Chapter 17 Financial Condition Analysis

Question 1

Financial Statement Analysis: Assess current condition and plan for the future.

Operating indicator analysis: Help identify the factors that contributed to the assessed financial condition

• Occupancy
• Patient mix
• lenght of stay
• Productivity

Question 2

Ratio Analysis:

• Uses Income Statement and Balance Sheet
• Create single numbers that have easily interpreted significance
• Choice of relevant ratios depends on the business being analyzed, the porpose of analysis, availability of comparative data

Question 3

Profitability Ratios

• Measures different dimensions of profitability
  
  • Total Margin
  • Operating Margin
  • Return on Assests (ROA)
  • Return on Equity (ROE)

Liquidity Ratios

• Business’ ability to meet current liabilities
  
  • Current Ratio
  • Days Cash on hand

Answer 3

1. Total Margin (Total profit margin)
   * Net income divided by all revenues, including operating and nonoperating (investment)

    Total margin = Net income / Total revenues

EX: 7.3% = earn 7.3 cents on each dollar of revenue

• Ability to generate revenues from all sources and to control expenses
• All else the higher the total margin, the lower the expenses i.e. expense control
• High margin could mean:
  
  • Charges are high
  • Contractual allowances are low
  • costs are low
  • high nonoperating revenue

Question 4

Operating margin

• Focuss on core business activities removing the incluence of financial gains and losses.

Return on Assets

• Return on Total Assets
• How productivley is the business using its assets
• The higher the ROA, the greater the net income for each dollar invested in assets and hence the more productive the assests.
• Measures both the business’s ability to control expenses and its ability to use its assets to generate revenue

Answer 4

Operating margin = Operating income divided by operating revenues (total revenues)

Operating margin = Operating Income / total revenues

Return on Assets

ROA = Net Income / Total assets

Ex: 5.7%

Each dollar of asset generates 5.7 cents in profit.

Question 5

Return on Equity

• How well are the managers using the owner supplied capital
• For not-for-profit businesses, tells the turstees and managers how well the community supplied capital is being used.

Answer 5

Return on Equity:

ROE = Net Income / Total Equity (net assets)

Ex: 8.0%

Gnerate 8 cents of income for each dollar of equity investment

Question 6

Liquidity: Will the business be able to meet its cash obligations as they become due?

• Main concern current liabilities

Liquidity Ratios

Current Ratio: Extent to which short-term claims are covered by liquid assets

• Current liabilities represent what % of current assets
  
  • Current liabilities / Current Assets

Answer 6

Current ratio = Current Assets / Current Liabilities

Ex: 2.3 times = $2.30 of cash for every $1 of current liabilities

If a business is in financial difficulty:

• It will begin paying its accounts payable more slowly
• Building up short-term bank loans (Notes)

Question 7

Days cash on hand ratio

• Denominator of the equation: (expenses - depreciation - provision for uncollectibles) / 365 estimates average daily cash expenses

Answer 7

**Days cash on hand = **

Cash + Marketable securities / (expenses - depreciation - provision for uncollectibles) / 365

Ex: 30.6 days

Question 8

Debt management: The degree to which an organization uses debt financing / financial leverage

• For-profit companies: Managers can maintain control with limited investment
• Allows not-for-profit organizations to provide more services than they could solely with contributions and earnings

Debt Ratios

1. Capitalization ratios: Uses balance sheet to determine the extent to which borrowed funds have been used to finance assets
   
   1. Debt Ratio
   2. Debt-to-capitalization ratio
2. Coverage ratios: Income statement is determine the extent to which fixed financial charges are covered by reported profits
   
   1. Times interest earned ratio
   2. Cash flow coverage ratio

Answer 8

Debt ratio

Debt ratio = Total debt / Total assets

*total debt = everything on the liabilities side except equity.

Ex. 29%

• Each dollar of asset was financed with 29 cents of debt and 71 cents of equity.
• Creditors prefer low debt ratios: The lower the ratio, the greater the cushion against creditors’ losses
• For-profit firms may seek higher leverage / higher ratio to leverage up returns or becasue selling new stock would mean giving up more control.

Question 9

Debt-to-capitalization ratio

• Proportion of debt used in a business’s permanent (long term) capital structure.

Coverage Ratio

Times Interest earned:

• Not-for-profit = EBIT = Net income + Interest expenses
• For profit = EBIT = Net income + interest expenses + taxes
• Number of dollars of accounting income available to pay each dollar of interest expense
• The extent to which interest can decline before it is less than annual interest costs

Answer 9

Debt-to-capitalization ratio =

Long-term debt / long-term debt + equity

• Low ratio indicates unused debt capacity.

Coverage Ratio

Times Interest Earned =

Earnings before Interest and Taxes / Interest charges

Ex = 6.6 times

$6.60 available to pay each dollar of interest expense.

