There has been a mix of good news and bad news recently for not-for-profit health system margins. The good news is that after doubling down on costs, health systems have made progress reining in expenses. The bad news is that median not-for-profit operating margins are 1.7 percent, so there is still little room for error. Health systems remain vulnerable to further declines in volume, growing bad debts, inflation and a weakening stock market.
To bolster financial performance, health systems are looking to more aggressive and transformative strategies. Many health systems are having difficult discussions with bond rating agencies and financing partners. They’re trying to strike a balance between improving days cash on hand and strategically investing in non-hospital assets. Eric Young leads our health system finance team. He recently had the opportunity to spend several days in meeting with bond rating agencies and major investment houses in New York. We took away several insights from these discussions, including three important priorities for health system finance leaders.
Nail the four metrics that matter the most
To understand the underlying performance of an organization, bond rating agencies examine a wide array of factors during a rating review. These include payer mix trends, market position, and utilization metrics. But when asked which performance metrics most heavily influence ratings and guidance, the agencies unanimously emphasized four key metrics.
• EBIDA margin: A healthy organization should be achieving at least a 10 percent EBIDA cash flow margin, and should aim to exceed 12 percent.
• Liquidity: Unrestricted days cash on hand should be at least 150 days, and ideally higher than 250 days.
• Debt leverage: Unrestricted cash and investments to total debt should be more than 100 percent and ideally more than 180 percent.
• Revenue: Three-year total operating revenue compound annual growth rate (CAGR) should be positive, with top performers surpassing 8 percent.
Underperformance on even one metric matters, since these metrics tend to move together. Take, for example, a recent financial rating review with a regional health system in the South. The CEO noted that their days cash on hand, debt leverage ratio, and revenue growth were all in the top percentiles today. However, they have declined significantly in the past two years due to low EBIDA margin performance. Therefore the system is undertaking aggressive margin improvement initiatives to improve EBIDA.
Focus on your trend lines
A second point of emphasis arose in our discussions. The trend line of each metric over time is almost as important as current performance. Health system leaders should be able to explain the current and forecasted trajectory of their performance. When needed, they should also be able to describe their plans to improve. The agencies evaluate management’s ability depending on their success or failure in their commitments. As one analyst noted, “It isn’t our place to test the quality of their plans. But we want to know if they regularly execute them successfully, and if the plans produce the intended results.”
For example, a community hospital in Ohio had their bond rating downgraded a few years ago. Management developed a comprehensive turnaround plan that included selling non-performing assets, bolstering revenue cycle performance, and trimming operating costs. They presented this plan in great detail during their bond rating review, including financial forecasts with sensitivity analytics. The results they anticipate from these initiatives will take some time to return their overall performance to desired levels. But the bond rating agencies recognize the hospital’s positive trend lines and are maintaining a “stable” forecast for them.
Connect the dots for your management team
Our third recommendation is one that’s becoming increasingly important for CFOs and finance leaders. That is to routinely educate your entire leadership team on the realities of your system financial performance. Achieving financial targets is no longer the sole responsibility of finance. Strong performance depends on the collective effort and understanding of the entire leadership team. Yet all too often, broader system leadership has a very limited — and even inaccurate — understanding of financial results.
Recently a CFO of a Midwest health system changed her monthly financial review presentation for leadership. She realized that her peers were not very concerned that the system had dipped into cash reserves for two months to meet payroll. She replaced her usual budget-to-actual report with a cash-flow detail report. This allowed her to better illustrate that daily cash expenses were outpacing daily receipts on a year-to-date basis by more than $4 million. And the gap was expanding each month. Soon after, leadership collaborated to develop a recovery plan that:
· Halted adding new positions
· Delayed non-urgent capital purchases
· Prompted an accounts receivable cash acceleration project
The financial landscape for health systems is undergoing significant transformation. Keeping our eye on the ball matters now more than ever before.
John Johnston is a Senior Vice President at Optum and Eric Young is Vice President at Optum.
