Health Care Finance and Reimbursement

Goth Medical Center: Assessing Hospital Performance

Goth Medical Center is a 210 bed, not-for-profit, acute-care hospital with a long-standing reputation for providing quality healthcare services to a growing service area. Goth competes with three other hospitals in its metropolitan statistical area – two not-for-profit and one for profit. It is the smallest of the four, but has traditionally been ranked highest in patient satisfaction polls. Goth passed its latest Joint Commission accreditation with flying colors, receiving full accreditation, the highest of six accreditation categories.

In recent years, competition among the four hospitals in the Goth service area has been keen, but friendly. However, a large for profit chain recently purchased the for-profit hospital, which has resulted in some anxiety among the managers of the other three hospitals, because of the chain’s reputation for aggressively increasing market share in the markets they serve.

Relevant financial and operating data for Goth are contained in Tables 1.1 through 1.4, and selected industry data are contained in Tables 1.5 and 1.6. In addition to the data in the exhibits, the following information was extracted from the notes section of Goth’s annual report.

1. A significant portion of the hospital’s Net Patient Service Revenue was generated by patients who are covered either by Medicare, Medicaid, or other government programs, or by various private plans, including managed care plans, that have contracts with the hospital that specified discounts from charges. In general, the proportional amount of deductions is similar between inpatients and outpatients. The Gross/Net Revenue breakdown for both inpatient and outpatient services is given below (in millions of dollars);

Breakdown For Both Inpatient and Outpatient Services Is Given Below (In Millions of Dollars):
	2005	2006	2007	2008	2009
Gross Patient Service Revenue
	Inpatient		$25,161	$25,275	$26,117	$29,148	$33,216
	Outpatient		4748	5969	6535	91. 30	11,912
		Gross Patient Revenue	$29,909	$31,244	$32,652	$38,278	$45,128
Revenue Deductions
	Contractual Allowances		$2489	$2053	$1729	$5196	$7516
	Charity Care		1759	1955	2127	2506	3030
		Total Deductions	$4248	$4008	$3856	$7702	$10,546
Net Patient Service Revenue	$25,661	$27,236	$28,796	$30,576	$34,582

2. Inventories are stated at market value.

3. The breakdown of Operating Expenses between inpatient and outpatient activities is as follows (in millions of dollars):

Breakdown of Operating Expenses Between Inpatient and Outpatient Activities (In Millions of Dollars)
	2005	2006	2007	2008	2009
Inpatient Expenses	$18,635	$19,221	$20,573	$22,229	$24,771
Outpatient Expenses	5261	6062	6831	8098	9187
Total Operating Expenses	$23,896	$25,283	$27,404	$30,327	$33,958

4. Goth Medical Center has a pension plan that covers substantially all of its employees. Participants can contribute up to 20% of earnings to the pension plan. The hospital matches, on a dollar for dollar basis, employee contributions of up to 2% of wages and pays $.50 on the dollar for contributions over 2%, and up to 4%. Because the plan is a defined contribution plan (as opposed to a defined benefit plan), there are no underfunded pension liabilities. Pension expense was approximately $543 million in 2004, and $588 million in 2005.

5. The hospital is a member of the State Hospital Trust Fund under which it purchases professional liability insurance coverage for individual claims up to $1 million (subject to a deductible of $200,000 per claim). Goth Medical Center is self insured for amounts above $1 million, but less than $5 million. Any liability award in excess of $5 million is covered by a commercial liability policy; for example, the policy pays $2 million on a $7 million award. The hospital is currently involved in eight lawsuits involving claims of various amounts that could ultimately be tried before juries. Although it is impossible to determine the exact potential liability in these claims, management does not believe that the settlement of these cases would have a material effect on the hospital's financial position.

Assumptions for the Exercise

Assume that you have just joined the staff of Goth Medical Center as an Assistant Administrator. On your first day of the job, the Administrator, Melissa Randolph, stated that the best way to get to know the financial and operating condition of the hospital is to do a thorough Financial Statement and Operating Indicator Analysis; thus, she assigned you the task. Although you also believe that this is a good way to start, you wonder whether Melissa has any ulterior motives. Perhaps the hospital is having problems, and she thinks that you can spot them, or perhaps she wants to test your analytical skills. Melissa is from the old school on hospital management and has been looking for someone to bring modern management methods to the hospital.

