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1. 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

2. 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.

3. 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.

4. 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.

5. 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.

6. 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?

7. 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

8. 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

9. 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

10. 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

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

12. 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

13. 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)

14. 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

15. 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

16. 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?

17. 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?

18. 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

19. How about an example?? • Refer to Gapenski (Ch.17) • Income statement (p.510) • Balance sheet (p. 511) • Cash flow statement (p.512)

20. 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.

21. 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

22. 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% ROE 8.0% 2.4% 8.4%

23. 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.

24. 1998 1997 Ind. CR 2.3x 1.7x 2.0x DCOH 22.5 18.9 30.6

25. 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

26. 1998 1997 Ind. DR 29.0% 33.5% 43.3% TIE 6.6x 2.6x 4.0x

27. 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

28. Net patient accounts rec. ACP = Net patient service rev. / 365 \$21,840 = = 73.4 days. \$108,600 / 365 1998 1997 Ind. FATO 0.98 0.90 2.2 TATO 0.78 0.73 0.97 ACP 73.4 77.7 64.0

29. 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%.

30. 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?

31. 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

32. 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.

33. 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)

34. Net Price Per Discharge (1998) Net inpatient revenue NPPD = Total discharges \$93,740,000 = = \$5,128. 18,281 Industry average = \$5,510.

35. 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%.

36. 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.

37. 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