Why revenue and bottom-line profit are not enough to manage a home health agency

The financial figures in this article are approximate, and certain details have been generalized to protect client confidentiality.

Several years ago, the owner of a Medicare-certified home health agency contacted me because her agency’s profitability had been declining for approximately 18 months.

On the surface, the agency appeared stable. Annual revenue was approximately $3 million, including over $2 million in Medicare revenue. Revenue, referral sources, and payor mix had remained relatively consistent for more than three years. The agency had an established management team, including an owner who served as president and CEO, a director of nursing, and a controller responsible for maintaining the books and preparing the financial statements.

Nevertheless, profitability continued to decline.

Management had recognized the problem and attempted to address it. The team reviewed the agency’s Trial Balance, identified expense accounts that appeared reducible, and made several cost-cutting decisions. Those efforts did not improve profitability. In some cases, they created additional operational problems.

Eventually, the owner concluded that management might be too close to the situation to see what was happening and asked me to provide an outside perspective.

The financial statements showed the problem—but not its cause

I began by reviewing three years of Medicare Cost Reports, the current year’s monthly Trial Balances, and monthly visit information by payor.

The trend was immediately visible. The agency’s profit margin had fallen from approximately 15% to 12% and then to about 7%. Current monthly results indicated that profitability was continuing to decline—and that the rate of deterioration was accelerating.

The agency’s Accounts Receivable had also increased substantially. Days in Accounts Receivable, which had previously been in the upper 50s, had risen to more than 100 days.

Management knew that profits were declining, but it could not determine why.

One reason was the way the agency’s financial information was being presented. Like many home health agencies, it received a cumulative, year-to-date Income Statement. Consequently, management concentrated primarily on two numbers:

• Total revenue at the top of the statement
• Net income at the bottom

Both numbers were important, but neither explained what was changing within the agency.

A cumulative Income Statement can obscure significant month-to-month movement. An unfavorable change in one month can be absorbed into the results of the preceding months. As the year progresses, emerging problems become increasingly difficult to see because each new month represents a smaller portion of the cumulative total.

The agency had financial information, but it did not have financial clarity.

Information must be connected to operations

Traditional financial statements tell leaders what happened financially. They rarely explain why it happened operationally.

To identify the cause of the agency’s declining profitability, we needed to connect its financial results with the operating activity that produced them. That meant examining more than revenue and total expenses. It required looking at measures such as:

• Monthly revenue and expenses
• Revenue and visits by payor
• Discipline-specific costs per visit
• Accounts Receivable and Days in Accounts Receivable
• Accounts Payable and Days in Accounts Payable
• Staffing costs and productivity
• Patient volume and utilization trends
• Changes in other financial and operational performance indicators

I organized this information into what I refer to as a Monthly Financial-Operational Analysis, or FOA Review.

The resulting analysis produced dozens of performance indicators the owner had heard about but had never seen calculated for her own agency. More importantly, we examined how those indicators had changed over time.

That distinction mattered. A performance indicator viewed for only one period provides limited insight. Its real value often comes from understanding the direction and rate at which it is changing.

The agency already possessed most of the information

The most revealing part of the engagement was that the information needed to identify the problem had been present within the agency all along.

It existed in the accounting system, billing records, payroll information, visit data, Medicare Cost Reports, and other operating records. What was missing was an analytical structure that brought the information together and converted it into something management could understand and use.

Once the information was organized properly, I could have simply identified the problem and told the owner what needed to be done. Instead, I offered her a choice.

I could give her the answer, or we could work through the information together so that she could learn how to recognize what the financial and operational results were telling her.

The second approach would require additional time and cost slightly more, but it would also strengthen her ability to identify similar problems earlier in the future.

She chose the second approach.

With guidance, the owner followed the information, identified the sources of the financial leakage, and determined how they should be addressed. She was justifiably proud that she had solved the riddle herself once she was given the information in a form that made the underlying relationships visible.

The agency corrected the problems and returned to stronger financial performance. Just as importantly, its owner emerged better prepared to recognize future deterioration before it became an organizational crisis.

Monthly financial-operational analysis is a business fundamental

Before the implementation of the Home Health Prospective Payment System in 2000, many agencies routinely performed detailed financial and operational analyses. Under cost-based reimbursement and relatively narrow margins, managers could not afford to operate without closely monitoring costs, utilization, productivity, and collections.

When PPS initially made profitability easier to achieve, many agencies reduced or discontinued these analyses. Over time, an important business discipline was lost.

Home health agencies are not required to perform monthly FOA Reviews. But they should.

An agency should not have to experience 18 months of declining profitability before management can understand what is changing. Nor should leaders be forced to make cost-cutting decisions based solely on a cumulative Income Statement and a Trial Balance.

Indiscriminate cost reductions may temporarily reduce expenses, but they can also weaken operations without addressing the actual cause of the problem. If management is treating the symptom rather than the cause, the problem will remain—and may become worse.

What are your financials trying to tell you?

The owner of this agency was correct: the agency was not producing the profits its otherwise stable operations should have generated.

Its financial statements were trying to communicate that something had changed. The problem was not an absence of information. It was an absence of understanding.

That is the broader lesson for home health leaders:

Your organization may already possess the information needed to identify a developing financial or operational problem. The question is whether that information is being organized, analyzed, and presented in a way that allows management to understand what it is saying.

Revenue tells you how much the agency generated. Net income tells you what remained. Neither, by itself, tells you why.

And until management understands why, it cannot know whether it is solving the problem—or merely responding to its symptoms.