Gapenski's Fundamentals of Healthcare Finance, 3rd Edition

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 AUPHA/HAP Editorial Board for Undergraduate Studies

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Theresa Barry, PhD

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Jennifer B. Groebner, EdD

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Michael H. Kennedy, PhD, FACHE

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 Health Administration Press, Chicago, Illinois
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Copyright © 2018 by the Foundation of the American College of Healthcare Executives. Printed in the United
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Library of Congress Cataloging-in-Publication Data

Names: Reiter, Kristin L. (Kristin Leanne) author. | Song, Paula H., author.
Title: Gapenski’s fundamentals of healthcare finance / Kristin L. Reiter, Paula H. Song.
Other titles: Fundamentals of healthcare finance
Description: Third edition. | Chicago, Illinois : Health Administration Press; Washington, DC : Association
of University Programs in Health Administration, 2018. | Revision of: Fundamentals of healthcare finance /
Louis C. Gapenski. c2013. 2nd ed.
Identifiers: LCCN 2018000639| ISBN 9781567939750 (alk. paper) | ISBN 9781567939774 (xml) |
ISBN 9781567939781 (epub) | ISBN 9781567939798 (mobi)
Subjects: LCSH: Medical economics.
Classification: LCC RA410 .G37 2018 | DDC 338.4/73621—dc23 LC record available at
https://lccn.loc.gov/2018000639

The paper used in this publication meets the minimum requirements of American National Standard for
Information Sciences—Permanence of Paper for Printed Library Materials, ANSI Z39.48-1984. ∞ ™

Acquisitions editor: Janet Davis; Project manager: Theresa L. Rothschadl; Cover designer: James Slate;
Layout: Cepheus Edmondson

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Health Administration Press Association of University Programs

A division of the Foundation of the in Health Administration
American College of Healthcare Executives 1730 M Street, NW
300 South Riverside Plaza, Suite 1900 Suite 407
Chicago, IL 60606-6698 Washington, DC 20036
(312) 424-2800 (202) 763-7283

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 We dedicate this book to the memory of our dear friend and colleague,
Louis C. Gapenski, whose textbooks have touched countless students of
healthcare finance.

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 BRIEF CONTENTS

Preface.......................................................................................................................xv
Purpose of the Book..............................................................................................xxi

Part I: Foundation Concepts

Chapter 1 Introduction to Healthcare Finance...................................................... 3

Chapter 2 Healthcare Business Basics.................................................................. 25

Chapter 3 Paying for Health Services.................................................................. 49

Part II: Planning, Managing, and Control

Chapter 4 Estimating Costs................................................................................ 85

Chapter 5 Pricing Decisions and Profit Analysis................................................ 118

Chapter 6 Planning and Budgeting................................................................... 153

Chapter 7 Managing Financial Operations........................................................ 184

vii

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 viii Brief Contents

Part III: Financing and Capital Investment Decisions

Chapter 8 Business Financing and the Cost of Capital...................................... 215

Chapter 9 Capital Investment Decision Basics.................................................. 246

Chapter 10 Project Cash Flow Estimation and Risk Analysis.............................. 281

Part IV: Reporting Results

Chapter 11 Reporting Profits.............................................................................. 315

Chapter 12 Reporting Assets, Financing, and Cash Flows................................... 350

Chapter 13 Assessing Financial Condition.......................................................... 382

Glossary.................................................................................................................. 417
Index........................................................................................................................ 433
About the Authors............................................................................................... 455

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 DETAILED CONTENTS

Preface.......................................................................................................................xv
Purpose of the Book..............................................................................................xxi

Part I: Foundation Concepts

Chapter 1 Introduction to Healthcare Finance...................................................... 3

Theme Set-Up: Careers in Healthcare Management............................................ 3
Learning Objectives............................................................................................ 4
1.1 Introduction................................................................................................. 5
1.2 Defining Healthcare Finance........................................................................ 5
1.3 The Role of Finance in Health Services Organizations.................................. 6
1.4 The Structure of the Finance Department................................................... 10
1.5 Healthcare Settings..................................................................................... 10
1.6 Regulatory and Legal Issues........................................................................ 18
1.7 Current Challenges..................................................................................... 21
Theme Wrap-Up: Careers in Healthcare Management..................................... 21
Key Concepts................................................................................................... 22
End-of-Chapter Questions................................................................................ 24