In any event, she has already scheduled a Financial and Operating Performance Analysis Presentation at the next Board of Trustees meeting as a way for you to meet the Board members. To help you structure your presentation, Melissa suggested that you make the following points:

1. Interpret the hospital’s, Statement of Cash Flows;

2. Present an overview of the hospital's financial position by analyzing financial ratios;

3. Use Operating Indicator Analysis to identify the operational factors that explain the hospital's current financial condition;

4. Based on the above, identify the hospitals financial strengths and weaknesses;

5. Summarize your evaluation of the hospitals financial condition. However, she advises that you not just rehash the numbers; rather, present your views on the potential underlying economic and managerial factors that might have caused any problems that surfaced in the financial and operating analysis.

6. Create Dashboards for the Board presentation.

7. Make any recommendations that you believe the hospital should follow to ensure future financial soundness.

In preparing for the presentation, several relevant factors came to light.

You discovered that Board members were complaining that “too much time is being spent at quarterly meetings discussing the hospital's financial condition." A Board member stated, “there is so much to accomplish that we just don't have the time to consider a large number of ratios at each meeting."

You know that many healthcare providers are now using Dashboards to focus on Key Performance Indicators. A Dashboard is nothing more than a way to summarize an organization's financial and operating performance. Of course, the name stems from an automobile Dashboard, which contained gauges that give drivers the essential information about the cars performance and operating condition.

Thus, you plan to develop two dashboards, each containing no more than five key performance indicators. One dashboard will use financial ratios to focus on financial performance, while the other will use operating indicator ratios to focus on operating performance. You plan to present your recommendations for the content of these dashboards, along with the rationale for the ratios chosen, at the Board meeting. Your ultimate goal is to replace the full financial and reporting performance discussion at future Board meetings with a limited discussion of the Key Performance Indicators.

Exhibit 1.4 – Goth Medical Center: Selected Operating Data
	2005	2006	2007	2008	2009
Medicare Discharges	3008	2916	2721	2816	2741
Total Discharges	9680	9311	8784	8318	8576
Outpatient Visits	30,754	31,916	32,285	32,878	36,796
Licensed Beds	210	210	210	210	210
Staffed Beds	192	196	193	197	178
Patient Days	45,296	45,983	44,085	42,434	40,062
Case Mix Index	1.2531	1.2674	1.2869	1.2993	1.3161
Full-Time Equivalents	604.5	618.1	610.8	625.8	619.3

Table 1.5 – 2009 Selected Industry Financial Data (200 – 299 Beds)
		+ Quartile Upper 25%	Median	- Quartile Lower 25%
Profitability Ratios
	Deductible Ratio	0.34	0.26	0.18
	Profit (Total) Margin	5.58%	3.48%	0.53%
	Return on Assets	5.80%	3.10%	0.40%
	Return on Equity	15.66%	6.01%	0.62%
Liquidity Ratios
	Current Ratio	2.53	1.99	1.48
	Days Cash on Hand	32.35	15.89	6.24
Debt Management Ratios
	Debt Ratio	62.90%	48.40%	35.20%
	Long-Term Debt to Equity	127.00%	64.70%	26.90%
	Times Interest Earned	4.29	2.23	1.14
	Fixed Charge Coverage	2.18	1.35	1.02
	Cash Flow Coverage	5.32	3.22	1.76
Asset Management Ratios
	Inventory Turnover	98.68	63.95	43.99
	Current Asset Turnover	3.94	3.38	2.88
	Fixed Asset Turnover	2.20	1.76	1.49
	Total Asset Turnover	1.04	0.89	0.75
	Average Collection Period (Days)	87.53	75.67	63.33
	Average Payment Period (Days)	71.24	56.52	45.84
Other Ratios
	Average Age of Plant (Years)	8.86	7.39	6.14

Exhibit 1.1 – Goth Medical Center: Statements of Operations (Millions of Dollars)
		2005	2006	2007	2008	2009
Revenues
	Net Patient Service Revenue	$25,661	$27,236	$28,796	$30,576	$34,582
	Other Revenues	1305	1261	1237	1853	1834
	Total Revenues	$26,966	$28,497	$30,033	$32,499	$36,416
Expenses
	Salaries And Wages	$10,829	$11,135	$12,245	$12,468	$13,994
	Fringe Benefits	1496	1731	1830	2408	2568
	Interest Expense	1341	1305	1181	1598	1776
	Depreciation	1708	1977	2350	2658	2778
	Provision For Bad Debts	546	589	622	655	776
	Professional Other Liability	102	157	140	201	218
	Other	7874	8389	9036	10,339	11,848
	Total Expenses	$23,896	$25,283	$27,404	$30,327	$33,958
Excess of Revenues Over Expenses	$3070	$3214	$2629	$2102	$2458

