115 Financial and Operating Ratios as Performance Measure s 11 C H A P T E R THE IMPORTANCE OF RATIOS Ratios are convenient and uniform measures that are widely adopted in healthcare financial management. They are important because they are so widely used, es- pecially because they are used for credit analysis. But a ratio is only a number. It has to be considered within the context of the operation. There is another caveat: ratio analysis should be conducted as a comparative analysis. In other words, one ratio standing alone with nothing to compare it with does not mean very much. When inter- preting ratios, the differences between periods must be considered, and the reasons for such differences should be sought. It is a good practice to compare results with equivalent computations from outside the organization— regional figures from similar institutions would be a good example of such outside sources. Caution and good man- agerial judgment must always be exercised when working with ratios. Financial ratios basically pull together two elements of the financial statements: one expressed as the numerator and one as the denominator. To calculate a ratio, divide the bottom number (the denominator) into the top number (the numerator). The Case Study in Appendix 25-A entitled “Using Financial Ratios and Benchmark- ing: A Case Study in Comparative Analysis” uses financial ratios as indicators of financial position. We highly rec- ommend that you spend time with this Case Study, as it will add depth and background to the contents of this chapter. In this chapter we examine liquidity, solvency, and profitability ratios. Exhibit 11-1 sets out eight basic ratios After completing this chapter, you should be able to 1. Understand four types of liquidity ratios. 2. Understand two types of solvency ratios. 3. Understand two types of profitability ratios. 4. Successfully compute ratios. P r o g r e s s N o t e s 116 CHAPTER 11 Financial and Operating Ratios as Performance Measures Exhibit 11–1 Eight Basic Ratios Used in Health Care Liquidity Ratios 1. Current Ratio Current Assets Current Liabilities 2. Quick Ratio Cash and Cash Equivalents + Net Receivables Current Liabilities 3. Days Cash on Hand (DCOH) Unrestricted Cash and Cash Equivalents Cash Operation Expenses ÷ No. of Days in Period (365) 4. Days Receivables Net Receivables Net Credit Revenues ÷ No. of Days in Period (365) Solvency Ratios 5. Debt Service Coverage Ratio (DSCR) Change in Unrestricted Net Assets (net income) + Interest, Depreciation, Amortization Maximum Annual Debt Service 6. Liabilities to Fund Balance Total Liabilities Unrestricted Fund Balances Profitability Ratios 7. Operating Margin (%) Operating Income (Loss) Total Operating Revenues 8. Return on Total Assets (%) EBIT (Earnings before Interest and Taxes) Total Assets Courtesy of Resource Group, Ltd., Dallas, Texas. that are widely used in healthcare organizations: four liquidity ty.

1. 115
Financial and
Operating Ratios as
Performance
Measure s
11
C H A P T E R
THE IMPORTANCE OF RATIOS
Ratios are convenient and uniform measures that are
widely adopted in healthcare financial management.
They are important because they are so widely used, es-
pecially because they are used for credit analysis. But a
ratio is only a number. It has to be considered within the
context of the operation. There is another caveat: ratio
analysis should be conducted as a comparative analysis. In
other words, one ratio standing alone with nothing to
compare it with does not mean very much. When inter-
preting ratios, the differences between periods must be
considered, and the reasons for such differences should
be sought. It is a good practice to compare results with
equivalent computations from outside the organization—
regional figures from similar institutions would be a good
example of such outside sources. Caution and good man-
agerial judgment must always be exercised when working
with ratios.
Financial ratios basically pull together two elements of

2. the financial statements: one expressed as the numerator
and one as the denominator. To calculate a ratio, divide
the bottom number (the denominator) into the top
number (the numerator). The Case Study in Appendix
25-A entitled “Using Financial Ratios and Benchmark-
ing: A Case Study in Comparative Analysis” uses financial
ratios as indicators of financial position. We highly rec-
ommend that you spend time with this Case Study, as it
will add depth and background to the contents of this
chapter.
In this chapter we examine liquidity, solvency, and
profitability ratios. Exhibit 11-1 sets out eight basic ratios
After completing this chapter,
you should be able to
1. Understand four types of
liquidity ratios.
2. Understand two types of
solvency ratios.
3. Understand two types of
profitability ratios.
4. Successfully compute ratios.
P r o g r e s s N o t e s
116 CHAPTER 11 Financial and Operating Ratios as
Performance Measures
Exhibit 11–1 Eight Basic Ratios Used in Health Care

3. Liquidity Ratios
1. Current Ratio
Current Assets
Current Liabilities
2. Quick Ratio
Cash and Cash Equivalents + Net Receivables
Current Liabilities
3. Days Cash on Hand (DCOH)
Unrestricted Cash and Cash Equivalents
Cash Operation Expenses ÷ No. of Days in Period (365)
4. Days Receivables
Net Receivables
Net Credit Revenues ÷ No. of Days in Period (365)
Solvency Ratios
5. Debt Service Coverage Ratio (DSCR)
Change in Unrestricted Net Assets (net income)
+ Interest, Depreciation, Amortization
Maximum Annual Debt Service

4. 6. Liabilities to Fund Balance
Total Liabilities
Unrestricted Fund Balances
Profitability Ratios
7. Operating Margin (%)
Operating Income (Loss)
Total Operating Revenues
8. Return on Total Assets (%)
EBIT (Earnings before Interest and Taxes)
Total Assets
Courtesy of Resource Group, Ltd., Dallas, Texas.
that are widely used in healthcare organizations: four liquidity
types, two solvency types, and
two profitability types. All are discussed later.
LIQUIDITY RATIOS
Liquidity ratios reflect the ability of the organization to meet its
current obligations. Li-
quidity ratios measure short-term sufficiency. As the name
implies, they measure the ability
of the organization to “be liquid”: in other words, to have
sufficient cash—or assets that can

5. be converted to cash—on hand.
Current Ratio
The current ratio equals current assets divided by current
liabilities. For instance, consider
this example
Current Assets
�
$120,000
� 2 to 1
Current Liabilities $60,000
This ratio is considered to be a measure of short-term debt-
paying ability. However, it
must be carefully interpreted. The standard by which the current
ratio is measured is 2 to 1,
as computed previously.
Quick Ratio
The quick ratio equals cash plus short-term investments plus net
receivables divided by cur-
rent liabilities. In our example
Cash and Cash Eqivalents � Net Receivables
�
$65,000
� 1.08 to 1
Current Liabilities 60,000

6. The standard by which the quick ratio is measured is generally 1
to 1. This computation,
at 1.08 to 1, is a little better than the standard.
This ratio is considered to be an even more severe test of short-
term debt-paying ability
(even more than the current ratio). The quick ratio is also
known as the acid-test ratio for
obvious reasons.
Days Cash on Hand
The days cash on hand (DCOH) equals unrestricted cash and
investments divided by cash
operating expenses/365. In our example
Unrestricted Cash and Cash Equivalents
�
$330,000
� 30 days
Cash Operating Expenses $11,000
� No. of Days in Period
Liquidity Ratios 117
118 CHAPTER 11 Financial and Operating Ratios as
Performance Measures
There is no concrete standard for this computation.
This ratio indicates cash on hand in relation to the amount of
daily operating expense.

7. This example indicates the organization has 30 days worth of
operating expenses repre-
sented in the amount of (unrestricted) cash on hand.
Days Receivables
The days receivables computation is represented as net
receivables divided by net credit rev-
enues/365. In our example
Net Receivables
�
$720,000
� 60 days
Net Credit Revenue/No. of Days in Period $12,000
This computation represents the number of days in receivables.
The older a receivable
is, the more difficult it becomes to collect. Therefore, this
computation is a measure of
worth as well as performance.
There is no hard and fast rule for this computation because
much depends on the mix of
payers in your organization. This example indicates that the
organization has 60 days worth
of credit revenue tied up in net receivables. This computation is
a common measure of
billing and collection performance. There are many “days
receivables” regional and na-
tional figures to compare with your own organization’s
computation.
Figure 11-1 shows how the information for the numerator and

8. the denominator of
each calculation is obtained. It takes the Westside Clinic
balance sheet and the statement
of revenue and expense that were discussed in the preceding
chapter and illustrates the
source of each figure in the four ratios just discussed. The
multiple computations for days
cash on hand and for days receivables are further broken down
into a three-step process.
If you study Figure 11-1 and work with the Appendix 25-A Case
Study, you will own this
process.
SOLVENCY RATIOS
Solvency ratios reflect the ability of the organization to pay the
annual interest and princi-
pal obligations on its long-term debt. As the name implies, they
measure the ability of the
organization to “be solvent”: in other words, to have sufficient
resources to meet its long-
term obligations.
Debt Service Coverage Ratio
The debt service coverage ratio (DSCR) is represented as
change in unrestricted net assets
(net income) plus interest, depreciation, and amortization
divided by maximum annual
debt service. In our example
Change in Unrestricted Net Assets (Net Income)
� Interest, Depreciation, and Amortization
�
$250,000

9. � 2.5
Maximum Annual Debt Service $100,000
This ratio is universally used in credit analysis and figures
prominently in the Mini-Case
Study.
Each lending institution has its particular criteria for the DSCR.
Lending agreements
often have a provision that requires the DSCR to be maintained
at or above a certain figure.
Liabilities to Fund Balance (or Debt to Net Worth)
The liabilities to fund balance or net worth computation is
represented as total liabilities di-
vided by unrestricted net assets (i.e., fund balances or net
worth) or total debt divided by
tangible net worth. In our example
Solvency Ratios 119
Figure 11–1 Examples of Liquidity Ratio Calculations.
Courtesy of Resource Group, Ltd, Dallas, Texas.
Assets December 31, 20X2
Current Assets
Cash and cash equivalents $190,000
Accounts receivable (net) 250,000
Inventories 25,000
Prepaid Insurance 5,000

