Cashing in on Revenue Cycle Improvements

There is nothing more important to potential creditors than a borrower’s liquidity position. With all of the uncertainty in the healthcare industry — and the economy today for that matter — there is no substitute for the margin of safety and flexibility that cash provides.

The article below is reprinted with permission from The Capital Issue, a quarterly newsletter published by Lancaster Pollard.

Most healthcare providers recognize the importance of liquidity and treat the cash on their balance sheet as sacred. But defending the balance sheet is only part of the battle. Surprisingly, many managers fail to take the necessary steps to increase their liquidity position.

Of course, there are myriad factors that can undermine a hospital's efforts to generate cash flow from operations: payer reimbursement, economic conditions, competitive landscape, cost and supply of labor, demographics of the market, etc. While it is true that hospital management has little to no control over these factors, there are other areas where it could have an equal — if not greater — impact to the credit profile.

In particular, managing the payment cycle can help cash flow, but it also serves as a signal to potential creditors. Having a consistent focus on improving these measures demonstrates to creditors that management is competent and attentive to issues that it can affect. Conversely, large fluctuations in bad debt expense and/or days in accounts receivable or a large percentage of "old" receivables causes a financial analyst to question the competency of management and the integrity of the historical income statements.

Challenges to increasing liquidity
The Patient Protection and Affordable Care Act introduces additional uncertainty into an already murky revenue picture for healthcare providers throughout the country. Who is covered by insurance and how much will the insured be required to self-fund will likely remain uncertain for some time. Although state budgets have improved somewhat, uncertainty remains in state Medicaid reimbursement programs. The integration of technology, such as electronic health records, holds great long-term promise, but short-run costs, shifting requirements and implementation challenges make planning difficult. Most creditors will expect a competent management team to have a plan, which is robust enough to provide flexibility with each of the above factors; however, banks and other creditors also recognize that these issues are challenges and any plan to address them will be fraught with uncertainty.

Given the uncertainty of supply/demand, pricing and expenses, it is imperative that providers improve cash flow through factors that are within their control. Indeed, it is more important than ever that management develop a "fortress balance sheet," to borrow a term often used in the banking industry.

One clear indication of the importance of liquidity is the view of the rating agencies. The measures: cash to debt and days cash on hand have the clearest correlation to hospital ratings of all the metrics shown in the Standard and Poor’s industry medians. Obviously, increasing revenue and cutting expenses are two ways of increasing cash, but options for affecting the profit and loss statement are usually limited. One can do nothing about the supply/demand balance and there is little to be done about reimbursement rates. Cutting expenses is always good, but by far the largest expense—personnel costs—is the hardest and most painful to cut. Other sources of revenue—investment income, contributions, government allocations, etc.—are usually dependent on external factors, which defy management intervention.

Uncovering cash trapped in working capital
Given the lack of options for intervention on the revenue side and the challenges for affecting change on the expense side, one might feel as though balance sheet improvement is not possible. This view fails to recognize that there might be significant cash tied up in working capital and this is an area where management can exert influence. In fact, decreasing just five days in the payment cycle can have huge impact on company's balance sheet.

The example may appear trivial, but five days of accounts receivable (AR) represents more than $4 million in this case. Many healthcare providers can achieve changes of this magnitude in six months to one year, with proper attention and a focus on gradual improvements. Representatives of Community Hospital Corp., a company that provides consulting and management services to rural and community hospitals, noted that even more extreme examples exist. In one case, a hospital was showing more than 30 days of "unbilled" accounts, resulting in serious cash flow shortfalls. The example in the table also points out the increased margin of safety from turning over accounts receivable. If an emergency occurred, this organization would not have excess cash to cover its obligations; likely, it would have to sell assets, factor receivables or execute some other compromise. This demonstrates the danger of looking at working capital as a measure of short-term liquidity strength. Reducing its days in accounts receivable by 10 percent effectively creates an emergency fund of more than $4 million. Furthermore, an increase in accounts receivable balances often signals to an analyst a number of problems: revenue may have been overstated, bad debt may have been understated, management is unable or unwilling to effectively deal with its payers, processes and procedures are not adequate to process claims and a host of other deficiencies that relate to management effectiveness.

The process of filing and collecting claims is lengthy even in the best of circumstances, but oftentimes hospitals focus solely on the tail end of the process (i.e., collections). Clearly, collecting for services rendered is vital, but there are a number of steps prior to collections, which provide an opportunity to eliminate waste. This is an area where hospitals can learn from process improvement techniques used in other industries.

Process improvement
Using Toyota Production System's or other Lean manufacturing methodology, providers can focus on eliminating waste and making the process more efficient. As with any process, there is an opportunity to eliminate waste at every stage and there are many different kinds of waste: transportation, inventory, motion, waiting, overprocessing, overproduction, defects, resources and talent. All of which can contribute to time in the process.

One key point that the most effective providers emphasize is precertification on the front end. Obtaining authorization before a patient even arrives is a key to eliminating waste later in the process. The idea is that taking extra time and devoting resources before the patient arrives eliminates the need to hassle patients or negotiate with insurers later in the process and more importantly, upfront authorization greatly reduces bad debt due to misunderstanding over coverage or inability to pay. Precertifcation also provides an opportunity to improve patient satisfaction. By clearly articulating the patient's financial responsibility before a procedure, indeed before the patient arrives, the hospital avoids promoting sticker shock and limits difficult conversations when a patient does not have the capacity to pay. Failure to precertify procedures tends to create waste of overproduction and overprocessing.

Another key aspect of efficiency within the revenue cycle is the education and training of persons responsible for tasks throughout the billing cycle. With the rapid changes in the healthcare industry, it is difficult to stay up to date on requirements. In addition, constantly evolving technology and system infrastructure can create a stressful environment for those responsible for managing the system. Keeping the workforce confident that they are performing the job accurately is important and training is vital in this regard. Perhaps equally important is ensuring that the staff is accountable for and empowered in performing the tasks from scheduling through billing and collections. Generally, billing errors are the result of poor training or a failure of institutional focus on the importance of quality. Errors of this type are known as "defects" in Lean manufacturing terminology and this is perhaps the most expensive form of waste as defects often lead to performing the same task two or more times.

Ideally, work teams can be cross-trained to ensure a full understanding of the process and the organizational structure is arranged to minimize hand-offs between departments. Movement of activities between departments tends to create waste by "inventory" build-up, "waiting" times, and increases the risk of "defects."

Many providers despair of the inability to make significant reductions in bad debt or days in accounts receivable, but as with any task, advancement is a gradual evolution of marginal improvements. Considering the demands on time of management and staff, it may seem difficult to justify devoting resources to process improvement, but the benefit of increased liquidity and demonstration of management effectiveness can greatly enhance a provider's credit profile.

Ritchie Dickey is a vice president with Lancaster Pollard and is based out of the firm’s office in Atlanta. He may be reached at

More Articles on Hospital Balance Sheets:

Investment Oversight: Board Performance as an Indicator of Mission Success
Smart Moves: How Hospitals Manage Risk When Borrowing


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