Exhibit 1.2 – Goth Medical Center: Balance Sheets (Millions of Dollars)
		2005	2006	2007	2008	2009
Assets
	Cash and Investments	$3513	$5799	$4673	$5069	$2795
	Accounts Receivable (Net)	5915	4832	4359	5674	7413
	Inventories	338	403	432	523	601
	Other Current Assets	693	294	308	703	923
	Total Current Assets	$10,459	$11,328	$9772	$11,969	$11,732
	Gross Planned and Equipment	$37,999	$42,005	$47,786	$55,333	$59,552
	Accumulated Depreciation	8831	10,092	11,820	14,338	17,009
	Net Plant and Equipment	$29,168	$31,913	$35,966	$40,995	$42,543
	Total Assets	$39,627	$43,241	$45,738	$52,964	$54,275
Liabilities and Net Assets
	Accounts Payable	$1068	$1273	$928	$1253	$1760
	Accruals	692	942	1460	1503	1176
	Current Portion of Long-Term Debt	136	290	110	1341	1465
	Total Current Liabilities	$1896	$2505	$2498	$4097	$4401
	Long-Term Debt	15,959	15,775	15,673	19,222	17,795
	Net Assets	21,772	24,961	27,567	29,645	32,079
	Total Liabilities and Net Assets	$39,627	$43,241	$45,738	$52,964	$54,275

Table 1.3 – Goth Medical Center: Statements of Cash Flows (Millions of Dollars)
	2006	2007	2008	2009
Cash Flows From Operating Activities
Income From Operations	$3214	$2629	$2102	$2458
Non-Cash Expenses	1952	2326	2633	2756
Change in Accounts Receivable	1083	473	(13 15)	(1739)
Change in Inventories	(65)	(29)	(91)	(78)
Change in Other Current Assets	339	(14)	(395)	(220)
Change in Accounts Payable	205	(345)	325	507
Change in Accruals	250	518	43	327
Change in Current Portion of Long-Term Debt	154	(180)	1231	125
Net Cash Flow Operations	$7192	$5378	$4533	$3481
Cash Flows From Investing Activities
Fixed Asset Acquisitions	($4722)	($6402)	($7686)	($4328)
Cash Flows From Financing Activities
Increase (Decrease) Long-Term Debt	($184)	($102)	$3549	($1427)
Net Increase (Decrease) in Cash	$2286	($1126)	$396	($2274)
Beginning Cash and Investments	$3513	$5799	$4673	$5069
Ending Cash and Investments	$5799	$4673	$5069	$2795

	Goth Medical Center
	2005	2006	2007	2008	2009
Total Margin	11.38	11.28%	8.75%	6.48%	6.75%
Total Asset Turnover	0.68	0.66	0.66	0.61	0.67
ROA	7.75%	7.43%	5.75%	3.97%	4.53%
ROE	14.10%	12.88%	9.54%	7.09%	7.66%
Profit margin	11.38%	11.28%	8.75%	6.48%	6.75%
Operating Margin	4.18%	3.96%	3.65%	3.30%	2.94%
Debt service coverage	4.14	4.07	4.77	2.16	2.16
Times interest earned	3.29	3.46	3.23	2.32	2.38
Equity financing ratio	54.94%	57.73%	60.27%	55.97%	59.10%
Average age plant	5.17	5.1	5.03	5.39	6.12
Fixed age of plant	0.92	0.89	0.84	0.79	0.86
Days in A/R	84.13	64.76	55.25	67.73	78.24
Days cash on hand	57.79	90.82	68.08	66.87	32.72

