs. nongovernmental, 275
GPRA Modernization Act of 2010, 286
GPRA of 1993. See Government Performance
and Results Act of 1993
graphs, scatter, 77–78
gross domestic product (GDP), 250, 325, 362
gross margin, 83, 490–492
gross revenue, 38
H
HAC Program. See Hospital Acquired Conditions Program
health care, system works in, 11–12
financing, costs of, 258–259
First-In, First-Out (FIFO) inventory method, 83
fiscal year, 19
fixed assets, 88
net book value of, 89–90
fixed costs, 65–69
budgeting, 179, 179f
examples of, 69
operating room, 69–71
views of, 67f
vs. variable costs, 179, 179f
fixed expense, 217
fixed-rate dividend payment, 248
flexible budget variance analysis, for an infusion
center, 216, 217t
flexible budgets, 184–186, 185t–186t, 216–217
flowsheets
for address confirmation, 13f
function of, 13–14
for verification of patient information, 14f
food cost, 65
forecasts
in business plans, 311
capacity level issues in, 158–159
equipment acquisition, 314
importance of, 152–153
operating revenue, 153–155
staffing, 156–158, 156f–157f
use of, 153–154, 154f, 155f
vs. projections, 153
foreign currency measures, 169
for-profit company
Tenet Healthcare Corporation, 276
vs. not-for-profit organization, 275
for-profit organizations
net cash flow, 264–265, 265t
net worth terminology, 35
present value, 267, 267t
revenue retention, 258
four coder productivity indicators, 431–432
four external error indicators, 432
FQHCs. See federally qualified health centers
fraction, 253
“freight in,” 82
frequency distribution, 252
full-time equivalent (FTE), 69, 103, 106, 312
annualizing positions, 103–106
calculation of, 106–108
scheduled-position method, 106–107
Fund Balance, 36
Index 599
High Value Healthcare Collaborative,
335
high–low method, 70–73
Hill–Burton Act, 112
HMOs. See health maintenance organizations
home care systems, 14, 43, 44f
Home health agencies (HHAs), 409
Home Health Compare website, 345
Home Health Value-Based Program (HHVBP),
337
home health visit scenario, 456t
horizontal analysis, 150–151, 152t
Hospital Acquired Conditions (HAC) Program,
336
Hospital Compare website, 345
hospital departmental code, 51–52
hospital insurance (HI), 39
Hospital Readmission Reduction (HRR)
Program, 336
hospital rehab services variance analysis,
214–215
Hospital Statistical Data, 468, 484–487
Hospital Survey and Construction Act of 1946.
See Hill–Burton Act
Hospital Taxing-District Status, 277
Hospital Value-Based Purchasing (HVBP)
Program, 336
hospital’s clinical research example, of data
mining, 237
hospital’s patient safety research example, of
data mining, 237
hourly base rates, staff, 107
Housing and Urban Development (HUD)
subsidized independent housing,
43
HRR Program. See Hospital Readmission
Reduction Program
HSAs. See health systems agencies
HUD. See Housing and Urban
Development
HVBP Program. See Hospital Value-Based
Purchasing Program
I
IASB. See International Accounting Standards
Board
ICD-9-CM, 426–427
ICD-10. See International Classification of
Diseases, 10th Revision
health delivery system
definition of, 317
elements of, 318
stakeholders in, 318–319, 318f
vs. healthcare finance, 321–323, 322f, 324f,
327
health information exchanges (HIEs), 26
health information technology, changes in,
25–26
Health Information Technology for Economic
and Clinical Health Act (HITECH)
legislative funding, 338–339
health maintenance organizations (HMOs).
