How to Improve Operating Margins

Chapter 11

Analyzing Financial Statements

Outline

Ø  How is financial position assessed through dashboards?

Ø  What is the most important financial principle?

Ø  How can performance be improved through key indicators and dashboard analysis?

Ø Tools that help in the collection and communication of financial and operating information

Ø Neatly formatted reports that display the organization’s performance for “key indicators” (usually selected by management)

What is a “Dashboard” or “Balanced Scorecard?”

Balanced Scorecard History

Ø  1990 Research study by Nolan Norton Institute ü  Over-reliance on summary financial

performance measures may hinder value creation

ü  Four critical dimensions were defined

Ø  The Balanced Scorecard by Robert Kaplan and David Norton, 1996, Harvard Business School Press

Four Key Elements in Dashboards 1. What is most important to the firm’s success?

2. What are the critical drivers that influence

performance attainment?

3. What are the most relevant measures that reflect critical driver relationships?

4. What relevant benchmarking data are available to assess performance?

What is most important?

‘Sustainable growth’ is key principle Ø Over long-term, no business can grow

assets faster than equity v Why?

What is most important? ‘Sustainable growth’ is key principle

Ø  Over long-term, no business can grow assets faster than equity v Why?

o Quite simply, in the real-world, no lender will continue to bear the full risk of the business by financing 100% of its assets o Also, what do you think happens to interest rates as risk increases? This creates additional operating burdens for the organization to pay increasingly higher interest payments.

What is most important?

If ‘Sustainable Growth’ is the key principle to be a viable organization, then, the organization must be focused on Equity Growth.

incomeNet equityinChangex

Equity incomeNet

Equity equityinChange

=

Growth Rate in Equity Expressed in Formula

What is most important?

incomeNet equityinChangex

Equity incomeNet

Equity equityinChange

=

Growth Rate in Equity Expressed in Formula

Equals ‘1’ for most non-profits

Return on Equity

What is most important?

Return on Equity

ROE is therefore the primary financial criterion that should be used to evaluate and target financial

performance

What are the critical drivers of performance?

If an organization needs to be focused on Return on Equity – then we should explore the critical drivers in

the ROE formula (stated two ways below):

Assets) Net Equity(or Income NetROE =

Equity Assetsx

Assets Revenuex

Revenue incomeoperatingNonincomeOperatingROE −+

=

What are the critical drivers of performance?

How can ROE be improved?

Equity Assetsx

Assets Revenuex

Revenue incomeoperatingNonincomeOperatingROE −+

=

Improve operating margins

Increase total asset

turnover (generate more $ from the things

you own)

Improve non- operating margins

Increase debt

financing (but return must be

greater than rate you borrow at)

What are the critical drivers of performance?

Ultimately, you can ‘peel’ ROE back into a critical driver map (next slide) using Key Performance

Indicator Areas

Figure 11–2 Micro and

Macro Drivers

What are the most relevant metrics?

1.  The number of metrics on a Dashboard should be limited in order to keep the information manageable

2.  The performance areas in a Dashboard should tie back to the Key Performance Map that will help improve ROE and build business value

3.  The metrics should be able to be externally validated and benchmarked (compared with other time periods and organizations)

What are the most relevant metrics?

There are 13 key metric areas in the case hospital Dashboard:

1. Market factors 2. Pricing 3. Coding 4. Contract negotiation 5. Overall cost 6. Labor costs 7. Departmental costs 8. Supply and drug costs 9. Service Intensity 10. Non-operating income 11. Investment efficiency 12. Plant obsolescence 13. Capital position

What benchmark data should be used?

1.  Most healthcare organizations have access to public use data for their facility and other comparable facilities. Typically, these data are from governmental sources – primarily, Medicare.

2.  The comparison data used in the case hospital dashboard relies on three data sources: a)  Medicare cost reports b)  Standard analytical outpatient file (Medicare

outpatient claims) c)  MedPar file (Medicare inpatient claims)

CASE HOSPITAL DASHBOARD

The Hospital Cost Index®, developed by Cleverley + Associates, compares the Medicare cost per discharge and Medicare cost per visit at the hospital (both adjusted for case complexity and wage index differences) to the US median value for each measure. The result is the most objective overall cost comparison available. A high index score indicates a higher relative cost position.

Figure 11–3 Analysis of Overall Cost