A hospital's total revenue margin is the most commonly used measure of financial viability. This measure equals the difference between total net revenues and total expenses as a percentage of total net revenues and is the most direct indicator of whether the hospital is able to cover its overall expenses with its overall revenues. Since a critical question for targeting DSH payments is whether the hospital would be financially viable in the absence of those payments, the hospital's total margins net of DSH payments is a better measure of financial viability for purposes of identifying financially vulnerable safety net hospitals. Comparing total margin net of DSH to total margin including DSH subsidies under alternative DSH allocation methodologies provides an indication of how the hospital's financial viability would be affected assuming no behavioral changes occur in the services it provides or in the revenues it receives from Medicaid and other payers. One of the issues in interpreting the measure is the extent to which Medicaid DSH funds represent "new money" to the hospitals.
The literature suggests that margins alone- and a single year margin in particular- should not be used to assess hospital financial viability. Drawing on the studies discussed in Chapter 2, (AHA 1998; Bazzoli 1995; Prince 1998; Zeller 1997), we constructed a composite index that takes into account four financial indicators:
- Total margin net of Medicare DSH and the federal share of Medicaid DSH payments. This measure is defined as (net income - DSH)/net revenues.
- Current ratio. This measure (total assets/total liability) is a widely-used measure of liquidity.
- Cash flow to total debt. Cash flow is defined as net income plus depreciation. Cash flow as a percentage of total liabilities is used as a measure of capital structure to predict future financial problems (CHIPS 2000).
- Fixed asset turnover. This commonly used measure of operating efficiency is defined as the ratio of net patient revenues to fixed assets.