Financial Management of Health Care Organizations An Introduction 4th edition, Zelman

1. Financial Statement Analysis
Chapter 4

2. Learning Objectives
• Analyze the financial statements of healthcare organizations using
the horizontal analysis, vertical analysis and ratio analysis
• Calculate and interpret liquidity, profit, activity and capital structure
ratios

3. C1 Building Blocks of Analysis
Liquidity
and
Efficiency
Solvency
Profitability
Market
Prospects
Ability to meet
short-term
obligations and
to efficiently
generate
revenues
Ability to
generate future
revenues and
meet long-term
obligations
Ability to
generate
positive
market
expectations
Ability to provide
financial rewards
sufficient to
attract and retain
financing
13-3

4. Standards for Comparison
When interpreting measures, we need to decide
whether the measures indicate good, bad, or
average performance. We can use the following to
make that judgment:
• Intra-company
•Competitor
• Industry
• Guidelines (rule of thumb)
C 2
13-4

5. C 1 Tools of Analysis
Horizontal Analysis
Comparing a company’s financial condition and
performance across time.
Vertical Analysis
Comparing a company’s financial condition and
performance to a base amount.
Measurement of key
relations between
financial statement items 13-5

6. Horizontal Analysis
• Looks at the percentage change in a line item from one year to the
next
• Goal – What is the percentage change in a line item from one year
to the next year ?
• An issue with horizontal analysis is that small percentage changes
can hide major dollar effects
• Another issue is that large percentage changes from year to year
may be relatively inconsequential in terms of dollar amounts
• 푯풐풓풊풛풐풏풕풂풍 푨풏풂풍풚풔풊풔 =
풔풖풃풔풆풒풖풆풏풕 풚풆풂풓−풑풓풆풗풊풐풖풔 풚풆풂풓
풑풓풆풗풊풐풖풔 풚풆풂풓
푿 ퟏퟎퟎ

7. Comparative Statements
Calculate Change in Dollar Amount
Dollar
change
Analysis period
amount
Base period
= amount –
Since we are measuring the amount of
the change between 2011 and 2010, the
dollar amounts for 2010 become the
“base” period amounts.
P 1
Calculate Change as a Percent
Percent
change
Dollar change
= × 100
Base period amount
13-7

8. CLOVER CORPORATION
Comparative (partial) Balance Sheet
December 31, 2011
2011 2010
Dollar
Change
Percent
Change*
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) (48.9)
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200 1,800
Total current assets $ 155,000 $ 164,700
$12,000 –
$23,500 =
$(11,500)
Property and equipment:
Land 40,000 40,000 - 0.0
Buildings and equipment, net 120,000 85,000
Total property and equipment $ 160,000 $ 125,000
Total assets $ 315,000 $ 289,700
* Percent rounded to first decimal point.
($11,500 ÷
$23,500) × 100 =
48.9%
P 1
13-8

9. CLOVER CORPORATION
Comparative (Partial) Balance Sheet
December 31, 2011
2011 2010
Dollar
Change
Percent
Change*
Assets
P 1
Current assets:
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) (48.9)
Accounts receivable, net 60,000 40,000 20,000 50.0
Inventory 80,000 100,000 (20,000) (20.0)
Prepaid expenses 3,000 1,200 1,800 150.0
Total current assets $ 155,000 $ 164,700 $ (9,700) (5.9)
Property and equipment:
Land 40,000 40,000 - 0.0
Buildings and equipment, net 120,000 85,000 35,000 41.2
Total property and equipment $ 160,000 $ 125,000 $ 35,000 28.0
Total assets $ 315,000 $ 289,700 $ 25,300 8.7
* Percent rounded to first decimal point.
13-9

10. 13-10
CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2011
2011 2010
Dollars
Change
Percent
Change
P 1
Revenues $520,000 $480,000 $40,000 8.3%
Costs and expenses:
Cost of sales 360,000 315,000 45,000 14.3
Selling and admin. 128,600 126,000 2,600 2.1
Interest expense 6,400 7,000 (600) (8.6)
Income before taxes 25,000 32,000 (7,000) (21.9)
Income taxes (30%) 7,500 9,600 (2,100) (21.9)
Net income $17,500 $22,400 ($4,900) (21.9)
Net income per share $0.79 $1.01
Avg. # common shares 22,200 22,200
Percent changes rounded to first decimal point.