Table 1. List Of Relevant Financial Indicators
Year	2005	2006	2007	2008	2009	Industry Average
Du Pont Analysis
ROE	14.10%	12.88%	9.54%	7.09%	7.66%	8%
1/EFR	1.82	1.73	1.66	1.79	1.69
TAT	68.05%	65.66%	65.66%	61.23%	67.10%	1.00%
Profit margin	11.38%	11.28%	8.75%	6.48%	6.75%	3%-5%
Profitability
Non-operating gain	1.78%	1.55%	1.72%	2.91%	2.20%	5.00%
Operating Margin	4.18%	3.96%	3.65%	3.30%	2.94%	1%-3%
Capital structure
Debt service coverage	4.14	4.07	4.77	2.16	2.16	2 to 4
Times interest earned	3.29	3.46	3.23	2.32	2.38	2 to 3
Equity financing ratio	54.94%	57.73%	60.27%	55.97%	59.10%	40%-50%
Activity
Average age plant	5.17	5.1	5.03	5.39	6.12	10
Fixed age of plant	0.92	0.89	0.84	0.79	0.86	2
Liquidity
Days in a/r	84.13	64.76	55.25	67.73	78.24	45-55
Days cash on hand	57.79	90.82	68.08	66.87	32.72	30-45

Table 1.6 – 2009 Selected Industry Operating Data (200 – 299 Beds)
		+ Quartile	Median	- Quartile
Profit Indicators
	Profit Per Discharge	$89.04	($21.30)	($120.08)
	Profit Per Visit	$6.22	$.66	($7.01)
Net Price Indicators
	Net Price Per Discharge	$4091	$3411	$2815
	Net Price Per Visit	$201	$139	$98
	Medicare Payment Percentage	43.47%	36.60%	31.25%
	Bad Debt/Charity Percentage	7.89%	4.76%	2.97%
	Contractual Allowance Percent	25.27%	20.02%	12.12%
	Outpatient Revenue Percent	25.26%	21.03%	17.44%
Volume Indicators
	Occupancy Rate	67.12%	58.10%	47.84%
	Average Daily Census	173.23	144.73	114.39
Length Of Stay Indicators
	Average Length Of Stay (Days)	6.80	6.07	5.41
	Adjusted Length Of Stay	6.48	5.36	4.52
Intensity Of Service Indicators
	Cost Per Discharge	$3937	$3392	$2972
	Adjusted Cost Per Discharge	$3417	$2924	$2572
	Cost Per Visit	$202.23	$141.97	$111.53
	Case Mix Index	1.2795	1.1756	1.0259
Efficiency Indicators
	FTE Per Occupied Bed	4.59	4.15	3.77
	Outpatient Man – Hours Per Visit	4.68	5.84	8.66
Unit Cost Indicators
	Salary Per FTE	$24,447	$22,517	$20,347
	Employee Benefits Percentage	19.58%	17.04%	15.18%
	Liability Costs Per Discharge	$80.94	$42.05	$18.31

Analysis

Interpret the hospital’s Statement of Cash Flows;

The statements of cash flows give broad insights into the hospital’s cash transactions over the period; hence, they highlight trends in (1) basic operating profitability, (2) investment activities, and (3) financing activities. In essence, this statement tells where an organization gets its cash and what it does with it. Exhibit 1.3 in the case contains the hospital’s statements of cash flows for 2006 through 2009. The interpretation follows.

From 2006 to 2009, the hospital’s net cash flow from operations decreased by over 50 percent. This is by far the most significant element of information in these statements. Also, over this period the hospital spent an average of almost $6 million dollars per year on fixed asset additions. Because the hospital had about $40 million in book value fixed assets at the beginning of this period, this investment represents a significant increase (almost 50 percent). However, the hospital remained at 210 licensed beds throughout this period, so the fixed asset additions were probably used to upgrade existing inpatient facilities and/or to upgrade or expand outpatient facilities. (The number of staffed beds actually declined from 192 to 178.) Regarding financing activities, the hospital increased its use of long-term debt on net by $1,836,000 over the period, which is modest considering its substantial investment in fixed assets.

The end result of these activities was a decrease in the cash balance over the three years of about $3 million, which accounts for some of the funding of new fixed assets. (The remainder came from operating cash flows.) Note, however, that the change in the cash balance itself is not a critical piece of information, because it can be controlled by financing actions.

