9 Points for ASCs on Achieving Financial Solvency

Financial solvency is important for surgery centers as they consider their options for long-term growth and viability. "The recent global financial crisis has shown the importance of maintaining solvency and a healthy balance sheet," says Rajiv Chopra of The C/N Group.  "When most people think of solvency, they relate to financial measures, which are quantitative in nature. When you want to evaluate the quantitative aspects of long term financial stability, the best place to start is the surgery center's financial statements. However, there is a qualitative aspect to solvency, and you must look beyond the financial statements to predict what the future may hold."

Mr. Chopra discusses the key aspects of achieving financial solvency.

1. Beware large debt.
When surgery centers have a high level of debt, they are under intense pressure to make debt service payments — this could mean financial distress, much like we saw in the housing market during the recent debt crisis for homeowners. "If an ASC is carrying a lot of debt, chances are they will have trouble making investments in the center going forward," says Mr. Chopra. "Existing centers often need a fresh coat of paint, new OR lights or replacement of aging equipment. If there is a lot of debt on the balance sheet, it becomes a challenge for an ASC to invest in its future."

Some centers have a fair amount of debt because they have borrowed money for strategic purposes in recent years due to generationally low interest rates. In this case, having a big cash balance on the books is good because when they hit a rough spot down the road — such as a wave of capital investment or physicians retirements — they'll be able to weather the storm. One key metric to consider is "Net Cash," which is defined by cash minus long-term debt.  

"One reason Ford survived the recent financial crisis better than General Motors is because it made a strategic move to establish a huge cash balance by drawing on its credit lines well before the crisis hit," says Mr. Chopra. "GM didn't have that option or didn't make that strategic move and ultimately filed for bankruptcy."

2. Pay attention to accounts receivable.
On the assets side, look at how quickly the center is collecting its receivables. "Consistent cash flow is the mother's milk of a surgery center. If you aren't collecting on a timely basis from Medicare and private payors, you don't have any cash coming in the door," says Mr. Chopra. "If you don't have cash flow, you can't meet your obligations. You want to see 30 days to 40 days receivables turnover."

3. Take the liquidity test. The liquidity test compares your cash and accounts receivable to short term liabilities. The dollars you have in cash and receivables represent the numerator of the equation and the short term liabilities (vendor payables, bills for the cleaning company, etc.) are the denominator.

"If you have less in the numerator than the denominator, that means the center doesn't have enough cash on hand to meet its current liabilities," says Mr. Chopra. "The liquidity test is short term assets over short term liabilities and really is a nice indicator of whether or not an ASC can make ends meet."

Having a large accounts payable balance is a red flag. If an ASC takes 90 days to 120 days to pay its bills to vendors that could spell trouble. "This says the centers don't have the cash flow to keep up with the vendors and may experience a disruption in obtaining basics such as medical supplies," says Mr. Chopra.

4. Know what banks are looking at. Banks and other institutions which lend to ASCs have a set of solvency measures they typically utilize. Debt service coverage ratio is typically defined by EBITDA over principle and interest payments on your debt. "Banks are looking for 1.25 to 1.5 for a healthy operation," says Mr. Chopra. "A ratio of 1:1 means the ASC is generating just enough cash to cover its bank payments. You should have more than that to maintain a cushion to continue your operations."

Banks are also looking at leverage ratios: Bank Debt over EBIDTA. Take the outstanding debt you owe to the banks and finance companies in the numerator and EBIDTA is the denominator, which is proxy for cash flow. "If you are over 3:1, that's when the banks start getting nervous," says Mr. Chopra. "In go-go times, banks become more relaxed and you may see them lending at 3:1 or 4:1. However, when the economy is in trouble they tighten evaluations and underwriting standards."

5. Comb your income statement for red flags. The income statement or "P&L" will tell you what has happened with the surgery center over a period of time, including the patient volume trend. Red flags on the bank statement include:

•    Declining volume
•    Margins going down

"If you are looking at long term solvency, you are going to look at the income statement for trends to extrapolate the future," says Mr. Chopra. "If your margins go down but case volume goes up, that means you are probably taking on cases that aren't profitable."