11. Trend Analysis
Compares changes over a longer period of time by comparing each
year with a base year.

12. Trend Analysis
• Trend analysis is used to reveal patterns in data covering successive
periods.
• It is a type of analysis that looks at changes in line items compared with
a base year.
Trend
percent
Any subsequent year – base year
= Base year × 100
P 1
13-12

13. Trend Analysis
Berry Products
Income Information
For the Years Ended December 31,
Item 20X0 20X1 20X2 20X3 20X4
Operating Income $1,054,186 $ 330,909 $ 500,098 $1,232,565 $ 1,453,567
Percentage
change from 20X0 -68.6% -52.6% 16.9% 37.9%
20X0 is the base period so its
amounts will equal 100%.
P 1
13-13

14. Trend Analysis
We can use the trend
percentages to construct a
graph so we can see the
trend over time.
P 1
13-14

15. Vertical (Common-Size) Analysis
• Purpose is to answer the general question, What percentage of one
line item is another line item?
• Vertical analysis is useful for analyzing the balance sheet
• Called common size because it converts every line item to a
percentage, thus allowing comparisons between the financial
accounts of the organizations of different sizes.
• Vertical analysis =
푳풊풏풆 풊풕풆풎 풐풇 풊풏풕풆풓풆풔풕
푩풂풔풆 풍풊풏풆 풊풕풆풎
퐗ퟏퟎퟎ

16. CLOVER CORPORATION
Comparative (Partial) Balance Sheet
December 31, 2011
Common-Size
Percents*
2011 2010 2011 2010
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 3.8% 8.1%
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets $ 155,000 $ 164,700
Property and equipment:
Land 40,000 40,000 12.7%
Buildings and equipment, net 120,000 85,000
Total property and equipment $ 160,000 $ 125,000
Total assets $ 315,000 $ 289,700
* Percent rounded to first decimal point.
($12,000 ÷
$315,000) ×
100 = 3.8%
($23,500 ÷
$289,700) ×
100 = 8.1%
P 2
13-16

17. CLOVER CORPORATION
Comparative (Partial) Balance Sheet
December 31, 2011
Common-Size
Percents*
2011 2010 2011 2010
Assets
P 2
Current assets:
Cash and equivalents $ 12,000 $ 23,500 3.8% 8.1%
Accounts receivable, net 60,000 40,000 19.0% 13.8%
Inventory 80,000 100,000 25.4% 34.5%
Prepaid expenses 3,000 1,200 1.0% 0.4%
Total current assets $ 155,000 $ 164,700 49.2% 56.9%
Property and equipment:
Land 40,000 40,000 12.7% 13.8%
Buildings and equipment, net 120,000 85,000 38.1% 29.3%
Total property and equipment $ 160,000 $ 125,000 50.8% 43.1%
Total assets $ 315,000 $ 289,700 100.0% 100.0%
* Percent rounded to first decimal point.
13-17

18. CLOVER CORPORATION
Comparative (Partial) Balance Sheets
December 31, 2011
Common-Size
Percents*
2011 2010 2011 2010
Liabilities and Shareholders' Equity
P 2
Current liabilities:
Accounts payable $ 67,000 $ 44,000 21.3% 15.2%
Notes payable 3,000 6,000 1.0% 2.1%
Total current liabilities $ 70,000 $ 50,000 22.2% 17.3%
Long-term liabilities:
Bonds payable, 8% 75,000 80,000 23.8% 27.6%
Total liabilities $ 145,000 $ 130,000 46.0% 44.9%
Shareholders' equity:
Preferred stock 20,000 20,000 6.3% 6.9%
Common stock 60,000 60,000 19.0% 20.7%
Additional paid-in capital 10,000 10,000 3.2% 3.5%
Total paid-in capital $ 90,000 $ 90,000 28.6% 31.1%
Retained earnings 80,000 69,700 25.4% 24.1%
Total shareholders' equity $ 170,000 $ 159,700 54.0% 55.1%
Total liabilities and shareholders' equity $ 315,000 $ 289,700 100.0% 100.0%
* Percent rounded to first decimal point.
13-18

