Basic Understanding of Financial Statements
by Dr Kate Rohr
This article will be directed towards understanding further details of the “Statement of Revenue and Expenses.” Remember that Mendocino Coast District Hospital (MCDH) uses the accrual accounting method. The financial entries in this report therefore do not represent actual cash on hand, but rather, they represent the cash that it is expected will be realized at some time in the future. It will be helpful when reading this article to refer a recent MCDH financial report, specifically “page 5.”
The first section of the report is labeled “Gross Patient Service Revenues”. This entry is further subdivided into categories such as “inpatient”, “swing bed”, etc. These entries represent the gross revenue (charges) produced by the business activities in those categories. The “Total Patient Service Revenue” is then the total of all those charges. For reasons which are both historical and the result of billing regulations, those charges are almost never fully realized. The “Total Patient Service Revenue”, cannot therefore be considered the expected actual income that will be generated from those business activities.
To correct for this, the second section, labeled “Deductions from Revenue”, is generated to adjust the above revenue (charges) to the amount of income it is reasonable to expect will eventually be realized from those activities. In healthcare, “Contractual Allowances” is generally defined as the difference between what a hospital bills for a service and what they will receive from third party payers. For example, if the hospital has a contract with an insurance company that stipulates the insurance company will only pay “X” dollars for service “Y”, the difference is the contractual allowance. This is generally a large negative adjustment for MCDH because the vast majority of the hospital’s business is either contracted or its payments are limited by government programs such as Medicare, all of which pay less than the current charges. “Policy discounts” are generally deductions produced when certain payment conditions are met. For example, billing may allow a 5% discount if the bill is paid in full within 30 days. “Bad debt” is the more challenging adjustment. Basically, it represents the amount of a bill the hospital originally believed it would eventually collect, but after repeated attempts, it now realizes it is unlikely it will ever receive payment (i.e. is unrealizable). “Charity care” is self-explanatory. Added together, these become the total deductions.
The “Net Patient Service Revenues” is then calculated by subtracting the total deductions from the total revenues. For the month ending July 31, 2017 this equaled $3,924,220. To this the hospital then adds some additional corrections as listed in the third section of the report to obtain a gross “Total Operating Revenues.” Remember from a prior article that “operating” revenue is the income that is generated by day-to-day business and that more readily responds to short term business decisions. It is not clear why MCDH includes certain tax revenues in its operating calculations, which can best be explained by administration.
To arrive at a final estimate of its monthly Net Operating Income MCDH then calculates and subtracts its total operating expenses. In the month ending July 31, 2017, expenses exceeded income so the expected result for the day-to-day activities of caring for patients generated an expected loss of $250,039.
The last section of the report is entitled “Non-operating Revenues (Expenses)”. This section calculates the expected income or loss from other hospital financial activities such as donations, taxes, etc. This category is particularly important when considering the impact of other potential income sources such as a parcel tax. Adding the Net Operating and Non-Operating Incomes produces a final estimate of the financial impact of all of the past month’s business activity.
The next article will focus on the MCDH actual business metrics and how they relate to the various entries in the financial statements. This will highlight opportunities and challenges our hospital faces to improve its finances and assure its survival.
Editor’s note: This is the third article by Dr. Kate Rohr, previous MCDH Board of Director’s member, to help us understand some basic accounting principles as they pertain to the hospital. The first 3 articles have basic information and her next articles will more specifically delve into the MCDH budget.