You have decided to open up a medical practice in Fort Lauderdale, Florida to lease to surgeons to perform surgeries.  There are 3 partners (including yourself).  Consider the capital structure required to start-up your business and answer the following questions:

Refer to Chapter 9 on page 115 and then answer the following questions:

You have decided to open up a medical practice in Fort Lauderdale, Florida to lease to surgeons to perform surgeries.  There are 3 partners (including yourself).  Consider the capital structure required to start-up your business and answer the following questions:

Will you mostly take out loans (debt) to finance your business, look for investors (equity), use savings, etc.  Justify your answer with resources (textbook or outside resources).
List at least 2 potential risks the practice will face due to your capitalization decision.




DEStech Publications, Inc.

Essentials for Advanced Practice Nurses

and Interdisciplinary Care Teams

Mary A. Paterson, PhD, RN Ordinary Professor, School of Nursing The Catholic University of America

Washington, DC

Technical Editor

Alexander V. Telyukov, PhD




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Table of Contents

Preface ix

Acknowledgments xi

Section 1 1. Introduction to Healthcare Finance . . . . . . . . . . . . . . . 3

1.1. Chapter Objectives 3 1.2. What Do Healthcare Providers Need to Know about

Finance and Financial Policy? 3 1.3. Characteristics of Financial Systems in Healthcare—

The Social Compact 4 1.4. Health or Healthcare—The Social Goal and the

Financial Objective 7 1.5. Concept Checkout 9 1.6. Discussion Questions 9 1.7. References 10

2. Models of Healthcare Financing . . . . . . . . . . . . . . . . . 11 2.1. Chapter Objectives 11 2.2. The Household as a Central Stakeholder in Healthcare 11 2.3. The Stakeholders in All Health-Financing Models 12 2.4. The Essential Approaches to Healthcare Financing 15 2.5. The Financial Flows in Healthcare Systems 18


Table of Contentsiv

2.6. Concept Checkout 19 2.7. Discussion Questions 19 2.8. References 20

Section 1 Case Study—The Island Nation of Tekram . . . . . 21

Section 2 3. Health Insurance in Public and

Private Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 3.1. Chapter Objectives 27 3.2. The Nature of Risk 27 3.3. Estimating Risk in Health Insurance 29 3.4. Managing Costs as a Risk-Control Strategy 31 3.5. The Budget Approach to Health Insurance 33 3.6. Risk Control Strategies in Health Insurance 34 3.7. Concept Checkout 35 3.8. Discussion Questions 36 3.9. References 36

4. Healthcare System Strategy and Finance . . . . . . . . . 39 4.1. Chapter Objectives 39 4.2. Goal Setting in the U.S. Healthcare System 39 4.3. The Relationship between Goals and Financial

Strategy 41 4.4. Goals, Strategy, and Finance in the U.S. Healthcare

System 43 4.5. Strategic Dilemmas in U.S. Healthcare 47 4.6. Concept Checkout 50 4.7. Discussion Questions 50 4.8. References 50

Section 2 Case Study—The Prisoner’s Dilemma . . . . . . . . 53

Section 3 5. Financial Management in Healthcare Markets . . . . . . 59

5.1. Chapter Objectives 59 5.2. Financial Incentives in the U.S. Healthcare Market 59 5.3. Healthcare Financial Management Strategies as a

Response to Market Incentives 63


vTable of Contents

5.4. The Linkage between Healthcare Financial Management and Operations Management 65

5.5. The Organizational Financial Plan 66 5.6. Concept Checkout 67 5.7. Discussion Questions 67 5.8. References 68

6. Costs and Cost-Finding in the Practice . . . . . . . . . . . 69 6.1. Chapter Objectives 69 6.2. Cost Behavior in Ambulatory Care Practices 69 6.3. Step-down Cost Analysis 71 6.4. Costing Systems Useful to Ambulatory Care

Practices 75 6.5. The Organizational and Policy Uses of Cost Data 78 6.6. Concept Checkout 80 6.7. Discussion Questions 81 6.8. References 81

Section 3 Case Study—Homegrown Healthcare Inc.: A Rural Accountable Care Organization . . . . . . . . . . . . . . . 83

Section 4

7. Revenue Planning and Management . . . . . . . . . . . . . 91 7.1. Chapter Objectives 91 7.2. Managing Revenue 91 7.3. Allocating Revenue to Accounts: The Account-

