Has Critical Access Certification Financially
Stabilized Rural Kentucky Hospitals?
Kentucky Rural Hospital Flexibility Program Evaluation FY 06 - 07
Bethany F. Adams, MHA, CHE
Eric A. Scorsone, Ph.D.
December 2006
Table of Contents
Executive Summary
3
Preface
7
Introduction
8
Literature Review
9
The Need for Financially Stable Rural Hospitals
Rural Hospital Flexibility Program Authorization
Ratio Analysis
Financial Condition of Rural Hospitals
9
10
11
13
Methodology
16
Results
21
Liquidity Ratios
Capital Structure Ratios
Profitability Ratios
Asset Efficiency Ratios
21
23
24
25
Discussion
27
Conclusions
34
Appendix
37
Table 5: Liquidity Ratios
Table 6: Capital Structure Ratios
Table 7: Profitability Ratios
Table 8: Asset Efficiency Ratios
Table 9: Ratios and Definitions
Graph 1: Current Ratios for Groups 1 and 2
Graph 2: Current Ratio for Early and Late Converting CAHs
Graph 3: Days in Patient Accounts Receivable for Groups 1 and 2
Graph 4: Days Cash On Hand for Groups 1 and 2
Graph 5: Days Cash On Hand for Early and Late Converting CAHs
Graph 6: Long - Term Debt to Capitalization for Groups 1 and 2
Graph 7: Long - Term Debt to Capitalization for Early and Late Converting CAHs
Graph 8: Total Margin for Groups 1 and 2
Graph 9: Total Margin for Early and Late Converting CAHs
Graph 10: Return on Equity for Groups 1 and 2
Graph 11: Return on Equity for Early and Late Converters
Graph 12: Total Asset Turnover for Groups 1 and 2
Graph 13: Total Asset Turnover for Early and Late Converters
Graph 14: Fixed Asset Turnover for Groups 1 and 2
Graph 15: Fixed Asset Turnover for Early and Late Converters
References
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2
Executive Summary
Many rural hospitals have operated in the red since the imposed DRG prospective
payment system in the early 80s. Because of the DRG system, low patient volume and high
fixed costs, many rural hospitals have closed causing reduced access to health care for rural
Americans. To financially stabilize rural hospitals, the U.S. Congress enacted the Medicare
Rural Hospital Flexibility Program, which allows rural hospitals to convert to critical access
certification and receive reasonable cost base reimbursement.
The Kentucky State Office of Rural Health (KSORH) and the Kentucky Rural Hospital
Flexibility Program (KRHFP) staff initiated this evaluation program to track Kentucky CAHs in an
effort to evaluate the overall success of the KRHFP, and critical access certification process.
The KRHFP staff began the evaluation program at the onset of the implementation of the
Program. At the present time and to the best of our knowledge, the KSORH is the only state
office of rural health to have implemented an on-going financial ratio trend and comparative
analysis for their annual Rural Hospital Flexibility Program evaluation.
This study evaluates whether critical access certification has financially stabilized
Kentucky critical access hospitals (CAHs). A comparative and trend financial ratio analysis was
performed on two Kentucky hospital peer groups. Group 1 represents rural hospitals that have
not converted to critical access, and group 2 consists of critical access certified hospitals
(CAHs). In addition, the CAHs were subdivided into two groups for further comparison of their
financial position. The early converting CAHs are those hospitals that were certified between
2000 and 2002, and the late converters were certified between 2003 and 2005. The idea of the
early and late converting CAH groups is to assist the KSORH in targeting the needs of the
Kentucky CAHs, and directing its resources and technical services to those low performing
hospitals.
Four financial ratio categories, which included liquidity, capital structure, profitability and
asset efficiency ratios, were utilized to assess the condition of Kentucky’s CAHs. These four
3
categories include the following eight ratios: current ratio, days in patient accounts receivable,
days cash on hand, long-term debt to capitalization, total margin, return on equity, total asset
turnover, and fixed asset turnover. The financial ratios from the two peer groups were
compared to Kentucky and national industry standards. National industry standards for 1999 –
2004 were obtained from a national benchmarking company along with the hospital financial
ratios for 1999 – 2000. The most current industry standards that were available at the time of
study were from 2004. The hospital financial ratios for 2001 - 2005 and Kentucky rural hospital
standards were computed directly from CMS Worksheet G Series.
Overall, the Kentucky CAHs performed unfavorably when compared to the state and
national industry standards for current ratio, days in patient account receivable, and days cash
on hand. The current ratio analysis indicates that the Kentucky CAHs have greater difficulty
raising cash to cover short-term liabilities than the eligible, non-converting rural hospitals. The
results show that CAHs are less profitable and have more debt than their peer group. The early
converting CAHs have lower current ratios, and more debt than the late converters. The early
converters appear to have less capability to pay short-term debt, and are more at risk for
insolvency than the late converters. Late converting CAHs have higher current ratios, and lower
long-term debt to capitalization ratio values than the early converting CAHs. This may help
explain their delay in becoming certified as critical access hospitals.
Kentucky CAHs did show a positive improvement in days in patient accounts receivable.
The shorter collection period gives greater ability to meet short-term liabilities and pay their bills
as they come due, which in turn, improves financial stability. The days cash on hand ratios
illustrate that CAHs still have serious cash flow problems, and difficulties meeting short-term
liabilities. It is evident by the low days cash on hand ratio values that Kentucky CAHs have a
greater difficulty paying their average daily expenditures compared to their peer groups. The
late converting CAHs appear to be slightly more secure in the short-term than the early
4
converters, which may further explain why this group waited later to become certified as critical
access.
The long-term debt to capitalization ratio values show that Kentucky CAHs have more
debt, and are less solvent than the eligible, non-converting rural hospitals. CAHs are at greater
financial risk than their peer groups, and performed unfavorably compared to the state and
national industry standards. The evidence shows that the early converting CAHs have higher
debt than the late converters, and are more financially vulnerable.
The total margin and return on equity (ROE) ratios provide the best evidence of the
overall success of Kentucky critical access hospitals, and consequently, the KRHFP. The total
margin values indicate that the Kentucky CAHs are more financially stable under critical access
certification. Moreover, the total margin ratio results show that the CAHs have improved their
financial condition since conversion to critical access. In 2004 and 2005, there was a large
increase in return on equity for the CAHs compared to the eligible rural Kentucky hospitals. The
total margin and ROE results support the possibility that CAHs are achieving control over their
expenses. It is important to note that CAHs are not making a profit under the cost base
reimbursement. CAHs are usually non-profit institutions that have low patient volume and high
fixed costs. This explains, at least to some degree, the comparatively low liquidity, and
profitability ratios.
While the CAH total margin ratios are lower than the peer group median values, a
positive total margin may demonstrate that CAHs are in the process of becoming more
financially stable. Since the implementation of the KRHFP in 2000, the total margin ratios for
the CAHs have improved with results only slightly below the industry standards in 2004 and
2005. The early converting CAH total margin values remained relatively steady from 2000 to
2003, and in 2004 showed a positive trend upward. In 2004 and 2005, the early converters
performed favorably when compared to the state and national total margin industry standards.
The goal of the KRHFP was to financially stabilize small rural hospitals that converted to critical
5
access certification. The program objectives seem to be effective as shown by the favorable
total margin ratios produced in 2004 and 2005 by the early converting CAHs.
It is important to highlight Kentucky CAHs relatively high total and fixed asset turnover
ratios. The majority of the Kentucky CAHs are older Hill-Burton facilities that acquired their
equipment years ago. If compared to a new hospital with similar physical plant assets, the older
hospital would report a higher turnover ratio because of the much lower book value (Gapenski,
2001). While a higher fixed asset turnover value may be considered favorable, it may not be a
positive indicator for CAHs due to the possible lower book value of their fixed assets.
Overall, critical access certification appears to have improved the financial position of
rural Kentucky hospitals. More importantly, the financial condition of Kentucky CAHs has not
worsened since the implementation of the KRHFP in 2000. However, Kentucky CAHs are not
as financially sound as the eligible, non-converting hospital group. Evidence from this study
suggests that it is too early to withdraw technical or financial assistance from the Kentucky
CAHs. It is recommended that funds be redirected to further assist the low performing CAHs to
ensure their financial stability. This analysis should be repeated to evaluate the on-going
conversion process, and overall success of the KRHFP. It is recognized that this study is
limited by the fact that only five years of financial data is available from the initial implementation
of the KRHFP.
6
PREFACE
This project was funded through the Kentucky Rural Hospital Flexibility Program, and
was contracted through the Kentucky Rural Health Works Program (KRHW). KRHW Program is
a partnership between the Kentucky State Office of Rural Health, the University of Kentucky
Department of Agricultural Economics, and the University of Kentucky Cooperative Extension
Service. For more information regarding this report, contact Dr. Rick Maurer, Mr. Larry Allen, or
Dr. Alison Davis-Reum at the University of Kentucky.