Chapter 2 Healthcare Business Basics.................................................................. 25

Theme Set-Up: Business Goals.......................................................................... 25

ix

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 x Detailed Contents

Learning Objectives.......................................................................................... 26
2.1 Introduction............................................................................................... 27
2.2 Concept of a Business................................................................................. 27
2.3 Legal Forms of Businesses........................................................................... 29
2.4 Alternative Forms of Ownership................................................................. 33
2.5 Organizational Goals.................................................................................. 39
2.6 Tax Laws.................................................................................................... 42
Theme Wrap-Up: Business Goals..................................................................... 45
Key Concepts................................................................................................... 46
End-of-Chapter Questions................................................................................ 47
End-of-Chapter Problems................................................................................. 48

Chapter 3 Paying for Health Services.................................................................. 49

Theme Set-Up: Big Sky’s Revenue Sources....................................................... 49
Learning Objectives.......................................................................................... 50
3.1 Introduction............................................................................................... 51
3.2 Basic Insurance Concepts............................................................................ 51
3.3 Third-Party Payers...................................................................................... 57
3.4 Managed Care Organizations...................................................................... 62
3.5 Alternative Reimbursement Methods.......................................................... 63
3.6 The Impact of Reimbursement on Financial Incentives and Risks............... 70
3.7 Medical Coding: The Foundation of Fee-for-Service Reimbursement......... 74
3.8 Healthcare Reform..................................................................................... 76
Theme Wrap-Up: Big Sky’s Revenue Sources................................................... 78
Key Concepts................................................................................................... 80
End-of-Chapter Questions................................................................................ 81

Part II: Planning, Managing, and Control

Chapter 4 Estimating Costs................................................................................ 85

Theme Set-Up: Cost Structure.......................................................................... 85
Learning Objectives.......................................................................................... 86
4.1 Introduction............................................................................................... 87
4.2 The Basics of Managerial Accounting.......................................................... 87
4.3 Cost Classification 1: Fixed Versus Variable Costs...................................... 89
4.4 Cost Classification 2: Direct Versus Indirect (Overhead) Costs................... 96
4.5 Cost Allocation........................................................................................... 97
4.6 Service Line Costing................................................................................. 103
Theme Wrap-Up: Cost Structure.................................................................... 111
Key Concepts................................................................................................. 112

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 Detailed Contents xi

End-of-Chapter Questions.............................................................................. 113

End-of-Chapter Problems............................................................................... 114

Chapter 5 Pricing Decisions and Profit Analysis................................................ 118

Theme Set-Up: Profit Analysis........................................................................ 118
Learning Objectives........................................................................................ 119
5.1 Introduction............................................................................................. 120
5.2 Healthcare Providers and the Power to Set Prices..................................... 120
5.3 Price-Setting Strategies............................................................................. 121
5.4 Target Costing.......................................................................................... 124
5.5 Profit Analysis........................................................................................... 125
5.6 Breakeven Analysis.................................................................................... 131
5.7 Marginal Analysis..................................................................................... 135
5.8 Profit Analysis in a Capitated Environment.............................................. 139
5.9 The Impact of Cost Structure on Financial Risk....................................... 143
Theme Wrap-Up: Profit Analysis.................................................................... 145
Key Concepts................................................................................................. 147
End-of-Chapter Questions.............................................................................. 148
End-of-Chapter Problems............................................................................... 149

Chapter 6 Planning and Budgeting................................................................... 153

Theme Set-Up: Actual Versus Expected Results.............................................. 153
Learning Objectives........................................................................................ 155
6.1 Introduction............................................................................................. 156
6.2 Strategic Planning..................................................................................... 156
6.3 Operational Planning............................................................................... 159
6.4 Introduction to Budgeting........................................................................ 161
6.5 Budgeting Decisions................................................................................. 162
6.6 Budget Types............................................................................................ 167
6.7 Variance Analysis...................................................................................... 172
Theme Wrap-Up: Actual Versus Expected Results.......................................... 178
Key Concepts................................................................................................. 179
End-of-Chapter Questions.............................................................................. 180
End-of-Chapter Problems............................................................................... 181

