Interest rates for borrowed money are the lowest they have been in years, and many home health care company owners and managers are taking advantage of this to obtain inexpensive capital to grow their businesses. But if you are thinking of using your assets to obtain financing for growth, you need to make sure you know what those assets are worth.

From a home care business standpoint, you have two big assets on your balance sheet: your inventory and your accounts receivable (AR). Chances are that your AR is the biggest of those two assets, and, as such, your AR may be the greatest leverage you have in securing a variety of financial instruments. But there are many factors that affect the ease of using your AR as a financial tool in your business.

Who Decides Your AR’s Worth?
There are at least two perspectives you must consider when evaluating your AR. The first is your perspective as the owner or manager of the business. Generally, you would look at your AR and assume that 100% of it will become cash. Further, you would most likely focus on the common measurement DSO (Days Sales Outstanding) and instruct your staff to lower your DSO so that you collect your cash as fast as possible.

The other perspective is that of lenders or “buyers” who are evaluating the worth of your AR. Their perspective is that something less than 100% of your AR will become cash in the bank and they will use various methods to quantify the discount they will take against your receivable before they allow you to borrow against it or “sell” it.

Another conflict in these two perspectives is that most owners and managers focus on what is happening in their businesses now and in the immediate future. Lenders and buyers tend to focus on historical data buried in reports to determine what a company’s performance really is. Add to this the common industry practice of unbilled receivables and you will have conventional lenders looking at you as though you have three heads.

If you, as an owner or manager in home care, want to use your AR as a financial business tool, it is imperative that you consider the perspectives of lenders and buyers in order to prevent misunderstandings and/or high-risk financial contracts.

Key AR Value Indicators
There are three factors that are commonly used to value AR. The first is bad debt expense as a percentage of net revenues. There are industry statistics that reveal the bad debt percentages in the HME and home infusion business based on those companies that participate in the industry financial surveys. These industry figures are used as benchmarks from which your company’s performance will be measured. Thus, your company’s bad debt expense as a percentage of net revenue will be one of the factors used to discount the value of your AR.

The second measurement is your cash collections to net revenue as a determinant of your actual collections percentage. There are several ways of doing this type of analysis, but, in simple terms, this analysis will take your revenues as reported in a given month (October 2002 for example) or even the last 3 months of revenues and compare that against cash collections received against that month(s) revenues. Thus, the analysis seeks to determine how much of October’s revenues have actually been collected as of today (February 1, 2003, for example). Or, in other words, how much of October’s revenues have been collected in the 4 months since the revenue was recognized?

The third and final measurement is the length of your DSO and the age of your receivables. DSO is also captured in industry financial surveys and used to benchmark your company’s performance. However, savvy lenders or buyers know that DSO figures alone can be deceiving. Thus, they may perform a more detailed aging analysis. The degree of detail usually is based on the perception of risk associated with home care receivables. If a lender or buyer is very sensitive to risk, the aging analysis of your AR may be quite detailed and include:

• An evaluation of your aging based on service date (rather than the date billed).
• An analysis of your payor types and any contracts attached to large payors.
• An analysis of your AR against the terms contained in payor contracts.

The flip side to that level of detail is when a lender evaluates the aging categories of your AR regardless of payor type and applies a subjective discount percentage to the aging categories seen on an Aged Trial Balance report.

However, regardless of how the evaluation is done, the bottom line is that an outsider to your business will evaluate your AR to arrive at a discounted AR figure. While I have profiled three common factors, an analysis of your receivables may include one of the three or possibly introduce another factor not mentioned. The person or institution doing this analysis may have some knowledge of your business, but then again, that person or institution may not. The only thing that is certain is that the evaluator will bring personal opinions and experiences to the table. Thus, it falls back on the home care business owner or manager to be intimately aware of the historical performance of the company’s AR. That way he or she can be proactive when dealing with lenders and potential buyers.

Types of Deals
There is a tremendous amount of freedom that comes with being debt free, regardless of how low interest rates are. If I were advising a home care owner or manager, I would start by evaluating funding for his or her own growth first. Can the company’s own AR be used to generate the cash flow needed to grow. If the AR is in poor shape, the cost of adding good staff to improve collections may be less expensive than even the lowest interest rates for borrowed money.

However, if that is not an option, there are a variety of deals. Obtaining a line of credit (LOC) against your AR is common, and, depending on the relationship your company has with its local business bank, it may be able to obtain an adequate LOC with virtually no evaluation of its bad debt expense, DSO, or cash to revenue rate.

The current low interest rates have also created opportunities for private investors to use “cheap” money to buy or invest in home care businesses. Interested investors or buyers are generally not interested in truly “buying” a home care company’s AR. Rather they are interested in buying its assets and revenue stream. An evaluation of the company’s historical AR performance tells these types of individuals an awful lot about the company’s revenue stream.

One of the less discussed opportunities for using AR to obtain cash in hand is commonly referred to as “factoring.” Essentially, a financial institution will discount your receivables (usually a double digit discount) and advance you the cash immediately against the now discounted receivable balance. But be careful. Long term, these types of arrangements can hurt your company’s profits.

There are many, many more types of deals where your AR may be used as collateral, but whatever the deal, the key is to treat your AR as though you could use it at any time to obtain financing in your business. This means thinking of your cash flow and collections as a normal part of doing business as opposed to an afterthought. In addition, the types of evaluations commonly used to value AR should become a normal part of your management reporting process—bad debt expense, DSO and aging analysis, and cash to net revenue are important landmarks every owner or manager should be watching.

Lisa Thomas-Payne has provided consulting services to providers of HME and infusion therapy for more than 17 years and is the founder of Medical Reimbursement Systems Inc, Albuquerque, NM. Contact her online at www.lisathomaspayne.com.