Hospital Working Capital: An Empirical Study

Abstract

The hospital industry has been criticized at length for poor financial management on many dimensions. This study presents some empirical measures of hospital working capital levels prior to the creation of Medicare which suggest the blanket criticism is not merited. While the data is old, 1960-64, it permits assessments of structural and behavioral conditions without having to consider the impact of the many aspects of Medicare's (and Medicaid's) frequently illogical regulations on the management of hospitals. It is assumed the objective of the not-for-profit hospitals considered here is to minimize the net funds used in the short-term financing function. This is not inconsistent with general objectives specified by Feldstein [1971], Pauly and Redisch [1973], Baron [n.d.], and Lave and Lave [1970]. The net funds used in the short-term financing function are defined as net working capital: current assets less current liabilities. Hospitals exist in the same economic milieu as the typical for-profit firm with respect to this financing function. Minimum cash balances are required for ongoing operators and emergencies. Customers must be extended credit. Inventories must be maintained. Prepayments are required. Suppliers extend credit, provide discounts, and impose penalties for late payments. Payroll tax accruals must be met to avoid penalties. Acceptable current ratios are required by existing and prospective lenders. It is certain that the not-for-profit hospitals did manage their short-term assets and liabilities under the same general set of marketplace constraints that affect profit-maximizing firms. It follows that hospitals with relatively lower net working capital levels performed the short-term financing function at a lower cost to their communities.