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Photocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Fifth Edition First Page -1, (1) Lines: 0 to 22 ——— 487.212pt PgVar ——— Normal Page PgEnds: PageBreak -1, (1) BOOKCOMP, Inc. — Health Administration Press / Pagei/3rdproof/ Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. AUPHA HAP Editorial Board Leonard Friedman, Ph.D., Chair Oregon State University G. Ross Baker, Ph.D. University of Toronto Caryl Carpenter, Ph.D. Widener University -2, (2) Barry Greene, Ph.D. University of Iowa Lines: 22 to 115 Richard S. Kurz, Ph.D. ——— Saint Louis University 25.393pt PgVa ——— Sarah B. Laditka, Ph.D. Normal Page University of South Carolina PgEnds: PageBreak Stephen S. Mick, Ph.D., CHE Virginia Commonwealth University -2, (2) Michael A. Morrisey, Ph.D. University of Alabama-Birmingham Peter C. Olden, Ph.D. University of Scranton Janet E. Porter, Ph.D. Dana-Farber Cancer Institute Sandra Potthoff, Ph.D. University of Minnesota Lydia M. Reed AUPHA Sharon B. Schweikhart, Ph.D. The Ohio State University Nancy H. Shanks, Ph.D. Metropolitan State College of Denver Dean G. Smith, Ph.D. University of Michigan BOOKCOMP, Inc. — Health Administration Press / Page ii / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. UNDERSTANDING HEALTHCARE FINANCIAL -3, (3) MANAGEMENT Lines: 115 to 153 Fifth Edition ——— 128.01999pt PgVar ——— Normal Page PgEnds: Eject -3, (3) Louis C. Gapenski In Collaboration with George H. Pink Health Administration Press, Chicago, Illinois AUPHA, Washington, DC AUPHA HAP BOOKCOMP, Inc. — Health Administration Press / Page iii / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. Your board, staff, or clients may also benefit from this book’s insight. For more information on quantity discounts, contact the Health Administration Press Marketing Manager at (312) 424-9470. This publication is intended to provide accurate and authoritative information in regard to the subject matter covered. It is sold, or otherwise provided, with the understanding that the publisher is not engaged in rendering professional services. If professional advice or other expert assistance is required, the services of a competent professional should be sought. The statements and opinions contained in this book are strictly those of the author(s) and -4, (4) do not represent the official positions of the American College of Healthcare Executives, of the Foundation of the American College of Healthcare Executives, or of the Association of University Programs in Health Administration. Lines: 153 to 248 Copyright © 2007 by the Foundation of the American College of Healthcare Executives. ——— Printed in the United States of America. All rights reserved. This book or parts thereof may 27.209pt PgVa not be reproduced in any form without written permission of the publisher. Opinions and ——— views expressed in this book are those of the author and do not necessarily reflect those Normal Page of the Foundation of the American College of Healthcare Executives or the Association of PgEnds: Eject University Programs in Health Administration. 1110090807 54321 -4, (4) The paper used in this publication meets the minimum requirements of American National Standards for Information Sciences—Permanence of Paper for Printed Library Materials, ™ ANSI Z39.48–1984.   Library of Congress Cataloging-in-Publication Data Gapenski, Louis C. Understanding healthcare financial management / Louis C. Gapenski. — 5th ed. p. cm. Includes bibliographical references and index. ISBN-13: 978-1-56793-264-5 ISBN-10: 1-56793-264-9 (alk. paper) 1. Health facilities—Business management. 2. Health facilities—United States—Business management. 3. Medical care—United States—Finance. 4. Health services administration—Economic aspects—United States. I. Title. RA971.3.G37 2006 362.11068'1—dc21 2006049050 Project Manager: Jane Calayag; Acquisition Editor: Janet Davis; Web Icon Designer: Robert Rush Health Administration Press Association of University Programs A division of the Foundation in Health Administration of the American College of 2000 14th Street North Healthcare Executives Suite 780 Arlington, VA 22201 1 North Franklin Street, Suite 1700 Chicago, IL 60606-3491 (703) 894-0940 (312) 424-2800 BOOKCOMP, Inc. — Health Administration Press / Page iv / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. BRIEF CONTENTS First Page Preface xiii -5, (1) PART I The Healthcare Environment Lines: 0 to 53 ——— 1 Introduction to Healthcare Financial Management............. 3 55.30106pt PgVar ——— 2 The Third-Party-Payer System.............................. 41 Normal Page PgEnds: PageBreak PART II Basic Financial Management Concepts -5, (1) 3 Time Value Analysis ....................................... 