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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
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Overview
One of the most important characteristics 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.
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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.
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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.
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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.
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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?
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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
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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
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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
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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
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Liquidity Ratios (continued)
Need for analysis of cash flow
statements to identify source(s) of
liquidity/lack thereof.
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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
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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)
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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
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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
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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?
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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?
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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
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How about an example??
Refer to Gapenski (Ch.17)
Income statement (p.510)
Balance sheet (p. 511)
Cash flow statement (p.512)
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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.
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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
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Net income
ROE =
Total equity
$8,572
=
= 0.080 = 8.0%.
$107,364
TM
ROA
ROE
1998
7.3%
5.7%
8.0%
1997
Ind.
2.2% 5.0%
1.6% 4.8%
2.4% 8.4%
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Liquidity Ratios (1998)
$31,280
CA
CR = CL = $13,332 = 2.3 times.
Cash + Marketable securities
DCOH =
Cash expenses / 365
$4,263 + $2,000
=
=
22.5
days.
$277.93
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1998
1997
Ind.
CR
2.3x
1.7x
2.0x
DCOH
22.5
18.9
30.6
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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
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1998
1997
Ind.
DR
29.0% 33.5% 43.3%
TIE
6.6x
2.6x
4.0x
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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
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Net patient accounts rec.
ACP =
Net patient service rev. / 365
$21,840
=
= 73.4 days.
$108,600 / 365
FATO
TATO
ACP
1998
0.98
0.78
73.4
1997
0.90
0.73
77.7
Ind.
2.2
0.97
64.0
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Total
TA
Equity
margin x turnover x multiplier = ROE
NI
Rev
x
Rev
TA
x
TA
TE
= ROE .
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%.
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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?
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Economic Value Added (EVA)
Funds available
EVA =
to investors
Dollar cost of
capital employed
= AT op. income
-
Dollar capital costs
= (EBIT x [1 - T])
-
(Total assets x CCC).
Here, CCC = corporate cost of capital.
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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.
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Benchmarking
The process of comparing a business’ ratios
to selected standards is called benchmarking.
Here are Riverside’s total margin benchmarks:
1998
National/GFB
Ind. top quartile
St. Anthony's
Riverside
Industry median
Pennant Healthcare
Ind. lower quartile
Woodbridge Memorial
1997
9.8%
8.4
8.0
7.3
5.0
4.8
1.8
0.5
National/GFB
9.6%
Ind. top quartile
8.0
St. Anthony’s
7.9
Pennant Healthcare
5.0
Industry median
4.7
Riverside
2.2
Ind. lower quartile 2.1
Woodbridge Memorial (1.3)
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Net Price Per Discharge (1998)
Net inpatient revenue
NPPD =
Total discharges
$93,740,000
=
= $5,128.
18,281
Industry average = $5,510.
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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%.
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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.
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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
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