19. CLOVER CORPORATION
Comparative Income Statements
For the Years Ended December 31, 2011
Common-Size
Percents*
2011 2010 2011 2010
P 2
Revenues $520,000 $480,000 100.0% 100.0%
Costs and expenses:
Cost of sales 360,000 315,000 69.2% 65.6%
Selling and admin. 128,600 126,000 24.7% 26.3%
Interest expense 6,400 7,000 1.2% 1.5%
Income before taxes $ 25,000 $ 32,000 4.8% 6.7%
Income taxes (30%) 7,500 9,600 1.4% 2.0%
Net income $ 17,500 $ 22,400 3.4% 4.7%
Net income per share $ 0.79 $ 1.01
Avg. # common shares 22,200 22,200
* Rounded to first decimal point.
13-19

20. Common-Size Graphics
This is a graphical analysis of Clover
Corporation’s common-size income
statement for 2011.
Cost of Sales
69.2%
Selling and
Admin.
24.7%
Net Income
3.4%
Income Taxes
1.4%
Interest
Expense
1.2%
P 2
13-20

21. Ratio Analysis
Liquidity
Let’s use the following financial
statements for Norton Corporation for
our ratio analysis.
and
Efficiency
Solvency
Profitability Market
Prospects
P 3
13-21

22. Ratio Analysis
• Preferred approach for gaining an in depth understanding of
financial statements
• Ratio expresses the relationship between 2 numbers as a single
number. This provides an indication of the organization’s ability to
cover current obligations with current assets (ability to pay short
term debt

23. Categories of Ratios
• Liquidity-How well is the organization positioned to meet its short-term
obligations?
• Profitability-How profitable is the organization?
• Activity- How efficiently is the organization using its assets to
produce revenues?
• Capital structure- How are the organization’s assets financed and
ability to take on new debt?

24. A. Liquidity Ratios
• There are 6 liquidity ratios:
• Current Ratio-proportion of all current assets to all current liabilities
• Quick Ratio-used in industries in which net accounts receivable is
relatively liquid (not usually used in health care organizations)
• Acid Test Ratio-most stringent test of liquidity How much cash is
available to pay off all current liabilities?
• Days in Accounts Receivable ratio-How quickly a hospital is converting its
receivables into cash
• Days Cash on Hand ratio -number of days worth of expenses an
organization can cover with its most liquid assets
• Average Payment Period -How long on average it takes an organization to
pay its bills

25. P 3 Liquidity and Efficiency
Current
Ratio
Quick Ratio
Acid-test
Ratio
Average
payment
period
Days’ cash
on hand
ratio
Days’ in
Accounts
receivables
ratio
13-25

26. P 3 1. Current Ratio
Current
ratio
Current assets
Current liabilities
=
This ratio measures the
short-term debt-paying
ability of the company.
13-26

27. Steps:
• 1. identify the dollar amount of current assets on the balance sheet.
• 2. identify the dollar amount of current liabilities on the balance sheet.
• 3. divide the current assets by current liabilities
• Example:
Year Current ratio = Current
assets
/ Current liabilities
20X1 1.80 = $ 2,514,335 / $ 1,395,190
20X0 0.58 = $ 1,954,134 / $ 3,394,418
Benchmark = 2.11
Desired position = Above

28. P 3 2. Quick Ratio
Quick
ratio
cash + marketable securities + Net accounts receivables
Current liabilities
=
Is commonly used in
industries in which net
accounts receivables is
relatively liquid.
13-28

29. Steps:
• 1. identify the dollar amount of cash, marketable securities, and net accounts receivables
on the balance sheet.
• 2. identify the dollar amount of current liabilities on the balance sheet.
• 3. divide the sum of cash, marketable securities and net accounts receivables by current
liabilities
• Example:
Year Quick
ratio
= (Cash & marketable
securities + net accounts
receivables )
/ Current liabilities
20X1 1.36 = ($ 363,181 + 1,541,244) / $ 1,395,190
20X0 0.46 = ($ 158,458 + 1,400,013) / $ 3,394,418
Benchmark = 1.52
Desired position = Above

30. 3. Acid-Test Ratio
Cash + Marketable securities
Current liabilities
Acid-test =
ratio
P 3
This ratio provides the most
stringent test for liquidity.
It looks at how much cash is on hand
or readily available from marketable
securities to pay off all current
liabilities.
13-30

