Financial Management of Health Care Organizations An Introduction 4th edition, Zelman

1. Working Capital
Management
Chapter 5

2. Learning Objectives
• Define working capital and the revenue cycle
• Understand working capital and revenue cycle management
• Construct a cash budget
• Understand receivables and payables management

3. Working Capital
• Working capital refers to both current assets and current
liabilities
• Net working capital refers to the difference between current
assets and current liabilities
• In day to day operations there is an ongoing flow of cash
incoming and outgoing
• In healthcare payments where payment for services may be
out 2 months or more, there must be sufficient cash on hand
to pay bills

4. Working Capital Cycle

5. Working Capital Management
Strategies
• Defined as the amount of working capital an organization
must keep as a cushion
• 2 components:
• Asset Mix-amount of working capital an organization keeps on
hand relative to its potential working capital obligations
• Financing Mix-how an organization chooses to finance its
working capital needs

6. Asset Mix Strategy
• Continuum between aggressive and conservative
• Aggressive-attempts to maximize returns by investing excess
funds in non-liquid assets expected to have high earnings
• Conservative-minimizes its risk of having insufficient short-term
funds by maintaining higher liquidity
Aggressive Conservative
Goal Maximize returns Minimize risk
Liquidity Low High
Risk High Low
Return High Low

7. Financing Mix Strategy
• 3 rules to follow to decide between short term and long term
borrowing to finance working capital needs:
• Finance short term working capital needs with short term
debt
• Finance long term working capital needs with long term
financing
• Finance fluctuating needs for working capital by employing a
mixed strategy
Short-Term Long–term
Interest Rate Lower Higher
Interest Cost Lower Higher
Profit Higher Lower
Volatility Risks Variable Fixed

8. Cash Management
• Refers to currency and cash equivalents (interest-bearing
savings and checking accounts
• 3 major reasons to hold cash:
• Daily operations purposes: meeting daily operations
purposes requires holding cash to pay day-to-day bills.
• Precautionary purposes: holding cash to meet unexpected
demands, such as unforeseen maintenance.
• Speculative purposes: holding cash to take advantage of
unexpected opportunities, such as buying a competing group
practice that has decided to sell.

9. Sources of Temporary Cash
• 2 primary sources of short term funds are:
1. Bank Loans-lines of credit, commitment fees, compensating
balances, transaction notes
2. Extension of credit from suppliers (trade payables)
Lines of credit:
a. Normal line of credit: an agreement established by a bank and a
borrower that establishes the maximum amount of funds that
may be borrowed and the bank may loan the funds at its own
freedom of choice.
b. Revolving line of credit: an agreement established by a bank and
a borrower that legally requires the bank to loan money to the
borrower at any time requested, up to a pre-negotiated limit.
commitment fees: is a percentage of the unused portion of the
credit line that is charged to the potential borrower.

10. Trade credit discount
• Compute the approximate annual interest cost of not taking a
discount, using each of the following scenarios?
a. 2/10 net 20
b. 2/10 net 30
c. 2/10 net 40
d. 2/10 net 50
e. 2/10 net 60
A
Discount
percent
B
Discount
period
(days)
C
Payment
due
(days)
D
Days/
Year
E
Approximate Interest Rate
[A/(1-A) x D/(C-B)
2% 10 20 365 74.5%
2% 10 30 365 37.2%
2% 10 40 365 24.8%
2% 10 50 365 18.6%
2% 10 60 365 14.9%

11. Trade credit discount
• Compute the approximate annual interest cost of not taking a
discount, using each of the following scenarios?
a. 1/15 net 20
b. 1/15 net 30
c. 1/15 net 40
d. 1/15 net 50
e. 1/15 net 60
A
Discount
percent
B
Discount
period
(days)
C
Payment
due
(days)
D
Days/
Year
E
Approximate Interest Rate
[A/(1-A) x D/(C-B)
1% 15 20 365 73.7%
1% 15 30 365 24.6%
1% 15 40 365 14.7%
1% 15 50 365 10.5%
1% 15 60 365 8.2%

