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Institutional Issues

Analysis of Cash Flow in Academic Medical Centers in the United States

McCue, Michael J. DBA; Thompson, Jon M. PhD

Author Information
doi: 10.1097/ACM.0b013e318226a1ef

Abstract

Academic medical centers (AMCs) in the United States play a significant role in the provision of a full range of patient care services in addition to their role in the support of clinical research and the education of medical students and residents. These centers, also termed teaching hospitals, are usually part of an academic health center along with medical schools (that may or may not be owned by a university) and one or more other health professions schools (e.g., of public health, nursing, or dentistry).1 Recent information shows that although teaching hospitals represent only 6% of all hospitals nationwide, these facilities provide about 20% of all hospital care.2,3 As well, compared with acute care community hospitals, they provide much higher proportions of specialized services, such as those available through their neonatal, trauma, burn care, and heart transplant programs.2,3 However, several major environmental influences within the past decade have affected the financial performance of AMCs. These influences include declining reimbursements from payers, the high costs of their teaching missions, increasing competition from acute care community facilities, and their growing role as safety-net providers serving an expanding number of uninsured patients and patients covered by Medicaid.3–5 In addition, the location of many teaching hospitals in urban areas, including inner-city high-poverty areas, has contributed to the growing financial pressures on these facilities.2 Operating margins for AMCs have declined precipitously during the past 10 years, and in 2009 almost one-half of teaching hospitals reported a significant decrease in total profit margin.3 As a result, AMC managers have turned their attention to monitoring more closely, evaluating, and improving the financial performance of their organizations in order to effect better financial management and to balance services and financial outcome.6 However, the financial performance of AMCs continues to remain an important and challenging issue as operating margins continue to decline, in turn threatening the ability of AMCs to achieve their tripartite mission of patient care, research, and clinical education.5

Given the recent turbulent times for the nation's AMCs, focusing on those measures and financial factors that contribute to positive financial performance is helpful. Most studies of the financial performance of acute care community hospitals and of AMCs have used the common measure of operating profit margin (or total profit margin) to measure financial performance.1,7,8 However, this measure—an AMC's net income (or bottom line profit value)—may be misleading because it includes noncash accounts such as depreciation. In the case of capital-intensive AMCs, which own large numbers of depreciable buildings and pieces of equipment, the depreciation expense account may be much higher than that of the typical community hospital. Thus, cash flow, the amount of cash generated and expended in a given period, is a better indicator of financial performance because it adjusts for the noncash account of depreciation. In addition, cash flow has been used in other recent studies to examine the financial performance of hospitals.8

The purpose of this report is to examine cash flow margin, a measure of the efficiency of converting income to capital, in AMCs in an effort both to determine the significant differences in a set of operational and financial factors known to influence cash flow for high- and low-cash-flow AMCs and to discuss how these findings affect AMC operations. Following Cleverley,9 we use cash flow as a key measure of financial performance because it more accurately (than net income) reflects the financial position of an AMC. Whereas operating and total profit margins have declined and are negative for many AMCs, recent data on cash flow margin for major teaching hospitals indicate an increase in cash flow margins from 8.31% in 2003 to 9.06% in 2005.10 Using cash flow margin as a measure of financial performance will not only assist policy makers in their examination of the complex issues affecting AMC funding and operations but will also help AMC administrators better understand financial performance in terms of critical drivers of performance.9 In addition, our findings will allow these administrators to compare the measures of their individual hospital's performance with average data and thereby gain a perspective of their relative performance.