Rick Maurer, Ph.D.
Extension Professor
Community and Leadership Development
513 W. P. Garrigus Building
Lexington, KY 40546-021
Email: richard.maurer@uky.edu
Larry Allen, MA,
Director
State Office of Rural Health
UK Center for Rural Health
B426 750 Morton Boulevard
Hazard, KY 41701
E-mail: lalle2@uky.edu
Alison Davis-Reum, Ph.D.
Assistant Extension Professor
Agricultural Economics
400 Charles E. Barnhart Building
Lexington, KY 40546-0276
Email: alison.reum@uky.edu
7
INTRODUCTION
Since the implementation of the DRG prospective payment system, rural hospitals have
operated at or below profit margins. Consequently, many rural hospitals have closed across the
country causing reduced access to health care for rural Americans. In an effort to financially
stabilize rural hospitals, the U.S. Congress created the Rural Hospital Flexibility Program (Flex
Program) as part of the 1997 Balanced Budget Act (Rural Policy Research Institute, 2001).
Under the Flex Program, rural hospitals can convert their state licensure to critical access
certification and receive reasonable cost base reimbursement from Medicare. In some states,
including Kentucky, critical access hospitals (CAHs) may receive cost base reimbursement from
Medicaid. The goal of the Flex Program is to financially stabilize rural hospitals, and to increase
access to primary and short-term acute care for rural citizens.
This study evaluates whether critical access certification has improved the financial
stability of rural Kentucky hospitals. A comparative and trend financial ratio analysis was
performed on two groups of rural Kentucky hospitals. The first peer group represents program
eligible rural hospitals that have not converted to critical access certification. The second group
contains rural hospitals that have been certified as critical access. A trend analysis evaluated
the performance of these two groups over time in a longitudinal analysis. In addition, the critical
access hospital group was subdivided into two groups for further evaluation. The first CAH
group (group A) converted in 2000 - 2002, and group B converted between 2003- 2005. The
two peer groups were then benchmarked against a Kentucky and national standard.
By 2005, the trend appears to be that critical access certification has improved the
financial position of these hospitals. More importantly, the financial position of critical access
hospitals has not worsened since 2000. However, Kentucky CAHs do not appear to be as
financially viable as the peer group. This analysis should be repeated following more time in the
program.
8
LITERATURE REVIEW
The Need for Financially Stable Rural Hospitals
Health Resources and Services Administration considers critical access hospitals
(CAHs) to be health care safety nets for rural areas. For example, 91 percent of CAHs are
located in Health Professional Shortage Areas or Medically Underserved Areas (Poley, 2001;
Zelman et al., 2001). In general, CAHs serve poorer populations since rural areas typically
have higher poverty rates than urban vicinities. Private health insurance is also more commonly
available to urban residents than rural citizens. Subsequently, the number of uninsured and
underinsured are greater in rural areas than in urban regions. (Rural Information Center Health
Service).
Nearly 83 percent of CAHs are located in counties where people 65 or older are greater
than the state average (Poley, 2001). Elderly people make up a larger proportion of the rural
population when compared to urban areas, and Medicare beneficiaries are more likely to reside
in rural areas (Rural Information Center Health Service). For the average CAH, Medicare
patients represent approximately 60 to 70 percent of the total patient mix. With 20 percent of
the total U.S. population living in rural areas, rural hospitals have a lower patient volume than
urban hospitals (Rural Information Center Health Service). Because of the low patient volume,
high percentage of Medicare, underinsured and uninsured patients, rural hospitals are more
likely to be financially stressed than urban hospitals.
Rural hospitals are a viable part of their communities and play a major role in economic
development. First, the health care system is an economic base industry that attracts external
dollars. Second, hospital employees and other health care institutions are purchasers of local
goods and services. Lastly, the health care system is a major factor in the recruitment and
retention of industry and business (Scorsone, 2001; Doeksen et al, 1992). The health care
sector is often the second largest employer in rural areas following the school system and may
account for 15 to 20 percent of all jobs within a community (Scorsone, 2001; Shelton et al,
9
2001). Doeksen et al (1990) argued, thousand of jobs and businesses in hundreds of rural
communities are affected by rural health policies, and that rural hospitals play a vital role in local
economy. By allowing rural hospitals to receive reasonable cost base reimbursement, rural
hospitals and their communities may remain financially stable (Shelton et al., 2001).
Rural Hospital Flexibility Program Authorization
In the late 80’s, the federal government recognized the negative effects of the DRG
prospective payment system on rural hospitals. In an effort to financially stabilize rural
hospitals, the government initiated two pilot projects to determine the feasibility of implementing
a national rural hospital program. The Flex Program is now an extension of the pilot projects
and has incorporated several of the pilot components in the critical access hospital certification.
In 1987, Montana created a rural hospital licensure called the Montana Medical
Assistance Facility (MAF). MAFs provided emergency care and short term, low-intensity
inpatient services with relaxed staffing requirements, which reduced operational costs. The
Health Care Financing Administration eventually approved cost base reimbursement for these
facilities.
In 1989, Congress authorized the Essential Access Community Hospital (EACH) and the
Rural Primary Care Hospital (RPCH) certifications. EACHs acted as referral hospitals to Rural
Primary Care Hospitals, which qualified the EACHs for enhanced DRG reimbursement rates
(Health Care in Rural America, 1990). RPCHs provided emergency and limited inpatient care
services with flexible staffing requirements, and thus, received cost base reimbursement from
Medicare (Health Care in Rural America, 1990). The EACH / RPCH referral model has been
incorporated into the Flex Program. The referral networks, flexible staffing, use of mid-level
practitioners and limited inpatient service was shown to reduced operational costs and has been
incorporated into critical access certification (Henderson & Coopey, 2000).
10
Congress authorized the Flex Program under the 1997 Balanced Budget Act (BBA).
States were required to assist rural hospitals in converting their state licensure from acute care
to critical access certification. The certification requires hospitals to reduce the number of
staffed beds to twenty-five, participate in a referral network, and limit the length of stay. Most
importantly, critical access certification provides reasonable cost base reimbursements to
participating hospitals. By the end of 2000, the Flex Program had completed its first year of the
implementation process. However, rural hospitals were still struggling financially. In 2000, the
Benefits Improvement and Protection Act increased provisions to CAHs, which enhanced the
overall reimbursement and assisted in them in becoming more financially secure.
Ratio Analysis
Ratio analysis is commonly used to assess the financial condition of a business. “Ratios
are valuable tools since they standardize balance sheet and income statement numbers.
Differences in a hospital bed size will not affect the analysis. Ratios can examine trends and
determine reasons for financial changes” (Lee, Finnerty & Norton, 1997). According to Cleverly
(1997), “financial ratios are empirically tested to determine their value in predicting business
failure. Ratios analysis can discern potential problems in financial conditions up to 5 years
before their emergence”. A ratio analysis usually focuses on 3 key components; liquidity ratios
to evaluate short-term debt, capital structure ratios to evaluate long-term debt and profitability
ratios. However, efficiency ratios are important in evaluating how well assets are being utilized
and should be considered in an analysis as well.
Cleverly defines liquidity ratios as an “important dimension in the assessment of financial
condition. Most hospitals that experience financial problems do so because of a liquidity crisis”.
“Liquidity ratios measure the ability of a hospital to meet maturing financial obligations and
recurring operation expenses that are due within one year” (Lee, Finnerty, & Norton, 1997).
11
Three liquidity ratios are examined in this analysis; current ratio, days cash on hand and days in
accounts receivable.
Current ratio measures “the extent to which short-term claims are covered by assets that
are expected to be converted to cash in the near term. This ratio shows that a hospital’s current
assets would provide “X” dollars for every one-dollar of its current liabilities” (Gapenski, 2001).
Days cash on hand measures the ability of a hospital to make payments as their liabilities come
due. “This liquidity ratio measures the number of days an entity could meet its average daily
expenditures and defines the maximum period of safety” (Cleverly, 1997). Days in accounts
receivable measures the ability of the hospital to collect payments in a timely manner. “High
ratios of 75 days or more can indicate problems in collection times, collection polices and billing
systems” (Cleverly, 1997).
“Capital structure ratios compare funds supplied by owners (equity) with the funds
provided by creditors (debt)” (Lee, Finnerty & Norton, 1997) “The higher the percentage, the
more risk in becoming insolvent and the less flexibility in meeting future financial needs of the
organization” (Neumann & Boles, 1998). Long-term debt to capitalization is a capital structure
ratio that is commonly utilized by hospitals. “Higher values for this ratio imply a greater reliance
on debt financing, and may imply a reduced ability to carry additional debt” (GE Healthcare
Financing Services, 2006). “In the last twenty years, hospitals have increased their percentages
of debt financing. This makes capital structure ratios vitally important” (Cleverly, 1997).