12. Trade credit discount
• Compute the approximate annual interest cost of not taking a
discount, using each of the following scenarios?
a. 2/5 net 30
b. 2/10 net 30
c. 2/15 net 30
d. 2/20 net 30
A
Discount
percent
B
Discount
period
(days)
C
Payment
due
(days)
D
Days/
Year
E
Approximate Interest Rate
[A/(1-A) x D/(C-B)
2% 5 30 365 29.8%
2% 10 30 365 37.2%
2% 15 30 365 49.7%
2% 20 30 365 74.5%

13. • Compensating balances: the borrower is required to maintain a
designated dollar amount on deposit with the bank.
• The effect of compensating balance is to increase the true of effective
interest rate that the borrower must pay.
• 풆풇풇풆풄풕풊풗풆 풊풏풕풆풓풆풔풕 풓풂풕풆 =
(풊풏풕풆풓풆풔풕 풆풙풑풆풏풔풆 풐풏 풂풎풐풖풏풕 풃풐풓풓풐풘풆풅+풕풐풕풂풍 풇풆풆풔)
(풂풎풐풖풏풕 풃풐풓풓풐풘풆풅−풄풐풎풑풆풏풔풂풕풊풏품 풃풂풍풂풏풄풆)
• Transaction notes: is a short-term, unsecured loan made for some
specific purpose such as financing inventory purchases.
2. Trade Credit or Payables:
a. Trade credit: short term credit offered by the supplier of a good or
service to the purchaser.
b. Trade payables: short term debt that results from supplies
purchased on credit for a given length of time.
This allows an organization to use the supplier’s money to pay for
the purchase up until the time it pays the supplier the amount owed.

14. Example:
• On January 2, 20X1, Uptown Hospital established a line of
credit with First Union National Bank. The terms of the line of
credit called for a $400,000 maximum loan with an interest rate
of 3 percent. The compensating balance requirement is 5
percent of the total line of credit (with no additional fees
charged).
• What would be the effective interest rate for Uptown Hospital
if 50 percent of the total amount were used during the year?
• What would be the effective interest rate if only 25 percent of
the total loan were used during the year?
• How would the answer to question a change if the additional
fees were $500?
• How would the answer to question b change if the additional
fees were $1,000?

15. Solution:
A
Interest
rate
[Given]
B
Line of
credit
[Given]
C
Portion of
credit
borrowed
[Given]
D
Amount
borrowed
B x C
E
Interest
expense to
borrow
A x D
F
Additional
fees
[Given]
G
Compensating
balance
percent
[Given]
H
Compensatin
g balance
B X G
I
Effective
Interest
Rate
[(E+F)/(D-H)]
3% $400,000 50% $200,000 $6,000 $0 5% $20,000 3.3%
3% $400,000 25% $100,000 $3,000 $0 5% $20,000 3.8%
3% $400,000 50% $200,000 $6,000 $500 5% $20,000 3.6%
3% $400,000 25% $100,000 $3,000 $1000 5% $20,000 5.0%

16. Revenue Cycle Management
• Several hindrances can delay the billing process and collection of cash.
For example:
• 1. patients who use more than one name or who have had name
changes.
• Address change or no address or phone number on file.
• Lack of clarity about who is responsible for paying the bill, or outdated
insurance information.
• Specific requirements demanded by various insurers, such as
retrospective reviews.
• Successful cash management is driven by a billing process that must be
timely and accurate.
• Ensuring a timely and accurate billing process determines the success
of cash management

17. Revenue Cycle Management

18. Methods to Monitor Revenue Cycle
Performance

19. Example

20. Solution a.
Cost to Collect Accounts Receivable:
Unadjusted
Formula
A. Net patient revenues Given $225,000,000
B. Cash collections Given $210,000,000
C. Cash as percentage of net patient
revenues
[B / A] 93.3%
D. Costs incurred in collection Given $8,000,000
E. Cost to collect [D / B] 3.8%