Chapter 7 Managing Financial Operations........................................................ 184

Theme Set-Up: Revenue Cycle Management.................................................. 184
Learning Objectives........................................................................................ 185
7.1 Introduction............................................................................................. 186
7.2 The Revenue Cycle and Receivables Management..................................... 186
7.3 Cash Management.................................................................................... 195

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 xii Detailed Contents

7.4 Supply Chain Management...................................................................... 197

7.5 Monitoring Operations............................................................................. 201
Theme Wrap-Up: Revenue Cycle Management.............................................. 206
Key Concepts................................................................................................. 207
End-of-Chapter Questions.............................................................................. 209
End-of-Chapter Problems............................................................................... 209

Part III: Financing and Capital Investment Decisions

Chapter 8 Business Financing and the Cost of Capital...................................... 215

Theme Set-Up: Starting a New Medical Practice............................................ 215
Learning Objectives........................................................................................ 216
8.1 Introduction............................................................................................. 217
8.2 Setting Interest Rates................................................................................ 217
8.3 Debt Financing......................................................................................... 218
8.4 Debt Contracts......................................................................................... 222
8.5 Debt Ratings............................................................................................ 223
8.6 Equity Financing...................................................................................... 225
8.7 The Choice Between Debt and Equity Financing..................................... 228
8.8 The Choice Between Long-Term Debt and Short-Term Debt.................. 235
8.9 Cost of Capital......................................................................................... 236
Theme Wrap-Up: Starting a New Medical Practice........................................ 241
Key Concepts................................................................................................. 241
End-of-Chapter Questions.............................................................................. 243
End-of-Chapter Problems............................................................................... 244

Chapter 9 Capital Investment Decision Basics.................................................. 246

Theme Set-Up: Evaluating a Project’s Financial Merit.................................... 246
Learning Objectives........................................................................................ 247
9.1 Introduction............................................................................................. 248
9.2 Project Classifications............................................................................... 248
9.3 The Role of Financial Analysis in Capital Investment Decisions............... 249
9.4 Overview of Capital Investment Financial Analysis................................... 250
9.5 Creating the Time Line............................................................................ 251
9.6 Breakeven Analysis.................................................................................... 252
9.7 Discounted Cash Flow Analysis................................................................ 254
9.8 Return on Investment............................................................................... 264
9.9 Project Scoring......................................................................................... 272
9.10 The Postaudit.......................................................................................... 274
Theme Wrap-Up: Evaluating a Project’s Financial Merit................................ 276
Key Concepts................................................................................................. 276

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 Detailed Contents xiii

End-of-Chapter Questions.............................................................................. 277

End-of-Chapter Problems............................................................................... 278

Chapter 10 Project Cash Flow Estimation and Risk Analysis.............................. 281

Theme Set-Up: Estimating a Project’s Cash Flows and Assessing Risk............ 281
Learning Objectives........................................................................................ 282
10.1 Introduction........................................................................................... 283
10.2 Cash Flow Estimation............................................................................. 283
10.3 Estimating the Cash Flows for Bayside’s Open MRI Project................... 288
10.4 Risk Analysis........................................................................................... 292
10.5 Incorporating Risk into the Decision Process.......................................... 302
10.6 An Overview of the Capital Investment Decision Process....................... 304
10.7 Capital Rationing................................................................................... 305
Theme Wrap-Up: Estimating a Project’s Cash Flows and Assessing Risk........ 306
Key Concepts................................................................................................. 307
End-of-Chapter Questions.............................................................................. 308
End-of-Chapter Problems............................................................................... 309

Part IV: Reporting Results

Chapter 11 Reporting Profits.............................................................................. 315

