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On the Cash Conversion Cycle for Healthcare Organizations

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Understanding Why Cash Flow is King

By Dr. David Edward Marcinko; MBA, CMP™

[Publisher-in-Chief]

The manager, administrator or COO of a hospital’s working capital, or physician executive of a private medical practice, strives to optimize the amount of cash on hand to ensure daily operations. Too much cash generates little return, while too little may jeopardize the healthcare enterprise, incur borrowing costs or cause missed investment opportunities.

Also, the extent to which current assets cover current liabilities, determines whether the entity is considered liquid and thus able to meet its payment obligations on time.

The Balancing Act

When faced with the management balancing act of current assets and current liabilities, the alternative with the highest net present value (NPV) and internal rate of return (IRR) is typically selected. This is often a difficult balancing act since providing healthcare services generates little immediate cash, and then cash receipts are variable depending upon payers or other third parties.

Yet, each hospital or practice distribution transaction requires immediate liquid cash for employees, vendors, debt holders, and investors in the form of dividend payouts or retained earning disbursements. The cash conversion cycle (CCC) length measured in days is composed of two ratios:

  1. The first is the average inventory holding period (ending inventory divided by revenues per day),
  2. The second is the collection period (ending ARs divided by revenue per day). For both ratios, faster is better.

CCC Averages

Sample CCCs for an industry-average hospital (45 days average-non-electronic) are:

1. hospital admission to patient discharge (5 days);

2. patient discharge to hospital bill completion (5 days);

3. hospital bill completion to insurance (third-party administrator or TPA) payor receipt (5 days);

4. receipt by TPA to mailing of hospital payment (25 days);

5. payment mailed to receipt by hospital (3 days); and

6. payment receipt by hospital to bank deposit (2 days).

Assessment

Naturally, healthcare managers, administrators, physicians and hospital executives should be interested in motivating changes in the behavior of staff such that processes within the control of the enterprise can be streamlined and completed in less time.

For example, a day or two reduction in the amount of time it takes from patient discharge to hospital bill completion, as achieved with the use of electronic charts and medical records systems, can significantly increase cash flow. Likewise, the use of electronic funds transfers and/or lock box collection mechanisms can reduce the amount of time it takes for an account receivable to make it into the bank.

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One Response

  1. MO Passes Timely Payment Law

    Did you know that Missouri health plans will now be required to make “timely payments” to healthcare providers in the state, according to a new law signed by Gov. Jay Nixon (D) on April 27, 2010.

    H 1498 was prompted by a 2009 report from the Missouri Department of Insurance that showed almost 26% of claims at urban hospitals, and more than 37% of claims at rural hospitals, are past due by 90 days or more.

    The new law requires insurers to either pay or deny claims within 45 days of receipt, and eradicates the insurers’ ability to “suspend” claims. Plans that don’t pay claims within 45 days will pay a daily penalty to the healthcare provider of 1% of the outstanding claim.

    Source: Health Plan Week [5/3/10]

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