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Hospital Financial Management:What Is the Link Between RevenueCycle Management, Profitability,and Not-for-Profit Hospitals' Abilityto Grow Equity?Simone Rauscher Singh, PhD, assistant professor. Department of Health SystemsAdministration, Ceorgetown University, Washington, DC, and John Wheeler, PhD,professor, health management and policy. School of Public Health; faculty associate.Survey Research Center, Institute for Social Research; and faculty associate andprofessor, pediatrics and communicable diseases. Medical School, University ofMichigan, Ann Arbor

E X E C U T I V E S U M M A R YEffective revenue cycle management—firom appointment scheduling and patientregistration at the front end of the revenue cycle to billing and cash collections at theback end—plays a crucial role in hospitals' efforts to improve their financial perfor-mance. Using data for 1,397 bond-issuing, not-for-profit US hospitals for 2000 to2007, this study analyzed the relationship between hospitals' performance at manag-ing the revenue cycle and their profitability and ability to build equity capital. Hospi-tal-level fixed effects regression analysis was used to model four different measures ofprofitability and equity capital as functions of two key financial indicators of revenuecycle management—amount of patient revenue and speed of revenue collection. Theresults indicated that higher amounts of patient revenue in relation to a hospital'sassets were associated with statistically significant increases in operating and totalprofit margins, firee cash flow, and equity capital (p < 0.01 for all four models); that is,hospitals that generated more patient revenue per dollar of assets invested reportedimproved financial performance. Likewise, a statistically significant link existedbetween lower revenue collection periods and all four indicators of hospital financialperformance (p < 0.01 for three models; p < 0.05 for one model). Hospitals that col-lected faster on their patient revenue reported higher profit margins and larger equityvalues. For revenue cycle managers, these findings represent good news: Streamlininga hospital's management of the patient revenue cycle can advance the organization'sfinancial viability by improving profitability and enabling equity growth.

For more information on the concepts in this article, contact Dr. Rauscher Singhat [email protected].

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JOURNAL OF HEALTHCARE MANAGEMENT 57:5 SEPTEMBER/OCTOBER 2012

I N T R O D U C T I O NHospitals' profitability and ability togrow equity are key factors in theirefforts to maintain the up-to-date facil-ities and equipment needed to attractwell-trained healthcare professionalsand provide high-quality patient care.Profitable hospitals are able to retainand reinvest more of their earnings,which translates into higher growth inequity capital. For not-for-profit hos-pitals in particular, retained earningsrepresent the most important source ofequity. Unlike their for-profit counter-parts, not-for-profit hospitals cannotraise equity externally by issuing shares(Rivenson et al. 2000). Managers ofnot-for-profit hospitals have to focustheir efforts to build equity on theirorganizations' internal operations andsupplement these efforts with profit-able nonoperating activities, includ-ing raising capital through donationsand gifts and managing their financialinvestments. In the current businessenvironment, however, many hospitalshave experienced investment losses andshrinking donations and gift receipts,and the importance of boosting theprofitability' of operating activitieshas increased (Reiter and Song 2011;McCue 2010).

Hospitals' core operating activityis the provision of patient care. Hence,managing the flow of patients throughthe hospital—from appointment sched-uling and patient registration at theftont end of the revenue cycle to billingand cash collertion at the back end—iscrucial. Aimed at generating higherrevenues and reducing average collec-tion periods (Rauscher and Wheeler2008), the effective management of the

patient revenue cycle has the potentialto boost hospitals' profitability and thusstrengthen their ability to grow equity.Despite practitioners' interest in revenuecycle management (see, for instance,Danielson and Fuller 2007; Hammer2005; May 2004), no empirical studyhas explicitly focused on exploring therelationship between hospitals' perfor-mance at managing the revenue cycleand their long-term financial perfor-mance. Descriptive studies of the factorsassociated with hospitals' profitabilityhave supported the idea that revenuecycle management plays an importantrole in financial performance (Clev-erley 1990). Profitable hospitals havebeen found to experience both higheramounts of patient revenue as a resultof higher gross charges and lower rev-enue deductions and average collectionperiods as a result of lower investmentsin accounts receivable (Cleverley 1990).Empirical analyses of the determinantsof hospitals' profitability, however, havegenerally ignored the potential benefitsof effective revenue cycle managementfor hospitals' profitability (see, forinstance, Cody, Friss, and Hawkinson1995; Capenski, Vogel, and Langland-Orban 1993; Younis, Rice, and Barkou-las 2001; Younis et al. 2003; McCue andDiana 2007).