Theme Set-Up: Interpreting an Income Statement.......................................... 315
Learning Objectives........................................................................................ 316
11.1 Introduction........................................................................................... 317
11.2 Financial Accounting.............................................................................. 317
11.3 Historical Foundation............................................................................. 318
11.4 Financial Statement Regulation and Standards....................................... 319
11.5 Reporting Methods................................................................................. 321
11.6 Income Statement Basics........................................................................ 324
11.7 Revenues................................................................................................. 326
11.8 Expenses................................................................................................. 331
11.9 Operating Income.................................................................................. 334
11.10 Nonoperating Income........................................................................... 336
11.11 Net Income.......................................................................................... 338
11.12 Net Income Versus Cash Flow.............................................................. 340
11.13 Income Statements of Investor-Owned Firms....................................... 342
11.14 A Look Ahead: Financial Condition Analysis........................................ 342
Theme Wrap-Up: Interpreting an Income Statement...................................... 344
Key Concepts................................................................................................. 344
End-of-Chapter Questions.............................................................................. 346
End-of-Chapter Problems............................................................................... 347

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 xiv Detailed Contents

Chapter 12 Reporting Assets, Financing, and Cash Flows................................... 350

Theme Set-Up: Understanding the Balance Sheet and
the Statement of Cash Flows.................................................................. 350
Learning Objectives........................................................................................ 351
12.1 Introduction........................................................................................... 352
12.2 Balance Sheet Basics............................................................................... 352
12.3 Assets...................................................................................................... 357
12.4 Liabilities................................................................................................ 363
12.5 Equity (Net Assets)................................................................................. 365
12.6 Fund Accounting.................................................................................... 369
12.7 The Statement of Cash Flows.................................................................. 371
12.8 A Look Ahead: Financial Statement Analysis.......................................... 375
Theme Wrap-Up: Understanding the Balance Sheet and
the Statement of Cash Flows.................................................................. 376
Key Concepts................................................................................................. 377
End-of-Chapter Questions.............................................................................. 378
End-of-Chapter Problems............................................................................... 379

Chapter 13 Assessing Financial Condition.......................................................... 382

Theme Set-Up: Techniques for Evaluating Financial Statements.................... 382
Learning Objectives........................................................................................ 383
13.1 Introduction........................................................................................... 384
13.2 Financial Statement Analysis................................................................... 384
13.3 Interpreting the Statement of Cash Flows............................................... 385
13.4 Ratio Analysis......................................................................................... 388
13.5 Comparative and Trend Analysis............................................................ 400
13.6 DuPont Analysis..................................................................................... 404
13.7 Other Analytical Techniques.................................................................. 406
13.8 Limitations of Financial Statement Analysis............................................ 407
Theme Wrap-Up: Techniques for Evaluating Financial Statements................ 409
Key Concepts................................................................................................. 409
End-of-Chapter Questions.............................................................................. 410
End-of-Chapter Problems............................................................................... 411

Glossary.................................................................................................................. 417
Index........................................................................................................................ 433
About the Authors............................................................................................... 455

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 PREFACE

A
lmost 30 years ago, Louis C. Gapenski published his first healthcare finance text-
book, Understanding Healthcare Financial Management. Over time, his experiences
prompted him to write others, including this book, Fundamentals of Healthcare
Finance. When he passed away on April 20, 2016, the field of healthcare finance lost a
gifted scholar, writer, teacher, mentor, and friend.
By traditional academic metrics, Lou was a successful scholar: many peer-reviewed
articles, other publications and book reviews, and presentations at academic and profes-
sional conferences. However, Lou was best known for his compendium of best-selling
textbooks on corporate finance and healthcare financial management. His collaboration
with Eugene Brigham served as a textbook factory: Lou was a coauthor of five editions of
Financial Management: Theory and Practice (translated into Bulgarian, Chinese, French,
Indonesian, Italian, Portuguese, and Spanish), six editions of Intermediate Financial Manage-
ment, and five editions of Cases in Financial Management (all three from Dryden Press). In
the early 1990s, Lou turned his attention to the nascent discipline of healthcare financial
management and was among the first to argue that the theory and application of corporate
finance was both relevant and necessary to the training of healthcare managers. Over the
next 25 years, Lou authored seven editions of Understanding Healthcare Financial Manage-
ment, five editions of Cases in Healthcare Finance, six editions of Healthcare Finance: An
Introduction to Accounting and Financial Management, and two editions of Fundamentals of
Healthcare Finance (all four from Health Administration Press). By any standard, this was
an extraordinary level of textbook productivity and was a constant source of amazement
and curiosity among his colleagues.

xv

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