CHAPTER 5 WORKING CAPITAL Two Key Components of Working Capital: 1. Cash 2.

. Accounts Receivables Four Phases of Working Capital Cycle: 1. Obtaining cash 2. Turning cash into resources and paying bills 3. Using the resources to provide services 4. Billing and collecting revenues earned so that the cycle can be continued Two Components of Working Capital Management Strategies: 1. Asset mix refers to the amount of working capital the organization keeps on hand relative to its potential working capital obligations. 2. Financing mix refers to how the organization chooses to finance its working capital needs. Unsecured Bank Loans: 1. Line of credit is an informal agreement established by the bank and the borrower with respect to the maximum amount of funds which can be borrowed. Thus, the bank is not legally obligated to fulfill the borrowers credit request. Short term bank loan 2. Revolving line of credit legally requires the bank to fulfill the borrowers credit request up to the pre-negotiated limit. 3. Trade Credit: Short term credit offered by the supplier of a good or service. 4. Trade Payables: also called Accounts Payable: Short-term debt that results from supplies purchased on credit Wimpy example Collecting Cash Payments: Collection Centers Lockboxes Wire Transfers Investing Cash On A Short Term Basis Treasury Bills Certificates of Deposit Commercial Paper -IOU Money Market Mutual Funds Factoring : Selling accounts receivable at a discount, usually to a financial institution. Pledging Receivables as Collateral: A tangible asset which is pledged as a promise to repay a loan. If the loan is not paid, the lending institution as a legal recourse may seize the pledged asset. Working Capital Cycle Obtain Cash Purchase resources and pay bills Provide services Billing and Collections Discount Terms Ex $1,000 for supplies 2/10 net 30 (2% discount if paid within 10 days otherwise full due in 30) Bill = $980, Bill+ Interest = $1,000; Interest to borrow $980 for 20 days = $20; $20/$980 = 2.04%; 365/20=18.25; 2.04% (.0204) X 18.25 = Int rate = 37.2% Definitions a. Aging Schedule: a table which shows the percentage of receivables outstanding by the month they were incurred. Also called an Age Trial Balance (ATB). b. Approximate Interest Rate: the annual interest rate incurred by not taking advantage of a supplier's discount offer to pay bills early. c. Asset Mix: The amount of working capital an organization keeps on hand relative to its potential working capital obligations. d. Claims scrubbing: is an editing function that reduces the number of processing errors and subsequent audits. e. Collateral: A tangible asset which is pledged as a promise to repay a loan. If the loan is not paid, the lending institution as a legal recourse may seize the pledged asset. f. Commitment Fee: A percentage of the unused portion of a credit line which is charged to the potential borrower. g. Compensating Balance: A designated dollar amount on deposit with a bank which a borrower is required to maintain. h. Effective Interest Rate: The true interest rate that a borrower pays. i. Factoring: Selling accounts receivable at a discount, usually to a financial institution. The latter then assumes the role of trying to collect upon the outstanding payment obligations. j. Financing Mix: How an organization chooses to finance its working capital needs. k. HIPAA: Health Insurance Portability and Accountability Act. A public law designed to improve efficiency in healthcare delivery by standardizing