Literature Review

In the past two decades, the financial performance of AMCs has become the subject of heightened scrutiny in both the popular press and the health services literature. The complex tripartite mission of AMCs has raised questions about their actual level of financial performance and their appropriate level of financial performance compared with other hospitals.5 Prior research has clearly shown that AMCs engage in cross-subsidization: The incremental costs of teaching and research activities are absorbed by the provision of patient care services, which contribute the most to AMC operating revenues.11,12

Prior research on the financial performance of AMCs shows an increasingly challenging financial scenario. Whitcomb and Cleverley7 conducted early studies of the financial performance of AMCs and found that their financial performance had stabilized from 1987 to 1991, compared with a period in the early 1980s, when AMCs had the lowest profit margins in the hospital industry. These researchers found that total margin and return on equity increased during the study period because of better efforts to manage costs and revenues. Debt financing also increased during the study period, which, the authors suggested, forced AMCs to reduce the rate of investment in new plants and equipment. These researchers also noted that the financial performance of public-sector teaching hospitals (government-owned facilities) was weaker than that of private-sector teaching facilities (not-for-profit hospitals) because of the higher percentage of Medicaid patients cared for by public-sector facilities.7

In a 1999 report, Anderson and colleagues1 analyzed the financial performance of AMCs during the mid-1990s. They found that during this time period, AMCs had significantly higher costs than community hospitals because of their mission, but AMCs also had profit margins that exceeded 20%. The authors reported that total margins at AMCs were the highest they had been in 10 years.1 They found that the same pattern held for operating margins in the prospective payment system under Medicare (these margins were 21.4% in 1995) and that public AMCs experienced the lowest margins. These researchers concluded that the financial performance of AMCs was driven largely by Medicare and commercial insurer payments exceeding the actual cost of care. Additional financial performance measures for AMCs during this period (1993–1997) show that performance improved; AMCs, compared with all hospitals, had more cash on hand, lower return on equity, more long-term debt-to-equity, lower asset turnover ratios, and higher net assets per bed.1

In the late 1990s, the financial performance of major teaching hospitals declined after reaching a peak in 1996. AMCs reported average negative operating margins in each of the study years (1990–1999) while the average total profit margin remained just above breakeven.13 During this period, AMCs were subjected to increased sources of financial pressure, including the expansion of managed care organizations, changes in public payment policy, growth in the number of uninsured patients, and increases in input prices.13 Medicare payment reductions under the Balanced Budget Act and reductions in Medicaid payments under the Medicaid Disproportionate Share Hospital Program also contributed significantly to the declines in operating and total margins.13 As well, the growth in uncompensated care due to a higher number of uninsured patients receiving care at AMCs negatively affected teaching hospital financial performance during this period. In response to these financial pressures, teaching hospitals reduced the length of stay, downsized capacity, increased labor productivity, and expanded outpatient services.4,13

Dobson and colleagues12 reported similar findings in their study of AMCs. They found that the total profit margins of AMCs declined from 1996 to 2000 and that operating margins were negative in 1999 and 2000. They also reported that margins were clearly on a downward trend, as the aggregate total margins and aggregate operating profit margins for AMCs were lower in 2000 than at any other time since 1994, and these measures were lower for AMCs than for nonteaching hospitals. These researchers also pointed out that the poor financial performance of AMCs severely challenged their ability to fulfill the tripartite mission of patient care, clinical research, and education. Finally, Dobson and colleagues noted that both the higher operating costs of AMCs, compared with other hospitals, as well as the growing caseload of uncompensated care at AMCs further constrained their financial performance.

In the early 2000s, AMCs adopted more strategic management approaches to better compete with community hospitals and to grow their overall business.14 At this time, through strategic planning and clearly defining clinical and operational expectations, AMCs expanded the services offered, much like complex business enterprises might, to increase quality and reach new patients and new payers.15,16 In addition, AMCs invested in clinical care resources (e.g., diagnostic and treatment technologies) and staffing. The latter is best reflected in enhancements to nursing staff and achievement of nursing magnet status (which is granted by the American Nurses Credentialing Center to those hospitals meeting standards for nursing excellence). Improvements to nursing and achievement of magnet status included increasing the competitiveness of salaries and benefits and improving the availability of adequate resources (such as advanced practice nurses, who are educated at the postgraduate level, possess advanced didactic and clinical education, knowledge, and skills, and have a larger scope of practice). Another improvement was providing professional and career development opportunities for nurses. These initiatives to increase nursing staff and achieving magnet status yielded positive benefits in terms of quality and financial performance.17

More recent information provided by the Medicare Payment Advisory Commission18 indicates that Medicare operating margins for major teaching hospitals declined from 4.6% in 2004 to −1.5% in 2008. This reduction in margin for major teaching hospitals is largely the result of costs per case increasing much more quickly than payments per case.18 However, Medicare margins for teaching hospitals still remain higher than those for the average prospective payment hospital because of payments received through indirect medical education and disproportionate share adjustments.18

In sum, the financial performance of AMCs has been highly variable during the past two decades, and the most recent financial information for these institutions indicates a downward trend in their financial performance.

