Financial analysis concepts and methods

Financial Analysis

The auditor's opinion letter is a basic form letter that says it conducted the audit according to accepted auditing principles, and that the financial statements of Major Medical Center accurate reflect the financial condition of the organization. It is impossible to tell from the auditor's statement itself that anything is wrong -- this is the standard form for such a statement and most of them look like this.

The first thing to look for would be numbers that have changed a lot when there is not much reason for them to change -- the outlying events are quite important. The revenue has not changed much, so this looks like a mature business. Therefore, there should not be major changes in other line items. Salaries and wages have increased in line with the increase in revenues, which makes sense. The one thing that concerns me is "Net assets released from restrictions." I have no idea what that phrase means, but it sounds like a balance sheet item, not an income statement item. That change accounts for more than the sum total in operating income. That is a huge red flag. There is actually something called "increase in unrestricted net assets" as the bottom line on the income statement. Assets don't go on the income statement -- they go on the balance sheet. So this is something that needs to be explained immediately.

There is an issue with the valuation on the plant, property and equipment. This shows a 2013 valuation of $89,777, with depreciation and amortization of $22,541, and investment of $10,043. This value thus should have declined, but instead it increased. There's something that seems amiss there. I also see a similar issue with long-term debt. $13,326 of this was paid down, but the amount has increased -- that increase does not show on the statement of cash flows.

Looking at inventories, average cost is used, which is acceptable under GAAP. The inventory level decreased where one might have expected it to increase, but this level does not seem unreasonable. I'm not sure why "due from affiliates" is a long-term asset -- how long should these affiliates take to pay their debts? Pledges receivable is listed as a short-term asset and a long-term asset -- I'd like to know why as well. The interest expense should not be listed under operating expenses. That is not GAAP and should be fixed. Splitting out benefits from salaries is odd -- it probably can be done but it's unusual. An auditor doesn't like unusual.

Of course the two more obvious issues are just starting points. An audit requires going through individual receipts and records, not just taking a quick look at the financial statements. The statements represent a starting point, and the two issues identified above make for a good starting point, to uncover why their basic arithmetic does not add up.

3.The notes were not provided. I would consider that a red flag, when the financial statements make explicit reference to the notes and the notes are not provided.

4. The common size statements are as follows:

Income Statement

2014

CS

2013

CS

Revenue

420985

386225

Salaries and Wages

207141

49.20%

196453

50.86%

Employee Benefits

44456

10.56%

44860

11.61%

Supplies & Expenses

137505

32.66%

117838

30.51%

Dep & Amort

22541

5.35%

18856

4.88%

R&D

0.58%

0.57%

Interest Exp

1.06%

1.36%

Net Income

0.58%

0.19%

Balance Sheet

Cash

4.11%

5.11%

Assets limited

0.51%

0

0.00%

ST investments

0.71%

0.73%

Receivables

49719

25.34%

47614

27.03%

Pledges receivable

0.92%

1.25%

Inventories

0.86%

1.32%

More receivables

3.33%

0

0.00%

Govt Grants

0

0.00%

0.27%

Other current assets

1.14%

1.94%

Total Current Assets

72448

36.92%

66315

37.64%

Sinking Fund

14487

7.38%

13410

7.61%

Compensating Bal.

0.47%

0

0.00%

LT Investments

0.58%

0.35%

Due from affiliates

1.74%

2.01%

Pledges rec

0.96%

0.83%

PPE

98555

50.22%

89777

50.96%

Deferred financing

0.67%

0

0.00%

Other

2065

1.05%

0.59%

Total LT Assets

123791

63.08%

109859

62.36%

Total Assets

196239

176174

Current LT Debt

11608

5.92%

11488

6.52%

Accounts payable

29489

15.03%

25311

14.37%

Accrued salaries

25572

13.03%

20096

11.41%

3rd party

0

0.00%

1.06%

Advances

0.81%

0

0.00%

Total Current Liabilities

68256

34.78%

58769

33.36%

LT Debt

55539

28.30%

47709

27.08%

Benefits

3.07%

3.42%

Other

16445

8.38%

17014

9.66%

Total LT Liabilities

78007

39.75%

70740

40.15%

Total Liabilities

146263

74.53%

129509

73.51%

Equity?

49976

25.47%

46665

26.49%

They do not appear to show anything specific that would be cause for alarm, other than the issues listed above.

The ratios are as follows:

Ratios

2014

2013

Current

1.06

1.13

Quick

1.04

1.09

Days' cash

7.52

9.10

Receivables Turn

8.47

8.11

Avg Collection Period

43.11

45.00

Fixed Asset Turn

4.27

4.30

Total Asset Turn

2.15

2.19

Debt Ratio

39.75%

40.15%

D/E

n/a

n/a

X Interest Earned

1.55

1.14

Operating Margin

0.58%

0.19%

Total Margin

0.58%

0.19%

ROA

1.24%

0.43%

RONA

4.86%

1.61%