For-Profit Enterprise in Health Care (1986) / Chapter Skim
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3 Financial Capital and Health Care Growth Trends
3 Financial Capital and Health Care Growth Trends
Pages 47-73
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From page 47... ...
. Ta bles 3.1 and 3.2 show the balance sheets of two heal care organizations a not-for-profit HMO (the Harvard Community Health Pow)
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From page 48... ...
f Liabilities and Fund Balances (cumulative sources of funded Current Liabilities Accounts payable and accrued expenses Amounts payable to HCHP Fndn., Inc., net Accrued claims payable- hospitals and physicians Unearned premium revenue and advance payments Unearned grant revenues Current installments of long-term debt Total current liabilities Construction Costs Payable, from trusteed Finds Long-Term Debt, less current installments Fund Balances Operating funds Utilization reserve Operating and board-designed fiend balances Total Liabilities and Fund Balance (total sources of funds) $ 22,742,810 8,743,152 2,876,677 80,457 722,790 1,255,271 765,624 1,116,130 38,302,911 59,506,139 15,303,907 3,764,405 2.076,127 80,650,578 $118,953,489 $ 10,178,124 279,237 11,997,683 2,106,509 116,485 206,636 24,944,674 5,090,405 63,528,205 1S,912,155 9.478,050 25.390.205 $118,953,489 SOURCE: Adapted from Harvard Community Health Plan, Inc.
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From page 49... ...
Current Assets Cash and cash equivalents Accounts receivable less allowance for loss of $59,215 Inventories Other current assets Total current assets Property Equipment, at cost Land Buildings Equipment Construction in progress (estimated cost to complete and equip aRer August 31, 1984: $246,000) Subtotal Accumulated depreciation Other Assets Total Assets (total uses of fiends)
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From page 50... ...
Funds accumulated Tom business operations are, in principle, a source of financial capital that is available to any ongoing organization, regardless of ownership type. Such funds are created when an organiza tion's annual cash revenues exceed its corresponding annual cash expenses.
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From page 51... ...
Increase in other assets617,280 Increase in funds held by trustees15,276,873 J Repayment of Debt Decrease in accounts payable421,126 Repayment of long-term debt5,209,148 5,630,274 (8%) Other Bond issue cash Decrease in unearned premiums Net Increase in Cash and Marketable Securities Total Uses of Funds in 1984 SOURCE: Adapted from Harvard Community Health Plan, Inc.
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From page 52... ...
Uses of Cash Investments in Assets Increases in current assets Increases in property and equipment Increases in investment in subsidiaries Reductions in Debt Repayment of short-tenn debt Repayment of long-terTn debt Redemption of Preferred Stock Payment of Cash Dividend Over Uses of Cash Increase in Cash Balance Total Uses of Cash in 1984 $ 72,841 445,741 23,566 )
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From page 53... ...
In reporting the sources of"funds from operations" in its flow-of-funds statement, TABLE 3.5 Income Tax Obligations and Payments of Four Investor-Owned Health Care Corporations, Fiscal Year Ending 1983 (in thousands of dollars) AMI Humana HCA NME Gross revenues$2,217,862$2,298,608$3,917,057$2,148,000 Net income before taxes233,441288,782391,718170,000 Statutory tax obligations107,383132,840180,19078,200 Provision for income taxb104,100128,133148,50075,000 Currently payable income taxi Federal40,70092,12873,16718,000 State7,40010,28014,4665,000 Average Tax actually paid a % of gross revenue2.24.42.21.1 2.5d Tax actually paid a % of net income20.635.522.313.5 24.1 Tax actually paid am % of statutory rate44.877.148.629.4 52.4 Tax actually paid as % of provision for taxes shown in annual report to shareholders 46.2 80.0 58.9 30.7 57.3 recalculated simply a 46 percent of the net income figure reported to shareholders.
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From page 54... ...
That amount includes the year's amortization of depreciable assets on the balance sheet and, for for-profits, deferred taxes. Trends in Sources of Financial Capital Although no comprehensive source of data on sources of capital funds is available, data on funding for hospital construction provide a substantial part of the picture.
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From page 55... ...
. A small irony in the financing of hospital construction is that for-profit lenders (e.g., banks, insurance companies, investment companies)
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From page 56... ...
The central government's National Health Service develops the nation's health plan on the basis of consultation with local health officers and local Canada Hospitals are predominantly owned by lay boards of trustees or by communities United Kingdom France Separate capital budgets are granted upon specific approval of proposed investments by the · 1 provmc~a1 governments Hospitals are owned by the central Separate capital budgets are controlled by the government's central government National Health through its National Service Health Service About 70% of all hospital beds are publicly owned (mainly by local governments) ; the rest are privately owned Netherlands Hospitals are owned by local communities or lay boards of trustees Sweden Annual prospective global budgets controlled by the provincial governments Annual prospective global budgets controlled by the National Health Service (i.e., the central government)
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From page 57... ...
