Ratio Analysis in Healthcare Organizations

Professional affiliation

Healthcare providers often face the task of managing their facilities under very tight budgets. Whether the provider is a big healthcare organization or a newly founded one, it all comes down to financial analysis.

Financial analysis entails the use of ratios and this process of using ratios to rate your company’s performance is what is known as financial ratio analysis. There are several ratios computed in the financial analysis and these ratios are then analyzed in a more intensive manner using several criteria. For a healthcare provider, a comparison of the ratios with other ratios of other healthcare providers will ultimately give a clear picture of the performance and effectiveness of your organization. This needs not to be done by a good financial analyst who can give the management adequate information as to the results of the ratios. For the management the financial ratio analysis is an invaluable asset to them.

Importance of ratio analysis

Several financial statements are produced during an accounting period of a business, whether it is healthcare related or not. They may be produced quarterly, semi-annually or even annually. In the end the management has several financial statements to look at namely the balance sheet, the cash flow statement and the profit and loss account statement. These statements, when presented to the management are very complex and they find it hard to get the required picture of the organization. Therefore, the financial ratio analyses come in to simplify the statements by utilizing professional analysts of the financial statements. This in turn helps the management in the comparison of the healthcare organizations performance with that of other successful companies.

These statements are also important by the mere fact that they assist the management in the assessment of the healthcare company’s position financially. Basically any business set up should be geared towards growth and without this the management will close shop. Therefore, as they attempt to read the financial statements they, they become well versed on the standing of the business financially and they will be able to make proper budgeting plans for the facility.

Finally, financial ratio analysis will help the healthcare organization to determine its financial liquidity on demand. This is otherwise called as the firm’s liquidity position, while at the same time an analysis of these firms will ensure that the management has a clear understanding of the organizations long-term solvency.

Given that one is to analyze a company, for this matter a healthcare facility’s financial statement, the analyst will have to compute several types of ratios. They are;

1. Liquidity ratio

2. Profitability ratio

3. Activity ratio and,

4. Leverage ratio.

Liquidity ratio: a healthcare company’s capability to repay its short-term debts on demand is calculated using this ratio. It contains several ratios under its name for example; the current ratio, the acid test ratio.

The current ratio: it shows the ratio of the current assets to the current liabilities

Current ratio =

For example given the following data it is easy to calculate the current ratio for the organization:

The two ratios are calculated as below and for any current ratio above 1 it implies that the healthcare facility has more current assets than current liabilities in both years. However the second year has slightly increased therefore it means that the facility increased its service delivery. The acid test ratio is calculated as =

Description

Year 1 $

Year 2 $

Current assets

400,000

450,000

Current liabilities

305,260

321,025

Inventory

100,000

150,000

Current ratio

1.31

1.40

Acid ratio

0.98

0.93

The acid ratio in year 1 and year two shows that they are below 1 which in essence the ratio should only be at 1:1 therefore the healthcare facility should go back to the drawing board to look at its credit policy. The acid ratio is also known as the quick ratio.

Profitability ratios: these ratios when calculated, they provide the healthcare providers management with a quantifiable picture of its operating efficiency. This means that the company’s income should be seen to flow in rather than no profits. There are several of these ratios namely; gross profit margins, net profit margin, return on assets, and return on capital employed.

Net profit margin =

Return on assets: this ratio measures the income generated by the company’s assets per unit.

Year 1

Year 2

Net profit after tax and interest

250000

285000

Net sales

904285

1365050

Average total assets

1

1200000

Net profit margin

0.28

0.21

Return on assets

0.25

0.24

The above table shows calculations of net profit margin and return on assets ratios

Activity ratios: these ratios are concerned with the management of the assets of the facility. They are turnover ratios (receivables, and inventory).

Debt turnover ratio; it relates to the timeframe within which debtors pay their debts. It is calculated as =;

Therefore the smaller the ratio the better the performance of the company in terms of debt collection therefore in a healthcare facility, it is up to the management to make sure they recover the money offered for their services from the debtors promptly

Inventory turnover ratio; this is an indicator of how quickly stock is sold and replaced. If there is a low turnover the management should be cautioned that they are not using any of the materials they had bought e.g. medicines and other consumables. In short they are not making any sales for their services.

Leverage ratios: these ratios are used in the determination of the long-term financial position of the healthcare organization some of the ratios are; debt equity ratio, and the total debt ratio. The ratio is also known as the capital structure ratios.

Debt equity ratio: calculated as =; many financial analysts use this ratio to get a general idea of the company owners debts and liability relationship. A high ratio shows that creditors have much higher stake in the healthcare facility than the shareholders.

Debt ratio; it is calculated as the ratio of total debts (including long-term liabilities) to total assets. It shows the fraction of assets that the healthcare facility being used and are being financed by these liabilities.

Bibliography

Daniel L.J. (1997). Advanced Accounting, McGraw-Hill College Publishing,

Eric Press. (1999). Analyzing Financial Statements, Lebahar-Friedman.

Leopold B., John W. (2000). Analysis of Financial Statements, McGraw-Hill

Martin M. Et al., (1994) Accounting for Effective Decision Making. Irwin Professional Press,

Harold M. (1992). Financial Management: study pack, Strathmore University distance learning centre. Macmillan publishers