Management Challenge 94 7.4. Revenue Optimization and Account Evaluation 96 7.5. Account Negotiation Strategies 97 7.6. Concept Checkout 98 7.7. Discussion Questions 98 7.8. References 98

8. Budgeting for Ambulatory Care Practices . . . . . . . . 101 8.1. Chapter Objectives 101 8.2. Strategic Planning, Budgeting, and Budget

Evaluation 101 8.3. Constructing Budgets: A Focus on Revenue

and Expense 103


Table of Contentsvi

8.4. Expense Budgets and Categories 105 8.5. Building a Chart of Accounts 106 8.6. Evaluating Budget Performance: Goal Achievement 107 8.7. Concept Checkout 109 8.8. Discussion Questions 109 8.9. Reference 110

Section 4 Case Study—New Day Health and Associates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

Section 5

9. Capitalization Structure and Investment Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 9.1. Chapter Objectives 115 9.2. Capitalization Structure Planning 115 9.3. The Effect of Capitalization Structure on

Performance 116 9.4. The World of Taxation and Its Effects on Capital 117 9.5. Risk and Capitalization 119 9.6. Capital Structure Planning for the Primary Care

Provider 120 9.7. Concept Checkout 121 9.8. Discussion Questions 121 9.9. References 122

10. Basic Financial Statements . . . . . . . . . . . . . . . . . . . . 123 10.1. Chapter Objectives 123 10.2. The Four Basic Financial Reports 123 10.3. Putting the Financial Picture Together: The Interaction

of the Income and Expense Statement and the Balance Sheet 124

10.4. Understanding Cash Flow and Its Effect on the Balance Sheet 128

10.5. The Financial Position of a Practice: Financial Statements and Ratios 129

10.6. Concept Checkout 131 10.7. Discussion Questions 131 10.8. References 132


viiTable of Contents

Section 5 Case Study—General Practice Affiliates and Titus Lake Hospital: A Provider Leasing Proposal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133

Section 6

11. Financial Performance Evaluation . . . . . . . . . . . . . . 143 11.1. Chapter Objectives 143 11.2. Financial Ratios as an Analytical and

Comparative Tool 143 11.3. Ratio Categories and Their Purposes in

Financial Analysis 144 11.4. Basic Ratio Relationships and Financial

Performance Diagnosis 146 11.5. Concept Checkout 150 11.6. Discussion Questions 150 11.7. References 151

12. Projecting Financial Performance . . . . . . . . . . . . . . 153 12.1. Chapter Objectives 153 12.2. The Pro Forma Financial Analysis: Purpose

and Use 153 12.3. Using Evidence to Build the Pro Forma Analysis 154 12.4. Building the Pro Forma Financial Plan 156 12.5. Financial Barriers and Supports: SWOT Analysis 158 12.6. Financial Interrelationships and Financial Strategy 159 12.7. Concept Checkout 160 12.8. Discussion Questions 161 12.9. References 161

Section 6 Case Study—Provider Financial Goals and Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163

Section 7

13. Project Financial Management: Planning and Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 13.1. Chapter Objectives 167 13.2. Project Financial Planning and Budgeting 167 13.3. Accounting for Project Expenses 172


Table of Contentsviii

13.4. Integrated Project Management Plan and Team 173 13.5. Project Financial Management 174 13.6. Concept Checkout 176 13.7. Discussion Questions 176 13.8. Reference 177

14. Project Financing and Valuation . . . . . . . . . . . . . . . . 179 14.1. Chapter Objectives 179 14.2. Constructing Project Financial Flows 179 14.3. Project Valuation Methods 181 14.4. Impact of the Financial Environment on Projects 184 14.5. Project Financial Evaluation 186 14.6. Concept Checkout 188 14.7. Discussion Questions 188 14.8. Reference 189

Section 7 Case Study—General Practice Affiliates Electronic Medical Records Project . . . . . . . . . . . . . . . . . 191

15. Concluding Thoughts on the Healthcare Financial Enterprise . . . . . . . . . . . . . . . . . . . . . . . . . . 193 15.1. Chapter Objectives 193 15.2. The Relationship Between Finance and

Population Health 193 15.3. The Emerging Trends Affecting Healthcare

Financing 194 15.4. Aging Societies and Longevity 195 15.5. Worldwide Health Protection 196 15.6. The Consumer 197 15.7. The Roles of Macro- and Micro-Financing in

