100414 beckers using metrics to analyze hospital performance · 2014-10-20 · using metrics to...

1Copyright 2010 Kaufman, Hall & Associates, Inc. All rights reserved.

Hospital and Health System

Improving Profitability and Business and Legal Issues Conference

Using Metrics to Analyze Hospital Performance

Copyright 2010 Kaufman, Hall & Associates, Inc. All rights reserved.

Chicago, Illinois / April 14, 2010

Hospitals and Health System





Introduction to Kaufman HallAt a Glance

CAPITAL ALLOCATION

Kaufman Hall helps organizations design and implement capital allocation processes which

provide consistent and rigorous methodologies to guide

the capital decision-making process.

FINANCIAL AND CAPITAL PLANNING

Introduced concept of strategic financial planning to healthcare

field in 1983. Kaufman Hall has prepared financial and capital plans for over 800 hospitals and healthcare

systems.

DEBT-RELATEDFINANCIAL ADVISORY

Since 1985, Kaufman Hall has acted as financial advisor

to more than 830 healthcare debt transactions. Total debt and

swaps issued on behalf of our clients is almost $84 billion

and exceeds $42 billion, respectively.

MERGERS, ACQUISITIONS,

AND DIVESTITURES

Kaufman Hall has advised clients on hundreds of M&A-related engagements including analyzing,

structuring, negotiating and executing mergers,

acquisitions, divestitures, joint ventures, strategic

partnerships and affiliations.

ENUFFSOFTWARE SUITE®

Over 1,300 software licenses are in place nationwide. The ENUFF Software Suite uses

corporate finance principles to directly support the financial

management cycle.

STRATEGIC SERVICES

Kaufman Hall provides a broad range of strategy-related services to support

organizational management and decision making. Kaufman Hall pioneered the development of

the integrated strategic financial plan.




Agenda for Today’s Discussion

• Industry and Capital Markets Update

• Planning Context

• Measuring and Monitoring Performance

• Discussion




Industry and Capital Markets Update




Pension funding

Investment losses

Increasingly competitive markets

Reimbursement Pressures and RAC/

Short Stay Issues

Equipment replacement/ new technology

Aging Infrastructure

Impact on operating cash flow and balance sheet stability?

A Whole Host of Pressures Facing the Healthcare Industry Today

Information technology needs

Physician shortages/ recruitment/ retention/

employmentCapital access/ cost and the need to fund

growth strategies

Specialty hospital/ ambulatory niche

competitionPayor mix

deterioration with rising bad debt and charity

Bond covenants




1.7%1.6%

2.1%

2.9%2.7%

2.4%

1.8%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

2002

2003

2004

2005

2006

2007

2008

91.1%90.3%

96.7%

104.0%106.4%

110.7%

102.0%

80.0%

85.0%

90.0%

95.0%

100.0%

105.0%

110.0%

115.0%

2002

2003

2004

2005

2006

2007

2008

133%

142%

131%

140%

149%152%

157%

125%

135%

145%

155%

165%

2002

2003

2004

2005

2006

2007

2008

2.83.0

3.43.7

3.9 4.0

3.3

1.5

2.5

3.5

4.5

2002

2003

2004

2005

2006

2007

2008

129.9

140.2

148.7

156.9161.6

166.6

145.8

120.0

140.0

160.0

180.0

2002

2003

2004

2005

2006

2007

2008

Deteriorating Industry Metrics Beginning in 2008

Operating margin Debt service coverage

Days cash on hand Cash to debt

Debt to capitalizationCapital expenditures as a

% of depreciation

Note: Based on overall median information published by Fitch Ratings, Moody’s Investors Service and Standard & Poor’s. Some differences in ratio definitions and in credits are included.

40.0%

41.0%

39.5%

40.1%

39.1%

38.3%

40.9%

37.0%

38.0%

39.0%

40.0%

41.0%

42.0%

2002

2003

2004

2005

2006

2007

2008

Pre-healthcare reform the industry has already experienced:

• Strained operating performance (volume decline, reimbursement, bad debt/ charity, etc.)

• Considerable pressure on liquidity (investments, pension, etc.)

