Slides for Class 6 and 7 February 14 and 21, 2002 Using financial ratios to make sense from the general-purpose financial statements of a HCO.

Analyzing financial statements Cleverly’s rationale for promoting financial ratios. To stay competitive, an HCO must grow it assets. To achieve this sustained growth, a not-for-profit HCO has to pay for these new assets through increases in its net assets. For an HCO to increase its net assets, it must perform at a level that results in positive levels of Return on Equity. Financial ratios can help the board and management monitor and take steps to meet a target level of ROE: See Strategic Management Model Fig. 7-2, page

Categories of Financial Ratios: Ratio Analysis Liquidity Ratios (LR) Capital Structure Ratios (CSR) Activity Ratios (AR) Profitability Ratios (PR) Other ratios (OR)

Liquidity Ratios: Measures that indicate an HCO’s ability to meet its short term obligations. Current Ratio CR –^ CR means an ^ in HCO’s liquidity Days in Patient Accounts Receivable Ratio DPARR – ^ DPARR means drop in HCO’s liquidity Average Payment Period Ratio APPR –^ APPR means drop in HCO’s liquidity Days Cash-On-Hand Ratio DCOHR – ^ DCOHR means ^ in HCO’s liquidity

Capital Structure Ratios: Useful in assessing the long-term solvency of an HCO: Ability to Manage Debt Equity financing Ratio EFR –^ EFR means ^ financial condition of HCO Long-term Debt to Equity (read net assets for not-for- profit HCOs) Ratio LTDER –^ LTDER means drop in financial condition Times Interest Earned Ratio TIER –^ TIER means ^ in financial condition Debt Service Coverage Ratio DSCR –^ DSCR means ^ in financial condition Cash Flow to Debt Ratio CFDR –^ CFDR means ^ in financial condition

Activity Ratios: Indicates an HCO’s Efficiency Total Asset Turnover Ratio –^ TATR means ^ in efficiency Fixed Asset Turnover Ratio –^ FATR means ^ in efficiency Current Asset Turnover Ratio –^ CATR means ^ in efficiency Other Asset Turnover Ratio –^ OATR means ^ in efficiency

Profitability Ratios: Ratios that indicate the profitability of the HCO Total Margin Ratio –^ TMR means ^ in HCO’s profitability Operating Margin Ratio –^ OMR means ^ in HCO’s profitability Operating Margin Price Level Adjusted Ratio –^ OMPLAR means ^ in HCO’s profitability Non-operating Gain Ratio –^ NOGR means ^ in HCO’s profitability Return on Equity Ratio (read net assets for not-for-profit HCOs) –^ ROE means ^ in HCO’s profitability

FOCUS ON ROE ROE = Total Margin Ratio * Total Asset Turnover Ratio * [1 / Equity Finance Ratio] ROE will ^ when TMR ^, when TATR ^, and when EFR drops. ROE will ^ when prices ^ and/or operating costs are reduced, efficiency ^, and when leverage on net assets ^.

Replacement Viability Ratio: Assessing the feasibility of future plant replacement Replacement Viability Ratio –^ in RVR means drop in future need for debt financing or in the costs of debt. Also possibility of investing in assets the returns from which would increase total revenues.