FOR ACE WRITES

To better understand how the information for the numerator and the denominator of each calculation is obtained, Figure 11–1 below illustrates the process. This figure takes the balance sheet and the statement of revenue and expense that were discussed in the preceding chapter and illustrates the source of each figure in the four liquidity ratios. The multiple computations in days cash on hand and in days receivables are further broken out into a three-step process to better illustrate sources of information.

Figure 11–1 Examples of Liquidity Ratio Calculations.

This ratio is universally used in credit analysis and figures prominently in the Mini-Case Study.

Each lending institution has its particular criteria for the DSCR. Lending agreements often have a provision that requires the DSCR to be maintained at or above a certain figure.

Liabilities to Fund Balance (or Debt to Net Worth)

The liabilities to fund balance or net worth computation is represented as total liabilities divided by unrestricted net assets (i.e., fund balances or net worth) or total debt divided by tangible net worth:

This figure is a quick indicator of debt load.

Another indicator that is more severe is long-term debt to net worth (fund balance), which is computed as long-term debt divided by fund balance. This computation is somewhat equivalent to the quick ratio discussed previously in its restrictiveness to net worth computation.

A mirror image of total liabilities to fund balance is total assets to fund balance, which is computed as total assets divided by fund balance.

Figure 11–2 below shows how the information for the numerator and the denominator of each calculation is obtained. This figure again takes the Westside Clinic balance sheet and statement of revenue and expense that were discussed in the preceding chapter and illustrates the source of each figure in the two solvency ratios just discussed, along with each figure in the two profitability ratios still to be discussed. When multiple computations are necessary, they are further broken down into a two-step process.

Figure 11–2 Examples of Solvency and Profitability Ratio Calculations.

This is a broad measure in common use. Note the acronym EBIT, as its use is widespread in credit analysis circles. (Some analysts use an alternative computation for Return on Total Assets. They compute this ratio as Net Income divided by Total Assets.)

This concludes the description of solvency and profitability ratios. Again, if you study Figure 11–2 and work with the Mini-Case Study entitled “Comparative Analysis (Financial Ratios and Benchmarking) Helps Turn Around a Hospital”, you will master this

PROFITABILITY RATIOS

Profitability ratios reflect the ability of the organization to operate with an excess of operating revenue over operating expense. Nonprofit organizations may not call this result a profit, but the measurement ratios are still generally called profitability ratios, whether they are applied to for-profit or nonprofit organizations.

Operating Margin

The operating margin, which is generally expressed as a percentage, is represented as operating income (loss) divided by total operating revenues:

This ratio is used for a number of managerial purposes and also sometimes enters into credit analysis. It is therefore a multipurpose measure. It is so universal that many outside sources are available for comparative purposes. The result of the computation must still be carefully considered because of variables in each period being compared.

Return on Total Assets

The return on total assets is represented as earnings before interest and taxes (EBIT) divided by total assets:

(Baker 125-127)

Baker, Judith J. Health Care Finance, 4th Edition. Jones & Bartlett Learning, 08/2013. VitalBook file.

The citation provided is a guideline. Please check each citation for accuracy before use.