Financial Status of Critical Access Hospitals In Kentucky

Has Critical Access Certification Financially

Stabilized Rural Kentucky Hospitals?

Kentucky Rural Hospital Flexibility Program Evaluation FY 06 - 07

Bethany F. Adams, MHA, CHE

Eric A. Scorsone, Ph.D.

December 2006

Table of Contents

Executive Summary 3

Preface 7

Introduction 8

Literature Review 9

The Need for Financially Stable Rural Hospitals 9Rural Hospital Flexibility Program Authorization 10Ratio Analysis 11Financial Condition of Rural Hospitals 13

Methodology 16

Results 21

Liquidity Ratios 21Capital Structure Ratios 23Profitability Ratios 24Asset Efficiency Ratios 25

Discussion 27

Conclusions 34

Appendix 37

Table 5: Liquidity Ratios 38Table 6: Capital Structure Ratios 39Table 7: Profitability Ratios 39Table 8: Asset Efficiency Ratios 40Table 9: Ratios and Definitions 41Graph 1: Current Ratios for Groups 1 and 2 42Graph 2: Current Ratio for Early and Late Converting CAHs 42Graph 3: Days in Patient Accounts Receivable for Groups 1 and 2 43Graph 4: Days Cash On Hand for Groups 1 and 2 43Graph 5: Days Cash On Hand for Early and Late Converting CAHs 44Graph 6: Long - Term Debt to Capitalization for Groups 1 and 2 44Graph 7: Long - Term Debt to Capitalization for Early and Late Converting CAHs 45Graph 8: Total Margin for Groups 1 and 2 45Graph 9: Total Margin for Early and Late Converting CAHs 46Graph 10: Return on Equity for Groups 1 and 2 46Graph 11: Return on Equity for Early and Late Converters 47Graph 12: Total Asset Turnover for Groups 1 and 2 47Graph 13: Total Asset Turnover for Early and Late Converters 48Graph 14: Fixed Asset Turnover for Groups 1 and 2 48Graph 15: Fixed Asset Turnover for Early and Late Converters 49

References 50

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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

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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

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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

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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.

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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 ProfessorCommunity and Leadership Development513 W. P. Garrigus BuildingLexington, KY 40546-021Email: [email protected]

Larry Allen, MA,DirectorState Office of Rural HealthUK Center for Rural HealthB426 750 Morton BoulevardHazard, KY 41701E-mail: [email protected]

Alison Davis-Reum, Ph.D.Assistant Extension Professor Agricultural Economics400 Charles E. Barnhart BuildingLexington, KY 40546-0276Email: [email protected]

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mailto:[email protected]



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.

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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,

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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).

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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).

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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).

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“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

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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

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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).

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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.

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Table 3: Financial Ratios

PROFITABILITY RATIOSDesired Position

Trend Median

Total Margin Up Above

Return on Equity Up Above

LIQUIDITY RATIOSDesired Position

Trend Median

Current Ratio Up Above

Days Accounts Receivable Down Below

Days Cash On Hand Up Above

CAPITAL STRUCTURE RATIOSDesired Position

Trend Median

Long-Term Debt to Capitalization Down Below

ASSET EFFICIENCY RATIOSDesired Position

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

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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.ingenixonline2 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.

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Table 4: Industry Standards and Peer Groups

Standard / Peer GroupNumber in Peer Group

National Rural Hospital Standard N/A

Kentucky Rural Hospital Standard 36

Group 1: KY eligible rural hospitals that have not converted 8

Group 2: KY Critical Access Hospitals 28

Early Converters: Group 2A - KY CAHs certified between 2000 and 2002 13

Late Converters: Group 2B - KY CAHs certified between 2003 and 2005 15

Ingenix, Inc. (Ingenix is a national benchmarking company and an industry leader)

collects Medicare cost report data at fixed points throughout the calendar year, and

acknowledges that errors do occur in their reporting system. For example, the company

purchases different parts of the Medicare cost reports at fixed times throughout the calendar

year. Second, hospitals turn in cost reports based on their fiscal year verses a calendar year.

Lastly, there can be a lag time in the release of the Medicare cost reports from the Centers for

Medicare and Medicaid Services (CMS) from 6 months to a year.