See also managed care
plan descriptions, 41
health system organization chart, 8f
health systems agencies (HSAs), 113
health systems, case study, 459–469
healthcare analytics, 233, 238–239
challenges for, 239
healthcare business, 4
healthcare finance
duties associated with, 319–320
health delivery system vs., 321–323, 322f,
324f, 327
reform, 449–450
responsibilities of, 319
vs. reimbursement, 323–324
healthcare financial manager, strategic
planning and, 273–308
healthcare foundation, financial responsibility,
278
healthcare industry, big data in, 234–235
health-care organization, 226–227, 245
healthcare reimbursement
duties associated with, 320–321
healthcare finance vs., 323–324
responsibilities with, 320
healthcare revenue, sources of, 39–41, 42t
healthcare service organizations, 59
healthcare spending, government support in,
325–326, 326f
“HealthConnect” project, 349
HHAs. See Home health agencies
HHS. See Department of Health and Human
Services
HHVBP. See Home Health Value-Based
Program
HI. See hospital insurance
HIEs. See health information exchanges
600 Index
information flow, 12–14
information systems
manager’s challenge in changes of, 424
structure of, 12–13
information technology (IT), 323
assessing, 26–27
strategic planning cycle, 288–290, 289f
goal/objectives, 290–291
innovation, 276
inpatient care settings, 50
Inpatient rehabilitation facilities (IRFs), 408
input–output analysis, 213
inputs, information systems, 12–13
insider claims, 33
insurance company
databases, 13
verification systems, 13
insurance cost centers, 48–49
insurance verification, 504
Integrated Healthcare Association (IHA),
341–344
Intercontinental Exchange (ICE), 249
interest, 123
compound, 136
expenses, 258–259
fund, 481
points, 259
interim reports, 19
Intermountain Health (IH), financial outcomes
of, 346
internal coding and systems action plan issues,
435–436
internal error indicator results, 434
internal monthly statements, 224
internal rates of returns (IRRs), 137, 199,
207–208
International Accounting Standards Board
(IASB), 120, 268
International Classification of Diseases, 10th
Revision (ICD-10), 421
internet protocol (IP), 25
interoperability, 26
inventory, 34, 59, 61
calculating turnover, 87–88
concept of, 81
costs of goods sold and, 82–83
distribution systems, 86–87
methods, 83–84
necessary adjustments, 85–86
overview, 81
ICD-10 e-records
benefits and costs of, 423–425
code users, 429
coders, 428
conversion costs for Midwestern Community
Hospital, 445–446
developmental steps, 439–440
e-record standards, 422–423
ICD-10-CM and ICD-10-PCS, 427
managers, 424
overview and impact of, 421
physicians, 429
providers and suppliers impacted by
transition to, 422
revised final compliance date, 422f
situational analysis, 437
strategic steps, 439
system implementation planning, 438f
systems and applications affected by, 425
technology issues and problems, 426–427
training and lost productivity costs, 428
ICE. See Intercontinental Exchange
identified vs. allocated costs, 179, 179f
IH. See Intermountain Health
IHA. See Integrated Healthcare Association
Improving Medicare Post-Acute Care
Transformation Act of 2014
(IMPACT Act), 108, 339–341,
405–407, 406f, 407f, 414–415
incentive payment base period
vs. QP performance period, 378
income. See also revenues (inflow)
monthly statements, 489, 492
operation, 120, 122
for retail pharmacies, 477
income statement projections, 312–313
independent living facilities, 43, 43f
“indexed to inflation,” 249
indirect costs, 56–57, 56t–57t
definition, 55
examples, 56–57, 56f, 56t–57t
individual practice association (IPA) model, 41
individual retirement accounts (IRAs), 246
industry trend, researching acquisition,
450–451
inflation
comparative data and, 168–169
factors, 162, 168–169
vs. deflation, 249–250
inflow (revenues), 37–45
Index 601
legislative reform, 362–363
legislative requirements
for performance reporting, 286
for strategic planning, 286
lengths of stay, 485–486
leverage ratios, 485, 487
liabilities
on balance sheets, 119–120
comparative analysis, 149, 151
description of, 33
examples of, 35
to fund balance, 131–132, 133f
long- and short-term, 35
trend analysis, 150–151, 150t
