Hospital and health system board members are frequently required to interpret the financial “language” of healthcare—in both the financial statements and ratios of their organization and essential industry reports—in order to make informed decisions. As important as it is to understand the financial picture, the terminology can be daunting. An excerpt from a recent Special Comment from Moody’s Investors Service illustrates the point.
2011 represented a material decline in hospital and health system credit rating volatility, largely due to the benefits from expense reductions that took place at the beginning of the recession, and improved balance sheet measures . . . While negative pressures continue, management teams have been able to maintain margins by creating greater efficiencies and savings.
Downgrades were driven in part by volume declines and weaker or negative revenue growth contributing to weakening operating performance and debt service coverage, declines in liquidity, increased debt load that stresses leverage measures, increased competition, and management and governance issues. Most upgrades were due to maintenance of strong financial performance, growth in liquidity, improved debt measures, favorable volume trends, strong market share, and strong management.
Moody’s Investors Service. Special Comment. U.S. Not-For-Profit Healthcare Ratings in 2011: Volatility Declined but Downgrades Still Exceeded Upgrades. February 2, 2012.
The iProtean course Hospital Financial Statements and Ratios serves as a primer for the financial language used by not-for-profit hospitals. Marian Jennings (M. Jennings Consulting) and Lisa Goldstein (Moody’s Investors Service) cover the basics and intricacies of hospital financial statements and ratios—necessary for those new to healthcare and an excellent review for experienced board members with non-financial expertise.
Marian Jennings, M. Jennings Consulting
The reason we are interested in the balance sheet is that it is the foundation for credit worthiness and, in particular, we’re very interested in two questions that we would answer. One question is, how leveraged are we? That’s the financial question. In plain English that means, how much we are relying on debt to support our asset base.
The second big question that we want to ask about the balance sheet is how much cash do we have? Just like in your personal life, cash gives you financial flexibility, so if you have a fair amount of cash on your balance sheet, that gives you more financial stability and flexibility moving forward.
Lisa Goldstein, Moody’s Investors Service
As a first step, it is probably most important to review the income statement. The income statement shows if the hospital is earning money from its core business from operations or, conversely, if it is losing money from operations. The first area of focus would likely be top line revenue. Basically it is taking an analysis of your volumes—how many people come to the hospital—and converting it into the ‘sales’ for treating those patients, or revenues as we call it in not-for-profit accounting. The revenue analysis is a function of looking at the different payers that reimburse hospitals for the care that they provide.
From our perspective . . . any hospital board member should look at trends—from year to year. Are revenues increasing—and revenues should be increasing just as inflation grows every year—or are revenues decreasing? From a board members perspective, if revenues are actually decreasing from year to year, I would see that as a red flag, and a board member would start asking questions of senior management as to why revenues are decreasing.
Marian Jennings, M. Jennings Consulting
Liquidity is a measure of cash, and liquidity ratios indicate cash relative to an organization’s financial needs. Two key liquidity ratios are: days cash on hand, which measures the ability to continue operations when payments for services stop, and cash to debt ratio, a calculation of cash compared to outstanding debt.
Lisa Goldstein, Moody’s Investors Service
Financial ratios and benchmarking against financial ratios are very important. It is a way for a finance committee of a board or the entire board to measure how their particular hospital is doing against national trends.
There are six key core financial ratios where most of the industry tends to focus. Two are on the income statement: the operating margin, basically operating income compared to revenues; and operating cash flow, which is your operating margin, then adding back your interest on your debt and depreciation on your buildings measured against revenues. For those two measurements, the higher the better, so the higher the margin the more profitable you are; you will have a greater ability to fund future capital if you are producing more income, if you are producing more cash flow . . .
So right there, that’s six ratios: operating margin, operating cash flow margin, days cash on hand, cash to debt, maximum annual debt service coverage and debt to cash flow. Those are the six financial indicators that the industry seems to focus on when we evaluate credit worthiness of hospitals.
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iProtean Symposium & Workshop
Mark the Date!! October 10 – 12, 2012 at The Lodge at Torrey Pines, La Jolla, CA. Faculty: Barry Bader, Dan Grauman, Marian Jennings and Brian Wong, M.D. For more information, click here.
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