Another issue is whether the hospital's overall financial condition should be taken into account in allocating DSH funds, e.g., whether operating losses- whether or not they are directly associated with serving low-income patients- should be considered in an allocation policy. Such measures may be more suitable for evaluating whether the payments are targeted toward the more financially vulnerable hospitals than as an allocation statistic.
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. It is the most direct indicator of whether the hospital is able to cover its overall expenses with its overall revenues. Hospitals with very low total margins (including many safety net hospitals) find themselves without sufficient funds to pay off debt, increase capital assets, expand services, or finance social missions. A hospital's total margin includes its current subsidies for serving low- income populations. 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 margin 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.
The literature suggests that margins alone should not be used to assess hospital financial viability. A hospital with positive margins may have inadequate liquid assets to meet its obligations. Negative margins may reflect changes in accounting rules or a decision to write-off a large expense over a period of years rather than financial distress (Bazzoli 1995). In addition to profitability, an assessment of financial viability should consider liquidity (the ability to pay bills), capital structure (the ability to pay long-term debt), and asset efficiency (how well assets are used in generation of revenues) (Bazzoli 1995; AHA 1998; Zeller 1997). Other factors that have been identified as important indicators of financial condition are working capital efficiency, fixed-asset age, and Medicare case mix index (Prince 1998; Zeller 1997). It is not necessary to use all financial measures in assessing a hospital's financial viability since many of the financial measures are highly correlated (Zeller 1997). Factor analysis has been used to identify the measures or measure sets that are most important in describing a hospital's financial condition (Bazzoli 1995; Zeller 1997).
We note that an advisory panel convened by the American Hospital Association (AHA) felt that both financial and non-financial factors are important considerations in assessing the on-going viability of hospitals (AHA 1998). The panel suggested that bond ratings have value as a leading indicator of financial viability because they take both types of factors into consideration. However, not all hospitals have a bond rating and the ratings include subjective "risk aversion" considerations.2
(Reflecting a tightening of standards, current "BBB" ratings have financial ratios comparable to "A" ratings of several years ago (CHIPS, 2000)). Moreover, there are administrative advantages to using indicators that can be readily generated on an on-going basis from Medicare cost report data.
2. Alternative approaches to using bond ratings as a direct measurement of financial viability would be to draw on research using statistical models to predict bond ratings or to use the financial data on hospitals with poor bond ratings to define financially distressed hospitals. For example, Bazzoli (1995) used the financial ratios for hospitals with BBB- bond ratings from Standard and Poor's to identify a set of financially distressed hospitals (those hospitals that had at least 6 of 8 financial indicators below the median values for the BBB-hospitals).