electronic data interchange, and protect the confidentiality and security of health data through setting and enforcing standards. controls l. Liquidity: a measure of how easily an asset can be converted into cash. m. Lockbox: a post office box located near a Federal Reserve Bank or branch which will pick up and process checks quickly, but for a fee. n. Net Working Capital: The difference between current assets and current liabilities. o. Normal Line of Credit: An agreement established by a bank and a borrower which establishes the maximum amount of funds that can be borrowed, and the bank may loan the funds at its own discretion. p. Required 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 the expected outflows during the next forecasting period. q. Revenue Cycle Management: To achieve timely collection of billing, health care providers need to integrate the areas of scheduling, pre-registration, charge capture, coding, electronic billing, and payment. r. Revolving Line of Credit: An agreement established by the bank and the borrower that legally requires the bank to loan money to the borrower at any time requested up to the pre-negotiated limit. s. Trade Credit: Short term credit offered by the supplier of a good or service to the purchaser. t. Trade Payables: Short-term debt that results from supplies purchased on credit for a given length time. This allows an organization to use the suppliers money to pay for the purchase up until the time it pays the supplier the amount owed. u. Transaction Note: A short-term, unsecured loan made for some specific purpose. v. Working Capital: The combination of current assets and current liabilities which together turn the capability of non-current assets into the provision of services. w. Working Capital Strategy: How much extra working capital an organization determines it must keep as a cushion. Formulas CASE #27 Average Collection Period (ACP) ACP = weighted sum of (Collection %) x (days) ACP= 0.30(10) + .50(30) + .20(60) = 30 days 3 + 15 + 12 = 30 Average Daily Sales (ADS) ADS = 800,000(total sales forecast) X $5 per unit =$11,111.11 360 days Average Accounts Receivable (ACP)(ADS) =30(11,111.11) = $333,333 (AAR) Average Daily Billings (ADB) (.80) Receivables Balance (RB) ADB x ACP(AKA as AAR) = RB 20% contribution margin = 20% profit 80% cost of business (ADB) (ADB).80 (AAR)($333,333) = $266,667(RB) Retained Earnings = AAR(333,333)-RB(266,667) Average Annual Cost of Carrying Receivable Bank loan=10% annual rate Project annual cost = annual rate x RB .10(266,667) = $26,667 projected annual cost per year Aging Schedule Remaining Uncollected Balance Schedule based on aging schedule add subsequent aging percents and subtract from 100%

Create Aging Sched: Gross Sales for month Ex March (400,000) Assumed collection pattern (0-30) 35% 100%-35% = 65% outstanding collections Sales Mix Forecast for Payer Ex. Lrg Ret Chain 40% Outstanding Collections Lrg Retail 1 = .4($400,000)=$16,000 x 65%= $104,000 Gross Sales for month Ex Feb (250,000) Assumed collection pattern (30-60) 35%+50%= 85% 100%-85% = 15% outstanding collections Sales Mix Forecast for Payer Ex. Lrg Ret Chain 40% Outstanding Collections Lrg Retail 1 = .4($250,000)=$10,000 x 15%= $15,000 Vendor charges $500 to collect receivables to reduce carrying costs To increase 0-30 by 15% (35+15) (50%), 30-60 (50-15+15) (50%) 60-90=0% If old carrying cost new carrying cost (cost must be reduced by more than cost of service ($500) or it is not worth it.

f. g. h.

Simple interest method: A method to calculate interest only on the original principal amount. The principal is the amount invested. Time value of money: The concept that a dollar received today is worth more than a dollar received in the future. Present value table: Table of factors which shows what a single amount to be received in the future is worth today at a given interest rate.

CHAPTER 6 TIME VALUE OF MONEY

Two Methods to Calculate Interest: 1. Simple Interest: Interest is calculated only on the original principal. 2. Compound interest: Interest is calculated on both the principal and accumulated interest. Comparison of Future value (FV) & Present Value (PV): 1. Future value (FV): What an amount invested today (or a series of payments made over time) will be worth at a given time in the future using the compound interest method, which accounts for the time value of money. To find future value you use the concept of compounding 2. Present value (PV): The value today of a payment (or series of payments) to be received in the future, taking into account the cost of capital. To find the present value you use the concept of discounting. 3. Compounding: Converting a present value into its future value 4. Discounting: Converting future cash flows into their present value Ordinary Annuity when a series of equal annuity payments made or received at the end of each period Annuity Due when a series of equal annuity payments made or received at the beginning of each period Perpetual Annuity is for an infinite period of time a. Annuity: series of equal payments made or received at regular time intervals b. Annuity Due: series of equal annuity payments made or received at the beginning of each period c. Compound interest method: a method which calculates interest on both the original principal and on all the interest accumulated since the beginning of the investment period d. Compounding: converting a present value into its future value taking into account the time value of money e. Discounting: converting future cash flows into their present value taking into account the time value of money. Opposite compounding.

