Discussion 05.2: Comparing Balance Sheets
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9781284118308_SLID_CH12.pptChapter 12: Financial and Operating Ratios as Performance Measures
The Importance of Ratios (1 of 2)
- Ratios are important because they are so widely used.
- Financial ratios are especially important because they are used for credit analysis.
- See Appendix 33-A for multiple examples of financial ratios as used for credit analysis and financing purposes.
The Importance of Ratios (2 of 2)
- Three types of ratios: liquidity, solvency, and profitability
- These three types include eight basic ratios that are widely used in health care organizations.
- Liquidity: Current ratio; quick ratio; days cash on hand; days receivables
- Solvency: Debt service coverage; liabilities to fund balance
- Profitability: Operating margin; return on total assets
Liquidity Ratios (1 of 4)
- Current Ratio: A measure of short-term debt-paying ability (but it must be carefully interpreted).
- Computed as:
current ratio = current assets/current liabilities
(Also see practice exercises for this chapter.)
Liquidity Ratios (2 of 4)
- Quick Ratio: An even more severe test of short-term debt-paying ability (it also must be carefully interpreted).
- Computed as:
quick ratio = cash and cash equivalents + net receivables / current liabilities
(Also see practice exercises for this chapter.)
Liquidity Ratios (3 of 4)
- Days Cash on Hand (DCOH): Indicates cash on hand in relation to amount of daily operating expenses.
- Computed as:
DCOH = unrestricted cash and cash equivalents / cash operating expenses / # of days in period.
(Also see practice exercises for this chapter.)
Liquidity Ratios (4 of 4)
- Days Receivables: Represents number of operating days in receivables (a measure of worth as well as performance).
- Computed as:
days receivables = net receivables / net credit revenues / # of days in period
(Also see practice exercises for this chapter.)
Solvency Ratios (1 of 2)
- Debt Service Coverage (DSCR): Represents the ability to meet required debt service (this ratio is universally used in credit analysis).
- Computed as:
DSCR = change in unrestricted net assets (net income) + interest, depreciation, and amortization / maximum annual debt service
(Also see practice exercises for this chapter.)
Solvency Ratios (2 of 2)
- Liabilities to fund balance: Represents the relationship of liabilities to fund balance (or liabilities to net worth). A quick indicator of
bad debt. - Computed as:
liabilities for fund balance = total liabilities / unrestricted net assets (fund balances) or (net worth)
(Also see practice exercises for this chapter.)
Profitability Ratios (1 of 2)
- Operating Margin (expressed as a percentage): Represents the relationship of operating revenues to operating income. A multi-purpose measure, used for many managerial purposes; sometimes also used for credit analysis
- Computed as:
operating margin = operating income (loss) / total operating revenues
(Also see practice exercises for this chapter.)
Profitability Ratios (2 of 2)
- Return on total assets (expressed as a percentage): Represents the yield received in relation to total assets. A broad measure in common use.
- Computed as:
return on total assets = earnings before interest and taxes (EBIT) / total assets
(Also see practice exercises for this chapter.)
Importance of Ratios
- Remember, ratio analysis should be conducted as a comparative analysis.
- When interpreting ratios, the differences between periods must be considered, and the reasons for such differences should be sought.
Current Ratio
Current Ratio
Quick Ratio
2. Quick Ratio
Days Cash on Hand Ratio
44.unknown
Days Receivable Ratio
45.unknown
Return on Total Assets
46.unknown
Operating Margin Ratio
6. Operating Margin (%)
Liabilities to Fund Balance Ratio
7. Liabilities to Fund Balance
Debt Service Coverage Ratio
49.unknown
Practice Exercise 12-1:
Liquidity Ratios Solution
- Current Ratio = 2.33 to 1
- Quick Ratio = 2.167 to 1
Assignment Exercise 12-1:
Liquidity Ratios Solution
- Current Ratio = 1.824.1
- Quick Ratio = 1.468 to 1
- Days Cash on Hand = 13.35 days
- Days in Receivables = 79.44 days
Practice Exercise 12-2:
Solvency Ratios Solution
- Debt Service Coverage Ratio = 5.1
- Liabilities to Fund Balance Ratio = 2.5
Assignment Exercise 12-2:
Solvency Ratios Solution
- Debt Service Coverage Ratio = 4.939
- Liabilities to Fund Balance Ratio = 0.526
Practice Exercise 12-3:
Profitability Ratios Solution
- Operating Margin = 44.4%
- Return on Total Assets = 8.3%
Assignment Exercise 12-3:
Profitability Ratios Solution
- Operating Margin = 0.484 or 48.4%
- Return on Total Assets = 0.065 or 6.5%
470,000Current Assets
1.362
345,000Current Liabilities
=
190,000250,000
1.275
345,000
Cash and Cash Equivalent + Net Receivabl
es
Current Liabilities
+
=
Step 1
1,885,000
(40,000)
1,845,000
3. Days Cash on Hand (DCOH)
Step 2
Unrestricted Cash and Cash Equivalents
1,845,000
Cash Operating Expenses divided by # days in period (365)
For the Year Ending
365
December 31, 20x2
= 5,055
Step 3
190,000
5,055
= 37.5 days
Step 14. Days Receivables
2,000,000Percent of Credit Revenues
x 90%
Information obtained elsewhere
1,800,000
Step 2
Net Receivables
1,800,000
Net Credit Revenue divided by # days in period (365)
365
= 4931
Step 3
250,000
4931
= 50.7 days
December 31, 20x2
Step 1
5. Return on Total Assets (%)
120,000
(20,000)
100,000
EBIT (Earnings Before Interest and Taxes)
Total Assets
Step 2
100,000
963,000
= 10.03%
115,000Operating Income (Loss)
0.0575%
2,000,000Total Operating Revenues
=
545,000Total Liabilities
1.304
418,000Unrestricted Fund Balance
=
Step 18. Debt Service Coverage Ratio (DSCR)
December 31, 20x2
Change in Unrestricted Net Assets (net income)
120,000
Change in Unrestricted Net Assets (net income)
plus Depreciation-Amortization
20,000
plus Depreciation-Amortization
plus Interest
40,000
plus Interest
Maximum Annual Debt Service
180,000
Maximum Annual Debt Service
Step 2
180,000
Maximum Annual Debt Service
72,000
Information derived elsewhere
= 2.5