• Capital needs to address aging facilities, IT, physician integration and strategic investment out weighing available resources

• Negative industry outlook by all three rating agencies

• More downgrades expected




Ratio of Downgrades to Upgrades Shows Volatile Industry Dynamics

Relative stability (pre-BBA, Hillary-

care fails)Volatility post-BBA/

managed careStabilization

returns

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

4Q

08

1Q

09

2Q

09

3Q

09

4Q

09

Medicare DRG, Tax Reform Act of ‘86;

early 90s recessionDeep

recession

Source: Moody’s Investors Service

Too Soon

to Tell




Sources: “Not-for-Profit Healthcare Sector Outlook Revised to Negative from Stable,” November 2008 and “Diagnosing Not-for-Profit Hospital Downgrades,” December 2008; Moody’s U.S. Public Finance Special Comments.

Rati

on

ale

Wh

at

to E

xp

ect

• Impaired access to capital– Severely restricted access to bond

insurance

– Collapse of the auction rate market

– Loss of liquidity support from local banks

• Greater-than-anticipated erosion in performance and liquidity

– Increasing charity care and bad debt

– Investment losses weakening balance sheets

– Softening volumes, particularly in surgical cases

• Importance of sound management decisions about operating costs and capital investment

• Skilled oversight and direction from hospital Boards is a must

• Budget to actual analysis key

• Maintain strong cash reserves

• Budget for higher interest expense

• Likely higher cost of borrowing in the future (access may be non-existent for lower-rated hospitals)

• Increased risk from variable rate debt structures

• Higher demands on hospital cash for pension funding and physician employment/ practices

• Pressure on growth in reimbursement-based revenues; increasing divergence from growth in costs

• Re-evaluate debt structure– Likely move to a more conservative

approach

• Re-assessments and delays in major capital projects

– However, most organizations cannot afford to delay plans indefinitely

• Likely increase in merger and acquisition activity

Negative Industry Outlooks by All Three Rating Agencies




Why Do Credit Ratings Matter?

• Virtually no hospital organization is able to fund its long-term capital requirements from operating cash flow and/ or cash reserves

– Access to outside capital, over the long-term, is an imperative

• Creditworthy organizations have improved capital market opportunities

– Less restrictive bond document/ insurer requested covenants

– Access to commercial banks (direct loans/ letters of credit)

– Access to credit enhancement

– Taxable or tax-exempt debt

– Access to derivative options (e.g., swaps and synthetic interest rates)

– Avoidance of debt service reserve fund and/ or mortgage

• Creditworthy organizations have a lower cost of capital

– Credit spreads are high: “AA” to “A” = 50+ bps; “A” to “BBB” = 290 bps!

– Access to low cost variable rate debt

– Lower issuance costs: insurance premium, letter/ line of credit, underwriting/ remarketing

• Creditworthy organizations are market winners

– There are market winners and losers; nationwide, organizations with the highest credit rating have been the most attractive partners, have excess capital capacity and the lowest cost of capital to remain successful in the market




Though benchmark rates are trending lower, credit spreads remain wide but are tightening for “A” or better credits

'AA', 'A', and 'BBB' Healthcare Credit Spreads over MMD 'AAA' Index

0%

1%

2%

3%

4%

5%

6%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

30Y AA Spread 30Y A Spread 30Y BBB Spread

Spread to MMD (1/4/00)

AA 21 bps

A 40 bps

BBB 76 bps

Spread to MMD (3/8/10)

AA 91 bps

A 149 bps

BBB 417 bps

Statistics30Y AA

Healthcare

30Y A

Healthcare

30Y BBB

Healthcare

Current 0.91% 1.49% 4.17%

Average 0.41% 0.82% 1.46%

High 1.67% 2.55% 4.80%

Low -0.06% 0.17% 0.28%

Current Credit Spreads




• Financial trends and expectations

– Ratio analysis: consistent operating performance and stable liquidity are key

• Market position

– Location, market share, competition and population demographics

• Governance/ management

– Effective and accountable leadership

• Strategic and financial planning

– Effective market strategy, quality planning process, organizational culture of achieving targeted results (show five years of budget vs. actual)

• Payor mix

– Reimbursement: price maker vs. price taker in the market

• Physician relations

– Loyalty, average age, growth and specialties represented

• Debt position

– High debt levels increase risk and lead to lower ratings

• Size

– Critical mass

• Industry trends and external perception of risk

Credit Ratings Are Largely a Function of …




Strategic Planning How do you maintain or improve your market position in your service area? How much will it realistically cost? Are you prepared to do what’s necessary to compete aggressively? How will competitors react? Then what? How do the physicians fit into your long-term strategy?

Financial Planning Can you afford your strategic plan within an acceptable credit and execution risk context? What if you're wrong? Then what? Is it too risky?