10. Total Current Assets $470,000
Property, Plant, and Equipment
Land $100,000
Buildings (net) 0
Equipment (net) 260,000
Net Property, Plant, and Equipment 360,000
Other Assets
Investments $133,000
133,000
Total Other Assets
Total Assets $963,000
Liabilities and Fund Balance
Current Liabilities
Current maturities of long-term debt $52,000
Accounts payable and accrued expenses 293,000
Total Current Liabilities $345,000
Long-Term Debt $252,000
Less Current Maturities of Long-Term Debt (52,000)
Net Long-Term Debt 200,000
Total Liabilities $545,000
Fund Balances
Unrestricted fund balance $418,000
Restricted fund balance 0
Total Fund Balances 418,000
Total Liabilities and Fund Balance $963,000

11. For the Year Ending
Revenue December 31, 20X2
Net patient service revenue
$2,000,000
Total operating revenue $2,000,000
Operating Expenses
Medical/surgical services $600,000
Therapy services 860,000
Other professional services 80,000
Support services 220,000
General services 65,000
Depreciation 40,000
Interest 20,000
Total operating expenses $1,885,000
Income from Operations $115,000
Nonoperating Gains (Losses)
Interest Income $5,000
Net nonoperating gains 5,000
Revenue and Gains in Excess of
Expenses and Losses $120,000
Increase in Unrestricted Fund Balance $120,000
470,000
345,000
= 1.362
Current Assets
Current Liabilities

12. 1. Current Ratio
Step 2
1,845,000
365
= 5,055
Step 3
190,000
5,055
= 37.5 days
Step 1
1,885,000
(40,000)
1,845,000
190,000 + 250,000
345,000
= 1.275
Cash and Cash Equivalent + Net Receivables
Current Liabilities
2. Quick Ratio
3. Days Cash on Hand (DCOH)
Unrestricted Cash and Cash Equivalents
Cash Operating Expenses divided by # days in period (365)

13. Step 2
1,800,000
365
= 4,931
Step 3
250,000
4,931
= 50.7 days
Step 1
2,000,000
× 90%
1,800,000 4. Days Receivables
Net Receivables
Net Credit Revenue divided by # days in period (365)
Percent of Credit Revenues
Information obtained elsewhere
Statement of Revenue and Expenses
Balance Sheet
120 CHAPTER 11 Financial and Operating Ratios as
Performance Measures

14. Total Liabilities
�
$2,000,000
� .80
Unrestricted Fund Balances $2,250,000
This figure is a quick indicator of debt load.
Another indicator that is more severe is long-term debt to net
worth (fund balance),
which is computed as long-term debt divided by fund balance.
This computation is some-
what equivalent to the quick ratio discussed previously here in
its restrictiveness to net
worth computation.
A mirror image of total liabilities to fund balance is total assets
to fund balance, which is
computed as total assets divided by fund balance.
Figure 11-2 shows how the information for the numerator and
the denominator of each
calculation is obtained. This figure again takes the Westside
Clinic balance sheet and state-
ment of revenue and expense that were discussed in the
preceding chapter and illustrates
the source of each figure in the two solvency ratios just
discussed, along with each figure in
the two profitability ratios still to be discussed. When multiple
computations are necessary,
they are further broken down into a two-step process.
PROFITABILITY RATIOS

15. Profitability ratios reflect the ability of the organization to
operate with an excess of oper-
ating revenue over operating expense. Nonprofit organizations
may not call this result a
profit, but the measurement ratios are still generally called
profitability ratios, whether they
are applied to for-profit or nonprofit organizations.
Operating Margin
The operating margin, which is generally expressed as a
percentage, is represented as op-
erating income (loss) divided by total operating revenues. In our
example
Operating Income (Loss)
�
$250,000
� 5.0%
Total Operating Revenues $5,000,000
This ratio is used for a number of managerial purposes and also
sometimes enters into
credit analysis. It is therefore a multipurpose measure. It is so
universal that many outside
sources are available for comparative purposes. The result of
the computation must still be
carefully considered because of variables in each period being
compared.
Return on Total Assets
The return on total assets is represented as earnings before

16. interest and taxes (EBIT) di-
vided by total assets. In our example
EBIT
�
$400,000
� 10%
Total Assets $4,000,000
This is a broad measure in common use. Note the acronym
EBIT, as its use is widespread
in credit analysis circles. (Some analysts use an alternative
computation for Return on Total
Assets. They compute this ratio as Net Income divided by Total
Assets.)
This concludes the description of solvency and profitability
ratios. Again, if you study
Figure 11-2 and work with the Appendix 25-A Case Study, you
will own this process too.
Profitability Ratios 121
Figure 11–2 Examples of Solvency and Profitability Ratio
Calculations.
Courtesy of Resource Group, Ltd, Dallas, Texas.
Balance Sheet
Assets December 31, 20x2
Current Assets $190,000