This study attempts to fill some ofthe gaps in the literature and exploreswhether effective revenue cycle man-agement can help hospital managersimprove their organizations' profit-ability, strengthen their ability to growequity, and thus remain financially via-ble in the long term. More specifically,this study analyzes the relationshipbetween two key financial indicators of

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HOSPITAL FINANCIAL MANAGEMENT

effective revenue cycle management—the amount of patient revenue a hos-pital generates in relation to its assetsand the speed with which a hospitalcollects its patient revenue—and fourindicators of financial performance—operating and total profit margins, freecash flow, and the value of the hospital'sequity capital. We answer the follow-ing research questions: What is the linkbetween revenue cycle management per-formance and hospitals' operating andtotal profit margins? What is the linkbetween revenue cycle management per-formance and hospitals' free cash flows?And, finally, does effective revenue cyclemanagement translate into higher valuesof equity capital and hence stronger bal-ance sheets for not-for-profit hospitals?Besides filling an important gap in theliterature, the findings of this study areof particular interest to hospital revenuecycle managers and consultants as theyseek to improve their organizations'long-term financial viability by investingin revenue cycle excellence.

CONCEPTUAL FRAMEWORKPatient care revenue makes up the bulkof a hospital's revenue (McKay andCapenski 2009). Management of theflow of patients through the hospitaland the associated revenues thus hasimportant implications for a hospi-tal's financial performance. Ceneratinghigher amounts of patient revenue isdirectly linked with improved profit-ability and equity growth. As partof their management of the revenuecycle, hospital managers may pursuemore aggressive pricing and attemptto reduce revenue deductions, in par-ticular contractual allowances granted

to third-party payers and charity care,resulting in higher net patient revenues(Criffith and White 2006). In addition,more effective revenue cycle manage-ment may reduce the number of unin-sured and self-pay patients a hospitalserves through improved financial coun-seling, and it may consequently lowerthe hospital's bad debt and operatingexpenses. Higher net patient revenueand lower operating expenses resultin higher operating and total margins,thus improving a hospital's profitabilityand allowing it to build equity capital.We therefore hypothesize that greaterpatient revenues in relation to a hospi-tal's assets will be associated with higherhospital profits and equity values.

Managing the flow of patient rev-enue also involves managing patientaccounts receivable. Under the currentthird-party payer system, hospitals gen-erally do not collect revenue at the pointof service but rather bill the patient'sthird-party payer afrer services have beenrendered. As a result, a significant por-tion of a hospital's revenue is outstand-ing at any point in time. Along withcash and inventories, accounts receiv-able represent a large share of a hospi-tal's current assets. Models designed tooptimize current asset balances reflectbalancing of the benefits of holding theasset with the costs of holding the asset(Baumöl 1952; Miller and Orr 1966).Unlike cash and supplies stocks, whichhave clear benefits in terms of transac-tion convenience and lower out-of-stockcost, there is little benefit to accountsreceivable as an asset, in particular forhealthcare organizations. Hence, manag-ers have generally sought to minimizeaccounts receivable so as to minimize

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the costs of financing the asset (Griffithand White 2006). Besides reduc-ing short-term liabilities and interestexpense (Soenen 1993), shorter collec-tion periods may also generate surpluscash that can be reinvested. Unlike theirfor-profit counterparts, which have anincentive to return excess cash to share-holders in the form of dividends andstock repurchases, not-for-profit hospi-tals tend to hoard excess cash (Rivensonet al. 2000). Invested in both short- andlong-term securities, these cash reservesfrequently generate substantial nonoper-ating income and thus improve the hos-pital's bottom line (Song, Wheeler, andSmith 2008). We therefore hypothesizethat lower balances of accounts receiv-able will be associated with improvedprofitability and higher equity values.

METHODSData and SampleFor the purpose of this study, we ana-lyzed audited financial statementinformation collected by MerrittResearch Services for all bond-issuing,not-for-profit US hospitals.' The analysiswas limited to the years 2000 to 2007.Since complete longitudinal data werenot available for all hospitals, separatesamples were derived for the analysesof hospitals' profitability and equityvalues to preserve the sample size asmuch as possible (see Exhibit 1). Ofthe 1,502 hospitals (9,871 hospital-yearobservations) for which financial datawere available, 1,170 hospitals (6,062hospital-year observations) had suf-ficient information for our analysis ofhospital profitability, and 879 hospitals(3,310 hospital-year observations) hadsufficient information for our analysis of

hospital equity values. The final samplesrepresented 77.9 percent and 58.5 per-cent of all hospitals in the initial dataset, respectively.

Indicators of Hospital FinancialPerformanceThe dependent variables used in thisstudy consisted of four measures ofhospital financial performance: totalprofit margin, operating profit margin,free cash flow, and hospital equity value.Total profit margin is considered one ofthe most popular indicators of hospi-tal profitability (Cleverley, Song, andCleverley 2010). Total profit margin iscalculated as the difference between ahospital's total revenues and expenses(i.e., its excess of revenues over expenses,or net income) divided by total rev-enues. It represents the overall profit-ability ofthe firm per dollar of revenueearned. A second commonly used mea-sure of hospital profitability is operatingprofit margin, which measures profit-ability solely with respect to patient careservices and other operating activities(Cleverley, Song, and Cleverley 2010).Operating profit margin is calculated asthe difference between a hospital's oper-ating revenues and operating expenses(i.e., its operating income) divided byoperating revenues.

Unlike profit margins, free cashflow is based on an organization'scash inflows and outflows rather thanits accounting earnings. Some financescholars have argued that a hospital'strue financial condition is more closelyrelated to the cash flows it generatesthan to its reported income, which canbe subject to managerial manipula-tion (Phillips 2003). Free cash flow is

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E X H I B I T 1Sample Derivation

Profitability Equity Value

9,871 9,871Number of hospital-year observations in the initial data set

Observations excluded due to missing or implausible values

for:

Operating profit margin^

Total profit margin''

Free cash flow

Equity value''

Days in net accounts receivable

Net patient revenue per total assets

Days in accounts payable

Average age of property, plant, and equipment

Debt financing ratio

Financial asset ratio"̂

Patient days

Revenue growth

Number of hospital-year observations in the final sample (asa percentage of hospital-year observations in the initial dataset)

Number of hospitals in the final data set (as percentage ofhospitals in the initial data set)

" Implausible values for both operating and total profit margin were defined as those values smaller than -20 percent or largerthan 20 percent.

'' Of the 5,174 hospital-year observations that were excluded because of missing values for hospitals' equity values, 1,981

observations were excluded because their forecasted free cash flow was missing or negative, which prevented the use of the

simplified discounted cash flow valuation model developed above and would have required more detailed analysis and

valuation on a case-by-case basis; 35 observations were dropped because earnings quality could not be assessed and no reliable

estimate of the growth rate of the free cash flows could thus be calculated; 3,088 observations were excluded because the

estimated return on equity was missing or negative; 71 observations were dropped because the weighted average cost of capital

was missing or negative; and 9 observations were excluded because information on long-term investments was missing.

' Implausible values were defined as those smaller than 0 or larger than 1.

294

34

7

N/A

377

120

91

32

141

22

2,691

0

6,062

(61.4%)

1,170

(77.9%)

N/AN/A

N/A

5,174

9

25

27

6

0

0

1,320

0

3,310

(33.5%)

879

(58.5%)

calculated as the change in net assetsplus interest and noncash expensesminus investments in fixed assets andnet working capital. It represents theamount of cash left over after undertak-ing the firm's operations and making all

investments necessary to ensure its con-tinued operation (Homgren et al. 2006).