79 4 Financial Risk and Required Return ........................ 115 PART III Capital Acquisition 5 Debt Financing .......................................... 153 6 Equity Financing and Investment Banking .................. 191 7 Securities Valuation, Market Efficiency, and Debt Refunding .. 221 8 Lease Financing.......................................... 261 PART IV Cost of Capital and Capital Structure 9 Cost of Capital .......................................... 293 10 Capital Structure Decisions................................ 333 BOOKCOMP, Inc. — Health Administration Press / Pagev/3rdproof/ Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. 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PART V Capital Allocation 11 The Basics of Capital Budgeting ........................... 377 12 Project Risk Analysis...................................... 423 PART VI Financial Condition Analysis and Forecasting 13 Financial Condition Analysis .............................. 463 14 Financial Forecasting ..................................... 501 -6, (2) PART VII Other Topics Lines: 53 to 88 15 Working Capital Management ............................. 539 ——— 234.85603pt P 16 Business Valuation, Mergers, and Acquisitions ............... 575 ——— Normal Page PgEnds: PageBreak 17 Capitation, Rate Setting, and Risk Sharing .................. 613 18 Financial Risk Management ............................... 647 -6, (2) Glossary 679 Index 697 About the Authors 715 BOOKCOMP, Inc. — Health Administration Press / Page vi / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. 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DETAILED CONTENTS -7, (3) Preface xiii Lines: 88 to 154 PART I The Healthcare Environment ——— 0.54802pt PgVar 1 Introduction to Healthcare Financial Management............. 3 ——— Normal Page The Role of Financial Management in the Health Services Industry, 6; PgEnds: T X E Current Challenges, 8; Alternative Forms of Business Organization, 8; Hybrid Forms of Organization, 11; Alternative Forms of -7, (3) Ownership, 13; Organizational Structures, 17; Organizational Goals, 20; Tax Laws, 24; Depreciation, 32 2 The Third-Party-Payer System.............................. 41 Insurance Concepts, 42; Generic Reimbursement Methods, 49; Major Health Insurers (Third-Party Payers), 56; Other Issues, 69 PART II Basic Financial Management Concepts 3 Time Value Analysis ....................................... 79 Time Lines, 80; Future Value of a Lump Sum (Compounding), 81; Present Value of a Lump Sum (Discounting), 87; Opportunity Costs, 90; Solving for Interest Rate and Time, 92; Annuities, 94; Perpetuities, 99; Uneven Cash Flow Streams, 100; Using Time Value Analysis to Measure ROI, 102; Semiannual and Other Compounding Periods, 105; A Review of Interest Rate Types, 110 4 Financial Risk and Required Return ........................ 115 The Many Faces of Financial Risk, 115; Introduction to Financial Risk, 116; Portfolio Risk and Return, 124; Portfolio Risk of Business BOOKCOMP, Inc. — Health Administration Press / Page vii / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. 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Investments, 133; Portfolio Risk of Stocks (Entire Businesses), 139; Portfolio Betas, 140; Relevance of the Risk Measures, 141; Interpretation of the Risk Measures, 143; The Relationship Between Risk and Return, 143; Some Thoughts About Beta and the CAPM, 147 PART III Capital Acquisition 5 Debt Financing .......................................... 153 The Cost of Money, 153; Interest Rate Levels, 155; Long-Term Debt, 156; Term Loans, 157; Bonds, 158; Short-Term Debt, 163; Debt Contracts, 169; Credit Ratings, 171; Credit Enhancement, 174; -8, (4) Interest Rate Components, 175; The Term Structure of Interest Rates, 180; Economic Factors That Influence Interest Rate Levels, 182; Lines: 154 to 226 Advantages and Disadvantages of Debt Financing, 184 ——— -12.92497pt P 6 Equity Financing and Investment Banking .................. 191 ——— Long Page Preferred Stock, 191; Rights and Privileges of Common PgEnds: T X E Stockholders, 194; Classified Stock, 197; Selling New Common Stock, 198; The Decision to Go Public, 203; The Decision to List, 205; -8, (4) Advantages and Disadvantages of Common Stock Financing, 206; Securities Regulation and the Investment Banking Process, 207; Equity in Not-for-Profit Firms, 214 7 Securities Valuation, Market Efficiency, and Debt Refunding .. 221 The General Valuation Model, 222; Debt Valuation, 223; Preferred Stock Valuation, 236; Common Stock Valuation, 237; Security Market Equilibrium, 247; Informational Efficiency, 248; The Risk/Return Trade-off, 251; Debt Refunding, 252 8 Lease Financing.......................................... 