One possible limitation of this analysis is selection bias. Selection bias is a possibility

since hospitals self-determine to convert to critical access certification. Consequently, the

financial ratio trend and comparative analysis is based on those hospitals that converted versus

those that have chosen to retain their acute care licensures. Moreover, individual hospital

conversion dates may have also impacted the financial ratio analysis. Because hospitals

converted to critical access hospitals at different times, their reasonable cost based

reimbursement payments would have been initiated and received at different points in time. It is

hypothesized that a newly converted CAH would conceivably receive reimbursement from CMS

under the prospective payment and the reasonable cost base system within the same year. Of

course, this would be dependent upon the month of conversion and the hospital’s critical access

application process. Therefore, the conversion process itself may affect the financial ratio

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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.

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RESULTS

Tables 5 through 8 show the financial trends for two Kentucky hospital peer groups and

the comparative analysis with a state and national standard (see appendix for Tables 5 – 8).

Study group 1 represents those rural hospitals that are eligible to convert, but chose not to be

certified as critical access, and decided to retain their current licensure. Peer group 2 is

comprised of all Kentucky critical access hospitals (CAHs). This analysis also divides CAHs by

conversion year, and categorizes them either as early or late converters. Early converters

(group 2A) are those rural hospitals that were certified as critical access between 2000 and

2002. Late converters (group 2B) were certified between 2003 and 2005. The purpose of the

early and late groups is to further illustrate the financial position of CAHs, and is not considered

two separate study groups.

Liquidity Ratios

Table 5 shows three liquidity ratios: current ratio, days in patient accounts receivable,

and days cash on hand. It is evident in Table 5 and Graph 1 that the national rural hospital

current ratio standard has remained steadily neutral from 1999 through 2005. The trend for the

Kentucky standard has also remained neutral, but has ran slightly higher than the national

median values. Group 1 (eligible Kentucky rural hospitals that have not converted to critical

access) showed a decrease in 2001, but then trended positively upward through 2004. In 2005,

group 1 demonstrated a slight decline in their current ratio. However, group 1 performed above

the national and state industry standards, and the Kentucky critical access hospitals (CAHs).

Therefore, group 1 compared favorably to both standards. As for the Kentucky CAHs (group 2),

it is evident that they performed well below group 1, and the national and state industry

standards. Group 2 showed a slight increase from 2000 to 2002, but then steadily declined

through 2004. In 2005, Kentucky CAHs did trend positively upward, but still finished below the

peer groups. Overall, the Kentucky CAHs compare unfavorably to the state and national

21

standards (see Graph 1 in appendix). The early converters (CAHs that were certified between

2000 and 2002) showed a dramatic increase following the initial implementation of the Medicare

Rural Hospital Flexibility Program in 2000. This early converting group then proceeded to

steadily decline from 2000 through 2003, but then trended slightly upward through 2004. In

2005, the early converters showed a decreased current ratio, which illustrates an overall

negative downward trend for the early converting CAHs. The early converters performed well

below the national median and the late converters, and compare unfavorably to the peer

groups. The late converters (CAHs certified between 2003 and 2005) exhibited a decline from

1999 to 2000, but then trended positively upward through 2002. While the late converters

demonstrated another decline in 2003 and 2004, they performed positively in 2005. Overall, the

late converters performed above the early converters, and as well as the national standard. The

overall trend for the late converters is upward, and this group compared favorably to its peer

group (see Graph 2 in the appendix). The early and late groups further illustrate the actual

current ratio results of Kentucky CAHs.

For days in patient accounts receivable, Graph 3 illustrates that the national and

Kentucky industry standards have steadily declined from 2000 through 2005. Group 1 also

demonstrates a steady downward trend, and performed well below the Kentucky standard. In

2004, Group 1 decreased their days in accounts receivable to below the national median, which

allows them to compare very favorably to both standards. Group 2 CAHs improved in days

accounts receivable by showing a steady decline from 2001 through 2005, and performed

relatively close to the Kentucky standard. However, Group 2 results are still above the state

and national median values, which compares unfavorably (see Table 5 and Graph 3 in the

appendix).

Days cash on hand from short-term sources have remained relatively consistent for the

national rural hospital standard. The national trend has been neutral with the median number of

days cash on hand maintaining in the upper twenties. The Kentucky standard days cash on

22

hand has steadily declined from 2000 to 2003, but showed a positive trend upward in 2004 and

2005. The eligible rural hospitals (group 1) demonstrated a sharp decline from 2000 to 2002,

but peaked sharply in 2003. In 2004 and 2005, Group 1 further exhibited a negative trend

downward. However, this group performed well above the industry median and its peer group.

Therefore, Group 1 compares favorably to both standards. While Group 2 CAHs exhibited a

positive trend upward in 2000 following conversion, these hospitals then trended negatively

downward through 2003. In 2004, group 2 did peak slightly, but further declined in 2005.