Our study of cash flow margins in AMCs will not only help determine the differences between high- and low-cash-flow AMCs but also will provide a perspective of their financial health in the mid- to late 2000s.

Method

AMCs versus for-profit hospitals

Although not-for-profit, short-term, acute care hospitals (such as AMCs) do not have stockholders, researchers claim that nonprofit hospitals operate financially like for-profit hospitals by maximizing their cash flows.19 AMCs have financial goals similar to those of any hospital (to support their missions and to reinvest in the latest medical technology and equipment). Because nonprofit AMCs do not issue stock to fund capital expenditures, these facilities depend on less expensive, tax-exempt debt (i.e., bonds) as the primary source of financing.

Greater access to tax-exempt debt capital is available for nonprofit hospitals that have higher levels of cash and long-term investments.20 This high liquidity position is caused by two factors. First, access to cheaper, tax-exempt debt allows nonprofit hospitals to retain their cash and investments and to invest in securities that earn a substantially higher taxable return than the lower interest rate they pay on their tax-exempt debt. The earnings from taxable securities are retained in the cash and investments, which contribute to their growth. Second, bondholders and bond rating agencies consider hospitals with more cash and investments than debt to be more creditworthy because they hold sufficient cash and investments to retire their debt. As a result, hospitals, including AMCs, have been pressured by credit rating agencies to increase their liquidity position not only to gain access to debt capital but also to achieve a higher credit rating and obtain a lower interest rate.21

We applied Cleverley's9 basic conceptual framework of overall hospital financial performance (using cash flow) to examine the financial performance of AMCs. Cleverley defines cash flow as net income plus depreciation expense and interest expense. He views the hospital's profitability and its sources and uses of capital as the primary drivers of cash flow. Further, he considers the underlying drivers of profitability to be the hospital's revenue and expense measures as well as operational measures related to patient volume. Sources of capital are related to a hospital's cash and investments (which are necessary for updating and expanding its plant and equipment) and to its debt. Use of capital relates to the AMC's management of its working capital and the amount spent on plant and equipment.

Variables

In our study, we examined operational variables as well as revenue, expense, payer mix, and profitability variables. Appendix 1 lists all the variables used in this study as well as our definition of each.

Operational variables.

Operational variables relate to volume and staffing, which may indirectly influence the cash flow of AMCs. These measures assess how well AMCs control their staffing levels and manage their labor costs. One would expect AMCs that operate at lower staffing levels and treat less complex cases to incur lower costs and earn higher profits and generate a higher cash flow position.8

Revenue, expense, payer mix, and profitability variables.

These variables relate to the types of payers, the revenue generated, the expenses incurred, and the profit earned in operating the AMC. We expect revenue, expense, payer mix, and profitability variables to directly impact the cash flows of the AMC. AMCs with higher cash flows and higher profit margins from operations will likely generate higher patient revenues and incur lower operating costs. AMCs serving a greater proportion of lower-paying Medicaid patients will likely experience a reduced cash inflow. AMCs generating higher patient revenues from higher prices and/or greater patient volume are expected to be high-cash-flow-generating hospitals. AMCs controlling their operating expenses are expected to be high-cash-flow-generating hospitals as well. Because the majority of operating expenses are salary and benefits, one would also expect lower salary expenses for high-cash-flow-generating hospitals.

Other sources of capital.