17. Accounts receivable (net) 250,000
Inventories 25,000
Prepaid Insurance 5,000
Total Current Assets $470,000
Property, Plant and Equipment
Land $100,000
Buildings (net) 0
Equipment (net) 260,000
Net Property, Plant and Equipment 360,000
Other Assets
Investments $133,000
133,000
Total Other Assets
Total Assets $963,000
Liabilities and Fund Balance
Current Liabilities
Current maturities of long-term debt $52,000
Accounts payable and accrued expenses 293,000
Total Current Liabilities $345,000
Long-term Debt $252,000
Less current maturities of long-term debt -52,000
Net Long-term Debt 200,000
Total Liabilities $545,000
Fund Balances
Unrestricted fund balance $418,000
Restricted fund balance 0
Total Fund Balances 418,000

18. Total Liabilities and Fund Balance $963,000
Statement of Revenue and Expenses
For the Year Ending
Revenue December 31, 20x2
Net patient service revenue $2,000,000
Total operating revenue $2,000,000
Operating Expenses
Medical/surgical services $600,000
Therapy services 860,000
Other professional services 80,000
Support services 220,000
General services 65,000
Depreciation 40,000
Interest 20,000
Total operating expenses 1,885,000
Income from Operations $115,000
Nonoperating Gains (Losses)
Interest Income $5,000
Net nonoperating gains 5,000
Revenue and Gains in Excess of
Expenses and Losses $120,000
Increase in Unrestricted Fund Balance $120,000
Step 1 5. Return on Total Assets (%)

19. 120,000
20,000
140,000
Step 2
140,000
963,000
= 14.54%
6. Operating Margin (%)
115,000
2,000,000
5.75%
7. Liabilities to Fund Balance
545,000
418,000
= 1.304
Step 1 8. Debt Service Coverage Ratio (DSCR)
120,000
20,000
40,000
180,000
Step 2
180,000 Maximum Annual Debt Service
72,000 Information derived elsewhere

20. = 2.5
IT (Earnings Before Interest and Taxes)
Total Assets
Operating Income (Loss)
Total Operating Revenues
Total Liabilities
Unrestricted Fund Balance
Change in Unrestricted Net Assets (net income)
plus Depreciation-Amortization
plus Interest
Maximum Annual Debt Service
122 CHAPTER 11 Financial and Operating Ratios as
Performance Measures
INFORMATION CHECKPOINT
What Is Needed? Reports that use ratios as measures.
Where Is It Found? Possibly in your supervisor’s file; in the
administrator’s of-
fice; in the chief executive officer’s office.
How Is It Used? Use as a measure against outside benchmarks
(as discussed
in this chapter); also use as internal benchmarks for de-
partments/divisions/units; also use as benchmarks at
various points over time.

21. KEY TERMS
Current Ratio
Days Cash on Hand (DCOH)
Days Receivables
Debt Service Coverage Ratio (DSCR)
Liabilities to Fund Balance
Liquidity Ratios
Operating Margin
Profitability Ratios
Quick Ratio
Return on Total Assets
Solvency Ratios
DISCUSSION QUESTIONS
1. Are there ratios in the reports you receive at your workplace?
2. If so, do you use them? How?
3. If not, do you believe ratios should be on the reports? Which
reports?
4. Can you think of good outside sources that could be used to
obtain ratios for com-
parative purposes? If the outside information was available,
what ratios would you
choose to use? Why?
Doctors Smith and Brown:
Statement of Net Income
for the Three Months Ended March 31, 2___

22. Revenue
Net patient service revenue 180,000
Other revenue -0-
Total Operating Revenue 180,000
Expenses
Nursing/PA salaries 16,650
Clerical salaries 10,150
Payroll taxes/employee benefits 4,800
Medical supplies and drugs 15,000
Professional fees 3,000
Dues and publications 2,400
Janitorial service 1,200
Office supplies 1,500
Repairs and maintenance 1,200
Utilities and telephone 6,000
Depreciation 30,000
Interest 3,100
Other 5,000
Total Expenses 100,000
Income from Operations 80,000
Nonoperating Gains (Losses)
Interest Income -0-
Nonoperating Gains, Net -0-
Net Income 80,000
Chapter 10 373
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23. 3468
374 EXAMPLES AND EXERCISES, SUPPLEMENTAL
MATERIALS, AND SOLUTIONS
Doctors Smith and Brown
Balance Sheet
March 31, 2___
Assets
Current Assets
Cash and cash equivalents 25,000
Patient accounts receivable 40,000
Inventories—supplies and drugs 5,000
Total Current Assets 70,000
Property, Plant, and Equipment
Buildings and Improvements 500,000
Equipment 800,000
Total 1,300,000
Less Accumulated Depreciation (480,000)
Net Depreciable Assets 820,000
Land 100,000
Property, Plant, and Equipment, Net 920,000
Other Assets 10,000
Total Assets 1,000,000
Liabilities and Capital

