Distress detectors measures for predicting financial trouble in hospitals: early-warning systems that anticipate financial distress can provide management with powerful tools to help identify and rectify problems before they reach a crisis

Healthcare Financial Management, August, 2005 by Corbett A. Price, Andrew E. Cameron, Devin L. Price

FUNDS FLOW COVERAGE RATIO

EBITDA / interest   debt repayment / 1 - tax rate  
preferred dividends / 1 - tax rate

WARNING! Investigate further if the FFC ratio is less than 1.0.

Funds flow coverage ratio. The FFC ratio indicates how well the company can meet its interest and, if applicable, tax obligations and preferred dividend payments. The FFC is valuable for predicting the risk of near term loan default. A hospital cannot survive in the long run if it does not generate enough cash to meet its unavoidable expenditures. Some of the obligations reflected in the OCF ratio can be extended if absolutely necessary. For example, hospitals facing financial pressure can defer accounts payable expenditures. Debt and interest payments, by contrast, are contractually obligated, and nonpayment results in technical default.

The FFC ratio's numerator consists of earnings before interest and taxes plus depreciation and amortization. The denominator reflects the organization's unavoidable cash commitments--namely, interest expense plus tax adjusted debt repayment plus, if applicable, tax adjusted preferred dividends. (Tax-exempt organizations, of course, would eliminate the tax adjustment in the calculation.)

CASH INTEREST COVERAGE RATIO

cash flow from operations   interest paid   taxes paid / interest paid

WARNING! Investigate further if the cash interest
coverage ratio is less than 1.0.

Cash interest coverage ratio. The cash interest coverage ratio is preferable to the more often used coverage ratio (or interest coverage ratio) because the former begins with cash flow, whereas the latter includes all sorts of noncash earnings. Cash must be used for interest payments, so a ratio that reflects cash coverage is better. The cash interest coverage ratio reflects a hospital's ability to generate cash sufficient to make the interest payments on its debt. A value less than 1.0 means the organization must take immediate steps to raise cash externally to cover its interest payments.

CASH FLOW TO TOTAL DEBT RATIO

cash flow from operations / total debt

WARNING! Investigate further if the cash flow
to total debt ratio is less than 1.0.

Cash flow to total debt ratio. Whereas the first three cash flow ratios focus on near-term liquidity, the cash flow to total debt ratio reflects a hospital's ability to cover future debt obligations. Thus, it has a longer term orientation than the previous ratios. It can be used to indicate a hospital's capacity for taking on additional debt. Another way this ratio can be used is by taking its reciprocal to predict about how much time the firm would need to repay all of its debt if all cash flow were directed to debt repayment (assuming no new debt and stable cash flow generation). A low value of this ratio means the company has less financial flexibility.

TOTAL FREE CASH FLOW RATIO

net income   accrued and capitalized interest expense  
depreciation and amortization   operating lease and rental expense -
declared dividends - capital expenditures / accrued and capitalized
interest expense   operating lease and rental expense  
current portion of long-term debt  
current portion of capitalized lease obligations

WARNING! Investigate further if the total free
cash flow ratio is less than 1.0.