Clear as glass: transparent financial reporting: if your financial statements aren't transparent, you may be setting your organization up for scrutiny

Healthcare Financial Management, August, 2005 by Robert M. Valletta

Financial executives at many not-for-profit hospitals and health systems are feeling like a bull's eye at target practice these days. Increased scrutiny of financial reports and requests for information are coming from all angles--the IRS, creditors, bondholders, regulatory bodies, legislators, class action attorneys, community and patient-advocate groups, even consumers.

Each entity has its reasons for poring through hospital financial statements, and not-for-profit hospitals have good reason to open their books, whether it is to access capital or to defend and promote the organization's public image, reputation, and competitive advantage in the market.

In a post-Sarbanes-Oxley world, not for profit institutions are being held to the same high standards of corporate governance, risk management, and financial reporting as their public counter parts. Although the Sarbanes-Oxley Act of 2002 does not expressly apply to not for profit hospitals, strong arguments exist to support efforts by state charity regulators, the IRS, and the American Institute of Certified Public Accountants Accounting Standards Executive Committee to increase disclosure requirements for not for-profit entities.

Foremost among these arguments is that it's important to provide potential donors, as well as bondholders, with reliable, timely financial information concerning the organization, because many hospitals are making capital access initiatives an annual event. Such information is also useful to stakeholders as an early warning sign of hospitals in financial distress.

The most recent interest in financial reporting by not for-profit hospitals stems from growing speculation over not-for-profit hospitals' tax-exempt status, potential tax abuses, and whether these hospitals should continue to be granted tax exemption. Hospital financial executives are being asked to supply volumes of detailed information such as the breakdown of charity care and debt, income streams related to joint ventures, cost sharing arrangements, the allocation of expenses, and the standards by which financial information is collected, monitored, and reported.

The bottom line is that there is a tremendous burden on healthcare financial managers not only to produce more information but also to ensure the accuracy of financial statements and disclosures.

Although the risk of errors and misstatements in financial reporting at a not-for-profit health system is not close to what a public company faces, the stakes are higher than ever. Not-for-profit hospitals would be well served to emulate their public counterparts by going beyond responding to requests for information and incremental increases in disclosure requirements that address individual issues separately and instead strive for transparency.

The current focus of Congress will likely lead to reforms affecting financial reporting by charitable organizations that in many ways emulate Sarbanes-Oxley provisions. In addition, more states will emulate provisions in legislation targeting not for-profit organizations, such as legislation passed in Massachusetts and California. Major market reforms have traditionally been initiated by regulators and legislators and resisted by the industry, and compromise is discovered somewhere in the middle. For this reason, hospitals and health systems need to take the initiative and seek transparency if they desire a better outcome.

What Is Transparency?

Financial disclosure, while necessary for stakeholders to obtain the information they need, does not, in itself, constitute transparency. The cur rent reporting model focuses narrowly on financial reporting and fails to provide a clear picture of a hospital's or health system's results and associated risks.

Transparency means improved disclosure beyond generally accepted accounting principles, Governmental Accounting Standards Board, or statutory reporting requirements, where and when needed, to provide users with the information they need to make informed decisions about an organization. It entails not only financial information but also nonfinancial information accompanying, by either law or custom, the audited financial statements.

Improving transparency means articulating the "whole story" of an organization as seen through the eyes of management, including nonfinancial indicators of current and future performance, risks, and other factors necessary to better understand the business. Some of this information is already conveyed in corporate and community reports, but the reporting model can and should evolve to include important information about growth strategy, people issues, brand and market share, and supply chain issues, supported by quantitative nonfinancial performance measures and operating metrics. In addition, transparency includes improving access to, timeliness of, and relevance of information that is useful to stakeholders.

Telling the Whole Story

Health care has operating characteristics that differentiate it from other market segments. While publicly traded companies may be watching earnings reports, healthcare providers are focused on admissions, patient days, payment, and contractual allowances. Key challenges for healthcare providers to communicate include: