What’s Better? Maximizing Operating Income or Strategic Balance Sheet Management
Hospitals face mounting financial pressures: declining reimbursement rates, rising operating costs, and an ever-growing demand for high-quality, patient-centered care. This reality has made it increasingly challenging for hospitals to sustain their operations solely through traditional income sources. In response, many hospital leaders are asking a crucial question: “Is there a better way to support our mission than relying on operating income alone?”
This question opens the door to an alternative approach—strategic balance sheet management. By optimizing financial assets for long-term investment, hospitals can create an additional, sustainable source of non-operating income, allowing them to reinvest in resources, staff, and services that directly benefit their communities.
In this post, we’ll explore how each approach can impact a hospital's financial outlook over the long term. We’ll look at the potential for operating income alone versus a value-based investment strategy for balance sheet assets. Using hypothetical but realistic assumptions, we’ll outline which path yields the best financial support for the organization’s mission over the next 10 and 20 years.
The Current Model: Operating Income as the Financial Backbone
Let’s start by examining the typical operating income model. Consider a hospital with $100 million in gross revenue. After contractual adjustments and third-party deductions, net revenue would be approximately $50 million. With an industry-average net income margin of 1-3%, the hospital might bring in between $500,000 and $1.5 million in net income each year.
Challenges with Relying Solely on Operating Income:
Declining Margins: Reimbursement rates are often pressured and/or reduced year after year, while operating expenses continue to rise.
Resource Constraints: Meeting the community’s healthcare needs with limited funding often leads to tough decisions on staffing, service offerings, and investments in equipment.
Sustainability: Even with a strong 3% margin, it can be difficult to build reserves that offer any meaningful cushion against unforeseen financial shocks, leaving little room for growth or reinvestment.
While this approach prioritizes operating efficiency, it doesn’t offer much in the way of long-term financial security or growth.
The Alternative: Strategic Use of Financial Assets on the Balance Sheet
Now, let’s imagine the same hospital with $20 million in financial assets on its balance sheet. If the hospital adopts a balanced, long-term investment strategy, it could potentially achieve annual returns of 5-9%, compounded over time. Here’s how this approach could benefit the organization:
Compounded Growth: Through consistent, value-based investing, the hospital’s assets could grow significantly over 10 and 20 years, providing a reliable source of income that can be reinvested in mission-critical initiatives.
Reduced Dependence on Operating Income: By generating non-operating income, the hospital can buffer itself against operational revenue fluctuations, allowing greater flexibility to sustain quality services, even in lean years.
Mission Support: With a dedicated focus on strategic investments, the hospital gains a means of reinvesting in people, technology, and facilities—critical components in providing high-quality, patient-centered care.
A Side-by-Side Financial Comparison
To visualize the benefits, let’s project where the hospital could be financially after 10 and 20 years under each model.
Side by side comparison of Operating Income vs. Investment Strategy
With compounding, the difference in available funds is staggering. By investing balance sheet assets, the hospital could potentially realize over $77 million in additional funds over 20 years, compared to just $10 million through operating income alone. These funds represent reinvestment in the mission, whether by enhancing community services, updating infrastructure, or supporting staff well-being.
Beyond Operating Margins: A Strategic Shift in Financial Thinking
While a 1-3% margin on operating income is an achievement in today’s healthcare environment, it doesn’t fully meet the long-term needs of hospitals committed to fulfilling their missions. Shifting focus from a purely operational financial model to one that integrates strategic balance sheet management can create a vital revenue stream independent of traditional reimbursement.
Looking Ahead: Building a Mission-Driven Balance Sheet
With this approach in mind, hospitals have an opportunity to rethink the role of their balance sheet as an active player in mission support, rather than a passive repository of funds. By adopting a responsible, long-term investment strategy, they can leverage their assets to support sustainable growth and provide critical reinvestment for the communities they serve.
What’s Next: A Series on Strategic Balance Sheet Management
This blog post is the start of a five-part series where we’ll dive deeper into the components of responsible balance sheet management. Each article will focus on a different aspect of using financial assets to support the mission and address the operational and capital needs of healthcare organizations. Here’s what’s to come:
Establishing Financial Goals for Balance Sheet Management
Choosing the Right Investment Strategy: Risk Management and Allocation
Implementing a Governance Framework for Asset Management
Creating a Sustainable Pooled Investment Strategy
Tracking Performance and Adapting to Market Conditions
Through this series, we’ll explore how hospitals can strategically and responsibly harness their balance sheets to create lasting value for their communities. Stay tuned to learn more about each step in this journey toward financial resilience and mission alignment.
If you're interested in exploring how a fundamental, value-based investment strategy can help support your hospital's mission and strengthen financial stability, consider reaching out to Frontier Strategy Partners. Our team can connect you with experienced advisors who specialize in value-driven, long-term investment approaches tailored to healthcare organizations. By working with professionals who understand the unique financial needs of hospitals, you can unlock the full potential of your financial assets, creating new opportunities for reinvestment in staff, services, and community care. Let us help you take the first step toward a more resilient, mission-aligned financial strategy.
Disclaimer: This article is for informational purposes only and should not be considered financial or investment advice. It is intended to provide general insights into the potential benefits of strategic balance sheet management in healthcare organizations. Readers interested in exploring investment strategies based on fundamental, value-based principles are encouraged to consult with qualified financial professionals. We have established a partnership to assist healthcare organizations in understanding and implementing these concepts responsibly. If you would like to discuss these ideas further or seek introductions to financial advisors experienced in this approach, please reach out for more information.
