Selling accounts receivable can improve cash flow

Healthcare Financial Management, Sept, 1989 by Mel Spiegel

Selling accounts receivable can improve cash flow

New financing programs especially geared to accounts receivable allow healthcare organizations to convert these assets into cash literally overnight and at costs below the prime interest rate. Certain pooled versions of the financing strategy include non-recourse features that guard against sharing bad debts among the participants. These pooled programs generally allow hospitals to continue managing and billing their own accounts.

For healthcare organizations under pressure to meet payroll, pay bills, or reduce debt, "selling" accounts receivable provides a new source for low-cost, readily available cash.

Asset-backed--or "securitized" --financing recently brought dramatic changes to the way financial institutions use assets (such as credit card receivables, automobile loans, and home equity loans) to reduce debt burdens and improve cash flow.

Now hospitals are following suit with similar results. By converting accounts receivable to cash or its equivalent, they can add muscle to financing day-to-day activities.

The method works like an internal bank and offers an alternate way of reaching traditional sources of capital, such as Wall Street firms, banks, leasing companies, and joint venture partners. The structure also resembles off-balance-sheet financing by removing receivables from the books and selling them on a non-recourse basis for their fair market value.

Source of working capital

Accelerating cash flow has become necessary for hospitals hardest hit by changes in Medicare's periodic interim payment (PIP) program. Previously, the program sent payments to hospitals twice each month, with a final adjustment made at the year's end. To better manage the Federal cash flow, the Health Care Financing Administration (HCFA) has instructed fiscal intermediaries to slow the payment of claims.

Third-party payers, in turn, slowed their payment cycles by using intense retroactive reviews of medical records, among other means. Modified payment methods by health maintenance organizations and preferred provider organizations have brought additional cash flow delays.

One of the most important benefits of selling receivables is that it permits hospitals to build working capital at a time when new sources of funds are limited at best.

Pressure to reduce the national deficit, for instance, could compel the Federal government to take steps toward limiting the use of hospital revenue bonds as tax-exempt investment vehicles. As a result, traditional financing through hospital revenue bonds could be modified to resemble that of Industrial Development Agency revenue bonds.

By selling receivables, hospitals gain welcome flexibility in managing their obligations. The method improves liquidity and cash flow through reduced days outstanding in receivables. Proceeds enable hospitals to retire some debts, thus holding down debt-to-equity ratios and enhancing borrowing power in the marketplace.

Because the method can reduce short-term debt through borrowing at lower interest rates over longer periods of time, it also helps maintain favorable credit ratings. This increases the likelihood of future transactions and enhances debt service coverage ratios.

While most hospitals borrow funds at or above the prime interest rate, selling accounts receivable allows them to reach capital markets at costs below the prime rate.

These savings and improved flexibility give hospitals the ability to pay vendors more quickly, creating an opportunity to negotiate better contracts and prices.

Receivables financing also allows hospitals to use new-found liquid assets to increase yields. For example, assets can be used as a more effective way of funding depreciation costs by investing receivable proceeds for longer than normal periods and at higher rates. If the maturity date on the investment is placed further out, yields are greater than under traditional terms.

By keeping internal banking transactions at arm's length, hospitals can use those funds to make loans to for-profit subsidiaries or joint venture partnership at market or below-market rates, without threatening their tax-exempt status.

A new concept

The concept of financing accounts receivable is relatively new for hospitals. Only recently has a variety of financing programs become available, most of them currently sponsored by banks, financial groups, and through group pooling arrangements.

Traditionally, hospitals had access only to factoring programs, a process that involved pledging their accounts receivable as collateral in exchange for cash. Exercising this option also depended on the hospital's creditworthiness. Covenants of hospital bond issues, however, often prohibited them from pledging those assets and using factoring as a source of capital.

On the other hand, accounts receivable financing, if done on a non-recourse basis, involves the actual sale of these assets in keeping with terms of the Financial Accounting Standards Board Statement 77, which views the transactions as true sales. Now, most hospitals can take advantage of the method without violating the terms of their bond covenants.