Responding to These Trends 197 15.8. Discussion Questions 198 15.9. Reference 199

Index 201




HEALTHCARE in the United States is a complex blend of private, state, and federal systems with conflicting incentives that result

in seemingly irrational financing policies. Over the more than twenty years that I have taught healthcare finance to clinical professionals, I have struggled to explain these systems in the short time allocated to this subject in a clinical program. The available healthcare finance textbooks are usually not intended for clinical students; they are either overly complex or too narrowly focused on the hospital enterprise or the entire healthcare financing system. This book provides an introduc- tion to the healthcare financing system and a guide to the financial man- agement of a healthcare practice. The book supports a semester-long class that prepares clinicians to participate knowledgeably in practice financial management and understand general concepts of the U.S. healthcare financing system.

The book is divided into two main sections. The first introduces the financing system, general models of healthcare financing with a focus on the concepts of risk and return, and health insurance models. The section concludes with a discussion of financial incentives and how they shape the costs of care. The second section focuses on financial man- agement of the ambulatory care practice. This section provides a guide to cost finding, revenue analysis and management, and financial report- ing. It concludes with two chapters focused on the planning, financial management, and evaluation of projects. These two chapters support not only capital investment analysis but also investment decisions on funded projects that the practice is considering. Taken together, the sec- tions develop an understanding of the financing environment surround-


x Preface

ing any clinical practice, the reasons for the state and federal financing policies with which a typical ambulatory care practice needs to comply, and the future challenges that are likely to develop given the new direc- tions healthcare financing is taking with the Patient Protection and Af- fordable Care Act. Additionally, the book provides the practitioner with the basic financial tools necessary to survive as a business. The cases at the end of each section enable students to apply the material to practical problems in healthcare finance at the system and practice levels.

Healthcare finance is frequently taught in clinical programs by fac- ulty who are not financial specialists. I provide simple, jargon-free ex- planations and examples to clarify financial theory and principles. I also provide an extensive instructor’s manual with model syllabi, guides to all the cases, explanations of the problem sets, and PowerPoint slides intended to present the essential material in each chapter. Additionally, each chapter begins with clearly specified instructional objectives so that the material can be adapted to online instruction as well as class- room presentation. Students are provided with a review of essential concepts necessary to complete the chapter, along with study questions and problem sets that reinforce the material. The material is appropriate for a graduate class in healthcare finance, for clinical professionals such as nurse practitioners, physician’s assistants, physical or occupational therapists, clinical psychologists, and social workers. It would also be applicable to graduate physicians interested in ambulatory care prac- tice.

It has been both a challenge and a pleasure to compile this text with the clinical faculty and student in mind. I believe that well-informed clinical professionals are our best hope for a responsive and financially viable healthcare system. I wish all who use this book well as they be- gin the study of healthcare finance.




THE material presented in this book is the result of a thirty-year dia- logue with my teachers and students. I have found that the best edu-

cation is a conversation between those who understand and those who seek to understand. This conversation is exciting, challenging, at times frustrating, and, above all, enlightening. This book could not have been written without my teachers, particularly Dr. Kyle Grazier, formerly at the University of California, Berkeley, and now at the University of Michigan, Ann Arbor. It could also not have been written without the many students who worked to understand, asked excellent questions, and insisted on clarity and simplicity. I am most grateful to them, but especially to the Doctor of Nursing Practice students at The Catholic University of America who pilot-tested much of this material when it was in draft form.

The educational dialogue between teacher and student is supported by our families. I thank my family and friends for their unfailing sup- port of this work and the enrichment they bring to my life.

Finally I thank my colleagues at The Catholic University of America and at the American Association of Colleges of Nursing for their pa- tience and forbearance as I struggled to complete this book, most espe- cially to Dean Patricia McMullen who gave me the precious gift of time to focus on this project. I am grateful to all of you.


Section 1




Introduction to Healthcare Finance

1.1. Chapter Objectives

After completing this chapter you should be able to:

1. Define the terms macro-finance and micro-finance. 2. Discuss why healthcare providers need to know basic principles of

financial economics. 3. Understand why government healthcare systems in the United

States always have a political as well as administrative dimension. 4. Discuss the concept of states’ rights and its implications for gov-

ernment healthcare systems. 5. Understand the evolving social compact in U.S. society in regards

to healthcare financing. 6. Discuss the resource allocation issues inherent in the societal goal

of health and healthcare.