Free cash flow plays an importantrole in estimating a hospital's equityvalue. While the market value of for-profit hospitals' equity can be calculated

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as the product of share price and thenumber of shares outstanding, esti-mating equity values for not-for-profithospitals is challenging (Long 1976;McCue, McCue, and Wheeler 1988;Phillips 2003) and involves forecastinga hospital's future free cash flows andthen discounting these cash flows at thefirm's weighted average cost of capital(see, for instance, Brealey, Myers, andAllen 2007). Notationally,

FCE," (WACCf

+ ExcessCashlnv„

whereby FCF^ is the projected free cashflow in period t, WACC is the weightedaverage cost of capital, and ExcessCash-InVg and LTDebt^ are the excess cash andinvestments and the long-term debt ahospital holds at the time of the valua-tion, respectively. While future free cashflows would ideally be projected basedon forecasted financial statements, forthe purpose of this study free cash flowswere estimated using the simple aver-age of the free cash flow of the currentand two prior periods multiplied by anaverage annual growth rate of 7.3 per-cent (based on data from the AmericanHospital Association for 1990 to 2005),which was adjusted for differences in ahospital's quality of earnings (Phillips2003).

A hospital's weighted average cost ofcapital was calculated as

D" D + E ^ D-^E

whereby, following Wheeler and Smith(1988), D represents the book valueof the hospital's debt, E represents thebook value of the hospital's equity, r is

the cost of debt financing (calculated asnet interest expense divided by a hospi-tal's long-term liabilities), and r̂ is thecost of equity financing (calculated asthe average of the hospital's return onequity over the past five years).^

Indicators of Revenue CycleManagement PerformanceRevenue cycle management was mea-sured using two key financial indicatorsof hospitals' ability to (1) generateand (2) collect patient revenue. Days innet accounts receivable, also known asthe average collection period, representsthe most important financial measureof hospitals' performance at managingthe revenue cycle (Berger 2008; Hammer2005; May 2004; Prince and Ramanan1992; Quist and Robertson 2004).Calculated as net patient accountsreceivable times 365 days divided by netpatient revenue, the average collectionperiod describes the number of daysof net patient revenue that a hospitalhas due from patient billings after allrevenue deductions.

Besides the speed of revenue col-lection, Rauscher and Wheeler (2008)have argued that an equally importantindicator of revenue cycle managementperformance is a hospital's ability togenerate patient revenue by reducingrevenue deductions and write-offs.We measured the amount of revenuea hospital generates in relation to itsassets as a hospital's case mix-adjustednet patient revenues divided by its totalassets. Scaling revenues by the case mixindex adjusts for differences in patients'severity of illness across hospitals.Expressing revenues as a percentage oftotal assets adjusts for differences in

330


hospital sizes and thus differences in thevolume of care provided.

Analytic ModelThe relationship between revenue cyclemanagement and not-for-profit hospi-tals' financial performance was analyzedusing ordinary least squares regressionswith hospital-level fixed or randomeffects. We estimated two models:

The dependent variables analyzed in thefirst model, P.̂ were the three measuresof hospital profitability discussed above,while the dependent variable analyzedin the second model, V.^ was a measureof hospital equity value. The inde-pendent variables of interest for bothmodels were indicators of a hospital'sperformance at managing the revenuecycle, RCM.^. A set of control variables,X.j and Y.^ was included in each modelcontaining hospital-level organizationaland financial characteristics as well asstate and year dummy variables (seeExhibit 2). The subscripts i and t referredto hospital i in year t. Because of thepotential for hospital-level variationin financial performance, we includedhospital-specific error terms, p., tocontrol for unobserved, time-invariantheterogeneity aaoss facilities, such asa hospital's management style. How-ever, our analytic model does not takeinto account the effect of unobserved,time-varying factors, such as changes ina hospital's payer environment, and canthus produce biased regression coeffi-cient estimates. In all regressions, robuststandard errors were calculated using

White's correction for heteroskedasticityto adjust for correlations of error termsaaoss observations.

