This paper addresses foundational concepts in healthcare finance through a series of focused questions and answers. Topics covered include the four sources of long-term debt financing and their five key characteristics, the effect of added debt on a healthcare provider's financial flexibility, basis point calculations, and the distinction between working capital and net working capital. The paper also compares aggressive and conservative asset mix strategies with respect to goals, liquidity, and risk, and examines general borrowing rules for short- versus long-term needs. Additional sections address cash budgets, long-term financial planning, and applied problems involving required annual yield and hospital billing collections.
Long-term debt is employed to finance business investments that have lengthier payback periods. There are four sources of long-term debt financing: term loans, bonds, hire purchase, and debentures.
Several key characteristics distinguish long-term debt financing. First, long-term debt typically carries a greater principal balance than other debt obligations, because individuals do not normally obtain long-term loans for smaller purchases. Second, long-term debt usually comes with lower rates of interest compared to short-term financing. This is because debts such as mortgages and car loans are generally secured with property as collateral, which reduces the lender's risk.
Collateral is a third characteristic of long-term debt. While personal loans, credit cards, and store cards are normally accessible without collateral, one usually cannot make a large purchase without offering security for the debt. A fourth characteristic concerns cash flow: taking on long-term debt has a more lasting impact on a consumer's monthly cash flow, since high monthly debt obligations reduce the amount of money available for expenditures such as entertainment and vacations. Finally, the defining characteristic of long-term debt is that it is repaid over a period longer than 12 months (Kokemuller, 2016).
Adding debt decreases the flexibility of a healthcare provider. When the total amount of debt is higher, the organization's available funds must be allocated primarily toward servicing that debt, leaving fewer resources for other operational or strategic needs.
A basis point is equal to 0.01%. To calculate the number of basis points between 6 5/8% and 6 3/4%:
6.75% − 6.625% = 0.125%
Since 1 basis point = 0.01%, there are 12.5 basis points between the two rates.
Working capital is defined as the difference between a company's current assets and its current liabilities. It represents the amount of money available to meet the immediate short-term operating needs of a business. The distinction between working capital and net working capital is that "working capital" is sometimes used to refer solely to current assets, whereas net working capital is specifically defined as the difference between current assets and current liabilities. Non-cash working capital further refines this by considering the difference between non-cash current assets and current liabilities (Horngren et al., 2012).
The purpose of working capital is to provide a measure of both the efficiency of a company and its short-term financial health. It is calculated by subtracting a firm's current liabilities from its current assets (Horngren et al., 2012).
Many financial institutions and investment advisory services offer investors various allocation models as tools and guidelines for constructing investment portfolios. Depending on the relative composition of assets in these portfolios, a particular asset mix may be considered either aggressive or conservative.
A significant difference exists between the two approaches: a conservative asset mix strategy tends to favor lower risk and income generation, while an aggressive asset mix strategy is more willing to accept risk in exchange for potentially higher returns. However, despite these differences, the two strategies share several common elements — for example, both may hold some of the same portfolio components (Xi, 2016).
With respect to risk and volatility, the two approaches have opposing risk tolerances. An aggressive portfolio, in its worst form, might experience a decline of approximately 30%, a loss level that would be unacceptable to a conservative, risk-averse investor who would be more comfortable with a maximum loss of around 15% (Xi, 2016).
"Rules, advantages, and disadvantages of borrowing options"
"Cash budget similarities, yield problems, and billing collections"
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