Not-for-profit hospitals and health systems rely on
three interdependent functions to contribute to the
financial resilience of the organization: namely, the
ability to withstand adverse changes to these core
functions and continue to provide services to the
community (Figure above).

Ÿ The Operating Function:

The Operating Function
manages the portfolio of clinical services and
strategic initiatives that define the charitable mission
of the organization. Clinical services generate
patient revenue, and if that revenue creates a
positive margin (i.e., exceeds expenses), that excess
is invested back into the health system. Operating
margins are, on average, very low in not-for-profit
healthcare. For example, for the not-for-profit
hospitals and health systems rated by Moody’s
Investors Service, median operating margins from
2017–2021 ranged between 2.1% and 2.9%. These
rated organizations represent only a few hundred
of the thousands of hospitals and health systems
in the country and are among the most financially
healthy. A 2018 study of a wider group of more than
2,800 hospitals found an average clinical operating
margin of -2.7%.

Ÿ The Finance Function:

Because the positive margins
generated by the Operating Function are rarely
enough to support the intensive capital needs of
maintaining and improving acute-care facilities, care
delivery models, and technology, not-for-profit health
systems rely on the Finance Function for internal
and external capital formation. The Finance Function
builds cash reserves and secures external financing

(e.g., bond proceeds, bank lines of credit) to support
the capital spending needs of the organization. The
cash reserves maintained by the Finance Function
also help the organization meet daily expenses at
times when expenses exceed revenues.

Ÿ The Investment Function:

Not-for-profit hospitals
and health systems will also endeavor to invest
some of their cash reserves to generate returns
that, first, act as an additional hedge against
potential risks that could disrupt operations or cash
flow, and second, pursue independent returns.
Any independent returns generated serve as an
important supplement to revenues generated
through the Operating Function.

The three functions described above are common to
all not-for-profit organizations. The main differences
are mostly within the Operating Function. In higher
education, for example, tuition revenue takes the
place of clinical revenue. While higher education also
maintains enterprise risk, the Operating Function
for colleges and universities is less vulnerable to
volume swings as enrollment is typically steady and
predictable. Likewise, higher education is less labor
intensive than healthcare.

Financial reserves include all liquid cash resources
and unrestricted investments held in the Finance and
Investment Functions. These reserves are equivalent
to the emergency funds individuals are encouraged
to maintain to help them meet living expenses for
six to twelve months in case of a job loss or other
disruption to income.

Absolute reserve levels are important, as discussed
above, but they must also be viewed relative to
a hospital’s daily operating expenses. A common

metric used to describe these reserves is Days Cash
on Hand. If an organization has 250 Days Cash on
Hand, that means that it would be able to meet its
operating expenses for 250 days if revenue was
suddenly shut off. The size of Days Cash on Hand will
be proportionate to the size of the hospital and health
system. Some of the largest not-for-profit health
systems have annual operating expenses approaching
$30 billion annually: meeting those expenses for 250
days would require Days Cash on Hand of more than
$20 billion.

The shutdown that occurred in the early days of the
pandemic (March through May 2020) is an example
of a time when cash flow nearly shut off for most
hospitals (except for emergency care). Reserves,
measured in absolute and relative terms such as
Days Cash on Hand, allowed hospitals that were
nearly empty to maintain staffing and operations
throughout the period. Other hospitals that were
inundated with patients during the initial surge
were able to fund increased staffing and personal
protective equipment costs through their reserves.
Other examples of how reserves provide a buffer

against unexpected events include natural disasters
such as hurricanes, tornadoes, deep freezes, and
wildfires, which can require the temporary shutdown
of operations; cyberattacks, which can halt a hospital’s
ability to provide services; a defunct payer that is unable
to reimburse hospitals for care already provided; or an
escalation in labor costs as experienced by many during 2022.

Without the reserves to pay for contract labor or
premium pay, many hospitals would have undoubtedly
had to close or limit services to their community.

KEY TAKEAWAYS

Ÿ Financial reserves are created through the
interdependent relationship of operating, finance,
and investment functions in not-for-profit health
systems.

Ÿ These reserves build financial resilience: the ability
to withstand adverse changes to core functions and
continue to provide services to the community.

Ÿ Financial reserves play an important role in
supplementing any shortfalls in revenue or capital
formation in one or more of these three functions.

Ÿ Financial reserves are equivalent to individual
emergency funds—both are intended to cover
expenses if income or revenue flows are
significantly disrupted.

Ÿ A common metric used to describe financial
reserves is Days Cash on Hand: an organization’s
combined liquid, unrestricted cash resources and
investments, measured by how many days these
reserves could cover operating expenses if cash
flows were suddenly shut off.

Financial reserves, measured in absolute
and relative terms such as Days Cash
on Hand, allowed hospitals that were
nearly empty during the early days of
the pandemic to maintain staffing and
operations throughout the period. Other
hospitals that were inundated with patients
during the initial surge were able to fund
increased staffing and personal protective
equipment costs through their reserves.

A Comparison: Financial Reserves and Higher Education Not-for-Profits

Not-for-profit hospitals and health systems are
not alone in their reliance on financial reserves;
most not-for-profit organizations carry reserves
that enable them to maintain operations and
make needed investments even in times of weaker
operating performance. Higher education is
probably most comparable to healthcare, with
significant overlaps between the two sectors.
Moody’s Investors Service, one of the three major
rating agencies, notes that 16% of its rated higher
education institutions have affiliated academic
medical centers (AMCs), and revenue from patient
care at these AMCs contributes to 28% of the
overall revenues for the higher education sector.

The magnitude of Days Cash on Hand levels
varies by industry; financial reserves maintained
by private not-for-profit higher education

institutions, for example, are significantly greater
than those maintained by not-for-profit hospitals
and health systems. For comprehensive private
universities across all rating categories, Moody’s
reports median Days Cash on Hand in 2021 of 498
days for assets that could be liquidated within a
year. This compares with a median 265 Days Cash
on Hand in 2021 across all freestanding hospitals,
single-state, and multi-state healthcare systems
rated by Moody’s.

Financial reserves are a critical measure of
financial health across both healthcare and higher
education. They help ensure that not-for-profit
colleges, universities, hospitals, and health systems
can continue to fulfill their vital societal functions
when operations are disrupted, or when they are
experiencing a period of sustained financial distress.