Present an overview of the hospital's financial position by analyzing financial ratios ;

Here is the hospital’s ratio analysis

:
	2009 Industry Data (200-299 Beds)
PROFITABILITY RATIOS	2005	2006	2007	2008	2009	+Quartile	Median	-Quartile
Deductible ratio	0.14	0.13	0.12	0.20	0.23	0.34	0.26	0.18
Total margin	11.38%	11.28%	8.75%	6.48%	6.75%	5.58%	3.48%	0.53%
Return on assets	7.75%	7.43%	5.75%	3.97%	4.53%	5.80%	3.10%	0.40%
Return on equity	14.10%	12.88%	9.54%	7.09%	7.66%	15.66%	6.01%	0.62%
LIQUIDITY RATIOS:
Current ratio	5.52	4.52	3.91	2.92	2.67	2.53	1.99	1.48
Days cash on hand	57.79	90.82	68.08	66.87	32.72	32.35	15.89	6.24
DEBT MANAGEMENT RATIOS:
Debt ratio	45.06%	42.27%	39.73%	44.03%	40.90%	62.90%	48.40%	35.20%
LT debt to equity	73.30%	63.20%	56.85%	64.84%	55.47%	127.00%	64.70%	26.90%
Times interest earned	3.29	3.46	3.23	2.32	2.38	4.29	2.23	1.14
Fixed charge coverage	2.99	2.83	2.95	1.26	1.31	2.18	1.35	1.02
Cash flow coverage	4.56	4.98	5.22	3.98	3.95	5.32	3.22	1.76
ASSET MANAGEMENT RATIOS:
Inventory turnover	79.78	70.71	69.52	62.01	60.59	98.68	63.95	43.99
Current asset turnover	2.58	2.52	3.07	2.71	3.10	3.94	3.38	2.88
Fixed asset turnover	0.92	0.89	0.84	0.79	0.86	2.20	1.76	1.49
Total asset turnover	0.68	0.66	0.66	0.61	0.67	1.04	0.89	0.75
Average collection period	84.13	64.76	55.25	67.73	78.24	87.53	75.67	63.33
Average payment period	31.19	39.23	36.39	54.05	51.52	71.24	56.52	45.84
OTHER RATIOS
Average Age of Plant	5.17	5.10	5.03	5.39	6.12	8.86	7.39	6.14

To facilitate interpretation, the ratios have been divided into five categories: profitability, liquidity, debt management, asset management, and other.

Profitability Ratios . Profitability is the net result of a large number of policies and operating decisions. In general, these measures indicate the ability of the hospital’s assets and capital to generate funds for future reinvestment. The hospital’s profitability obviously has suffered dramatically over the past five years, although the hospital still shows higher profitability than the average peer hospital.

Note that the deductible ratio has dramatically increased in the last two years. This may mean an increase in managed care penetration, which might explain the increasing pressure on the total margin and the other profitability measures.

Although the hospital’s comparative profitability remains sound, the five-year trend is worrisome, and the hospital’s managers must ensure that it does not continue. Perhaps the turnaround in 2009 is an indication that the trend is being reversed.

Liquidity Ratios . One of the first concerns of most managers is the firm’s liquidity: Will the hospital firm be able to meet its obligations as they become due? Goth’s liquidity ratios show the same general situation as its profitability ratios. The trend is downward, but still above the industry averages (actually, in the top quartile). Thus, the hospital’s liquidity is quite good when compared with its peers, but not nearly as good as it was in the past.

Debt Management Ratios . The extent to which a firm uses debt financing has three important implications:

(1) By raising funds through debt, owners can maintain control of the firm with a limited investment. For not-for-profit firms, debt financing allows the organization to provide more services than it could if it were solely financed with fund capital. (2) Creditors look to owner-supplied funds (or fund capital) to provide a margin of safety. If the owners (or community) have provided only a small proportion of total financing, then the risks of the enterprise are borne mainly by its creditors. (3) If the firm earns more on investments financed with borrowed funds than it pays in interest, the return on the owners’ (fund) capital is magnified or “leveraged.”

Two different types of debt management ratios are used: (1) capitalization ratios measure the extent to which borrowed funds have been used to finance assets, and (2) coverage ratios measure the number of times fixed financial charges are covered by operating profits. The two sets of ratios are complementary, and most analysts use both types.

All in all, the debt management ratios reveal that Goth uses slightly less debt than does the average hospital. However, an interesting problem of interpretation occurs with the fixed charge coverage ratio, which shows the ability of the hospital to meet its principal and interest payments. This ratio was well above the industry average until 2007, but it fell by over 50 percent in 2009. At first glance, it would appear that Goth’s position has weakened, but this is not necessarily the case. The balance sheet shows that the hospital retired $1.3 million and $1.5 million in long-term debt in 2008 and 2009, respectively, and the large principal repayments adversely affected the coverage ratio for those years. If we assume a more typical principal repayment amount, the hospital’s fixed charge coverage ratio increases substantially.

