Arcadia Hospital: 2005 and 2006 Financial Statement Ratio Assessment Research Paper

Current Ratio

“The current ratio measures a company’s ability to meet its current financial obligations by dividing its current assets (such as cash, accounts receivable, etc.) by its current liabilities.” (Current ratio: Definition, 2009, para.1).

The current ratio is the ratio by which the company can understand its financial position. The current ratio is calculated by dividing current assets by current liability. The result obtained after the calculation reflects the ability of the firm to meet its current liability. As per our calculation, we can see that the current ratio in 2005 – is 2.16 times and in 2006 it is 1.81 times. This indicates that the ability of the firm to meet its current liability has decreased. This should not happen. So before taking long-term loans for the company the capacity of the company to pay should also be considered.

Inventory Turn Over Ratio

“The inventory turnover ratio measures the efficiency of the business in managing and selling its inventory. This ratio gauges the liquidity of the firm’s inventory.” (Peavler, 2009, Answer, para.2).

The inventory turnover ratio indicates how an organization is managing its inventories. It is calculated by dividing sales by inventories. There are various methods of managing inventory efficiently such as ABC analysis, Economic order quantity, VED analysis, etc. the selection of the method should be based on the raw materials required for the production process and financial stability of the company. Here we can see the inventory turnover ratio has increased from 2005 to 2006. this indicates that the firm is efficiently managing its inventory.

Total Asset Turn Over Ratio

“The total asset turnover ratio measures the ability of a company to use its assets to generate sales. The total asset turnover ratio considers all assets including fixed assets, like plant and equipment, as well as inventory and accounts receivable.” (Peavler, 2009, Answer, para.1).

The asset turnover ratio indicates that the firm has the capacity to generate sales by using its assets. It is calculated by dividing sales by total assets. The assets include all types of assets such as the fixed assets, accounts receivables, the plant and machinery purchased, etc. here the total asset turnover ratio in 2005 is 0.037 times and in 2006 is 0.038 times. The slight variation shows that the company has taken necessary measures to increase its sales.

Current Ratios

The current ratio in 2005 was 2.16 times and the current ratio in 2006 was 1.81 times. The current ratio which is less than 1.0 times in considered being a dangerous situation, it may lead to bankruptcy. Here the current ratio in 2006 is less than the current ratio in 2005. It shows that the firm’s ability to meet its long-term debt is reducing. More measure has to be taken to reduce the accounts payable and other accrued liabilities.

The inventory turnover ratio in 2005 was 0.71 times and in inventory turnover ratio in 2006 was 0.84 times. Too low inventory ratio indicates that the company is holding out-of-date stocks that cannot be sold anymore. The inventory turnover ratio has increased from 0.71 times to o.84 times. This increase in ratio indicates that the company is managing the inventories efficiently.

Asset Turn Over Ratio

The asset turnover ratio in 2005 was 0.037 times and 0.038 times in 2006. There is a slight variation in the ratio of 2005 and 2006. The asset turnover ratio has slightly increased, to 0.038, which sales have increased. The low asset turnover ratio indicates that there is a problem with any of the assets. It will be easy to analyze if the assets are categorized. Immediate measures have to be taken after analyzing the problem of the asset.

Valuation of the hospitals’ worthiness with respect to the data in 2005 and 2006

The valuation of an organization’s performance can be measured by using three methods. They are rule of thumb, adjusted book values, and discounted cash flow method. The rule of thumb method measures the organization’s performance by categorizing all the transactions into a separate group. But the analysis based on this method may not give accurate data.

Rule of thumb

Form a number of transactions, average prices are taken into consideration and are converted into a common element which is done in all companies particularly in industries. The value of an organization can be calculated by using rules of thumb which does not consist of any exact measurement.

Adjusted Book Value

It is the value of the assets that are recorded in the books of account, which is all the assets that are recorded in the balance sheet and are historic transactions. Book value = total asset – total liability.

Adjusted book value represents the transactions that are historical in nature and are calculated by deducting total liability from the total asset available. The adjusted book value in 2005 was $7900 and in 2006 it is $7955. this indicates that the recording of the historic transactions has increased when compared to the previous.

Discounted Cash Flow

The discounted cash flow method uses a discount rate and uses those cash flows that are discounted. Here the time value of money is taken into consideration. Time value of money means the value of the money when time passes. It is said that the present value of the money will be more valuable than the same amount of money in the future.

Comparing the financial statements and valuations of 2005 and 2006 of Arcadia Hospital

Having compared the income statement, it was found that the profitability of the concern has increased when compared with the last year’s profit:

1. The increase in total operating revenue indicates that there is an increase in sales generated.
2. At the same time, the operating expenses are also increasing.
3. The net income has also increased from $32 million to $55 million, which indicates a high profit for the firm.
4. Even though the operating expenses are increasing with operating revenue, the firm is in a position to earn its required profit.

By comparing the balance sheet of 2005 and 2006:

1. The amount of cash on the balance sheet has increased from $100 million to $ 345 million.
2. The purchase of plant and machinery has also increased, this shows that the firm is investing more in the purchase of fixed assets.
3. The reduced rate in accounts receivables indicates that the firm’s debt collection policy is doing well.
4. The total asset also increased from $17900 million to $18055 million which indicated a sound financial position of the firm.
5. The total liability of the organization has slightly increased from $7900 million to $7955 million, which is affordable for the firm to pay off.

Revenue Variances

Revenue variances are used by the organization to find out whether there are any deviations in their revenue and it also helps the organization to take remedial measures for that. It isolates the sales price and matches the unit of goods that are sold in the organization.

Revenue variances indicate variations in the revenue. In the year 2005, the total revenue was $568 million and in the year 2006, the total revenue was $672 million. The increase in revenue indicates that the firm’s financial position is increasing tremendously. The net income in the year 2005 is $32 million whereas in the year 2006 the net income earned was $55 million. The increase in the net income indicates that the earnings of the firm are increasing from year to year and the organization is managing the resources effectively.

Findings

It is seen that organizations net income has been increasing when compared with the data given in the year 2005. The increasing operating indicates that the volume of sales generated is increasing. When the volume of the sales is increasing it ultimately shows huge earnings. When the operating revenue is increasing, the operating expenses are also increasing this is because when the sale of the product increases, the company will increase the production volume. In health care organizations it is important to give more focus on financial management principles. The financial management principles help the organization to take corrective financial decisions.

As it is a health care organization the purchase of raw materials and purchase of machines and equipment are very expensive. So proper balance should be taken while allocating the cost for various purchases. The person responsible to prepare the financial records should have deep knowledge in finance to increase the production volume the organization requires raw materials, as it is a health care organization the raw materials incur huge expenses, this is the reason for increased operating expenses when the operating revenue is increasing.

Therefore, proper measures must be taken while allocating the cost for purchasing the raw materials.

Recommendations

1. Accounting and financial management principles should be employed in the organization.
2. Allocation of cost should be done very carefully.
3. Purchase of the raw material should be taken into consideration while preparing accounts.
4. The financial reports should be verified from time to time.
5. The time value of money should be considered before investing in the business.
6. The organization should maintain a balance between the total revenue earned and the total expense incurred in the operations of the business.
7. Among the value method, it is better to use the discount cash flow method because it shows the real figure.

References

Current ratio: Definition. (2009). Teen Analyst. com: Investing Made Easy. Web.

Peavler, R. (2009). What is the inventory turnover ratio and how is it calculated: Answer. About. Business Finance. Web.

Peavler, R. (2009). What is the total asset turnover ratio and how is it calculated: Answer. About. Business Finance. Web.