Question 10

Coverage Ratios

Cash-flow-coverage ratio:

• The amount by which cash flow covers fixed financial requirements

Answer 10

Cash-flow-coverage ratio =

EBIT + Lease payments + Depreciation expense /

Interest expense + Lease payment + debt principal / (1-T)

Question 11

Asset Management ratios

• How effectively are the assets being utilized?
• The amount of each type of asset reported on the balance sheet seems reasonable in view of current or projected operating levels

Asset Management Ratios

1. Fixed Asset turnover ratio
2. Total asset turnover ratio
3. Average Collections period

Answer 11

Fixed Asset turnover ratio:

• Utilization of property and equipment

Fixed Asset turnover ratio = Total revenue / Net fixed Assets

Ex: .98

• Each dollar of fixed assets generated 98 cents in total revenue.
• Does not take into consideration inflation and depreciation. May inflate the Fixed Asset turnover ratio of older hospitals as compared to newer hospitals.

Question 12

Total Asset Turnover ratio:

• Turnover (utilization) of all of a business’s assets.

Average Collections Period:

• Number of days that it takes an organization, on average, to collect its receivables.

Answer 12

Total Asset turnvoer = Total revenue / Total assets

Ex: .78 times

Each dollar of total assets generated 78 cents of total revenue.

Average Collections period =

Net patient accounts receivable / Net patient service revenue / 365

Question 13

Average Age of Plant

• Rough measure of the average age in years of a business’s fixed assets

Ratio’s for Invetor-Owned Firms: (Market value ratios)

Price / earnings ratio

• How much are investors willing to pay per dollar of reported profits.
• Higher for firms with high growth prospects
• Lower for risker firms

Market / Book Ratio

• Companies with high rates of return on equity generally sell at highter multiples of book value

Answer 13

Average age of plant =

Accumulated Depreciation / Depreciation expense

Ex. 6.1 years

Market value ratios

Price / earnings ratio =

Price per share / Earnings per share

**Market / Book Ratio = **

Price per share / Book value per share

*Book value per share = total equity / total shares outstanding

Question 14

Trend Analysis: Trend of a single ratio is analyzed over time.

• Is a business’s finanacial situation improving, holding constant, or deteriorating

Question 15

Du Pont Analysis:

• Overveiw of a business’s financial condition
• Understnad relationship among several ratios

Answer 15

Du Pont Equation:

ROE = Total margin x Total asset turnover x Euity mult.

ROE = Net Income / Total equity

Total margin = Net Income / Total revenue

Total asset turnover = Total revenue / Total assets

Equity multiplier = Total assets / Total equity

*Note: Total margin x Total asset turnover = ROA

So…

ROE = ROA x Equity multiplier

Question 16

Operating indicator analysis

• Examining operating variables with the goal of explaining a business’s financial condition

Operating indicators

1. Net price per discharge
2. Medicare payment percentage
3. Outpatient revenue percentage
4. Occupancy Percentage (Rate)
5. Average Length of Stay
6. Cost per discharge

Answer 16

• Net price per discharge: Average revenue collected on each inpatient discharge (maybe a function of case mix)

Net price per discharge =

Net inpatient revenue / total discharges

• Medicare payment percentage: The exposure of a hospital to medicare patients…payments determined by political, rather than economic, process

Medicare payment percentage =

Medicare discharges / Total discharges

Question 17

Outpatient Revenue Percentage:

• Measures the mix between outpatient and inpatient revenues

Occupancy Percentage Rate:

• Measures the extent of utilization of a hospital’s beds and hence fixed assets.
• Higher occupancy spreads fixed costs over more patients increasing per patient profitability

Average Length of Stay

• Number of days an average inpatient is hospitalized with each admission

Cost per discharge

• measures the dollar amount of resources, on average, spent on each discharge.

Answer 17

**Outpatient Revenue percentage = **

Net outpatient revenue / Net patient service revenue

**Occupancy percentage (rate) = **

Inpatient days / number of lic. beds (365)

Length of Stay = Inpatient days / Total discharges

**Cost per discharge = **

Inpatient operating expenses / Total discharge

Question 18

Economic Value added: A single measure that provides information on both financial condition and managerial performance.

• Measures the dollar profit above the economic dollar cost of creating that profit
• Does not require market data, can be applied to for-profit and not-for-profit.
• Depends both on operating efficiency
  
  • effects profits
• Balance sheet management
  
  • effects assets and capital
• For not-for-profit companies, let’s managers know how they are using the organizations contributions and earnings to create value for the community

Answer 18

**Economic Value Added (EVA) = **

Net Operating profit after taxes (NOPAT) - (Total capital x Corporate cost of capital)

• NOPAT = All operating costs, including taxes (if applicable), but excluding interest expense =
  
  • EBIT x (1 - T)
• Total capital = Sum of the book values of investor supplied (interest bearing) debt and equity
• Corporate Cost of capital: business’s cost of financing

Question 19

EVA improved by:

• Increasing revenue and decreasing costs
• Decreasing the amount of assets used to create NOPAT
• Decreasing business’s capital costs.