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Assessing the Financial Health of Hospitals (continued)
Implementing Common Measures of Financial Status
Available Data Sources
There are five main data sources that have been used for analysis of hospital financial status and examining the financial status of safety net providers:
- Audited financial reports.
- State hospital financial and statistical reports.
- Medicare cost reports.
- The American Hospital Association (AHA) Annual Survey.
- Internal Revenue Service (IRS) data.
These sources vary in availability, level of detail reported, and accuracy.
Audited Financial Reports
The audited financial report is considered to be the gold standard of financial reporting. A complete report consists of a revenue and expense (income) statement, balance sheet, statement of changes in net assets, cash flow statement, and notes describing key accounting principles and sometimes providing additional detail. The advantages of these data are that they are timely and prepared and certified by outside auditors (with an understanding that they will often be reviewed by a hospital's creditors and others) in accordance with standard accounting rules.
These reports are not without drawbacks. They can vary in the level of detail reported and need not report information on the composition of expenses, operating statistics, or payer mix. A single report may be prepared for a multihospital system or for a parent corporation that includes hospitals and other entities, making it impossible to examine the financial status of a single component of the system. Public hospitals may not prepare separate audited financial reports, but instead may have their finances intermingled with and reported in the general accounts of the government that owns them.
In addition, while audited financial reports of public corporations are available from the Securities and Exchange Commission, no comparable reporting requirements exist for individual hospitals.
State Hospital Financial and Statistical Reports
As of 2001, 20 States collected either audited financial statements or required hospitals to submit detailed State financial reports that were made publicly available. These States were: Arizona, Arkansas, California, Florida, Indiana, Maine, Maryland, Massachusetts, Michigan, Missouri, Montana, New Hampshire, New Jersey, New York, Oregon, Pennsylvania, Rhode Island, Vermont, Washington, and West Virginia (Kane and Magnus, 2001).
The level of detail in these State reports varies. Some, such as those from California, Massachusetts, and New York, provide extensive detail on revenue and expenses by cost center and payer, detailed revenue and expense (income) statements, balance sheets, cash flow statements, data on restricted accounts and funds, and extensive data on operations, including units of service, staffing, and services provided. Others provide highly aggregated summary data.
Where available, these reports can provide detailed and comparable data across hospitals in the State, although hospitals can exercise some discretion in reporting. Infrequently used data elements, or data that the State government does not itself use, may not be accurately reported. At a minimum, the internal validity and reasonableness of the data reported for each hospital should be assessed prior to conducting detailed analysis.
Medicare Cost Reports
A third widely used source of information on hospital finances and operations is the Medicare cost report, Form CMS-2552. These reports are available for every hospital participating in the Medicare program. They were originally designed to collect data on hospital expenses when Medicare paid hospitals on the basis of costs that were allocated to Medicare. The forms collect substantial detail on costs by cost center, gross charges by cost center for Medicare and other payers, and some operating statistics. The forms also include a revenue and expense statement, balance sheet, and statement of changes in fund balances.
Because the Medicare cost report was designed to collect expense data and data for allocation expenses between Medicare and other payers, the information in the section G worksheets on the balance sheets and revenue and expense statements has not been used by Medicare and not been audited. It has been reported that the data contain many errors (Kane and Magnus, 2001). Key data for safety net providers, such as the provision of uncompensated care, are not reported. Nonetheless, for detailed cost analysis, the Medicare cost report is a useful and detailed source of data.
AHA Annual Survey Data
Every year, the AHA conducts an annual survey of hospitals. A large majority, but not all hospitals, respond to this survey. It includes questions on gross and net revenues for Medicare, Medicaid and other payers, uncompensated care, tax appropriations, nonoperating revenue, total expenses, and some data on fixed assets, but no other balance sheet or cash flow data. The financial elements of the survey are confidential and not generally available for public analysis. Some States, however, require hospitals to submit their AHA Annual Survey to the State and make the financial data elements publicly available; the data can also be made available with the written consent of the hospital.
The data elements are limited and unaudited, but the data set is generally consistent across hospitals and over time. The Medicare Payment Advisory Commission (MedPAC) contracts with AHA for analysis of hospital margins over time from the annual survey data.
IRS Form 990—Return of Organizations Exempt from Income Taxes
Nonprofit hospitals and corporations, but not for-profit or government entities, must file this financial report with the IRS. This includes a revenue and expense statement, balance sheet and statement of changes in net assets as well as some supporting documents. There are many reported problems in using these data for analysis. The error rates appear to be high, they are often filed late, and the form is generic, making it difficult to conduct some types of analysis, including analysis of uncompensated care and payer specific analysis (Kane and Magnus, 2001; Smith, Wheeler, and Clement, 1995). On the other hand, the data provide an overview of revenues and expenses and some financial data. Data for individual hospitals are available directly from the hospital, from the IRS, and through some Web-based services.
Audited financial data and State hospital financial reports offer the most complete data sets for analyzing the status of safety net hospitals. Where available, they are the preferred source of data for analysis. AHA, Medicare, and IRS 990 data all have significant limitations, but allow some analysis of aggregate financial status.
Constructing Common Measures
Analyzing the financial status of safety net hospitals requires comparing the financial measures:
- For the same hospital over time.
- With those from other hospitals.
- To specific standards or goals for the provider.
