Calculating quality of revenue is critical in healthcare deals
Alongside the quality of earnings analysis in a healthcare transaction, quality of revenue is a top consideration because it can influence the target company’s valuation. As such, investors often seek to validate the credibility of revenue recorded prior to making an investment.
Though quality of revenue is a key facet of the valuation process, ensuring the accuracy of the valuation is a complex undertaking for finance professionals. First and foremost, patient services revenue is the main driver of EBITDA in healthcare; if your revenue accrual is inaccurate, then your overall EBITDA is inaccurate. The complex financial arrangements between healthcare providers, patients, and payors mean that revenue recognized in any given period is an estimate of future cash collections.
How quality of revenue is assessed
A comprehensive analysis of quality of revenue starts with a high-level evaluation of the company’s revenue cycle management function. The assessing professional collaborates with key stakeholders to learn about key areas such as policies and processes for charge capture, billing and collections, and any changes in payor or procedure mix, reimbursement rates, or revenue cycle performance.
For the quality of revenue analysis, raw billing data – gross charges at the date of service, along with corresponding contractual adjustments and other applicable billing adjustments – and collections data at the billing-code level from the company’s billing system for the period(s) under consideration are obtained. The collections information is then reconciled with deposits recorded in the company’s bank statements. A collections waterfall analysis is used to assess the historical payments to charges ratio (collection rate).
The evaluation of collections forms the basis of the estimate of accrual basis patient services revenue.
How does this analysis impact transactions?
When the completed estimate is compared to the revenue recorded on the company’s income statement, any differences in reported earnings will be calculated. If any discrepancies are identified, further analysis will be performed to determine the reasons for the differences. Regardless of the cause of these discrepancies, it is critical to understand these issues prior to closing the transaction.
There are various elements that may result in the misstatement of these future collections. For example, variance in data is often the result of the company recording revenue on a cash basis, i.e., when payment is received. The differences can also be due to limitations within the company’s revenue cycle management function, disturbances in workflow, and limitations in technology. This poses an added challenge because elements such as identifying, capturing, and reporting revenue are within the control of the company.
There are influencing factors wherein the company cannot control requirements or processes. In these cases, the company’s success can be hindered if external regulations are not properly managed internally. Higher-performing companies optimize their revenue position by leveraging their operational processes and aligning them with external influences.
How can this analysis identify opportunities post-transaction?
We see the success of a company’s revenue cycle as the sum of all stakeholder efforts and organization-wide processes coming together to provide an interdependent strategy that optimizes revenue. As part of our more comprehensive analysis offering, we evaluate the entire revenue cycle performance of the company using a combination of tailored questionnaires and interviews, medical to billing documentation assessments, and data analysis of encounter-level claims activity. Any opportunities that we determine can drive efficiencies, reduce costs, and increase revenue will be identified and can be implemented post-closing to help ensure long-term profitability.
Reach out to our team for more information.
Claudine M. Cohen, Managing Principal, Transactions & Turnaround Advisory
Anna Kostanian, Director, Transactions & Turnaround Advisory
Kemi Sulaimon, Manager, Transactions & Turnaround Advisory
Caroline Znaniec, Managing Director, CohnReznick Advisory, Healthcare