Week 4 Day 4 CheckPoint

Ratio Analysis 2005 Selected Ratios for Arcadia Hospital

1. Current ratio = (current assets/current liabilities) 6900/3200 = 2.16, which is slightly higher than the standard so it is fine. Total asset turnover (total operating revenue/total assets) 568/17900 = .03 which is extremely low compared to the sector average ²perhaps there is a buildup of inventory or a problem with recalls of the product. Compared to the 1999 median ratios for Arcadia¶s peers, Arcadia is superior in being able to cover its current obligations out of its current assets, which indicates better liquidity. However, the Total Asset Turnover Ratio is drastically weaker for Arcadia, by a difference of .98; this variance may just indicate that Arcadia is much more capital-intensive than its peers, but it may also signal severely underperforming assets. The overall financial status, then, is a bit clouded; current assets are slightly strong compared to peers, yet the overall profitability of total assets is markedly low. The low Total Asset Turnover Ratio indicates that the hospital may be in financial trouble over the medium- to long-run. 2. Asset/equity (total assets/total equity) 17,900/7,900 = $2.27 a leverage ratio-capital structure Long-term debt/equity (total liabilities/total equity) 10,000/7,900 = 1.2658 leverage ratio-coverage Total margin (total operating revenue/net income) 32/568 = 5.63% profitability ratio The first two ratios are measures of leverage, as the Asset/Equity Ratio shows to what extent Assets are based on Equity (as opposed to Debt and Liabilities in general), and the Long-Term Debt/Equity Ratio¶s use as a leverage ratio is rather self-evident. The Asset/Equity ratio is therefore an indicator of capital structure, as it shows how the amount of assets in the business relate the amount of equity; lower values this ratio indicate greater degrees of a leveraged capital structure, all other things held constant. The Long-Term Debt/Equity Ratio is also an indicator of capital structure, as it shows the relationship between how the right hand of the basic accounting equation (Assets = Liabilities + Equity) is set up for an organization; more debt automatically means more leverage and less equity, and less shareholder/owner rights over creditors in the event of bankruptcy. The difference between coverage and capital structure ratios is a really a matter of whether a ratio indicates an ability to pay for debts and so forth out of certain classes of assets (e.g., the Current, Quick, Cash Coverage, EBITDA, and other such ratios, which are all coverage ratios), or if a ratio essentially crystallizes certain elements of the balance sheet and thereby shows a relationship between those elements within it without necessarily showing repayment ability (e.g., Debt/Equity, Assets/Equity, Debt, and other such ratios). The former are coverage ratios, while the latter are capital structure ratios.

The Total Margin, however, is a profitability ratio that shows how much of each revenue dollar actually translates into cents of profit. As such, it is a profitability ratio. However, for such a capital-intensive enterprise that is reliant upon high levels of accounts receivable (such as a hospital), this ratio on its own can often be misleading. Indeed, ratios such as Average Collection Period, Days in Accounts Receivable, A/R Turnover, Fixed Asset Turnover, Days Cash Coverage, and other ratios focusing on specific financial statement areas more relevant to hospitals provide much more information than the boilerplate ratios used in most other enterprises. What the above three ratios can tell us about Arcadia, however, is how it is structured and where it has either strengths or weaknesses, especially compared to its peers. For instance, Arcadia¶s Long-Term Debt/Equity Ratio of 86% shows it be incredibly leveraged, especially compared to its peers that are only 31.16% leveraged through long-term debt, on average. This structural attribute of Arcadia may show that the company is overleveraged, which can have very poor performance results²for instance, excessive interest expense and unfavorable borrowing terms on new debt. Arcadia¶s Total Margin of 6 cents on the dollar seems fairly good; however, one lacks the comparable data for its competitors, which may mean that this 6 cents on the dollar proved Arcadia to be inefficient at turning its resources into profits. It is also just as possible that Arcadia is blowing the competitions out of the water; one lacks the necessary information. Regardless, this ratio does show that Arcadia is currently profitable, which by virtually any measure is a positive indicator all on its own. Finally, the Asset/Equity Ratio of 2.27 shows very little on its own, except that the overall level of assets to equity is more than double, meaning that liabilities play a larger role in funding assets than does equity. The industry median ratio can be found by multiplying ROE by 1/ROA (Net income / Equity x Assets / Net Income = Assets / Equity), calculated as 2.72. Therefore, compared to its peers, Arcadia¶s assets are less funded from liabilities than its peers. That the Asset/Equity Ratio is lower than peers¶, while the Long-Term Debt/Equity Ratio is much higher than peers¶, shows that Arcadia¶s peers have a much greater proportion of Current Liabilities to LongTerm Debts, which may indicate that Arcadia has relied too much upon long-term borrowings.