Differences in Measurement of Operating Margin (Briefing Paper #17)

Publication Date: Mar 2008
Author(s): Pink GH, Howard HA, Holmes GM, Thompson RE, Slifkin RT
Research Center(s): North Carolina
Project: Analyzing Financial and Operational Performance of CAHs
Topic(s): Finance
Notes: Briefing Paper #17

Recently, Modern Healthcare published a list of the 25 most profitable critical access hospitals, based on operating margin, as calculated by Thomson Healthcare. However, the operating margins reported in Modern Healthcare differed from the operating margins for the same hospitals calculated by the North Carolina Rural Health Research and Policy Analysis Center (NCRHRPAC), although both use 2005 Medicare cost report data. This briefing paper considers how differences in measurement of operating margin can affect the reported values.

Key Findings

  • The definition of operating margin used by Thomson Healthcare to produce the list of the 25 most profitable CAHs reported in Modern Healthcare differs from the definition used by the NCRHRPAC and Cost Report Data Resources (a company that provides comparative financial ratios based on Medicare cost reports.)
  • Although there is agreement that operating margin is defined as operating revenues minus operating expenses (operating income) over operating revenue, there is not agreement on the specific components that should be included in the numerator and denominator.
  • There are three schools of thought regarding which components to include in the revenue and expenses used to calculate operating margin: only patient care (PC), patient care and other operations (PCO), and patient care, other operations and government appropriations (PCOG).
  • The PC operating margin is less than the PCO operating margin which is less than the PCOG operating margin. Inclusion of income from other operations and government appropriations can have a large effect on calculated values of operating margin.
  • The PCO operating margin is probably the best operating margin measure of a hospital’s performance because there is good matching of operating revenues to operating expenses; however, other definitions may be more appropriate for specific questions.