Capital Allocation How much should you spend? Is spending directed at the right strategies? What is the risk adjusted discounted cash flow return of the capital project portfolio? How has actual versus projected performance measured up?

Capital Structure What is the right amount, mix, structure, and cost of debt and equity? How risky is the capital structure?

Budgeting/ Reporting Do you have the tools and process to deliver a credible budget tied to your strategic financial plan? Is it achievable? Is there accountability for results? What if you fall short? Then what?

Exit Rules/ Options Which services or facilities? Under what conditions? How?

The Credit Markets Are Expecting Long-Term Market Winners to Have Good Answers to These Questions




Performance Context




The Critical Relationship

Between Strategy and Financial Capability

Corr

idor o

f Contr

ol

Short-term Concern

Long-term Concern

High $

Strategyand RelatedInvestment

Low $

Financial Capability High $

“Over Investment”

“Under Investment”

The corridor of control is the balancing point between two opposing goals:

1. Compete as effectively as you can, which requires aggressive investment of capital and commitment of operating dollars, BUT

2. Respect the fiduciary role of the Board and management to protect the long-term financial integrity of a community asset.




Striking a Long-Term Balance Between

Sources and Uses of Capital

Capital scale

Balancing sources and uses

Uses

Debt paymentsCash payments

Minimum cash balanceWorking capital

Capital spending

Sources

New debtAsset sale

PhilanthropyCurrent cash

Operating cash flow




What Levers Do We Have to Work With?

How should these tradeoffs be optimizedwithin an appropriate credit and risk context?

Cash Debt

Capital Operations

How much cash?

How much capital?

How much debt?

How much profitability?Philanthropy and

Other Sources?




Measuring and Monitoring Performance




The challenge is translating a huge amount of data into meaningful

information in order to support organizational decision making.

"Tis not knowing much, but what is useful, that makes a wise man."

Thomas Fuller, 1608-1661

The Challenge




Introduction to the Three Key Financial Statements

IncomeStatement

BalanceSheet

Statement ofCash Flow

What Does it Tell Us?

Things YouMight/Might Not

Already Know

Revenue- Expenses= Profitability

• Also called P&L

• Most intuitive of the statements

• Only illustrates performance over a defined period of time

• Not all items shown reflect cash in/ outflow

Snapshot of:• What we have• What we own • What we owe

• Where you find info on cash balances, debt

• Statement that tells us the most about an organization’s financial health

• Snapshot of a point in time

Analogy to Personal Finance

Detailed accounting of cash in/ outflows

• Divides cash flows into 3 groupings: Operating, Investing, and Financing

• Provides context for Income Stmt and Bal Sheet

Paycheck

- Monthly Exp

= Savings

Home mortgage, equity, car&loan, checking, stocks retirement acct

Checkbook register




A Closer Look at the P&L (Income Statement)

Net Patient Revenue+ Other Operating Revenue= Total Operating Revenue

Salaries, Wages and Benefits+ NonSalary Cash Op. Expenses

+ Depreciation+ Interest

Total Operating Expenses

Total Operating Revenues- Total Operating Expenses

= Income from Operations

+ Non Operating Income

Net Income

• What does this tell us?

• What DOESN’T this tell us?

– Revenue generated from Ops.

– Cash operating expenses (salaries, supplies, etc.)

– Accounting profitability

– Capital spending

– Debt service

� Notice: includes interest but not principal payments

– New borrowing

– Cash generated from Ops.

� Depreciation is a non-cash item… but WHAT DOES THIS MEAN?




A Few Things About the Balance Sheet…

Assets - Liabilities = Net Assets

• Cash• Receivables• Inventory• Property• L.T. Assets

• Debt• Payables• L.T. Liabilities

• What We Own

Cash & CapitalSpending

Debt &Borrowing

How much cash does an organization need?

