1 Introduction
Objectives
In this section, we will discuss:
The healthcare revenue cycle and it’s main components.
The meaning of the DAR metric and its relation to revenue cycle management.
The importance of understanding the key aspects of the healthcare revenue cycle.
1.1 Healthcare Economic Model
One of the most telling measurements indicating the efficiency of a medical practice’s financial management is the collection ratio. Although variations of this ration are used in a variety of businesses, its determinants are unique in healthcare service entities because of the fundamental economics of their business model.
For companies that sell their products/services directly to consumers, this measurement is typically different because they are often paid on an immediate fee-for-service basis (i.e., consumers render at point of service.) For business-to-business companies, this can be more important because fees for services/products rendered in this model are typically invoiced, and most businesses remit payments on a monthly basis. Therefore, it can take 30 or more days for a company to receive payment for its services or products from another business. If that number increases dramatically, this could mean the business is having more difficult time collecting payment from its customers. The reason could range from the basic timing of cash flow fluctuations to liquidity and/or insolvency issues, the latter of which could easily result in the original business never receiving any payment for its services or products. All of this is critical when considering that business’ financial health, in addition to the fact that managers within that business must incorporate these trends into the budgeting and capital planning processes.
The collection ratio for a medical practice, however, goes beyond the basic scenario outlined above, because in addition to the general fluctuations in the business’ cash flows, there is an additional variable that most businesses do not have to consider, and that is the practice’s contractual adjustments.
Contractual Adjustments Although medical practices are more consumer-centered business models in nature, the presence of third-party reimbursement and contractual pricing adjustments essentially means that medical practices must operate in a business-to-business revenue model while the services model is business-to-consumer. This can double a practice’s financial stress, in that the timing of billing and collections can create cash flow challenges, in addition to the general difference between actual income derived after contractual adjustments.
Contractual adjustments refers to the values for certain services negotiated between a medical provider (individual or entity) and third party payers. Simply put, although a physician may bill a specific amount (X) for certain services or procedures, which in theory have a certain value attached, the third party payers with which the provider contracts will only actually pay a portion of that amount (X - n).
There is a fundamental economic inefficiency in this model, in that prices for health care services are not set by market forces (i.e., supply and demand) as they typically are in an open-market system. Instead, prices are set by individual contractual arrangements, which are negotiated on an even further individual basis, ultimately resulting in no real demand or pricing curve. The impact of this key inefficiency in the health care economic pricing model is a much larger issue that extends beyond the scope of this discussion; however, this concept is critical in understanding the basic profitability and degree of financial stability for any health care service business where third party payer contracts are involved.
Ultimately, a practice’s collection ratio will typically indicate how well it is collecting for services rendered - or, from the more pessimistic perspective, how significant the gap is between the value of services rendered and the actual amount paid for the same services. Collection ratios are going to range significantly among different types of practices, based on size, specialty, region, and demographic makeup of the practice’s patient base (i.e., payer mix.) Practices involving specialties where there is substantial reimbursement from Medicare and certain private insurance payers continue to watch the gap between charges and collections grow, ultimately depressing these businesses’ margins severely. Conversely, some practices have evolved to find new ways to expand profitability and maintain margins, despite reimbursement pressure. While it is unclear how collection ratios will evolve for practices in the long run, one thing that is certain is the need for practices to find new methods of sustaining profitability. Although there is a difference in timing of the charges being collected today versus those placed on the books at a later date, a collection ratio clearly presents a percentage of such performance relative to adjusted charges.
1.2 Accounts Receivable
Accounts Receivable (AR) represents money owed to the healthcare practice by patients and/or insurance carriers. The Accounts Receivable cycle begins with the delivery of service and continues until payment for the service is reconciled to a zero balance.
Accounts Receivable management is a system that assists providers in the collection of the reimbursement for services rendered. The functions of Accounts Receivable management include insurance verification, insurance eligibility, prior authorization, billing and claims submission, posting payments, and collections.
The Accounts Receivable department manages the amounts owed to a facility by patients who received services but whose payments will be made at a later date by the patients or guarantors or their third-party payers. After the claim is submitted to a TPP1 for reimbursement, the time allowed to remit a payment to Accounts Receivable begins. Typical performance statistics maintained by the accounts receivable department include Days in AR and Aging of Accounts.
The AR dollar amount is the total Gross Charges entered and/or submitted to an insurance payer or patient but have not yet been collected. The AR balance can be reduced by receiving payments or by entering contractual or write-off adjustments. Claims become more difficult and costlier to collect the older they become.
