9/1/2014

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management

PROBLEM 1
Pharma Drug Store is a pharmacy in Portland, Maine, owned by Jane Smith, a local pharmacist. Pharma
business has been good, but Ms. Smith finds that she frequently runs out of cash. To date, she has dealt with
this cash shortfall by delaying payment to the drug suppliers, which is starting to cause problems. Instead
of delaying payment, Ms. Smith has decided that she should borrow from the bank to have cash ready when
needed. To have an estimate of how much she must borrow over the next three months, she must
prepare a cash budget.
All of Pharma's sales are made on a cash basis, but drug purchases must be paid for during the following
month. Ms. Smith pays herself a salary of $4,800 per month, the rent on her store is $2,000 per month,
and a $12,000 payment for taxes is due in December. On December 1, there is $400 cash on hand, but
Ms. Smith wants to maintain a target cash balance of $6,000. Pharma's estimated sales are $160,000 for
December, $40,000 for January, and $60,000 for February. Estimated drug purchases are $140,000 for
November, $40,000 for December, $40,000 for January, and $40,000 for February.
Prepare a cash budget for December, January, and February.
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 2
James Buchanan Orthotics and Prosthetics is planning to request a line of credit from its bank.
The company has produced sales estimates, and these appear in the worksheet below. Collection
estimates are as follows: 10 percent within the month of sale, 75 percent in the month following
the sale, and 15 percent in the second month following the sale. Labor and supplies estimates also
appear in the worksheet below. Payments for labor and supplies are typically made during the
month following the one in which these costs have been incurred. General and administrative
salaries will amount to approximately $27,000 a month; lease payments under long-term lease
contracts will be $9,000 a month; depreciation charges will be $36,000 a month; miscellaneous
expenses will be $2,700 a month; income tax payments of $63,000 will be due in both September
and December; and a progress payment of $180,000 on a new building must be paid in October.
Cash on hand on July 1 will amount to $132,000, and a minimum cash balance of $90,000 will be
maintained throughout the cash budget period. What loan will be the company require in
October?
ANSWER
May
Collections worksheet:
Billed charges
Collections
Within 30 days
30-60 days
60-90 days
Total collections
Supplies worksheet:
Amount of labor and supplies
Payments made for labor and supplies
Net cash gain (loss):
Total collections
Total purchases
General and administrative salaries
Lease payments
Miscellaneous expenses
Taxes
Progress payment
Total payments
Net cash gain/loss
Borrowing/surplus summary:
Cash at beginning with no borrowing
Cash at end with no borrowing
Target cash balance (given)
Cumulative surplus cash / loan balance