Alternative strategies for accelerating receivables collections discounts for payments received in timely manner. Cost of strategy is forgone revenue. Discounts should not exceed reduced carrying costs. If receivable balances are diff than the 1st year it could be growth in sales A/R management and cash flow relation Time/effort to collect debt versus outsourcing collection to agency DENIAL RATES and cash management getting denied, not getting paid. Days in collection will go up. Improved payment process will impact working capital cycle because you will create cash and time it so you are getting what is owed quickly and paying out slowly. High deductibles impact AR and cash processes makes collection more difficult individual versus lump payment from insurance i. Future value (FV): What an amount invested today (or a series of payments made over time) will be worth at a given time in the future using the compound interest method, which accounts for the time value of money. See also Present Value. j. Future value factor: The factor used to compound a present amount to its future worth. It is the reciprocal of the present value factor and is calculated using the formula (1+i)n. k. Future value factor of an annuity (FVFA): A factor that when multiplied by a stream of equal payments equals the future value of that stream. See also Present Value Factor of an Annuity. l. Future value of an annuity: What an equal series of payments will be worth at some future date using compound interest. See also Future Value factor of an Annuity and Present Value of an Annuity. m. Future value of an annuity table: Table of factors which shows the future value of equal flows at the end of each period, given a particular interest rate. n. Future value table: Table of factors which shows the future value of a single investment at a given interest rate. o. Opportunity cost: Proceeds lost by forgoing other opportunities. p. Ordinary annuity: A series of equal annuity payments made or received at the end of each period. q. Perpetuity: An annuity for an infinite period of time. Also called a perpetual annuity. r. Present value (PV): The value today of a payment (or series of payments) to be received in the future, taking into account the cost of capital. s. Present value factor: The factor used to discount a future amount to its current worth. It is the reciprocal of the future value factor and is calculated using the formula 1/(1+i)n. t. Present value factor of an annuity (PVFA): A factor that when multiplied by a stream of equal payments equals the present value of that stream. See also Present Value Factor of and Annuity. u. Present value of an annuity: What a series of equal payments in the future is worth today taking into account the time value of money. v. Present value of an annuity table: Table of factors which shows the worth today of equal flows at the end of each future period, given a particular interest rate. w. Present value table: Table of factors which shows what a single amount to be received in the future is worth today at a given interest rate. x. Simple interest method: A method to calculate interest only on the original principal amount. The principal is the amount invested. y. Time value of money: The concept that a dollar received today is worth more than a dollar received in the future. Formulas Necessary Components: PV, FV, Number of periods (NPR), Interest (i) and Payment amount Or use Excel PMT function

Work Out Time Line 0 1 2 3 4 Std AN $ $ $ $ $ A-Due $ $ $ $ Std AN $ $ $ $ Note that the first two are equivalent depending timing of pmt Excel Functions: PV, FV, NPER, RATE and PMT FVFA multiple by PMT to derive Future Value FVFA = [(1 + i)^n 1]/i