“Profitability ratios measure the aggregate financial performance of a hospital and show
how a hospital uses its assets and equity to generate returns” (Gapenski, 2001; Lee, Finnerty &
Norton, 1997). Two industry significant profitability ratios are evaluated; total margin and return
on equity. Total margin “is used by many analysts as a primary measure of total profitability”
(Cleverly, 1997). Total margin indicates how well a hospital controls its expenses and explains
that the “hospital makes “X” dollars on every 100 dollars of total revenues” (Gapenski, 2001).
12
“Return on equity ratio is one of the primary tests of profitability for both voluntary and
investor-owned health care facilities. Failure to maintain a satisfactory ROE ratio may prevent
the hospital from obtaining equity capital in the future” (Cleverly, 1997). Return on equity (ROE)
measures the ability to utilize debt and how efficient managers use owner-supplied capital. The
ROE explains that the “hospital generates “X” dollars of income for every 100 dollars of equity
invested” (Gapenski, 2001).
According to Neumann and Boles (1998), “most managers find that turnover is one of
the more significant factors that can be affected by managerial decisions”. Turnover indicators
(these indicators are also known as asset management or activity ratios) measure how
effectively management utilizes assets within an organization (Gapenski, 2001). “Total asset
turnover measures “X” dollars of revenue that is generated for every dollar of assets utilized by
the hospital. Fixed asset turnover considers fixed assets only, such as plant and equipment,
and demonstrates that for every dollar of fixed assets generates “X” dollars in revenue
(Gapenski, 2001; Neumann and Boles, 1998).
Financial Condition of Rural Hospitals
A pre-conversion financial profile of critical access hospitals (CAHs) was created by
Poley (2001) from HCFA’s 1998 hospitals cost reports. The pre-conversion profile gives a
picture of the general operational and financial status of CAHs (Poley, 2001). Table 1 shows
the pre-conversion financial and utilization ratios, which illustrates the negative values for total
and operating margins.
Table 1: CAH Pre-Conversion Profile
Financial Ratios
Average Daily Census (acute)
Average Length of Stay (acute)
Operating Margin
Total Margin
Medicare Utilization – Days
13
National Median
3.0
3.3
-9.9
-0.3
63.3
Fruhbeis and Dalton (2003) developed a pre-conversion financial profile of CAHs using
data obtained from the 1999 Medicare cost reports. The financial ratios where then compared
to a peer group, which consisted of rural, low-volume, non-critical access hospitals. Table 2
illustrates CAHs negative profitability ratios for 1999. Fruhbeis and Dalton (2003) reported that
86.8 percent of CAHs had a negative operating margin compared to 72.4 percent by the peer
group, and 57.5 percent of the CAHs had a negative total margin versus 38.6 percent of the
non-converting rural hospitals.
Table 2: CAH Pre-Conversion Profile
Financial Ratios
Operating Margin
Total Margin
CAHs
-10.6
-1.1
Non-converting Rural Hospitals
-4.7
1.7
Zelman et al (2001) performed a comparative financial ratio analysis on 3 groups of rural
hospitals: 1) non-participating, rural hospitals that did not convert to critical access, 2) hospitals
that converted to critical access, and 3) pilot project hospitals that converted to critical access.
Zelman et al (2001) calculated median values of key financial ratios from 1996 through 2000,
which was obtained from a benchmarking company and by a survey methodology. They
reported that, profitability for all groups decreased over the study period, but CAHs were
operating with lower margins compared to other rural hospitals. The CAHs and the rural
hospitals reported negative values for total margin and return on equity ratios. However, the
CAHs improved slightly in 2000 with a positive total margin of 0.16 while the peer group
continued to decline to negative 1.22. They also showed that there was minimum change in the
liquidity ratios for CAHs compared to other rural hospitals. Zelman et al (2001) reported that
days cash on hand for all study groups steadily declined from 1996 to 1999 and indicated that
the groups had less than 25 days cash on hand. Their study demonstrated that small rural
facilities tend to have older fixed assets than do larger rural facilities. The amount of long-term
14
debt steadily increased from 1996 to 2000 for CAHs, but it remain substantially below the
relative debt levels of larger rural facilities. Since their analysis showed little change in liquidity,
they suggested that CAHs have severe difficulties raising funds for capital projects.
Shelton et al (2001) illustrated the changes in hospital services data following conversion
to critical access certification. Shelton et al (2001) reported that the average number of licensed
beds decreased by almost half (41 to 23 beds), the average daily census increased and the
percent of Medicare discharges remained consistent at 66 percent. Their study further showed
that the average loss in net income before conversion for the sample survey hospitals was
$703,597.00 with a range of negative 2.8 million to a negative $29,000 in loses. However, rural
hospitals that converted to critical access had an average gain of $268,615 in net income.
Zelman et al (2001) reported the median net income prior to conversion was a negative
$200,000 while the median projected impact following two years after conversion was a positive
$250,000.
Wendling et al (2002) performed a program evaluation of the Kansas Rural Hospital
Flexibility Program. Their study compared the financial ratios of 7 Kansas CAHs to 7 peer
group hospitals. They collected data from Medicare cost reports and evaluated the changes
from 1994 - 2000 in a trend analysis. Wendling et al (2002) reported that the average CAH
outpatient revenues increased faster than the peer group. Their study demonstrated that the
acute inpatient services sharply declined as a result of the 96-hour length of stay limitation rule.
They concluded that critical access certification enhanced the financial stability relative to the
peer group (Wendling et al., 2002).
15
METHODOLOGY
This study utilizes a financial ratio analysis to assess the financial position of Kentucky
critical access hospitals (CAHs) that participate in the Kentucky Rural Hospital Flexibility
Program. In addition, this study compares the financial ratios of CAHs to rural Kentucky
hospitals that have not converted to critical access. The analysis evaluates eight common
industry financial ratios to assess the financial condition of critical access hospitals (see Table 3
below). These eight ratios concentrate on four significant financial categories to determine the
overall fiscal condition of Kentucky’s rural hospitals. The four categories include profitability,
liquidity, capital structure, and asset efficiency ratios. Profitability ratios evaluate the financial
viability of an organization, and may well be the most important group of ratios as it affects
many areas of decision-making for hospital administrators. Liquidity ratios evaluate cash flow,
and determine how well hospitals can meet short-term liabilities. Capital structure ratios
evaluate solvency of an organization, and illustrates how an organization utilizes debt financing.
Asset efficiency ratios determine how efficient assets are being utilized within the organization.
Table 3 below contains the ratios used in this study, and illustrates the desired trend for
that ratio. Furthermore, Table 3 demonstrates the desired position of that trend compared to the
industry standard median value (Ingenix, 2006). For example, for the profitability ratio total
margin, the desired trend is up and above the median value compared to the industry standard
or peer group. This interpretation is used to analyze the trend and comparative results (Tables
5 – 8 in the appendix). See Table 9 in the appendix for a list of the ratios and their definitions.
16
Table 3: Financial Ratios
Desired Position
PROFITABILITY RATIOS
Trend
Median
Total Margin
Up
Above
Return on Equity
Up
Above
Desired Position
LIQUIDITY RATIOS
Trend
Median
Current Ratio
Up
Above
Days Accounts Receivable
Down
Below
Days Cash On Hand
Up
Above
Desired Position
CAPITAL STRUCTURE RATIOS
Long-Term Debt to Capitalization
Trend
Median
Down
Below
Desired Position
ASSET EFFICIENCY RATIOS
Trend
Median
Total Asset Turnover
Up
Above
Fixed Asset Turnover
Up
Above
Source: 2006 Almanac of Hospital Financial and Operating Indicators
Based on a financial ratio analysis, this study evaluated whether critical access
certification has financially stabilized rural Kentucky hospitals. In the comparative ratio analysis,
two Kentucky hospital peer groups were compared to two industry standards. The two study
groups and the two industry standards were then evaluated in a trend ratio analysis. The first
peer group consists of eight eligible, non-participating rural Kentucky hospitals that have not
converted to critical access certification. The second group represents twenty-eight Kentucky
critical access hospitals (CAHs). The CAHs (peer group 2) were subdivided into two groups
(groups 2A and 2B) for a further comparison. The purpose of these two groups is to illustrate
the financial position of the CAHs, and is not considered two separate study groups in this
analysis. CAH group 2A represents early converters while group 2B includes the late
converters. CAH group 2A is composed of thirteen rural Kentucky hospitals that converted to
17
critical access certification between 2000 and 2002. Group 2B contains fifteen CAHs that
converted between 2003 and 2005 (See Table 3 below).