31. Steps:
• 1. identify the dollar amount of cash, marketable securities on the balance
sheet.
• 2. identify the dollar amount of current liabilities on the balance sheet.
• 3. divide the sum of cash, and temporary investments by current liabilities
• Example:
Year Acid-test
ratio
= Cash & marketable
securities
/ Current liabilities
20X1 0.26 = $ 363,181 / $ 1,395,190
20X0 0.05 = $ 158,458 / $ 3,394,418
Benchmark = 0.30
Desired position = Above

32. 4.Days in Accounts Receivable
Net Patient Accounts receivables
Net Patient Revenues/365
Days in
Accounts
receivable
=
• This ratio provides an estimate of
how many day’s revenues have not
yet been collected.
• Values above the benchmark
indicate problems relating to credit
collection policies.
• Values below the benchmark
indicate ability to collect
receivables on time.
P 3
13-32

33. Steps:
• 1. identify the dollar amount of net patient revenues on the
statement of operations
• 2. divide net patient revenues by 365 to compute average net
patient revenues per day
• 3. identify the dollar amount of net patient accounts receivables on
the balance sheet
• 4. divide net patient accounts receivables by average net patient
revenues per day.

34. Example: benchmark = 49
desired position: below
Steps 1 & 2:
Year Net
patient
revenues
/ 365
days
= Average net patient
revenues per day
20X1 $10,778,272 / 365 days = $ 29,530
20X0 $10,566,176 / 365 days = $ 28,948
Steps 3 & 4:
Year Net patient
accounts
receivables
/ Average
net patient
revenues
per day
= Day’s in Accounts
Receivables
20X1 $1,541,244 / $ 29,530 = 52
20X0 $ 1,400,013 / $ 28,948 = 48

35. 5. Day’s Cash on Hand Ratio
Cash + Marketable Securities + Long Term
Investments
(Operating Expenses – Depreciation and
amortization)/365
Day’s Cash on
Hand
=
• This ratio provides an indication of
the no. of day’s worth of expenses
an organization can cover with its
most liquid assets: cash and
marketable securities.

36. Steps:
• 1. identify the dollar amount of operating expenses and
depreciation and amortization expenses on the statement of
operations.
• 2. divide operating expenses minus depreciation and amortization
expenses by 365 days to compute average cash operating expense
per day.
• 3. identify the dollar amount of cash, marketable securities and
long term investments on the balance sheet.
• 4. divide cash and marketable securities and long term investments
by the average cash operating expense per day

37. Example: benchmark = 86
Desired Position: above
Steps 1 & 2:
Year (operating
expenses
- Depreciation
&
amortization
expenses )
/ 365
days
= Operating
expense per day
20X1 ($ 10,681,112 - $ 383,493) / 365 days = $ 28,213/ day
20X0 ($ 9,765,507 - $ 420,238) / 365 days = $ 25, 603 / day
Steps 3 & 4:
Year Cash +
Marketable
Securities +
Long Term
Investments
/ Operating
expense per
day
= Day’s cash on hand
20X1 $ 3,777,913 / $ 28,213 = 134 days
20X0 $ 4,683, 934 / $ 25, 603 = 183 days

38. 6. Average Payment P 3 Period Ratio
Current Liabilities
[(Operating Expenses –
Depreciation & Amortization) /
365]
It is a measure of how long, on
average, it takes an organization
to pay its bills.
Average
Payment Period
=
13-38

39. Steps:
• 1. identify the dollar amount of operating expenses and
depreciation and amortization expenses on the statement of
operations.
• 2. divide operating expenses minus depreciation and amortization
expenses by 365 days to compute average cash expense per day.
• 3. identify the dollar amount of current liabilities on the balance
sheet.
• 4. divide the current liabilities by the average cash expense per day

40. Example: benchmark = 50
desired position: organizationally dependent
Steps 1 & 2:
Year (operating
expenses
- Depreciation
&
amortization
expenses )
/ 365
days
= Average cash
expense per day
20X1 ($ 10,681,112 - $ 383,493) / 365 days = $ 28,213/ day
20X0 ($ 9,765,507 - $ 420,238) / 365 days = $ 25, 603 / day
Steps 3 & 4:
Year Current
Liabilities
/ Average
cash
expense per
day
= Average Payment
Period Days
20X1 $ 1,395,190 $ 28,213 = 49 days
20X0 $ 3,394,418 $ 25, 603 = 183 days