June

July

August

September

$180,000

$180,000

$360,000

$540,000

$720,000

$90,000

$90,000

$126,000

$882,000

$306,000

October

November December January

$360,000

$360,000

$90,000

$234,000

$162,000

$90,000

$180,000

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 3
On a typical day, Park Place Clinic writes $1,000 in checks. It generally takes four days for those
checks to clear. Each day the clinic typically receives $1,000 in checks that take three days to clear.
What is the clinic's average net float?
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 4
Drugs 'R Us operates a mail-order pharmaceutical business on the West Coast. The firm receives an
average of $325,000 in payments per day. On average, it takes four days for the firm to receive payment,
from the time customers mail their checks to the time the firm receives and processes them. A lockbox
system that consists of ten local depository banks and a concentration bank in San Francisco would cost
$6,500 per month. Under this system, customers' checks would be received at the lockbox locations one
day after they are mailed, and the daily total would be wired to the concentration bank at a cost of $9.75
each. Assume that the firm can earn 10 percent on marketable securities and that there are 260
working days and hence 260 transfers from each of the ten lockbox locations per year.
a. What is the total annual cost of operating the lockbox system?
b. What is the dollar benefit of the system to Drugs 'R Us?
c. Should the firm initiate the lockbox system?
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 5
Suppose one of the suppliers to Seattle Health System offers terms of 3/20, net 60.
a. When does the system have to pay its bills from this supplier?
b. What is the approximate percentage cost of the costly trade credit offered by this supplier? (Assume
360 days per year.)
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 6
Langley Clinics, Inc., buys $400,000 in medical supplies a year (at gross prices) from its major supplier,
Consolidated Services, which offers Langley terms of 2.5/10, net 45. Currently, Langley is paying the
supplier the full amount due on Day 45, but it is considering taking the discount, paying on Day 10, and
replacing the trade credit with a bank loan that has a 10 percent annual cost.
a. What is the amount of free trade credit that Langley obtains from Consolidated Services? (Assume
360 days per year throughout this problem.)
b. What is the amount of costly trade credit?
c. What is the approximate annual percentage cost of the costly trade credit?
d. Should Langley replace its trade credit with the bank loan? Explain your answer.
e. If the bank loan is used, how much of the trade credit should be replaced?
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 7
Milwaukee Surgical Supplies, Inc., sells on terms of 3/10, net 30. Net sales for the year are
$1.2 million, and the collections department estimates that 30 percent of the customers pay on the tenth
day and take discounts; 40 percent pay on the thirtieth day; and the remaining 30 percent pay, on average,
40 days after the purchase. (Assume 360 days per year.)
a. What is the firm's average collection period?
b. What is the firm's current receivables balance?
c. What would be the firm's new receivables balance if Milwaukee Surgical toughened up on its
collection policy, with the result that all nondiscount customers paid on the 30th day?
d. Suppose that the firm's cost of carrying receivables was 8 percent annually. How much would the
toughened credit policy save the firm in annual receivables carrying expense? (Assume that the entire
amount of the receivables had to be financed.)
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 8
Fargo Memorial Hospital has annual net patient service revenues of $14.4 million. The hospital's patient
accounts manager estimates that 10 percent of third party payers pay on Day 30, 60 percent pay on Day 60,
and 30 percent pay on Day 90.
a. What is Fargo's average collection period? (Assume 360 days per year throughout this problem.)
b. What is the firm's current receivables balance?
c. What would be the firm's new receivables balance if a newly proposed electronic claims system resulted
in collecting from third-party payers in 45 and 75 days, instead of in 60 and 90 days?
d. Suppose the firm's annual cost of carrying receivables was 10 percent. If the electronic claims system
costs $30,000 a year to lease and operate, should it be adopted? (Assume that the entire receivables
balance has to be financed.)
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 9
Jones Surgicenter uses 90,000 bags of IV solution annually. The optimal safety stock (which is on hand
initially) is 1,000 bags. Each bag costs the center $1.50, inventory carrying costs are 20 percent, and
the cost of placing an order with the supplier is $15.
a. What is the economic order quantity?
b. What is the maximum inventory of IV solution bags?
c. What is the center's average inventory of IV solution bags?
d. How often must the center order (in days)?
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 10
Cross Drugs currently fills mail orders from all over the U.S., and receipts come in to a head office
in Little Rock, Arkansas. The firm's average accounts receivable (A/R) is $2.5 million and is
financed by a bank loan with 11 percent annual interest. Cross is considering a regional lockbox
system to speed up collections which it believes will reduce A/R by 20 percent. The annual cost
of the system is $15,000. What is the estimated net annual savings to the firm from implementing
the lockbox system?
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 11
Phranklin Pharms Inc. purchases merchandise from a company that gives sales terms of 2/15,
net 40 days. Phranklin Pharms has gross purchases of $819,388 per year. What is the maximum
amount of costly trade credit Phranklin could get, assuming it abides by the suppliers credit
terms? (Assume a 365-day year.)
ANSWER

UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT

Chapter 15 -- Revenue Cycle and Current Accounts Management
PROBLEM 12
Fullerton IV Company currently has a policy of reordering inventory every 30 days. Using the data
below, how much could Fullerton reduce its total inventory cost if it used the EOQ?
Ordering cost
Carrying cost
Purchase price
Total sales per year
Safety stock
Days per year
ANSWER

F
C
P
S

$10 per order

20% of purchase price
$10 per unit
1,000 units
0
360