By Bob Vento

The typical hospital’s business model and revenue stream are so markedly different from other businesses, its level of financial distress can be difficult to diagnose. The following early warning signs will help hospital leaders more clearly identify and proactively react to financial distress. While no single metric can accurately identify early-stage distress in all hospitals, the following financial indicators can offer helpful insight into the outlook of a hospital that might be in trouble.

Days Cash on Hand: Trend Analysis
The number of days of cash a hospital has on hand is a classic solvency metric. Astute analysts will track long-term trends, as well as review individual instances. Analyzing multiple-year and/or monthly trend lines can add clarity to assessing hospital performance. Further investigation can help determine if large movements resulted from a favorable change, such as an increase in net patient revenue; a neutral change, such as an influx in cash from a real estate divestiture; or an unfavorable change, such as an investment loss.

Benchmark: Simply stated, decreasing cash from year-to-year or month-to-month is a sign of financial distress. In addition, an interim snapshot that reveals the number of Days Cash on Hand at a point materially lower than historical patterns or bond covenant requirements may well be cause for immediate review, concern and follow-up.

Current Ratio: Trend Analysis
Just like Days Cash on Hand, reviewing a hospital’s current assets compared to its current liabilities can be more instructive as a trend than as a single snapshot, especially for early detection of financial distress. Developing a Current Ratio trend line for multiple years supplemented by a cycling of the most recent 12 months will likely provide compelling predictive value.

Benchmark: In general, a trending decline that has reached 1.5 is an early sign of financial distress. Any single instance that is 1.0 or less warrants timely investigation.

Accounts Receivable (AR) Days: Trend Analysis
An increase in AR Days is often indicative of a hospital with poorly negotiated managed care contracts, unfavorable market changes, or ineffective collection practices. The challenge of reducing AR Days is both critically important and exceptionally challenging in the healthcare industry due to highly complex and unorganized payment systems. Reviewing a 12-to-18-month trend of AR Days can indicate a hospital’s ability to meet these challenges. Poor revenue cycle management will quickly exacerbate hospital financial distress.

Benchmark: Any trend of increasing AR Days is a sign of trouble; however, an average of 55 days paired with a trending increase is especially concerning. This is even more concerning when coupled with growing bad debt, a relevant consideration as increasing numbers of American workers find themselves unemployed and uninsured. The quality of the AR aging file is another relevant factor when evaluating the revenue cycle management process. That is, if
AR aging categories by payer are worsening over time, the probability that liquidity will suffer is
high – an obvious indicator of distress.

Capital Expenditures vs. Annual Depreciation
Capital improvements are critical for hospitals to recruit physicians, attract patients and deliver quality care. A hospital that does not upgrade its facility and equipment to offset the depreciation of its capital assets, especially in revenue-generating areas of the hospital, is headed for trouble over the longer term. The effect of delayed expenditures is compounding, and the cost to “catch up” on postponed improvements can be far greater than an initial investment. A hospital’s capital expenditures and annual depreciation should be calculated for each of the past 10 years to determine if it is keeping pace.

Benchmark: If depreciation has outpaced capital improvements in more than three of the past 10 years – or if this is the case for the most recent two years – the hospital is likely experiencing distress. In addition, if the facility’s next scheduled capital project relies on funds exposed to market performance (investment income, grants from foundations or charitable donations), more serious financial issues may exist. This is especially true for hospitals nationwide that are facing challenges in accessing debt financing due to today’s tight credit markets.

Internally Prepared Financial Statements
Clear financial statements are critical for sound decision making. A hospital that prepares a confusing, inadequate, or poorly organized set of financial statements may be unable to analyze data, look beyond the numbers, or make informed decisions. Reviewing several hospital monthly financial statements can show data being used to make routine and strategic decisions. A fundamental benefit of financial statements is predictive value.

Benchmark: General purpose financial statements that do not contain some narrative, lack compelling financial information (e.g., key statistics and cash flow data), and generally lack substance may be indicative of a hospital that is making decisions based on incomplete or erroneous information. Left unchecked, this can lead to unfavorable financial outcomes and ultimately financial distress.

The challenges are great for our nation’s hospitals and health systems. Many need immediate intervention to prevent crisis situations. Early detection and swift intervention can help ensure that: (a) communities maintain access to the healthcare services they need, and (b) risk is mitigated for financial stakeholders in the hospital.

Bob Vento is a senior vice president for QHR Intensive Resources. For additional information on QHR’s consulting solutions, contact vice president Susan Hassell at (866) 371-4669.

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