1.3 Aging of Accounts
An “account” is a billable episode of care. It begins to “age” once it is billed to a TPP or patient. The aging of accounts is maintained in 30-day increments (0 - 30, 31 - 60, 61 - 90, and so forth.) Facilities monitor the number of accounts outstanding and the total dollar value in each increment (sometimes called “bins” or “buckets.”) The older the account or the longer the account remains unpaid, the less likely the facility will receive reimbursement for the encounter.
Most claims are originally billed to insurance, and until the insurance makes a payment, the responsibility for the payment continues to be with the insurance carrier. After the insurance carrier makes or denies a payment (and there is no just cause for an appeal), the responsibility for the balance of the account will switch to either the physician (to be written off) or to the patient (to be sent an invoice.)
Aging categorizes AR according to the length of time charges have been outstanding as well as the responsible parties. These time periods are commonly 0 - 30 days, 31 - 60 days, 61 - 90 days, 91 - 120 days, and 121+ days. Aging is usually represented as a dollar amount and a percentage.
Aging can (and should) be broken down by many metrics, such as Provider, Patient, Insurance Types (Commercial, Primary, Secondary, Worker’s Compensation, Managed Care), Facility, Diagnosis/Procedure code, Specialty, etc.
1.4 Days in Accounts Receivable
Days in Accounts Receivable (also known as DAR or Days in AR) is a common financial metric belonging to a group of ratios called efficiency ratios. It measures the average amount of time it takes for a business to collect money owed from the responsible party for services rendered and billed.
As its name implies, the unit of measurement employed by this particular metric is days, or rather the average number of days from the moment a physician provides a service until the patient or guarantor pays for that service. This number can tell you much about the financial health of the business.
1.5 What is Days in AR?
At its simplest, Days in AR is a mathematical formula that calculates the average amount of time it takes claims in your Accounts Receivable to pay. Put another way, it is the average number of days that the average invoice will remain outstanding before payment is made. Regularly calculating and monitoring your accounts receivable days gives you insight into how effective your business is at collecting payment on outstanding invoices.
Good management of AR is also imperative to maintaining a good cash flow for the business. A poor AR process can result in loss of money to the business and, thus, financial strain on its owners. If all of these tasks are being done properly, the DAR number should be low. A high DAR number tells you that there is a problem in your revenue cycle.
1.6 What Does the Number Mean?
So now you know that a low DAR number is good and a high number is bad. How low is good though? How high is bad? Is a DAR of zero the best? For instance, let’s say that a practice has a DAR of 95 days. This means that, on average, it takes the practice 95 days to collect it’s outstanding balances. That does not sound particularly good. Maybe it’s normal for that particular practice? Is a DAR of 95 good? Is it bad? How bad or good is it?
1.6.1 The Simple Answer
Spend just a few minutes researching KPIs online and you will find as many different suggestions and “best practices” think-pieces as there are minutes in the day. Many practices look to more reputable organizations such as MGMA2 for industry-specific KPI3 standards or thresholds. The table below is representative of a common scale for Days in AR you will come across when searching for benchmarking standards:
We’ll explore these and other “rules of thumb” later, but the point of my highlighting these “easy” answers is that they are, in fact, excellent general answers. However, each medical practice is a unique animal, made up of a complex web of distinct attributes. Benchmarking standards, however well-meaning they intend to be, apply to the average of all medical practices surveyed by the organization that publishes them.
1.6.2 The Complex Answer
Let’s go back to the DAR of 95 days and what it means for the practice from the example. The immediate insight is that it takes, on average, 95 days for this practice to collect it’s unpaid balances. The deeper insight is that at least three months of working capital is required to maintain the practice’s cash flow needs.
95 days is roughly equal to three months, thus, there’s three months of unpaid work sitting in Accounts Receivable. Therefore, if the practice is going to meet its financial obligations (i.e., payroll, rent, etc.), it’s going to need three months of cash reserves available, or it will have to borrow these amounts, which will in turn have additional repercussions.
The “ideal” average Days in AR depends entirely upon the medical practice, its customers (patients), and its customers’ payers, whether they be third-party payers or the patient themselves. It also depends on the services it supplies and the providers performing those services. Finally, it will depend on the financial situation of the practice and its stakeholders.
A practice’s DAR number can have different meanings across different types of practices as well. Having a very high DAR number can be indicative of a too-lenient policy with late-paying customers, or it could simply be standard for your specialty. On the other hand, having a very low DAR number could indicate a great working relationship with your patients, or that you have a hard-line approach to your payment policy that is alienating longtime patients and potentially cutting off new business.