Overall, the CAHs performed well below both industry standards and the peer group, and

compared unfavorably (see Table 5 and Graph 4). Graph 5 illustrates a negative trend

downward since pre-conversion in 1999 through 2004 for the early converting CAHs. Although,

these CAHs did gain two and half days cash on hand in 2005. The early converters performed

well below the late converters, and have substantially less days cash on hand than the peer

group. The late converters show a sharp decline in days cash on hand from 2000 to 2003.

Following conversion of the initial hospitals in 2003, this group trended positively upward in

2004 and 2005, but still performed well below the national standard (see graph 5).

Capital Structure Ratios

The national rural hospital long-term debt to capitalization standard has remained

consistent from 2001 through 2004. The Kentucky rural hospital standard trends upward and

performed well above the national median values from 2003 through 2005. The long-term debt

to capitalization ratios for group 1 (eligible, non-converting hospitals) declined from 2001

through 2003. In 2004, group 1 increased slightly, but then remained relatively neutral in 2005.

Overall, group 1 performed favorably when compared to the Kentucky and national industry

standards. The Kentucky CAHs (group 2) trend upward from 2003, and performed well above

the peer group and both standards from 2003 through 2005 (see Table 6 and Graph 6 in the

appendix). Therefore, group 2 compared unfavorably to the state and national standards. It is

23

evident in Graph 7 that early converters trend steadily upwards from 2002, and performed

poorly when compared to the peer group and the industry standards. While the late converters

trend negatively upwards, their results are closer to the state median values. However, the late

converters still performed unfavorably compared to the state and national standards.

Profitability Ratios

The national and the Kentucky total margin standards trended negatively downward from

2001 through 2003, but showed a positive response in 2004 (see Graph 8 in the appendix).

However, the Kentucky total margin standard performed well below the national level. Group 1

(Kentucky rural hospitals that have not converted to critical access) performed favorably to both

industry standards (see Table 7). Since 2002, the total margin has been declining for these

hospitals, but group 1 still performed well above the industry medians. From 2000 through

2002, the total margin ratios for group 2 Kentucky CAHs have been well below industry

standards. In 2003, the CAH total margin results show a positive trend upward, but the median

values remain well below the peer group and standards. Overall, the CAHs have performed

unfavorably when compared to the state and national standards (see Graph 8). In Graph 9, the

early converting CAHs show an increase from a pre-conversion negative total margin ratio in

1999 to a positive post-conversion value in 2001. While there was a decline in 2002, the early

converting hospitals further demonstrate a positive trend in 2004 and 2005, which compared

favorably to the national industry. The late converting CAHs show a negative trend downward

from 1999 through 2002. Following the initial critical access certification of the late converters in

2003, these hospitals begin to trend upwards, but remain below the peer group and the national

industry standard.

The overall national trend for return on equity (ROE) has been relatively neutral for rural

hospitals. The Kentucky rural hospital ROE standard trended downward from 2001 through

2003, but then shows a steady increase since 2004. Group 1 performed slightly below the state

24

and national standards in 2004 and 2005, and therefore, compared unfavorably to both.

However, the eligible Kentucky rural hospitals (group 1) have remained relatively neutral over

time with two peaks in 2002 and 2003, which were above the standard medians (see Table 8

and Graph 10 in the appendix). Group 2 CAHs show a decline from 2001 to 2003, but then

trends positively upwards from 2004 to 2005. This group performed as well as the industry

standards in 2004, and above the Kentucky median in 2005. Therefore, the CAHs compared

favorably to the industry standards. While both the early and late converters show sporadic

ROE results in Graph 11, it is interesting to note that the early converters did perform slightly

better than the late converters in 2004 and 2005.

Asset Efficiency Ratios

The national rural hospital trend for total asset turnover has remained consistent since

1999. The trend for the Kentucky rural hospital standard shows a slight, but steady, increase

overtime. Group 1 eligible Kentucky rural hospitals have also remained stable over time with

the national standard. However, group 1 performed slightly below and unfavorably when

compared to the state standard. Group 2 Kentucky CAHs performed well above the median

values of both industry standards (see Table 8). Moreover, group 2 shows an increase from

2001 through 2003, but has remained steady since 2004 (see Graph 12 in the appendix).

Graph 13 demonstrates a slight upward trend in 2005 for the early converting hospitals. Graph

13 also illustrates that the late converters trended upwards from 2000 through 2004, but

declined in 2005. Overall, the total asset turnover results have remained relatively consistent

for all Kentucky CAHs, and these hospitals have performed above the national standard.

