Risk & Compliance

How High Court Vote Could Affect Health Industry’s Cash

The likely result of a thumbs-up decision? A brighter free-cash profile for health-care providers.
David KatzMay 4, 2012

If the U.S. Supreme Court lets the Patient Protection and Affordable Care Act stand, it could boost the revenues of the nation’s health-care providers and improve their ability to spawn free-cash flow as they grow.

Then again, if the Justices retain a provision in the new law curbing the rise of Medicare reimbursements over a baseline rate to the tune of $500 billion, that would shrink the payment pool for providers after the court writes its opinion on PPACA, as it’s expected to do in June.

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True, the net effect of a thumbs-up decision is likely to be a brighter free-cash profile (FCP) for the industry and many of its individual companies, according to Charles Mulford, a professor of accounting at Georgia Tech who invented the metric. The FCP is designed to forecast the ability of a company or an industry to produce cash as it grows. (See “How the Free Cash Profile Works,” below.)

“If national health care goes through, I view it as a positive for the health-care industry, because we’ll have more people covered by insurance,” says Mulford. “If they were to get more care, better care, I would think that somebody’s got to provide that care and it’s the health care industry.”

If the industry’s revenues rise, that would mean its “operating cushion” — a key element of the FCP — will improve. (Operating cushion is operating profit excluding depreciation and amortization, divided by revenue from core operations.)

Mulford, however, has a caveat for the industry about a positive ruling on the act. Although Medicare spending will continue to rise under the PPACA, there will be a $500 billion difference over 10 years between expected, or “baseline,” Medicare spending and what that spending will be as a result of changes the act will make to curb expenditures. Those savings will come at the expense of the health-care providers, largely through skimpier reimbursements. “That would clearly hurt margins and reduce [the industry’s] free-cash profile,” Mulford adds.

If so, the changes would merely dim a free-cash-generating potential that’s been stellar. Basing his research on data for the 12 months ended with the fourth quarter on or nearest to December 31, 2011, Mulford finds that the health-care business shows a median free-cash profile of 7.56%. “That compares very favorably with the results we are reporting for all nonfinancials for 2011 of 3.88%,” according to the professor.

For this particular industry snapshot, he looked at 71 companies in five subindustries: home health, medical labs, hospitals, nursing and personal care, and clinics. (Data for the report is supplied by Cash Flow Analytics, a firm at which Mulford is research director.)

For each industry Mulford looks at, he focuses on a target group of middle-market companies with annual revenues ranging from $300 million to $800 million. Usually, the middle-market companies tend to score higher than the overall industry in terms of working capital performance, perhaps because they are much larger than most other companies and therefore have the clout to get their bills paid faster while paying their own bills more slowly. (One measure of working capital performance is the sum of accounts receivable and inventory minus accounts payable.)

The health-care industry is different, however. In measuring working capital performance, lower is better, and the 13 target companies scored a median percentage of operating working capital to revenue of 4.82%. That was a far worse performance than the -0.74% scored by the industry as a whole.

Why are middle-market health-care firms lagging in their working capital performance? By process of elimination, Mulford found the culprit may well be lax bill collection. That’s because none of the other components of working capital appear to be at fault.  

Health-care companies in general don’t have any inventories to speak of, and thus don’t have to tie up working capital to finance them. Another potential differentiator is the ability to be paid in advance, but most companies in this industry are paid via insurance or Medicare — and those groups don’t prepay.  Finally, the target firms and the industry don’t differ much in terms of the time taken to pay bills. 

“What I found was that the reason for differences in working capital is accounts receivable.  The target firms are getting paid more slowly than the industry as a whole,” Mulford says. At the median, the target firms are getting paid in 55 days, while the industry as a whole is getting paid in 46 days. 

“It would appear that there is room for some management action here among the target firms groups,” says Mulford. “They are underperforming the industry on the rate at which receivables are being collected, and primarily because of this one reason, are generating less free-cash flow as they grow.”

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