How much debt can it afford?Key Questions




Community Hospital Historical Income Statement

$ in Millions 2004 2005 2006 2007

Statement of Revenue and Expenses

Net Patient Service Revenue 56,527 65,387 76,338 83,587

Contracts and Other Operating Revenue 814 788 988 1,004

TOTAL REVENUES 57,341 66,175 77,326 84,591

Salaries and wages 24,509 27,027 29,793 33,785

Benefits and payroll taxes 5,762 5,829 9,214 10,237

Supplies and Other Expenses 19,872 22,421 26,084 26,990

Depreciation 3,080 3,234 3,384 4,018

Bad Debt 2,484 3,487 4,160 5,656

Interest 239 275 795 1,272

TOTAL EXPENSES 55,946 62,274 73,430 81,958

INCOME FROM OPERATIONS 1,396 3,901 3,896 2,633

Investment Income 128 378 1,398 1,608

Unrestricted Gifts and Bequests - 253 73 219

Other - - (44) (151)

0.2% 1.0% 1.8% 2.0%

EXCESS OF REVENUE OVER EXPENSES 1,523 4,532 5,323 4,309

Fiscal Year Ended




Community Hospital Historical Balance Sheet

$ in Millions 2004 2005 2006 2007

Assets

Cash & Equivalents 6,255 11,023 12,920 23,511

Short Term Investments 5,179 12,175 14,678 6,986

Net Patient A/R 5,269 4,137 5,667 5,955

Assets whose use is limited for current liabilities 403 2,571 2,866 3,218

Prepaid, Inventories & Other Assets 2,273 2,600 2,512 2,505

TOTAL CURRENT ASSETS 19,380 32,506 38,644 42,175

TOTAL ASSETS WHOSE USE IS LIMITED 1,059 1,884 20,381 5,252

NET PP&E 36,315 40,661 52,245 67,595

Long-term Investments - - 2,168 2,319

TOTAL ASSETS 56,754 75,052 113,438 117,341

Liabilities

Current Maturities 515 540 750 961

Third Party Payables and Other Current Liabilities 5,251 10,935 11,430 9,841

TOTAL CURRENT LIABILITIES 5,766 11,475 12,180 10,802

Long Term-Debt 8,925 14,985 44,700 44,473

Other LT Liabilities - 413 2,778 4,862

TOTAL LIABILITIES 14,691 26,873 59,658 60,137

Unrestricted Net Assets 41,298 46,332 52,274 56,061

Temporarily and Permanently Restricted Net Assets 765 1,874 1,506 1,143

TOTAL NET ASSETS 42,063 48,206 53,780 57,204

TOTAL LIABILITIES AND FUND BALANCE 56,754 75,079 113,438 117,341

Fiscal Year Ended




Operating Margin:Operating Income

Total Operating Revenue

Operating Margin:Operating Income


Operating EBIDA Margin:Operating Income + Depreciation, Amortization and Interest


Operating EBIDA Margin:Operating Income + Depreciation, Amortization and Interest


Days Cash on Hand:Cash and Marketable Securities + Board Desig. Funds

((Total Operating Expense - Depreciation) / 365)

Days Cash on Hand:Cash and Marketable Securities + Board Desig. Funds

((Total Operating Expense - Depreciation) / 365)

Cash to Debt:Unrestricted Cash / Long-term Debt + Short-term Debt

Cash to Debt:Unrestricted Cash / Long-term Debt + Short-term Debt

MADS Coverage:Net Income + Depreciation + Interest Expense

Maximum Annual Debt Service

MADS Coverage:Net Income + Depreciation + Interest Expense

Maximum Annual Debt Service

Days in Accounts Receivable:Accounts Receivable x 365

Net Patient Revenue

Days in Accounts Receivable:Accounts Receivable x 365

Net Patient Revenue

Average Age of Plant:Accumulated Depreciation

Annual Depreciation Expense

Average Age of Plant:Accumulated Depreciation

Annual Depreciation Expense

Excess Margin:Excess of Revenues Over Expenses

Total Operating and Non-operating Revenue

Excess Margin:Excess of Revenues Over Expenses

Total Operating and Non-operating Revenue

Compensation Ratio:Salaries, Wages and Benefits, Contract Labor

Net Patient Revenue

Compensation Ratio:Salaries, Wages and Benefits, Contract Labor

Net Patient Revenue

Debt to Capitalization:Long-term Debt

Long-term Debt + Unrestricted Net Assets

Debt to Capitalization:Long-term Debt

Long-term Debt + Unrestricted Net Assets

Definitions of Key Financial Ratios

Capital Spending Ratio:Additions to Plant, Property and Equipment

Depreciation Expense

Capital Spending Ratio:Additions to Plant, Property and Equipment

Depreciation Expense

Capital Spending to Revenue:Annual Capital SpendingTotal Operating Revenue

Capital Spending to Revenue:Annual Capital SpendingTotal Operating Revenue




Financial Ratio Explanations

Operating Profitability

• Operating margin – reflects the profitability of an organization from its active patient care and related operations

