Thomas M. Schuhmann
Financial indicators derived from Medicare cost report data are reliable tools for assessing the effectiveness of a hospital's operations.
At a Glance
- Hospitals may wish to compare their performance with that of their peers to identify areas for possible improvement.
- Comparing financial indicators over five years shows directional trends and the influence of environmental factors such as regulatory change.
- For-profit hospitals appear to outperform their not-for-profit counterparts.
- Rural hospitals generally exhibit better financial performance than urban hospitals.
- Nonteaching hospitals show more desirable operating margins than teaching hospitals.
The delivery of patient care has not been especially lucrative for short-term acute care hospitals (STACHs) in recent years. Financial indicators derived from Medicare cost reports show that these hospitals are actually losing money on patient care. Indeed, these financial indicators have much to tell hospitals about their overall financial performance, and hospital financial executives should be attentive to their message.
For hospital financial executives seeking to assess their organizations' performance over time and in comparison with that of peer facilities, Medicare cost reports are among the most reliable sources of comparative information. The reason is that these data sources are available for most, if not all, hospitals. Financial indicators derived from Medicare cost reports can be used to examine trends for individual hospitals and for groups of hospitals over several years. On the macro level, such trends can help in understanding how the healthcare industry is affected by regulatory changes, shifts in utilization, and other factors that have an industrywide impact. And on the micro level, individual hospitals can use these indicators to identify areas in which their performance falls short of best practices and to highlight areas for possible improvement.
To demonstrate the value of these financial indicators, we examined a set of indicators commonly used within the industry, looking at comparative data for the five most recent years available (see Exhibit 1).
Although there are many useful indicators to choose from, we focused on the 11 listed below, which are well-known within the industry for evaluating individual hospital performance, benchmarking with peer groups, and studying particular systems or groups of hospitals (see Exhibit 2):
- Maintained bed occupancy (percentage)
- Average length of stay (days)
- Operating margin (percentage)
- Current ratio
- Cash on hand (days
- Accounts receivable (days)
- Average payment period (days)
- Inpatient gross revenue (percentage)
- Outpatient gross revenue (percentage)
- Contractual allowance write-off (percentage)
- Personnel expense (percentage of operating revenue)
These indicators are used to measure an organization's overall financial health, major utilization characteristics, and important management efficiencies. The first seven of these indicators are among 14 indicators for which HFMA publishes national values each year based on contributions from various sponsoring companies (see HFMA Key Hospital Financial Statistics and Ratio Medians 2007; go to HFMA.org and search on first five words of title). Bond rating agencies, in particular, use these indicators as a means to determine a hospital's financial health.
All of the indicators are defined by data that are generally available from Medicare cost reports. This common basis enables benchmarking, comparative analysis, and industry trending that would otherwise not be possible.
The findings of our study show stability in occupancy, average length of stay (LOS), and inpatient/outpatient mix (see Exhibit 3). But the data also disclose some unexpected trends. Most important is the finding presented at the opening of this article: stachs have been losing money from patient care services for the last five years. A hospital's operating margin percentage is one of the most important indicators of financial viability. Notwithstanding some recent improvement, hospital operating margin percentages remained negative during the period studied: from -1.88 percent in FY03 to -1.14 percent in FY07. The financial stability of the entire hospital industry may be threatened if this trend continues.
Yet in spite of this threat, other financial indicators have remained solid and have even improved over the period studied. Current ratios have improved, hospitals have more cash on hand, and hospitals are collecting receivables and paying bills faster as an industry. At the same time, hospitals have been able to reduce personnel costs.
Also, improvements in financial indicators have not been seen uniformly across all types of hospitals. Certain types of hospitals have performed better than other types.
For-profit hospitals are outperforming their not-for-profit counterparts. For-profit hospitals as a group showed better financial performance than not-for-profit hospitals (see Exhibit 4). Their operating margins remained positive for all years, ranging from 8.87 percent in FY03 to 5.45 percent in FY07. During the same time, operating margin percentages for not-for-profit hospitals remained negative, ranging from -1.86 percent in FY03 to -0.54 percent in FY07. In terms of overall financial health, for-profit hospitals had fewer days cash on hand than not-for-profit hospitals, but their current ratios suggest a greater preparedness to meet short-term obligations.
For-profit hospitals had significantly lower maintained bed occupancy percentages, which also remained stable over five-years. Meanwhile, not-for-profits saw this indicator increase from 66.38 percent in FY03 to 69.41 percent in FY07. Similarly, the average LOS for for-profit hospitals was slightly less than for not-for-profit hospitals and remained stable for both groups over the five years. Not-for-profit hospitals showed higher outpatient gross revenue percentages than for-profit hospitals. Although the inpatient-outpatient mix remained stable for not-for-profit hospitals, the outpatient percentage increased for for-profit hospitals from 30.52 percent in FY03 to 33.60 percent in FY07.
The financial indicators also suggest several differences in financial management practices and trends between the two groups. Accounts receivable (A/R) days were significantly lower for not-for-profit hospitals, and both groups reduced their days over the period studied: Not-for-profits decreased their A/R days by 7.48, while days for for-profits dropped by 12.33. Data also indicate that for-profits pay bills faster than not-for-profits: They decreased their average payment period by 8.28 days, while not-for-profits actually saw an increase of 4.08 days.The contractual allowance write-off percentage was higher for for-profits than for not-for-profits, and the percentage was increasing for both groups. These trends suggest that for-profits may have higher average charges than not-for-profits. Write-offs for not-for-profits showed a more rapid increase, however, which suggests that their average charges are rising faster than the average payments from their payers.
