Financial Status of Critical Access Hospitals In Kentucky

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Financial Status of Critical Access Hospitals In Kentucky

  1. 1. 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
  2. 2. Table of Contents Executive Summary 3 Preface 7 Introduction 8 Literature Review 9 The Need for Financially Stable Rural Hospitals 9 Rural Hospital Flexibility Program Authorization 10 Ratio Analysis 11 Financial Condition of Rural Hospitals 13 Methodology 16 Results 21 Liquidity Ratios 21 Capital Structure Ratios 23 Profitability Ratios 24 Asset Efficiency Ratios 25 Discussion 27 Conclusions 34 Appendix 37 Table 5: Liquidity Ratios 38 Table 6: Capital Structure Ratios 39 Table 7: Profitability Ratios 39 Table 8: Asset Efficiency Ratios 40 Table 9: Ratios and Definitions 41 Graph 1: Current Ratios for Groups 1 and 2 42 Graph 2: Current Ratio for Early and Late Converting CAHs 42 Graph 3: Days in Patient Accounts Receivable for Groups 1 and 2 43 Graph 4: Days Cash On Hand for Groups 1 and 2 43 Graph 5: Days Cash On Hand for Early and Late Converting CAHs 44 Graph 6: Long - Term Debt to Capitalization for Groups 1 and 2 44 Graph 7: Long - Term Debt to Capitalization for Early and Late Converting CAHs 45 Graph 8: Total Margin for Groups 1 and 2 45 Graph 9: Total Margin for Early and Late Converting CAHs 46 Graph 10: Return on Equity for Groups 1 and 2 46 Graph 11: Return on Equity for Early and Late Converters 47 Graph 12: Total Asset Turnover for Groups 1 and 2 47 Graph 13: Total Asset Turnover for Early and Late Converters 48 Graph 14: Fixed Asset Turnover for Groups 1 and 2 48 Graph 15: Fixed Asset Turnover for Early and Late Converters 49 References 50 2
  3. 3. 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
  4. 4. 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
  5. 5. 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
  6. 6. 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
  7. 7. 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
  8. 8. 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
  9. 9. 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
  10. 10. 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
  11. 11. 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
  12. 12. 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
  13. 13. “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 National Median Average Daily Census (acute) 3.0 Average Length of Stay (acute) 3.3 Operating Margin -9.9 Total Margin -0.3 Medicare Utilization – Days 63.3 13
  14. 14. 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 CAHs Non-converting Rural Hospitals Operating Margin -10.6 -4.7 Total Margin -1.1 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
  15. 15. 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
  16. 16. 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
  17. 17. 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 Trend Median Long-Term Debt to Capitalization 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
  18. 18. 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). 1 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. 18
  19. 19. Table 4: Industry Standards and Peer Groups Number in Standard / Peer Group 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 application process. Therefore, the conversion process itself may affect the financial ratio 19
  20. 20. 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
  21. 21. 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
  22. 22. 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
  23. 23. 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
  24. 24. 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
  25. 25. 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
  26. 26. 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
  27. 27. 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
  28. 28. “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
  29. 29. 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
  30. 30. 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
  31. 31. 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
  32. 32. 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 short- term 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
  33. 33. “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
  34. 34. 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