The hospital financial ratios for 1999 – 2000 were obtained from a national
benchmarking company.1 The 2001 - 2005 financial ratios were calculated directly from the
Centers for Medicare and Medicaid Services (CMS) Worksheet G Series. The CMS Worksheet
G Series represent the income and balance sheet statements that are submitted by hospitals to
CMS. The Worksheet G Series for all thirty-six hospitals for the years 2001 - 2005 were
requested under the Freedom of Information Act for the purpose of this analysis. 2005 is the
most current CMS data available and the 2006 Worksheet G Series was not available at the
time of this study.
The financial ratios from the two peer groups were compared to a Kentucky standard
and a national industry standard. The national industry ratios for 1999 – 2004 were obtained
from a national benchmarking company, and represent the median values of all rural hospitals.2
The most current national data is through 2004, and 2005 data was not available at the time of
study. The 1999 – 2000 Kentucky rural hospital standards are the median values of the collated
financial ratios obtained from the same national benchmarking company. However, for years
2001 through 2005, the ratios for all thirty-six rural hospitals were computed directly from CMS
Worksheet G Series, and subsequently, collated to prepare a Kentucky standard. Therefore,
The Kentucky standard represents the median values for all thirty-six rural Kentucky hospitals
that compose the two peer groups (See Table 4 below).
The individual hospital financial ratios for 1999 – 2000 were obtained through a prepaid secure website produced by
Ingenix, Inc. See website for available health care benchmarking products: www.ingenixonline
2 The financial ratios for the national standards were obtained from the 2006 Almanac of Hospital Financial and
Operating Indicators: A Comprehensive Benchmark of the Nation’s Hospitals, which is produced by Ingenix
TrendMetrics®. This book was formally known as The Hospital Finance Almanac, which was previously produced by
the Center for Healthcare Industry Performance Studies (CHIPS). For more information, see the website
www.ingenixonline.com/expert or call 1(800) INGENIX.
1
18
Table 4: Industry Standards and Peer Groups
Standard / Peer Group
Number in
Peer Group
National Rural Hospital Standard
N/A
Kentucky Rural Hospital Standard
36
Group 1: KY eligible rural hospitals that have not converted
8
Group 2: KY Critical Access Hospitals
28
Early Converters: Group 2A - KY CAHs certified between 2000 and 2002
13
Late Converters: Group 2B - KY CAHs certified between 2003 and 2005
15
Ingenix, Inc. (Ingenix is a national benchmarking company and an industry leader)
collects Medicare cost report data at fixed points throughout the calendar year, and
acknowledges that errors do occur in their reporting system. For example, the company
purchases different parts of the Medicare cost reports at fixed times throughout the calendar
year. Second, hospitals turn in cost reports based on their fiscal year verses a calendar year.
Lastly, there can be a lag time in the release of the Medicare cost reports from the Centers for
Medicare and Medicaid Services (CMS) from 6 months to a year.
One possible limitation of this analysis is selection bias. Selection bias is a possibility
since hospitals self-determine to convert to critical access certification. Consequently, the
financial ratio trend and comparative analysis is based on those hospitals that converted versus
those that have chosen to retain their acute care licensures. Moreover, individual hospital
conversion dates may have also impacted the financial ratio analysis. Because hospitals
converted to critical access hospitals at different times, their reasonable cost based
reimbursement payments would have been initiated and received at different points in time. It is
hypothesized that a newly converted CAH would conceivably receive reimbursement from CMS
under the prospective payment and the reasonable cost base system within the same year. Of
course, this would be dependent upon the month of conversion and the hospital’s critical access
19
application process. Therefore, the conversion process itself may affect the financial ratio
analysis for a particular hospital in a certain year. However, by the end of 2005, all hospitals
that would have converted to critical access would have already completed the process.
20
RESULTS
Tables 5 through 8 show the financial trends for two Kentucky hospital peer groups and
the comparative analysis with a state and national standard (see appendix for Tables 5 – 8).
Study group 1 represents those rural hospitals that are eligible to convert, but chose not to be
certified as critical access, and decided to retain their current licensure. Peer group 2 is
comprised of all Kentucky critical access hospitals (CAHs). This analysis also divides CAHs by
conversion year, and categorizes them either as early or late converters. Early converters
(group 2A) are those rural hospitals that were certified as critical access between 2000 and
2002. Late converters (group 2B) were certified between 2003 and 2005. The purpose of the
early and late groups is to further illustrate the financial position of CAHs, and is not considered
two separate study groups.
Liquidity Ratios
Table 5 shows three liquidity ratios: current ratio, days in patient accounts receivable,
and days cash on hand. It is evident in Table 5 and Graph 1 that the national rural hospital
current ratio standard has remained steadily neutral from 1999 through 2005. The trend for the
Kentucky standard has also remained neutral, but has ran slightly higher than the national
median values. Group 1 (eligible Kentucky rural hospitals that have not converted to critical
access) showed a decrease in 2001, but then trended positively upward through 2004. In 2005,
group 1 demonstrated a slight decline in their current ratio. However, group 1 performed above
the national and state industry standards, and the Kentucky critical access hospitals (CAHs).
Therefore, group 1 compared favorably to both standards. As for the Kentucky CAHs (group 2),
it is evident that they performed well below group 1, and the national and state industry
standards. Group 2 showed a slight increase from 2000 to 2002, but then steadily declined
through 2004. In 2005, Kentucky CAHs did trend positively upward, but still finished below the
peer groups. Overall, the Kentucky CAHs compare unfavorably to the state and national
21
standards (see Graph 1 in appendix). The early converters (CAHs that were certified between
2000 and 2002) showed a dramatic increase following the initial implementation of the Medicare
Rural Hospital Flexibility Program in 2000. This early converting group then proceeded to
steadily decline from 2000 through 2003, but then trended slightly upward through 2004. In
2005, the early converters showed a decreased current ratio, which illustrates an overall
negative downward trend for the early converting CAHs. The early converters performed well
below the national median and the late converters, and compare unfavorably to the peer
groups. The late converters (CAHs certified between 2003 and 2005) exhibited a decline from
1999 to 2000, but then trended positively upward through 2002. While the late converters
demonstrated another decline in 2003 and 2004, they performed positively in 2005. Overall, the
late converters performed above the early converters, and as well as the national standard. The
overall trend for the late converters is upward, and this group compared favorably to its peer
group (see Graph 2 in the appendix). The early and late groups further illustrate the actual
current ratio results of Kentucky CAHs.
For days in patient accounts receivable, Graph 3 illustrates that the national and
Kentucky industry standards have steadily declined from 2000 through 2005. Group 1 also
demonstrates a steady downward trend, and performed well below the Kentucky standard. In
2004, Group 1 decreased their days in accounts receivable to below the national median, which
allows them to compare very favorably to both standards. Group 2 CAHs improved in days
accounts receivable by showing a steady decline from 2001 through 2005, and performed
relatively close to the Kentucky standard. However, Group 2 results are still above the state
and national median values, which compares unfavorably (see Table 5 and Graph 3 in the
appendix).
Days cash on hand from short-term sources have remained relatively consistent for the
national rural hospital standard. The national trend has been neutral with the median number of
days cash on hand maintaining in the upper twenties. The Kentucky standard days cash on
22
hand has steadily declined from 2000 to 2003, but showed a positive trend upward in 2004 and
2005. The eligible rural hospitals (group 1) demonstrated a sharp decline from 2000 to 2002,
but peaked sharply in 2003. In 2004 and 2005, Group 1 further exhibited a negative trend
downward. However, this group performed well above the industry median and its peer group.
Therefore, Group 1 compares favorably to both standards. While Group 2 CAHs exhibited a
positive trend upward in 2000 following conversion, these hospitals then trended negatively
downward through 2003. In 2004, group 2 did peak slightly, but further declined in 2005.
Overall, the CAHs performed well below both industry standards and the peer group, and
compared unfavorably (see Table 5 and Graph 4). Graph 5 illustrates a negative trend
downward since pre-conversion in 1999 through 2004 for the early converting CAHs. Although,
these CAHs did gain two and half days cash on hand in 2005. The early converters performed
well below the late converters, and have substantially less days cash on hand than the peer
group. The late converters show a sharp decline in days cash on hand from 2000 to 2003.
Following conversion of the initial hospitals in 2003, this group trended positively upward in
2004 and 2005, but still performed well below the national standard (see graph 5).
Capital Structure Ratios
The national rural hospital long-term debt to capitalization standard has remained
consistent from 2001 through 2004. The Kentucky rural hospital standard trends upward and
performed well above the national median values from 2003 through 2005. The long-term debt
to capitalization ratios for group 1 (eligible, non-converting hospitals) declined from 2001
through 2003. In 2004, group 1 increased slightly, but then remained relatively neutral in 2005.