261 Lease Parties and Types, 261; Tax Effects, 264; Financial Statement Effects, 266; Evaluation by the Lessee, 269; Evaluation by the Lessor, 277; Lease Analysis Symmetry, 279; Setting the Lease Payment, 280; Leveraged Leases, 280; Motivations for Leasing, 282; Additional Issues, 285 PART IV Cost of Capital and Capital Structure 9 Cost of Capital .......................................... 293 Overview of the Cost of Capital Estimation Process, 293; Estimating the Cost of Debt, 295; Estimating the Cost of Equity to Large BOOKCOMP, Inc. — Health Administration Press / Page viii / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. Investor-Owned Businesses, 298; Estimating the Cost of Equity to Not-for-Profit Businesses, 311; Estimating the Corporate Cost of Capital, 316; An Economic Interpretation of the Corporate Cost of Capital, 318; Flotation Costs, 321; Divisional Costs of Capital, 322; Warning Warning Warning, 323; Cost of Capital Estimation for Small Businesses, 324; Factors That Influence a Business’s Cost of Capital, 327 10 Capital Structure Decisions................................ 333 Impact of Debt Financing on Risk and Return, 334; Business and -9, (5) Financial Risk, 337; Capital Structure Theory, 341; Criticisms of the MM and Miller Models, 350; Financial Distress Costs, 351; Trade-off Models, 352; Asymmetric Information Model of Capital Structure, 355; Lines: 226 to 294 A Summary of the Capital Structure Models, 357; Application of ——— Capital Structure Theory to Not-for-Profit Firms, 359; Making the 1.86801pt PgVar Capital Structure Decision, 361; Capital Structure Decisions for Small ——— Investor-Owned Businesses, 364; The Debt Maturity Decision, 365 Long Page PgEnds: T X E PART V Capital Allocation -9, (5) 11 The Basics of Capital Budgeting ........................... 377 Project Classifications, 378; The Role of Financial Analysis in Health Services Capital Budgeting, 379; Overview of Capital Budgeting Financial Analysis, 380; Cash Flow Estimation, 381; Cash Flow Estimation Example, 389; Breakeven Analysis, 397; Return on Investment Analysis, 399; Some Final Thoughts on Breakeven and Profitability Analysis, 405; Evaluating Projects with Unequal Lives, 406; Economic Life Versus Physical Life (Abandonment Value), 410; Capital Budgeting in Not-for-Profit Businesses, 412; The Post-Audit, 416; Using Capital Budgeting Techniques in Other Contexts, 416 12 Project Risk Analysis...................................... 423 Types of Project Risk, 424; Relationships Among Stand-Alone, Corporate, and Market Risks, 425; Risk Analysis Illustration, 427; Sensitivity Analysis, 429; Scenario Analysis, 432; Monte Carlo Simulation, 435; Qualitative Risk Assessment, 438; Incorporating Risk into the Decision Process, 439; Final Risk Assessment and Incorporation for the MRI Project, 442; Incorporating Debt Capacity into the Decision Process, 443; Adjusting Cash Outflows for Risk, 444; Real (Managerial) Options, 446; The Real Option of Abandonment, 449; An Overview of the Capital Budgeting Decision Process, 453; Capital Rationing, 455 BOOKCOMP, Inc. — Health Administration Press / Page ix / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. PART VI Financial Condition Analysis and Forecasting 13 Financial Condition Analysis .............................. 463 Financial Reporting in the Health Services Industry, 464; Financial Statement Analysis, 470; Ratio Analysis, 470; Tying the Ratios Together: Du Pont Analysis, 481; Common Size Analysis, 483; Percentage Change Analysis, 484; Operating Indicator Analysis, 485; Limitations of Financial Statement and Operating Indicator Analyses, 489; Economic Value Added, 491; Benchmarking, 492; Key Performance Indicators and Dashboards, 494 -10, (6) 14 Financial Forecasting ..................................... 501 Lines: 294 to 345 Strategic Planning, 501; Operational Planning, 504; Financial ——— Planning, 504; Revenue Forecasts, 507; Creating Forecasted Financial 25.60402pt Pg Statements, 510; Constant Growth Forecasting, 511; Factors That ——— Influence the External Financing Requirement, 517; Problems with the Normal Page Constant Growth Approach, 520; Real-World Forecasting, 521; PgEnds: PageBreak Computerized Financial Forecasting Models, 525; Financial Controls, 526; The Cash Budget, 527 -10, (6) PART VII Other Topics 15 Working Capital Management ............................. 539 Cash Management, 540; Marketable Securities Management, 544; Long-Term Securities Management, 546; Receivables Management, 547; Credit Policy, 553; Supply Chain Management, 556; The Economic Ordering Quantity Model, 559; Accruals, 563; Accounts Payable (Trade Credit), 564 16 Business Valuation, Mergers, and Acquisitions ............... 