In 2005, the Kentucky state fixed asset turnover ratio standard has trended upward, but

previous results have been fairly constant overtime. When comparing the state and national

standards, the Kentucky fixed asset turnover ratio values have been well above the national

median (see Table 8 and Graph 14). The national hospital standard has remained consistent

25

over time, but also showed a slight increase in 2004. Group 1(the eligible rural hospitals)

compares favorably with the national results, but performed below the state standard. Graph 14

illustrates that group 1 has trended upward since 2000. Group 2 CAHs show a slightly

increasing trend in 2005 following a decline from 2002. The CAHs performed well above the

peer groups and standards. Graph 15 shows that the overall fixed asset turnover ratio results

for the early converting CAHs have been various overtime. These hospitals trended downward

in 2003, but have remained neutral since 2004. The late converters show a slight increase

since 2004, but the overall trend has been fairly consistent over time. While the late converters

performed well above the national median, the early converters demonstrated sporadic results,

but the values remained at or above the national median.

26

DISCUSSION

This study was performed for the Kentucky State Office of Rural Health (KSORH) to

evaluate the Kentucky Rural Hospital Flexibility Program. The objective of this study was to

determine if critical access certification has financially stabilized rural Kentucky critical access

hospitals (CAHs). This study assesses whether critical access certification, and thus,

reasonable cost base reimbursement, has improved the financial condition of rural hospitals by

comparing two hospital peer groups through a trend and comparative ratio analysis. Group 1

consists of eligible rural hospitals that did not convert to critical access, and retained their

current licensure. Group 2 represents all Kentucky critical access hospitals (CAHs). This CAH

group was then divided into two groups (early and late converters) to further illustrate the

financial status of the CAH group. Early converting CAHs represent those hospitals that

converted to critical access between 2000 and 2002, and late converters are those hospitals

that were certified between 2003 and 2005. This evaluation does not consider the early and

late converting CAHs to be separate study groups. The early and late groups are used to clarify

how the CAHs are performing overall. The idea of the early and late converting CAH groups is

to assist the KSORH in targeting the needs of the Kentucky CAHs, and directing its resources

and technical services to those low performing hospitals.

This study used a ratio analysis to assess the financial status of Kentucky critical access

hospitals (CAHs). Each indicator was evaluated over time in a trend analysis, and then

compared to a peer group and industry standard. Four financial ratio categories, which included

liquidity, capital structure, profitability and asset efficiency were utilized to assess the condition

of Kentucky’s CAHs. These four categories include the following eight ratios: current ratio, days

in patient accounts receivable, days cash on hand, long-term debt to capitalization, total margin,

return on equity, total asset turnover, and fixed asset turnover.

When comparing the eligible rural hospitals (group 1) to the CAHs (group 2), it is evident

that the non-converting hospitals have higher current ratio and total margin median values.

27

“Current ratio and total margin are positively correlated with the more profitable hospitals having

higher current ratios” (Ingenix, 2005). The current ratio analysis indicates that the CAHs have

greater difficulty raising cash to cover short-term liabilities than their peer group. The results

show that CAHs are less profitable and have more debt than the eligible, non-converting rural

hospitals.

From 2003 through 2005, the current ratios for the early converting CAHs ranged from

1.26 to 1.40. According to Neumann and Boles (1998), “a value of less than one may indicate

potential financial distress.” While these hospitals are above one, they have remained less than

two since 2003, and they are substantially lower than the late converters. In addition, the early

converters have more debt than the late converters as illustrated in the capital structure ratio.

Therefore, the early converters appear to have less capability to pay short-term debt, and are

more at risk for insolvency than the late converters.

The current ratio for the late converters indicates that these CAHs have a greater ability

to meet short-term financial obligations than the early converters. Late converting CAHs have

higher current ratios, and lower long-term debt to capitalization ratio values than the early

converting CAHs. This may help explain their delay in being certified as a critical access

hospital.

Kentucky CAHs showed a positive improvement in days in patient accounts receivable.

The downward trend may suggests that CAHs are becoming more efficient in collecting

receivables or may be more aggressive in collecting receivables in order to compensate for the

lower days cash on hand. A shorter collection period allows hospitals to increase short-term

cash and reduce short-term debt. The shorter collection period gives greater ability to meet

short-term liabilities and pay their liabilities as they come due, which in turn, improves financial

stability. Longer collection periods restrict short-term cash flow and extend short-term debt. It is

possible that the decreased days in patient accounts receivable may be sustaining the slightly

improved current ratio values.

