Liquidity ratios (Current ratio, Days Cash-on-Hand, Quick Ratio)

Sample Solution

The Value of Ratio Analysis in Decision-Making for Healthcare Organizations

Ratio analysis is a cornerstone of financial analysis in any industry, and healthcare is no exception. It involves calculating key metrics that provide insights into a healthcare organization's financial health, performance, and operational efficiency. By analyzing these ratios, healthcare leaders can make informed decisions about resource allocation, investment strategies, pricing structures, and overall financial sustainability.

This paper will discuss the value of ratio analysis for healthcare organizations. We will delve into four specific ratios, one from each major group in financial statements:

• Liquidity Ratio (Current Ratio): This metric assesses an organization's short-term ability to meet its financial obligations.
• Profitability Ratio (Return on Equity - ROE): This ratio measures the profitability generated from shareholders' investments.
• Leverage Ratio (Debt-to-Equity Ratio): This metric indicates the organization's reliance on debt financing compared to equity.
• Non-Financial Ratio (Average Length of Stay - ALOS): This metric provides insights into bed utilization and operational efficiency.

Current Ratio:

The current ratio measures the relationship between an organization's current assets (those convertible to cash within one year) and its current liabilities (obligations due within one year). It indicates the ability to pay off short-term debts with readily available resources.

Calculation:

Current Ratio = Current Assets / Current Liabilities

Meaning and Financial Health:

A current ratio greater than 1 indicates the organization has sufficient current assets to cover its short-term debts. However, a very high ratio could suggest inefficient use of resources, while a ratio too low could signal potential difficulty meeting short-term obligations. A benchmark current ratio for healthcare organizations typically falls between 1.5 and 2.5 (American Hospital Association, 2023).

Full Answer Section

Factors Affecting Results:

• Billing practices: Slow collections from patients or insurers can decrease current assets.
• Inventory management: Holding high levels of inventory can inflate current assets but decrease liquidity.
• Debt structure: High short-term debt obligations can increase current liabilities.

Example Calculation (Using Sample Help4UHMO Statements): (Note: Specific figures may not be available in resources provided for this assignment)

Let's assume Help4UHMO has Current Assets of $20 million and Current Liabilities of $15 million.

Current Ratio = $20 million / $15 million = 1.33

Based on this example, Help4UHMO's current ratio is 1.33. While it suggests some short-term solvency, it might be beneficial to analyze trends over time or compare it to industry benchmarks to gain a more comprehensive understanding of the organization's liquidity.

Return on Equity (ROE):

ROE measures the profitability generated on shareholders' investments. It indicates how much net income (profit) the organization earns for each dollar of shareholder equity.

Calculation:

ROE = Net Income / Shareholders' Equity

Meaning and Financial Health:

A higher ROE indicates the organization is effectively using its equity to generate profits. However, a very high ROE might suggest aggressive accounting practices or unsustainable financial activities. A low ROE could suggest inefficiency or a need for improved profitability. Industry benchmarks for ROE in healthcare can vary depending on the organization's size and specialty (American College of Healthcare Executives, 2023).

Factors Affecting Results:

• Profitability: Higher net income will lead to a higher ROE.
• Capital structure: A higher proportion of debt financing compared to equity can inflate ROE (due to financial leverage).
• Dividend payouts: Distributing a larger portion of profits as dividends can decrease shareholders' equity and lower ROE.

Debt-to-Equity Ratio:

This ratio measures the organization's capital structure by comparing its total debt to its total equity. It indicates the degree to which the organization relies on debt financing.

Calculation:

Debt-to-Equity Ratio = Total Debt / Total Equity

Meaning and Financial Health:

A lower debt-to-equity ratio suggests a more conservative financial structure with less reliance on debt. However, a very low ratio might indicate missed opportunities for growth through debt financing. Conversely, a high ratio raises concerns about the organization's ability to manage its debt obligations. Industry benchmarks for this ratio in healthcare can vary depending on the organization's size and risk tolerance (Melton & McManamy, 2019).

Factors Affecting Results:

• Debt financing: Issuing new debt will increase the total debt and raise the ratio.
• Equity issuance: Selling additional shares of stock will increase total equity and decrease the ratio.
• Asset sales: Selling assets can decrease total debt and equity, potentially impacting the ratio.

**Average Length of Stay (AL