His Majesty's Government of Nepal has embarked on an ambitious social welfare programme of increasing the accessibility of primary education and health care services in rural communities. The implications on the financing of health care services are substantial, as the number of health posts has increased twelve-fold from 1992 to 1996, from 200 to 2597. To strengthen health care financing, government policy-makers are considering a number of financing strategies that are likely to have a substantial impact on household health care expenditures. However, more needs to be known about the role of households in the current structure of the health economy before the government designs and implements policies that affect household welfare. This paper uses the Nepal Living Standards Survey, a rich, nationally-representative sample of households from 1996, to investigate level and distribution of household out-of-pocket health expenditures. Utilization and expenditures for different types of providers are presented by urban/rural status and by socioeconomic status. In addition, the sources of health sector funds are analyzed by contrasting household out-of-pocket expenditures with expenditures by the government and donors. The results indicate that households spend about 5.5% of total household expenditures on health care and that households account for 74% of the total level of funds used to finance the health economy. In addition, rural households are found to spend more on health care than urban households, after controlling for income status. Distributing health care expenditures by type of care utilized indicates that the wealthy, as well as the poor, rely heavily on services provided by the public sector. The results of this analysis are used to discuss the feasibility of implementing alternative health care financing policies.