575 Level of Merger Activity, 575; Motives for Mergers: The Good, the Bad, and the Ugly, 578; Types of Mergers, 582; Hostile Versus Friendly Takeovers, 583; Merger Regulation, 584; Mergers Involving Not-for-Profit Businesses, 588; Business Valuation, 590; Unique Problems in Valuing Small Businesses, 596; Setting the Bid Price, 598; Structuring the Takeover Bid, 600; Due Diligence Analysis, 602; The Role of Investment Bankers, 602; Who Wins? The Empirical Evidence, 604; Corporate Alliances, 606; Goodwill, 607 BOOKCOMP, Inc. — Health Administration Press / Pagex/3rdproof/ Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. 17 Capitation, Rate Setting, and Risk Sharing .................. 613 An Overview of Capitation, 614; Provider Incentives Under Capitation, 615; Financial Risk Under Capitation, 617; Development of Premium Rates, 626; Risk-Sharing Arrangements, 634 18 Financial Risk Management ............................... 647 Fundamentals of Financial Risk Management, 648; Risk Management of Capitated Contracts, 651; Debt Portfolio Immunization, 657; An Overview of Derivatives, 661; Options, 663; Futures, 668; Swaps, 671; -11, (7) The Use and Misuse of Derivatives, 673 Glossary 679 Lines: 345 to 375 ——— Index 697 364.37602pt PgVar ——— About the Authors 715 Normal Page PgEnds: PageBreak -11, (7) BOOKCOMP, Inc. — Health Administration Press / Page xi / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. -12, (8) Lines: 375 to 376 ——— 0.0pt PgVar ——— Normal Page PgEnds: T X E -12, (8) BOOKCOMP, Inc. — Health Administration Press / Page xii / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. PREFACE First Page fter years of teaching corporate finance and writing related textbooks -13, (1) and casebooks, I began teaching the healthcare financial management Acourse in the University of Florida’s Graduate Program in Health and Lines: 0 to 19 Hospital Administration. The first thing that struck me was that no textbook ——— was available that truly focused on healthcare financial management. To me, 5.444pt PgVar financial management primarily involves analysis and decision making, yet the ——— textbooks available at the time mostly covered accounting and institutional Normal Page detail, with only a very limited number of pages devoted to financial manage- PgEnds: T X E ment. Thus, I set about creating a textbook that emphasized (1) financial -13, (1) management rather than accounting and (2) analysis and decision making rather than institutional detail. In creating this textbook, I set out to do two things. First, I adopted a very broad definition of the health services industry that included medical practices, managed care organizations, nursing homes, and home health care providers, in addition to hospitals. Today, more and more health services administration students are electing careers outside the hospital industry, and it is important that a textbook on healthcare financial management presents a broad range of provider settings. Second, I identified the environmental factors that are unique to the health services industry and hence make healthcare financial management different from corporate finance. Then, I made sure that these factors played an important role in the textbook discussions. Concept of the Textbook My goals in writing the first edition were to create a textbook that provided health services administration students with (1) an operational knowledge of financial management theory and concepts, (2) the opportunity to apply these ideas to real-world healthcare business settings, and (3) the opportunity to use spreadsheet analyses to help make better financial decisions. Additionally, I wanted to create a textbook that could be used as a reference during intern- ships and residencies as well as after graduation. Finally, I wanted a textbook that students would find user friendly, meaning one that they would enjoy xiii BOOKCOMP, Inc. — Health Administration Press / Page xiii / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. xiv P r eface reading and could learn from on their own. If students don’t find a textbook interesting, understandable, and useful, they won’t read it This fifth edition of the textbook continues to meet those goals. It be- gins with basic concepts about both the health services industry and financial management. The textbook then progresses to show how financial manage- ment theory and concepts can be applied to healthcare businesses to help managers make better decisions, where “better” is defined as promoting the financial well-being of the organization. Intended Market and Use -14, (2) The textbook is targeted for the healthcare financial management course required in graduate programs in health services administration. Students typically have some background in basic