Asset Management Ratios . Asset management ratios are designed to measure how effectively the firm is managing its assets. These ratios help to answer this question: Does the total amount of each type of asset as reported on the balance sheet seem reasonable, too high, or too low in view of current operating levels? Goth and other hospitals must borrow or raise equity capital to acquire assets. If they have too many assets, their interest expenses will be too high, and their profits will be depressed. On the other hand, if assets are too low, profitable sales may be lost or vital services may not be offered.

Examination of the asset management ratios raises three main points:

1. All turnover ratios indicate that Goth is not able to use its assets as efficiently as the average hospital. The problem is particularly acute when fixed assets are considered. These ratios basically confirm that Goth is staffing only 178 out of 210 licensed beds. Furthermore, the hospital’s occupancy rate on staffed beds is only 62 percent, which translates into 53 percent occupancy on licensed beds. Clearly, the fixed assets on the books are not doing a good job of generating revenues.

2. Note, though, that Goth has been aggressively adding new fixed assets over the past five years. Due to inflation and depreciation of existing assets, replacement values are significantly higher than existing book values, so hospitals with newer assets tend to have higher book values, and hence show lower turnover ratios.

3. Goth’s average collection period (ACP; days in patient accounts receivable) has risen dramatically since 2007 and is now slightly above average. The ability to make timely collections reduces the need for other financing, and thus increases profitability. The hospital needs to take a hard look at its revenue cycle management and take actions to speed up collections and reduce collection expenses.

4. Goth’s average payment period has also risen significantly. Although students may not fully understand the nuances of short-term financing when this case is assigned, it might be useful here to point out the difference between free trade credit, costly trade credit, and stretching. If Goth is now using costly trade credit, its expenses would increase and its profit margin would be adversely affected. If the hospital is stretching its payments to suppliers, it is obtaining additional free credit, but at the expense of potentially damaging its reputation with suppliers.

Other Ratios . Here, we consider only one additional ratio. The average age of plant ratio indicates that Riverview’s facilities increased only about one year in age over a five-year period. Thus, it is obvious that the hospital has been adding significant new fixed assets. This confirms other indications of new plant additions.

In closing the financial statement ratio analysis discussion, note that other techniques are available to help analysts interpret financial statements. Two frequently used additional techniques are (1) common-size analysis and (2) percentage change analysis. The case, but not the detailed questions, encourages students to use these techniques. To keep the solution manageable, we have not included these analyses here. However, our students are rewarded for extending their work to include common-size or percentage change analyses or any other additional techniques not covered in this solution.

Use Operating Indicator Analysis to identify the operational factors that explain the hospital's current financial condition;

Operating indicator analysis goes one step beyond financial statement analysis, in that it examines operating variables with the goal of explaining a firm’s financial condition. Like ratio analysis, operating indicators typically are grouped into major categories to make interpretation easier. One common classification groups hospital operating indicators into seven categories: (1) profit indicators, (2) net price indicators, (3) volume indicators, (4) length of stay indicators, (5) service intensity indicators, (6) efficiency indicators, and (7) unit cost indicators. In this case, we use Riverview to illustrate some of the more commonly used operating ratios, which, along with industry data, are shown in the following table:

	2009 Industry Data (200-299 Beds)
PROFIT INDICATORS:	2005	2006	2007	2008	2009	+Quartile	Median	-Quartile
Profit per inpatient discharge	$305.00	$301.98	$280.03	$126.72	$79.61	$89.04	($21.30)	($120.08)
Profit per outpatient visit	($38.61)	($26.87)	($33.07)	($24.49)	($1.60)	$6.22	$0.66	($7.01)
NET PRICE INDICATORS:
Net price per discharge	$2,230	$2,366	$2,622	$2,799	$2,968	$4,091	$3,411	$2,815
Net price per visit	$132	$163	$179	$222	$248	$201	$139	$98
Medicare payment %	31.07%	31.79%	30.98%	34.38%	31.96%	43.47%	36.60%	31.25%
Bad debt/charity %	5.88%	6.26%	6.51%	6.55%	6.71%	7.89%	4.76%	2.97%
Contractual allowance %	8.32%	6.57%	5.30%	13.57%	16.65%	25.27%	20.02%	12.12%
Outpatient revenue %	15.87%	19.10%	20.01%	23.85%	26.40%	25.26%	21.03%	17.44%
Volume Indicators:
Occupancy rate	64.63%	64.28%	62.58%	59.01%	61.66%	67.12%	58.10%	47.84%
Average daily census	124.10	125.98	120.78	116.26	109.76	173.23	144.73	114.39
LENGTH OF STAY INDICATORS:
Length of stay (days)	4.68	4.94	5.02	5.10	4.67	6.80	6.07	5.41
Adjusted length of stay	3.73	3.90	3.90	3.93	3.55	6.48	5.36	4.52
INTENSITY OF SERVICE INDICATORS:
Cost per discharge	$1,925	$2,064	$2,342	$2,672	$2,888	$3,937	$3,392	$2,972
Adjusted cost per discharge	$1,536	$1,629	$1,820	$2,057	$2,195	$3,417	$2,924	$2,572
Cost per visit	$171	$190	$212	$246	$250	$202.23	$141.97	$111.53
Case mix index	1.2531	1.2674	1.2869	1.2993	1.3161	1.2795	1.1756	1.0259
EFFICIENCY INDICATORS:
FTEs per occupied bed	4.10	3.97	4.04	4.10	4.15	4.59	4.15	3.77
Outpatient labor hours/visit	6.49	7.69	7.88	9.44	9.24	8.66	5.84	4.68
UNIT COST INDICATORS:
Salary per FTE	$17,914	$18,015	$20,047	$19,923	$22,596	$24,447	$22,517	$20,347
Employee benefits %	13.81%	15.55%	14.94%	19.31%	18.35%	19.58%	17.04%	15.18%
Liability costs/disc	$10.54	$16.86	$15.94	$24.16	$25.42	$80.94	$42.05	$18.31

Here are some observations:

Profit Indicators . The profit indicators show a severe downward trend in profit per discharge but an upward trend in profit per visit. However, inpatient profitability remains well above that of an average hospital, while outpatient profitability remains well below. In fact, outpatient services show a loss. The trend in outpatient profitability is encouraging, especially when coupled with the fact that the hospital is expanding its outpatient services while shrinking its inpatient services. Note, however, that cost allocations between inpatient and outpatient services can often be quite arbitrary, so any indicators that have costs as a component are subject to accounting cost allocation distortions.

Net Price Indicators . The net price indicators raise the following points:

1. Although net price per discharge has increased, it is still well below the industry average. Since Riverview’s bad debt/charity and contractual allowances are slightly less than average, the low net price per discharge stems from low charges. Thus, the hospital may be able to raise its charges and hence increase its margin.

2. Conversely, net price per visit appears well into the upper quartile. This indicates much higher than average charges for outpatient services. Note, however, that the case assumes that the same deduction percentage for bad debt/charity care and allowances applies to inpatient and outpatient care. If this assumption is invalid, then the net price per discharge and net price per visit indicators are biased, and one should be higher and the other lower.

3. Medicare payment percentage has held steady at somewhat below average. If Medicare reimbursement is lower than reimbursement from other payers, a low Medicare payment percentage is good news.

4. Goth’s bad debt/charity allowance is above average, and it has remained relatively steady. As a not-for-profit hospital, Riverview should be willing to provide services to truly indigent patients but must be aggressive in collecting from those self-paying patients who are capable of paying. On the other hand, the hospital’s contractual allowances, although they doubled over the period, are well below average, which is a positive sign.

5. Finally, the hospital’s proportion of outpatient revenue has climbed steadily over the period and is now in the upper quartile. This is consistent with the goal of increasing outpatient services.

Volume Indicators . The volume indicators, which focus on inpatient activity, confirm that the hospital’s fixed asset investment in inpatient care is being underused, although it is not out of line with the industry.

Length of Stay Indicators . The length of stay (LOS) indicators show an upward and then downward trend over the period. However, the hospital still falls in the lower quartile in LOS and LOS adjusted for case mix. This could mean that patients are being discharged “quicker and sicker,” but it could also mean that the hospital’s patient clientele is somewhat younger or otherwise healthier than average (as evidenced by the below average Medicare percentage) or that the hospital is doing a good job of utilization management. When reimbursement is on a per discharge (or admission) basis as with Medicare, a short LOS is good. However, if reimbursement is on a per diem basis, a short LOS is bad.

