financial statement application: analyzing financial performance

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Copyright © 1999 by the Foundation of the American College of Healthcare Executives

Financial Statement Application:Analyzing Financial Performance

Purpose of performance analysisTypes of analysis

Financial statement analysisOperating analysisMVA and EVA analysis

Problems with performance analysis

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One of the most important character-istics of a business is its financial performance.

Financial performance analysis assesses a business’ financial condition: Does it have the financial capacity to meet its mission.

Results sometimes focus on financial strengths and weaknesses.

Overview

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Several techniques are used:Financial statement analysis focuses on the information in a

business’ financial statements with the goal of assessing financial condition.

Operating analysis focuses on operating data with the goal of explaining financial performance.

MVA and EVA analysis focuses on assessing managerial performance.

Overview (Cont.)

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Ratio analysis is a technique used in financial statement analysis (and in other analyses).

It combines values from the financial statements to create single numbers that:Have easily interpretable economic significance.Facilitate comparisons.

Ratio Analysis

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A single ratio value has little meaning. For example, a total margin of 7.3%.

Therefore, two techniques are used to help interpret “the numbers”:Trend (time series) analysisComparative (cross-sectional) analysis

Both techniques will be illustrated in the in the examples to follow.

Interpreting Ratios

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Profitability: Is the business generating sufficient profits?

Liquidity: Can the business meet its cash obligations?

Debt management: Right mix of debt and equity?

Asset management: Right amount of assets for its utilization level?

Ratio Analysis Categories

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Profitability Ratios

What do they measure?Total margin - net income/revenue

divided by total revenueOperating margin - net income/revenue

less non-operating sources of revenue divided total operating revenue

Return on assets (ROA) - net income or revenue divided by total assets.

Return on equity (ROE) - net income divided by total equity

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Profitability Ratios (continued)

Version of net income/revenues to use? (FP vs. NFP)

Interpretation of ratios?

ROA vs. ROE as a measure of org. profitability?

Relationship between ROA and ROE: DuPont analysis

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DuPont Analysis

Allows for more specific determination of profitability

ROE as a function of ROA and the equity multiplier

Interpretation of DuPont results - identification of highly leveraged organizations

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Liquidity Ratios

What do they measure?

Current ratio (CR): current assets divided by current liabilities

Quick ratio (Acid test): current assets less inventory and prepaids divided by current liabilities

Days of cash on hand: cash plus securities - average expenses/day

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Liquidity Ratios (continued)

Need for analysis of cash flow statements to identify source(s) of liquidity/lack thereof.

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Debt Management Ratios


Use of debt in FP/NFP organizations

Is there such a thing as too much leverage? Leverage and the risk of default

Capitalization ratios

Coverage ratios

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Debt Management Ratios (continued)

Capitalization ratiosTotal debt to total assets (FP/NFP)Total debt to total equity (FP)

Coverage ratiosTimes interest earned (TIE) ratio - net

income/revenue divided by total interest expense

Cash flow coverage (CFC) ratio - net income/revenue (cash) divided by debt service expenses (pre-tax)

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Asset Management Ratios


Fixed asset turnover ratio - total revenue divided by NET fixed assets

Total asset turnover ratio - total revenue divided by total assets

Current asset turnover ratio - total revenue divided by current assets

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Asset Management Ratios (continued)

Net days in accounts receivable (NDAR) - net A/R divided by average net daily patient service revenue

Other analytical methodsCommon size analysis - rationaleTrend analysis - rationale% change analysis - rationaleMVA and EVA analysis

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MVA/EVA Analysis

Rationale for use

Market value added (MVA) analysisWhat does it measure?Difference between market value and

book value of shareholder equity stakeHow to estimate?

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MVA/EVA Analysis (continued)

Economic value added (EVA) analysisWhat does it measure?Difference between net income/revenue

less interest expense (why?) and total organizational cost of capital

How to estimate?

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Operating Analysis

Rationale for use - adjunct to financial statement analysis (root cause analysis)

Examples of operational indicatorsNet price per dischargePayer/service discharge %Occupancy rateAverage length of stay (ALOS)Cost per discharge

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How about an example??

Refer to Gapenski (Ch.17)

Income statement (p.510)

Balance sheet (p. 511)

Cash flow statement (p.512)

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Operations provided $11.2 million in net cash flow in 1998.

Riverside invested $4.3 million in new fixed assets.

Riverside paid off $5.6 million in debt and invested $2.0 million in marketable securities.