business topics such as financial and Lines: 19 to 33 managerial accounting, probability and statistics, spreadsheet analysis, and ——— perhaps even corporate finance. However, the textbook contains a great deal 0.0pt PgVar of background information in these areas, and it can be used in programs ——— where students have not had prior exposure to business topics. The textbook Normal Page is useful also to healthcare professionals, including both those holding general PgEnds: T X E management positions and those working as members of financial staffs. -14, (2) Alternative Course Formats There is no single best approach to teaching a healthcare financial manage- ment course. The optimal approach varies with students’ backgrounds, in- structors’ interests, class contact hours, and the role of the course in the overall curriculum. Because these factors change, most instructors vary their approaches over time. Still, it may be useful to adopters to learn how the textbook has been used at the University of Florida. In the Florida program, students first take an introductory healthcare finance course that covers both accounting and financial management. The healthcarefinancialmanagementcourseisthesecond,andfinal,financecourse in the curriculum unless a student elects to take an advanced independent study course. The second financial management course in any curriculum gen- erally is taught either as a theoretically based lecture course, as a pragmatically based pure case course, or as a blend of theory and practice where lectures are combined with some cases. Over time, I have used all three approaches, but the one that I have found best is a blend of theory and practice, but with a strong bias toward practice. Thus, I lecture occasionally but use a large num- ber of cases to provide insights into the complex financial decisions faced by practicing healthcare managers. Understanding Healthcare Financial Management provides both the theory and concepts behind financial decision making in the health services industry and the “nuts and bolts” tools required to implement the theory BOOKCOMP, Inc. — Health Administration Press / Page xiv / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. P r eface xv and concepts. Students learn the theory and concepts of healthcare financial management from the textbook and periodic lectures and then implement the material by working cases. In the first two editions, the cases were contained in the textbook. However, the editorial and production burden of having both textbook and casebook in a single edition created constraints that became too confining. The publisher and I agreed that the optimal solution to this problem was to separate the cases from the textbook, which we implemented in the third edition. I will have much more to say about this decision later in the preface. I cover most of the textbook, along with 12 cases (one per week, after some introductory material), in a one-semester course. In addition, I -15, (3) typically include a few accounting-oriented cases from the casebook as a re- fresher. However, the dominant theme is financial management because a well-grounded understanding of financial decision making is more important Lines: 33 to 44 for most students than a better understanding of accounting. Also, our stu- ——— dents are studying to be general managers, not financial staff specialists, and 0.0pt PgVar hence I am willing to sacrifice depth to expose students to a large range of ——— topics. The course runs fast and furious, but this tends to keep students, and Normal Page instructors, on their toes and in high gear. PgEnds: T X E Although the textbook is designed for use in the second course in financialmanagement,agreatdealofintroductorymaterialhasbeenincluded. -15, (3) In spite of the fact that the Florida students have already had one finance course, I have found that many of them still do not have a good grasp of the basic fundamentals of financial management. Thus, they appreciate the fact thatUnderstandingHealthcareFinancialManagement reviewsbasicconcepts in addition to presenting new material. After all, repetition is the key to learning. Because the textbook contains so much introductory material, it is also suitable for use in courses in which students have not had an introductory financecourse,includingtwo-coursesequences.Inthissituation,Iwouldtend to go slower to give students more time to digest the material, and the lectures would be more frequent and extensive to ensure that students really know the fundamentals before working the cases, which would be fewer in number. In a two-course sequence, instructors can easily supplement the textbook with outside readings and/or additional cases. Changes in the Fifth Edition Since