Other sources of capital include the financial measures of (the number of) days cash-on-hand ratio and the long-term-debt-to-total-capital ratio. Uses of capital includes age-of-plant ratio, and—to measure how well AMCs manage their working capital—the days-in-accounts-receivable ratio. We expect that facilities that reduce the time to collect their receivables would be able to increase their cash and investment levels, especially if they have higher patient revenues. Moreover, we expect that AMCs retaining a greater number of days of cash on hand and investments (in order to comply with the high liquidity credit benchmarks of the bond rating agencies and thereby gain access to cheaper, tax-exempt debt capital) will likely be AMCs with higher cash flow.21 The amount of long-term debt that an AMC carries relative to its total capital is a direct measure of its debt position. We would expect AMCs that have a lower debt position (resulting from their higher liquidity and cash flow position) to have higher cash flow.

One would expect AMCs with greater access to debt capital and strong cash flow performance to achieve greater capital investment. In fact, a 2004 capital investment survey reported expected growth in capital investment among all hospitals during the past decade22; however, the data set used in that study no longer provides capital expenditure data. Therefore, we were unable to develop a capital expenditure ratio. We did, however, use the age-of-plant ratio as a proxy measure. A lower value indicates AMCs that have invested in their infrastructure with new buildings and equipment, whereas a higher value reflects AMCs with an aging plant. We expect AMCs with a lower age-of-plant ratio to have higher cash flow.

Sample

We examined AMCs identified by University HealthSystem Consortium (UHC), which comprises 107 AMCs. From this sampling frame, we accessed the relevant operational and financial information for each AMC from the Medicare Hospital Cost Report Information System (HCRIS) data set for three consecutive fiscal years (2005, 2006, and 2007). The 2005 fiscal year included ending reporting dates from September 30, 2004, through August 31, 2005. The 2006 fiscal year included ending reporting dates from September 30, 2005, through August 31, 2006. The 2007 fiscal year included ending reporting dates from September 30, 2006, through August 31, 2007.

Data analysis

On the basis of the data we procured, we classified the AMCs into high- and low-cash-flow margin groups. The high-cash-flow AMCs met the following criteria: Their individual cash flow margin ratio values were greater than the sample averages for each year, and their collective cash flow margin ratios were greater than those of the low-cash-flow AMCs for three consecutive years. We listed AMCs that did not meet these criteria as low-cash-flow AMCs. Given the limited sample size, we conducted a basic descriptive analysis that compared the high-cash-flow AMCs with low-cash-flow AMCs. We applied the t test to test for significance of the mean differences between the two cash flow groups for each of the study variables (Appendix).

Both age-of-plant and days cash-on-hand ratios had outliers beyond the 95th percentile and 5th percentile values. Therefore, for these two ratios, we set values above the 95th percentile at the 95th percentile and values below the 5th percentile at the 5th percentile. In addition, the age-of-plant ratio had 35 zero values for the accumulated depreciation, so we limited the sample to AMCs with nonzero values for the age-of-plant ratio. The only organizational trait that we measured was private versus public AMC.

We conducted this study in the first quarter of 2010. We used Microsoft Excel (Redmond, Washington) to create the study database using the UHC and HCRIS data referenced above, and we used STATA (10.0, STATA Corp, College Station, Texas) to carry out the analysis.

Results

The AMCs with available organizational, operational, and financial data for all three years totaled 103 facilities (96% of the 107 within the consortium).

We found that 74% of the private institutions were high-cash-flow AMCs and 26% were low-cash-flow institutions. Table 1 presents the mean values and standard deviations for the operational variables; for the revenue, expense, payer mix, and profitability variables; and for the sources and uses of capital. The findings in each area are presented below.

Table 1
Table 1:
Operational and Financial Performance Measures of Study Hospitals

Operational variables

Compared with low-cash-flow AMCs, high-cash-flow AMCs were larger-bed-size facilities (P < .05) and treated cases of significantly greater complexity (1.86 versus 1.78; P < .05). The other remaining operational measures—occupancy rate, discharges per bed, and number of full-time equivalent (FTE) employees per census—were statistically insignificant.

Revenue, expense, payer mix, and profitability variables

The average net patient revenue per adjusted discharge that high-cash-flow AMCs generated was significantly higher than that of low-cash-flow AMCs ($8,875 versus $7,991; P < .05). Salary and benefit expense per FTE also was significantly higher for high-cash-flow AMCs compared with low-cash-flow AMCs ($60,648 versus $53,730; P < .05). High-cash-flow AMCs served a significantly lower percentage of Medicaid discharges compared with low-cash-flow AMCs (17.12% versus 20.93%; P < .01).

