Industry Insights

Critical Access Hospital Cash Management Mistakes Following a Construction Project

September 2015
Authors:  Matt Klauser

Matt Klauser

Director

Transaction Services

Health Care
Manufacturing & Distribution

14241 Dallas Parkway, Suite 1100
Dallas, Texas 75254-2961

Dallas
972.702.8262

 & Andy Kaempfe

Andy Kaempfe

Senior Managing Consultant

Transaction Services

Health Care

910 E. St. Louis Street, Suite 200
P.O. Box 1190
Springfield, MO 65801-1190 (65806)

Springfield
417.865.8701

Both large hospital systems and small rural hospitals need to consider the cash flow implications of a capital project. However, critical access hospitals (CAH) are especially susceptible to cash management mistakes following a major construction project.

The main incentive for a CAH to complete a major renovation or replacement facility project is the cost reimbursement provided by Medicare (and in certain states, Medicaid). Under the current reimbursement methodology, a CAH can fund a portion of the debt service for a project with the increased reimbursement rates provided by these programs.

However, interest expense declines over the life of a project, and the average depreciable life of the assets purchased with the project debt may be shorter than the term of the debt. This creates declining Medicare reimbursement over the term of the project debt—despite the fact that amortization of the debt will be consistent on an annual basis. A CAH’s Medicare/Medicaid payor mix will determine the extent of the disparity. 

The following example illustrates the disparity between the cash flow received through increased cost-based reimbursement and the annual principal and interest payments related to the project debt. This scenario is built with the following assumptions:

For this scenario, we assumed that, on average, the CAH receives approximately 50 percent overall cost reimbursement. Thus, for every $1 of additional expense reported on the cost report, reimbursement increases by 50 cents. In this example, total expenses reported on the cost report over the 30-year term of the project debt are as follows:

The following chart depicts the declining cost-based reimbursement over the term of the project debt in relation to overall debt service. The cash shortfall represents the annual debt service not covered by increased reimbursement. At the project’s onset, approximately 80 percent of the project debt service is covered by the increased cost-based reimbursement. However, this percentage decreases to 18 percent in the final year of the project debt. 

Since cash flow through increased cost reimbursement does not correlate with project debt service, management should consider establishing a savings plan to accumulate excess cash flow that can be used to supplement cash flow in the later years. By computing estimated annual average cost reimbursement over the project debt term ($9,757,715 divided by 30 years = $325,257 per year) and comparing the average to each year’s expected cost reimbursement, the cash flow excess (shortfall) is computed as illustrated below:

In this example, management should consider setting aside excess cash flow over the first half of the project to supplement cash flow in the second half of the project. This will allow the CAH to avoid increasing financial burden over the term of the project debt. Excluding any investment return on the accumulated savings, the savings account balance would be as follows:

Using this type of savings plan would allow the CAH to stabilize cash outflow over the life of the project. The chart below illustrates the differences between net annual cash outflow with and without the use of a savings plan. Annual cash outflow is computed as total principal and interest payments less the increased cost-based reimbursement received, adjusted for any deposits to or withdrawals from accumulated savings.

Often, a forecast or projection is completed to evaluate whether the CAH can absorb the debt service for the project. While these prospective statements typically look forward three to five years, understanding the cash flow impact of a large capital project over the entire term of the project financing is vital to the decision making and cash management processes. Many debt instruments require establishing a debt service reserve fund, but the nature and amount of such a reserve fund doesn’t satisfy the need for the savings plan described in this article. 

For more information on financial budgeting and forecasting, contact your local BKD advisor.

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