Financing maneuvers: two opportunities to boost a hospital's working capital - factoring and asset-backed securities - Special Report

Healthcare Financial Management, Oct, 1991 by Sandra Ferconio, Michael R. Lane

* Divestiture of a facility. After a facility is sold (fixed assets only), a parent hospital can sell receivables of this facility to provide immediate cash flow;

* Interim financing for small acquisitions until sufficient volume is reached to finance with tax-exempt bonds. Proposed U.S. Treasury regulations, however, may eliminate this benefit; and

* Interim financing for subsidiaries not eligible for tax-exempt financing. Receivables financing can provide inexpensive funds for construction projects, such as a medical office building.

Creating a steady and predictable flow of cash resulting from continuous participation in a financing program, is, of course, the primary reason why healthcare providers enter into financing programs. Predictable cash flow makes business decisions easier.

With elimination of the periodic interim payment (PIP) program for all but disproportionate-share hospitals, predictability of cash flow has become much more difficult. Bi-weekly PIP payments often were used to meet periodic operating expenses, such as payroll. Without PIP, hospitals have become more susceptible to external influences and internal efficiency of operations in registration, medical records, and patient accounting departments.

Another benefit of both financing programs is that they treat a transaction as the sale of an asset. Under Financial Accounting Standards Board Statement No. 77, accounts receivable sold as an asset can be removed from the sellers' balance sheet. Along with providing a more consistent cash flow, removing factored receivables from a seller's balance sheet means that no corresponding liability must be recorded, as would be the case with capital or working capital financing. Furthermore, debt covenants of tax-exempt revenue bonds or other long-term capital financing agreements typically are not affected, and a seller's ability to obtain additional long-term capital financing will not be hindered.

Certain private placements having non-standardized bond covenants may prohibit this type of transaction. Public offerings generally will not prohibit an asset-backed transaction if accounts receivable are sold at fair market value. Discounted purchases common in factoring, however, may not be allowed.

Where they differ

As more hospitals seriously consider converting their receivables into a source of working capital, they must decide which financing option best meets their needs at an acceptable cost and level of risk. Although both programs accomplish the same goal, their structures and incentives vary. Generally, they differ in terms of the level of advance funding, cost of participation, degree of control over account servicing, and eligibility for program participation.

Level of advanced funding. The level of funds a factor advances to a seller differs significantly between factoring and securitization. In a typical factoring transaction, advance funding approximates 50 percent of the discounted value of net eligible receivables. The remaining value of the sold asset, net of administrative fees, is paid to the seller as third-party payments are received by the factor.