21. Solution b.
Cost to Collect Accounts Receivable:
Adjusted for Human Intervention
Formula
F. Cash collections Given $210,000,000
G. Percentage cash collections requiring
Given 35%
human intervention
H. Cash collections incurring human
intervention
[F x G] $73,500,000
I. Costs incurred in collection Given $8,000,000
J. Less Electronic Data Interchange (EDI)
Given ($600,000)
costs
K. Revised costs incurred in collection [I - J] $7,400,000
L. Cost to collect for requiring human
[K / H] 10.1%
intervention
M. Cost to collect standard Given 3.0%

22. Interpretation:
• Penn's unadjusted cost to collect of 3.8% (Row E) is close to
the industry standard of 3% (Row M).
• However, after adjusting for those cash collections that
involve human intervention, the cost to collect
• rises dramatically to 10.1% (Row L), which is well above a 3%
standard.
• The hospital should invest in updating its software and
hardware IT services to try to improve its
• electronic data cash collections.
• This may require the provider to work within stricter health
plan claims requirements to achieve greater
• cash collections electronically, which in turn would decrease
the need for as much human intervention.

23. Collecting cash payments
• More and more of the payment responsibility with copays and
deductibles resides with the patient at time of service
• By electronically accepting cash payments, providers avoid the
costs of billing and carrying accounts receivable
• Additional avenues for collecting payments include: decentralized
collection centers, lockboxes, wire transfers

24. Investing Cash on a Short Term Basis
• Treasury Bills
• Negotiable Certificates of Deposit
• Commercial Paper
• Money Market Mutual Funds

26. Forecasting Cash Surpluses and Deficits
• In planning financially timing of cash flows in and out must
be known.
• Forecast of the above is useful for short term planning
• Cash Balance-The amount of cash an organization must have
on hand at the end of the current period to ensure that it has
enough cash to cover expected outflows during the next
forecasting period.

27. Accounts Receivable Management
• Most is paid by a third party payer making up about 75% of a
health care providers current assets
• Providers continuously face the problem of trying to control a
largely external process in order to ensure the timely payment of
accounts.
• Timely and accurate billing is essential and an internal process
• Aging schedule
• Receivables as a percentage of revenue is a means to judge the
management’s success in collecting revenues

28. Example

29. Givens (in '000)
1 Time Sep Aug Jul Quarter
2 Days outstanding 1-30 31-60 61-90 1-90
3 Net accounts receivable $5,000 $3,000 $12,000 $20,000
4 Net patient revenue $12,000 $6,000 $20,000 $38,000
Calculations: Formula Sep Aug Jul Quart
er
A. Aging schedule [a] 25% 15% 60%
B. Days [Given 2] 30 30 30 90
C. Average daily patient revenue [Given 4 / B] $400 $200 $667 $422
D. Days in accounts receivable [Given 3 / C] 47
E. Receivables as percent of
revenues
[Given 3 /
Given 4]
42% 50% 60%
[a] [Given 3] (month) / [Given 3] (quarter)

30. Givens (in '000)
5 Time Dec Nov Oct Quarter
6 Days outstanding 1-30 31-60 61-90 1-90
7 Net accounts receivable $13,000 $1,000 $6,000 $20,000
8 Net patient revenue $20,000 $6,000 $12,000 $38,00
Calculations: Formula Sep Aug Jul Quart
er
F. Aging schedule [b] 65% 5% 30%
G. Days [Given 6] 30 30 30 90
H. Average daily patient revenue [Given 8 / G] $667 $200 $400 $422
I. Days in accounts receivable [Given 7 / H] 47
J. Receivables as percent of
revenues
[Given 7 /
Given 8]
65% 17% 50%
[b] [Given 7] (month) / [Given 7] (quarter)

31. Fraud and Abuse
• Comply with laws and regulations related to patient billing,
cost reporting , physician transactions and occupational
health and safety to ensure fraud and abuse are eradicated.
• HHS, CMS and OIG have programs and approaches to help
minimize fraud and abuse as well as structure for compliance
programs

32. Summary
• Working capital is needed because it turns the capacity of a
health care organization into services and revenues.
• All health care organizations must have sufficient working
capital available to meet everyday needs.
• Working capital management strategies must chosen and
utilized to meet the financial needs of the health care
organization.