[Solved] ratio analysis 3

This paper aims to undertake a financial analysis of Hospital of St. Raphael so as to ascertain its financial health. The analysis will take considerations of liquidity, solvency, activity and profitability point of view.

Liquidity:

The current ratio (current assets / current liabilities) is considered as the most important and informative tool with which to assess the liquidity of the firm. According to Schweser (2008), the ratio speaks of the ability of the firm to meet near short term obligations as and when they fall due by utilizing those assets that are cash or near term cash convertible instruments (P.46). The current ratio for the HSR has improved from 1.19 (04) to 1.35 (05) as a result of current liabilities falling by 11% although the current asset position did not change by much. This speaks of financial prudence on behalf of the hospital as it has been able to reduce its short term obligations while maintaining its current asset position.

Another important determinant is the average collection days of accounts receivables figure. According to BPP (2008), a low average receivables days outstanding figure is a good omen as it speaks of low investment and hence low financial cost in receivables, less risk of doubtful debts and higher cash flow for the firm (P.251).  Surprisingly, the hospital has made improvement here to with the average receivable days outstanding falling from 43 days (04) to 39 days (05) as a result of higher revenue and more cash settlements resulting in falling receivables (the effect of which is shown as a rise in the cash reserves). This speaks of financial strength on behalf of the firm as it is able to attract sales without offering extended credit.

While this company’s liquidity position has improved over the past two years, it is important to note that there is still room for further improvement. Ideally, a current ratio of 2:1 is desirable.

Capital Structure

On the solvency (or long term liquidity) side, the HSR has witnessed a detoriating trend over the past two years with the equity financing ratio (measuring the level of owners own equity in the business) depicting a fall from 0.12 to 0.04 and the long term debt to equity ratio (measuring the level of debt as a percentage of owner’s equity) depicting an increase from 435% to 1351% times.

This worsening of affairs can be attributed to a rise in debt financing (notes payable by approximately 16.67%) and a fall in the general fund balance, the main source of owner’s equity for the hospital, which fell by $21m during the year under review, party due to a net loss recognized on the income statement and a fall in the other assets position by $12m. It is pertinent to mention that the company remains highly leveraged with owner’s equity being only 4% of the total financial resources committed to the entity and the level of debt being 1300 times the level of owners equity.

Activity

According to the CFA institute (2008) activity ratio’s measure how efficiently the management utilizes the assets of the company (P.153). The prime tool here is the total asset turnover ratio from which other ratios focusing on the different categories and types of assets are derived from. For HSR, the total asset turnover ratio has increased slightly from 3.4 (04) to 3.66 (05). This improvement has been possible due to two factors; increase in revenues (the nominator) by 5.5% and a fall in total assets (the denominator) by 2.02% due to a fall of $12 m in the other assets figure. Thus, on a net efficiency level, the hospital has become negligibly efficient for if the effect of fall in total assets is taken into account, the turnover ratio comes to 3.5 for the year 2005.

Profitability

On the profitability side, the HSR has witnessed a consistently negative and widening operating margin as its operating expenditures have risen above its net revenues between the two years under review.  The operating margin has widened from -3% in 2004 to -5.3% in 2005. This deserves attention as the operating activities of the hospital are becoming increasingly unprofitable due to a lack of control on costs, even though there has been improvement in revenues.

From a net margin perspective, the hospital did not fare to bad. Already at a miniscule net margin of 1.4% in 2004, the widening operating margin deficit absorbed the other income head (which, to contribute further to the company’s vows) remained stagnant causing the net margin to rest at -1.2% in 2005.

Conclusion

To conclude, the HSR does not seem to be in good financial health. It is unprofitable and the gap between revenues and expenses continues to widen. The entity’s capital structure presents a problem as the hospital is highly leveraged and its solvency remains a critical issue. Management’s ability to actively utilize the assets of the hospital casts a further shadow of doubt on the entity’s prospects. Furthermore, the stagnation in asset growth and the huge fall in the other assets position, points to problems that need to be looked into and the factors addressed. The only positive thing going the entity’s way it seems is the liquidity position although with continued un profitability, this would slowly erode too.

Appendix A Ratio Analysis

Ratio
Formula
Result (04)
Result (05)
Current ratio
Current Assets / Current Liabilities
1.19 times
1.35 times
Average Days Receivables
Accounts Receivables / Average Daily Revenue
43 days
39 days
Equity Financing Ratio
Net Assets / Total Assets
0.12 times
0.04 times
Long term Debt to Equity ratio
Long term Debt / Net Assets
435%
1351%
Total Asset Turnover Ratio
Total Revenue /  Total Assets
3.4 times
3.66 times
Operating Margin Ratio
Net operating income / total revenue
-3%
-5.3%

References

Schweser, (2008). CFA Level One: Financial Statement Analysis. London: Kaplan

BPP, (2008). ACCA Paper F7: Financial Reporting. London: BPP Learning Media

CFA Institute (2008). CFA Level One: Financial Statement Analysis. Boston: Pearson

About, Inc., (2004). Investing for Beginners – Financial Ratios. Retrieved on August 6, 2004 from

http://beginnersinvest.about.com/od/financialratio/.

Bushman, M. (2007). Using ratio analysis to assess financial stability. Retrieved on February 26, 2008 from
http://www.associatedcontent.com/article/111527/using_ratio_analysis_to_asses s_financial.html

Investopedia, Reading the balance sheet. Retrieved on February 26, 2008 from http://www.investopedia.com/articles/04/031004.asp

Accountingcoach.com, Explanation of financial ratios Retrieved on February 26, 2008 from
http://www.accountingcoach.com/online-accounting-course/03Xpg01.html

Inverstorguide.com, Explanation of the income statement Retrieved on February 26, 2008 from
http://www.investorguide.com/igu-article-427-investing-basics-explanation-of-the-income-statement.html

 

[opskill_register_order]

"Looking for a Similar Assignment? Order now and Get a Discount!

Hey, wait!You Don't want to miss this offer!

Before you go, let us offer you a 20% discount coupon for your next purchase.