Statement of Cash Flows Analysis

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Profitability Ratios (1998)

Total margin = Net income

Total revenue

= = 0.073 = 7.3%. $8,572

$117,476

ROA =

= = 0.057 = 5.7%. $8,572

$151,278

Net incomeTotal assets

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1998 1997 Ind.TM 7.3% 2.2% 5.0%ROA 5.7% 1.6% 4.8%ROE 8.0% 2.4% 8.4%

ROE =

= = 0.080 = 8.0%. $8,572$107,364

Net incomeTotal equity

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Liquidity Ratios (1998)

CR = = = 2.3 times.

DCOH =

= = 22.5 days.

CACL

$31,280$13,332

$4,263 + $2,000$277.93

Cash + Marketable securitiesCash expenses / 365

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1998 1997 Ind.

CR 2.3x 1.7x 2.0x

DCOH 22.5 18.9 30.6

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Debt Management Ratios (1998)

Debt ratio = Total debt

Total assets

= = 0.290 = 29.0%. $43,814

$151,278

TIE ratio =

= = 6.6 times. $10,114$1,542

EBITInterest expense

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1998 1997 Ind.

DR 29.0% 33.5% 43.3%

TIE 6.6x 2.6x 4.0x

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Asset Management Ratios (1998)

FA turnover = Total revenueNet fixed assets

= = 0.98 times. $117,476$119,998

TA turnover = Total revenueTotal assets

= = 0.78 times. $117,476$151,278

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1998 1997 Ind.FATO 0.98 0.90 2.2TATO 0.78 0.73 0.97ACP 73.4 77.7 64.0

ACP =

= = 73.4 days. $21,840

$108,600 / 365

Net patient accounts rec.Net patient service rev. / 365

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x x = ROE

Totalmargin

TAturnover

Equitymultiplier

NI Rev

RevTA

TA TE

1997: 2.22% x 0.73 x 1.50 = 2.43%.1998: 7.30% x 0.78 x 1.41 = 7.98%. Ind: 5.00% x 0.97 x 1.73 = 8.39%.

x x = ROE .

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Market Value Added (MVA)

MVA = MV of equity - BV of equity.Assume on November 1, 1998 that Columbia/ HCA had an equity book value of $7.5 billion, that its stock price was $25, and that it had 643 million shares outstanding.

MVA = ($25 x 643 million) - $7.5 billion = $16.1 - $7.5 = $8.6 billion.

What does this MVA value mean?Does the MVA concept apply to NFP firms?

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Economic Value Added (EVA)

EVA = -

= AT op. income - Dollar capital costs

= (EBIT x [1 - T]) - (Total assets x CCC).

Here, CCC = corporate cost of capital.

Funds availableto investors

Dollar cost ofcapital employed

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AT operating income = ($8,572 + $1,542) x (1 - 0.0) = $10,114.

Dollar capital costs = $151,278 x 0.10 = $15,128.

EVA = $10,114 - $15,128 = -$5,014.

EVA Example ($000s)

Here is Riverside’s 1998 EVA:

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Benchmarking

The process of comparing a business’ ratios to selected standards is called benchmarking. Here are Riverside’s total margin benchmarks:

National/GFB 9.8% National/GFB 9.6% Ind. top quartile 8.4 Ind. top quartile 8.0St. Anthony's 8.0 St. Anthony’s 7.9 Riverside 7.3 Pennant Healthcare 5.0Industry median 5.0 Industry median 4.7Pennant Healthcare 4.8 Riverside 2.2Ind. lower quartile 1.8 Ind. lower quartile 2.1Woodbridge Memorial 0.5 Woodbridge Memorial (1.3)

1998 1997

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Net Price Per Discharge (1998)

NPPD =Net inpatient revenue

Total discharges

= = $5,128. $93,740,000

18,281

Industry average = $5,510.

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Occupancy Percentage (Rate) (1998)

OR =Inpatient days

Number of staffed beds x 365

= = 0.579 = 57.9%. 95,061

450 x 365

Industry average = 44.9%.

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Limitations of Financial Performance Analysis?

Comparison with industry averages is difficult if the business operates many different divisions.

“Average” performance not necessarily good performance.

Seasonal factors can distort ratios.Inflation effects can distort

financial statement data.

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Different operating and accounting practices can distort comparisons.

Sometimes, it is hard to tell if a ratio is “good” or “bad.”

It is often difficult to tell whether company is, on balance, in a strong or weak position:Multiple discriminant analysisFinancial flexibility index

Limitations (Cont.)

financial statement application: analyzing financial performance

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