For example, one goal might be to ensure that the safety net provider breaks even, i.e., has a non-negative margin. Despite the limitations of the available data noted above, substantial analysis can be conducted using these data sets. This section illustrates how the data sources described above can be used to construct common measures of financial status.
Overall margin is the aggregate profit, taking into account all sources of revenue and all expenses. It can be constructed from State reports, the Medicare cost report, and the AHA data.
Calculation of operating margins is also straightforward using these data sources. A key issue in constructing the operating margin is to decide how tax appropriations should be treated. For example, in California State hospital financial reports, county indigent care funds, restricted donations, and subsidies for indigent care are treated as operating revenues, while tax appropriations are considered nonoperating revenues. The Medicare cost report does not distinguish between nonpatient operating revenue and nonoperating revenues, but includes separate lines for contributions, donations, and bequests and government appropriations. The analyst would make a final distinction what would be included in operating revenues. In the AHA data, tax appropriations are identified separately from patient care revenues and could be included in operating revenues or excluded based on the definition selected.
Patient Care Margins
There are two challenges to constructing patient care margins using these data. First, as with operating margins, those doing the analysis must decide whether to include tax appropriations, donations, and other funds not directly tied to payment for a specific patient in the revenues. This is a matter of choice. It is useful to construct alternative versions of this measure to determine how sensitive the financial status of the safety net provider is to receiving these funds. Thus, one might construct a narrow definition of patient care revenues that includes only net payments from insurers and other third parties and the hospitalized patients, and construct a broader definition that adds other funds available for indigent patient care. The difference in margins calculated with each of these measures would indicate the sensitivity of the financial status to access to these other funds.
The second challenge is constructing a measure of patient expenses. The Medicare cost report includes such a measure and is a primary reason why the report was created. A comparable measure can be constructed in the State reports that includes a detailed step down allocation of all expenses to patient care revenue centers.
For data sets such as the AHA annual survey, patient care expenses must be estimated more coarsely. One standard approach is to assume that hospitals earn little or no profit on their nonpatient care operations. If this is the case, then nonpatient care operating expenses will equal nonpatient care operating revenues. Patient care expenses are then estimated by subtracting nonpatient care operating revenues from total operating expenses. Patient care margin is then calculated as follows:
Patient revenues - Patient care expenses
To construct payer-specific margins, one needs to allocate patient care expenses across payers and determine the net revenue from each payer. Net revenue is computed by subtracting contractual allowances and other deductions from revenue identified by payer from gross revenues by payer. Patient care expenses for a given payer are estimated by multiplying the patient care expenses by the share of total gross charges (gross revenues) billed to that payer.
In the AHA data set, one could construct payer-specific margins for Medicare, Medicaid, and all other payers. The AHA data allows for the construction of a separate estimate for self-pay patients and those covered by nongovernment third parties. Because bad debt and charity care are usually not split by self-pay and other nongovernment payers in State reports, the Medicare cost report, or the Form 990, this calculation is not possible from these other data sets, and the estimate from the AHA data is likely to be imprecise.
Free Cash Flow, Liquidity, and Solvency Measures
To construct other financial measures requires both a revenue and expense statement and a balance sheet. With both available, as they are with the audited financial reports, some State financial reports, and the IRS Form 990, the construction of these measures is straightforward, as long as one constructs them at the organizational level at which the data are reported. That is, if reporting is at the hospital level, constructing the measures for the hospital; if at the multihospital system level, constructing them for the system.
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This chapter has discussed how the financial health of safety net hospitals can be assessed. It discussed the conceptual issues, data sources, and illustrated the construction of selected measures. The major challenges in conducting such analyses are twofold. First, there is the challenge of obtaining reliable and comprehensive data. The best data available are from audited financial reports and State hospital financial and statistical reports, but these are not available for all providers or all States. The Medicare cost report, AHA data, and IRS Form 990 data offer fallbacks, although they each have limitations with respect to levels of detail, payer-specific information, and reported accuracy problems.
The second major challenge is conceptual. Safety net providers are supported through a wide range of financial streams: direct patient care funds like the county indigent program in California or free care pools in New York and Massachusetts, special payment arrangements such as disproportionate share payments under Medicare and Medicaid, government appropriations not tied specifically to indigent care, annual philanthropy, and endowments for indigent care. Each of the reporting systems examined treat these streams differently. They are not always explicitly accounted for, and depending on the system, may be reported in either operating or nonoperating revenues. For those analyzing the financial health of the safety net at the State or local level, therefore, it is critical that all these flows be identified and an understanding be developed of how they appear in the data so their affect on the financial health of the providers can be fully examined.
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Kane NM, Magnus SA. The Medicare cost report and the limits of hospital accountability: improving financial accounting data. J Health Polit Policy Law 2001 Feb;26(1):81-105.
Lane SG, Longstreth E, Nixon V. A community leader's guide to hospital finance: evaluating how a hospital gets and spends its money. Boston: The Access Project; 2001. Available at: http://www.accessproject.org/downloads/Hospital_Finance.pdf. Accessed November 18, 2003.
Petrie A. Ingenix almanac of hospital financial & operating indicators. Salt Lake City: Ingenix, Inc; 2003.
Smith DG, Wheeler JR, Clement JP. Fundraising, government grants, and donations to nonprofit hospital charities. Health Serv Manage Res 1995 Aug;83(3):198-208.
Current as of December 2003
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