types, 120
LIFO inventory method. See Last-In, First-Out
inventory method
line chart, 254
lines of authority
cost center designations, 48–49
nursing staff classification by, 156, 156f
organization charts and, 6–7
liquidity ratios, 129–130, 131f, 485, 487
loans
amortization schedules, 258
costs of, 259
decision-making about, 260
short-term, 258
long-term borrowing, 258
long-term care, 43, 43f
Long-term care hospitals (LTCHs), 408
long-term debt, 120, 481–482
long-term investments, 245, 246–248
LTCHs. See Long-term care hospitals
M
MACRA. See Medicare Access and CHIP
Reauthorization Act of 2015
MACRS. See Modified Accelerated Cost
Recovery System
MACs. See Medicare Administrative Contractors
major diagnostic categories (MDCs), 43, 50–51
managed care, 40–41, 45
contractual allowances, 38
revenue sources, 40–41
standardized input and, 171
management responsibilities, 58, 103–113
within strategic planning cycle, 291–292,
292f
periodic inventory system, 85
tracking, 84–86
types of, 81
inventory turnover, calculation, 87–88
investments
indicator, 249–250
payback period, 137–138
in stocks, 248
terminology of, 245–250
IP. See internet protocol
IPA model. See individual practice association
model
IRAs. See individual retirement accounts
IRFs. See Inpatient rehabilitation facilities
IRRs. See internal rates of returns
isolate internal coding problems, 435
isolateinternal systems problems, 436
IT. See information technology
IT Management Accountability Report
(IT MAR), 291
J
Johns Hopkins Medicine, 281
joint costs, 55
Jones Group Home, 65–66
semivariable cost, 66f
variable cost, 66f
K
Kaiser Permanente (KP), 347, 349
L
labor market forecasts, 157
labor utilization, 484–485
land, as asset, 34
Last-In, First-Out (LIFO) inventory
method, 83
lease-purchase agreements, 263–264
leases
accounting principles, 268
capitalizing, 263
lease-versus-purchase decisions, 264
leasing equipment, 263–264
financial lease, 263–264
operating lease, 264
vs. owning equipment, 263–268
least squares method, 77
602 Index
Medicare program, 39–40, 45
incentive payments, 397, 398
Medicare program (Title XVIII), 39-40, 52
mental health services, 40, 460
Merit-Based Incentive Payment System (MIPS),
339–340, 397
benefits and costs of, 388
composite performance score, 367–368, 368f
eligible professionals for, 365–367
group reporting, 374
individual reporting, 374
Measure Development Plan for, 383, 384f
new quality measures for, 383
pay-for-performance incentives, 362–363,
363f, 364f
Payment Adjustments and Timelines,
366–367, 367f
payment structure, 364, 365f
performance category, 369f, 371t
Advancing Care Information, 369, 374
Clinical Practice Improvement Activities,
369–370, 374
cost, 370, 374
quality, 368, 374
performance period, 373–374
Physician Quality Reporting System, 389
reporting by intermediaries, 375
required reporting, 373
scoring works, 370–372, 371t, 373f
Metropolis clinic security guard staffing, 104
Metropolis Health System (MHS), 459–469
excerpts from notes, 471–482
financial statements, 461–463
pharmacy to a hospital in, 489–494
statistics and organizational structure,
463–469, 468f–469f
system’s financial statements, 471–482
MHS. See Metropolis Health System
mid-level management responsibilities, 292, 292f
Midwestern Community Hospital, conversion
costs, 422
migrant healthcare services, 40
milestones, 287
MIPS. See Merit-Based Incentive Payment System
mission statement, strategic planning, 274, 274f
Mayo Clinic, 277
Parkland hospital, 277
Regions Hospital, 278
Saint Barnabas Medical Center Foundation,
278
manager, 11
ICD-10 and, 424
information system changes and, 424
portfolio, 246
managerial accounting, 7
managerial-level responsibilities, 292, 292f
managers responsibilities, strategic planning,
284–285
master staffing plans, 105, 106, 157, 157f
maternal and child health services, 40
Mayo Clinic, 277
Value Creation System, 334
MDCs. See major diagnostic categories
MDP. See Measure Development Plan
mean, 251, 252t
meaningful use (MU), 340, 390, 397–398
of electronic health records. See Advancing
Care Information
requirements, 400–401
stages, 398–400, 399f, 400t
Measure Development Plan (MDP)
