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

Total free cash flow ratio. The total free cash flow ratio is the most forward looking of all of the measures discussed in this article. It is an indicator of the hospital's ability to meet future cash commitments, and as such, it portrays a hospital's ability not simply to survive but to thrive. Unlike the previous measures, it includes capital expenditures. Continued capital investment is necessary for any hospital to thrive in the long run. Thus, the board and management should use this ratio to ascertain the capacity of the firm to meet its long term strategic vision and mission.

Distress Remedies

How should you respond if you find that some of these ratios suggest financial distress or a lack of long term viability? The answer obviously depends on your organization's particular situation and the unique set of circumstances that caused it. The potential causes of and cures for financial distress obviously are too numerous to be described in this article, but some of the more common responses are listed below. In general, responses can be categorized as short- and long-term, although these categories often overlap.

Short-term responses. Obtaining additional financing through debt (such as a line of credit) or equity is a short-term response available to some hospitals, but many firms experiencing financial distress will not have this option. Other common short-term responses of hospitals to financial distress include stepping up fundraising efforts, including those focused on increased philanthropy, and seeking local governmental or tax support. Many hospitals find short term relief through sale of assets, such as land, divisions, buildings (perhaps through sale/leaseback arrangements), equipment, and factoring receivables.

Long-term responses. At times, extreme financial distress can force a hospital to reconsider its strategic vision and mission. Such a response typically requires a thorough market analysis and assessment of local economic conditions. Other actions that may be required that have long-term implications include bankruptcy reorganization: reconfiguration of assets and services: and joint ventures, mergers, or sale of the hospital.

Make It Routine

The seven measures described above, used in combination, provide a balanced and thorough approach to analyzing an organization's financial health. Using these financial measures, any board member, manager, or analyst can detect--long before corporate failure whether an organization is approaching financial distress. Short of significantly fraudulent financial reports, we know of no cases of corporate failure that would not have been predicted using one or more of these measures.

To make effective use of these tools, monitoring must be routine. Tracking the seven ratios regularly and consistently is the only way to be assured of seeing the signs of impending financial distress far enough in advance to respond effectively. Keep in mind, too, that the ratios should be interpreted in the context of your organization's particular situation. These ratios sometimes reach unfavorable levels briefly because of a one-time occurrence or planned activity, giving little cause for concern, gut if the ratios were to remain at unfavorable levels for an extended period, immediate corrective action would likely be needed to ensure your organization's continued viability.