The average operating profit margin and cash flow margin ratios were also significantly higher for high-cash-flow AMCs. Both AMC groups were operating at a loss; however, the average operating margin loss of the high-cash-flow AMCs was only −2.84%, compared with a substantially lower operating loss of −12.87% for the low-cash-flow AMCs (P < .05). From a cash flow standpoint, both groups generated a positive cash flow. Nonetheless, once again, the high-cash-flow group was significantly greater, with an average positive cash flow margin of 18.79% compared with 5.74% for low-cash-flow AMCs (P < .05).

Source of capital

Days cash-on-hand ratio was statistically significant, whereas the long-term-debt-to-total-capital ratio, which measures the source of debt, was insignificant. The days cash-on-hand was over 85 days higher for high-cash-flow AMCs than for the low-cash-flow AMCs. The average of 184.92 of days cash-on-hand ratio for the high-cash-flow AMCs indicates that these facilities would have more than six months of cash and investments to pay their daily operating expenses if they were to cease generating revenues.

Uses of capital

The days-in-accounts-receivable ratio was statistically significant, and the age-of-plant ratio was insignificant. The high-cash-flow AMCs were, on average, faster in their collection of receivables, collecting cash payments every 52.41 days, compared with the low-cash-flow AMCs, which collected cash payments every 61.48 days (P < .01).

Discussion

The overall findings of this study with regard to AMC financial performance show that high-cash-flow AMCs were able to maximize revenues and profits, which supports Robinson's20 perspective (i.e., that high-performing hospitals have focused on their core inpatient business in order to maximize revenues). We defined high-cash-flow AMCs as facilities that generated cash flows greater than the average value for three consecutive years relative to low-cash-flow AMCs. High-cash-flow AMCs generated an average cash flow margin ratio that was three times that of the low-cash-flow AMCs. Although this study is descriptive in nature and does not directly test the association of net patient revenues to cash flow margin, the findings suggest that higher net patient revenue per adjusted discharge—rather than operating expense per adjusted discharge—is a key contributor to the cash flow position among high-cash-flow AMCs. Their higher net patient revenues may stem from receiving greater payments from treating Medicare patients whose cases are more complex (the case mix index was significantly higher among the high-cash-flow AMCs). From an operating margin ratio perspective, both groups operated at a financial loss during the three-year reporting period. The operating loss of the high-cash-flow AMCs, however, was minimal, whereas the low-cash-flow AMCs operated at a substantial loss.

The findings regarding differences in number of beds, acuity of patients, and net patient revenue suggest that high-cash-flow AMCs have been successful because they have the capacity to serve patients who are more complex, which drives overall patient revenues for these facilities. These findings are in line with literature that indicates AMCs have expanded their strategic focus by selectively expanding clinical services.14,16 Going forward, AMCs should carefully consider how they plan for, develop, and expand selected clinical services to serve a population of patients with increasingly complex cases (especially cases that will also support their research and teaching missions).

Even though we detected no differences in the operating expenses of the two groups, surprisingly, we did find that salary and benefit expense per FTE was significantly higher for the high-cash-flow AMCs compared with the low-cash-flow AMCs. This finding suggests that the AMCs that have invested in nursing and in salaries, benefits, and career development for staff have experienced higher cash flow. Greater investment in nursing has been shown to yield improvements in employee satisfaction, patient satisfaction, and financial outcomes.23 Although AMCs clearly must be active in controlling expenses, they should consider salaries and benefits to be a long-term, competitive investment.