for MIPS and APMs, 382–383, 384f
stages, 382–383, 384f
measurement tools, 229–231, 252
median, 251, 252t
Medicaid program (Title XIX), 40, 45, 52, 480
Medicaid reimbursement rates, 456
medical records division, 48
Medicare, 454
EHR incentive program, 390
reimbursement rates, 456
Shared Savings Program, 390
Medicare Access and CHIP Reauthorization Act
of 2015 (MACRA), 327–328, 339–340,
348f, 362–363, 397
Advanced APMs. See Advanced Alternative
Payment Models
MIPS. See Merit-Based Incentive Payment System
quality measures development
CMS framework for, 385–387, 387f
domains for, 385, 386f
National Quality Strategy (NQS) domains,
387
priorities for, 384, 385f
timelines for, 383–384, 384f
Medicare Administrative Contractors (MACs), 40
Medicare Advantage, 40
Medicare Learning Network (MLN), 338
Medicare Part B Physician Fee Schedule
(MPFS), 389
Index 603
domains, 385, 387
National Quality Priority Domain, 351–352, 353t
nine strategic levers, 351, 352t
NCA. See National Cemetery Administration
NCCN. See National Comprehensive Cancer
Network
NCQA. See National Committee for Quality
Assurance
NCTM. See National Council of Teachers of
Mathematics
negative view, researching acquisition, 450
net book value, 89–90. See also book values
net cash flow, 198, 207, 207t
effects of owning vs. leasing equipment,
265–266, 266t
net patient service revenue, 478, 479–481
net present value (NPV), 199, 207
computations, 207
net purchases, 82
net rates, staffing, 107
net revenue, 216
net worth
on balance sheets, 119
description of, 33
forms of, 35–36
statement of changes, 122–123
terminology, 36
Network Emphasizes Financial Structure,
278–279
new capital asset, 197, 198
New York Stock Exchange (NYSE), 249
no-method inventory, 84
noncash, concept, 123
noncompetitors, 228
Nonoperating Gains (Losses), 122
nonproductive time, 104–105, 107–108
nonprofit organization, revenues and, 47
notes payable, 35
notes receivable, 34
not-for-profit organizations
church-affiliated, 258
donations from, 41
for-profit company vs., 275
net cash flow, 265–266, 266t, 268
net worth terminology, 36
present value, 267t, 268
Regions Hospital, 278
revenue retention, 258
Sutter Health, 276
voluntary, 6
Sutter Health, 276
Tenet Healthcare Corporation, 277
Texas Oncology, 278
mixed costs, 69
analysis, 69–73
characteristics, 70
scatter graph analysis, 77–78
step methods, 70
MLN. See Medicare Learning Network
mobile devices, 25
mode, 251, 252t
Modified Accelerated Cost Recovery System
(MACRS), 92
monetary unit measurement, 162
money market funds, 246
money, time value of, 135–139
mortgage, 35, 259
bonds, 247
repayment of, 260
Motto, 280
MPFS. See Medicare Part B Physician Fee
Schedule
multiple performance measures, 282, 283f
municipal bonds, 247
My Health Manager, 349
N
NASD. See National Association of Securities
Dealers
NASD Automated Quotation system
(NASDAQ), 249
NASDAQ. See NASD Automated Quotation
system
National Association for Home Care and
Hospice, 454
National Association of Securities Dealers
(NASD), 249
National Cemetery Administration (NCA), 287
National Committee for Quality Assurance
(NCQA), 342
National Comprehensive Cancer Network
(NCCN), 335
National Council of Teachers of Mathematics
(NCTM), 250
National Health Planning and Resources
Development Act, 113
National Quality Strategy (NQS), 415–416
aims and spriorities, 350–351
and CMS strategic goals, 352, 353t
604 Index
outflow (expenses), 47–53
outpatient care settings, 50–51
outpatient infusion center, capacity level
checkpoints for, 159
outputs, information systems, 12–13
outsider claims, 33
over the counter (OTC), 249
overhead, 313
Owner’s Equity, 35
owning equipment vs. leasing equipment,
263–268
P
P4P. See pay-for-performance
PAC. See post-acute care
parametric analysis, 228
Pareto analysis, 229–230
Pareto diagram, 229–230
Pareto principle, 229
Parkland Hospital, Hospital Taxing-District
Status, 277
partial qualifying eligible professionals
(PQEPs), 376, 378–379
patient days, 468
patient engagement, 23–24
engaged patient, 23–24
rapid change, 24
patient information, confirmation, 504
patient mix assumptions, 154
patient revenue, 466
Patient-Centered Comparative Effectiveness
