Healthcare Financial Services - Capital Analysis Self-Tutorial - Module 3: Finance Fundamentals for Non-Finance Managers

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Capital Analysis Self-Tutorial
Module 3: Finance Fundamentals for Non-Finance Managers

Key Financial Ratios
Ratios describe the various relationships among accounts in the balance sheet and income statement. These primary analytical tools of financial analysis are used to judge the financial health of an institution, and to project future earnings and cash flow. Investors and lenders use ratios to determine the health of an organization and the risk associated with lending or investing funds in it. Management within your organization use ratios to prepare pro forma projections and to portray how their institution is doing financially to the Board.

Ratios describe the various relationships among accounts in the balance sheet and income statement. These primary analytical tools of financial analysis are used to judge the financial health of an institution, and to project future earnings and cash flow. Investors and lenders use ratios to determine the health of an organization and the risk associated with lending or investing funds in it. Management within your organization use ratios to prepare pro forma projections and to portray how their institution is doing financially to the Board.

The results of your Capital Analysis Tool powered by Kaufman Hall projections, the income statement, cash flow statement, and net preset value (NPV) analysis, will be rolled into the overall financial plan for the organization from which these ratios will be calculated. To understand how your pro forma results are used as part of the financial plan let’s look at key financial ratios. You should recognize all of the elements of the formulas from the previous sections. The more your project can positively impact these ratios, the more likely your project will be a seriously considered.

Investment bankers and bond analysts will tell you that, while they will look at all the ratios below, the most important ratios are generally days cash on hand, debt service coverage, cushion ratio and operating margin. The first three have a common theme. They all have cash as the major ratio component. Your organization’s ratings will move up as the ratios indicate that you have enough cash to pay your bond debts in a timely manner. The fourth most important ratio, operating margin, is the way in which your organization will be able to accomplish the first three. The higher the operating margin, the better off your organization’s financial health will be.

All of the ratios below will be important to your organization’s CEO, CFO and Board because they represent the financial profile of your organization to both the outside world (bondholders, in particular) and allow a comparison between your organization and others.

PERFORMANCE MEASURES	FORMULA	IMPORTANCE OF FORMULA:
Days Cash on Hand	((Cash and Cash Equivalents + Board Designated Funds for Capital)* 365) / Total Operating Expenses – Depreciation & Amortization Expenses	Cash Flow – Ability to pay your debts (obligations, liabilities).
Debt Service Coverage	(Excess of Revenues over Expenses + Depreciation + Interest Expenses) / (Principal + Interest Payments)	Cash Flow – Allows your organization to understand whether or not your cash flow is sufficient to service the debt
Cushion Ratio	(Cash + Short Term Investments + Unrestricted Long Term Inv.) / (Principal + Interest Payments)	After paying all fixed debt expenses, this tells you what % is left to cover debt.
Operating Margin	(Total Operating Revenues – Total Operating Expenses) / Total Operating Revenues	Level of Profitability From Operations – The level at which your organization’s revenues are exceeding its expenses, or visa versa. Operating margin is not the best indicator of cash flow, but there will be some degree of relationship, based upon the level of the margin. The higher the operating margin, the better.
Current Ratio	Current Assets / Current Liabilities	A current ration less or equal to 1 is bad, as this indicates technical insolvency. A current ration over 2.0 is good.
Excess Margin	(Total Operating Revenues + Non-Operating Revenues – Total Operating Expenses)/(Total Operating Revenues + Non-Operating Revenues)	Total margin available that includes investment income and non-operating items. The higher the level, the better for the organization.
Days in Accounts Receivable	(Net patient accounts receivable x 365) / Net Patient Revenues	Cash Flow – How much cash is tied up in your account receivables.
Average Payment Period	Current Liabilities / ((Total Expenses – Depreciation) / 365))	Cash Flow – How quickly you are paying your bills. Look at yearly trends. If getting longer, this may indicate a cash flow problem.
Average Age of Plant	Accumulated Depreciation / Depreciation Expense	The lower the ratio, the newer the facility, the more you’re investing. If the trend is increasing, your building and equipment are aging. Also used to look at your ratio compared to that of your competition.
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) Margin	EBITDA / (Total Operating Revenues + Non-Operating Revenues)	Margin – A higher % reflects a more profitable institution

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