Overall, group 1 performed favorably when compared to the Kentucky and national industry
standards. The Kentucky CAHs (group 2) trend upward from 2003, and performed well above
the peer group and both standards from 2003 through 2005 (see Table 6 and Graph 6 in the
appendix). Therefore, group 2 compared unfavorably to the state and national standards. It is
23
evident in Graph 7 that early converters trend steadily upwards from 2002, and performed
poorly when compared to the peer group and the industry standards. While the late converters
trend negatively upwards, their results are closer to the state median values. However, the late
converters still performed unfavorably compared to the state and national standards.
Profitability Ratios
The national and the Kentucky total margin standards trended negatively downward from
2001 through 2003, but showed a positive response in 2004 (see Graph 8 in the appendix).
However, the Kentucky total margin standard performed well below the national level. Group 1
(Kentucky rural hospitals that have not converted to critical access) performed favorably to both
industry standards (see Table 7). Since 2002, the total margin has been declining for these
hospitals, but group 1 still performed well above the industry medians. From 2000 through
2002, the total margin ratios for group 2 Kentucky CAHs have been well below industry
standards. In 2003, the CAH total margin results show a positive trend upward, but the median
values remain well below the peer group and standards. Overall, the CAHs have performed
unfavorably when compared to the state and national standards (see Graph 8). In Graph 9, the
early converting CAHs show an increase from a pre-conversion negative total margin ratio in
1999 to a positive post-conversion value in 2001. While there was a decline in 2002, the early
converting hospitals further demonstrate a positive trend in 2004 and 2005, which compared
favorably to the national industry. The late converting CAHs show a negative trend downward
from 1999 through 2002. Following the initial critical access certification of the late converters in
2003, these hospitals begin to trend upwards, but remain below the peer group and the national
industry standard.
The overall national trend for return on equity (ROE) has been relatively neutral for rural
hospitals. The Kentucky rural hospital ROE standard trended downward from 2001 through
2003, but then shows a steady increase since 2004. Group 1 performed slightly below the state
24
and national standards in 2004 and 2005, and therefore, compared unfavorably to both.
However, the eligible Kentucky rural hospitals (group 1) have remained relatively neutral over
time with two peaks in 2002 and 2003, which were above the standard medians (see Table 8
and Graph 10 in the appendix). Group 2 CAHs show a decline from 2001 to 2003, but then
trends positively upwards from 2004 to 2005. This group performed as well as the industry
standards in 2004, and above the Kentucky median in 2005. Therefore, the CAHs compared
favorably to the industry standards. While both the early and late converters show sporadic
ROE results in Graph 11, it is interesting to note that the early converters did perform slightly
better than the late converters in 2004 and 2005.
Asset Efficiency Ratios
The national rural hospital trend for total asset turnover has remained consistent since
1999. The trend for the Kentucky rural hospital standard shows a slight, but steady, increase
overtime. Group 1 eligible Kentucky rural hospitals have also remained stable over time with
the national standard. However, group 1 performed slightly below and unfavorably when
compared to the state standard. Group 2 Kentucky CAHs performed well above the median
values of both industry standards (see Table 8). Moreover, group 2 shows an increase from
2001 through 2003, but has remained steady since 2004 (see Graph 12 in the appendix).
Graph 13 demonstrates a slight upward trend in 2005 for the early converting hospitals. Graph
13 also illustrates that the late converters trended upwards from 2000 through 2004, but
declined in 2005. Overall, the total asset turnover results have remained relatively consistent
for all Kentucky CAHs, and these hospitals have performed above the national standard.
In 2005, the Kentucky state fixed asset turnover ratio standard has trended upward, but
previous results have been fairly constant overtime. When comparing the state and national
standards, the Kentucky fixed asset turnover ratio values have been well above the national
median (see Table 8 and Graph 14). The national hospital standard has remained consistent
25
over time, but also showed a slight increase in 2004. Group 1(the eligible rural hospitals)
compares favorably with the national results, but performed below the state standard. Graph 14
illustrates that group 1 has trended upward since 2000. Group 2 CAHs show a slightly
increasing trend in 2005 following a decline from 2002. The CAHs performed well above the
peer groups and standards. Graph 15 shows that the overall fixed asset turnover ratio results
for the early converting CAHs have been various overtime. These hospitals trended downward
in 2003, but have remained neutral since 2004. The late converters show a slight increase
since 2004, but the overall trend has been fairly consistent over time. While the late converters
performed well above the national median, the early converters demonstrated sporadic results,
but the values remained at or above the national median.
26
DISCUSSION
This study was performed for the Kentucky State Office of Rural Health (KSORH) to
evaluate the Kentucky Rural Hospital Flexibility Program. The objective of this study was to
determine if critical access certification has financially stabilized rural Kentucky critical access
hospitals (CAHs). This study assesses whether critical access certification, and thus,
reasonable cost base reimbursement, has improved the financial condition of rural hospitals by
comparing two hospital peer groups through a trend and comparative ratio analysis. Group 1
consists of eligible rural hospitals that did not convert to critical access, and retained their
current licensure. Group 2 represents all Kentucky critical access hospitals (CAHs). This CAH
group was then divided into two groups (early and late converters) to further illustrate the
financial status of the CAH group. Early converting CAHs represent those hospitals that
converted to critical access between 2000 and 2002, and late converters are those hospitals
that were certified between 2003 and 2005. This evaluation does not consider the early and
late converting CAHs to be separate study groups. The early and late groups are used to clarify
how the CAHs are performing overall. The idea of the early and late converting CAH groups is
to assist the KSORH in targeting the needs of the Kentucky CAHs, and directing its resources
and technical services to those low performing hospitals.
This study used a ratio analysis to assess the financial status of Kentucky critical access
hospitals (CAHs). Each indicator was evaluated over time in a trend analysis, and then
compared to a peer group and industry standard. Four financial ratio categories, which included
liquidity, capital structure, profitability and asset efficiency were utilized to assess the condition
of Kentucky’s CAHs. These four categories include the following eight ratios: current ratio, days
in patient accounts receivable, days cash on hand, long-term debt to capitalization, total margin,
return on equity, total asset turnover, and fixed asset turnover.
When comparing the eligible rural hospitals (group 1) to the CAHs (group 2), it is evident
that the non-converting hospitals have higher current ratio and total margin median values.
27
“Current ratio and total margin are positively correlated with the more profitable hospitals having
higher current ratios” (Ingenix, 2005). The current ratio analysis indicates that the CAHs have
greater difficulty raising cash to cover short-term liabilities than their peer group. The results
show that CAHs are less profitable and have more debt than the eligible, non-converting rural
hospitals.
From 2003 through 2005, the current ratios for the early converting CAHs ranged from
1.26 to 1.40. According to Neumann and Boles (1998), “a value of less than one may indicate
potential financial distress.” While these hospitals are above one, they have remained less than
two since 2003, and they are substantially lower than the late converters. In addition, the early
converters have more debt than the late converters as illustrated in the capital structure ratio.
Therefore, the early converters appear to have less capability to pay short-term debt, and are
more at risk for insolvency than the late converters.
The current ratio for the late converters indicates that these CAHs have a greater ability
to meet short-term financial obligations than the early converters. Late converting CAHs have
higher current ratios, and lower long-term debt to capitalization ratio values than the early
converting CAHs. This may help explain their delay in being certified as a critical access
hospital.
Kentucky CAHs showed a positive improvement in days in patient accounts receivable.
The downward trend may suggests that CAHs are becoming more efficient in collecting
receivables or may be more aggressive in collecting receivables in order to compensate for the
lower days cash on hand. A shorter collection period allows hospitals to increase short-term
cash and reduce short-term debt. The shorter collection period gives greater ability to meet
short-term liabilities and pay their liabilities as they come due, which in turn, improves financial
stability. Longer collection periods restrict short-term cash flow and extend short-term debt. It is
possible that the decreased days in patient accounts receivable may be sustaining the slightly
improved current ratio values.
28
The days cash on hand ratios illustrate that CAHs still have serious cash flow problems,
and difficulties meeting short-term liabilities, even with reasonable cost base reimbursement. It
is evident by the low median days cash on hand ratios that Kentucky CAHs (again, in particular,
the early converting CAHs) have a greater difficulty paying their average daily expenditures
compared to other rural hospitals. The late converting CAHs appear to be more secure in the
short-term, which may further explain why this group waited later to become certified as critical
access. Graph 5 illustrates that it may have been more advantageous for the late converters to
have been certified earlier than 2003. Regardless, even after converting to critical access, it is
evident that the CAHs are still performing well below the national standard, and need further
assistance to ensure financial stability.
The long-term debt to capitalization ratio values show that Kentucky CAHs are less
solvent, and are at greater financial risk than the eligible, non-converting rural hospitals. The
Kentucky CAHs probably have greater difficulty generating funds through debt financing. Not
being able to raise funds through debt financing is a disadvantage for CAHs and undermines
the overall stability of these institutions. The long-term debt to capitalization ratio indicates that
CAHs may find it difficult to effectively utilize debt financing in the future. Moreover, the
evidence shows that the early converting CAHs have higher debt than the late converters, and
are more at risk of becoming insolvent.