Research Center (PCERC), 335
patient-centered medical homes, 391
patients, insurance verification for, 12–13
payback methods, 199
input, 205t
payback period, 137–138
payer action plan issues, 436
payer mix, 39, 40, 45
payers
changes, 155
definition, 39
private, 41
pay-for-performance (P4P), 325, 341
payrolls
register, 109
taxes, 35
PCERC. See Patient-Centered Comparative
Effectiveness Research Center
NPV. See net present value
NQS. See National Quality Strategy
numerator, 253
nursing facilities, 41
Nursing Home Compare rates, 414
Nursing Home Compare website, 345
nursing practice and administration, 468f
nursing services cost centers, 48–49
NYSE. See New York Stock Exchange
O
obsolete items, in inventory, 86
occupancy rates, 485
occupational health services, 460
Office of Management and Budget (OMB), 287
Office of Value Creation, 334, 350
OffTheScale (OTS), 24
OMB. See Office of Management and Budget
Oncology Care Model, 375
150% Declining Balance (150% DB) Method, 91
online Patient Action Plan (oPAP), 349
open imaging center, static budget variance
analysis for, 215–216
operating data, analysis, 151–152, 151t–152t
operating expenses, 120, 122, 467
operating income, 120, 122, 218
operating lease, 264
operating margins, 132, 133f
operating reports, 19
operating revenue, 120, 122
forecasts, 153–155, 154f–155f
operating room
comparative data analysis, 151, 152t
costs, 69–71
forecasts, 153–155, 154f, 155f
operations budget, 197
operations expenses, 49, 54
opportunity assessment, 228
opportunity costs, 202
organization charts, 6–7, 7f
case study, 468f
chart of accounts and, 15
organizations
purpose of, 5, 7, 274
structure and types of, 5–7
original records, 11
OTC. See over the counter
Other Payer Advanced APMs, 376
OTS. See OffTheScale
Index 605
population health, 26–27
assessing information technology, 26–27
challenges, 26
delivery systems, 27
population-based payment model, 391
portfolio managers, 246
positive usage indicator, 432
positive view, researching acquisition, 450
post-acute care (PAC)
alternative payment model, 408–409, 409f
digital interoperability, 407, 411
escalating costs, 407
Improving Medicare Post-Acute Care
Transformation Act, 405–407, 406f,
407f, 414–415
innovation, 416–418
leadership decisions, 417, 417f, 418
measurement framework, 411–413, 412f
measurement implementation phases, 410f
payment model, 408
public reporting of, 414
standardized data, 407, 410
statistics, 408t
strategic goals, 415–416
timeline requirements, 413–414
PQEPS. See partial qualifying eligible
professionals
PQRS. See Physician Quality Reporting System
predetermined per-person payments, 38
predictive analytics approach, 235
preferred provider organizations (PPOs), 41
preferred stock, 248
prescription drug benefit, 40
present value
annuity, 136
cost of owning vs. leasing equipment,
266–268, 268t
net, 199
tables, 136
presentations, tips, 315
present-value analysis, 136
price variance, 212
private payers, 41
privately held companies, 248
procedure codes, 50, 52t
ICD-9-CM and ICD-10-CM comparison,
426–427
procedures, expense grouping, 49–50
process analysis, 228
process viewpoint, 4
peak-load problem, WIC, 498
peer groups, 228
pension cost centers, 49
percent, 253
percentage-based measurement, of ACI,
401–403, 402f
percentile rankings, 483
performance gaps, 227
performance measures, 127–133
adjusted over time, 227
benchmarking, 227–229
liquidity ratios, 129–130, 131f
profitability ratios, 132, 133f
solvency ratios, 130–132, 133f
variety of, 226–227
performance period, 254
of MIPS, 373–374
performance reporting, legislative
requirements for, 286
period costs, 59–61, 60f
periodic inventory system, 85
perpetual inventory system, 84–85
petty cash fund, 48
PFPMs. See physician-focused payment models
pharmacy addition, case studies, 489–494
PHOM. See Public Health Outcome Measures
Report
physician groups, 43–44, 44f
physician practice, economic impact of,
225–226
Physician Quality Reporting Initiative, 389
Physician Quality Reporting System (PQRS),
389
physician reimbursement, 327–328
Physician Value-Based Modifier (PVBM)
Program, 336
physician-focused payment models (PFPMs),
382