28

The days cash on hand ratios illustrate that CAHs still have serious cash flow problems,

and difficulties meeting short-term liabilities, even with reasonable cost base reimbursement. It

is evident by the low median days cash on hand ratios that Kentucky CAHs (again, in particular,

the early converting CAHs) have a greater difficulty paying their average daily expenditures

compared to other rural hospitals. The late converting CAHs appear to be more secure in the

short-term, which may further explain why this group waited later to become certified as critical

access. Graph 5 illustrates that it may have been more advantageous for the late converters to

have been certified earlier than 2003. Regardless, even after converting to critical access, it is

evident that the CAHs are still performing well below the national standard, and need further

assistance to ensure financial stability.

The long-term debt to capitalization ratio values show that Kentucky CAHs are less

solvent, and are at greater financial risk than the eligible, non-converting rural hospitals. The

Kentucky CAHs probably have greater difficulty generating funds through debt financing. Not

being able to raise funds through debt financing is a disadvantage for CAHs and undermines

the overall stability of these institutions. The long-term debt to capitalization ratio indicates that

CAHs may find it difficult to effectively utilize debt financing in the future. Moreover, the

evidence shows that the early converting CAHs have higher debt than the late converters, and

are more at risk of becoming insolvent.

Hospitals must continue to make capital and technical improvements to continue to

provide quality health care, and to remain competitive in a tight market. Evidence from current

literature indicates that nearly 30 percent of the population bypasses the local hospital. One of

the main factors that affect the consumers’ (patients’) decision to bypass a local hospital is the

overall physical appearance and the application of newer technology. The majority of the

Kentucky CAHs are Hill-Burton facilities that have older, depreciated fixed assets. Many

Kentucky CAH administrators have reported that they would like to renovate their facilities. This

may help explain the rapid increase in the long-term debt to capitalization values since 2003.

29

The total margin values may indicate that reasonable cost base reimbursement has

allowed Kentucky CAHs to gain some control over their expenses. While the total margin ratios

are lower than the peer group median values, a positive total margin may demonstrate that

CAHs are in the process of becoming more financially stable. Moreover, the lower total margin

results may also suggest that CAHs may not be as efficient as other larger facilities, and may

have a greater difficulty in controlling expenses.

It is important to note that since the implementation of the Kentucky Rural Hospital

Flexibility Program in 2000, the total margin ratios for the CAHs have improved with results only

slightly below the industry standards in 2004 and 2005. When the CAHs are divided into early

and late categories, it is evident that those early converters are more dependent upon the

enhanced reimbursement, which is provided through the Kentucky Rural Hospital Flexibility

Program. To illustrate, Table 7 shows that in 1999 the early converts were operating below the

margin at -2.6 percent. In 2000, a few rural hospitals began to convert their licensure to critical

access, and started to participate in the Kentucky Rural Hospital Flexibility Program. Following

conversion to critical access in 2000, these hospitals increased their total margin to 1.4 percent.

The early converters remained relatively steady from 2000 to 2003. However, this group shows

a positive trend upwards from 2004, and has performed favorably when compared to the total

margin industry standards.

The late converters showed a positive total margin in 1999, but also demonstrated a

steady decline to below the margin at -1.6 percent in 2002. A few late converters were certified

in 2003, and began to receive reasonable cost base reimbursement. As shown in Table 7,

these hospitals increased their total margin to 0.7, and have steadily increased to 2.9 in 2005.

While the late converters are showing a positive trend upwards, they are still performing

unfavorably compared to both standards. The negative total margin values may demonstrate

why these hospitals decided to convert to critical access, and may find it increasingly difficulty to

control expenses without the assistance of reasonable cost base reimbursement. Graph 9

30

illustrates the negative decline in total margin ratios for the late converters compared to positive

trend of the early converters.

It is important to note that CAHs are not making a profit under the cost base

reimbursement. CAHs are usually non-profit institutions that have low patient volume and high

fixed costs. This explains, at least to some degree, the comparatively low days cash on hand.

Of the total patient population served in Kentucky CAHs, approximately 64 percent are

Medicare patients. With over half of the patient mix being Medicare patients, it is difficult for

CAHs to show a competitive total profit margin. However, cost base reimbursement has

allowed CAHs to at least breakeven. The goal of the Kentucky Rural Hospital Flexibility

Program was to financially stabilize small rural hospitals. The program objectives seem to be

effective as shown by the low, but positive, total margin ratios. .

The fluctuation in the total margin can be explained by examining the denominator of the

equation. Total margin is net income divided by total revenues. Total revenue equals net

patient revenue plus total other income. Because of other sources of income, total margin may

vary from year to year. Many small rural hospitals depend heavily on philanthropy, gifts, and

other sources of non-patient income. Other income sources distort the total margin ratio and

the interpretation as it pertains to financial performance. Therefore, the operating margin is a

better indicator of profitability than total margin. However, since total margin is primarily utilized

within the industry as the major profitability indicator, operating margin was not evaluated in this

report.

