Since the Great Recession, not-for-profit hospitals have hoarded cash as evidenced by improving rating agency liquidity ratios. Faced with a growing list of capital projects and mediocre investment returns, CFOs are now wondering how much cash to keep on hand.

Can not-for-profit hospitals have too much cash in the bank?

Hospitals have piled up cash and investments in recent years after scrapping large capital projects, waiting for healthcare reform to play itself out.


The median days’ cash on hand for hospitals in the BBB category was reported by Fitch last year at 161 days, up 42% from 2008. This comes close to six months of expenses and almost enough to pay off all outstanding debt. In the “AA” category, the median was 289 days, more than twice average outstanding debt (see Rating Agencies Raise the Bar on Hospital Key Ratios).

Considered the most critical of all hospital key ratios, days’ cash on hand (DCOH) is defined as the number of days that cash and unrestricted investments could cover operating expenses. DCOH excludes debt service reserve funds, construction funds, and captive insurance investments.

Cash on hand provides a cushion against fluctuations in volumes and reimbursement, particularly for hospitals with thin operating margins or elevated competitive threats, and where cash can mean the difference between survival and consolidation.

In the for-profit world, corporations faced with excess cash have it easy. When they run out of ways to generate sufficient returns, they simply pay the excess cash back to shareholders as a dividend or a share repurchase.

In muniland, options are more limited. Without shareholders, not-for-profit entities have no one to return excess cash to. Cash is either retained (invested), spent on projects, or used to pay down debt.

Cheered on by rating agencies, some hospitals decided that the more cash the better, even if this means taking on more debt or postponing strategic projects.

But disappointing investment returns in the last few months have some hospitals rethinking how they set liquidity targets.

Setting cash targets can be done in different ways, but the process is relatively similar to capital budgeting in that it involves evaluating different and competing uses for cash based on a hospital’s specific situation.

What may work for a dominant care provider with steady volumes and no immediate capital plans may not be enough for a #3 provider in a three-hospital market with unfavorable payer mix.

The process looks at three key areas:

  • Operations – Keeping the hospital running comes first, and cash offers a cushion against operational volatility. With low cash reserves, a hospital experiencing a decline in volumes or reimbursement may not be able to cover expenses. The amount of the cushion depends on the hospital’s “worst case scenario” projections. Uncertainty in the healthcare sector has led hospitals to err on the side of caution and over-reserve.
  • Investments – Some hospitals are able to earn more from investments than from operations and may want to make investments a priority, setting higher targets. Others with investment returns below their cost of debt (negative arbitrage) may want to use cash to pay down debt, reduce interest expense, and improve operating margins.
  • Capital Projects – Hospitals with large projects must determine how liquidity will impact access to, and cost of debt. As rates and hospital credit spreads have compressed in recent years, the cost of debt (yield) differential across ratings has shrunk considerably (see Hospital All-In Cost of Debt Lowest Ever), but may become more of a driver as rates climb.



There are other factors for not-for-profit hospitals to consider when setting liquidity targets.

Most sophisticated donors know financial strength is a good thing and do not want to donate to a weak organization. At the other end of the spectrum, some in the general public and in legislative circles may expect not-for-profits to lose money and spend all cash on furthering the charitable mission, so liquidity targets may need to be adjusted accordingly.

Liquidity being the most critical of the so-called key ratios, any expected decline in days cash on hand should be discussed with rating agencies ahead of time to give the hospital an opportunity to make its case and avert a potential rating action.

But rather than setting absolute targets based on their peers or medians, hospitals ought to decide how much cash is enough based on their specific strategic, operating and investing environment.

Regardless of how hospitals go about setting their own liquidity targets, they ought to be revisited periodically to adjust for changes in the hospital’s situation.