41. Revenues, Expenses and Profitability Ratios

42. Operating revenue per adjusted discharge Ratio
Total operating Revenues
Adjusted Discharges
Operating
Revenue per
adjusted
discharge
=
• Discharges are adjusted by
multiplying hospital total
discharges by a factor defined as
gross patient revenue divided by
gross impatient revenue
measures total operating
revenues generated from the
patient care line of business
based on its adjusted inpatient
discharges

43. Steps:
• 1. identify operating revenue on the statement of operations.
• 2. identify adjusted discharges from utilization data.
• 3. divide operating revenue by adjusted discharges.
• Example:
Year Operating
revenue per
adjusted
discharge
= Total
operating
revenue
/ Adjusted discharges
20X1 $ 5,607 = $ 11,012,021 / 1,950
20X0 $ 6,011 = $ 10,819,693 / 1,800
Benchmark = $7,448
Desired position = Above

44. Operating Expenses per adjusted discharge Ratio
Total operating Expenses
Adjusted Discharges
Operating
Revenue per
adjusted
discharge
=
• Discharges are adjusted by
multiplying hospital total
discharges by a factor defined as
gross patient revenue divided by
gross impatient revenue
measures total operating expenses
incurred for providing its patient
care services based on its adjusted
inpatient discharges

45. Steps:
• 1. identify operating expenses on the statement of operations.
• 2. identify adjusted discharges from utilization data.
• 3. divide operating expenses by adjusted discharges.
• Example:
Year Operating
expense per
adjusted
discharge
= Total
operating
revenue
/ Adjusted discharges
20X1 $ 5,477 = $ 10,681,112 / 1,950
20X0 $ 5,425 = $ 9,765,507 / 1,800
Benchmark = $7,197
Desired position = Below

46. Salary and Benefit Expense as a Percentage of
Total Operating Expense Ratio
Total Salary and Benefit
Expenses
Total Operating Expenses
Salary and
Benefit
Expense as a
Percentage of
Total Operating
Expense
=
measures the percentage of total
operating expenses that are
attributed to labor costs.

47. Steps:
• 1. identify the total salary and benefit expenses on the statement of operations.
• 2. identify the total operating expenses on the statement of operations.
• 3. divide the total salary and benefit expenses by the total operating expenses
• Example:
Year Salary and
benefit
expenses as a
percentage of
total operating
expense
= Salary and
benefit
expense
/ Total operating
expense
20X1 53% = $ 5,644,880 / $ 10, 681,112
20X0 55% = $ 5,345,498 / $ 9,765,507
Benchmark = 40%
Desired position = Below

48. Operating Margin Ratio
Operating income
Total Operating Revenues
Operating
Margin
=
measures profits earned from the
organization’s main line of business.
the margin indicates the proportion of profit
earned for each dollar of operating revenue-that
is, the proportion of profit remaining after
subtracting total operating expenses from
operating revenues. .

49. Steps:
• 1. identify the operating income on the statement of operations.
• 2. identify the total operating revenues on the statement of operations.
• 3. divide the operating income by total operating revenues
• Example:
Year Operating
Margin
= Operating
income
/ Total operating
revenues
20X1 0.03 = $ 330, 909 / $ 11,012,021
20X0 0.10 = $ 1,054,186 / $ 10,819,693
Benchmark = 0.03
Desired position = Above

50. Non-Operating Revenue Ratio
Non-Operating Revenues
Total Operating Revenues
Non-Operating
Revenue
=
Non-Operating revenues may include: interest
income, dividends, gains from investment activities,
and assets released from restricted investment
accounts.
this ratio is to find out how dependent the
organization is on patient-related net
income.
the higher the ratio, the less the organization is
dependent on direct patient-related income and
the more it is dependent on revenues from
other, non-operating sources.