RESULTS

Descriptive FindingsThe hospitals analyzed in this studyreported a median of 59.1 days and anaverage of 60.8 days in net accountsreceivable (see Exhibit 2). While mosthospitals experienced reductions in aver-age collection periods during this time,substantial variation remained in thespeed with which hospitals were able tocollect on their patient revenues. Dur-ing the same time period, average netpatient revenues per total assets equaled0.64 (i.e., hospitals collected an averageof 64 cents in net patient revenue foreach dollar invested in assets). Mediannet patient revenues per total assets were0.61. Similar to average collection peri-ods, the amount of net patient revenuevaried considerably across hospitals.

With respect to financial perfor-mance, hospitals reported median totalprofit margins of 3.9 percent and medianoperating profit margins of 1.6 percent(see Exhibit 2). Average total and operat-ing profit margins were 3.9 percent and1.2 percent, respectively. Median fireecash flows amounted to $3,544,500,which translated into median dis-counted cash flow-based equity valuesof $144,763,600. At $7,295,800 and$390,940,000, respectively both averagefree cash flows and average equity valueswere substantially larger.

To assess whether the valuationmodel used in this study producedrealistic estimates of hospitals' equityvalues, we divided our estimates by thenumber of beds of each hospital, which

331


EXHIBIT 2Definition of Variables and Descriptive Results

Variable Definition Median Mean (s.d.)

Hospital profitability and equity values

Total profit margin (Total revenues - Total expenses) x100%/Total revenues

(Operating revenues - Operat-ing expenses) x 100%/Operatingrevenues

Change in net assets + Interestexpense + Noncash expense - Invest-ments in fixed assets - Investmentsin net working capital

See formula in the "Indicators"seaion

Operating profitmargin

Free cash flow

3.88

1.63

$3,544,500

3.93 (4.35)

1.18(4.58)

$7,295,772($37,212,600)

Discounted cashflow-based equityvalue

$144,763,600 $390,940,000($968,127,000)

Revenue cycle management performance

Days in net accounts (Net accounts receivable x 365 days)/receivable Net patient revenue

Net patient revenue (Net patient revenue/Case mixper total assets index)/Total assets

Control variables

Days in accountspayable

Average age ofproperty, plant, andequipmentFinancial asset ratio


Patient days

Revenue growth

(Accounts payable x 365 days)/Purchases

Accumulated depreciation/Deprecia-tion expense

(Long-term investments + Assetslimited as to use)/Total assets

Total liabilities/Total assets

Total number of inpatient days peryear

(Net patient revenue of current year- Net patient revenue of previousyear)/Net patient revenue of previ-ous year

Note: Summary statistics for the independent and control variables are calculated for the larger of the two samples, thesample derived for the analysis of hospital profitability, which included 1,170 hospitals and 6,062 hospital-year observations.Descriptive results for the independent and control variables for the sample used to analyze discounted cash flow-based equityvalues do not differ substantially from the results presented above and are thus not shown here.

59.12

0.61

15.9

9.6

0.27

0.48

53,764

0.080

60.76(16.85)

0.64(0.25)

19.10(11.61)

9.93(2.70)

0.27(0.15)

0.48(0.16)

97,950(172,584)

0.086(0.083)

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resulted in a median equity value of$581,835 per bed. This estimate wassomewhat higher than comparableestimates reported in prior empiricalstudies. Phillips (2003), for instance,found that for 30 hospital mergers andacquisitions between 1992 and 1996,the average price paid per bed—a proxyfor a hospital's equity value per bed—was $322,456. A more recent studyby McCue and Kim (2005) reportedmedian prices per bed of between$110,416 and $316,335 for 67 hospitalmergers and acquisitions between 1999and 2001. Civen that the estimatespublished in the literature were notadjusted for inflation and given that thehospitals analyzed in this study tendedto be larger, better performing hospi-tals, our valuation approach appears toproduce reasonable estimates of hospi-tals' equity values.