24. Current Liabilities
Current maturities of long-term 10,000
debt
Accounts payable and accrued 20,000
expenses
Total Current Liabilities 30,000
Long-Term Debt 180,000
Less Current Portion of Long-Term Debt (10,000)
Net Long-Term Debt 170,000
Total Liabilities 200,000
Capital 800,000
Total Liabilities and Capital 1,000,000
Doctors Smith and Brown
Statement of Changes in Capital
for the Three Months Ended March 31, 2___
Beginning Balance $720,000
Net Income 80,000
Ending Balance $800,000
78941_EXAM_355_430.qxd 11/30/09 12:54 PM Page 374
3468

25. Resources: Ch. 11 of Health Care Finance, Doctors Smith and
Brown Statement of Net Income and Balance Sheet
Use the Axia Material: Ratio Analysis Form to complete the
following:
Define each of the following ratios:
· Current ratio
· Quick ratio
· Debt service coverage ratio
· Operating margin
· Return on total assets
Explain the purpose of each ratio.
Compute the following ratios from Drs. Smith & Brown’s
financial statements located on the student website:
· Current ratio
· Quick ratio
· Debt service coverage ratio
· Operating margin
· Return on total assets
Explain what these ratios tell you about the status of the
organization. Compare to the median hospitals.
See the table in the Axia Material: Ratio Analysis Form.
Cite your references where indicated consistent with APA
guidelines.
Post your assignment as an attachment.
Ratio Analysis Form
HCA/270 Version 3
1
Associate Level Material
Ratio Analysis Form
Use the table on the next page to complete the Week Eight

26. assignment. In this assignment, you will review the textbook to
find the definitions for each ratio. Use the financial statements
for Drs. Smith and Brown, located on the student website, to
perform the calculations and complete the form.
Review the following example on how to perform the inventory
turnover calculation, which shows you how to complete the
table.
· Two different methods can determine the inventory turnover
ratio.
· Cost of goods sold—operating revenue of a hospital—divided
by ending inventory
· Total revenues plus net nonoperating gains divided by ending
inventory
This example uses the first method to perform the calculation.
Because a hospital provides a service, we would find the
number that reflects services provided. Total operating revenue
reflects money that is earned for providing services. Locate the
Statement of Net Income on the student website. Find the total
operating revenue. This is $180,000. Then, locate the ending
inventory number. To find the ending Inventory, use the
Balance Sheet on the student website. The ending inventory
number is 5000.
Cost of goods sold—operating revenue: 180,000 divided by
ending inventory of 5000; 180,000/5000 = 36
· Place this information in the table. You will do the same with
the rest of the ratios. Take the result of your calculations and
place in the grid, as in the example.
· In addition, you are responsible for stating whether the ratios
are solvency, leverage, or profitability ratios. Enter your

27. answers in the appropriate column. Then, explain what these
ratios tell us about the physician group practice.
Note.You will use the financial statements of Drs. Smith &
Brown to perform the calculations on the next page. To
calculate the debt service coverage ratio, you need the
maximum annual debt service, which is $22,200.
The following table shows the median financial ratios for acute
care hospitals. You can use this table to gauge the financial
viability of the physician group practice.
Ratio
Numbers from Arcadia financial statement
Result
Is it a liquidity, solvency, or profitability ratio?
Define the ratio and explain what the result shown in Column 3
means to the organization. Do not forget to provide your
references at the bottom of the form.
Inventory turnover (Example)
180,000/5000
36
N/A
Inventory turnover is calculated to determine how quickly the
inventory is used based on the services rendered. If the
inventory turnover is high, this means the hospital does not
have enough inventories on hand to accommodate the patient
load. For this example, the hospital is turning over their
inventory 36 times per year, which is about 3 times a month.
The opposite is true if the inventory turnover calculation is
lower than the median. This could mean that there is a build-up
of inventory due to lower than expected patient revenues.
Current ratio

28. Quick ratio
Debt service coverage ratio
/22,200
Operating margin
Return on total assets
References
115
Financial and
Operating Ratios as
Performance
Measure s
11
C H A P T E R
THE IMPORTANCE OF RATIOS

29. Ratios are convenient and uniform measures that are
widely adopted in healthcare financial management.
They are important because they are so widely used, es-
pecially because they are used for credit analysis. But a
ratio is only a number. It has to be considered within the
context of the operation. There is another caveat: ratio
analysis should be conducted as a comparative analysis. In
other words, one ratio standing alone with nothing to
compare it with does not mean very much. When inter-
preting ratios, the differences between periods must be
considered, and the reasons for such differences should
be sought. It is a good practice to compare results with
equivalent computations from outside the organization—
regional figures from similar institutions would be a good
example of such outside sources. Caution and good man-
agerial judgment must always be exercised when working
with ratios.
Financial ratios basically pull together two elements of
the financial statements: one expressed as the numerator
and one as the denominator. To calculate a ratio, divide
the bottom number (the denominator) into the top
number (the numerator). The Case Study in Appendix
25-A entitled “Using Financial Ratios and Benchmark-
ing: A Case Study in Comparative Analysis” uses financial
ratios as indicators of financial position. We highly rec-
ommend that you spend time with this Case Study, as it
will add depth and background to the contents of this
chapter.
In this chapter we examine liquidity, solvency, and
profitability ratios. Exhibit 11-1 sets out eight basic ratios
After completing this chapter,
you should be able to

