ASSESSMENT 3 HMGT

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Ratio Analysis

Health Services Management

HMGT 322: Healthcare Financial Management

University of Maryland Global Campus

Prof. Robert Parker

April 27, 2021

Discuss the meaning of ratio analysis in healthcare.

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A ratio analysis is a financial statement that portrays an image of an organization’s financial

health. “Tracking and analyzing financial ratios is a critical practice for health care

organizations”(Lazzari, 2018). Ratios are a way for organizations to make a comparison. These

comparisons not only encompass what is happening presently but can also be used to make

comparisons about numbers and ratios over time. It is a way for organizations to compare

themselves with other competitors and industries. “Ratio analysis compares line-item data from a

company's financial statements to reveal insights regarding profitability, liquidity, operational

efficiency, and solvency”. Ratio analysis can mark how a company is performing over time while

comparing a company to another within the same industry or sector. Ratios are important to

analyze where the organization’s operating costs are moving, help manage cash flow and

provide a great baseline for analyzing profitability. Financial ratio tracking is useful for every

Health Care Organizations from small private practice practices to large medical facilities.

Practicing ratio analysis in health care is particularly important because it reveals a trend and

shows whether the company is underperforming its competitors. In healthcare which is one of

the largest market sectors and growing, it is critical for healthcare organizations to track and

analyze financial ratios. It is one of the critical components of assessing a Health Care

Organization's financial condition. It is important to know where you stand as a business when

compared to the competitors and is necessary for the longevity of the company.

Ratio analysis provides important information for investors and for conducting risk

analysis. A healthcare organization can make comparisons about numbers and ratios over time

just by comparing historical and current financial statements. With the regulations and

reimbursement requirements constantly changing throughout the industry, this can become an

understandable concern in healthcare entities. Ratio analysis “summarize the financial statement

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into comparative figures, thus helping the management to compare and evaluate the

financial position of the firm and the results of their decisions” (Linkedin,2019).

Current Ratio

The current ratio is a type of ratio which measures a company’s ability to reimburse short-term

“obligations or those due within one year” (Fernando, 2021). Current ratio is also known as the

liquidity ratio and gives an insight into whether an organization has enough current assets to

fulfill its current debt obligations and other expenses within a year. It shows how able the

company is to convert assets into cash quickly. It discloses financial data to investors and

analysts and provides an analysis on “how a company can maximize the current assets to satisfy

its current debt and other payables". Current ratio is used to compare all the company’s current

assets to its current liabilities and is calculated by dividing your current assets by your current

liabilities. It helps investors understand a company’s ability to cover its short-term debt and helps

to make comparison with its “competitors and peers.”,

In a healthcare industry like the hospitals, the current ratio measures the hospital’s ability

to meet its current liabilities (e.g., accounts payable, taxes owed, or loans due within a year) with

its current assets (e.g., accounts receivable and inventory, as both can be turned into cash during

the fiscal year). If the ratio is higher than 1.0, it means that all current liabilities can be covered

by the hospital’s existing current assets.

Current Ratio Calculation (Help4U HMO):

Current Ratio = Total Current Assets / Total Current Liabilities

= $3,945.00 / $3,456.00

= 1.14 times

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An industry benchmark is 2 times, and that of this organization is significantly less than 2

due to lower current assets as compared to total current liabilities. This means that it has lower

current dollars available to pay current liabilities as compared to most other organizations. The

organization should try to reduce its current liabilities to about half that of the current assets or

needs to increase its current assets to increase its current ratio to be in a better financial position.

Total Margin

“Total Margin is used to measure the share of revenues that is left to pay operating expenses,

creditor interest and income taxes after you deduct the expenses” (UMGC Lecture, 2021). Total

margin ratio assesses an organization's revenue as a function of its expenses and includes

revenue from all of the organization's sources. A high ratio means the organization is making a

profit. The term total margin is mostly used by government and nonprofit entities, mainly

hospitals, whereas other for-profit businesses and industries call it net profit margin. The total

margin ratio is common in the health care industry. “The total margin provides a measure of a

hospital's overall profitability utilizing the net income or loss” ( Wright, n.d.). Hospitals use this

measure to compare the total hospital revenue and expenses for inpatient, outpatient, and non-

patient care activities. Analysts use total margin ratio as an important measure of a hospital’s

profitability. The total margin is calculated by subtracting total expenses from total revenue and

dividing by total revenue.

Total Margin Calculation (Help4U HMO):

Total Margin (gross profit ratio)

= (Net Income / Total Revenue) x 100

= ((Revenues – Expenses)/Total Revenues) x 100

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= {($28,613 – $27,395) / $28,613} x 100

= ($1,218 / $28,613) x 100

= 0.0425 x 100

= 4.25%

Total Margin is the portion of the revenue left after taking care of expenses that can be

used to pay expenses, interests, and taxes. The industry average is 5% which means that this

organization has slightly less than the average total margin or less share of revenues to pay its

expenses compared to other organizations and there is room for improvement. Though it is

still profitable, it should try to increase its revenues or reduce expenses to increase the total

margin ratio.

