Moody s Nonprofit Hospital Medians

Moody s Nonprofit Hospital Medians Category FY 2011 FY 2012 Operating margin 2.7 percent 2.5 percent Excess margin 5.1 percent 5.2 percent Operating cash flow margin 9.9 percent 9.5 percent Cash on hand 179.2 days 185.3 days Return on assets 4.5 percent 4.3 percent Annual debt service coverage 4.5x 4.6x Maximum annual debt service coverage 4.2x 4.3x Current ratio 1.9x 1.9x Cushion ratio 15.5x 16.2x Cash-to-debt ratio 119.2 percent 126.2 percent Accounts receivable 45 days 49.9 days Average payment period 59.3 days 64.3 days Debt-to-capitalization ratio 39.4 percent 38.9 percent Debt-to-cash flow 3.4x 3.4x Average age of plant 10.5 years 10.6 years Capital spending ratio 1.2x 1.2x Debt-to-total revenue 38 percent 37.6 percent Three-year operating revenue CAGR (*) 5.4 percent 5.1 percent Average length of stay 4.7 days 4.6 days Maintained bed occupancy 65.2 percent 63.5 percent Medicare case mix index 1.59 1.59 (*) Compound Annual Growth Rate 031

Cash Budgeting The following example illustrates how a small hospital would determine its cash needs during budgeting, assuming the following financial information: Beginning cash balance $4,500,000 Desired ending cash balance $2,000,000 Gross patient service revenue $100,000,000 Contractual discount percentage 35% Non-operating income (interest & dividends) 1,000,000 Transfer from hospital foundation for new ED unit $3,000,000 Construction of new ED unit $13,000,000 New diagnostic equipment for the new ED unit $2,000,000 Sale of old equipment $400,000 Principal payments $1,500,000 Interest payments $800,000 Total expenses $62,000,000 Depreciation and amortization $4,000,000 Sources of cash: Drawdown of cash 2,500,000 4,500,000 2,000,000 The drawdown frees cash for spending. Income from operations +3,000,000 Net patient service revenue(100,000,000 x (1 -.35)) less 62,000,000 total expenses Depreciation & +4,000,000 Depreciation & amortization are expenses that don t use cash. amortization Non-operating income +1,000,000 Assumes that all non-operating income comes from interest and dividends and none from unrealized gains and losses on trading securities. Recall from the financial statement in case study 1 that unrealized gains and losses on trading securities are included in net income and unrealized gains and losses on other than trading securities are excluded from net income and treated as a change in unrestricted net assets. Gift from hospital + 3,000,000 foundation Sale of old equipment + 400,000 Total sources 13,900,000 Less: Uses of cash Construction of new ED 13,000,000 New diagnostic +2,000,000 equipment Principal payments +1,500,000 Total uses 16,500,000 Cash needed 2,600,000 042

Breakeven or Cost-Volume-Profit (CVP) Analysis Breakeven or Cost-Volume-Profit (CVP) analysis provides management with profitability estimates. Profit is a function of sales, variable costs, and fixed costs: Sales Variable Costs Fixed Costs = Profit. Breakeven: Number of units where revenue, less variable costs, covers fixed costs and profit is zero. Contribution margin (CM): Amount of revenue after meeting variable costs (CM = Rev VC). Less: Equals: Less: Equals: Revenue - Variable costs = Contribution margin (CM) - Fixed costs = Profit For example, if widgets are sold at $2.00/unit and variable costs are $.40/unit, the contribution margin (CM) is $1.60/unit. At breakeven, CM = fixed costs. How to calculate breakeven by using the contribution margin concept: If widgets are sold at $2.00/unit, variable costs are $.40/unit, and fixed costs are $20,000, breakeven is: $2.00x = $.40x + $20,000 $1.60x = $20,000 x = $20,000/$1.60 = 12,500 units Breakeven revenue = 12,500 x $2.00 = $25,000. Formula for breakeven: Fixed costs Revenue per unit variable cost per unit = Fixed costs CM per unit = $20,000 $1.60 = 12,500 The contribution margin can also be expressed as a ratio or percent: Contribution margin (CM) ratio or percent: Contribution Margin Total revenue This means that for every dollar of sales, 80% goes to covering fixed costs and profit. = $20,000 $$25,000 = 80%, or: CM per unit Revenue per unit = $1.60 $2.00 = 80% Variation on the basic breakeven calculation: Target net income Selling price is $2.00, variable cost per unit is $.40, fixed costs are $20,000, and desired profit is $5,000. What is the level of sales in units? Fixed costs+proft Shortcut solution: CM per unit = $20,000+$5,000 = 15,625 units $1.60 046

