Financial Analysis and More Specifically Financial Ratios

¶ … financial analysis and more specifically financial ratios has been noted by Finkler, Marc and Baker (2007, p.253) to be important to managers since it can help them in making informed decisions. In this paper, we present the concept of ratio analysis as applied to healthcare facilities.

The concept and purpose of ratio analysis

Financial statement analysis is noted by Flex Monitoring Team (2005) to be very important to managers, boards, payers as well as lenders for them to effectively make the right judgments on the financial health of their organizations. Ratio analysis is one of the most accepted methods of assessing the financial health of an organization. The data that is used for ratio analysis is derived from income statements and balance sheets. It is a fact that most health care systems, hospitals as well as various other healthcare organizations routinely employ ratio analysis in evaluating their financial condition and then comparing the obtained values with those of other organizations or for previous periods. Their aim is to look out for any meaningful changes that may be exhibited in the differences obtained. Most healthcare organizations usually compare their own financial ratios with those of similar healthcare organizations in order to find any differences that may indicate either weaknesses or opportunities for organizational improvement. For instance it is very useful to compare the financial position of two or more Critical Access Hospitals (CAH) but very useless to compare the financial position of a major teaching hospital with that of a Critical Access Hospital (CAH). Such information may not be informative since these two categories of health care facilities have totally different organizational missions.

A large number of healthcare facilities are also noted to be in a quest of adopting the use of cost-effectiveness (CE) analysis in their decision making processes that are concerned with resource allocation (Eicher et al.,2004).

There are several types of financial ratios in use in assessing the financial health of organizations. Liquidity ratios for instance are used in measuring how easily a given firm can meet its various obligations. Profitability ratios on the other hand are used in indicating the earning potential of a given firm. Asset management ratios are used in measuring the efficiency of a given company turning its assets into sales. The Dent management ratios on the other had is important since they indicate the extent to which a given company is leveraged in terms of its own debt. These ratios also indicate how well as given firm can handle its debt using its operating income and assets. Finally, the Dividend/Market Value Ratios can be used in measuring the ability of a company to use its assets in earning generation for its investors. Financial ratios can therefore be used in providing meaningful information for comparing companies that operate within similar industries.

The factors to consider when interpreting results of ratio analysis

There are several factors to consider when interpreting ratio analysis. Key among them includes inflation, the type of industry, the financial year and duration as well as the seasonality of the firm's performance.

Sample ratio analysis calculation for a healthcare organization

Cost per discharge

Cost per discharge is a system level metric used in healthcare to refer to the costs that are related to the operations at the inpatient side of the business and is never associated in any way with the administrative cost.

Cost per discharge =Total cost/Discharges

For instance is a major hospital made $2 million the previous financial year with a discharge of 800 patients, the Cost per discharge would be $2,500. The low the value of cost per discharge, the better the management of the healthcare facility.

Managed Care ratios

In a managed care setting, the health care providers may use cost as well as utilization data in monitoring the managed care contracts. The monitoring and control ratios are important in this regard. Examples of such ratios are cost per patient day, variable cost per patient day, cost per discharge, labor to total cost ratio, revenue to cost per discharge ratio, cost per case-mix adjusted discharge as well as standard cost ratio.