Hospitals must continue to make capital and technical improvements to continue to
provide quality health care, and to remain competitive in a tight market. Evidence from current
literature indicates that nearly 30 percent of the population bypasses the local hospital. One of
the main factors that affect the consumers’ (patients’) decision to bypass a local hospital is the
overall physical appearance and the application of newer technology. The majority of the
Kentucky CAHs are Hill-Burton facilities that have older, depreciated fixed assets. Many
Kentucky CAH administrators have reported that they would like to renovate their facilities. This
may help explain the rapid increase in the long-term debt to capitalization values since 2003.
29
The total margin values may indicate that reasonable cost base reimbursement has
allowed Kentucky CAHs to gain some control over their expenses. While the total margin ratios
are lower than the peer group median values, a positive total margin may demonstrate that
CAHs are in the process of becoming more financially stable. Moreover, the lower total margin
results may also suggest that CAHs may not be as efficient as other larger facilities, and may
have a greater difficulty in controlling expenses.
It is important to note that since the implementation of the Kentucky Rural Hospital
Flexibility Program in 2000, the total margin ratios for the CAHs have improved with results only
slightly below the industry standards in 2004 and 2005. When the CAHs are divided into early
and late categories, it is evident that those early converters are more dependent upon the
enhanced reimbursement, which is provided through the Kentucky Rural Hospital Flexibility
Program. To illustrate, Table 7 shows that in 1999 the early converts were operating below the
margin at -2.6 percent. In 2000, a few rural hospitals began to convert their licensure to critical
access, and started to participate in the Kentucky Rural Hospital Flexibility Program. Following
conversion to critical access in 2000, these hospitals increased their total margin to 1.4 percent.
The early converters remained relatively steady from 2000 to 2003. However, this group shows
a positive trend upwards from 2004, and has performed favorably when compared to the total
margin industry standards.
The late converters showed a positive total margin in 1999, but also demonstrated a
steady decline to below the margin at -1.6 percent in 2002. A few late converters were certified
in 2003, and began to receive reasonable cost base reimbursement. As shown in Table 7,
these hospitals increased their total margin to 0.7, and have steadily increased to 2.9 in 2005.
While the late converters are showing a positive trend upwards, they are still performing
unfavorably compared to both standards. The negative total margin values may demonstrate
why these hospitals decided to convert to critical access, and may find it increasingly difficulty to
control expenses without the assistance of reasonable cost base reimbursement. Graph 9
30
illustrates the negative decline in total margin ratios for the late converters compared to positive
trend of the early converters.
It is important to note that CAHs are not making a profit under the cost base
reimbursement. CAHs are usually non-profit institutions that have low patient volume and high
fixed costs. This explains, at least to some degree, the comparatively low days cash on hand.
Of the total patient population served in Kentucky CAHs, approximately 64 percent are
Medicare patients. With over half of the patient mix being Medicare patients, it is difficult for
CAHs to show a competitive total profit margin. However, cost base reimbursement has
allowed CAHs to at least breakeven. The goal of the Kentucky Rural Hospital Flexibility
Program was to financially stabilize small rural hospitals. The program objectives seem to be
effective as shown by the low, but positive, total margin ratios. .
The fluctuation in the total margin can be explained by examining the denominator of the
equation. Total margin is net income divided by total revenues. Total revenue equals net
patient revenue plus total other income. Because of other sources of income, total margin may
vary from year to year. Many small rural hospitals depend heavily on philanthropy, gifts, and
other sources of non-patient income. Other income sources distort the total margin ratio and
the interpretation as it pertains to financial performance. Therefore, the operating margin is a
better indicator of profitability than total margin. However, since total margin is primarily utilized
within the industry as the major profitability indicator, operating margin was not evaluated in this
report.
In 2005, there was a large increase in return on equity for the CAHs compared to the
eligible rural Kentucky hospitals (see Graph 10). The 2004 and 2005 ROE results may further
support the possibility that CAHs are achieving control over their expenses. In 2002, the late
converters show an unexplained negative ROE value (-5.6), which began a reverse trend
upwards from conversion in 2003. This negative ROE value along with the negative and
declining total margin values may also explain why the late converters decided to seek critical
31
access certification. Alternatively, the early converters demonstrate a positive peak in 2002,
which may be a result the enhanced reimbursement from the critical access certification.
Since Kentucky critical access hospitals (CAHs) are still trying to improve their shortterm cash flow, and are in the process of addressing long-term solvency and profitability issues,
it is too early to evaluate asset efficiency. However, total and fixed asset turnover ratios are
provided for completion in Table 8, and will be used in the future once CAHs have resolved their
liquidity, long-term solvency and profitability issues. Therefore, it is important to highlight
Kentucky CAHs relatively high total and fixed asset turnover ratios.
“Total asset turnover measures the utilization of a hospital’s assets, and indicates how
many dollars of revenue are generated for each dollar of assets used to complete the hospital’s
mission” (Gapenski, 2001; Neumann and Boles, 1998). “Lower total asset turnover ratios may
indicate that a hospital has invested too much in assets, or may show that the hospital is not
generating revenue effectively through utilization of its assets” (Neumann and Boles, 1998).
Kentucky CAHs (group 2) high total asset turnover ratios show that these hospitals are more
effective in using their assets than the eligible rural hospitals (group 1). The evidence suggests
that CAHs generate the majority of their revenue from existing assets. A favorable turnover
ratio should trend upwards and above the industry standard median, but extraordinarly high
values can be considered unfavorable, especially for older, rural hospitals that are in need of
capital improvements. In general, rural hospitals have higher fixed and total asset turnover
values because of their older physical plants and equipment, and they have less invested funds
than urban hospitals. Furthermore, larger hospitals have newer technology that supports
specialty services, which in general, is not available at smaller rural hospitals (CHIPS, 2002;
Ingenix 2006). The majority of the Kentucky CAHs are older Hill-Burton facilities that acquired
their equipment years ago. If compared to a new hospital with similar physical plant assets, the
older hospital would report a higher turnover ratio because of the much lower book value
(Gapenski, 2001).
32
“The fixed asset turnover ratio measures the utilization of the hospital’s physical plant
and equipment, and indicates the amount of revenue generated due to each dollar of fixed
assets” (Gapenski, 2001). According to Ingenix (2006), “fixed asset turnover and the average
plant age are positively correlated because of the understated historical costs. Moreover, newer
physical plants are effectively utilized than those of older ones”. The evidence suggests that
Kentucky CAHs are utilizing their fixed assets more efficiently than the eligible rural hospitals.
Also it appears that CAHs generate a larger portion of their revenue from their fixed asset than
the eligible rural hospital group. Again, while a higher fixed asset turnover value may be
considered favorable, it may not be a positive indicator for CAHs due to the possible lower book
value of their fixed assets.
33
CONCLUSIONS
Rural hospitals have been struggling to remain financially secure since the early eighties
when Medicare imposed its prospective payment system (PPS) on providers. Rural hospitals
are highly susceptible to financial failure under the PPS because of low patient volume, high
fixed costs, and a high percentage of Medicare, Medicaid and uninsured patients. Rural
hospitals are, in general, more dependent on Medicare, have lower operating margins and
experience greater financial distress than urban hospitals, as evident by twice the number of
rural hospital closures than urban ones in 1989 (Vogel and Coward, 1995). Because of rural
hospital closures, access to health care services has declined through out rural America, and
caused economic hardships for their communities.
To compensate rural hospitals and their communities, the Medicare Rural Hospital
Flexibility Program was authorized under the 1997 Balanced Budget Act. This program grants
rural hospitals the opportunity to convert their licensure to critical access certification, which
allows them to receive reasonable cost base reimbursement for Medicare services. In some
states, including Kentucky, participating critical access hospitals (CAHs) may receive
reasonable cost base reimbursement from Medicaid. The overall goal of the Medicare Rural
Hospital Flexibility Program is to secure access to rural health care for rural Americans while
assisting rural hospitals in becoming more financially stable.
The Kentucky State Office of Rural Health (KSORH) and the Kentucky Rural Hospital
Flexibility Program (KRHFP) staff initiated this evaluation program to track Kentucky CAHs in an
effort to evaluate the overall success of the KRHFP, and critical access certification process.
The KRHFP staff began the evaluation program at the onset of the implementation of the
Program. To the best of our knowledge at the present time, the KSORH is the only state office
of rural health to have implemented an on-going financial ratio trend and comparative analysis
for their annual program evaluation, which is provided to the Federal Office of Rural Health
Policy. The KSORH assumes that if the federal program objectives are not being met or not
34
effective, then the financial condition of the CAHs would not improve overtime. Data provided
through this analysis will be utilized as a decision-making tool for the KSORH and KRHFP staff
to redirect future funds and ensure compliance with federal objectives. KRHFP staff will modify
and improve program activities based on this outside evaluation, and if necessary, will redirect
grant funds to support more effective programming.