30. 1. Understand four types of
liquidity ratios.
2. Understand two types of
solvency ratios.
3. Understand two types of
profitability ratios.
4. Successfully compute ratios.
P r o g r e s s N o t e s
116 CHAPTER 11 Financial and Operating Ratios as
Performance Measures
Exhibit 11–1 Eight Basic Ratios Used in Health Care
Liquidity Ratios
1. Current Ratio
Current Assets
Current Liabilities
2. Quick Ratio
Cash and Cash Equivalents + Net Receivables
Current Liabilities
3. Days Cash on Hand (DCOH)

31. Unrestricted Cash and Cash Equivalents
Cash Operation Expenses ÷ No. of Days in Period (365)
4. Days Receivables
Net Receivables
Net Credit Revenues ÷ No. of Days in Period (365)
Solvency Ratios
5. Debt Service Coverage Ratio (DSCR)
Change in Unrestricted Net Assets (net income)
+ Interest, Depreciation, Amortization
Maximum Annual Debt Service
6. Liabilities to Fund Balance
Total Liabilities
Unrestricted Fund Balances
Profitability Ratios
7. Operating Margin (%)
Operating Income (Loss)
Total Operating Revenues
8. Return on Total Assets (%)

32. EBIT (Earnings before Interest and Taxes)
Total Assets
Courtesy of Resource Group, Ltd., Dallas, Texas.
that are widely used in healthcare organizations: four liquidity
types, two solvency types, and
two profitability types. All are discussed later.
LIQUIDITY RATIOS
Liquidity ratios reflect the ability of the organization to meet its
current obligations. Li-
quidity ratios measure short-term sufficiency. As the name
implies, they measure the ability
of the organization to “be liquid”: in other words, to have
sufficient cash—or assets that can
be converted to cash—on hand.
Current Ratio
The current ratio equals current assets divided by current
liabilities. For instance, consider
this example
Current Assets
�
$120,000
� 2 to 1
Current Liabilities $60,000

33. This ratio is considered to be a measure of short-term debt-
paying ability. However, it
must be carefully interpreted. The standard by which the current
ratio is measured is 2 to 1,
as computed previously.
Quick Ratio
The quick ratio equals cash plus short-term investments plus net
receivables divided by cur-
rent liabilities. In our example
Cash and Cash Eqivalents � Net Receivables
�
$65,000
� 1.08 to 1
Current Liabilities 60,000
The standard by which the quick ratio is measured is generally 1
to 1. This computation,
at 1.08 to 1, is a little better than the standard.
This ratio is considered to be an even more severe test of short-
term debt-paying ability
(even more than the current ratio). The quick ratio is also
known as the acid-test ratio for
obvious reasons.
Days Cash on Hand
The days cash on hand (DCOH) equals unrestricted cash and
investments divided by cash
operating expenses/365. In our example

34. Unrestricted Cash and Cash Equivalents
�
$330,000
� 30 days
Cash Operating Expenses $11,000
� No. of Days in Period
Liquidity Ratios 117
118 CHAPTER 11 Financial and Operating Ratios as
Performance Measures
There is no concrete standard for this computation.
This ratio indicates cash on hand in relation to the amount of
daily operating expense.
This example indicates the organization has 30 days worth of
operating expenses repre-
sented in the amount of (unrestricted) cash on hand.
Days Receivables
The days receivables computation is represented as net
receivables divided by net credit rev-
enues/365. In our example
Net Receivables
�
$720,000
� 60 days

35. Net Credit Revenue/No. of Days in Period $12,000
This computation represents the number of days in receivables.
The older a receivable
is, the more difficult it becomes to collect. Therefore, this
computation is a measure of
worth as well as performance.
There is no hard and fast rule for this computation because
much depends on the mix of
payers in your organization. This example indicates that the
organization has 60 days worth
of credit revenue tied up in net receivables. This computation is
a common measure of
billing and collection performance. There are many “days
receivables” regional and na-
tional figures to compare with your own organization’s
computation.
Figure 11-1 shows how the information for the numerator and
the denominator of
each calculation is obtained. It takes the Westside Clinic
balance sheet and the statement
of revenue and expense that were discussed in the preceding
chapter and illustrates the
source of each figure in the four ratios just discussed. The
multiple computations for days
cash on hand and for days receivables are further broken down
into a three-step process.
If you study Figure 11-1 and work with the Appendix 25-A Case
Study, you will own this
process.
SOLVENCY RATIOS
Solvency ratios reflect the ability of the organization to pay the