51. Steps:
• 1. identify the non-operating revenues on the statement of operations.
• 2. identify the total operating revenues on the statement of operations.
• 3. divide the non-operating revenues by the total operating revenues
• Example:
Year Non-Operating
Revenue Ratio
= Non-
Operating
Revenues
/ Total operating
revenues
20X1 0.02 = $ 185,000 / $ 11,012,021
20X0 0.02 = $ 165, 000 / $ 10,819,693
Benchmark = 0.04
Desired position = Organizationally Dependent

52. Return on Total Assets Ratio
Excess of revenues over
expenses
Total Assets
Return on total
assets
=
It measures how much profit is earned for
each dollar invested in assets.

53. Steps:
• 1. identify the excess of revenues over expenses on the statement of
operations.
• 2. identify the total assets on the balance sheet.
• 3. divide the excess of revenues over expenses by total assets.
• Example:
Year Return on
total assets
= Excess of
revenues
over
expenses
/ Total Assets
20X1 0.05 = $ 515,909 / $ 10,876,736
20X0 0.11 = $ 1,219,186 / $ 11,315,585
Benchmark = 0.04
Desired position = Above

54. Return on Net Assets Ratio
Excess of revenues over
expenses
Net Assets
Return on Net
assets
=
It measures the rate of return fpr each
dollar in net assets.

55. Steps:
• 1. identify the excess of revenues over expenses on the statement of
operations.
• 2. identify the net assets on the balance sheet.
• 3. divide the excess of revenues over expenses by net assets.
• Example:
Year Return on Net
assets
= Excess of
revenues
over
expenses
/ Net Assets
20X1 0.20 = $ 515,909 / $ 2,542,655
20X0 0.64 = $ 1,219,186 / $ 1,911,683
Benchmark = 0.08
Desired position = Above

56. C. Activity Ratios
• May be called Efficiency Ratios
• Ask the question “For each dollar invested in assets, how many dollars
of revenue are being generated”?
• The higher the ratio, the more efficiently the assets are being generated
• In general: activity ratios=
푹풆풗풆풏풖풆풔
푨풔풔풆풕풔
• Some selected activity ratios are:
1. Total Asset Turnover Ratio
2. Fixed Asset Turnover Ratio
3. Age of Plant Ratio

57. 1. Total Asset Turnover Ratio
Total Operating Revenues
Total Assets
Total Asset
Turnover ratio
=
It measures the overall efficiency of the
organization’s assets in producing
revenue.

58. Steps:
• 1. identify the total operating revenues on the statement of operations.
• 2. identify total assets on the balance sheet.
• 3. divide total operating revenues by total assets.
• Example:
Year Total asset
turnover
= Total
Operating
Revenues
/ Total Assets
20X1 1.01 = $ 11,012,021 / $ 10,876,736
20X0 0.96 = $ 10,819,693 / $ 11,315.585
Benchmark = 1.07
Desired position = Above

59. 2. Fixed Asset Turnover Ratio
Total Operating Revenues
Net Plant & Equipment
Fixed Asset
Turnover ratio
=
It aids in the evaluation of the most
productive assets, plant and equipment.

60. Steps:
• 1. identify the total operating revenues on the statement of operations.
• 2. identify net plant and equipment assets on the balance sheet.
• 3. divide total operating revenues by net plant and equipment (fixed assets).
• Example:
Year Fixed asset
turnover
= Total
Operating
Revenues
/ Net Plant and
Equipment
20X1 2.56 = $ 11,012,021 / $ 4,306,754
20X0 2.41 = $ 10,819,693 / $ 4,495,122
Benchmark = 2.12
Desired position = Above

61. 3. Age of Plant Ratio
Accumulated Depreciation
Depreciation Expense
Age of Plant
ratio
=
This ratio provides an indication of the
average age of a hospital’s plant and
equipment.

62. Steps:
• 1. identify the accumulated depreciation on the balance sheet.
• 2. identify depreciation expense on the statement of operations.
• 3. divide the accumulated depreciation by the depreciation expense.
• Example:
Year Age of Plant = Accumulated
Depreciation
/ Depreciation
Expense
20X1 7.25 = $ 2,781,741 / $ 383,493
20X0 5.71 = $ 2,398,248 / $ 420,238
Benchmark = 10.31
Desired position = below

63. D. Capital Structure Ratios
• Define 2 areas
How are an organization’s assets financed?
How able is this organization to take on new debt?
• Greater understanding of these ratios can be gained by examining
the statement of cash flows to determine if significant long term
debt has been acquired or paid off
• OR
• if there has been a sale or purchase of fixed assets

64. Capital Structure Ratios
Continued…
There are 4 to be discussed
1. Long term debt to net assets-measures the proportion of debt to net
assets
2. Net assets to total assets-reflects the proportion of total assets
financed by equity
3. Times Interest Earned- enables creditors and lenders to evaluate a
hospitals ability to generate the earnings necessary to meet interest
expense requirements
4. Debt service Coverage- measures the ability to repay a loan

65. 1. Long-term debt to net assets
Ratio
Long-term Debt
Net assets
Long-term debt
to net assets
ratio
=
This ratio measures the proportion of debt to
net assets.