Service Intensity Indicators . The intensity of service indicators reveal dramatic increases in costs but an ending position where inpatient costs are well below average and outpatient costs are well above average. One possible explanation is Riverview’s allocation of overhead costs between inpatient and outpatient services. Another explanation could be that the new plant added over the past few years is primarily devoted to outpatient services, and hence the depreciation allocated to those services is extraordinarily high. Finally, the hospital’s case mix index is in the upper quartile, indicating a higher-than-average inpatient intensity of services. Considering this, the hospital is doing a good job of controlling inpatient costs. In addition, the greater intensity of services may provide Riverview the opportunity to increase its charges.

Efficiency Indicators . Inpatient FTEs per occupied bed are right at the industry average, but personnel hours per visit for outpatient services are well above average. One possible explanation is that Riverview recently opened a new outpatient facility that requires fixed assets and staffing for, say, 50,000 visits a year, but it will take several more years to achieve this volume. Thus, current excess capacity results in low profitability for outpatient care, but the hospital is positioned well for continued growth in outpatient services.

Unit Cost Indicators . Goth’s salary and fringe benefit structure is close to average, but its liability costs are well below average. This may be due to the fact that the hospital gets some liability coverage through a state pool

Based on the above, identify the hospitals financial strengths and weaknesses ;

Although a hospital’s strengths and weaknesses are often in the eye of the beholder, here is one opinion:

Strengths

1. Positive inpatient profitability

2. Positive trend in outpatient profitability

3. Lower than average debt burden

4. Relatively new plant

5. Lower than average Medicare percentage

6. Increasing proportion of outpatient services

7. Lower than average inpatient charges (especially relative to the intensity of services offered), and hence more opportunity for price increases

Weaknesses

1. Rapidly increasing expenses and a resulting decline in operating margin

2. Not using fixed assets (facilities) up to capacity

3. Excess inventory holdings

4. Increasing collection period

5. Rapidly increasing contractual allowance percentage

6. Negative outpatient profitability

On the basis of the limited amount of information provided in the case, what are your recommendations to the board to correct any weaknesses noted?

Goth’s management must focus on two critical areas. First, actions must be taken to stem the erosion in the hospital’s profit margin. Measures must be taken to decrease, or at least stabilize, operating costs and to increase revenues. Salaries and fringe benefits do not appear to be the source of the problem, but these areas must be continuously monitored. A detailed examination of “other” operating expenses must be undertaken to ascertain precisely what these expenses are, and what can be done to control them. On the revenue side, Riverview’s managers must examine its negotiation policy with its third party payers. Does Riverview have to give up so much in contractual allowances, or have they been poor negotiators in the past?

Although raising charges has been the traditional approach to increasing revenues, the current highly competitive environment coupled with payers’ ability to extract discounts and emphasis on keeping patients out of hospitals makes it exceedingly difficult to increase charges and at the same time maintain, or even increase, volume. Still, Goth’s greater intensity of services might provide justification for higher charges.

Second, the hospital must increase its utilization of fixed assets. If new outpatient facilities have come online and are grossly underused, the hospital must reconsider its outpatient marketing plan. Perhaps the hospital can get more involved in the workers’ compensation program or other similar endeavors to bring in more outpatients. Perhaps the hospital does not have a sufficient number of physicians with staff privileges. A similar problem exists with inpatient assets. If there is no hope of increasing inpatient volume, perhaps some of these assets can be converted to other, more productive uses.

Create Dashboards for the Board presentation.

Here, the students can be creative, and the best answer is in the eyes of the beholder. In essence, a key performance indicator (KPI) should measure a critical area of performance, while a dashboard presents the measures in a way that facilitates interpretation. Many dashboards contain KPIs related to patient satisfaction and other factors beyond financial and operating performance, but the intent in the case is to focus solely on financial and operating measures.

Here is one set of suggestions for five KPIs that measure financial performance and five that measure operating performance. Note that these are often presented as gauges on a dashboard. Also, it is common to have benchmark data presented simultaneously along with a simple assessment for each measure, such as number of stars, where 5 stars represents excellence in that measure and 0 stars indicates terrible performance. Finally, the lists that follow were restricted to the financial statement and operating indicators provided in the case.

Financial KPIs

Economic value added (EVA)

Total margin (or better yet, operating margin)

Days in patient accounts receivable

Debt ratio

Total asset turnover

Operating KPIs

Profit per inpatient day

Profit per outpatient visit

Occupancy rate

FTEs per occupied bed

Outpatient labor hours per visit

Goth Medical Center Page 13 of 13