1.6.3 A Starting Point for Further Analysis
Imagine this scenario: A tornado has hit your neighborhood while you are away and you are worried about your house. The only way to know the true state of your house is to go there and look around.
Judging the financial health of your medical practice by comparing it’s performance to industry-standard benchmarks is akin to trusting a stranger to tell you that your house is fine…while standing on the moon.
“See? It’s that dot right there, everything’s fine.”
The purpose of a good KPI (or group of KPIs) is to reduce the amount of time and cognitive load it requires to understand a large, complex set of data that is constantly being added to. The problem that many people run into is a lack of understanding of the basic foundations of these metrics and their fundamental inter-connectivity. End-users of the KPIs cannot then use them to properly anticipate and prevent the problems that they’re meant to highlight.
My proposal is a very simple one: familiarize yourself with the moving parts of the DAR metric and you will know how well it is running and what to do when it breaks down. You will be much better informed about not only Days in AR, but most every other significant KPI, as Days in AR connects to each of them in some way, however great or small.
1.7 The Essence of the Calculation
The core idea of the calculation to determine DAR is to go through each individual claim, count the days from the Date of Service to the Date of (full) Payment, add all of those up, and divide by the total number of claims. This is an extremely laborious process, so other formulas have taken it’s place. The most commonly used is as follows:
Divide the total Gross Charges by the Number of Days in the period that you are measuring. This is the Average Daily Charge for that period.
Divide the Ending AR Balance for the same period by the Average Daily Charge. This is the average Days in AR for that period.
1.7.1 Gross Charges as Opposed to Net Charges?
This is a great question and one that we’ll explore in more detail when we discuss the Revenue Cycle workflow. The short answer is that Net Charges excludes such things as contractual adjustments, and so it’s missing important information. Within the space of two numbers, AR Balance and Gross Charges, you can tell the story of an organization’s financial history. This idea of representing comes from the world of accounting and I find it brilliant in it’s simplicity.
To account is to bear witness. As the financial historian of a business entity, the accountant must be able to explain in the simplest terms possible, the financial events, past and present. As such, there is a restriction involved, called a monetary denominator.
Even if no reimbursement is involved, an event is described in terms of amounts of currency, rather than exhaustively describing the minutiae of each paper clip purchase. This number can be investigated extensively if the stakeholders see fit. And why wouldn’t they? It contains the entirety of the company’s financial history.
In much the same spirit, the Gross Charge figure contains the total account of work done while the Ending AR Balance is the exhaustive archive of compensation and recompense on behalf of that work.
1.8 Advantages & Disadvantages
A few more words on what the DAR metric is and is not. Again, it would not be appropriate to compare the DAR of medical practices with different specialties. For example, a cardiology group’s DAR would not compare to a plastic surgery practice’s DAR because the methods of reimbursement for these two entities are entirely different. Not only does the DAR metric depend on medical specialty, but also patient demographics, payer mix, and procedure sample.
Another disadvantage is that it is sensitive to the provider because it counts the lag time of unsubmitted claims for services already delivered. However, this lag time roughly averages across all payers, making DAR an effective comparison between payers for an individual provider, but invalidating it across multiple providers. One obvious advantage of the DAR metric is its independence of charges. The average feature of this metric eliminates sensitivity to a specific day or CPT, but it also hides the behavior shape of the AR curve.
To make up for these weaknesses, there are adjusted formulas as well as other metrics (such as PARBX4) that we’ll use to fill in these gaps.
Deferred Revenues AR (and, therefore DAR as well) may be artificially inflated by the inclusion of items such as deferred revenues. Deferred revenues represent amounts that customers, such as health maintenance organizations, have prepaid for care. Until the organization provides patient care, it shows the amount as a liability. Once it provides care, it eliminates the liability from the balance sheet and records revenue. Because the organization never really intends to repay these advances (it intends to provide care), it is not as critical if these amounts remain on the balance sheet for a number of days.
One final caution with respect to days in AR: many health care organizations are dominated by one or two payers, such as Medicare or Medicaid. Long term care facilities, for example, may have as much as 90% of their revenue come from a state Medicaid program. Programs like Medicaid have been known to skip payments to providers if the annual budget for their state is not passed on a timely basis. The providers typically have no recourse, and the state ultimately catches up. At the time of the skipped payment, however, the days in AR rises dramatically (i.e., the organization is carrying twice the normal receivables). Once again, this points to the fact that all ratios need to be taken with a grain of salt, and the analyst must look at the context within which the specific numerical value exists. It also shows the important of ratios, such as days of cash on hand. Can the organization sustain a period without cash collections?