Financial reserve: hospitals leery of credit lines, factoring receivables - Special Report

Healthcare Financial Management, Oct, 1991 by Donald E. Edwards, William C. Hamilton, Rex Hauser

To pay for routine operating expenses, many hospitals must work especially hard to develop and protect adequate cash reserves. Provisions must be made for covering short-term operating cash deficiencies through cash budgeting.

Like many other industries, health care may be able to establish and use operating lines of credit with a variety of organizations to meet temporary cash needs. When collecting receivables cannot be accelerated, factoring (selling) these assets may be feasible for securing operating cash.

Operating lines of credit provide cash on an ongoing basis to cover day-to-day needs. The cost of an operating line usually is somewhat higher than the prime interest rate, and collateral may be required. (a) Sufficient collateral must be maintained to support the outstanding line of credit. For hospitals, receivables could be a viable source of collateral in revolving credit arrangements.

When a hospital sells its receivables, accounts generally are sold at a discount to a financial institution. The buyer may or may not fully assume the risk of collecting them. Although some receivables may not be sellable because of government restrictions (see article on p. 90), accounts that can be sold represent a possibly large infusion of cash.

Data Source

In a recent survey, a questionnaire was sent to hospital administrators to measure the extent to which hospitals are establishing lines of credit and factoring receivables to secure operating cash. From the approximately 6,400 U.S. hospitals listed in the American Hospital Association's 1990 Guide to the Health Care Field, 863 were randomly selected to participate in the project. Replies were received from 281 of the 863 hospitals, a response rate of 32.6 percent.

The responses were proportionately consistent with the survey's sampling plan, in which a hospital with fewer than 100 licensed beds was considered small, a hospital with 100 to 250 beds was deemed medium, and a hospital with more than 250 beds was defined as large. The size of each group broke down as follows:

* Small: 128 hospitals or 45.6 percent of the 281 responses;

* Medium: 88 hospitals or 31.3 percent of responses; and

* Large: 65 hospitals or 23.1 percent of responses.

The statistics have a maximum error level of 5 percent, with a minimum confidence level of 90 percent.

Exhibit 1 shows the extent to which lines of credit are used by hospitals participating in the study. An interesting finding is that the majority (54.8 percent) of respondents currently do not use lines of credit. No statistically significant relationship appears between facility size and use of credit lines

Exhibit 2 depicts the major sources of lines of credit for the 127 hospitals that reported using such short-term financing. As might be expected, 123 (97 percent) of surveyed hospitals are using lines of credit with commercial banks. Some 68 percent of the respondents have lines of credit with vendors. Several other minor sources of credit were reported, including arrangements with savings and loan institutions and savings banks.

Statistical tests of expected and actual frequencies of responses showed that use of credit lines with vendors occurred more frequently than expected for each size of hospital. To a somewhat greater extent

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than would normally be expected, vendors are financing day-to-day operations of hospitals. Column totals would be meaningless in Exhibit 2, because many hospitals reported using multiple sources of credit lines.

Credit line authority

Respondents with lines of credit were asked to indicate titles of hospital officials who negotiate credit lines. Exhibit 3 shows that arrangements for credit normally are made at a very high level within an organization. Of the 127 responding hospitals, 77 indicated that credit lines were negotiated by a vice president, chief financial officer

EXHIBIT 1: Credit line use by hospital size (a)
                         Number of hospitals responding
                        Small   Medium   Large      Total
Credit lines used         59      36      32     127 (45.2%)
Credit lines not used     69      52      33     154 (54.8%)
                         128      88      65     281 (100%)
(a) Small = fewer than 100 beds; medium = 100-250 beds; large =
more than 250 beds.

(CFO), or both. Another 59 respondents reported that developing credit lines was the responsibility of either the administrator or chief executive officer.

In small hospitals, the survey showed that credit lines are negotiated most frequently by a hospital administrator. CFOs, on the other hand, were most often responsible for obtaining lines of credit in medium and large hospitals. Only four purchasing managers were involved in securing lines of credit at small hospitals, another indication that such matters are handled by top-level administrators. Again, column totals for Exhibit 3 would be meaningless, because some respondents indicated that several officials are involved in securing and developing lines of credit.