The document discusses various methods for measuring and analyzing the financial performance of healthcare organizations, including common size analysis, trend analysis, and ratio analysis. Common size analysis standardizes financial statement values by dividing items by total assets or operating revenue. Trend analysis compares values over time. Ratio analysis examines relationships between financial metrics and allows comparison to industry standards. Key ratios discussed include margins, liquidity, debt, and asset management ratios.

1. © 2018 American Health Information Management Association© 2018 American Health Information Management Association
Principles of Finance for
Health Information and
Informatics Professionals
Second Edition
Chapter 3
Financial Performance
Measurement

2. © 2018 American Health Information Management Association
Learning Objectives
• Explore the motivation for measuring
financial performance
• Calculate key financial ratios
• Understand the relationships between
the financial ratios
• Analyze the financial position of a
facility based on financial statement
data
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Financial Statement Review
• Four components of financial statements
1. Balance Sheet
2. Income Statement
3. Statement of Cash Flow
4. Statement of changes in net assets or equity
statement
• Comprehensive report of financial performance
for external audience
• Audited on an annual basis by an external
entity (accounting firm)
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Measuring Financial Performance
• Financial statements are a snapshot in time
• Powerful tool to assess financial health of an
organization
• Difficult to compare organizations to each other
or year-to-year comparisons without some sort
of standardization
• Two approaches:
– Common size financial statements
– Financial ratios
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Common Size Financial Statements
• Each value on the balance sheet and income statement is
standardized by common value
• Normalizes for differences in size of the entity
• Balance sheet: divide each value by the total assets
• Income statement: divide each value by the operating revenue
• Sometimes called “vertical common size”
• Useful when comparing year-to-year when significant change in
size of business occurred or in comparing two entities of different
sizes
• No common size version of cash flow statement
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Common Size Balance Sheet
• Total assets increased from 2016 to 2017
• Current assets increased from 45.2% to 55.4% of total assets – improved
cash position of Regional Hospital
• More of the increase is in cash and cash equivalents vs. AR – more liquid

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Common Size Balance Sheet
• Total net assets increased from 2016 to 2017, but a lower percentage of
total assets
• Movement in the mix of net assets observed
• Increase is unrestricted net assets is a positive indicator

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Common Size Income Statement
• Expenses are a smaller percentage of operating revenue resulting in an
increase in operating income
• Largest shift in expenses in salaries and benefits

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Trend Analysis
• Compare values from year to year
• Order of subtraction in numerator matters
– Positive value = increase
– Negative value = decrease
• Amount of increase/decrease relative to previous
value
• Sometimes called horizontal analysis
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𝑃𝑒𝑟𝑐𝑒𝑛𝑡 𝐶ℎ𝑎𝑛𝑔𝑒 =
(𝑁𝑒𝑤 𝑉𝑎𝑙𝑢𝑒 − 𝑂𝑙𝑑 𝑉𝑎𝑙𝑢𝑒)
𝑂𝑙𝑑 𝑉𝑎𝑙𝑢𝑒

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Balance Sheet Trend Analysis
• Shows significant growth in cash and cash equivalents
• Interpret carefully: if the total assets shifted significantly from year-to-
year then consider using common size comparison

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Balance Sheet Trend Analysis
• Net value of depreciable capital assets decreased
• This is expected unless significant capital purchases occurred during
the year.
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Income Statement Trend Analysis
• Significant increase in operating income
• Attributed mainly to decrease in salary and benefits and small increase
in net patient service revenue (NPSR)

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Cash Flow Statement Trend Analysis
• Significant
change in net
income due
to:
– Decrease in
bad debt
provision
– Increase in
AR
– Increase in
Third-Party
Settlements
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Ratio Analysis
• Financial Ratios
– Analyze relationship between financial statement figures
– Allow comparison of figures across components of the
financial statement
• Ratio Categories
– Profitability Ratios
– Liquidity Ratios
– Debt Performance Ratios
– Asset Management Ratios
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Profitability Ratios
• Standard measure of the overall financial
performance of an organization
• Are they making money?
Total Margin (TM)
Return on Assets (ROA)
Return on Equity (ROE)
Operating Margin (OM)
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Total Margin (TM)
• TM includes BOTH operating
and nonoperating revenue
and expenses
• Higher values are better