• Operating EBIDA margin – provides a good look at an organization’s ability to generate enough cash to meet interest and principal payments on debt

• Excess margin – reflects profitability from operations and includes revenue andexpenses from non-operating activities such as investment earnings and philanthropy

Debt Indicators

• Debt service coverage ratio – measures the ability of an organization’s cash flow to meet its debt-service requirements

• Debt to capitalization ratio – indicates how highly leveraged, or debt financed, the organization is – the higher the capitalization ratio, the higher the risk

Liquidity Indicators

• Days cash on hand – among the most important credit ratios in use today, reflects the number of days cash set aside by the organization to support operating expenses if revenue stream were to be reduced or eliminated

• Cash to debt ratio – measures the availability of an organization’s liquidity to pay off existing debt

Other Ratios

• Capital spending ratio – a relatively new metric, assesses capital spending as a percentage of depreciation

• Compensation ratio – measure how much personnel expenses are required to generate one dollar of revenues




Community Hospital Historical Credit Profile

S&P

$ in Millions "BBB-" (1) 2004 2005 2006 2007

Net Patient Service Revenue $87.7 $56.5 $65.4 $76.3 $83.6

Operating Income --- $1.4 $3.9 $3.9 $2.6

Operating EBIDA --- $4.7 $7.4 $8.1 $7.9

Excess Income --- $1.5 $4.5 $5.3 $4.3

Cash Flow (Net Inc + Depr) --- $4.6 $7.8 $8.7 $8.3

Unrestricted Cash --- $11.4 $23.2 $27.6 $30.5

Long-Term Debt --- $8.9 $15.0 $44.7 $44.5

Profitability

Operating Margin 1.8% 2.4% 5.9% 5.0% 3.1%

Operating EBIDA Margin (2) 11.2% 8.2% 11.2% 10.4% 9.4%

Excess Margin 3.3% 2.7% 6.8% 6.8% 5.0%

Leverage

MADS Coverage (x) 2.7 (x) 6.4 (x) 9.9 (x) 6.1 (x) 4.3 (x)

Debt to Capitalization 46.1% 18.6% 25.1% 46.5% 44.8%

Liquidity

Cash to Long Term Debt 63.5% 128.1% 154.8% 61.7% 68.6%

Days Cash On Hand 120.6 78.9 143.4 143.8 142.8

Days in A/R, net 48.8 34.0 23.1 27.1 26.0

Other

Average Age of Plant 10.1 8.3 8.9 8.7 7.8

Compensation Ratio (%) 49.1% 53.6% 50.2% 51.1% 52.7%

Capital Spending Ratio (%) 107.10% 60.9% 265.8% 381.7% 502.8%

(1) S&P U.S. Not-for-Prof it Health Care 2007 Stand-Alone Median Ratios

For the Fiscal Year Ended




A CFO Imperative – Improving Capital Capacity

• Creditworthiness is the key

– Improved access to external capital

– Reduced cost of capital

– Increased flexibility

• Focus on the balance sheet

– Balance sheet strength = protection against short-term operating changes

– A “broken” balance sheet takes years to mend

– Don’t run out of cash

• Communication and education provide the foundation

– Broad-based financial knowledge enhances acceptance of an integrated planning approach

– Monitoring and communicating results underscores the importance of constant measurement




How to Address Shortfalls in Performance?

Pros Cons

Capital reduction/ deferral

+ Easiest area to control

+ Opportunity to prioritize cash generating projects first

– May have a negative effect on strategic position, future cash flows, quality, etc.

Volume growth

+ Creates excitement in organization

+ You cannot shrink yourself to success

– Hard to achieve

– Management has minimal control

Expense reduction

+ Generates the most significant long-term result with cash flow improvements

– Many hospitals have already tried this

– Potential negative impact on physicians, employees, quality of care, etc.




Relentless pursuit of lowest cost of capital

Use capital structure to create capital

capacity

Maximize return on cash and investments

Improve operating processes

achieve lower costs

Identify financial goals necessary for

success under varied economic conditions

Assure the most careful

and constrained expenditure of capital

Continuous financial planning Scenario assessment; a live

roadmap to navigate constant economic uncertainty

Always maintain sufficient cash

Assuring Financial Excellence




Questions/ Comments?

Zachary Hafner

Kaufman, Hall & Associates, Inc.

(847) 441-8780

[email protected]

100414 beckers using metrics to analyze hospital performance · 2014-10-20 · using metrics to...

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