Balance Sheets and Ratio Analysis N287E Spring 2006 Joanne Spetz 5 April 2006

Administrative news Our classroom is now C701, except… April 26, either U506 or the Bailey Lounge May 10, HSW 303 Next week – guest lecturers Do the reading in advance!

What did we do last time? Defined “health economics” Defined “utility” Graphed indifference curves Talked about marginal costs and marginal benefits Learned the supply and demand magic

What did we do last time? Defined “perfect competition” Learned why perfect competition does not exist in health care Talked about nursing shortages Short-term supply and demand Long-term supply and demand

Questions for you… Is there an economic case for addressing nursing shortages? Do you think Huston 2003 makes the case well? Why or why not? What are the costs to our economy of nursing shortages? Rivers et al., 2005, recommends Magnet Certification as a key strategy. Do you agree?

Questions for you… Do you think the model proposed by Spetz & Given (2003) is adequate? What issues did they ignore in their analysis?

And on with the show… How do we assess the financial impact of anything on health care?

How do we assess whether firms are profitable? Profitability has many components Immediate profit Investments that lead to future profits In health care many firms are not-for- profit Religious and not-for-profit hospitals Community clinics

Firms keep records of financial information Most financial information is available to the public For-profit firms must share information if they are publicly held (stocks) Not-for-profit firms have an obligation to the public and must have information available Some states require reporting

What financial information do we want? Financial sheets Balance sheet Statement of revenues and expenses Statement of cash flows Statement of change sin fund balances or net assets Plus… footnotes to all these

Firms report financial data in standard way Financial sheets contain information about firm financial performance For most companies, these data are available to the public There are many accounting tricks to make these sheets “look good”

Balance Sheets The Balance Sheet provides the present value of the firm Two sections: Assets Current liabilities and equity Assets = liabilities + equity Equity (roughly) measures the value of the company Equity = Assets - liabilities

Types of assets Current assets (cash, securities, etc.)

Types of assets Limited-use assets

Types of assets Property, plant, and equipment (PPE) Note PPE is depreciated to get net PPE

Types of assets Investments, other assets

Types of assets Intangible assets Very hard to value There are some strong rules about valuation

Types of assets (restricted funds) Specific purpose funds

Types of assets (restricted funds) Plant replacement & expansion funds

Types of assets (restricted funds) Endowment

Types of liabilities Current liabilities

Types of liabilities Deferred credits

Types of liabilities Long-term debt

Types of liabilities (restricted funds) Money due to the restricted funds Specific purpose funds Plant replacement & expansion Endowment funds

Components of equity Non-profit (fund balance) For-profit Stock Capital Retained earnings

Statement of Revenues and Expenses Presents the year’s earnings Presents the year’s expenses Calculates the income or loss from operations

Components of statement of income Operating revenues Deductions from revenue Operating expenses Taxes Non-operating revenues Non-operating expenses

Operating revenues Money the firm receives

Deductions from revenues Particularly relevant for health care…

Operating expenses What does it cost to run the business?

Taxes Only if you’re a for-profit company

Non-operating revenue Revenue that isn’t connected to your line of business

Non-operating expenses Costs that aren’t associated with your production

Add it all up and you get… Net income

It can be important to adjust for inflation Inflation can increase value of assets Inflation can decrease cost of debts Inflation increases cost of future investment

To deal with future costs… Future costs come from: Inflation Investments Firms must have increases in their assets Assets = liabilities + net assets Asset increases come from increases in  Debt  Equity

Ways to measure growth Growth Rate in Equity (GRIE) GRIE=  equity =net incomex  equity equityequitynet inc. = return on equity = (net income/equity) reported income index (net income/  equity)

How to interpret GRIE… If a firm has no equity source other than net income No endowment No government transfers …then the reported income index = 1 GRIE is sometimes called Return on Equity (ROE)

To break down ROE more… ROE=net op income+net nonop income revenue xrevenuexassets assetsequity

To go farther than this… Ratio analysis Liquidity ratios – ability of firm to meet short-term financial obligations Capital structure ratios – quality of capital of firm Activity ratios – revenues and expenses Profitability ratios – revenues vs. expenses Other ratios

We can benchmark ratios Ratios get compared to national or regional averages/medians Different ratio goals for different industries In your problem set you will be computing ratios