Financial Ratio Analysis of Midwest Health Plan, Inc.

Introduction

Financial ratios are critical for decision-making purposes. Those who utilize information derived from the analysis of financial statements include lenders, managers, the government, and stockholders. This paper computes two financial ratios from Midwest Health Plan, Inc. in an attempt to determine the financial health of the organization.

Ratio Analysis in Healthcare Organizations

When it comes to decision-making in healthcare organizations, the relevance of ratio analysis cannot be overstated. Managers of a healthcare organization can use ratio analysis to identify changes in the financial condition of an entity by comparing current financial period ratios with previous financial period ratios. For instance, if an organization is found to have difficulties in settling its debts through the use of liquidity ratios, corrective measures can be taken promptly after the computation and comparison of the relevant ratios. Secondly, healthcare organizations can evaluate their performance by comparing their profitability and other relevant ratios with those of other organizations. Such comparison can shape decision-making by identifying both the key strengths and weaknesses of the concerned organization so that corrective action can be taken.

The two ratios analyzed in this case are return on equity (ROE) and debt ratio. The financial statements utilized are for the year ended December 31, 2011.

According to Dlabay, Burrow, and Kleindl (2011), the return on equity ratio shows the rate of return the owners are getting on the money they invested in the company. In the case of Midwest Health Plan, return on equity can be considered a means of measuring the organization's ability to generate sufficient returns necessary for the replacement of organizational assets and for handling service demand increases. The ratio is computed by dividing the figure for net income by that of common shareholders' equity (Gallagher & Andrew, 2007).

Return on Equity

Midwest Health Plan's Return on Equity Ratio = 5,936,900 ÷ 20,928,586 = 0.284

According to Baker and Powell (2005), return on equity helps in determining how effective the management of an organization is when it comes to the generation of net income using the resources availed by shareholders. Given that the ratio is often expressed as a percentage, a return on equity of 0.284 demonstrates that for every dollar of equity invested in Midwest Health Plan, the organization generates 0.284 dollars as profit. However, to correctly chart the effectiveness of its management with regard to profit generation using shareholder-provided resources, Midwest Health Plan should ideally compare its return on equity ratio with that of other similar organizations.

Debt Ratio

According to Baker and Powell (2005), the debt ratio is computed by dividing a firm's total liabilities (current and non-current) by its total assets. For Midwest Health Plan, the debt ratio is calculated as follows:

Midwest Health Plan's Debt Ratio = 30,800,896 ÷ 51,729,482 = 0.595

Factors Affecting Ratio Interpretation

The debt ratio, as Baker and Powell (2005) note, measures the percentage of a firm's total assets financed by debt. An organization having a debt ratio of less than 1 can be considered safer with regard to its debt load than an organization having a debt ratio of more than 1. Furthermore, an entity with a high debt ratio could be having a significant portion of its assets financed by creditors as opposed to owners. In this regard, Midwest Health Plan's debt ratio is an indicator that the organization's assets exceed its debt. Thus, more of the organization's assets are financed using equity as opposed to debt. For individuals wishing to acquire a stake in the organization, this ratio is critical as it aids in the determination of its risk level.

To obtain the full meaning of the ratios highlighted above, an organization should ideally compare such ratios with those of previous periods or with those of other organizations in the same field. Without any comparison, ratios tend to lose their meaningfulness. For instance, the ratios computed above maintain their usefulness if they are compared to those of organizations similar to Midwest Health Plan. It would be illogical and erroneous to compare the financial ratios of a hospital with fewer than 100 beds with those of another hospital having more than 100 beds, as significant variation exists in terms of fixed costs, revenues, and other factors.

Before comparing ratios from different entities, the accounting methods utilized in each case should be taken into consideration. Organizations using different accounting methods in the preparation of their financial statements may yield ratio values that are significantly different.

Conclusion

In conclusion, taking into consideration the ratios computed above, Midwest Health Plan's performance can be regarded as satisfactory. This is especially true with regard to its debt ratio, which demonstrates the organization's ability to keep its financial leverage under manageable levels. Furthermore, the organization's return on equity can be regarded as sufficient to not only meet service demand increases but also cover asset replacement costs.