Multivariate FindingsEffective revenue cycle managementwas associated with both improvedhospital profitability and greater equityvalues (see Exhibit 3). As hypothesized,we found negative coefficients on daysin net accounts receivable and posi-tive coefficients on net patient revenueper total assets in all four analyses. Adecrease in the average collection periodby one day was linked to increases intotal and operating profit margins of0.068 and 0.065 percentage points,respectively. Likewise, decreasing a hos-pital's days in net accounts receivable byone day was associated with increasesin free cash flow and discounted cashflow-based equity values of $50,830and $4,009,301, respectively. These find-ings are consistent with prior empirical

evidence of a strong positive relation-ship between shorter average collectionperiods and profitability for for-profitfirms in various industries (Lazaridisand Tryfonidis 2006; Deloof 2003;Wang 2002; Shin and Soenen 1998).The positive relationship between theeffective management of accountsreceivable and financial performancethus also holds true for not-for-profitorganizations, hospitals in particular.

Complementing the findings forspeed of revenue collection, an inaeaseof one percentage point in hospitals'amount of patient revenue per totalassets was associated with increases intotal and operating profit margins of0.02 and 0.03, respectively. A similarincrease in the amount of patient rev-enue was also linked to increases in freecash flow-based and discounted cashflow-based equity values of $12,971and $9,110,706, respectively. Cenerat-ing higher patient revenues was thusstrongly positively related to hospitals'financial performance. These findingsprovide evidence that, besides improv-ing the speed of revenue collectionthrough more effective management ofaccounts receivable, generating morepatient revenue plays an important rolein not-for-profit hospitals' profitabilityand ability to build equity capital.

D I S C U S S I O NSuccessful management of the patientrevenue cycle plays an important role innot-for-profit hospitals' efforts to boostprofitability, build equity capital, andthus remain financially viable over thelong term. This article demonstratesthat not-for-profit hospital profitabil-ity is dearly linked to revenue cycle

333


E X H I B I T 3Hospital-Level Fixed or Random Effects Regression Analysis of Hospital Profitability and EquityValues

Variables

Constant

Total ProfitMargin

8.37**

(.77)

Revenue Cycle Management Performance

Days in net accountsreceivable

Net patient revenue

per total assets

Control Variables

Days in accountspayable

Average age of

plant, property, andequipment


Financial asset ratio

Patient days (in 000s)

Revenue growth

Year dummies

Hospital fixed orrandom effeas

Adjusted R^

-.0677**

(.0056)

1.77**

(.53)

-.0318**(.0094)

.223**

(0.039)

-10.52**(.82)

7.21**

(.75)

.0025(.0016)

7.88**

(.90)

7 included

1,170 fixed

effects included

.21

Operating ProfitMargin

6.08**

(.59)

-.0649**

(.0049)

3.34**

(.38)

-.0536**(.0071)

-.008**(.031)

-7.66**(.57)

3.27**

(.58)

.0084

(.0061)

10.17**

(1.13)

7 included

1,170 random

effects included

.17

Free Cash Flow(in 000s)

-8,330.50*

(3,274.25)

-50.83*(24.70)

12,970.55**

(2,245.39)

-184.12**(52.70)

-336.22*

(157.78)

N/A

9,594.87**

(3,262.93)

.083**(017)

-926.66(5,609.04)

7 included

1,170 randomeffects included

.15

Equity Value(in 000s)

-847,814

(491,161)

-4,009.30**

(1,426.33)

911,070.60**

(157,983.80)

-4,335.95(2,595.65)

-699.24

(11,797.91)

518,754.60*

(217,767.70)

696,743.00**

(207,897.90)

4,090.35(3,762.15)

324,122.90

(184,681.10)

7 included

879 fixedeffects included

.33

Note: Heteroskedasticity robust White standard errors are in parentheses. Independent variables were lagged in all analyses.

* Statistically significant at the 5 percent confidence level.

* * Statistically significant at the 1 percent confidence level.

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management performance. Createramounts of patient revenue per totalassets and faster collection periods areassociated with improved operatingand, to a somewhat smaller degree, totalprofit margins. As hospitals adopt moreaggressive pricing policies and reducerevenue deductions and write-offs,operating revenue per patient increases,resulting in higher operating incomeand, consequently, higher operatingmargins. Higher average patient rev-enue also has a positive, albeit smaller,effect on total margin. While operatingincome represents an important elementof net income, the latter also dependson nonoperating activities, in particularthe management of endowments andfinancial investments (McCue 2010;Reiter and Song 2011). Larger, well per-forming not-for-profit hospitals, such asthose analyzed in this study, have beenfound to generate substantial amountsof nonoperating income, which maybe an important reason that net patientrevenue per total assets displays a stron-ger link with operating than with totalprofit margins.