  35. 35. 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
  36. 36. 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
  37. 37. APPENDIX 37
  38. 38. 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
  39. 39. Table 6: Capital Structure Ratios Long-Term Debt to Capitalization 1999 2000 2001 2002 2003 2004 2005 Trend KY Std National Std National Rural Hospital Standard 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 Neutral Favorable Favorable Group 2: KY Critical Access Hospitals 31.2 26.8 37.9 37.9 39.5 Up Unfavorable Unfavorable Group 2A: KY CAHs Converted 00 - 02 29.4 23.4 42.3 45.4 45.2 Up Unfavorable Unfavorable Group 2B: KY CAHs Converted 03 - 05 33.1 26.8 35.6 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 Return on Equity 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
  40. 40. 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
  41. 41. 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)
  42. 42. Graph 1: Current Ratios for Groups 1 and 2 4.5 Current Ratio National Rural 4.0 Hospital Std 3.5 KY Rural 3.0 Hospital Value Std 2.5 2.0 Group 1: 1.5 Eligible KY Rural 1.0 Hospitals 0.5 Group 2: 0.0 KY Critical 2000 2001 2002 2003 2004 2005 Access Hospitals Year Graph 2: Current Ratio for Early and Late Converting CAHs Current Ratio: Early & Late Converters National 3.5 Rural 3.0 Hospital Std 2.5 2.0 Group 2A: Value KY CAHs 1.5 Converted 00 - 02 1.0 0.5 Group 2B: KY CAHs 0.0 Converted 1999 2000 2001 2002 2003 2004 2005 03 - 05 Year
  43. 43. Graph 3: Days in Patient Accounts Receivable for Groups 1 and 2 Days in Patient Accounts Receivable National 85 Rural Hospital 80 Std KY Rural 75 Hospital Std 70 Days 65 Group 1: Eligible KY Rural 60 Hospitals 55 Group 2: KY Critical Access 50 Hospitals 2000 2001 2002 Year 2003 2004 2005 Graph 4: Days Cash On Hand for Groups 1 and 2 Days Cash On Hand National 80 Rural Hospital 70 Std 60 KY Rural Hospital 50 Std Days 40 30 Group 1: Eligible KY 20 Rural Hospitals 10 Group 2: 0 KY Critical 2000 2001 2002 2003 2004 2005 Access Year Hospitals
  44. 44. Graph 5: Days cash On Hand for Early and Late Converting CAHs Days Cash On Hand: Early and Late Converters 55 National 50 Rural Hospital 45 Std 40 35 30 Days Group 2A: 25 KY CAHs 20 Converted 00 - 02 15 10 5 Group 2B: 0 KY CAHs 1999 2000 2001 2002 2003 2004 2005 Converted 03 - 05 Year Graph 6: Long –Term Debt to Capitalization for Groups 1 and 2 Long-Term Debt to Capitalization National 45.0 Rural Hospital 40.0 Std 35.0 KY Rural 30.0 Hospital Std 25.0 Value 20.0 Group 1: 15.0 Eligible KY Rural 10.0 Hospitals 5.0 Group 2: 0.0 KY Critical Access 2001 2002 2003 2004 2005 Year Hospitals
  45. 45. Graph 7: Long-Term Debt to Capitalization for Early and Late Converting CAHs Long-Term Debt to Capitalization: Early and Late Converters National 50 Rural 45 Hospital Std 40 KY Rural 35 Hospital 30 Std 25 Value 20 F Group 2A: KY CAHs 15 Converted 10 00 - 02 5 Group 2B: 0 KY CAHs 2001 2002 2003 2004 2005 Converted Year 03 - 05 Graph 8: Total Margin for Groups 1 and 2 Total Margin National 6.0 Rural Hospital Std 5.0 KY Rural 4.0 Hospital Std Percent 3.0 Group 1: Eligible 2.0 KY Rural Hospitals 1.0 Group 2: KY Critical 0.0 Access 2000 2001 2002 2003 2004 2005 Hospitals Year
  46. 46. Graph 9: Total Margin for Early and Late Converting CAHs Total Margin: Early and Late Converters 5.0 National Rural 4.0 Hospital Std 3.0 2.0 Percent Group 2A: 1.0 KY CAHs Converted 0.0 00 - 02 -1.0 Group 2B: -2.0 KY CAHs Converted -3.0 03 - 05 1999 2000 2001 2002 2003 2004 2005 Year Graph 10: Return on Equity for Groups 1 and 2 Return on Equity National 14.0 Rural Hospital 12.0 Std KY Rural 10.0 Hospital Std Percent 8.0 6.0 Group 1: Eligible 4.0 KY Rural Hospitals 2.0 Group 2: KY Critical 0.0 Access 2000 2001 2002 2003 2004 2005 Hospitals Year
  47. 47. Graph 11: Return on Equity for Early and Late Converters Return on Equity: Early and Late Converters 16.0 National Rural 13.0 Hospital Std 10.0 7.0 Percent Group 2A: 4.0 KY CAHs Converted 1.0 00 - 02 -2.0 -5.0 Group 2B: KY CAHs -8.0 Converted 1999 2000 2001 2002 2003 2004 2005 03 - 05 Year Graph 12: Total Asset Turnover for Groups 1 and 2 1.6 Total Asset Turnover National Rural Hospital 1.4 Std 1.2 KY Rural Hospital 1.0 Std Value 0.8 Group 1: 0.6 Eligible KY Rural 0.4 Hospitals 0.2 Group 2: KY Critical 0.0 Access 2000 2001 2002 Year 2003 2004 2005 Hospitals

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