physicians
ICD-10 training and, 429
offices, 41
training costs, 429
pie chart, 254
Pioneer ACO model, 391
planner’s financial projection, 295–296, 295f
planning
managers’ responsibilities, 284
purpose of, 5
point-of-service models, 41
points, on loans, 259
606 Index
qualified electronic transmission standards, 388
Qualified Registry, 374
Qualifying APM Participant (QP) pathway,
377, 377f
qualifying eligible professionals (QEPs),
376, 378
Quality Payment Program (QPP), 328, 363, 364
APMs. See Advanced Alternative Payment
Models
benefits and costs of, 388
MIPS. See Merit-Based Incentive Payment
System
quality reporting programs, 342
quantity variance, 211
quarterly reports and statistics, 19
quartile computation, 231
quick ratio, 129, 131f
R
radiology departments, 50, 52t
radiology services, 58–59, 58f
rapid change, patient engagement, 24
rate of return
accounting, 199, 206
internal, 199, 207–208
internal, 137
unadjusted, 135
rate per day, 48
rate setting, 38
rate variance, 212
ratio analysis, 127
rationing available capital, 202–203
real estate financing, 259–260
real estate mortgages. See real estate financing
real estate taxes, 259
recording inventory and cost of goods sold, 82
record-keeping systems, 3
recovery services, 460
referrals
analyzing referral activity, 505
assessing admissions process, 503
e-referrals, 504
tracking and approval, 505
Regions Hospital, 278
regression lines, 77
rehabilitation centers, 58, 58f, 459
Relative Value Units (RVUs), 189
budget uses in, 189–190
renovations, budgeting for, 200
product cost, 59–61, 60f
productive time, 104–105, 108
professional services cost centers, 48–49
profit center, 57–58
profitability matrix, 485, 487, 490
profitability ratios
case study, 485, 487
types of, 132, 133f
profit-volume (PV) ratios, 74–76
program cost center, 52
programs
definition, 51–52
existing, 201
expenses grouped by, 51–52, 52t
new, 201
project management phases
phase 1
evaluate resources, 440
team creation, 440
projections, 7, 295–296
forecasts vs, 153
proprietary organizations, 6, 7
prospective data analytics, 236
Prospective payment reimbursement
methodology, 50
Providence Healthcare Network, 280
provider organizations PPOs. See preferred
provider organizations
providing accountability, managers’
responsibilities, 285
public companies, 249
public health clinics, 40
Public Health Outcome Measures Report
(PHOM), 345–346
public reporting, 343–346
purchasing equipment, 263
PV ratios. See profit-volume ratios
PVBM Program. See Physician Value-Based
Modifier Program
Q
QCDR. See Qualified Clinical Data Registry
QCDRs. See qualified clinical data registries
QEPs. See qualifying eligible professionals
QP pathway. See Qualifying APM Participant
pathway
QPP. See Quality Payment Program
qualified clinical data registries (QCDRs), 348
Qualified Clinical Data Registry (QCDR), 374
Index 607
statement of, 120, 122
types, 312
RIF. See Request for Information
robotic automation, 87
RVUs. See Relative Value Units
S
Saint Barnabas Medical Center Foundation, 278
salaries, 49, 53
salvage value, 88, 91t
Same-Day Surgery (SDS), 459
scatter graph analysis, 77–78
scatterplot, 254
Schedule of Operating Expenses, 467
Schedule of Patient Revenue, 466
Schedule of Property, Plant, and Equipment,
465, 474
scheduled-position method, 106–108
scheduling-system data, 12
school health programs, 40
SD. See standard deviation
SDS. See Same-Day Surgery
Seabury Nursing Center’s Home
Healthcare-Related Organization
Chart, 457f
Seabury’s Planning Department, 454
Seawell’s Chart of Accounts for Hospitals, 15
Securities and Exchange Commission (SEC),
249
security, in business plans, 313
semifixed costs, 65–69
semivariable costs, 65–69
sensitivity analysis
overview, 218
tools, 218–222
service lines, 42–43, 43f, 44f, 50–51
services
description, 310
disbursements for, 48
revenue for, 37–39, 39t
Westside Center, 58, 58f
SGR. See Sustainable Growth Rate
shortages, in inventory, 86
short-term borrowing, 258
situational analysis, 437
for strategic planning, 292–294
skilled nursing facilities (SNFs), 42–43, 43f, 406,
409, 459
value-based program, 336
rent, 65
reporting as a tool
balance sheet, 119–120