66. Steps:
• 1. identify the non-current debt on the balance sheet.
• 2. identify net assets on the balance sheet.
• 3. divide non-current debt by net assets.
• Example:
Year Long-term
debt to net
assets
= Total
Operating
Revenues
/ Net Plant and
Equipment
20X1 2.73 = $ 6,938,891 / $ 2,542,655
20X0 3.14 = $ 6,009,484 / $ 1,911,683
Benchmark = 0.21
Desired position = below

67. 2. Net Assets to Total assets Ratio
Net assets
Total assets
Net assets to
total assets
ratio
=
Creditors desire a strong equity position with
sufficient funds to pay off debt obligations.
So a high net asset or equity position is
enhanced either through the retention of
earnings or through private contributions
from the community.

68. Steps:
• 1. identify net assets on the balance sheet.
• 2. identify total assets on the balance sheet.
• 3. divide net assets by total assets.
• Example:
Year Net assets to
total assets
ratio
= Net assets / Total assets
20X1 0.23 = $ 2,542,655 / $ 10,876,736
20X0 0.17 = $ 1,911,683 / $ 11,315,585
Benchmark = 0.54
Desired position = Above

69. 3. Times interest earned Ratio
(excess of revenues over
expenses+ interest expense)
Interest expense
Times interest
earned ratio =
This ratio enables creditors and lenders to
evaluate a hospital’s ability to generate the
earnings necessary to meet interest
expense requirements.

70. Steps:
• 1. identify net assets on the balance sheet.
• 2. identify total assets on the balance sheet.
• 3. divide net assets by total assets.
• Example:
Year Times interest
earned ratio
= (Excess of revenues over
expenses + interest expense)
/ Interest
expense
20X1 2.03 = ($ 515,909 + $ 500,000) / $ 500,000
20X0 5.41 = ($ 1,219,186 + $ 276,379) / $ 276,379
Benchmark = 3.78
Desired position = Above

71. 4. Debt Service Coverage Ratio
(excess of revenues over
expenses + interest expense +
Depreciation and Amortization
Expenses) )
(Interest expense + Principal
Payments)
Debt Service
Coverage ratio =
This ratio enables the ability to repay a loan.

72. Steps:
1. identify excess of revenues over expenses on the statement of
operations.
2. identify interest expense on the statement of operations.
3. Identify principal payments on the statement of cash flows
4. Add the excess of revenues over expenses, interest expense and
depreciation and amortization expense from the statement of
operations.
5. divide the sum from step 4 by the sum of the interest expense
and principal payments.

73. Example: benchmark = 3.18
desired position: Above
Steps 1 & 2:
Year Cash Flow
before
interest
= (Excess of
Revenues
over
Expenses)
+ Interest
Expense
+ Depreciation
Expense)
20X1 $ 1,399,402 = ($ 515, 909 + $ 500,000 + $ 383,493)
20X0 $ 1,915,803 = ($ 1,219,186 + $ 276,379 + $ 420, 238)
Steps 3 & 4:
Year Debt Service
Coverage
Ratio
= Cash Flow
before
Interest
/ (Interest Expense +
Principal Payments)
20X1 2.00 = $ 1,399,402 / ($ 500,000 + $ 200,000)
20X0 4.02 = $ 1,915,803 / ($ 276,379 + $ 200,000)

74. Summary
• Three ways have been presented to analyze financial statements
• Horizontal analysis which examines year to year changes in line items of
financial statements
• Vertical analysis which compares one line item with another line item
for the same time period
• Ratio analysis which examines the ratio of one line item to another
• Ratio analysis is the preferred approach for detailed analysis of financial
statements of healthcare organizations