Debt ratio

“The debt ratio is one of the financial leverage ratios that measure the ratio of a company's total

debt against the total asset” (Global Finance, 2018). The debt ratio gives a view of how a

company is financed. The debt ratio determines how much risk a company has acquired and

gives an indication of the amount of leverage held by the business. Higher the debt ratio means

the company is highly leveraged and similarly lower the debt ratio the company is less leveraged

and has a strong equity position. It is always preferred to have a lower debt ratio because a high

debt ratio could indicate that the business is in danger of not being able to repay their loans to

their creditors on time.

Creditors/Lenders use debt ratio to estimate the amount of "lending risk they will

incur by extending credit to any organization". Investors double-check their decisions when

choosing highly leverage companies to invest in. " The debt ratio is the fundamental business

solvency ratio because investors, creditors, and banks are always concerned about the company's

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ability to pay them" (Global Finance, 2018). You can calculate the debt ratio by dividing its total

liabilities by total assets.

Debt Ratio Calculation (Help4U HMO):

Debt Ratio = (Total Liabilities / Total Assets) x 100

= ($7,751 / $9,869) x 100

= 78.53%

Assuming an industry average debt ratio of 42.3%, this debt ratio is very high at almost

double the industry average. This is due to extremely high liabilities or debts as compared to

the total assets. This presents a lending risk to creditors. If the organization doesn’t act

seriously on reducing its debt or implement debt management programs, it could be in serious

financial trouble if investors insist on returning the loan.

Occupancy Rate

Occupancy rate is referred to as the ratio of rented or "used space to the total amount of available

space and measures the ratio of occupied to total usable rental space" (Chen, 2020). It is used by

analysts and helps them understand the changes in any residential and commercial real estate

markets like hospitals, hotels, and any rental properties and they use it to evaluate the properties,

economic activity, and trends. Like hotels, hospitals have also studied the effect of occupancy

and its effect on profitability. The occupancy rate is calculated to show the actual utilization of

hospital occupancy for a given period of time. It is a valuable statistical measurement and is

usually calculated for a certain period of time. According to many hospital executives, the ideal

occupancy rate would be 85% to achieve profitability. Too low occupancy means too many staff

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sitting ideally and the hospital losing money and too high occupancy would be excessive work

for nurses which can lead to hurting their morale.

Hospital occupancy rates also vary by the time of day and are generally based on

"midnight census", taken on the number of patients in bed at midnight. “The problem with the

midnight census is that it turns out to be the time when the fewest patients are in the hospital

over a 24-hour day”(Allen, 2017). Additionally, other factors such as hospital size, day of the

week, number of hospitals in the area, location demand for service, location in the hospital also

affect occupancy rates and vary. According to Allen, (2017, they are ways hospitals can control

the occupancy rate like scheduling surgery wisely, avoiding overlap time when discharging

patients, ensuring that the housekeeping /environmental services department are adequately

staffed, hospitals should also analyze the length of stay so that their stay "index is at or below

1.00" and strategically assigning beds”. The bottom line is hospital occupancy rates should

neither be too much nor fall below resulting in loss of revenue.

Occupancy Rate Calculation (Help4U HMO):

Occupancy Rate = (Average Daily Census) / (Number of Staffed Beds)

= (26,350 / 32,000) x 100

= 82.3%

This shows a very good occupancy rate or most of the beds are occupied out of the

total number of beds available.

In conclusion, the current ratio (1.14%) and total margin (4.25%) are less than the industry

average but the occupancy rate is very good at 82.3% and the organization is still profitable. It

however has an extremely high debt ratio (78.53%) than the industry average. The

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organization should try to reduce its expenses and implement programs to better manage the

debts as well as try to increase the assets and revenues to be more profitable than at present.

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References

Allen, J.(2017). What is the ideal Hospital Occupancy Rate?

https://hospitalmedicaldirector.com/what-is-the-ideal-hospital-occupancy-rate/

CHIA.(n.d.). Interpretation of Financial Ratios. https://www.chiamass.gov/interpretation-of-

financial-ratios/

Chen, J.(2020). Occupancy Rate. https://www.investopedia.com/terms/o/occupancy-

rate.asp#:~:text=Occupancy%20rate%20is%20the%20ratio,rental%20units%2C

%20among%20other%20categories.

Fernando, J.(2021). Current Ratio. https://www.investopedia.com/terms/c/currentratio.asp

Global Banking and Finance Review. (2018). Financial Leverage Ratios to Measure Business

Solvency. https://www.globalbankingandfinance.com/financial-leverage-ratios-to-

measure-business-solvency/

HMGT 322 UMGC Lecture.(2021). Week 6: Assessing Performance Through Ratio Analysis.

https://learn.umgc.edu/d2l/le/content/551214/viewContent/20322919/View

Lazzari, Z. (2018). What Is the Importance of Financial Ratios in Health Care Organizations?

https://yourbusiness.azcentral.com/importance-financial-ratios-health-care-organizations-

27142.html

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LinkedIn. (2019). 4 Key Financial Ratios Healthcare Providers should track.

https://www.linkedin.com/pulse/4-key-financial-ratios-healthcare-providers-should-

hospaccx

Wright, T, C.(n.d.). What Is the Total Margin Ratio in a Business?

https://yourbusiness.azcentral.com/total-margin-ratio-business-17331.html