The objective of this study was to evaluate if critical access certification has financially
stabilized Kentucky critical access hospitals (CAHs). A comparative and trend financial ratio
analysis was performed to determine whether Kentucky CAHs have improved their financial
position since conversion to critical access. The CAHs were compared to a peer group that
consisted of eligible, non-converting rural Kentucky hospitals. These hospitals chose not to
convert to critical access and retained their current licensure. These two peer groups were then
evaluated against state and national industry standards. The CAHs were subdivided into 2
groups based on their conversion year. The early converters represent those CAHs that
converted to critical access between 2000 and 2002. The late converters consist of hospitals
that were certified as critical access between 2003 and 2005. The purpose of the subgroups,
the early and late converters, is to further illustrate the financial condition of Kentucky’s CAHs.
These two groups were not considered to be additional study groups in this evaluation. They
were used to further define how the CAHs are performing since conversion in 2000. The idea of
the early and late converting CAH groups is to assist the KSORH in targeting the needs of the
Kentucky CAHs, and directing its resources and technical services to those low performing
hospitals.
This analysis has shown that the CAHs total margin ratios have remained positive since
conversion in 2000. The total margin ratios provide the best evidence of the overall success of
the critical access hospitals, and consequently, the KRHFP. The total margin values indicate
that the Kentucky CAHs are more financially stable under critical access certification. Moreover,
the total margin ratio results show that the CAHs have improved their financial condition since
35
conversion to critical access. However, it is also evident that the early converting CAHs are still
financially vulnerable as evident in the current ratio, days cash on hand and long-term debt to
capitalization ratio values. The early converting CAHs are still heavily dependent upon the
technical assistance and financial support that is provided through the KRHFP. The late
converting CAHs seem to be financially sustained by the reasonable cost base reimbursement,
but may still need technical assistance that is provide through the KRHFP.
Kentucky CAHs are not as financially stable as the non-converting peer group hospitals,
and are still performing below the state and national industry standards. Evidence from this
study suggest that it is too early to withdraw technical or financial assistance from the Kentucky
CAHs, especially the weakly positioned, early converting hospitals. To ensure the financial
stability of the CAHs, it is recommended that other program funds be redirected to further
supplement the technical and financial assistance provided by and through the Kentucky Rural
Hospital Flexibility Program and the Kentucky State Office of Rural Health. It is also
recommended that KRHFP continue to track Kentucky CAHs in a trend and comparative
financial ratio analysis to better improve future programming. This analysis should be repeated
to evaluate the conversion process and overall success of the KRHFP. It is recognized that this
study is limited by the fact that only five years of financial data is available from the initial
implementation of the KRHFP. However, it does provide base line information for current
decision-making and future evaluations.
36
APPENDIX
37
Table 5: Liquidity Ratios
Current Ratio
1999
2000
2001
2002
2003
2004
2005
Trend
KY Std
National Std
National Rural Hospital Standard
2.21
2.24
2.26
2.25
2.27
2.32
N/A
Neutral
KY Rural Hospital Standard
2.67
2.69
2.44
2.78
2.26
2.39
2.48
Neutral
Group 1: Eligible KY Rural Hospitals
4.81
4.33
2.87
3.02
3.30
3.50
3.07
Down
Favorable
Favorable
Group 2: KY Critical Access Hospitals
2.26
2.13
2.22
2.64
1.94
1.72
2.17
Up
Unfavorable
Unfavorable
Group 2A: KY CAHs Converted 00 - 02
1.52
2.67
2.23
2.18
1.26
1.53
1.40
Down
Unfavorable
Unfavorable
Group 2B: KY CAHs Converted 03 - 05
2.59
1.72
2.22
2.78
2.59
2.32
2.88
Up
Favorable
Favorable
Days in Patient Accounts Receivable
1999
2000
2001
2002
2003
2004
2005
Trend
KY Std
National Std
National Rural Hospital Standard
67.6
67.8
64.7
61.9
60.2
57.8
N/A
Down
KY Rural Hospital Standard
77.1
80.4
78.4
69.5
65.1
62.6
58.1
Down
Group 1: Eligible KY Rural Hospitals
64.9
80.4
72.5
61.1
62.6
54.4
54.7
Down
Favorable
Favorable
Group 2: KY Critical Access Hospitals
78.9
82.5
82.6
71.1
65.7
63.1
58.7
Down
Unfavorable
Unfavorable
Group 2A: KY CAHs Converted 00 - 02
82.6
85.8
134.9
72.9
66.7
62.3
56.7
Down
Favorable
Unfavorable
Group 2B: KY CAHs Converted 03 - 05
76.6
80.0
67.7
69.5
65.7
63.4
63.9
Down
Unfavorable
Unfavorable
Days Cash On Hand, Short-Term Sources
1999
2000
2001
2002
2003
2004
2005
Trend
KY Std
National Std
National Rural Hospital Standard
27.0
23.8
27.6
27.2
29.0
29.6
N/A
Neutral
KY Rural Hospital Standard
39.1
46.9
28.0
20.9
14.1
24.2
32.7
Up
Group 1: Eligible KY Rural Hospitals
69.8
71.0
42.7
39.9
68.5
45.7
37.8
Down
Favorable
Favorable
Group 2: KY Critical Access Hospitals
37.2
46.9
24.5
12.7
9.5
16.9
14.0
Down
Unfavorable
Unfavorable
Group 2A: KY CAHs Converted 00 - 02
29.8
20.7
17.8
8.0
6.6
1.0
3.5
Up
Unfavorable
Unfavorable
Group 2B: KY CAHs Converted 03 - 05
44.5
53.6
39.9
29.9
9.7
23.0
22.6
Down
Unfavorable
Unfavorable
38
Table 6: Capital Structure Ratios
Long-Term Debt to Capitalization
1999
2000
2001
2002
2003
2004
2005
Trend
21.3
22.6
22.5
24.1
24.6
N/A
Neutral
KY Rural Hospital Standard
31.2
26.8
34.4
33.8
36.5
Up
Group 1: Eligible KY Rural Hospitals
32.1
29.0
23.7
26.9
24.1
Group 2: KY Critical Access Hospitals
31.2
26.8
37.9
37.9
Group 2A: KY CAHs Converted 00 - 02
29.4
23.4
42.3
Group 2B: KY CAHs Converted 03 - 05
33.1
26.8
35.6
National Rural Hospital Standard
KY Std
National Std
Neutral
Favorable
Favorable
39.5
Up
Unfavorable
Unfavorable
45.4
45.2
Up
Unfavorable
Unfavorable
32.1
38.8
Up
Unfavorable
Unfavorable
Table 7: Profitability Ratios
Total Margin
1999
2000
2001
2002
2003
2004
2005
Trend
KY Std
National Std
National Rural Hospital Standard
3.8
2.9
3.4
3.1
2.4
3.4
N/A
Up
KY Rural Hospital Standard
1.1
2.3
2.6
1.5
1.0
3.3
3.6
Up
Group 1: Eligible KY Rural Hospitals
0.9
4.7
4.2
5.6
5.1
4.5
3.7
Down
Favorable
Favorable
Group 2: KY Critical Access Hospitals
1.1
1.6
1.6
0.3
0.7
3.1
3.2
Up
Unfavorable
Unfavorable
Group 2A: KY CAHs Converted 00 - 02
(2.6)
1.4
3.8
1.5
1.3
3.5
4.0
Up
Favorable
Favorable
Group 2B: KY CAHs Converted 03 - 05
2.7
1.7
1.2
(1.6)
(0.7)
1.8
2.9
Up
Unfavorable