the fourth edition of the textbook was published, I have used the text- book several times in courses I have taught and have received many comments fromusersatotheruniversities.Furthermore,HealthAdministrationPresshas solicited and received a number of thoughtful reviews. The reaction of stu- dents, other professors, and the market in general has been overwhelmingly positive—every comment indicates that the basic concept of the textbook is BOOKCOMP, Inc. — Health Administration Press / Page xv / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. xvi P r eface sound. Even so, nothing is perfect, and the health services industry is evolving at a dizzying pace. These circumstances have led to a number of changes to the textbook; the most important of which are listed below: • First and foremost, this edition was written in collaboration with George H. Pink, a well-known healthcare finance professor at the University of North Carolina at Chapel Hill. George brings new insights to the book that, over time, will have a profound and positive impact. • Time value calculations, particularly in Chapter 3, now focus exclusively on spreadsheets, with pictorials used to illustrate solution techniques. Students overwhelmingly state that because they do not use financial -16, (4) calculators for time value problems, the inclusion of calculator solutions was a distraction. Note, however, that a calculator tutorial is available as an ancillary to the text. Lines: 44 to 75 • Many students, as well as instructors, have asked that a glossary be added ——— to the book. This edition has one. -0.021pt PgVa • A new chapter, Chapter 19: Distributions to Owners: Bonuses, Dividends, ——— and Repurchases, has been added as an ancillary. It is available online. Normal Page • Short introductions have been added to each part page to introduce the PgEnds: T X E topics contained in the chapters of that part. • All aspects of the text discussion as well as references have been updated -16, (4) and clarified as needed. Particular care was taken to include the most recent reimbursement changes and to update the real-world examples. • New sections have been added or existing sections have been expanded for the following topics: municipal bond pools, cost of capital for not-for-profit and small businesses, modified IRR, subjective risk assessment, supply chain management, stop-loss insurance, current challenges for healthcare managers, and health savings accounts. Ancillary Materials Several ancillary materials have been designed to enhance the learning expe- rience associated with this text. MaterialsforInstructors Two very useful ancillaries are available to instructors who adopt this text: 1. Slideshow. A set of PowerPoint® slides that cover the essential topics contained in each chapter is available. Concepts, graphs, tables, lists, and calculations are presented in about 40 slides per chapter, much as an instructor might do on a blackboard. However, the slides are more crisp, clear, and colorful and can be displayed on a screen almost instantaneously. Furthermore, hard copies of the slides can be provided to students for use as lecture notes, which I have found that students truly appreciate. Many BOOKCOMP, Inc. — Health Administration Press / Page xvi / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. P r eface xvii instructors will find these slides useful, either as is or as customized to best meet unique course and student requirements. 2. End-of-chapter problem solutions. As indicated below, a set of problems in spreadsheet format is available for most chapters. These problem sets, which focus on key concepts, can be assigned as graded homework or used in any way that the instructor desires. A section at the end of each chapter indicates when problems are available. MaterialsforStudentsandInstructors Four useful ancillaries are available to students (and instructors) who use this text: -17, (5) 1. Text models. Most of the chapters in the text have accompanying Lines: 75 to 103 Excel® models that illustrate the text calculations as well as additional ——— calculations that are relevant to the chapter material. The purpose of 11.979pt PgVar these spreadsheet models is twofold. First, students can learn the material ——— better because they can more easily visualize how various input factors Normal Page influence a particular calculation. For example, the spreadsheet model PgEnds: Eject for capital budgeting allows students to change input values, such as volume and average reimbursement, and immediately see the effects -17, (5) on profitability. Second, the spreadsheets permit students to learn the mechanics of spreadsheet analysis in a less challenging context than the cases (discussed below) because these models typically are not part of a graded assignment. Note that sections of the text that have accompanying models are designated by a web icon: . Also, a section at the end of each chapter indicates when text models are available. 