statement of fund balance/net worth,
122–123
statement of revenue and expense, 120–122
subsidiary reports, 124–125
reporting system, 11
reports, 19
director’s summary, 58–59, 60f
external, 7
financial statements, 119–125
lines of, 7
reserve for depreciation, 89
staffing costs, 108
Request for Information (RIF), 383
researching acquisition viewpoints
industry trend, 450–451
negative view, 450
positive view, 450
resource
allocation, 25
electronic media, 25
website, 25
evaluation, 138–139
resource use, performance category, 370, 374
Respiratory Care Department, diagnosis-related
groups for, 190–193
responsibility centers, 42, 57–59, 58f
retail medicine clinics, 27
Retained Earnings, 35
retrospective analytics approach, 235
retrospective data analytics, 236
return on total assets, 132, 133f
returns on investment, 202
revenue bonds, 247
revenue centers, 42
revenue retention, 258
revenue stream, 37
revenues (inflow), 45
amount, 312
contractual allowances, 38–39, 39t
deductions from, 38–39, 39t
equity and, 47
grouping, 42–45
nonprofit organization and, 47
operating, 120, 122
projections, 312
for services, 37–39
sources, 39–41, 42t, 312
608 Index
stock investments, 248
stock warrants, 248
stockholders, 7
straight-line depreciation method, 90
strategic mission statements, 287
strategic objectives, 274f, 275, 281–283, 291
strategic planning, 7, 13, 42, 273–308, 453,
455f
action plan, 274f, 275, 282
basic elements of, 281
cycle, 281, 283–284
VA office of IT, 288–290, 289f
definition of, 273
financial emphasis, 278–279
financial projection for, 294–296, 295f
goals, 274–275, 274f, 281, 282, 290–291
IT MAR, 291
legislative requirements for, 286
major components of, 273–275, 274f
managers’ responsibilities, 284–285
objectives, 274f, 275, 281, 282, 291
operational plan, 291
performance measures, 291
process flow, 281–283, 281f, 283f
program plan, 291
results of, 279–281
situational analysis for, 292–294
status/focus, 276–278
timeframes, 286
tools for, 292–294
varied approaches to, 275–276
strengths-weaknesses-opportunities-threats
(SWOT), 440
analysis, 293–294, 293f
matrix for ICD-10
background, 440
building, 440–441
summary, 440–441
worksheets, 293, 299–308
stub period, 19
subsidiary journals, 18, 19f, 108
subsidiary reports, 124–125
Sum-of-the-Year’s Digits (SYD) method, 91
super bill, healthcare reimbursement, 321
supplementary medical insurance (SMI), 39
supplies, 69, 312–313
support center reports, 59
support services expenses, 49, 54
Sustainable Growth Rate (SGR), 327, 362
Sutter Health, 276
Skilled Nursing Facility Value-Based Program
(SNFVBP), 336
SMI. See supplementary medical insurance
SNFs. See skilled nursing facilities
SNFVBP. See Skilled Nursing Facility
Value-Based Program
social media, 24–25
data report, 25
digital media, 24
Social Security Act, 39, 40
Social Security taxes, 49–50
solvency ratios
case study, 485, 487
types of, 130–132, 133f
space occupancy, 313
spending variance, 212
staffing
calculations to annualize positions, 105–106
calculations to fill scheduled positions,
106–107
capacity issues, 158–159
Certificate-of-Need (CON), 113
classification by lines of authority, 156, 156f
comparative hours report, 111
costs, 69, 108
definition, 106
forecasts, 156–158, 156f–157f
FTEs for annualizing positions, 103–106
labor market and, 157
manager responsibility, 103–113
nursing home, 113
operating room calculations, 107t
requirements, 103, 106, 108–113
stakeholders, 283, 284
standard deviation (SD), 252
standardized data, post-acute care, 407, 410
standardized measures, 170–171, 252
standardized scale, 252
startup cost concept, 200
statement of cash flows, 123
statement of fund balance/net worth, 122–123
statement of revenue and expense, 120–122
case study, 463
checklist for review of, 125
state-only general assistance programs, 40
static budgets, 183, 184t, 185, 185t, 215–216
statistical benchmarking, 228–229
statistical support, 13
statistically significant, 252
statistics, 250–251
Index 609
transaction, 17–18
progress of, 18f
records, 108
treasury bills, 246
treasury notes, 246
trend analysis, 150–151, 150t
assumptions, 155
capacity level issues in forecasting, 158–159