5 $ $

CHAPTER 7 NPV & INVESTMENT DECISIONS Capital Investments Strategic Decisions: Capital investment decision designed to increase a health care organizations strategic (long-term) position. Expansion Decisions: Capital investment decision designed to increase the operational capability of a health care organization. Replacement Decisions: Capital investment decision designed to replace older assets with newer, cost saving ones. Financial Evaluation Techniques Payback: look for year of positive cash flow Net Present Value (NPV) >(gtr) 0 accept prj, <(less)0 reject Internal Rate of Return (IRR) NPV Key Concepts Cost of capital / Discount rate Discounted cash flows Incremental cash flows Required rate of return / Hurdle rate Internal rate of return life of projt =init investment (zero bal) Net present value dollar r eturn on investment Salvage value /Terminal value The eight steps in preparing Net Present value: 1. Identify initial cash flow 2. Determine revenue and expenses (net Income) 3. Add back depreciation 4. Add (subtract) non annual cash flows 5. Adjust for working capital 6. Determine Present value of each years cash flow 7. Sum the present value of all cash flows 8. Determine the Net Present value Internal Rate of Return (IRR) Breakeven Point A method to evaluate the financial feasibility of an investment decision which compares the investments rate of return to that return required by the organization. Rate of return, cost of capital, hurdle rate, discount rate same thing When using the IRR method the decision depends If IRR is > than rate of return, accept If IRR is < than rate of return, reject If IRR is = to rate of return, you would be indifferent a. Cannibalization: When a new service decreases the revenues and cash flows from other established services or product lines. These are considered cash outflows. b. Capital Investments: Large dollar capital outlays for plant and equipment. c. Capital investment decisions: three types of decisions: strategic, expansion, and replacement. d. Capital Appreciation: Occurs whenever an investment is worth more when it is sold than when it was purchased. e. Cost of capital: The rate of return required to undertake a project. The cost of capital accounts for both the time value of money and risk. Also called the hurdle rate or discount rate. f. Discount rate: Same as Cost of Capital. g. Discounted cash flows: Cash flows that have been adjusted to account for the cost of capital. h. Dividends: Represents the portion of profit that an organization distributes to equity investors. i. Expansion decision: Capital investment decision designed to increase the operational capability of a health care organization. j. Goodwill: An amount paid above and beyond the book value of an asset (typically a business) when it is sold, representing the value of intangible factors such as brand reputation, customer or supplier relationships, employee competencies, etc. k. Hurdle rate: Same as Required Rate of Return. l. Incremental cash flows: Cash flows that occur solely as a result of a particular action such as undertaking a project. m. Interest: A payment to creditors, those who have loaned the organization funds or otherwise extended credit. n. Internal rate of return: That rate of return on an investment which makes the net present value equal to $0, after all cash flows have been discounted at the same rate. It is also the discount rate at which the discounted cash flows over the life of the project exactly equal the initial investment. o. Internal rate of return method: A method to evaluate the financial feasibility of an investment decision which compares the investments rate of return to that return required by the organization. p. Net present value: The present value of future cash flows related to an investment net (less) the cost of the initial investment. It represents the difference between the initial amount paid for an investment, and the future cash inflows that the investment will bring in, after adjusting for the cost of capital.

q. Net present value method: A method to evaluate the financial feasibility of an investment decision based solely upon the resulting net present value. It represents the dollar return on the investment. r. Non-regular cash flows: Cash flows that occur sporadically or on an irregular basis. A common non-regular cash flow is salvage value, receipt of funds following a one-time sale of an asset at the end of its useful life. s. Operating cash flows: Cash flows that occur on a regular basis, oftentimes following implementation of a project. Also called regular cash flows. t. Opportunity costs: Lost proceeds by forgoing or delaying other opportunities. u. Payback method: A method to evaluate the feasibility of an investment by determining how long it would take until the initial investment is recovered, disregarding the time value of money. v. Regular cash flows: Same as Operating Cash Flows. w. Replacement decision: Capital investment decision designed to replace older assets with newer, cost saving ones. x. Required rate of return: An organization's minimally acceptable internal rate of return on any investment to justify an initial investment. Also called Cost of Capital or Hurdle Rate. y. Residual value: Same as Salvage Value. z. Retained earnings: A second type of benefit to an investor. These are in the form of the portion of the profits the organization keeps in-house to use in growth and support of its mission. aa. Salvage value: The amount of cash to be received when an asset is sold, usually at the end of its useful life. Also called Terminal Value. bb. Scrap value: Same as Salvage Value. cc. Straight-line depreciation: A method which depreciates an asset an equal amount each year until it reaches its salvage value at the end of its useful life. dd. Strategic decision: Capital investment decision designed to increase a health care organizations strategic (long-term) position. ee. Sunk costs: Costs which have already been incurred. ff. Terminal value: See Salvage Value. gg. WACC: Weighted average cost of capital Formulas

NPV can be calculated from values in Yellow using Excel Fx NPV IRR is % when NPV = $0.00 REMEMBER to add neg initial investment to answer below Ex. $-1,000,000 + 1499201 = $499,202 (Net present value)

