Financial ratios for healthcare capital allocation assessment

Financial Ratios are an important element in assessing the success of capital allocation within a business. Investing is paramount to the long-term success of a business. In order to be competitive in the healthcare industry, companies must invest in property, technology, employees, research and development, and much more. In many instances however, the capital needed to invest in these projects is very limited. Meanwhile, available projects for growth seem almost limitless. Management therefore must use financial ratios to assess the success of the investments made in the past, and to determine if a different strategy must be taken in order to become more successful. Ratios are particularly useful as they provide a guide that can be compared with competitors to assess strategy as well.

To begin, the level of management will determine, what ratios are important. From an executive management perspective, ratios such as the debt to equity ratio, the quick ratio, or the current ratio are needed. These ratios assess the solvency and liquidity of the firm. From a top-level perspective, management must be able to keep the company running as a going concern in the future. Excessive debt levels for example, may threaten the very existence of the firm. As an executive management, these individuals have a duty not only to shareholders but also to the employees and patients of the hospital. These individuals should not jeopardize the livelihood and well being of society by taking on excessive debt. The debt to equity ratio can help management realize if debt is becoming unsustainable. This is particular important in an economic downturn. Historically, healthcare has been a very stable industry, insulated from market shocks. However, with an excessive debt burden an economic downturn that is severe enough can threaten the solvency of the entire company.

Likewise, top management would need to study the liquidity of the company as well. Liquidity allows the company to better handle any short-term funding needs. For example, within a hospital setting, employees need to get paid. Also the company must keep the lights on, and the air conditioning running. The company may also need to purchase paper for the printer and replace a broken coffee machine. These short terms funding needs require liquidity. Going back to the economic downturn example above, ample liquidity allows the company to also make strategic investments when market prices are favorable. For example, during a downturn, a competitor, with excessive debt may fall into trouble. The competitor may be a great acquisition target and aligns with the company's strategic objectives. With ample liquidity, (and hopefully low debt), the company can acquire the company at a very favorable price and reap the benefits when the market normalizes. This advantage can only occur however, if the company has ample liquidity in the form of cash, inventory, or receivables. The current ratio and the current ratio can therefore be used.

Now, further down the leadership chain I would like to see reports that show the return on invested capital and any write-downs of assets. Return on invested capital shows the amount of profit generated by the amount of money put in the business. I think this is an important indicator of investment success. I would like to see the investments we are making and how those investments are making the firm money. In addition, I would like to see what investments did not make the hospital money. Asset write-downs indicate a destruction of capital. These two metrics are critical in assessing how well the company performed for the year. Finally, I would like to see profit margin and operating margin to determine if the hospital is seeing margin comprehension from increased competition within the healthcare sector overall. With profit margin expansion, the company is better able to raise prices, and achieve higher profitability.