Table: Present Value of an Ordinary Annuity of 1 Period 10% 11% 12% 13% 14% 15% 1.9091.9009.8929.8850.8772.8696 2 1.7355 1.7215 1.6901 1.6681 1.6467 1.6257 3 2.4869 2.4437 2.4018 2.3612 2.3216 2.2832 4 3.1699 3.1024 3.0373 2.9745 2.9137 2.8550 5 3.7908 3.6959 3.6048 3.5172 3.4331 3.3522 NPV and IRR Compared In most situations the internal rate of return method and present value provide the same choices. The IRR approach has the advantage of providing a rate of return that is easy to interpret. On the other hand, computing a rate of return is usually more difficult than computing a present value. Payback Period Method The payback method is simply the number of years in which the initial cash outlay of a project is fully recovered by its future cash inflows. Hospitals commonly use the payback method to provide a quick ranking of capital projects. It has the following advantages and disadvantages: Easy to calculate Useful in times of rapid inflation or changing technology Does not take into account the time value of money Ignores both the cash flows occurring after the payback period and the project s total physical life span OK if used in conjunction with another analytical method, such as NPV Examples: Gift Shop remodel, MRI and CT Scanner Initial cost: $365,000 for the gift shop remodel, $1,000,000 for the MRI and $600,000 for the CT scanner Annual cash flow for next five years: $100,000 for the gift shop, $300,000 for the MRI and $200,000 for the CT scanner Gift shop remodel payback period: $365,000 $100,000 = 3.65 years MRI payback period: $1,000,000 $300,000 = 3.33 years CT scanner payback period: $600,000 $200,000 = 3 years Capital Budgeting under Uncertainty Notice that the payback method comes to the same conclusion as the NPV method (i.e., the CT is a better investment than the MRI). The IRR (if we calculated it) would say the same thing. Because cash flows of a project often must be estimated on the basis of incomplete information, the capital budgeting evaluation must be performed in a climate of uncertainty. 053