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Return on Assets (ROA)
• ROA includes same
numerator as TM
• Total assets in denominator
• Higher values are better

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Return on Equity (ROE)
• ROE includes same
numerator as TM
• Total equity = Total net
assets
• Higher values are better
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐸𝑞𝑢𝑖𝑡𝑦 =
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

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Operating Margin (OM)
• Operating income and
revenues ONLY
• Higher values are better
2016 Operating Margin =
180,798
20,148,474
𝑥100 = 4.2%
2017 Operating Margin =
861,828
20,550,695
𝑥100 = 0.9%

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Liquidity Ratios
• Measures the ability of a company to
meet current obligations
• Can they pay the bills?
Current Ratio (CR)
Quick Ratio (QR)
Days Cash on Hand (DCOH)
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Current Ratio (CR)
• CR > 1 means facility has
enough readily available
assets to cover short term
liabilities
• Higher is generally better
• Too high may mean entity
not re-investing
2016 Current Ratio =
5,489,465
1,976,337
=2.78
2017 Current Ratio =
7,540,735
2,655,466
=2.84

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Quick Ratio (QR)
• QR <= CR
• QR is more conservative
• Higher is better, but not too
high compared to industry

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Days Cash on Hand (DCOH)
• Includes only actual cash
operating expenses in
denominator
• Higher is better, but not too high
compared to industry

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Debt Performance Ratios
• Used to judge credit worthiness of a
firm
• Should we loan them money?
Debt Ratio (DR)
Debt to Equity Ratio (DER)
Times Interest Earned (TIE)
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Debt Ratio (DR)
• Lower is better, but not
too low compared to
industry

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Debt to Equity Ratio
(DER)
• Recall that equity and
net assets are the
same figure
• Lower is better, but not
too low compared to
industry

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Times Interest Earned (TIE)
• EBIT = Net income plus interest or taxes
• Recall net income is change in net assets
• Interest displayed as a negative in
income statement since nonoperating
revenue (expense) reported together
• Larger is better

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Asset Management Ratios
• Activity ratios
• Measure how effective an organization is using assets
to improve financial strength
• Are they making smart investments in the company?
Fixed Asset Turnover (FAT)
Total Asset Turnover (TAT)
Days in Patient Accounts Receivable (DPAR)
Average Age of Plant (AAP)
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Fixed Asset Turnover (FAT)
• Net fixed assets is the
value of capital items
after depreciation
• Measures operational
size compared to
capital assets
• Larger is better
From Balance Sheet:
From Income Statement:

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Total Asset Turnover (TAT)
• Measures operational
size compared to total
assets
• Larger is better
From Income Statement:
From Balance Sheet:

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Days in Patient Accounts Receivable (DPAR)
• Measures number of
days of patient care
that have not been
collected upon
• Small is better, subject
to industry norms
From Income Statement:
From Balance Sheet:

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Average Age of Plant (AAP)
• Accumulated
depreciation on
balance sheet or in
notes
• Lower values are
better, indicative of
newer buildings and
equipment

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Regional Hospital Ratio Summary

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Regional Hospital Ratio Summary

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Ratio Definition Summary

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Ratio Definition Summary (Continued)

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Summary
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• To measure the financial performance of a facility, the
financial statement must be transformed into
standardized values
• Three strategies are used to normalize or standardize
the financial statement values:
o Common size, or vertical, analysis divides each
value on the balance sheet by the total assets
o Trend analysis, or horizontal analysis, compares one
facility’s performance over time
o Ratio analysis compares performance over time and
versus industry standard