In 2005, there was a large increase in return on equity for the CAHs compared to the

eligible rural Kentucky hospitals (see Graph 10). The 2004 and 2005 ROE results may further

support the possibility that CAHs are achieving control over their expenses. In 2002, the late

converters show an unexplained negative ROE value (-5.6), which began a reverse trend

upwards from conversion in 2003. This negative ROE value along with the negative and

declining total margin values may also explain why the late converters decided to seek critical

31

access certification. Alternatively, the early converters demonstrate a positive peak in 2002,

which may be a result the enhanced reimbursement from the critical access certification.

Since Kentucky critical access hospitals (CAHs) are still trying to improve their 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

“The fixed asset turnover ratio measures the utilization of the hospital’s physical plant

and equipment, and indicates the amount of revenue generated due to each dollar of fixed

assets” (Gapenski, 2001). According to Ingenix (2006), “fixed asset turnover and the average

plant age are positively correlated because of the understated historical costs. Moreover, newer

physical plants are effectively utilized than those of older ones”. The evidence suggests that

Kentucky CAHs are utilizing their fixed assets more efficiently than the eligible rural hospitals.

Also it appears that CAHs generate a larger portion of their revenue from their fixed asset than

the eligible rural hospital group. Again, while a higher fixed asset turnover value may be

considered favorable, it may not be a positive indicator for CAHs due to the possible lower book

value of their fixed assets.

33

CONCLUSIONS

Rural hospitals have been struggling to remain financially secure since the early eighties

when Medicare imposed its prospective payment system (PPS) on providers. Rural hospitals

are highly susceptible to financial failure under the PPS because of low patient volume, high

fixed costs, and a high percentage of Medicare, Medicaid and uninsured patients. Rural

hospitals are, in general, more dependent on Medicare, have lower operating margins and

experience greater financial distress than urban hospitals, as evident by twice the number of

rural hospital closures than urban ones in 1989 (Vogel and Coward, 1995). Because of rural

hospital closures, access to health care services has declined through out rural America, and

caused economic hardships for their communities.

To compensate rural hospitals and their communities, the Medicare Rural Hospital

Flexibility Program was authorized under the 1997 Balanced Budget Act. This program grants

rural hospitals the opportunity to convert their licensure to critical access certification, which

allows them to receive reasonable cost base reimbursement for Medicare services. In some

states, including Kentucky, participating critical access hospitals (CAHs) may receive

reasonable cost base reimbursement from Medicaid. The overall goal of the Medicare Rural

Hospital Flexibility Program is to secure access to rural health care for rural Americans while

assisting rural hospitals in becoming more financially stable.

The Kentucky State Office of Rural Health (KSORH) and the Kentucky Rural Hospital

Flexibility Program (KRHFP) staff initiated this evaluation program to track Kentucky CAHs in an

effort to evaluate the overall success of the KRHFP, and critical access certification process.

The KRHFP staff began the evaluation program at the onset of the implementation of the

Program. To the best of our knowledge at the present time, the KSORH is the only state office

of rural health to have implemented an on-going financial ratio trend and comparative analysis

for their annual program evaluation, which is provided to the Federal Office of Rural Health

Policy. The KSORH assumes that if the federal program objectives are not being met or not

34

effective, then the financial condition of the CAHs would not improve overtime. Data provided

through this analysis will be utilized as a decision-making tool for the KSORH and KRHFP staff

to redirect future funds and ensure compliance with federal objectives. KRHFP staff will modify

and improve program activities based on this outside evaluation, and if necessary, will redirect

grant funds to support more effective programming.

The objective of this study was to evaluate if critical access certification has financially

stabilized Kentucky critical access hospitals (CAHs). A comparative and trend financial ratio

analysis was performed to determine whether Kentucky CAHs have improved their financial

position since conversion to critical access. The CAHs were compared to a peer group that

consisted of eligible, non-converting rural Kentucky hospitals. These hospitals chose not to

convert to critical access and retained their current licensure. These two peer groups were then

evaluated against state and national industry standards. The CAHs were subdivided into 2

groups based on their conversion year. The early converters represent those CAHs that

converted to critical access between 2000 and 2002. The late converters consist of hospitals

that were certified as critical access between 2003 and 2005. The purpose of the subgroups,

the early and late converters, is to further illustrate the financial condition of Kentucky’s CAHs.

