Hospital margins decline in 2026 as expenses outpace revenue

As hospitals seek to shore up their finances in a challenging environment, cost-focused initiatives are taking priority.

“Organizations are saying, ‘We’ve got the revenue picture, [now] we’ve really got to get our expense picture to be sustainable with our revenue picture,’” said Steve Wasson, chief data and intelligence officer with Strata Decision Technology. “And what I see organizations doing is putting a lot more rigor around that and having operational excellence be a part of their strategy.”

The need for such an effort is indicated in Strata’s latest financial metrics for the hospital sector. While 2025 was “pretty stable,” Wasson said, performance declined during the first two months of 2026. After median operating margin came in at negative 0.6% in January, it ticked up to negative 0.3% year-to-date in February.

Expenses remain the primary concern, negating revenue growth. Namely, drug costs increased by 7.6% and supply costs by 7.8% year over year.

“That underlying cost of care is still really elevated, and people aren’t able to get their arms around that in a meaningful way,” Wasson said.

Stability in labor costs amid elevated total expenses

Labor costs have been more controlled, increasing by 4% relative to February 2025. Hospitals and ambulatory care settings continue to provide a major boost to the U.S. economy, with hospitals adding 10,900 jobs in February and 14,900 in March, according to federal data.

Despite hiring at a rapid clip, hospitals seem to be keeping labor costs in check, especially compared with supplies and pharmaceuticals, Wasson said.

“I think [the job growth] has to do with the demographics of our population,” he said. “People are aging, the baby boomers, etc.

“But on a per unit basis, meaning: ‘I saw a patient, how much did it cost me?’ — it’s been more stable.”

Revenue growth strengthens, led by outpatient volumes

Revenues appear to be solid on a sector-wide basis, at least in the near term. Gross operating revenue increased by 6% year over year in February, sparked by a 7.2% rise in outpatient revenue (compared with 3.5% on the inpatient side).

A potentially promising trend is the continued shift of volumes from inpatient units to hospital outpatient settings. Even though revenues may be lower in an outpatient department, such settings tend to do better on a marginal basis, Wasson noted.

“There’s less cost and better operating performance,” he said.

The migration nonetheless brings challenges.

“You’re changing your operation. You’re changing how you staff, changing how you contract,” Wasson said. “It changes a lot, and then you still have the old facility. So you have some of these fixed costs that now don’t necessarily go away immediately, so you have to think through what that means.”

Drop-offs in emergency department (ED) volumes, which plummeted by 10.3% year over year (and 14.7% from January to February) generally translate to downstream declines in inpatient revenue.

The ED “usually is an on-ramp to admissions, which drive revenue,” Wasson said. “But the actual setting of care is not the most efficient place to provide care. So it’s a double-edged sword sometimes.”

Revenue cycle gains offset by rising denials and leakage

Digging deeper into hospital revenues, the picture becomes mixed.

For example, hospitals are benefiting from recent rate increases from commercial plans, Wasson said. Improvement in those relationships also is indicated in revenue cycle metrics compiled by Kodiak, which recently published a report (registration required) showing increased cash flow stemming from factors such as faster average time to payment and reductions in accounts receivables days.

On the downside, “better cash flow did not convert into yield maximization” due to increases in revenue leakage, the report states. That issue resulted from a jump in the average initial denial rate and a decline in reversals of clinical initial denials (e.g., prior authorization), among other headwinds. Median final denials rose from 2.5% to 2.7% between 2024 and 2025, helping to drive a spike in net revenue leakage from $38.6 billion to $48.4 billion.

Beyond administrative friction in commercial contracts, another problem is that those contracts constitute a shrinking share of the payer mix. For many systems, Medicare and Medicaid combine to represent more than 60% of reimbursement, Wasson noted.

“The commercial payers, they’re paying at a pretty good rate,” Wasson said. “If you had a higher population of that, I think we’d see a difference in our margins.”

Medicaid risk and payer mix shifts heighten margin concerns

Given the prominence of government programs in the payer mix, looming cutbacks to those programs, particularly Medicaid due to provisions in the 2025 reconciliation bill, become an overriding concern as hospitals look to sustain their revenues.

In Strata’s nationwide survey of healthcare finance professionals, 66% cited government funding and Medicaid cuts as a leading concern. No other issue (e.g., labor costs, payer negotiations, margin compression) was named by a majority of respondents.

As revenue-related questions abound, cost reduction becomes a board-level strategic initiative rather than simply a focus of finance teams. There is a push to enhance “operational rigor, really getting at the expense lines as a strategic competency,” Wasson said.

Data continues to be deployed in service of cost efficiency, especially as a way to gauge areas in need of improvement. Even small operational tweaks can resonate when applied to high volumes.

“It’s just trying to find those areas where they can make a real difference, and dissecting that operation in a way that maybe they wouldn’t have been willing to do before,” Wasson said.

Six in 10 survey respondents said they plan to invest in better analytics and data-based insights. AI tools ranked lower, at 29%, but in practice, today’s analytics often are powered by AI.

“A lot of these organizations are constrained on the human capital required to really see what’s going on,” Wasson said.

For example, with the right analytics, he added, “You as an operator might be able to see: ‘My drug costs are up, but if I had made these changes in my formulary, that could have been different, or I can forecast it will be different.’”