. to supply financial capital to the health care sector, as appears to be the case, Americans must realize that the health care sector will increasingly conform to the performance e~fpectations of the financial markets, which are interested in the rendering of services to humankind only insofar as such services yield cash revenues.
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From page 58... ...
Forprofit institutions have one additional source of capital beyond the sources available to not-for-profit institutions the equity capital from investors. Several reasons for the trends in debt financing can be identified, in addition to the obvious factor the end of the Hill-Burton program's governmental grants.
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From page 59... ...
Philanthropy and Governmental Grants The expectations attached to philanthropic and governmental grants are to varying degrees explicit and detailed. The most general expectation, however, is that the
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From page 60... ...
The marked decline in the relative magnitude of these sources of capital financing helps to explain today's uncertainty and debate about the proper mission of health care institutions. Debt Financing If fiends are advanced in the form of debt instruments, they can be thought of as being "rented" for a specified period at a specified annual rate called interest.
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From page 61... ...
It is widely believed that the earnings retained by a corporation are a costless source of fiends and that financing procured by the issue of new stock certificates is cheap relative to debt financing. This inference appears to be based on the relatively low 61 dividend yield (defined as the ratio of dividends per share to market price)
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From page 62... ...
The for-profit sector also benefits from tax provisions (investment tax credits, accelerated cost recovery) that are designed to encourage investment and that allow deferral of corporate income taxes.
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First, a level playing field between forprofit and not-for-profit health care organizations would require that competitors procure resource inputs, including financial capital, in the same markets and on the same terms (i.e., at the same prices for given quantities)
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From page 64... ...
The alternative of institutions' abandoning traditional missions would be equally unfortunate. If in view of the widespread excess capacity in the hospital sector the government decides to constrain the flow of funds that allow capital fo`~ation in this sector, mechanisms should be created for establishing exceptions in situations of merit (e.g., tertiary care institutions with high costs for technology and specialized personnel, vital training centers committed to health professional education, institutions with a high indigent care burden, and so forth)
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From page 65... ...
3Laypersons not familiar with either accounting or corporation finance frequently think only of equipment, structures, and land when they speak of"capital." However, a firm's capital includes the sum total of the monetary value of all of its assets, both current and long-lived. In 1984, for example, the current assets of the Harvard Community Health Plan accounted for 32 percent of its total asset base; the corresponding figure for Humana, Inc., was 23 percent.
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From page 66... ...
During these three years, then, the taxes the firm showed as having been paid in its report to shareholders would exceed the truces it actually paid. This divergence gives rise to the so-called "deferred income taxes due" shown as a liability on the firings balance sheet.
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From page 67... ...
The Nature of Equity F'nanc~g Uwe Reinhardt Equity financing is a topic about which misconceptions exist, such as the beliefthat equity capital is a cheap and plentiful source of fiends. Although access to equity capital has significant advantages, these advantages are less than often supposed.
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From page 68... ...
The price of $40 per share can also be referred to as the present, discounted value of the future dividend stream, which is calculated as the sum p$6.00 $6.00 1.15 1.152 + $6.00 1.153 $6.00 0.15 = $40.00 = = FOR-PROFIT ENTERPRISE IN HEALTH CARE If management strives to live up to the promises it made when first marketing the stock issue, it must earn sufficient revenues to cover all production costs (such as wages and the cost of raw materials, energy, and other inputs) , all interest on debt, and all taxes and still leave a sufficiently large residual to finance the payment of an annual cash dividend of $6 per share to shareholders.
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From page 69... ...
ABC Corporation had led investors to expect not a flat annual cash dividend of $6, but a dividend stream growing at a steady annual growth rate of, say, 5 percent, with the first dividend payable one year hence projected at $4 per share. In this case potential investors would expect a dividend of $4.20 in the second year, $4.41 in the third, $4.63 in the fourth, and so on.
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From page 70... ...
Most investments in stock, it may be argued, are made in contemplation of the finite investment horizon of a few years, in which case it is not the expected future dividends but the expected future capital gains from a resale of the stock that drive its current market value. Would a finite investment horizon alter the insights illustrated above?
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From page 71... ...
That repayment would not be a charge against income, but the cash would have to be available at the date of maturity.2 In addition to the extra net income that would be required to service the $12 million of ad ditional debt, additional fixture earnings would be required to compensate the suppliers of the additional $13 million in equity financing. If we assume that the hospital chain's shareholders would be satisfied with a relatively modest annual rate of return of 15 percent of their funds, then the firm would have to achieve additional after-tax earnings of $1.95 million per year to keep shareholders whole.
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From page 72... ...
6. In conducting their affairs many inves tor-owned hospital chains appear to have cho sen low current dividend yields in exchange Equals profits for an implicit promise of rapid growth in fu ture earnings per share and dividends.
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From page 73... ...
The annual depreciation expense would not require a cash outlay in the year for which it is recognized. Rather, one can think of this expense as a form of earmarking cash revenues either for replacing the underlying assets when they are worn out or for repaying the debt that financed them.
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