The road to recovery from the operational and financial challenges resulting from of COVID-19 will be lengthy for hospitals and health systems. Quick hits or fast fixes may help an organization stay afloat in the short term, but for the most part, taking action now is a long-term play.
Across the board, the toll has been heavy
In the best of times, many healthcare providers operate with limited reserves and limited margins. In the current situation, financial positions are precarious due to the double burden of additional expenditures — such as extra safety precautions and personal protective equipment — and revenue lost to cancelled procedures and shifting patient behavior. Hospital revenues have plummeted by an average of 30% to 40%, according to Moody’s
, and the American Hospital Association estimates a loss of $202.6 billion
for hospitals and health systems from March 1 through June 30.
Because of the crisis and the resulting financial challenges, more healthcare providers are likely to be in violation of loan covenants. The overall issue is not as much making debt payments as it is maintaining certain agreed-upon thresholds. For instance, many borrowers subject to loan covenants are concerned about potential violations related to debt service coverage and days cash on hand requirements — and the resulting possibility of the acceleration of debt because of a technical default. While a substantial level of defaults hasn’t necessarily happened yet, a significant increase in defaults is likely to coincide with testing and reporting deadlines. As hospitals and health systems test and report their covenant compliance, we can expect to see a higher number of technical defaults than ever before.
Act now to get on the road to recovery
It’s wise to begin strategizing now, during the crisis, about how your operations and financial position may look down the road. If your organization is currently out of compliance or likely to be out of compliance soon, it may be too late to get in compliance for your next testing period. Now is the time to start thinking about how you will return to compliance down the road. In the healthcare sector, it can take time to see the financial impact on the financial statements of today’s decisions. What decisions can you make today to optimize your ability to comply with your covenants in future periods? To make fundamental changes, start with an improvement goal for Dec. 31, 2020, or even June 30, 2021.
In addition to the future financial impacts of your decisions, it is critical to consider that the operational and financial choices bringing short-term relief today may be difficult to reverse as recovery continues. For example, calling back primary care doctors after eliminating or minimizing a practice, for example, would be a tall hill to climb. The decisions you make today may fundamentally alter the course of your organization and may be irreversible.
A case study demonstrates the value of developing a forward-thinking mindset about operational and financial challenges. In fall 2019, Grant Thornton professionals worked with an organization focused on achieving desired outcomes for its June 30, 2020, covenant compliance reporting period. Though it might have appeared to be an abundance of allotted time, every day that went by diminished the organization’s ability to generate additional revenue or reduce incremental expenses for sufficient cash to return to compliance. In these situations, waiting results in more difficult decisions or operational challenges.
A case study in long-term thinking
Behavioral health organization with annual revenue of roughly $400 million and over 6,000 employees serving more than 20,000 individuals
Poor FY19 financial performance having led to violation of debt service coverage ratio, the organization sought independent guidance to return to more favorable financial footing
Management was assisted in developing a strategic plan and associated financial forecast scenarios to reveal implications of strategic decisions, with scenarios used to determine operational changes required to return to compliance.
The organization was on the road to recovery prior to COVID-19, which may derail FY20 results. But the organization is better equipped to conduct strategic planning and adjust for the future with dynamic financial models applicable through future years. Scenario planning provides knowledge for sound financial decisions for the long term. And the lender has more confidence in the management team, recognizing that they are proactively addressing the challenges.
Action step: Develop strategic plans, financial forecasts and scenarios including covenant calculations
Many organizations develop high-level strategic plans. However, not all convert those strategic plans to business plans assessing the financial implications of the strategic decisions. Putting pen to paper with a financial forecast based upon a strategic plan can provide not only insight into your financial position, but also confidence that your strategic plan is reasonable and sufficient to meet your objectives.
With a baseline financial forecast in hand, consider developing dynamic financial forecasts under a variety of scenarios. Conduct scenario planning to stress-test model assumptions, assess liquidity needs and understand your ability to service debt. These activities can be valuable in strategic planning and identifying opportunities to impact your future financial footing. Build on them monthly and roll them out in annual income statements, balance sheets and cash flow forecasts for expectations about the ends of fiscal years 2021, 2022 and 2023. Finally, layer on covenant compliance calculations to determine your confidence in being compliant based on a certain set of assumptions. If it appears you will not be in compliance, it may be beneficial to reconsider the operational decisions and strategic plans underlying the model assumptions.
Business planning and forecasting
Implications for tomorrow of decisions made today
- Analyze your current and forecasted financial position, developing a baseline scenario. This should include the impact of the current business environment on your financial results and operations.
- Consider sensitivity analyses and evaluate levers to generate revenue or manage costs.
- Evaluate your earnings and note significant deterioration or opportunities for improvement under various scenarios.
- Perform covenant compliance and borrowing base calculations as necessary.
The decisions you make today will play out in the months and years to come — well after the crisis passes. For some organizations in this crisis, every moment counts. Short-term cash flow is imperative. But if you’re comfortable that your short-term liquidity is sufficient, turn your attention to the longer term. In this situation, the best approach is to commit now to decision-making for the long game.
This content was developed in response to concerns shared in a discussion among health system financial leaders.
Grant Thornton’s Healthcare practice professionals facilitate biweekly discussions among health system CFOs, controllers and finance vice presidents from across the country. The forum offers executives an opportunity to share best practices, challenges and solutions in real time.
See additional perspectives in Health systems navigate operating losses and Health systems decisions about work-from-home
For more on COVID-19 concerns and action steps, visit Respond. Restore. Together
and the COVID-19 resource center
Principal, Health Care Transaction Advisory Services
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Senior Manager, Strategic Solutions
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