How financial distress forecasting can help hospitals avoid closure

Hospitals are increasingly experiencing financial hardships due to factors such as changing reimbursement models, lower patient volumes and more competition in some markets.

Amid these circumstances, some facilities find funding mechanisms or strategies, such as a system affiliation, to improve their financial picture and remain viable. However, others are forced to file for bankruptcy or close.

At least nine hospitals have closed since Jan.1. And closures have particularly affected rural hospitals. Eighty-five such facilities closed between January 2010 and July 2018, according to research from the North Carolina Rural Health Research Program.

Hospital closures, especially in smaller, more remote locations, can have negative effects on communities. When a hospital shuts down, the residents of the community it served are sometimes forced to travel much longer distances to receive certain types of medical services, and layoffs associated with hospital closures negatively affect the local economy.

But understanding how hospitals get in financial distress can help facilities avoid shutting their doors.

Identifying financially distressed hospitals

James Langabeer, PhD, a professor with the school of biomedical informatics at The University of Texas Health Science Center at Houston, and other researchers recently set out to determine the overall prevalence of distressed hospitals in Texas, as well as contributing factors to the facilities' distress.

For their 2018 study, they examined 310 acute care hospitals in Texas over the four-year period between 2012 and 2015 using data from the American Hospital Association's Annual Survey Database. To identify financially distressed hospitals, researchers calculated a z-score for every facility for each study year. The Altman z-score model is a weighted composite score of financial leverage, profitability, liquidity and capital structure. Hospitals are considered in "severe financial distress" if their score is less than 1.8, in "potential impending distress" if their score is between 1.81 and 3, and in "fair financial condition" if their score is greater than 3.

The study found 50, or 16.1 percent, of acute care hospitals in Texas were in financial distress in 2015, up from 14.5 percent in 2012. The study also found smaller hospitals with less intensive and limited outpatient services were most likely to be close to bankruptcy over the four-year period.

Strategies for combating financial distress

To combat financial distress and possibly prevent bankruptcy or closure, Dr. Langabeer recommended hospital leaders calculate a comprehensive composite score, such as the Altman z-score model, for their facilities. He recommended this type of score because it integrates financial leverage, profitability, liquidity and capital structure, rather than only looking at individual measures, such as net income and days cash on hand.

He said using a composite index can help hospitals predict and understand — mainly from balance sheet and income statement perspective — the factors that are driving trends in the organization's overall financial health. He recommended tracking those factors monthly.

"It allows you to see where you're trending and how close you are to bankruptcy conditions, or alternatively if you are getting healthier," said Dr. Langabeer. "I think the real crux of it is when you find yourself in grey zone or severely distressed category, you have to find a way to get out of it. We [at UTHealth] recommend thinking about it as turnaround because those with these low numbers will eventually go into bankruptcy, close or be acquired."

Plano, Texas-based Community Hospital Corp., which owns, manages and consults smaller market hospitals, agreed forecasting provides significant insights that can help hospitals understand their financial picture and where they need to focus their efforts to improve or maintain their financial position.

Before implementing a turnaround plan, it can be helpful for hospitals to see how they stack up against other hospitals. To help hospitals with this process, CHC has pulled data from hospitals' Medicare annual cost reports, and it can use that data to calculate different financial metrics for an individual hospital and compare those benchmarks to other facilities of similar size, according to vice president of due diligence and strategic analysis Michael Morgan.

CHC's financial forecasting model also focuses on revenue cycle management, expense management and other areas hospitals can look at to improve solvency. Additionally, the model may consider productivity measures, such as the number of full-time equivalent employees per occupied bed, to determine if the facility staffing levels are appropriate for volume.

"Often the more distressed hospitals are rural, independent. Those are the hospitals we're trying to help," said Mr. Morgan. "So, that's what we've done on the financial distress forecasting side, and what we want to do with the information is bring clarity with [the hospital's] leadership and board and help identify financial trends."

Tod Beasley, senior vice president of hospital financial operations at CHC, agreed.

"Having that information is really the start to them [hospitals] being able to make appropriate strategic decisions," he said. "Rural hospital[s], they're very fragile, so minor missteps can be big missteps and decisions that are not correct or based off of wrong data can lead to ruin. But being able to have this information can sometimes be a light that goes on in leaderships' mind[s] and shines a light on what they should be doing."

Once hospitals have information from financial distress forecasting, they should establish a specific turnaround strategy and think about the strategy in terms of supply chain, financials, operations, and strategic marketing, according to UTHealth's Dr. Langabeer.

For example, low patient volume is often a contributing factor to financial distress. So, hospitals must think about how to increase patient volume in the facility's strongest service lines, he said. He also encouraged hospitals to think about how to develop referral networks, expand to new markets, and build strategic partnerships with medical schools for residencies.

"Think about what you are going to do different? You can't keep doing the same thing. Think about it systematically from all angles," he said.

Dr. Langabeer noted that many hospitals use cost cutting as a primary part of their turnaround strategy. However, he believes an effective turnaround plan requires more than just cutting costs.

"We see people extend accounts payable cycles and [implement] layoffs, but they're not thinking about the business. They're thinking about the finance, and that doesn't work with this," said Dr. Langabeer. "Think about the business as a whole and not just efficiencies as much."

 

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