These two groups were not considered to be additional study groups in this evaluation. They

were used to further define how the CAHs are performing since conversion in 2000. The idea of

the early and late converting CAH groups is to assist the KSORH in targeting the needs of the

Kentucky CAHs, and directing its resources and technical services to those low performing

hospitals.

This analysis has shown that the CAHs total margin ratios have remained positive since

conversion in 2000. The total margin ratios provide the best evidence of the overall success of

the critical access hospitals, and consequently, the KRHFP. The total margin values indicate

that the Kentucky CAHs are more financially stable under critical access certification. Moreover,

the total margin ratio results show that the CAHs have improved their financial condition since

35

conversion to critical access. However, it is also evident that the early converting CAHs are still

financially vulnerable as evident in the current ratio, days cash on hand and long-term debt to

capitalization ratio values. The early converting CAHs are still heavily dependent upon the

technical assistance and financial support that is provided through the KRHFP. The late

converting CAHs seem to be financially sustained by the reasonable cost base reimbursement,

but may still need technical assistance that is provide through the KRHFP.

Kentucky CAHs are not as financially stable as the non-converting peer group hospitals,

and are still performing below the state and national industry standards. Evidence from this

study suggest that it is too early to withdraw technical or financial assistance from the Kentucky

CAHs, especially the weakly positioned, early converting hospitals. To ensure the financial

stability of the CAHs, it is recommended that other program funds be redirected to further

supplement the technical and financial assistance provided by and through the Kentucky Rural

Hospital Flexibility Program and the Kentucky State Office of Rural Health. It is also

recommended that KRHFP continue to track Kentucky CAHs in a trend and comparative

financial ratio analysis to better improve future programming. This analysis should be repeated

to evaluate the conversion process and overall success of the KRHFP. It is recognized that this

study is limited by the fact that only five years of financial data is available from the initial

implementation of the KRHFP. However, it does provide base line information for current

decision-making and future evaluations.

36

APPENDIX

37

Table 5: Liquidity Ratios

Current Ratio 1999 2000 2001 2002 2003 2004 2005 Trend KY Std National Std

National Rural Hospital Standard 2.21 2.24 2.26 2.25 2.27 2.32 N/A Neutral

KY Rural Hospital Standard 2.67 2.69 2.44 2.78 2.26 2.39 2.48 Neutral

Group 1: Eligible KY Rural Hospitals 4.81 4.33 2.87 3.02 3.30 3.50 3.07 Down Favorable Favorable

Group 2: KY Critical Access Hospitals 2.26 2.13 2.22 2.64 1.94 1.72 2.17 Up Unfavorable Unfavorable

Group 2A: KY CAHs Converted 00 - 02 1.52 2.67 2.23 2.18 1.26 1.53 1.40 Down Unfavorable Unfavorable

Group 2B: KY CAHs Converted 03 - 05 2.59 1.72 2.22 2.78 2.59 2.32 2.88 Up Favorable Favorable

Days in Patient Accounts Receivable 1999 2000 2001 2002 2003 2004 2005 Trend KY Std National Std

National Rural Hospital Standard 67.6 67.8 64.7 61.9 60.2 57.8 N/A Down

KY Rural Hospital Standard 77.1 80.4 78.4 69.5 65.1 62.6 58.1 Down


Group 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


KY Rural Hospital Standard 39.1 46.9 28.0 20.9 14.1 24.2 32.7 Up


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

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



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



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

Table 8: Asset Efficiency Ratios

Total Asset Turnover 1999 2000 2001 2002 2003 2004 2005 Trend KY Std National Std



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


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

Table 9: Ratios and Definitions

Ratio Definition

Total Profit Margin Net incomeTotal revenues

Return of Equity Net incomeNet assets

Current Ratio Current AssetsCurrent 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 revenuesFixed assets

Total Asset Turnover Total revenuesTotal assets

Long-Term Debt to Capitalization Total long-term debt(Total long-term debt + Net assets)

Graph 1: Current Ratios for Groups 1 and 2

Graph 2: Current Ratio for Early and Late Converting CAHs

Current Ratio: Early & Late Converters

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1999 2000 2001 2002 2003 2004 2005

Year

Val

ue

NationalRuralHospitalStd

Group 2A:KY CAHsConverted00 - 02

Group 2B:KY CAHsConverted03 - 05

Current Ratio

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2000 2001 2002 2003 2004 2005