1.2. What Do Healthcare Providers Need to Know about Finance and Financial Policy?

Economic theories are the basis for the concepts and principles that explain financial decisions. As students in healthcare fields, we may learn these principles as part of the required social science courses that we take before entry to professional study. Beginning healthcare students often find these concepts vaguely interesting but not very relevant for the work they intend to do. It is only after entry into practice that the impact of healthcare financing systems becomes apparent. For most of us, financial



issues present barriers and constraints to what we consider the optimal delivery of care, and we decide that we need a better understanding of why the healthcare financing system seems to function the way it does.

This book is intended to help healthcare practitioners develop a bet- ter understanding of healthcare finance. It answers basic questions pro- viders have concerning healthcare finance. The intention is not to de- velop a deep analytical expertise in accounting and finance; rather we provide an introduction to the main principles of healthcare financial policy and to some of the financial skills necessary to organize an effec- tive and efficient professional practice. Most healthcare providers are also involved in making healthcare policy and allocation decisions—as voters as well as providers of care. So we begin with discussion of macro-finance. This area of finance is concerned with the way financial policy affects various sectors of the economy. Later sections of the book offer basic financial management knowledge that can help providers better organize their practice and make sound business decisions. This area of study is known as micro-finance.

The principles of financial economics help shape the way healthcare resources are managed in our society. For example, as providers of care, the amount and timing of the payment we receive for our services is determined by the financial realities of the healthcare sector. The dis- tribution of healthcare to our patients is also determined by financial policy; whether services are paid or delivered pro bono, healthcare pro- viders need to receive some payment for the work they do. The source, amount, and method of payment are all subject to many variations. Un- derstanding financial economic and policy principles helps clarify not only the variations, but also the reasons for them.

1.3. Characteristics of Financial Systems in Healthcare— The Social Compact

The effect of the financial system on the distribution of healthcare has been the topic of many research projects, policy briefs, books, and dissertations. The U.S. approach to healthcare financing is shaped by a few fundamental ideas that reflect the social compact between U.S. citizens and their government. One of the most important of these ideas is the relationship of the government to the people expressed clearly in this passage from the Declaration of Independence:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.—That to secure these rights, Gov- ernments are instituted among Men, deriving their just powers from the consent of the governed.



This compelling statement defines the way the government relates to the people. It derives from ideas discussed by social philosophers of the time, such as John Locke, Thomas Hobbs, and Jean-Jacques Rousseau. These individuals believed that people come together and agree to give up some of their individual liberty in exchange for benefits from a gov- ernment that creates an orderly society for the good of all. However, if people judge that the government no longer serves the common good, individuals may act to change it. This relationship makes clear that the government serves the collective will of the people. If it does not, the people are free to change it.

The Declaration of Independence states that the fundamental power is with the people who agree to allow the government some role in sup- porting societal order. This arrangement implies that the people must agree with actions that the government takes on their behalf. Unlike governmental systems that concentrate power in a central government that may grant some rights to individuals, the U.S. system concentrates power with the individuals who grant rights to the government. This is an important allocation of power that has profound implications for any government healthcare system in the United States. In this country the people have the right to agree or disagree with any system of health insurance or healthcare that the government offers, and they also have the right to change it if they are not satisfied. Government healthcare systems in the United States are always subject to the will of the people and must have the approval of the majority of them in order to continue to exist. It is apparent, then, that government-managed healthcare will always have a political as well as an administrative aspect, and both are important if the system is to be sustainable.

A second important concept inherent in the U.S. system of govern- ment is the division between the rights and duties of state government and those of the federal government. The U.S. Constitution clearly es- tablishes a federalist system that allocates only specific powers to the federal government. Powers not specifically given to the federal gov- ernment remain with the states or with the people. The Tenth Amend- ment to the Constitution, often held to be redundant to reinforce ideas already inherent in the document’s main body, makes this division of power unambiguous: “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

The powers explicitly allocated to the federal government do not contain a reference to the establishment of healthcare or the right to healthcare; the involvement of the federal government in healthcare has been voluntary. For example, the establishment of federal programs to support care for active duty military and veterans, the Medicare pro-

Characteristics of Financial Systems in Healthcare



gram for the elderly, and the control of communicable disease were all established by Congressional action that contained no underlying man- date to provide health services for everyone. In fact, the federal gov- ernment’s right to regulate across state lines, including the right to tax and spend for the general welfare, stems from the commerce clause of the Constitution (Leonard, 2010). Constitutional scholars and the courts generally agree that health, welfare, and domestic safety are outside the boundaries of the commerce clause; therefore fall clearly within the powers reserved for the states. This is the reason that most government health programs in the United States have historically been the respon- sibility of the states, not the federal government.