common sizing, 149–150, 150t
operating data, analysis, 151–152, 151t–152t
trial balance, 18, 53
turning inventory, cost of goods sold, 82–83
two-variance analysis, 212–214
U
unadjusted rate of return, 135, 206
unexpired costs, 47, 54
Units of Production (UOP) depreciation
method, 91–92
UOP depreciation method. See Units of
Production depreciation method
urgent care medicine, 27
U.S. Securities and Exchange Commission
(SEC), 249
use variance, 211–212
useful life of asset, 88
utilization, 485–486
assumptions, 154
V
VA. See Department of Veterans Affairs
Value Modifier (VM), 336, 370, 389–390
“value-based” concept
digital outcomes, 347–349
education efforts, 337–338
financial outcomes, 346–347
legislative reform, 338–341
in private sector, 334–335
public reporting efforts, 343–346
in public sector, 335–337
quality measurement, 341–343
strategic planning, 350–354
value-based pay-for-performance initiatives,
363
Value-Based Payment Modifier, 389–390
value-based payments, 337
value-based performance payment models,
375
SWOT. See strengths-weaknesses-opportunitiesthreats
SYD method. See Sum-of-the-Year’s Digits
method
system elements, 14–18
books and records, 17–18
chart of accounts, 14–17
reports, 19
system-based measurement, of ACI, 401 402f
T
target operating income computation,
219–220
targets, 275
tax depreciation
computing, 92
defined, 92
tax revenues, 41
taxpayers, reporting to, 7
technology in healthcare, case studies, 503–506
telehealth, 24
Tenet Healthcare Corporation, 276
Texas Oncology, 278–279
third-party reimbursement, 325
three existing incentive programs, 364, 365f
three internal error indicators, 432
three variable cost elements, 213–214
three-level revenue forecast, 219f
three-part equation, 33–34
three-variance analysis, 214–218
time cards, 108, 110
time period, 59
time periods, 161
time value of money, 135–139
evaluations, 138–139
internal rate of return, 137
payback period, 137–138
present-value analysis36, 136
resources, 139
unadjusted rate of return, 135
timelines
for MIPS performance period, 373
for quality measures development, 383–384
timeliness considerations, estimates, 223
top-level management responsibilities, 292,
292f
total expense, 218
total quality improvement (TQI), 227
traffic flow, WIC, 499, 500f
610 Index
Veterans Benefits Administration (VBA), 287
Veterans Health Administration (VHA), 287
VHA. See Veterans Health Administration
viewpoints, responsibility centers, 178, 178f
vision statement, strategic planning, 274, 274f
Parkland Hospital, 277
Regions Hospital, 278
Sutter Health, 276
Texas Oncology, 278
Visiting Nurse Association (VNA), 454
VM. See Value Modifier
VNA. See Visiting Nurse Association
volume variance, 211
voluntary organizations, 6
vouchers, WIC, 497–499
W
wages, 49
warrants, stock, 248
Web 2.0, 23
website, 25
website downloads, 280
weekly operating reports, 19
weighted average cost, 226
weighted average inventory method, 83–84
wellness programs, 460
Westside Center, services types, 58, 58f
Wharton, Joseph, 3
Wharton School, 3
Women, Infants, and Children (WIC)
appointment, 497–499
clerk and nurse utilization rates, 499, 501
environment, 497–498
peak-load problem, 498
traffic flow, 499, 500f
vouchers, 497–499
value-based programs (VBPs), 335–337, 388,
407
internal strategic analysis for, 324f
procedural steps, 322–323
strategic relationship of, 322f
value-based purchasing (VBP), 325
values statement, strategic planning, 274, 274f
Mayo Clinic, 277
Sutter Health, 276
Tenet Healthcare Corporation, 277
variable costs, 65–69
examples of, 69
fixed vs., 179, 179f
operating room, 69–71
variable expense, 216
variance analysis
calculation of, 212–213
composition, 212
computation, 212
elements of, 212f, 213
examples, 214–218
overview, 211
percentile rankings and, 483
price (or spending) variance, 212
quantity (or use) variance, 211–212
summary, 218
two-variance/three-variance analysis
compared, 212–218
volume variance, 211
VBA. See Veterans Benefits Administration
VBP. See value-based purchasing
VBPs. See value-based programs
vendor software, and ICD-9 to ICD-10
transitions, 425, 425f
Venn diagram, 254
verification, 162
vertical analysis, 149, 151