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Ratio Analysis
1. Liquidity Analysis
Liquidity ratios measure the ability of the organization to pay current obligations.
Current ratio = current assets divided by current liabilities
Assets and liabilities are found on the Balance Sheet of an organization. To
determine the 2005 current ratio for Arcadia Hospital, the Balance Sheet provides two
sections Assets and Liabilities and Equity. The assets are divided into Current Assets
and Property, Plant, and Equipment or PPE. For the current ratio numerator you need
Current Assets, which is 6,900. The liabilities and equity are divided into Current
Liabilities, LT (long-term) Liabilities, and Equity. For the denominator you need
Current Liabilities, which is 3,200.
The current ratio is:
6,900/3,200 = 2.16 when this is compared to the standard in the book of 2.07 (Table
4-2 page 71), it is slightly higher than the standard, so this would be considered just
fine.
2. Turnover Ratios
These ratios measure how effective management is utilizing the assets of the
company to produce revenues.
Inventory turnover ratio the ability of an organization to sell its inventory quickly.
Inventory turnover ratio = cost of goods sold divided by ending inventory OR
total revenues plus net non-operating gains divided by ending inventory.
Since Arcadia Hospital is a service organization, it will not have a cost of
goods sold, therefore you will need to find the total revenues and divide that by the
ending inventory. The 2005 Income Statement has two sections, the Operating
Revenues and Operating Expenses. The numerator for this section is the Total Operating
Revenues, which is 568. The ending inventory (800) is the denominator and is found on
the Balance Sheet under the Current Assets section.
The inventory ratio is:
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568/800 = 0.71 compared to the standard in the book is low. This suggests that there is a
buildup of inventory.
Total asset turnover the ability of an organization to use its assets to generate
revenues.
Total asset turnover ratio = net sales divided by total assets OR total revenue
plus non-operating gains divided by total assets.
Since Arcadia Hospital is a service organization, it will not have a net sale,
therefore you will need to find the total revenues and divide that by the total assets.
From the above ratio, you know the total revenues are 568. Notice here the ratio utilizes
the total assets, which are different that the current assets. From the Balance Sheet, the
total assets for Arcadia in 2005 were in 17,900.
The total asset turnover is 568/17,900 = 0.0317 compared to the standard in the book
suggests that maybe there is too much investment in fixed assets relative to revenues.
3. Leverage ratios
These ratios evaluate a company’s relative reliance on debt and equity financing.
Too much reliance on debt is risky. Not enough debt means the company is not
effectively utilizing other people’s money to operate.
Asset/Equity ratio total assets divided by total stockholders equity
A total as set is found on Arcadia’s Balance Sheet. The total assets are equal to
all of the Current Assets plus PPE. In this case the total assets are 17,900, which is
the numerator. The denominator is the total stockholders equity, which in this case
is the total equity or 7,900.
The asset/equity ratio is 17,900/7,900 = \$2.27 which means that for every dollar of
assets, \$2.27 is controlled by equity.
Long-Term debt/Equity ratio total debt divided by total stockholders equity
The total dent is found on Arcadia’s Balance Sheet. The total debt is equal to
the total liabilities, which in this case is 10,000 and is the numerator. The total
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stockholders equity is the same number used in the asset/equity ratio or 7,900.
The Long-Term debt/equity ratio is 10,000/7,900 = 1.2658 which suggest high
leverage and high risk.
4. Profitability Ratios
These ratios measure how well an organization is able to control costs and how well
it is being managed.
Total margin is net income divided by sum of revenues and non-operating
gains.
The net income for Arcadia Hospital is found on the 2005 Income Statement.
The net income is 32 and is the numerator. The sum of the revenues is the total
operating revenue on the same statement which is 568 and is the denominator.
The total margin is 32/568 = 5.63%. Compared to Tenet in your textbook, this is
within the range (even a bit higher).
Valuation Approaches
Rules of thumb this is calculated using the annual revenues and multiply that
number times 2. As you have seen before, the Arcadia Hospital 2005 Income
Statement contains the total operating revenue, which is 568.
Rules of thumb 568 x2 = 1,136
Adjusted Book Value this is owners equity. As you have seen before, the Arcadia
Hospital Balance Sheet contains a section within the Liabilities and Equity part
called Equity. The total equity is 7,900, which is equivalent to the adjusted book
value.
Discounted Cash Flow this is the present value of the cash flow. The Arcadia
Hospital Statement of Cash Flows contains the Net Cash Flow from Operations,
which is 655. This is the Cash Flow amount used to determine the present value.
Discounted Cash Flow
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Revenue Variance Analysis
The revenue variance analysis is simply looking at the revenue generated for a
year and comparing that to what was budgeted. A negative variance is always
undesirable. This suggests that either the pricing was too low or a lower number of
services were performed than anticipated.
For example, if revenues were projected to be 200 and the total operating
revenue was 150, then 150 minus 200 equals a negative 50 or a negative variance. It is
simply taking actual minus budgeted to determine a positive or negative variance.
Cash Flow amount
Capitalization Rate
Value
655
6%
655/0.06 = 10,917
8%
655/0.08 = 8,817
10%
655/0.1 = 6,550
12%
655/0.12 = 5,458

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