The COSO framework describes internal control in terms of a multi-dimensional grid consisting of 5 components and 17 principles. Organizations are encouraged to map their internal controls against this grid. Since COSO is not a standard setter, it does not have the power to require an organization to adopt it. COSO updated Internal Control Integrated Framework in May 2013 in order to adapt it to the technological changes and globalization of business during the last two decades. Compliance Medicare is an ocean of money surrounded by people who want some. --Wall Street Journal, June 8, 2009 Compliance promotes adherence to applicable Federal and State law and regulations. Legal compliance promotes compliance with Federal and State laws; regulatory compliance promotes compliance with Federal and State statutes and regulations. Compliance = conformity with laws and regulations. Sample laws applicable to healthcare, in chronological order: False Claims Act 1863: whistleblower law originally enacted during the Civil War; allows the U.S. Department of Health & Human Services to recover monetary damages from providers for payment of funds by the federal government ($11,000 per false claim). Social Security Act 1935: Title V = Maternal and Child Health Services Block Grants; and 1965: Title XVIII = Health Insurance for the Aged and Disabled (=Medicare) and Title XIX = Grants to States for Medical Assistance Programs (=Medicaid for low-income pregnant women and children, low-income adults, individuals with disabilities, and low-income and disabled seniors). ERISA 1974: Employee Retirement Income Security Act, sets minimum standards for pension plans in private industry (funding; vesting; accountability of plan fiduciaries) and employerprovided, self-insured health insurance plans (anti-discrimination; accountability of plan fiduciaries). ERISA preempts state insurance regulations; i.e., ERISA plans are exempt from in state-mandated health insurance benefits. ERISA applies to the 60 percent of 149 million Americans with job-based coverage whose employers self-fund (rather than purchase) health coverage. COBRA 1985: Consolidated Omnibus Budget Reconciliation Act, establishes the right to continue health coverage for up to 18 months after a qualifying event such as the death of a covered employee, loss of eligibility due to termination or layoff, and divorce, by paying the employer and employee portions of the insurance premium plus up to a 2% administrative fee. Qualified beneficiaries have 60 days to elect whether to continue coverage, measured from the later of the coverage loss date or the date the notice to elect COBRA coverage is sent. Thus COBRA coverage is retroactive if elected and paid for. For example, a person who quit on December 31 and admitted to the hospital on February 15 can regain insurance coverage retroactively by paying two months of insurance premium by March 1. EMTALA 1986: Emergency Medical Treatment and Active Labor Act (anti-dumping law; establishes emergent patient s right to be stabilized and women in active labor to give birth in the Emergency Department without payment). The following excerpt from HFMA s Patient Financial Communications Best Practices (October 2013) describes an EMTALA-compliant registration process in the Emergency Department: 125

- Setting for discussions: No patient financial discussions will occur before patient is screened and stabilized. Once a patient has been stabilized, in accordance with EMTALA, the following timings and locations are appropriate for financial discussions: Emergent Patients: Discussions will occur during the discharge process. The discussion can also occur during the medical encounter as long as patient care is not interfered with and the patient consents to these conversations in order to expedite discharge. Patients who do not have an emergency medical condition: Following the medical screening, provider representative will have a discussion with the patient during the registration or discharge process. The discussion can also occur during the medical encounter as long as patient care is not interfered with and the patient consents to these discussions in order to expedite discharge. - Registration, insurance verification, and financial counseling discussions: No patient financial discussions will occur before patient is screened and stabilized, in accordance with EMTALA. Registration: The provider organization will first gather basic registration information including demographics, insurance coverage, as well as determining the potential need for financial assistance. Provision of care: Patient will be informed that their ability to pay will not interfere with treatment of any emergency medical conditions. Uninsured patients will be informed the goal of collecting information is to identify paying solutions or financial assistance options that may assist them with their obligations for this visit. Insurance verification: Once screening has occurred and the patient is stabilized, the provider organization will review insurance eligibility information with the patient to ensure information accuracy. Financial counseling: If appropriate, patient is referred to a financial counselor and/or offered information regarding the provider s financial counseling services and assistance policies. Anti-Kickback Statute 1987: prohibits remuneration, in cash or kind, for inducing or rewarding referrals of any items or services. Example: hospital can t reward physicians for the surgeries they perform at the hospital. Stark I (1989) and II (1993): prohibit physician self-referrals for health services. Example: physician can t steer patient to an imaging facility or surgery center in which the physician has a financial interest. HIPAA 1996: Health Insurance Portability and Accountability Act, limits restrictions or exclusions a group health plan can impose on benefits for preexisting conditions provided the individual had creditable continuous coverage for at least 18 months from another group plan or health insurance prior to enrolling in the new plan; establishes administrative simplification standards for transactions and code sets such as electronic claims (837), remittances (835), eligibility and benefit inquiries (270), and claim status requests (270) and notifications (271); and 2003: adds privacy and security provisions for protected health information (PHI) for covered entities (healthcare providers, health plans, and clearinghouses). The following are not considered covered entities under HIPAA: accident, disability, automobile and general liability insurance and workers compensation. Also excluded: providers that don t transmit any information in an electronic form in connection with a transaction for which HHS has adopted a standard. 126