2. End-of-chapter problems. A set of problems in spreadsheet format is available for most chapters. The problems may be assigned by the instructor as homework or worked by students on their own to gain an additional understanding of the topics in the chapter. A section at the end of each chapter indicates when problems are available. 3. Calculator tutorial. A short tutorial is available for those students who use financial calculators to solve time value problems. 4. Chapter 19. This chapter, Distributions to Owners: Bonuses, Dividends, and Repurchases, is available online either to instructors for coverage in class or to students for independent learning. ObtainingtheAncillaryMaterials All student ancillary materials can be accessed on this book’s companion web- site: ache.org/UnderstandingFinancialManagement5. Instructor ancillaries, which are contained in a secure area, are available only to adopters of this text. For access information, e-mail hap1ache.org. BOOKCOMP, Inc. — Health Administration Press / Page xvii / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. xviii P r eface TheCasebook In addition to the free ancillaries, many adopters pair this textbook with its accompanying casebook, Cases in Healthcare Finance. Of course, the most realistic application of healthcare finance occurs within health services orga- nizations, and there is no substitute for on-the-job experience. The next best thing, and the only real option for the classroom, is to use cases to simulate, to the extent possible, the environment in which finance decisions are actually made. Cases provide students with the opportunity to bridge the gap between learning concepts in a lecture setting and actually applying them on the job. By using cases, students can be better prepared to deal with the multitude of problems that arise in the practice of healthcare financial management. -18, (6) Cases in Healthcare Finance, 3rd edition, contains 30 cases that focus on the practice of healthcare finance, including accounting, within provider Lines: 103 to 116 organizations. In general, each case addresses a single financial issue, such as a capital investment decision; but the uncertainty of the input data, along with ——— 10.0pt PgVar the presence of relevant nonfinancial factors, makes each case interesting and ——— challenging. The case settings include a wide variety of provider organizations, Normal Page including integrated delivery systems and managed care organizations. In ad- PgEnds: T X E dition to cases that focus purely on financial decisions, the casebook contains eight mini-cases on ethics. The mini-cases are not quantitative in nature but -18, (6) rather are designed to promote discussion about a finance situation that has potential ethical implications. In general, cases may be classified as directed or nondirected. Directed cases include a specific set of questions that students must answer to complete the case, while nondirected cases (as I use the term) contain only general guidance to point students in the right direction. Most of the cases in the casebook are nondirected. The primary advantage of nondirected cases is that they closely resemble how real-world managers confront financial decision making because they require students to develop their own solution approach. The disadvantage is that students who stray from the key issues of the case often do not obtain full value from their effort. I have found that students with more advanced finance skills gain the most from nondirected cases, while students that have had less finance exposure gain most from directed cases. The online Instructor’s Manual for the casebook contains a set of case questions that can be used to convert each nondirected case to a directed case. Thus, instructors have the option of using the nondirected cases in either way, depending on the experience of the students, the objectives of the course, and the extent to which cases will be used. Spreadsheet analysis has become extremely important in all aspects of healthcare finance. Students must be given the opportunity to develop com- puter skills and be allowed, or required, to use spreadsheet programs to assist in case analyses. If students have not previously learned about spreadsheets, BOOKCOMP, Inc. — Health Administration Press / Page xviii / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. P r eface xix they must be exposed to them because functional literacy in any area of man- agement today means at least some knowledge of