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Financial Statement Application: Analyzing Financial Performance. Purpose of performance analysis Types of analysis Financial statement analysis Operating analysis MVA and EVA analysis Problems with performance analysis. Overview.

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Financial Statement Application: Analyzing Financial Performance

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Financial statement application analyzing financial performance

Financial Statement Application:Analyzing Financial Performance

  • Purpose of performance analysis

  • Types of analysis

    • Financial statement analysis

    • Operating analysis

    • MVA and EVA analysis

  • Problems with performance analysis


Overview

Overview

  • 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 cont

Overview (Cont.)

  • 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.


Ratio analysis

Ratio Analysis

  • 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.


Interpreting ratios

Interpreting Ratios

  • 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) analysis

    • Comparative (cross-sectional) analysis

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


Ratio analysis categories

Ratio Analysis Categories

  • 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?


Profitability ratios

Profitability Ratios

  • What do they measure?

    • Total margin - net income/revenue divided by total revenue

    • Operating 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


Profitability ratios continued

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


Dupont analysis

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


Liquidity ratios

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


Liquidity ratios continued

Liquidity Ratios (continued)

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


Debt management ratios

Debt Management Ratios

  • What do they measure?

  • 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


Debt management ratios continued

Debt Management Ratios (continued)

  • Capitalization ratios

    • Total debt to total assets (FP/NFP)

    • Total debt to total equity (FP)

  • Coverage ratios

    • Times 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)


Asset management ratios

Asset Management Ratios

  • What do they measure?

  • 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


Asset management ratios continued

Asset Management Ratios (continued)

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

  • Other analytical methods

    • Common size analysis - rationale

    • Trend analysis - rationale

    • % change analysis - rationale

    • MVA and EVA analysis


Mva eva analysis

MVA/EVA Analysis

  • Rationale for use

  • Market value added (MVA) analysis

    • What does it measure?

    • Difference between market value and book value of shareholder equity stake

    • How to estimate?


Mva eva analysis continued

MVA/EVA Analysis (continued)

  • Economic value added (EVA) analysis

    • What does it measure?

    • Difference between net income/revenue less interest expense (why?) and total organizational cost of capital

    • How to estimate?


Operating analysis

Operating Analysis

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

  • Examples of operational indicators

    • Net price per discharge

    • Payer/service discharge %

    • Occupancy rate

    • Average length of stay (ALOS)

    • Cost per discharge


How about an example

How about an example??

  • Refer to Gapenski (Ch.17)

  • Income statement (p.510)

  • Balance sheet (p. 511)

  • Cash flow statement (p.512)


Statement of cash flows analysis

Statement of Cash Flows Analysis

  • 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.


Profitability ratios 1998

Profitability Ratios (1998)

Net income

Total margin =

Total revenue

$8,572

= = 0.073 = 7.3%.

$117,476

Net income

ROA=

Total assets

$8,572

= = 0.057 = 5.7%.

$151,278


Financial statement application analyzing financial performance

Net income

ROE=

Total equity

$8,572

= = 0.080 = 8.0%.

$107,364

1998 1997 Ind.

TM 7.3%2.2%5.0%

ROA 5.7%1.6%4.8%

ROE8.0%2.4%8.4%


Liquidity ratios 1998

Liquidity Ratios (1998)

$31,280

$13,332

CA

CL

CR = = = 2.3times.

Cash + Marketable securities

Cash expenses / 365

DCOH =

$4,263 + $2,000

$277.93

= = 22.5 days.


Financial statement application analyzing financial performance

19981997Ind.

CR 2.3x1.7x2.0x

DCOH 22.518.930.6


Debt management ratios 1998

Debt Management Ratios (1998)

Total debt

Debt ratio =

Total assets

$43,814

= = 0.290 = 29.0%.

$151,278

EBIT

TIE ratio=

Interest expense

$10,114

= = 6.6 times.

$1,542


Financial statement application analyzing financial performance

1998 1997Ind.

DR 29.0% 33.5%43.3%

TIE 6.6x 2.6x4.0x


Asset management ratios 1998

Asset Management Ratios (1998)

Total revenue

FA turnover =

Net fixed assets

$117,476

= = 0.98 times.

$119,998

Total revenue

TA turnover =

Total assets

$117,476

= = 0.78 times.

$151,278


Financial statement application analyzing financial performance

Net patient accounts rec.

ACP=

Net patient service rev. / 365

$21,840

= = 73.4 days.

$108,600 / 365

1998 1997 Ind.

FATO0.980.90 2.2

TATO 0.780.73 0.97

ACP 73.4 77.7 64.0


Financial statement application analyzing financial performance

x x = ROE

Total

margin

TA

turnover

Equity

multiplier

x x = ROE .

Rev

TA

NI

Rev

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%.


Market value added mva

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?


Economic value added eva

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


Financial statement application analyzing financial performance

EVA Example ($000s)

Here is Riverside’s 1998 EVA:

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.


Benchmarking

Benchmarking

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

1998 1997

National/GFB 9.8% National/GFB 9.6%

Ind. top quartile 8.4 Ind. top quartile 8.0

St. Anthony's 8.0 St. Anthony’s 7.9

Riverside 7.3 Pennant Healthcare 5.0

Industry median 5.0 Industry median 4.7

Pennant Healthcare 4.8 Riverside 2.2

Ind. lower quartile 1.8Ind. lower quartile 2.1

Woodbridge Memorial 0.5 Woodbridge Memorial (1.3)


Net price per discharge 1998

Net Price Per Discharge (1998)

Net inpatient revenue

NPPD =

Total discharges

$93,740,000

= = $5,128.

18,281

Industry average = $5,510.


Occupancy percentage rate 1998

Occupancy Percentage (Rate) (1998)

Inpatient days

OR =

Number of staffed beds x 365

95,061

= = 0.579 = 57.9%.

450 x 365

Industry average = 44.9%.


Limitations of financial performance analysis

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.


Limitations cont

Limitations (Cont.)

  • 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 analysis

    • Financial flexibility index


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