We found no significant difference between groups in the percentage of Medicare patients treated; however, the high-cash-flow AMCs did, on average, admit fewer Medicaid patients who pay less. Although we were unable to measure directly the percentage of private payers, the payer mix findings may imply that the high-cash-flow AMCs are able to generate high patient revenues by receiving higher payments from commercial payers. AMCs should seek to broaden their payer mix to ensure higher cash flow. Again, this finding is supported by other literature that indicates AMCs have become more strategic in their business planning and have sought to appeal to commercial payers through the development of signature programs and Centers of Excellence, as well as through the designation of clinical product lines.16,24

In terms of the sources and uses of capital, we found no differences in the debt structure of the two groups; however, liquidity was significantly higher for high-cash-flow AMCs. The high cash position of the high-cash-flow AMCs suggests that these institutions retained their cash flow to support their liquidity position rather than expending it on capital.

Our findings also show that high-cash-flow AMCs have become better at managing their revenue cycle which can lead to better cash flow. Treating fewer Medicaid patients, who typically pay on a slower time line than private payers, may also have contributed to a faster collection of receivables by the high-cash-flow AMCs. From a business perspective, study findings suggest that AMCs can improve their cash flow by improving their efficiency in collecting receivables. To the degree that AMCs focus on enhancing collections, the level of write-offs will decline and cash flow will increase. Research has shown that some effective revenue-collecting strategies in AMCs are collecting co-payments and coinsurance on presentation for services, ensuring complete and accurate claims, reducing denials by streamlining authorization processes, and implementing payment plans as needed by the patient.25 In addition, AMCs have used scoring systems to segment uninsured and balance-after-insured accounts, and they have had success in increasing cash flow using models that predict payment behavior.26

Our study has several limitations. We were unable to develop a valid and reliable measure of the use of capital, specifically capital expenditures ratio, which would measure whether the high-cash-flow AMCs were investing their cash flow in the latest medical equipment and technology as well modernizing their plant. In addition, missing data precluded the ability to measure the age-of-plant ratio for all AMCs. Also, we were unable to account for the influence of market and location factors that impact AMC performance. Future studies should address market conditions, specifically the demand for medical services and the competitiveness of the local hospital market, and how they affect the financial performance of AMCs. In addition, we were unable to measure specific services offered at each AMC in our sample. The scope and mix of services of AMCs, specifically in the profitable service lines of cardiology, oncology, and orthopedics, should also be examined in future research to determine whether the availability of these services affects cash flow. Finally, the study did not include a measure of uncompensated care. The HCRIS data do provide uncompensated care cost information, but after cross-validating these data with selected information reported by some states, we questioned the reliability and validity of these values.

Conclusions

Our study findings imply that high-cash-flow AMCs were earning higher cash flow returns than low-cash-flow AMCs. Generating higher patient revenues, serving patients with more complex cases, and serving fewer Medicaid patients seem to be underlying drivers behind this higher cash flow position. High-cash-flow AMCs were also larger-bed-size facilities, which may have contributed to higher cash flow because they possessed the greater capacity to meet demand.

Although somewhat counterintuitive, high-cash-flow AMCs have higher staff expenses. We considered these expenses to be an investment in staff as well as in the organization, which enabled these AMCs to offer services for more complex cases and, in turn, drive patient revenue. Thus, the combination of investment in staffing and the delivery of complex care allows AMCs to maximize revenue and profitability. Despite paying higher salaries per employee, the high-cash-flow AMCs have implemented efficiencies in accounts-receivable management, which have not only improved their cash flow state but also increased their liquidity position. Although their current debt position is not significantly different than that of the low-cash-flow AMCs, the high-cash-flow AMCs' higher days cash-on-hand ratio enables them to increase their debt borrowings in the future.

Given our study findings, we believe AMCs should consider the following administrative actions to elevate their cash flow position:

  • Expand capacity
  • Provide services for a more complex patient population
  • Invest in staff, such as nurses, and in benefits and salary
  • Retain cash to increase liquidity
  • Develop efficient accounts-receivable plans

Acknowledgments:

The authors express their sincere gratitude to Dan Herlihy of the Virginia Commonwealth University Medical Center, Richmond, Virginia, for his helpful comments on an earlier version of this paper.

Funding/Support:

None.

Other disclosures:

None.

Ethical approval:

Not applicable.

References

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Appendix 1
Appendix 1:
Variables and Operational Definition
© 2011 Association of American Medical Colleges