Can you please assist me with the following question from Fundamentals of Health
ID: 2727837 • Letter: C
Question
Can you please assist me with the following question from Fundamentals of Healthcare Finance, Second Edition by Louis C Gapenski Problem 7.3 (Please show step by step solution). Fargo Memorial Hospital has annual patient service revenues of $14,400,000. It has two major third-party payers, and some of its patients are self-payers. The hospital's patient accounts manager estimates that 10 percent of the hospital's billings are paid (received by the hospital) on Day 30, 60 percent are paid on Day 60, and 30 percent are paid on Day 90. (Five percent of total billings end up as bad debt losses, but that figure is not relevant to this problem.) a. What is Fargo's average collection period? (Assume 360 days per year throughout this problem.) b. What is the hospital's current receivables balance? c. What would be the hospital'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 60 and 90 days? d. Suppose the hospital's annual cost of carrying receivables is 10 percent. If the electronic claims system costs $30,000 a year to lease and operate, should it be adopted? (Assume the entire receivables balance has to be financed.) I really would appreciate some assistance on this. Thanks :)
Explanation / Answer
Answer:
a. Average Collection Period (ACP) = (% of bills paid * No of days) + (% of bills paid * No. of days) +(% of bills paid * NO.of days)
Average Collection Period = (0.10*30) + (0.60*60) + (0.30*90) = 3+36+27 ACP = 66 days
b. Average daily billings = annual revenues/year (360 day year is assumed)
Receivables balance = average daily billings * ACP
= (14,400,000/360)*66 = 40,000*66
Receivables balance = $2,640,000
c. ACP = (0.10*30) + (0.60*45) + (0.30*75) = 3+27+22.5 ACP
= 52.5 days
Receivables balance = 40,000*52.5
= $2,100,000
d. Cost of carrying receivables = receivables balance (RB) * interest rate Cost of (RB-b)
= 2,640,000*0.10 = $264,000
Cost of (RB-c) = 2,100,000*0.10 = $210,000
Cost savings = Cost of (RB-b) – (Cost of (RB-c) + cost to lease/operate)
= 264,000 – (210,000 + 30,000)
= 264,000 – 240,000
Cost savings = $24,000
The cost at current ACP is $264,000; with the new system, the cost would be $210,000 plus the cost of the equipment to lease and operate which $30,000. Even with the extra expense of the system, there is a savings to the cost of carrying the receivables of $24,000. Since the system is providing an overall cost savings, it should be adopted.
Source :Fundamentals of Healthcare Finance, Second Edition by Louis C Gapenski