Chapter 17 Financial Condition Analysis Flashcards
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
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
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
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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
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
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.
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.
Return on Equity:
ROE = Net Income / Total Equity (net assets)
Ex: 8.0%
Gnerate 8 cents of income for each dollar of equity investment
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
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)
Days cash on hand ratio
- Denominator of the equation: (expenses - depreciation - provision for uncollectibles) / 365 estimates average daily cash expenses
**Days cash on hand = **
Cash + Marketable securities / (expenses - depreciation - provision for uncollectibles) / 365
Ex: 30.6 days
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
- Capitalization ratios: Uses balance sheet to determine the extent to which borrowed funds have been used to finance assets
- Debt Ratio
- Debt-to-capitalization ratio
- Coverage ratios: Income statement is determine the extent to which fixed financial charges are covered by reported profits
- Times interest earned ratio
- Cash flow coverage ratio
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.
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
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.
Coverage Ratios
Cash-flow-coverage ratio:
- The amount by which cash flow covers fixed financial requirements
Cash-flow-coverage ratio =
EBIT + Lease payments + Depreciation expense /
Interest expense + Lease payment + debt principal / (1-T)
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
- Fixed Asset turnover ratio
- Total asset turnover ratio
- Average Collections period
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.
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.
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
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
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
Trend Analysis: Trend of a single ratio is analyzed over time.
- Is a business’s finanacial situation improving, holding constant, or deteriorating
Du Pont Analysis:
- Overveiw of a business’s financial condition
- Understnad relationship among several ratios
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