6. Examine your surroundings to predict future trends.
Financial solvency isn't just an exercise about where you were and where you are now, but also where you are going in the future. Look broadly at industry trends to forecast what challenges lay ahead and how you will meet them. One of the biggest challenges today is dealing with declining reimbursements, but that isn't the only thing to consider.

"Look at what is going on in the local market," says Mr. Chopra. "If I drive by the surgery center and see another surgery center going up across the street, or the hospital is opening a surgery center and just acquired the largest orthopedic practice in town, you're going to have challenges competing with them."

Another factor to consider in the marketplace is the number of payors available. "If you are evaluating a center with five big commercial payors, and then there is a big wave of mergers that result in two major payors, the ability to achieve good rates will be hampered," says Mr. Chopra. "If the combined payor represents 40 percent to 50 percent of your business, the payor has more leverage in negotiations."

7. Consider the dynamics within the center.
Internal factors of the organization will have as big of an impact as the external market on the future of the surgery center. Right now, many surgery centers include several physician partners who are nearing retirement age and several who are just coming out of training, with fewer physicians in between.

"You have a set of experienced physicians who are looking to retire in the next three to five years, but they are also the ones who are generating a big chunk of your volume," says Mr. Chopra. "You also have a lot of young physicians coming into the practice who don't have the experience or patient base to carry the center. If you look at a center that has the vast majority of its volume coming from physicians who may retire in the next few years, numbers may be great now, but solvency for the future may be challenged."

When looking around the center, you should also consider future capital expenditures. If the surgery center has worn carpet, old equipment or hasn't painted the walls in a few years, you can predict those costs coming down the pipe.

"Look at when the surgery center opened and see how much money they have spent on capital expenditures," says Mr. Chopra. "If they haven't spent much in the past few years, they will need to spend more in the future. If they don't have much cash on hand and a lot of debt, that's one of those 'uh-oh' moments."

8. Innovate and take risks on up-and-coming specialties.
Projecting long term solvency is difficult because it means not only calculating the past and current state but also considering the future. "When considering long term solvency, a center might want to add new procedures or specialties that are not profitable today but represent the future of where outpatient surgery is going," says Mr. Chopra. "Spine might be one of those areas. If you are conservative, you might wait until reimbursement is up and the cost of supplies comes down. However, if you wait too long the physicians may go to another clinic or hospital and establish a long-term relationship. Long-term solvency also means taking calculated risks."

If you can't immediately incorporate a new specialist or procedure, develop a relationship with those physicians anyway and discuss your plans for the future. These conversations will build loyalty to your center that could be useful when you are able to bring on someone new.

It's important to continually consider what the next big ASC procedure will be in the future to stay financially solvent. By comparison, companies competing in the pharmaceutical industry like Pfizer must invest in research and development — even though the company is currently generating a lot of cash flow and is very solvent as a result of Lipitor — because if they don't chances are they won't develop the next blockbuster drug.

"Solvency is how the center reinvents itself," says Mr. Chopra. "We talk to the ASC management and physicians to get a sense of the market and how they are preparing themselves for the future."

9. Re-focus your mindset for the long-term. Whether an ASC's leaders are long-term or short-term focused has a big impact on financial solvency. "You can learn a lot by seeing how managers run their business," says Mr. Chopra. "If they don't take on debt, have a clean balance sheet and don't spend on things they don't need, they'll be more financially solvent. Financial solvency is driven by decisions made by the governance team."

The best managers have a long-term mindset and are constantly looking at their environment and what their competitors are doing. "These managers don't get too excited when things go well by giving bonuses and huge dividends," says Mr. Chopra. "But when things are bad, they don't panic either. These managers are always thinking about how to grow the center, but in the back of their minds they are preparing for rainy days."

Some centers have experienced success with the short-term focus, but they are left more vulnerable when challenges such as reimbursement cuts come along. "You've got to prepare for the worst, hope for the best, but always expect success," says Mr. Chopra.

Learn more about The C/N Group.

More Articles on Surgery Centers:
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Which Procedures Do Surgery Centers Perform Most: 40 Statistics on 4 Common Specialties

5 ASC Industry Leaders Weigh In on Physician Recruitment

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