spreadsheet modeling. Fur- thermore, spreadsheet models can reduce the amount of “busywork” required to perform the required calculations and hence leave students with more time to focus on financial management issues. Because of these factors, I developed well-structured, user-friendly spreadsheet models for those cases where models would help to create a more efficient analysis. Most of the cases can, of course, be done with a calculator, but the spreadsheet models are far more efficient and hence big time-savers, especiallywhenconductingriskassessmentusingtechniquessuchassensitivity and scenario analyses. In addition, spreadsheet models allow students to easily -19, (7) create graphics and other computer outputs that enhance the quality of both the analyses and any required presentations. The student versions of the case models are complete in the sense that Lines: 116 to 143 no modeling is required to obtain a base case solution. However, zeros have ——— been entered for all input data, and hence students must identify and then -2.0pt PgVar enter the appropriate input values. When this is done, the model automatically ——— calculates the base case solution. However, the models do not contain risk Normal Page analyses or other extensions such as graphics, so students must modify the PgEnds: T X E models as necessary to make them most useful in completing the cases. The instructor versions of the case models are similar to the student -19, (7) versions, except that the input values are intact. Thus, instructors can view the base case solution without entering any data. In addition, some instructor version models have additional modeling, such as risk analyses, included. The instructor versions of the case models are distributed with the online Instructor’s Manual to the casebook. Health Administration Press is keenly aware of the increasing financial burden that students face as course materials escalate in both quantity and price. The casebook is discounted 20 percent when purchased with this text. For more information, call Health Administration Press at (301) 362–6905 or e-mail happmds.com. Acknowledgments This book reflects the efforts of many people. First, I would like to welcome George Pink as a collaborator. His work on the text and ancillaries has been invaluable. Furthermore, my thanks go to the following individuals, who re- viewed previous editions of the textbook and provided many valuable com- ments and suggestions for improving it: Doug Conrad of the University of Washington Tom Getzen of Temple University Mike McCue of Virginia Commonwealth University Dean Smith of the University of Michigan Jack Wheeler of the University of Michigan BOOKCOMP, Inc. — Health Administration Press / Page xix / 3rd proof / Understanding Healthcare Financial Management 5th ed. / GapenskiPhotocopying and distributing this PDF is prohibited without the permission of Health Administration Press. For permission, please fax your request to (312) 424-0014 or e-mail hap1ache.org. xx P r eface Also, special thanks are due to Mike McCue and Jack Wheeler, who coauthored some sections. Colleagues, students, and staff at the University of Florida provided in- spirational support, as well as more tangible support, during the development and class testing of each edition of the textbook. And last, but certainly not least, I would like to thank the Health Administration Press staff, who were instrumental in ensuring the quality and usefulness of the textbook. Errors in the Textbook Last Page In spite of the significant effort that has been expended on this edition, it -20, (8) is safe to say that some errors exist. In an attempt to create the most error- free and useful textbook possible, we strongly encourage both instructors and students to write me at the address below with comments and suggestions for Lines: 143 to 172 improving the textbook. We welcome and value your input ——— 149.837pt PgV ——— Conclusion Normal Page Good financial management is vital to the economic well-being of the health PgEnds: T X E services industry. Because of its importance, financial management theory and concepts should be thoroughly understood, but this is easier said than done. -20, (8) We hope that Understanding Healthcare Financial Management will help you better appreciate the financial management problems faced by the health services industry today and that it will provide guidance on how best to solve them. Louis C. Gapenski, Ph.D. Submit comments to: Box 100195 Health Science Center University of Florida Gainesville, FL 32610-0195 BOOKCOMP, Inc. — Health Administration Press / Page xx / 3rd proof / Understanding Healthcare Financial Management 5th ed. / Gapenski

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