CHAPTER 8 FINANCING (LEASE) Equity Financing: Not-for- Profits equity financing is derived from retained earnings, government grants, sales of assets and contributions For Profit equity financing comes from issuance of stock and retained earnings Debt Financing: This alternative to equity financing requires borrowing money from others at a cost Term Loans are typically issued by a bank which has a maturity of 1 to 10 years. Bonds are a form of long-term financing whereby an issuer receives cash from a lender (an investor), and in return issues a promissory note (a "bond") agreeing to make principal and/or interest payments on specific dates which can be structured with either fixed or variable interest. Fixed Interestrate does not change Variable Interest.fluctuates Interest Rate Swap.. When the borrower exchanges or swaps interest rates (fixed-rate to variable-rate or variable-rate to fixed-rate) between another party, typically a bank or investment banking firm. Indenture and Covenant.terms and conditions of bond Debenture.a unsecured bond Subordinated Debentureunsecured bond junior to debenture Par Valueface value of bond Coupon Rate and Coupon Paymentstated interest rate and periodic payment Callable Bonds..may be redeemed before maturity Zero Coupon Bondsamount of interest that will be paid Serial Bonds.a smaller portion of fixed rate bond which matures earlier Basis Pointsthe spread or difference in interest rates Sinking Fund monies are set aside each year to ensure that a bond can be liquidated at maturity Secondary Market..buying and selling of issued bonds Debt Service Reserve Fund..funds set aside with trustee to safeguard against fault

Tax Exempt Bonds are exempt from federal income taxes & possibly state and local taxes Taxable Bonds are not only taxable, but generally are also issued at a higher interest rate SIX Steps in Tax - Exempt Bond Issuance Process 1. The health care borrower gets its house in order 2. The health care borrower identifies & selects the key parties in the parties 3. The health care borrower is evaluated by credit rating agency 4. The bond is rated by a credit rating agency 5. The health care borrower enters into loan agreement with issuer of bonds 6. Underwriter sells bonds. trustee provides proceeds to hc provder Operating Leases are used to lease an asset over a relatively short period of time and have a cancellation clause. Also, the lessor incurs all the ownership costs of maintenance, service, and insurance on the leased equipment Hidden from debt Capital lease also called Financial Lease Capital Leases are designed to lease an asset for its entire economic/useful life. The lessee does not have an option to cancel the lease without a substantial penalty and has an option to buy the leased asset at the end of the lease agreement Affect balance sheet increased debt ratio. Leases are hidden from debt not capt a. Amortization: The gradual process of paying off debt through a series of equal periodic payments. Each payment covers a portion of the principal plus current interest. The periodic payments are equal over the lifetime of the loan, but the proportion going toward the principal gradually increases. The amount of a payment can be determined by using the formula to calculate the present value of an annuity. b. Bond: A form of long-term financing whereby an issuer receives cash from a lender (an investor), and in return issues a promissory note (a "bond") agreeing to make principal and/or interest payments on specific dates. c. Bond issuance: A lengthy and arduous six-step process that a health care organization goes through to sell bonds in the open public market, starting with initial preparations and ending with receipt of cash. d. Capital lease: A lease that lasts for an extended period of time, up to the life of the leased asset. This type of lease cannot be canceled without penalty, and at the end of the lease period, the lessee may have the option to purchase the asset. Also called a financial lease. e. Collateral: An asset with clear value (such as land or buildings) which is pledged against a loan to reduce risk to the lender. If the loan is not paid off satisfactorily, the lender has a legal claim to seize the pledged asset. f. Debt capacity: The amount of total debt that an organization can be reasonably expected to take on and pay off in a timely manner. g. Discount: When the market rate is higher than the coupon rate, a bond is said to be selling at a discount from its par value. See also premium. h. Feasibility study: A study which examines market and management factors which affects the issuers ability to generate the necessary cash flows to meet principal and interest requirements. i. Financial lease: See capital lease. j. Fixed income security: A bond which pays fixed amounts of interest at regular periodic intervals, usually semi-annually. k. Hedging: The art of offsetting high variable rate debt payments with returns from high-rate investments. l. Interest rate swap: When the borrower exchanges or swaps interest rates (fixedrate to variable-rate or variable-rate to fixed-rate) between another party, typically a bank or investment banking firm. m. Lessee: An entity who negotiates the use of another's asset via a lease. n. Lessor: An entity who owns an asset which is then leased out. o. Letter of credit: Offered through a bank, this can be used to enhance the creditworthiness of an institution, and hence, a bond's rating. p. Market value: What a bond would sell for in todays open market. q. Net proceeds from a bond issuance: Gross proceeds less the underwriters and others' issuance fees. r. Off balance sheet financing: When an operating lease is not reported on the balance sheet under long-term debt, but instead is reflected on the income statement as an operating expense. s. Operating lease: A lease that lasts shorter than the useful life of the leased asset, typically one year or less. This type of leasing arrangement can be canceled at any time without penalty, but there is no option to purchase the asset once the lease has expired. t. Outstanding bond issue: A bond that trades in the market place. u. Par value: The face value amount of a bond. It is the amount the bondholder is paid at maturity. It does not include any coupon payments. v. POS: A preliminary official statement (POS) offered to prospective buyers of a bond by the underwriters to help determine a fair market price for the bond. w. Premium: When the market rate is lower than the coupon rate, a bond is said to be selling at a premium. See also discount.