In addition to the amount of patientrevenue, the speed with which hospitalscollect revenue plays an important rolein their financial performance. Shortercollection periods are associated withimproved operating and total profit mar-gins. Collecting patient revenues fasterreduces a hospital's balance in accountsreceivable and, consequently, its needfor short-term financing and its inter-est expense. Reduced interest expensetranslates into higher operating and netincome and improved profit margins.Unlike net patient revenue per totalassets, which is more strongly associated

with a hospital's operating performance,days in net accounts receivable displaysalmost equally strong links with bothoperating and total profitability. Civenthat reductions in interest expenses havea direct effect on a hospital's operatingperformance but only an indirect effecton its total profitability, this finding mayindicate that hospital managers use sur-plus cash as a result of shorter collectionperiods not only to reduce their orga-nizations' short-term liabilities but alsoto invest in interest-bearing securities,which produce additional investmentincome and, consequendy, increase non-operating income.

A second important finding of thisstudy is that effective revenue cycle man-agement is associated with not-for-profithospitals' ability to grow their equitycapital. Creater amounts of patientrevenue and shorter collection periodsare strongly linked to higher equityvalues. As expected, greater amounts ofpatient revenue and shorter collectionperiods are associated with higher freecash flows, which represents a key com-ponent of discounted cash flow-basedequity valuation. Cenerating morepatient revenue results in additionalcash inflows from patients and third-party payers, which boosts a hospital'scash flow from operations, one of themajor components of its free cash flow.Likewise, each reduction in accountsreceivable results in a one-time cashinflow as it reduces a hospital's invest-ment in net working capital and thusincreases its free cash flow.

While our conceptual model dis-cussed the pathways through whicheffective revenue cycle management ishypothesized to improve a hospital's

335


financial performance, the researchdesign of this study does not allow usto determine whether revenue cyclemanagement is indeed exogenous tofinancial performance. Not only doesmanaging the revenue cycle effectivelyaffect hospitals' financial results, butalso superior financial performance mayprovide hospitals with the resourcesthey need to improve their managementof the revenue cycle. Strong financialperformance may enable hospital man-agers to focus more of their time andresources, both of which may be morereadily available in organizations thatperform well, on managing the revenuecycle. Financially well-off hospitalsmay, for instance, have the resources toimplement a more sophisticated billingand denials management system andthus reduce their outstanding accountsreceivable and shorten their average col-lection periods.

Concerns regarding the reversecausality discussed above are, however,mitigated by empirical evidence thatover the past decade, not only the mostprofitable hospitals but also hospitalsacross the board achieved substantialimprovements in their revenue cycleperformance. Hospitals were able toboost their patient revenue by continu-ing the aggressive pricing policy manyof them had begun to adopt and collecttheir patient revenue faster (Solucient2005). While certain investments inrevenue cycle management, such asthe implementation of an electronichealth record system that collects andconnects all of a patient's clinical andadministrative data, are indeed difficultand costly to introduce (Eldenburg,Schäfer, and Zulauf 2004), others can

be implemented by reorganizing andstreamlining small but key aspects of therevenue cycle, such as standardizing theprocess of collecting patient informationduring registration through educationand training sessions for all staff mem-bers involved (May 2004).

The generalizability of our find-ings, however, is limited. Our sampledoes not represent a random sampleof US hospitals; it includes only bond-issuing, not-for-profit hospitals. Thesehospitals are generally larger and betterperforming than the average hospi-tal—they have higher occupancy rates,lower average lengths of stay, greatercash reserves, and stronger operatingand total profit margins. The findingsof this study thus likely hold true forlarger, financially well-off, not-for-profithospitals but may not be generalizableto smaller, poorer performing hospitals.Moreover, the results may not general-ize to for-profit hospitals, which havebeen found to differ from not-for-profithospitals on a number of organiza-tional and financial characteristics (see,for instance, Sloan 2000). Our findingsdo, however, hold for both individualhospitals and health systems. When weran our analyses separately for the sub-sets of individual hospitals and healthsystems in our sample, we found nomeaningful differences.