Unfavorable
1999
2000
2001
2002
2003
2004
2005
Trend
KY Std
National Std
National Rural Hospital Standard
5.9
5.0
5.7
5.2
4.4
5.9
N/A
Neutral
KY Rural Hospital Standard
4.1
5.3
6.6
5.1
3.4
5.6
8.6
Up
Group 1: Eligible KY Rural Hospitals
2.0
5.3
6.6
11.6
9.7
5.3
5.1
Neutral
Unfavorable
Unfavorable
Group 2: KY Critical Access Hospitals
5.1
5.3
6.0
3.6
0.5
5.6
12.6
Up
Favorable
Unfavorable
Group 2A: KY CAHs Converted 00 - 02
4.7
4.7
6.7
12.0
0.3
6.7
14.7
Up
Favorable
Favorable
Group 2B: KY CAHs Converted 03 - 05
5.4
5.9
5.2
(5.6)
2.9
3.3
10.5
Up
Favorable
Unfavorable
Return on Equity
39
Table 8: Asset Efficiency Ratios
Total Asset Turnover
1999
2000
2001
2002
2003
2004
2005
Trend
KY Std
National Std
National Rural Hospital Standard
0.97
1.00
1.03
1.07
1.07
1.08
N/A
Neutral
KY Rural Hospital Standard
1.29
1.25
1.06
1.25
1.30
1.31
1.35
Up
Group 1: Eligible KY Rural Hospitals
1.03
0.97
0.91
1.10
1.06
1.03
0.97
Neutral
Unfavorable
Favorable
Group 2: KY Critical Access Hospitals
1.39
1.29
1.13
1.40
1.52
1.41
1.44
Neutral
Favorable
Favorable
Group 2A: KY CAHs Converted 00 - 02
1.48
1.50
0.90
1.43
1.41
1.36
1.46
Up
Favorable
Favorable
Group 2B: KY CAHs Converted 03 - 05
1.38
1.26
1.49
1.38
1.54
1.98
1.34
Down
Favorable
Favorable
Fixed Asset Turnover
1999
2000
2001
2002
2003
2004
2005
Trend
KY Std
National Std
National Rural Hospital Standard
2.20
2.32
2.34
2.32
2.26
2.45
N/A
Up
KY Rural Hospital Standard
3.21
3.15
2.73
3.30
3.21
2.74
3.10
Up
Group 1: Eligible KY Rural Hospitals
1.95
2.04
2.30
2.59
2.65
2.64
2.82
Up
Unfavorable
Favorable
Group 2: KY Critical Access Hospitals
3.32
3.32
2.79
3.46
3.27
2.98
3.10
Up
Favorable
Favorable
Group 2A: KY CAHs Converted 00 - 02
3.24
3.21
2.20
3.69
2.81
2.42
2.45
Neutral
Unfavorable
Favorable
Group 2B: KY CAHs Converted 03 - 05
3.35
3.34
3.68
3.37
3.33
3.53
3.57
Up
Favorable
Favorable
40
Table 9: Ratios and Definitions
Ratio
Definition
Total Profit Margin
Net income
Total revenues
Return of Equity
Net income
Net assets
Current Ratio
Current Assets
Current Liabilities
Days in Accounts Receivable
Accounts receivable
(Total revenue / 365)
Days Cash on Hand
Cash and cash equivalents
(Cash operating expense / 365)
Fixed Asset Turnover
Total revenues
Fixed assets
Total Asset Turnover
Total revenues
Total assets
Long-Term Debt to Capitalization
Total long-term debt
(Total long-term debt + Net assets)
41
Graph 1: Current Ratios for Groups 1 and 2
Current Ratio
4.5
National
Rural
Hospital
Std
4.0
3.5
KY Rural
Hospital
Std
3.0
Value
2.5
2.0
Group 1:
Eligible KY
Rural
Hospitals
1.5
1.0
0.5
0.0
2000
2001
2002
2003
2004
2005
Year
Group 2:
KY Critical
Access
Hospitals
Graph 2: Current Ratio for Early and Late Converting CAHs
Current Ratio: Early & Late Converters
National
Rural
Hospital
Std
3.5
3.0
Value
2.5
Group 2A:
KY CAHs
Converted
00 - 02
2.0
1.5
1.0
0.5
0.0
1999
2000
2001
2002
2003
Year
42
2004
2005
Group 2B:
KY CAHs
Converted
03 - 05
Graph 3: Days in Patient Accounts Receivable for Groups 1 and 2
Days in Patient Accounts Receivable
85
National
Rural
Hospital
Std
80
KY Rural
Hospital
Std
Days
75
70
Group 1:
Eligible
KY Rural
Hospitals
65
60
55
50
2000
2001
2002
Year
2003
2004
2005
Group 2:
KY Critical
Access
Hospitals
Graph 4: Days Cash On Hand for Groups 1 and 2
Days Cash On Hand
National
Rural
Hospital
Std
80
70
60
KY Rural
Hospital
Std
Days
50
40
Group 1:
Eligible KY
Rural
Hospitals
30
20
10
0
2000
2001
2002
2003
Year
43
2004
2005
Group 2:
KY Critical
Access
Hospitals
Graph 5: Days cash On Hand for Early and Late Converting CAHs
Days Cash On Hand: Early and Late Converters
55
50
45
National
Rural
Hospital
Std
40
Days
35
30
Group 2A:
KY CAHs
Converted
00 - 02
25
20
15
10
5
0
1999
2000
2001
2002
2003
2004
2005
Group 2B:
KY CAHs
Converted
03 - 05
Year
Graph 6: Long –Term Debt to Capitalization for Groups 1 and 2
Long-Term Debt to Capitalization
National
Rural
Hospital
Std
45.0
40.0
35.0
KY Rural
Hospital
Std
Value
30.0
25.0
20.0
Group 1:
Eligible KY
Rural
Hospitals
15.0
10.0
5.0
0.0
2001
2002
2003
2004
Year
44
2005
Group 2:
KY Critical
Access
Hospitals
Graph 7: Long-Term Debt to Capitalization for Early and Late Converting CAHs
50
Long-Term Debt to Capitalization: Early and Late Converters
45
National
Rural
Hospital
Std
40
KY Rural
Hospital
Std
35
Value
30
25
20
Group 2A:
KY CAHs
Converted
00 - 02
F
15
10
5
0
2001
2002
2003
2004
2005
Year
Group 2B:
KY CAHs
Converted
03 - 05
Graph 8: Total Margin for Groups 1 and 2
Total Margin
6.0
National
Rural
Hospital
Std
5.0
KY Rural
Hospital
Std
Percent
4.0
3.0
Group 1:
Eligible
KY Rural
Hospitals
2.0
1.0
0.0
2000
2001
2002
Year
2003
45
2004
2005
Group 2:
KY Critical
Access
Hospitals
Graph 9: Total Margin for Early and Late Converting CAHs
Total Margin: Early and Late Converters
5.0
National
Rural
Hospital
Std
4.0
Percent
3.0
2.0
Group 2A:
KY CAHs
Converted
00 - 02
1.0
0.0
-1.0
-2.0
-3.0
1999
2000
2001
2002
2003
Year
2004
2005
Group 2B:
KY CAHs
Converted
03 - 05
Graph 10: Return on Equity for Groups 1 and 2
Return on Equity
National
Rural
Hospital
Std
14.0
12.0
KY Rural
Hospital
Std
Percent
10.0
8.0
Group 1:
Eligible
KY Rural
Hospitals
6.0
4.0
2.0
0.0
2000
2001
2002
Year
2003
46
2004
2005
Group 2:
KY Critical
Access
Hospitals
Graph 11: Return on Equity for Early and Late Converters
Return on Equity: Early and Late Converters
16.0
National
Rural
Hospital
Std
13.0
10.0
Percent
7.0
Group 2A:
KY CAHs
Converted
00 - 02
4.0
1.0
-2.0
-5.0
-8.0
1999
2000
2001
2002
2003
2004
2005
Group 2B:
KY CAHs
Converted
03 - 05
Year
Graph 12: Total Asset Turnover for Groups 1 and 2
Total Asset Turnover
1.6
National
Rural
Hospital
Std
1.4
1.2
KY Rural
Hospital
Std
Value
1.0
0.8
Group 1:
Eligible KY
Rural
Hospitals
0.6
0.4
0.2
0.0
2000
2001
2002 Year
2003
47
2004
2005
Group 2:
KY Critical
Access
Hospitals
Graph 13: Total Asset Turnover for Early and Late Converters
Total Asset Turnover: Early and Late Converters
National
Rural
Hospital
Std
2.0
1.8
1.6
1.4
Value
1.2
Group 2A:
KY CAHs
Converted
00 - 02
1.0
0.8
0.6
0.4
0.2
0.0
1999
2000
2001
2002
2003
2004
2005
Year
Group 2B:
KY CAHs
Converted
03 - 05
Graph 14: Fixed Asset Turnover for Groups 1 and 2
Fixed Asset Turnover
National
Rural
Hospital
Std
4.0
3.5
KY Rural
Hospital
Std
3.0
Value
2.5
2.0
Group 1:
Eligible KY
Rural
Hospitals
1.5
1.0
0.5
0.0
2000
2001
2002
Year
2003
48
2004
2005
Group 2:
KY Critical
Access
Hospitals
Graph 15: Fixed Asset Turnover for Early and Late Converters
Fixed Asset Turnover: Early and Late Converters
4.0
3.5
National
Rural
Hospital
Std
3.0
:
2.5
Group 2A:
KY CAHs
Converted
00 - 02
2.0
1.5
1.0
0.5
0.0
1999
2000
2001
2002
2003
Year
49
2004
2005
Group 2B:
KY CAHs
Converted
03 - 05
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51