Days Cash on Hand Does Not Tell the Full Liquidity Story

3 minute
Stethoscope and cash

Days cash on hand is one of the most important metrics in hospital credit analysis. The ratio calculates an organization’s unrestricted cash and investments relative to daily operating expenses.

Here’s a computation commonly used to calculate days cash on hand:

[Unrestricted cash and investments*365 days] / [Annual operating expenses – non-cash expenses]

Math aside, let’s unpack what days cash on hand really tells us. Days cash on hand gives an indication of a hospital’s flexibility and financial health. Essentially, it tells us how long a hospital could continue to operate if cash flow were to stop. From a ratings perspective, the higher the days cash, the better, to create a cushion or rainy-day fund for unexpected events.

While the sheer abatement of cash flow feels like a doomsday scenario, we don’t have to look far back to see examples. The shutdown in the early days of Covid and the recent Change Healthcare cyberattack are examples of events that can materially impact cash flow. While these may be considered extreme, there are plenty of more common events that can disrupt cash flow, including a delay in supplemental funding, an IT installation, a change in Medicare fiscal intermediary, an escalation in construction costs, or the bankruptcy of a payer.

Size and diversified business enterprises can impact days cash on hand. For example, small hospitals with outsized cash positions relative to operations often report a dizzying level of days cash on hand. Health systems with wholly owned health plans often show lower days cash when compared to like-sized peers without health plans. Analysts will also review a hospital’s cash-to-debt ratio, which is an indication of leverage and compares absolute unrestricted cash to long-term obligations. Cash-to-debt creates a more comparable ratio across the portfolio.

In the years leading up to the pandemic, the days cash on hand median increased steadily as the industry went through a period of stable financial performance and steady equity market returns. Hospitals took advantage of an attractive debt market to fund large capital projects or reimburse for prior capital spending. The median crested over 200 days. As discussed during our March 20, 2024, rating agency webinar, days cash median for 2023 is expected to decline or remain flat at best, not because of an increase in capital spending or deficit operations, but because daily expenses (mainly driven by labor) will grow faster than absolute cash. Expenses will outrun the bear, so to speak.

Days cash on hand will remain a pillar liquidity ratio for the industry, but equally important is the concept of liquidity. Days cash on hand doesn’t tell the whole story regarding liquidity. A hospital may compute that it has, say, 200 days cash on hand, but that calculation is based on total unrestricted cash and investments, which usually includes long-term investment pools. A sizable portion of that 200 days may not be accessible on a daily basis.

Recall that during the 2008 liquidity crisis, many hospitals had large portions of their unrestricted investment pools tied up in illiquid investments. When you needed it the most, you couldn’t get it. 2008 was a watershed moment that starkly showed the difference between wealth and liquidity and the growing importance of the latter. Days cash on hand didn’t necessarily mean “on hand.” Many hospitals scrambled for liquidity, which came in the form of expensive bank lines because liquidating equity investments in a down market would come at a huge cost. Nearly overnight, daily liquidity became a fundamental part of credit analysis.

While the events were different, Covid and Change Healthcare followed the same fact pattern: crisis occurred, cash flow abated, and hospitals scrambled for liquidity, drawing on lines of credit to fund operating needs. Within a quick minute healthcare went “back to the future,” and undoubtedly, there will be another liquidity crisis ahead.

Rating reports now include information on investment allocation and diversification within those investments, and report new ratios such as monthly liquidity to total cash and investments. A hospital with below average days cash on hand or cash-to-debt may receive more attention in the rating report regarding immediately accessible funds.

Irrespective of a high or low cash position or rating category, providing rating analysts with a schedule highlighting where management would turn to when liquidity is needed would be well received. For example, do you draw on lines of credit, hit depository accounts, pause capital, extend payables, or liquidate investments, and in what order? Some health systems are taking this a step further with an in-depth sophisticated analysis to quantify their operating risks and size their liquidity needs accordingly, which we call Strategic Resource Allocation. This analysis would boost an analyst’s confidence in management’s preparedness for the next crisis with the segmenting of true cash “on hand.” It would also help ensure that, when the next crisis arrives, management will know where to turn to maintain liquidity and meet daily cash needs.

Lisa Goldstein headshot
Lisa Goldstein is a nationally recognized analyst, speaker, writer, and expert on not-for-profit healthcare. At Kaufman Hall, she is a member of the Treasury and Capital Markets practice and Thought Leadership team.
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