Question

Why is financial ratio analysis crucial for understanding the financial position of a healthcare organization? Select any three of the commonly used financial ratios, provide the formula, and briefly explain what it tells us about the status of the healthcare facility.

Answer 1

Ans) Analyzing debt-to-capitalization ratios indicates the strength and long-term value of a health care organization.

- The ratio is important for investors and risk analysis.

- Health care organizations with heavy long-term debt loads, and low available capital and asset values present a risky business model.

- For any financial professional, it is important to know how to effectively analyze the financial statements of a firm. This requires an understanding of three key areas:

1. The structure of the financial statements
2. The economic characteristics of the industry in which the firm operates and
3. The strategies the firm pursues to differentiate itself from its competitors.

- There are generally six steps to developing an effective analysis of financial statements.

1. Identify the industry economic characteristics:
First, determine a value chain analysis for the industry—the chain of activities involved in the creation, manufacture and distribution of the firm’s products and/or services. Techniques such as Porter’s Five Forces or analysis of economic attributes are typically used in this step.

2. Identify company strategies.
- Next, look at the nature of the product/service being offered by the firm, including the uniqueness of product, level of profit margins, creation of brand loyalty and control of costs.

- Additionally, factors such as supply chain integration, geographic diversification and industry diversification should be considered.

3. Assess the quality of the firm’s financial statements:
- Review the key financial statements within the context of the relevant accounting standards. In examining balance sheet accounts, issues such as recognition, valuation and classification are keys to proper evaluation. The main question should be whether this balance sheet is a complete representation of the firm’s economic position. When evaluating the income statement, the main point is to properly assess the quality of earnings as a complete representation of the firm’s economic performance.

- Evaluation of the statement of cash flows helps in understanding the impact of the firm’s liquidity position from its operations, investments and financial activities over the period—in essence, where funds came from, where they went, and how the overall liquidity of the firm was affected.