HLTH 8430 Week 5 Liquidity and Debt Ratio Brief Example

Ratio Brief: Can Harmon Valley Health Borrow More? Liquidity, Debt Load and the Binding Constraint

Student Name

Walden University

HLTH 8430: Healthcare Financial Management

Instructor Name

Month Day, Year

Ratio Brief: Can Harmon Valley Health Borrow More? Liquidity, Debt Load and the Binding Constraint

The Question and the Answer

The finance committee is considering new borrowing. On the latest year's results, Harmon Valley Health's liquidity is comfortable and its debt load is not, and debt service coverage is the ratio that limits how much more it can borrow. All figures are illustrative, and peer comparisons are stated only as above or below the median for similarly rated systems, without printing a median value.

Five Ratios

Table 1 shows the five ratios the committee needs.

Table 1

Liquidity, Debt and Margin, Three Years (Illustrative)

Liquidity

Days cash on hand has risen to 212 and cash to debt to 1.9 times, both above the peer median. The system could fund a modest project from reserves without approaching its bond covenant of 100 days cash on hand. Healthcare finance texts treat these two ratios together as the main measures of a system's ability to meet obligations and absorb shocks (Cleverley & Cleverley, 2018).

Debt Load and Coverage

The debt ratios tell a different story. Debt to capitalization, at 42%, is higher than the peer median, meaning debt finances a larger share of the system's assets than at similar systems. Debt service coverage, which divides the cash a system generates for paying lenders by the principal and interest due each year, has fallen from 2.2 to 1.9 times and sits below the peer median. It is the ratio closest to the minimum the bond documents require, 1.25 times.

Coverage binds because it depends on operating cash flow, which depends on an operating margin of about 1%, below the median. National evidence shows that patient care margins are thin for many hospitals; Bai and Anderson's analysis of Medicare cost reports for fiscal 2013 found that fewer than half of acute care hospitals made a profit on patient care (Bai & Anderson, 2016). Strong reserves do not raise coverage, because coverage is measured against cash flow, not cash. Operating margin is therefore the ratio to watch: each half point of margin gained would add several million dollars a year of cash available for debt service and widen the headroom described below.

Headroom

At current cash flow, Harmon Valley could take on new annual debt service of about half its present level before coverage fell to the 1.25 minimum. A prudent board would keep a cushion above the covenant, since one weak year could erase it; staying at or above 1.5 times would limit new annual debt service to roughly a fifth of the current level. Lenders and analysts read coverage alongside operating margin for this reason (Gapenski & Reiter, 2016). Any borrowing beyond that range would need either a stronger operating margin or a decision to fund part of the project from reserves, which the system's liquidity can support.

References

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

Cleverley, W. O., & Cleverley, J. O. (2018). Essentials of health care finance (8th ed.). Jones & Bartlett Learning.

Gapenski, L. C., & Reiter, K. L. (2016). Healthcare finance: An introduction to accounting and financial management (6th ed.). Health Administration Press.