36. annual interest and princi-
pal obligations on its long-term debt. As the name implies, they
measure the ability of the
organization to “be solvent”: in other words, to have sufficient
resources to meet its long-
term obligations.
Debt Service Coverage Ratio
The debt service coverage ratio (DSCR) is represented as
change in unrestricted net assets
(net income) plus interest, depreciation, and amortization
divided by maximum annual
debt service. In our example
Change in Unrestricted Net Assets (Net Income)
� Interest, Depreciation, and Amortization
�
$250,000
� 2.5
Maximum Annual Debt Service $100,000
This ratio is universally used in credit analysis and figures
prominently in the Mini-Case
Study.
Each lending institution has its particular criteria for the DSCR.
Lending agreements
often have a provision that requires the DSCR to be maintained
at or above a certain figure.
Liabilities to Fund Balance (or Debt to Net Worth)

37. The liabilities to fund balance or net worth computation is
represented as total liabilities di-
vided by unrestricted net assets (i.e., fund balances or net
worth) or total debt divided by
tangible net worth. In our example
Solvency Ratios 119
Figure 11–1 Examples of Liquidity Ratio Calculations.
Courtesy of Resource Group, Ltd, Dallas, Texas.
Assets December 31, 20X2
Current Assets
Cash and cash equivalents $190,000
Accounts receivable (net) 250,000
Inventories 25,000
Prepaid Insurance 5,000
Total Current Assets $470,000
Property, Plant, and Equipment
Land $100,000
Buildings (net) 0
Equipment (net) 260,000
Net Property, Plant, and Equipment 360,000
Other Assets
Investments $133,000
133,000
Total Other Assets
Total Assets $963,000

38. Liabilities and Fund Balance
Current Liabilities
Current maturities of long-term debt $52,000
Accounts payable and accrued expenses 293,000
Total Current Liabilities $345,000
Long-Term Debt $252,000
Less Current Maturities of Long-Term Debt (52,000)
Net Long-Term Debt 200,000
Total Liabilities $545,000
Fund Balances
Unrestricted fund balance $418,000
Restricted fund balance 0
Total Fund Balances 418,000
Total Liabilities and Fund Balance $963,000
For the Year Ending
Revenue December 31, 20X2
Net patient service revenue
$2,000,000
Total operating revenue $2,000,000
Operating Expenses
Medical/surgical services $600,000
Therapy services 860,000
Other professional services 80,000
Support services 220,000
General services 65,000
Depreciation 40,000
Interest 20,000
Total operating expenses $1,885,000

39. Income from Operations $115,000
Nonoperating Gains (Losses)
Interest Income $5,000
Net nonoperating gains 5,000
Revenue and Gains in Excess of
Expenses and Losses $120,000
Increase in Unrestricted Fund Balance $120,000
470,000
345,000
= 1.362
Current Assets
Current Liabilities
1. Current Ratio
Step 2
1,845,000
365
= 5,055
Step 3
190,000
5,055
= 37.5 days

40. Step 1
1,885,000
(40,000)
1,845,000
190,000 + 250,000
345,000
= 1.275
Cash and Cash Equivalent + Net Receivables
Current Liabilities
2. Quick Ratio
3. Days Cash on Hand (DCOH)
Unrestricted Cash and Cash Equivalents
Cash Operating Expenses divided by # days in period (365)
Step 2
1,800,000
365
= 4,931
Step 3
250,000
4,931
= 50.7 days
Step 1

41. 2,000,000
× 90%
1,800,000 4. Days Receivables
Net Receivables
Net Credit Revenue divided by # days in period (365)
Percent of Credit Revenues
Information obtained elsewhere
Statement of Revenue and Expenses
Balance Sheet
120 CHAPTER 11 Financial and Operating Ratios as
Performance Measures
Total Liabilities
�
$2,000,000
� .80
Unrestricted Fund Balances $2,250,000
This figure is a quick indicator of debt load.
Another indicator that is more severe is long-term debt to net
worth (fund balance),
which is computed as long-term debt divided by fund balance.
This computation is some-
what equivalent to the quick ratio discussed previously here in

42. its restrictiveness to net
worth computation.
A mirror image of total liabilities to fund balance is total assets
to fund balance, which is
computed as total assets divided by fund balance.
Figure 11-2 shows how the information for the numerator and
the denominator of each
calculation is obtained. This figure again takes the Westside
Clinic balance sheet and state-
ment of revenue and expense that were discussed in the
preceding chapter and illustrates
the source of each figure in the two solvency ratios just
discussed, along with each figure in
the two profitability ratios still to be discussed. When multiple
computations are necessary,
they are further broken down into a two-step process.
PROFITABILITY RATIOS
Profitability ratios reflect the ability of the organization to
operate with an excess of oper-
ating revenue over operating expense. Nonprofit organizations
may not call this result a
profit, but the measurement ratios are still generally called
profitability ratios, whether they
are applied to for-profit or nonprofit organizations.
Operating Margin
The operating margin, which is generally expressed as a
percentage, is represented as op-
erating income (loss) divided by total operating revenues. In our
example