These key concepts illustrate the critical relationship of the indi- vidual to the government in the United States and elucidate the social compact that exists in regard to healthcare. Individuals generally ex- pect to provide healthcare for themselves, or in some cases to look to the state government for assistance. People historically do not expect the involvement of the federal government. Clearly, the advent of large federal programs such as Medicare and the significant federal share of Medicaid have changed this view. However, these relatively recent de- velopments do not change the fundamental social agreements reflect- ed in the documents that define the role of government in the United States. As shown in this brief discussion, historically there is a funda- mental social understanding that the federal government has a limited and voluntary role in healthcare programs.

Given the social compact that exists in this society, healthcare financ- ing can be expected to be primarily a private responsibility with some state involvement for vulnerable groups. The evolution of private health insurance, designed to assist individuals to bear the costs of healthcare services, reflects this societal expectation. Medicare and Medicaid, en- acted in 1965, are relatively recent programs that reflect a new role for the federal government in financing the cost of care. The rapidly in- creasing number of individuals eligible for these programs has created an expanding health-financing role for government and accompanying financial requirements. The new mandates enacted in March 2010 with the passage of the Patient Protection and Affordable Care Act further increase the government’s role in healthcare financing and promise to change further the expectations that U.S. citizens have for government involvement in the healthcare system.

The relatively recent emergence of this government role also illus- trates the need for expanded fiscal policy and regulatory structures, many of which are not yet fully developed. Notably, some individuals do not agree with the expanded role of government and are challeng- ing the constitutionality of these programs. The historic basis for these



challenges and the importance of the changing social compact between individuals and the government in healthcare areas reflect the basic re- lationships we have discussed in this section.

1.4. Health or Healthcare—The Social Goal and the Financial Objective

As federal money is increasingly spent on healthcare, many policy makers have started to ask questions regarding the societal goals of these funds and press for accountability. Households have similar but less complex concerns regarding their private spending for healthcare. The household decisions can be made with careful consideration of the household’s needs and resource allocations that match its members’ preferences. These preferences are somewhat easier to determine in the smaller household unit. Spending tax monies for healthcare introduces a new level of complexity because societal welfare as a whole must be considered. Allocation strategies that focus on the greatest health gain that can be achieved for society may conflict with individual healthcare needs that also require the expenditure of public funds.

A classic dilemma in the allocation of public funds is the conflict between health and healthcare. More than thirty years ago, health econ- omists posed this dilemma based on empirical analysis of the determi- nants of health in society (Fuchs, 1986, 274–279). If the goal for society is the overall health of its members, healthcare makes only a marginal contribution to health (Fuchs, 1986, 274; Newhouse and Friedlander, 1980). These early studies and many others have shown that strategies such as improving the educational level of society, improving the envi- ronment, and economic development in areas of poverty all make larger contributions to societal health than the delivery of healthcare. Howev- er, this does not remove the urgent need for individual healthcare when it is required. For most people improvement in education, environmen- tal conditions, and economic development will not affect the conditions that require treatment now.

As government assumes the responsibility to pay for healthcare as well as create societal conditions that support health, financial alloca- tion conflicts are certain to occur. The public health financing choices that ensue have no easy answer. For providers of healthcare, this dilem- ma has the following practical implications. Funds for healthcare are often found at the expense of reduced spending on education, environ- mental health, and social welfare. In this situation, healthcare providers still need to control healthcare spending but also deal with the adverse trends in public and personal health due to eroding social supports that create a healthy society. The classic example of the resulting conflict

Health or Healthcare—The Social Goal and the Financial Objective



is the hospitalization of malnourished individuals to ensure that they have access to food. If the state raises money for acute care services by cutting back on social welfare programs such as nutrition support, the providers of care


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