1. 2 - 1 CHAPTER 2 Healthcare Business Basics Concept of a business Legal forms of business FP versus NFP ownership Organizational goals Financial goals Taxes Copyright © 2013 by the Foundation of the American College of Healthcare Executives

2. 2 - 2 A business is an entity that: Raises money in the capital markets. Invests these funds in assets (land, buildings, equipment, inventories, and so on). Uses these assets to create products or services. Sells these products or services to sustain itself. A pure charity is different. Why? Concept of a Business Copyright © 2013 by the Foundation of the American College of Healthcare Executives

3. 2 - 3 There are four major categories of business organization (legal forms of businesses). Proprietorship (sole proprietorship) Partnership Corporation Hybrid forms  How much does the organizational form influence the practice of healthcare finance? Legal Forms of Business Copyright © 2013 by the Foundation of the American College of Healthcare Executives

4. 2 - 4 Advantages Ease of formation Subject to few regulations No corporate income taxes Disadvantages Limited life Difficult to transfer ownership Unlimited liability Difficult to raise capital Proprietorships and Partnerships Copyright © 2013 by the Foundation of the American College of Healthcare Executives

5. 2 - 5 Advantages Unlimited life Easy transfer of ownership Limited liability Ease of raising capital Disadvantages Cost of formation and reporting Double (or triple) taxation for investor- owned corporations Corporation Copyright © 2013 by the Foundation of the American College of Healthcare Executives

6. 2 - 6 Limited partnership (LP) General partners have control Limited partners are liable only for their initial contribution Not commonly used by healthcare providers Limited liability partnership (LLP) Partners share general business liability But, partners are liable only for their own malpractice actions Hybrid Forms of Organization Copyright © 2013 by the Foundation of the American College of Healthcare Executives

7. 2 - 7 Limited liability company (LLC) Members are taxed like partners Liability like stockholders Professional corporation (PC) or professional association (PA) Owners have benefits of incorporation However, still liable for malpractice Often used by individual clinicians Hybrid Forms of Organization (Cont.) Copyright © 2013 by the Foundation of the American College of Healthcare Executives

8. 2 - 8 In most industries, the only form of ownership is the investor-owned (for- profit) business. However, in the health services industry, a significant proportion of businesses, particularly hospitals, are organized as not-for-profit corporations. Alternative Forms of Ownership  How much does ownership influence the practice of healthcare finance? Copyright © 2013 by the Foundation of the American College of Healthcare Executives

9. 2 - 9 Investors become owners by purchasing shares of common stock. Primary market transactions Initial public offerings (IPOs) New common stock sales Secondary market transactions On exchanges In the over-the-counter market Stockholders have: Right of control Claim on residual earnings and residual liquidation proceeds Investor-Owned (For-Profit) Corporations Copyright © 2013 by the Foundation of the American College of Healthcare Executives

10. 2 - 10 If a business meets certain require- ments, it can qualify as a not-for- profit (nonprofit) corporation. These corporations: Generally have no shareholders, and hence do not have a single clientele to which managers are responsible. Receive various tax exemptions. Can be roughly thought of as being owned by “the community.” Not-For-Profit Corporations Copyright © 2013 by the Foundation of the American College of Healthcare Executives

11. 2 - 11 NFP corporations are required to file Form 990 (Return of Organization Exempt from Income Tax) with the IRS. This form, which is available to the public, provides information on corporate governance and executive compensation. In addition, NFP hospitals are required to attach Schedule H, which provides information about charity care, other community benefit activities, and collection practices. Not-For-Profit Corporations (Cont.) Copyright © 2013 by the Foundation of the American College of Healthcare Executives

12. 2 - 12 The primary goal of for-profit corporations is shareholder wealth (stock price) maximization. The primary goal of not-for-profit corporations is generally given by a mission statement, often in terms of service to the community.  What is the primary goal of proprietorships and partnerships? Organizational Goals Copyright © 2013 by the Foundation of the American College of Healthcare Executives

13. 2 - 13 All businesses have stakeholders, who are parties that have an interest (often financial) in the business Stakeholders include owners (if FP), managers, employees, suppliers, patients, and even the community at large. Not-for-profit managers must satisfy all stakeholders. For-profit managers are primarily concerned with satisfying owners. Stakeholders Copyright © 2013 by the Foundation of the American College of Healthcare Executives

14. 2 - 14 What responsibilities do FP businesses have to stakeholders other than owners? Should FP businesses behave ethically? If so, why? What is a benefit corporation (B corporation)? Discussion Items Copyright © 2013 by the Foundation of the American College of Healthcare Executives

15. 2 - 15 The primary financial goal of investor- owned corporations stems from their organizational goal: shareholder wealth (stock price) maximization. The primary financial goal of not-for- profit corporations is to ensure the financial viability of the organization.  Does the difference in financial goals lead to appreciably different behavior? Financial Goals Copyright © 2013 by the Foundation of the American College of Healthcare Executives

16. 2 - 16 Some understanding of tax laws is necessary because taxes influence: Financing decisions The operating cash flows available to an investor-owned business The ability to raise contribution capital There are several types of taxes: Federal versus state versus local Personal versus corporate Ordinary income versus capital gains Tax Laws Copyright © 2013 by the Foundation of the American College of Healthcare Executives

17. 2 - 17 Individuals pay federal (and perhaps state) taxes on salaries, interest, and other income at rates that can approach 50%. (Capital gains and dividends [in some years] are taxed at lower rates.) Taxes lower the amount of useable income. Consider a person paying 40% in taxes that receives $100 in interest: Personal Taxes AT amount = BT amount x (1 - T) = $100 x (1 - 0.40) = $100 x 0.60 = $60. Copyright © 2013 by the Foundation of the American College of Healthcare Executives

18. 2 - 18 Investor-owned corporations pay federal and state taxes on corporate income at rates that can exceed 40%. Not-for-profit corporations, for the most part, are not subject to taxation. Not-for-profit corporations have two additional tax benefits: Can issue tax-exempt (municipal) bonds Can receive tax-exempt contributions Corporate Taxes Copyright © 2013 by the Foundation of the American College of Healthcare Executives

19. 2 - 19 Taxable Versus Muni Bonds Assume FP Healthcare must offer a 10% interest rate on its new bonds. Jane Green, an individual investor with a 28% tax rate, buys one $1,000 bond. What is the effective (after-tax) annual interest? AT$ = (0.10 × $1,000) x (1 - 0.28) = $100 × 0.72 = $72. AT% = 10% × (1 - 0.28)= 10% × 0.72 = 7.2%. Copyright © 2013 by the Foundation of the American College of Healthcare Executives

20. 2 - 20 Discussion Items Assume NFP Healthcare can issue similar-risk municipal bonds with an 8% interest rate. Should Jane buy the NFP bond rather than the FP bond? At what rate on the FP bond would Jane be indifferent between the two bonds? AT% = BT% × (1 - T) 8% = BT% × (1 - 0.28) = BT% × 0.72 BT% = 8% / 0.72 = 11.1%. Copyright © 2013 by the Foundation of the American College of Healthcare Executives

21. 2 - 21 Not-for-profit businesses generally are exempt from local property taxes and state and federal income taxes. Should policymakers mandate that not-for- profit healthcare organizations provide indigent (charity care) services equal to the tax benefits received? Discussion Item Copyright © 2013 by the Foundation of the American College of Healthcare Executives

22. 2 - 22 This concludes our discussion of Chapter 2 (Healthcare Business Basics). Although not all concepts were discussed in class, you are responsible for all of the material in the text.  Do you have any questions? Conclusion Copyright © 2013 by the Foundation of the American College of Healthcare Executives