Slides for Class 6 and 7 February 14 and 21, 2002

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

2. 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 138-9.

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

4. 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

5. 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

6. 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

7. 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

8. 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 ^.

9. 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.