Year

Val

ue


KY RuralHospitalStd

Group 1:Eligible KYRuralHospitals

Group 2:KY CriticalAccessHospitals

Graph 3: Days in Patient Accounts Receivable for Groups 1 and 2

Days in Patient Accounts Receivable

50

55

60

65

70

75

80

85

2000 2001 2002 2003 2004 2005Year

Day

s


KY RuralHospitalStd

Group 1:EligibleKY RuralHospitals


Graph 4: Days Cash On Hand for Groups 1 and 2

Days Cash On Hand

0

10

20

30

40

50

60

70

80

2000 2001 2002 2003 2004 2005

Year

Da

ys


KY RuralHospitalStd



Graph 5: Days cash On Hand for Early and Late Converting CAHs

Days Cash On Hand: Early and Late Converters

0

5

10

15

20

25

30

35

40

45

50

55

1999 2000 2001 2002 2003 2004 2005

Year

Da

ys




Graph 6: Long –Term Debt to Capitalization for Groups 1 and 2

Long-Term Debt to Capitalization

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

2001 2002 2003 2004 2005Year

Val

ue


KY RuralHospitalStd



Graph 7: Long-Term Debt to Capitalization for Early and Late Converting CAHs

Long-Term Debt to Capitalization: Early and Late Converters

0

5

10

15

20

25

30

35

40

45

50

2001 2002 2003 2004 2005

Year

Val

ue


KY RuralHospitalStd



F

Graph 8: Total Margin for Groups 1 and 2

Total Margin

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2000 2001 2002 2003 2004 2005Year

Pe

rce

nt


KY RuralHospitalStd



Graph 9: Total Margin for Early and Late Converting CAHs

Total Margin: Early and Late Converters

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

1999 2000 2001 2002 2003 2004 2005Year

Pe

rce

nt




Graph 10: Return on Equity for Groups 1 and 2

Return on Equity

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

2000 2001 2002 2003 2004 2005Year

Pe

rce

nt


KY RuralHospitalStd



Graph 11: Return on Equity for Early and Late Converters

Return on Equity: Early and Late Converters

-8.0

-5.0

-2.0

1.0

4.0

7.0

10.0

13.0

16.0

1999 2000 2001 2002 2003 2004 2005

Year

Pe

rce

nt




Graph 12: Total Asset Turnover for Groups 1 and 2

Total Asset Turnover

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

2000 2001 2002 2003 2004 2005Year

Va

lue


KY RuralHospitalStd



Graph 13: Total Asset Turnover for Early and Late Converters

Total Asset Turnover: Early and Late Converters

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

1999 2000 2001 2002 2003 2004 2005Year

Va

lue




Graph 14: Fixed Asset Turnover for Groups 1 and 2

Fixed Asset Turnover

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2000 2001 2002 2003 2004 2005Year

Val

ue


KY RuralHospitalStd



Graph 15: Fixed Asset Turnover for Early and Late Converters

Fixed Asset Turnover: Early and Late Converters

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1999 2000 2001 2002 2003 2004 2005Year

:




REFERENCES

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Cleverly, W.O., Essentials of Health Care Finance – Fourth Edition, Aspen Publishers, 1997

Doeksen, G.A., Loewen, R. A., Strawn, D. A. A Rural Hospital’s Impact on a Community’s Economic Health, The Journal of Rural Health. January 1990, Vol. 6, No. 1,

Doeksen, G. A., Cordes, S., Shaffer, R. Health Care’s Contribution to Rural Economic Development, Federal Office of Rural Health Policy, Health Resources and Services Administration, U.S. Department of Health and Human Services, Rockville, MD. Unpublished report, December 1992

Finkler, S.A., Cost Accounting for Health Care Organizations: Concepts and Applications, 1994

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National Rural Health Resource Center; Technical Assistance and Services Center for the Medicare Rural Hospital Flexibility Program, www.ruralresource.org/flex.shtml

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Scorsone, E. A., Health Care Services: Three Critical Roles in Rural Economic Development, Economic and Policy Update, vol. 01, no. 13, October, 2001

Shelton, R.D., St. Clair, C.F., Doeksen, G.A., Schott, V., National Critical Access Hospital Evaluation Project. September, 2001

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Wendling, Noe, Nelson, and Johnson, LLC., Financial Success of the Critical Access Hospital Program in Kansas: A Comparative Study, Kansas Rural Health Options Project, February, 2002

Zelman, W. N., Stewart, S.R., Dalton, K., Poley, S., Fruhbeis, M., Cameron, A. E., Financial Condition of critical access hospitals: 1996 – 2000, Rural Hospital Flexibility Program Tracking Project, Year 2., Rural Policy Research Institute. 2001

Financial Status of Critical Access Hospitals In Kentucky

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