x. Rating of bond: bonds may receive a credit rating by a bond rating agency, which measures the credit default risk of a bond by assessing its financial, operational and market conditions y. Required market rate: The market interest rate on similar risk bonds. z. Sale/Leaseback arrangement: A type of capital lease whereby an institution sells an owned asset and then simultaneously leases it back from the purchaser. The selling institution retains rights to use the asset, but benefits from the immediate acquisition of cash from the sale. aa. Sinking fund: A fund into which monies are set aside each year to ensure that a bond can be liquidated at maturity. bb. Tax shield: An investment which reduces the amount of income tax which has to be paid, often because interest and depreciation expenses are tax deductible. cc. Term loan: A loan typically issued by a bank which has a maturity of 1 to 10 years. dd. Trustee: An agent for bondholders who ensures that the health care facility is making timely principal and interest payments to the bondholders and complies with legal covenants of the bond. ee. Yield to maturity: The rate at which the market value of a bond is equal to the bond's present value of future coupon payments plus par value.

Keeping Old vs. Replacement Old: Initial investment = $0.00 New: Investment = value of equipment as negative ($0.00) Compare NPV(old) vs. NPV(new) Higher NPV is better decision (usually) even if neg, than lower neg better decision

CHAPTER 9 MAKE or BUY Fixed Cost: A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses that have to be paid by a company, independent of any business activity. It is one of the two components of the total cost of a good or service, along with variable cost. Variable Cost: An expense that varies with output/services. Variable costs are those costs that vary depending on volume; they rise as services increase and fall as services decrease. Variable costs differ from fixed costs such as rent, advertising, insurance and office supplies, which tend to remain the same regardless of production output. Fixed costs and variable costs comprise total cost. Contribution Margin: A cost accounting concept that allows a company to determine the profitability of individual products and or services The phrase "contribution margin" can also refer to a per unit measure of a product's and or services gross operating margin, calculated simply as the product's price minus its total variable costs. CM = PRICE VARIABLE COST Avoidable Cost: An expense that will not be incurred if a particular activity is not performed. Avoidable cost refers to variable costs that can be avoided, unlike most fixed costs, which are typically unavoidable. While avoidable costs are often viewed as negative costs, they may be necessary to achieve certain goals or thresholds. Problem Setup: For Make v. Buy Volume Revenue (Price x Volume) Variable Cost (VC/unit x volume) Total Contribution Margin Avoidable fixed costs Product Margin (higher better or positive difference OTHER DEFINITIONS NAL = PV cost of leasing PV cost of owning Positive NAL indicates advantage to leasing Long-term loan and Direct Purchase are considered the same when comparing to lease DEBT TO ASSET RATIO DEBT (LIABILITIES)/ASSETS Use of lease (not capitalized) improves debt ratio Average Payable Period = Accounts Payable Balance/Average Daily Purchases on Account Average Daily Purchases on Account = Annual Purchases on Account/360 or 365 NAL = NPV Leasing NPV Buying = pos# than LEASE