Balance Sheets and Ratio Analysis

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Balance Sheets and Ratio Analysis

• N287E Spring 2006
• Joanne Spetz
• 5 April 2006

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Administrative news

• Our classroom is now C701, except
• April 26, either U506 or the Bailey Lounge
• May 10, HSW 303
• Next week guest lecturers
• Do the reading in advance!

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What did we do last time?

• Defined health economics
• Defined utility
• Graphed indifference curves
• Talked about marginal costs and marginal benefits
• Learned the supply and demand magic

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What did we do last time?

• Defined perfect competition
• Learned why perfect competition does not exist in
  health care
• Talked about nursing shortages
• Short-term supply and demand
• Long-term supply and demand

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Questions for you

• Is there an economic case for addressing nursing
  shortages?
• Do you think Huston 2003 makes the case well?
  Why or why not?
• What are the costs to our economy of nursing
  shortages?
• Rivers et al., 2005, recommends Magnet
  Certification as a key strategy. Do you agree?

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Questions for you

• Do you think the model proposed by Spetz Given
  (2003) is adequate?
• What issues did they ignore in their analysis?

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And on with the show

• How do we assess the financial impact of anything
  on health care?

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How do we assess whether firms are profitable?

• Profitability has many components
• Immediate profit
• Investments that lead to future profits
• In health care many firms are not-for-profit
• Religious and not-for-profit hospitals
• Community clinics

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Firms keep records of financial information

• Most financial information is available to the
  public
• For-profit firms must share information if they
  are publicly held (stocks)
• Not-for-profit firms have an obligation to the
  public and must have information available
• Some states require reporting

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What financial information do we want?

• Financial sheets
• Balance sheet
• Statement of revenues and expenses
• Statement of cash flows
• Statement of change sin fund balances or net
  assets
• Plus footnotes to all these

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Firms report financial data in standard way

• Financial sheets contain information about firm
  financial performance
• For most companies, these data are available to
  the public
• There are many accounting tricks to make these
  sheets look good

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Balance Sheets

• The Balance Sheet provides the present value of
  the firm
• Two sections
• Assets
• Current liabilities and equity
• Assets liabilities equity
• Equity (roughly) measures the value of the
  company
• Equity Assets - liabilities

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Types of assets

• Current assets (cash, securities, etc.)

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Types of assets

• Limited-use assets

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Types of assets

• Property, plant, and equipment (PPE)
• Note PPE is depreciated to get net PPE

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Types of assets

• Investments, other assets

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Types of assets

• Intangible assets
• Very hard to value
• There are some strong rules about valuation

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Types of assets (restricted funds)

• Specific purpose funds

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Types of assets (restricted funds)

• Plant replacement expansion funds

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Types of assets (restricted funds)

• Endowment

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Types of liabilities

• Current liabilities

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Types of liabilities

• Deferred credits

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Types of liabilities

• Long-term debt

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Types of liabilities (restricted funds)

• Money due to the restricted funds
• Specific purpose funds
• Plant replacement expansion
• Endowment funds

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Components of equity

• Non-profit (fund balance)
• For-profit
• Stock
• Capital
• Retained earnings

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Statement of Revenues and Expenses

• Presents the years earnings
• Presents the years expenses
• Calculates the income or loss from operations

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Components of statement of income

• Operating revenues
• Deductions from revenue
• Operating expenses
• Taxes
• Non-operating revenues
• Non-operating expenses

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Operating revenues

• Money the firm receives

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Deductions from revenues

• Particularly relevant for health care

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Operating expenses

• What does it cost to run the business?

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Taxes

• Only if youre a for-profit company

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Non-operating revenue

• Revenue that isnt connected to your line of
  business

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Non-operating expenses

• Costs that arent associated with your production

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Add it all up and you get

• Net income

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It can be important to adjust for inflation

• Inflation can increase value of assets
• Inflation can decrease cost of debts
• Inflation increases cost of future investment

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To deal with future costs

• Future costs come from
• Inflation
• Investments
• Firms must have increases in their assets
• Assets liabilities net assets
• Asset increases come from increases in
• Debt
• Equity

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Ways to measure growth

• Growth Rate in Equity (GRIE)
• GRIE Dequity net income x Dequity
• equity equity net inc.
• return on equity (net income/equity)
• reported income index (net income/Dequity)

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How to interpret GRIE

• If a firm has no equity source other than net
  income
• No endowment
• No government transfers
• then the reported income index 1
• GRIE is sometimes called Return on Equity (ROE)

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To break down ROE more
ROEnet op incomenet nonop income
revenue x revenue x assets assets equit
y
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To go farther than this

• Ratio analysis
• Liquidity ratios ability of firm to meet
  short-term financial obligations
• Capital structure ratios quality of capital of
  firm
• Activity ratios revenues and expenses
• Profitability ratios revenues vs. expenses
• Other ratios

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We can benchmark ratios

• Ratios get compared to national or regional
  averages/medians
• Different ratio goals for different industries
• In your problem set you will be computing ratios