I M P L I C A T I O N S F O RP R A C T I C EIn times of increasingly constrainedreimbursement, hospitals are challengedto provide high-quality care profitably.As our results have shown, improvingthe flow of patients and dollars throughthe hospital is strongly linked with better

336


financial outcomes. For revenue cyclemanagers and consultants, these find-ings provide empirical support for theircontinuous efforts to improve their orga-nizations' revenue cycle management.Examining each step of the revenue cyclefor potential improvement opportunitiesand thus streamlining the entire revenuecycle frequently is a worthwhile under-taking that has the potential to deliver apositive retum on investment.

As a result of healthcare reform,revenue cycle management willbecome more important in the future.Although the Affordable Care Act (ACA)is expected to reduce the number ofuninsured and thus hospitals' charitycare and bad debt burden, hospitalscan also expect to see cuts in Medicareand Medicaid reimbursement rates andin disproportionate share payments.In addition, hospitals will likely face agrowing self-pay population as employ-ers continue to shifr more of theiremployees to high-deductible healthplans or decide to drop health insur-ance coverage altogether. As a result,most hospitals can expect to experiencedeclines in their patient revenue base.Effective management of the revenuecycle has the potential to offset some ofthese revenue reductions and thus helphospitals maintain their liquidity andprofitability as the ACA takes full effectover the next few years. Hospitals will,however, need to redesign their revenuecycle by overhauling current practices.Among other things, hospitals willneed to adopt financial systems that canaccommodate higher patient volumes,facilitate coverage eligibility verification,and provide enhanced patient access tofinancial information.

Besides changes in insurance cov-erage and payment rates, the ACAwill further complicate revenue cyclemanagement for hospitals by fosteringalignment with physidans and otherhealthcare providers and introducing asystem of bundled payments. Hospitalsthat establish accountable care organi-zations (ACOs), for instance, will haveto manage not only their own revenuecycle but also the flow of patients anddollars throughout the ACO network.Effective revenue cycle management insuch multisetting care models will needto be redefined to include the capabilityto share information and manage pay-ments across multiple providers so thateveryone involved can avoid negativefinancial impacts and remain financiallyviable in the future.

NOTES1. Audited financial statement informa-

tion for bond-issuing, not-for-profithospitals was supplied by MerrittResearch Services LLC of Cedar Rapids,Iowa. The software to construrt the dataset used in this research was providedby InvestorTools, Inc. of Yorkville, Il-linois.

2. In theory, the cost of a firm's equitycapital should reflect the premiumdemanded by equity investors to investin a firm or project with comparablerisk. In the absence of a residual claim-ant, however, the cost of equity financ-ing for a not-for-profit hospital can bedifficult to determine and the hospital'sboard of direaors must usually provideguidance on the retum required by thecommunity for capital investments(Wheeler and Smith 1988). The rateof retum on a not-for-profit hospital'sequity should thus be derived from itslong-range financial plan, which indi-cates the rate of grov̂ t̂h necessary to

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achieve the institution's goals (Conrad1984; Wheeler and Clement 1990).Hence, one common approach to de-termining the required return on equityfor not-for-profit organizations is tocalculate the actual return on equityover the past few years, which can tiienserve as a starting point in establishingfuture target grov\^ rates (Wheeler andSmith 1988).

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P R A C T A P P C A T

Kirk Roden, MBA, FACHE, director of management operations, UT Health MedicalSchool, Houston, Texas

Scientifically determined data help managers improve their ability to run theirorganizations, and the authors of this article have done a fine job in establishing

the link between effective revenue cyde management (RCM) and the financial healthof nonprofit hospitals. This link is probably applicable to most healthcare deliveryorganizations.

One of the main reasons I chose a career in healthcare management was my strongdesire to comprehend complex systems and translate them into easily understandablecomponents. I was also passionate about applying these skills to increase the effective-ness of the delivery of quality care to patients and to help improve their lives.

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