Sarbanes-Oxley 2002: Post-Enron law strengthening auditor independence, corporate responsibility and enhanced financial disclosure; establishes stiffer penalties for corporate fraud. - The most costly provision of the law, Section 404 (improving internal control effectiveness over financial reporting) applies only to public companies; implementation by non-public healthcare organizations is optional. - Portions of the law that apply to not-for-profit healthcare entities: CEO certification of financial statements; audit committee composition and duties; accounting and auditing practice standards. HITECH Act 2009: reimburses providers for electronic health record (EHR) meaningful use ; part of the Great Recession economic stimulus package. PPACA 2010: Patient Protection and Affordable Care Act, healthcare reform ( Obamacare ). State-level Certificate of Need (CON) laws intended to restrain healthcare facility spending. Sample statutes and regulations: Internal Revenue Code (for example: Section 501 tax exemption; unrelated business income, Form 990 reporting). CFR (Code of Federal Regulations): the codification of the general and permanent rules published in the Federal Register by the executive departments and agencies of the Federal Government. Legal and regulatory compliance affects all Federal healthcare programs: Medicare Medicaid SCHIP (Note 1) CHAMPVA & TRICARE (Note 2) (1) The State Children's Health Insurance Program, created in 1997, provides health insurance to uninsured children in families with incomes too high to qualify for Medicaid (up to 200 percent of the federal poverty line). (2) CHAMPVA covers dependents of veterans with total and permanent service-related disabilities or who die while on active duty. TRICARE (called CHAMPUS before it was revamped into a managed care system in 1997) is a health program for active-duty and retired uniformed services members and their families. The two programs are mutually exclusive. The goal of all compliance programs is to prevent fraud and abuse. Fraud = intentional deception or misrepresentation of facts for gain (criminal penalties) Abuse = unintentional actions (errors) that are inconsistent with accepted, sound medical, business or fiscal practices (civil monetary penalties) 127

HFMA Certification Candidate Practicum Ratio and Operating Indicator Calculation Worksheet with Answers 12 Average payment period 1,806,625 1,618,109 7,751,740 382,204 89.5 7,346,801 360,233 365 365 84.5 13 Days cash on hand 527,703 358,307 2,517,647 495,363 213,124 2,208,147 7,751,740 382,204 168.6 7,346,801 360,233 365 365 152.4 Many bond covenants include unrestricted long-term investments in the numerator as shown here. Some also include long-term investments restricted for capital (i.e., funds the board has designated for capital projects). However, the HFMA study guide omits all long-term investments from the numerator. Unfortunately there is no industry-standard formula for days cash on hand. Capital structure ratios 2011 2010 14 15 16 17 Equity financing ratio Cash flow to total debt Long-term debt to equity Fixed assets financing 5,136,822 4,709,327 53.6% 9,579,070 8,677,308 54.3% 485,598 382,204 360,701 360,233 24.7% 1,806,625 1,705,313 1,618,109 1,542,089 1,705,313 930,310 1,542,089 807,783 51.3% 5,136,822 4,709,327 22.8% 49.9% 1,705,313 1,542,089 39.9% 4,272,212 3,983,448 38.7% 18 Times interest earned 485,598 65,387 360,701 68,788 8.4 65,387 68,387 6.3 19 Debt service coverage 485,598 65,387 382,204 360,701 68,788 360,233 1.6 48,145 454,200 65,387 48,675 465,525 68,788 1.4 20 Debt capitalization 48,145 454,200 1,705,313 48,675 465,525 1,542,089 30.1% 30.4% 5,136,822 502,345 1,705,313 4,709,327 514,200 1,542,089 Note that the Debt to Capitalization ratio has debt in the numerator and denominator, whereas Ratio #16 (Long-term Debt to Equity) does not. 357