43. Operating Income (Loss)
�
$250,000
� 5.0%
Total Operating Revenues $5,000,000
This ratio is used for a number of managerial purposes and also
sometimes enters into
credit analysis. It is therefore a multipurpose measure. It is so
universal that many outside
sources are available for comparative purposes. The result of
the computation must still be
carefully considered because of variables in each period being
compared.
Return on Total Assets
The return on total assets is represented as earnings before
interest and taxes (EBIT) di-
vided by total assets. In our example
EBIT
�
$400,000
� 10%
Total Assets $4,000,000
This is a broad measure in common use. Note the acronym
EBIT, as its use is widespread
in credit analysis circles. (Some analysts use an alternative

44. computation for Return on Total
Assets. They compute this ratio as Net Income divided by Total
Assets.)
This concludes the description of solvency and profitability
ratios. Again, if you study
Figure 11-2 and work with the Appendix 25-A Case Study, you
will own this process too.
Profitability Ratios 121
Figure 11–2 Examples of Solvency and Profitability Ratio
Calculations.
Courtesy of Resource Group, Ltd, Dallas, Texas.
Balance Sheet
Assets December 31, 20x2
Current Assets $190,000
Accounts receivable (net) 250,000
Inventories 25,000
Prepaid Insurance 5,000
Total Current Assets $470,000
Property, Plant and Equipment
Land $100,000
Buildings (net) 0
Equipment (net) 260,000
Net Property, Plant and Equipment 360,000
Other Assets
Investments $133,000
133,000
Total Other Assets

45. Total Assets $963,000
Liabilities and Fund Balance
Current Liabilities
Current maturities of long-term debt $52,000
Accounts payable and accrued expenses 293,000
Total Current Liabilities $345,000
Long-term Debt $252,000
Less current maturities of long-term debt -52,000
Net Long-term Debt 200,000
Total Liabilities $545,000
Fund Balances
Unrestricted fund balance $418,000
Restricted fund balance 0
Total Fund Balances 418,000
Total Liabilities and Fund Balance $963,000
Statement of Revenue and Expenses
For the Year Ending
Revenue December 31, 20x2
Net patient service revenue $2,000,000
Total operating revenue $2,000,000
Operating Expenses
Medical/surgical services $600,000
Therapy services 860,000

46. Other professional services 80,000
Support services 220,000
General services 65,000
Depreciation 40,000
Interest 20,000
Total operating expenses 1,885,000
Income from Operations $115,000
Nonoperating Gains (Losses)
Interest Income $5,000
Net nonoperating gains 5,000
Revenue and Gains in Excess of
Expenses and Losses $120,000
Increase in Unrestricted Fund Balance $120,000
Step 1 5. Return on Total Assets (%)
120,000
20,000
140,000
Step 2
140,000
963,000
= 14.54%
6. Operating Margin (%)
115,000

47. 2,000,000
5.75%
7. Liabilities to Fund Balance
545,000
418,000
= 1.304
Step 1 8. Debt Service Coverage Ratio (DSCR)
120,000
20,000
40,000
180,000
Step 2
180,000 Maximum Annual Debt Service
72,000 Information derived elsewhere
= 2.5
IT (Earnings Before Interest and Taxes)
Total Assets
Operating Income (Loss)
Total Operating Revenues
Total Liabilities
Unrestricted Fund Balance
Change in Unrestricted Net Assets (net income)
plus Depreciation-Amortization
plus Interest

48. Maximum Annual Debt Service
122 CHAPTER 11 Financial and Operating Ratios as
Performance Measures
INFORMATION CHECKPOINT
What Is Needed? Reports that use ratios as measures.
Where Is It Found? Possibly in your supervisor’s file; in the
administrator’s of-
fice; in the chief executive officer’s office.
How Is It Used? Use as a measure against outside benchmarks
(as discussed
in this chapter); also use as internal benchmarks for de-
partments/divisions/units; also use as benchmarks at
various points over time.
KEY TERMS
Current Ratio
Days Cash on Hand (DCOH)
Days Receivables
Debt Service Coverage Ratio (DSCR)
Liabilities to Fund Balance
Liquidity Ratios
Operating Margin
Profitability Ratios
Quick Ratio
Return on Total Assets
Solvency Ratios
DISCUSSION QUESTIONS

49. 1. Are there ratios in the reports you receive at your workplace?
2. If so, do you use them? How?
3. If not, do you believe ratios should be on the reports? Which
reports?
4. Can you think of good outside sources that could be used to
obtain ratios for com-
parative purposes? If the outside information was available,
what ratios would you
choose to use? Why?