Preparing Your Healthcare Financials for a First-Time Sale
As a healthcare provider, you have likely spent years studying your field, refining your skills, and working to provide the best care for your patients. You may have even set up your own practice, juggling the responsibilities of both an entrepreneur and a healthcare provider. As the healthcare landscape continues to expand and evolve, you may be considering how to obtain additional capital needed to grow your business. As you begin this process, the first step is marketing your practice to the investor community in order to access capital.
This marketing process typically involves inviting potential investors to tour the facilities, discussing operations and growth plans, and, of course, sharing financial data. While you have spent time building your practice and reputation, financial information can often fall short of investor expectations. As this information is likely to be front and center during the sale process, it is important to best prepare your healthcare financials before going to market by considering these three areas.
Getting your financial information prepared for investors can be challenging when trying to navigate a sale process and run a practice.
Cash versus accrual accounting
Many practice financials are accounted for on a cash basis. In fact, it is common for business owners use cash-basis accounting, which is easy to understand and can generally be accomplished with bank statements alone. However, investors generally want to see financials on an accrual-basis as it provides better information regarding profitability versus cash-basis accounting, which can be distorted based on the timing of payments. Furthermore, accrual-basis accounting is generally required for lender reporting requirements. Since most deals involve some sort of leverage, investors will need to present accrual basis financials to their lenders during the process. Moving from cash to accrual accounting involves evaluating the major elements of the business and putting together processes to recognize revenue/assets when earned, and expenses/liabilities when owed, versus when cash is received or expensed. For example, under accrual accounting, a company would recognize payroll expenses as employees work versus when they are paid. To do this, it would record payroll liabilities (and corresponding expenses) for the earned but unpaid payroll. Once paid, the liability is reversed. Most cash to accrual conversions are straightforward, even if they require a few additional processes to implement. However, this is not necessarily the case with healthcare revenue and the process to move between cash and accrual accounting tends to be more challenging.
Healthcare revenue is complex. First, the cash you receive today might be for services performed in the past, since it may take months for claims to be fully adjudicated. This means moving to accrual accounting is not as simple as shifting cash by a few days or weeks. Second, since accrual accounting requires recognizing revenue as services are performed, it might make sense to look at monthly billings to estimate accrual revenue. However, what gets billed and what gets collected are not always the same thing. Billing or chargemaster schedules might be set at a particular value, such as two times the Medicare rate or based on self-pay rates, but payers like insurers might only remit a fraction of that gross charge.
Remittances may also vary by payer and by procedure code. With numerous payers and codes being charged, it can be difficult to accurately estimate expected cash collections. When other nuances are factored in, such as denials, refunds, write-offs, changes in fee schedules, and revisions to reimbursement agreements, the exercise can become even more complex. So how do you determine how much cash you are owed on the day a service is performed?
Revenue waterfall analysis
For many practices, the best way to determine accrual revenue is through a waterfall analysis. This involves extracting billing and cash collection data from your practice management system and aligning the cash collections with the actual date of service. For dates of service when all claims have been fully adjudicated, the exercise is largely complete; however, for unadjudicated periods, which can potentially be many months depending on reimbursement times, additional analysis is needed to estimate the remaining cash collections. This typically involves breaking waterfalls out by payer since this ultimately dictates collection rates and speeds. Then, historical collection percentages (collections divided by gross charges) for fully adjudicated periods are determined and applied to unadjudicated periods. Throughout the analysis, different checks need to be performed to make sure the data is sound. For example, does the billing data contain all necessary fields? Does the cash collection data reconcile back to bank statements? Have there been major changes in reimbursement schedules? How are refunds factored into the data?
After performing this exercise, you should understand the collection rates to use for accrual accounting purposes. Should you maintain accrual accounting prospectively, periodic rate reviews may be warranted to confirm assumptions are still correct.
It may seem daunting to record everything on an accrual basis; however, the analysis ultimately provides investors with key information it is likely to request during a sale process, including billings, redemption rates, and collection speeds by provider, location, payer, and CPT code. Using this data, investors can better identify potential synergies or opportunities that may exist, ultimately benefiting you throughout a sale or recapitalization process.
Other adjustments and normalizations
Beyond cash to accrual adjustments, it is important to adjust the financials for other items such as significant out of period or nonoperational expenses. While these items are important to include to provide an accurate representation of the financial position of your business, providing additional financial information that excludes these things presents a view of the core operations that are expected to recur. You may also consider disclosing the financial impact of relatively recent changes to the business. For example, if you have recently renegotiated a significant contract that will benefit an investor prospectively, you may consider quantifying the annual impact of that new contract.
It is also important to adjust historical compensation levels to those that might take effect after a sale. Historically, many providers have taken home all net collections after back-office expenses are paid. After a sale, however, many providers work for a fixed salary with potential for equity distributions, reduce the percentage of collections they ultimately take home, or agree to allocate certain revenue streams to investors (e.g., ancillary services).
Finally, often the real estate used by a practice (e.g., offices, surgery centers) is either owned by the business or by a related party and rented at off-market rates. Consideration should be given to whether real estate will be included or excluded from the transaction. If it is excluded, it is important to consider the post-transaction rental rates.
Getting your financial information prepared for investors can be challenging when trying to navigate a sale process and run a practice. Even though healthcare M&A markets continue to be strong, investors tend to hold firm on most of their financial data requests.