HLTH 5653 Module 1 Financial Statement Analysis Example

A $5.7 Million Surplus That Is Really a $2.2 Million Operating Loss: Reading a Community Hospital's Balance Sheet and Income Statement Line by Line

Student Name

American College of Education

HLTH5653: Financial Analysis and Assessment in Healthcare Administration

Module 1 Assignment

Instructor Name

July 3, 2028

The Organization and Its Statements

The organization is a composite 124-bed nonprofit community hospital with an emergency department, surgical services, a small obstetrics unit and outpatient imaging and laboratory services, the sole hospital in its county. Its audited statements for the most recent fiscal year report an excess of revenue over expenses of $5.7 million, and the hospital's annual report to the community describes the year as financially sound. The purpose of this paper is to read the statements closely enough to test that description, before any ratios are calculated.

All figures are in millions of dollars. The income statement reports net patient service revenue of $212.4 and other operating revenue of $8.6, for total operating revenue of $221.0. Operating expenses total $223.2: salaries and benefits $121.5, supplies $38.7, purchased services and professional fees $29.4, depreciation and amortization $13.2, interest $4.1 and other expenses $16.3. Nonoperating income, mostly investment returns, is $7.9. The balance sheet reports total assets of $310.4, total liabilities of $152.4 and net assets of $158.0.

Where the Bottom Line Comes From

The first question is whether the hospital earned its surplus from caring for patients. It did not. Operating revenue of $221.0 minus operating expenses of $223.2 produces an operating loss of $2.2, an operating margin of negative 1.0 percent. The reported surplus of $5.7 exists only because investment income of $7.9 was added below the operating line. In the prior year, the hospital earned an operating income of $3.1 on operating revenue of $212.9, so the operating result swung by $5.3 in one year.

Relying on investment income is common, but it is not a stable basis for a hospital's finances. Bai and Anderson (2016), examining acute care hospitals' profit from patient care in fiscal year 2013, found that the median hospital lost $82 per adjusted discharge on patient care services and that only 45 percent were profitable on that basis. Investment returns vary with markets, and a year of poor returns would leave this hospital with a loss on its total results as well. A board that reads only the bottom line of this income statement would approve a budget that assumes the markets will cover the hospital's operations again.

Which Lines Grew Fastest

Operating revenue grew 3.8 percent, from $212.9 to $221.0, while operating expenses grew 6.4 percent, from $209.8 to $223.2. The gap is the source of the operating loss, and it comes mainly from labor. Salaries and benefits rose from $112.6 to $121.5, 7.9 percent, and they now make up 54 percent of operating expenses. Inside purchased services, the notes show contract labor, mainly travel nurses and respiratory therapists, rising from $2.1 to $7.4. Taken together, labor costs added more than $14 to expenses in a year when total operating revenue rose by $8.1.

Supplies grew more slowly, 3.2 percent, and depreciation and interest were nearly flat. The pattern points to a specific problem, the cost of staffing, rather than a general loss of control over spending. That distinction matters for the board's response: a hospital that cuts supply budgets to close a gap created by labor will not close it.

Revenue also deserves a question of its own. Inpatient days rose about 5 percent during the year, according to the statistics in the annual report, yet net patient revenue rose less than 4 percent. The notes show the share of gross charges from Medicare and Medicaid increasing while commercial insurance fell. Selden et al. (2015) documented a growing difference between the rates private insurers and public programs pay for inpatient hospital care, which means that a shift of even a few points in payer mix toward public coverage can slow revenue growth below volume growth. The payer mix will be examined in Module 3, but the income statement already suggests that the hospital is doing more work for less revenue per unit.

What the Balance Sheet Shows

The balance sheet tells a more reassuring story in some respects. Current assets total $59.0: cash of $18.2, net patient accounts receivable of $31.8 and other current assets of $9.0. Current liabilities total $41.0, including accounts payable and accrued expenses of $24.5, accrued salaries of $11.3 and $5.2 of long-term debt falling due within the year. The hospital also holds $96.4 in board-designated investments, which are not classified as current but are available to the board if needed. Long-term debt is $96.8, and other long-term liabilities, mostly a pension obligation, are $14.6. Net assets of $158.0 are slightly more than total liabilities.

Two lines deserve attention. Patient accounts receivable of $31.8 against net patient revenue of $212.4 means the hospital holds about 55 days of revenue in receivables, money earned but not yet collected. And property, plant and equipment is reported at a net value of $148.6, with accumulated depreciation of $171.6 disclosed in the notes. Dividing accumulated depreciation by annual depreciation expense gives an average age of plant of about 13 years, and the statement of cash flows shows capital spending of only $9.1 against depreciation of $13.2. The hospital is using up its buildings and equipment faster than it is replacing them.

What the Notes Reveal

The face of the statements hides several facts that the notes make clear. The revenue note shows that net patient service revenue is reported after contractual adjustments and an estimate for bad debt, and that the hospital provided charity care with an estimated cost of $4.8 during the year, which does not appear as revenue at all. The pension note shows that the plan's funded status fell by $3.9, driven by a lower discount rate, which could require larger contributions from operating cash in future years. The debt note shows that the hospital's bond agreement requires a debt service coverage ratio of at least 1.25 and at least 75 days of cash on hand, tested annually. Breaching either would allow bondholders to require remedies. Those covenants turn the ratios in the next module from indicators into obligations.

Why This Reading Matters

A hospital's financial position affects more than its bond rating. Ly et al. (2011), analyzing 3,262 nonpublic U.S. hospitals, found that hospitals in the bottom tenth of operating margins had worse process-of-care quality and higher readmission rates than those in the top tenth and were more likely to close, merge or convert to a critical access hospital; more than 15 percent of the lowest-margin hospitals changed operating status in the following year. The finding does not show that low margins cause poorer quality, but it shows that sustained operating losses are associated with outcomes that matter to patients and communities.

For a sole community hospital, closure or a reduction in services would leave residents traveling farther for emergency and obstetric care. The purpose of reading the statements closely is to recognize a deteriorating operating trend early, while the hospital still has $114.6 in cash and investments to fund a response, rather than after the reserves have been used to cover repeated losses.

Conclusion and Questions for the Ratio Analysis

Read line by line, the statements describe a hospital that lost money on operations for the first time in several years because labor costs, especially contract labor, grew twice as fast as revenue; that reported a surplus only because of investment income; that is using its plant faster than it replaces it; and that still holds substantial reserves. The annual report's description of a financially sound year is accurate for the balance sheet but not for operations. The next module should answer four questions with ratios: how many days of expenses the reserves cover, how close the hospital is to its bond covenants, how its debt load compares with its capacity to borrow for plant replacement and whether its collection of receivables is slowing.

References

Bai, G., & Anderson, G. F. (2016). A more detailed understanding of factors associated with hospital profitability. Health Affairs, 35(5), 889-897. https://doi.org/10.1377/hlthaff.2015.1193

Ly, D. P., Jha, A. K., & Epstein, A. M. (2011). The association between hospital margins, quality of care, and closure or other change in operating status. Journal of General Internal Medicine, 26(11), 1291-1296. https://doi.org/10.1007/s11606-011-1815-5

Selden, T. M., Karaca, Z., Keenan, P., White, C., & Kronick, R. (2015). The growing difference between public and private payment rates for inpatient hospital care. Health Affairs, 34(12), 2147-2150. https://doi.org/10.1377/hlthaff.2015.0706