From Crisis to Cash:Healthcare's AR Metrics Showdown

I anticipated the healthcare industry's AR metrics to be severely impacted after COVID, but was pleasantly surprised by the resilient numbers!

We examined the order-to-cash metrics of the top 25 healthcare companies* between 2019-22 to discern trends and establish benchmarking values. Ready to explore? Let's dive in!

I anticipated the healthcare industry's AR metrics to be severely impacted after COVID, but was pleasantly surprised by the resilient numbers!

The COVID-19 pandemic disrupted the revenue cycle of most healthcare businesses. Regulatory moratoriums suspended collections, leading to higher Days Sales Outstanding (DSO) and bad debt.

Fast forward three years, and healthcare enterprises have flexed their financial muscles, beefing up their order-to-cash cycle, DSO, DPO, and other working capital metrics. The cash conversion cycle has seen a commendable 16% reduction from 2020, while bad debt levels have maintained stability.

Revenues and AR increase by ~30% between 2019-2022

An increase in accounts receivable (AR) commensurate with revenue growth is nothing unusual. As your sales grow, there is bound to be a proportionate increase in accounts receivable as you offer credit to more customers.

Our analysis revealed a healthy sign both in revenue growth and an increase in AR for healthcare companies in the last four years except during 2020 (the year when the deadly COVID-19 struck).

Revenue and AR during COVID-19:

In 2020, the healthcare industry revenues dropped marginally (by 1%) while accounts receivable grew disproportionately, by 12%. But that was the first year of the pandemic, and businesses were still struggling to cope with the restrictions and new rules.

Revenue and AR post COVID-19:

In 2021 and 2022, the average revenue for the top 25 healthcare companies increased by 22% and 9%, respectively. Accordingly, the accounts receivables also grew by 7% during both the years (see graph).

How do the AR values of the healthcare industry stack up?

Large healthcare companies (such as Merck, Abbott, and Abbvie) average accounts receivable figure was $9.4 Bn in 2022. Accounts receivables as a percentage of overall sales has remained ~10% in all the years between 2019 and 2022, except for 2020 when it marginally increased to 11.5%.

This constant figure indicates that healthcare companies haven’t changed their credit policies or strategies much in the last few years.Next, we look at what is the DSO in the healthcare industry.

The Average DSO for Healthcare Industry is 45 days

In line with the unchanged credit policies of healthcare firms, the Days Sales Outstanding (DSO) of healthcare firms remained the same in 2021 and 2022.

Our analysis revealed a healthy sign both in revenue growth and an increase in AR for healthcare companies in the last four years except during 2020 (the year when the deadly COVID-19 struck).

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A deeper dive into the DSO numbers

• The average DSO for the healthcare industry for the last four years was 47 days.
• In 2021 and 2022, DSO remained constant at 45 days.
• DSO was 50 days in 2019 and declined slightly to 48 days in 2020 (see graph), supported by faster cash collections by hospitals and health insurance companies

Bad Debt Ratio Remains Constant At 0.2%

Businesses set aside a provision for bad debt so that the revenues don’t get directly impacted. The provision for doubtful accounts is a good indicator of how much bad debt is expected

Between 2019-2022, healthcare businesses’ average provision for credit losses was $196 Mn. Healthcare businesses increased this provision by almost 20% in 2020, anticipating losses due to COVID-19.

Since 2020, the provision has remained unchanged at about $203 Mn (see graph). This indicates that while healthcare businesses are cautious about bad debt, they do not see it spiking further.

The provision for bad debt to sales ratio stood at 0.2% in 2021 and 2022. It was 0.3% in 2020.

Within the broad healthcare sector, the average provision for credit losses for pharma and medical supplies businesses was much lower than that of insurance and healthcare service businesses, indicating a higher credit risk in the latter segment ($147 Mn vs $344 Mn).

Days Payable Outstanding Increases by 8%

Large healthcare businesses seem to be increasing their power over their suppliers. In 2022, they paid their credit dues three days later than in 2021.

The average Days Payable Outstanding (DPO) for the healthcare industry was 77 days in 2022 versus 71 days in 2019 (see graph).

Only during 2020, did healthcare companies pay their suppliers sooner.
Their average DPO in 2020 was 64 days.

This could be because of the need to procure more daily supplies and materials for research and development as the businesses invested in drug development, patient care, etc during COVID-19.

How do the accounts payables of the healthcare industry stack up?

The absolute value of Accounts Payables (AP) also increased by 9% during the period, touching, on average, $9.6 Bn.

Interestingly, the accounts payables for most healthcare companies were significantly higher than their receivables. This was even more evident for the top 5 healthcare companies. Their payables were 1.5X – 2X greater than their receivables. Larger players seem to be negotiating better terms with suppliers than smaller firms.

Wide Disparities in the Cash Conversion Cycles

The average cash conversion cycle for the healthcare industry between 2019-2022 was 61 days. This essentially means that a healthcare business would take about two months to convert the cash it spent on inventory back into cash

Healthcare businesses have shortened their cash cycle in the last four years (see graph), driven by their ability to collect faster while making payments to suppliers later.

The industry reduced its cash cycle by ~24% between 2019-2022, with the average in 2022 touching 54 days.

Despite the cash cycle getting reduced over the years, there is a wide disparity in the cash cycle for the different players.

Why is that so?

Business model differences: While health insurance and healthcare service providers like hospitals tend to have a negative cash cycle (-20 days), pharma and medical products/supplies companies have longer cash conversion cycles (85 days). This could be because of the longer time the latter set of companies take to sell their inventory.

Differences in inventory handling: The average Days Inventory Outstanding (DIO) of pharma and medical supplies companies was almost 5X that of insurance, healthcare service providers and hospitals. Inventory movement in pharma companies is much slower compared to hospitals where supplies are consumed faster.

Conclusion

The healthcare industry is an amalgamation of businesses of various kinds – pharmaceutical, biomedical, healthcare insurance, hospitals and healthcare services. While they share a common ecosystem, there are also many underlying differences in their business models and order-to-cash cycle.

But across all the segments within the healthcare industry, a common phenomenon of rebounding from the disruptions that COVID-19 posed can be seen. The industry has improved its cash conversion cycle by reducing DSO and increasing DPO. Its revenue growth was also impressive.

In 2024, smart tech, real-time payments, and new product types will likely influence the order-to-cash metrics (like DPO and DSO) of healthcarebusinesses.

*Note: The healthcare companies include a mix of pharma, medical supplies providers, hospital/healthcare service providers, and health insurance companies. These are the top 25 healthcare companies in the Fortune 500 list 2023.