Also, personnel expenses for for-profit hospitals were more than 20 percent less than those for not-for-profit hospitals. Personnel expenses are the largest expense for hospitals, accounting for slightly more than half of operating revenue. The fact that for-profit hospitals are able to keep their percentage so much lower than that for not-for-profit hospitals is probably the single biggest reason for the differences in their respective operating margin percentages.
Rural hospitals are enjoying better financial performance than are urban hospitals. Rural hospitals as a group showed better financial performance than urban hospitals (see Exhibit 5). Their operating margins increased from -1.06 percent in FY03 to 0.41 percent in FY07. During the same time, operating margin percentages for urban hospitals improved but remained negative, ranging from -2.01 percent in FY03 to -1.32 percent in FY07. In terms of overall financial health, rural hospitals had significantly more days cash on hand than urban hospitals and significantly better current ratios.Although the maintained bed occupancy percentages and the average LOS for both groups remained stable for all five years, both indicators are remarkably lower for rural hospitals. Similarly, rural hospitals had much higher outpatient gross revenue percentages than urban hospitals, and the difference continued to increase over the five years.
The financial indicators also suggest that urban hospitals tend to collect their receivables faster than rural hospitals, while rural hospitals tend to pay their bills more quickly. Accounts receivable days were significantly lower for urban hospitals, and both groups lowered their days over the period studied: Urban hospitals decreased their days by 6.18 and rural hospitals by 8.34. The average payment period for rural hospitals is significantly lower than for urban hospitals while the indicators for both groups have decreased gradually during the period studied.
The contractual allowance write-off percentage was lower for rural hospitals than for urban hospitals, suggesting that rural hospitals may have lower average charges than urban hospitals. The write-off percentages for both groups increased over the period studied, which suggests that both groups have been increasing average charges more rapidly than average payments.
The two groups also saw different trends in personnel expenses. Rural hospitals were able to decrease their personnel expense percentage from 52.42 percent in FY03 to 49.47 percent in FY07, while for urban hospitals, this measure remained relatively stable at about 50 percent for all years. Again, because personnel expenses are the largest expense for hospitals, this indicator helps explain why the operating margins were better for rural hospitals than for urban hospitals.
Nonteaching hospitals have better operating margins than teaching hospitals. Nonteaching hospitals as a group showed much better financial performance than teaching hospitals, with positive operating margins for all years, ranging from 0.87 percent in FY03 to 1.58 percent in FY07 (see Exhibit 6). During the same period, operating margins for teaching hospitals remained negative, ranging from -3.77 percent in FY03 to -3.02 percent in FY07. In terms of overall financial health, both groups had about the same days cash on hand, but nonteaching hospitals had higher current ratios, suggesting a better degree of preparedness to meet short-term obligations than teaching hospitals.
Although the maintained bed occupancy percentages and the average LOS for both groups remained relatively stable for all five years, both indicators were remarkably lower for nonteaching hospitals. Similarly, nonteaching hospitals had much higher outpatient gross revenue percentages than did teaching hospitals.
The financial indicators also suggest that teaching hospitals tend to collect their receivables faster than nonteaching hospitals, while nonteaching hospitals tend to pay their bills more quickly. Accounts receivable days are significantly lower for teaching hospitals, and both groups reduced their A/R days over the period studied: Teaching hospitals saw a decline of 5.31 days compared with a drop of 8.45 days for nonteaching hospitals. The average payment period for nonteaching hospitals was significantly lower than for teaching hospitals, while the indicators for both groups decreased significantly over the period studied (except for FY07 for teaching hospitals, during which time this measure increased dramatically against the downward trend)
The contractual allowance write-off percentage was slightly higher for nonteaching hospitals than for teaching hospitals, and the percentage showed a steady increase for both groups, which suggests that their average charges are rising faster than the average payments from their payers.
Personnel expenses were significantly lower for nonteaching hospitals than for teaching hospitals, and-as with for-profit versus not-for-profit hospitals and rural versus urban hospitals-this difference is probably the single biggest reason for the difference in operating margin percentages.
Implications for Action
The financial indicators we examined suggest that hospitals are more likely to have better operating margin percentages if they have lower occupancies, shorter LOS, lower personnel cost percentages, and higher outpatient gross revenue percentages. Five-year trends identified shifts from inpatient to outpatient services for some types of hospitals, improved collections as evidenced by lower A/R days, and the continuation of negative hospital margins for many hospitals.
Hospital financial leaders should compare their own organizations' indicators with the national averages presented and consider opportunities for improvement that are implied by the differences among types of hospitals. For example, if a hospital's personnel costs are higher than the averages reported for its peers, then this is an area that probably requires proactive attention.
Hospitals should also be aware that industry analysts and lending institutions monitor these and other indicators. Based on his experience covering many of the for-profit hospital companies, Robert R. Hawkins, CFA, vice president and stock analyst with Stifel Nicolaus, notes that stock and debt analysts are particularly interested in inpatient and outpatient shifts reflected by indicators such as maintained bed occupancy percentages, average LOS, and gross revenue percentages. Hawkins also suggests that hospital financial leaders should monitor their organizations' individual performance regarding personnel expense percentage versus industry averages, which remains at about 40 percent for for-profits. He also emphasizes that the contractual allowance write-off percentage can be an important indicator of the effectiveness of annual hospital rate increases.
In short, financial indicators are important in the measurement and control of an individual hospital and in the external evaluation of hospital operations. Public financial data for benchmarking are readily available both for hospital management and for external interests. These data offer hospital financial leaders a reliable means to identify where they should focus their efforts to improve their organizations' financial performance.
Thomas M. Schuhmann, JD, CPA, is senior vice president, finance, Cost Report Data Resources, LLC, Louisville, Ky (firstname.lastname@example.org).
Publication Date: Tuesday, July 01, 2008