Financial Accounting Balance Sheet and Income Statement Analysis December 2–5, 2017

Learning Objective Utilizing and interpreting the different types of financial statements and ratio analysis. 2

What Financial Information Do You Already Understand? GAAP = Generally Accepted Accounting Principles. These are our standard operating procedures! 3

Order of Battle Understanding the concept of Generally Accepted Accounting Principles and Financial Reports. Understanding the difference between Cash and Accrual basis of Accounting. 3. Reviewing and analyzing the Financial Statements; Income Statement Balance Sheet Cash Flow 4. Ratio Analysis DuPont Analysis Liquidity Profitability Asset Management Debt Management 4

Content of an Organization’s Annual Audit Report The Management Letter The Financial Statements: Balance Sheet Income Statement Statement of Stockholders’ Equity or Net Assets Statement of Cash Flows The Footnotes The Auditor’s Report Sarbanes-Oxley 5

Order of Battle Understanding the concept of Generally Accepted Accounting Principles and Financial Reports. Understanding the difference between Cash and Accrual basis of Accounting. 3. Reviewing and analyzing the Financial Statements; Income Statement Balance Sheet Cash Flow 4. Ratio Analysis DuPont Analysis Liquidity Profitability Asset Management Debt Management 6

Which Basis of Accounting is Used? Cash basis Financial effects are recorded in financial statements when cash is received or paid. Usually with small Physician Practices. Accrual basis Financial effects are recorded without regard to the timing of the cash flows. Transactions are counted when the services occur, regardless of when the money for them (receivables) is received. In other words, income is counted when the service occurs, and expenses are counted when the services are delivered. You don't have to wait for the money. All hospitals use accrual accounting. 7

Physician’s on Hold, Inc. Cash Balance Physician’s on Hold, Inc. What is the Cash Balance at the end of the year? 8

Order of Battle Understanding the concept of Generally Accepted Accounting Principles and Financial Reports. Understanding the difference between Cash and Accrual basis of Accounting. 3. Reviewing and analyzing the Financial Statements; Income Statement Balance Sheet Cash Flow 4. Ratio Analysis DuPont Analysis Liquidity Profitability Asset Management Debt Management 9

The Income Statement The income statement summarizes an organization’s collections (revenues) and expenses usually over 12 months. Key figures include net income, gross profit and operating income. Income and expenses help investors determine what makes a company profitable. 10

Depreciation Expense What is it? A systematic expensing of the cost of a tangible plant asset as time passes Management estimates the useful life of the asset Purpose is to match the cost with the related revenue Straight-line depreciation A method of expensing an equal portion of the asset’s cost each year Depreciation expense = Cost ÷ Useful life 11

Great Forks Hospital The Hospital reported net income for 2015 of $2.4 million on total revenue of $30 million. Depreciation expense totaled $1.0 million. A) What are Total Expenses for 2015? B) What are Total Cash Expenses for 2015? C) What was the Hospital’s 2015 Cash Flow? 12

Lets Discuss the Following Income Statements Hill Physicians Medical Group, Inc. Deaconess Health System 13

Is Net Income Equal to Your Cash? 14

The Balance Sheet The balance sheet reports the financial position at a point in time (end of the quarter or year). The balance sheet is divided into three major categories: Assets Liabilities Net Assets 15

The Balance Sheet (B/S) Assets - represent future benefit to the company, and are classified in order of liquidity (current assets; property, plant and equipment; long-term investments and intangibles) Liabilities - represent obligations of the company, and are classified according to payment date (current liabilities, long- term liabilities) Net Assets - represents the residual claims of the owners, and is classified based on source (contributed capital and retained earnings, or fund balance) 16

Assets = Liabilities + Net Worth Balance Sheet Assets = Liabilities + Net Worth Assets Current Assets Intangible Assets Property Plan & Equipment Long Term Investment Liabilities & Net Assets Current Liabilities Long Term Liabilities & Debt Net Assets 17

B/S Assets: Current Assets Current Assets include: Cash: checking and savings accounts; petty cash. Short-term investments: investments in stocks and bonds of other companies. Accounts receivable: amounts owed to a company from its customers. Inventory: products on hand designated for sale to customers. Prepaid expenses: amounts paid for future expenses. 18

Any others that you can think of? B/S Assets: Intangible Assets Intangible Assets are assets that CANNOT be seen, touched or counted. Typical intangible assets in healthcare are: Software Restrictive agreements/covenants Goodwill Trained employees Reputation Bed licenses Medical records Regulatory approvals Any others that you can think of? 19

B/S Assets: Property, Plant and Equipment Property, Plant, and Equipment are assets that are used in the production of goods and services. These productive assets are long-term in nature, and include the following: Land: property upon which the productive facilities are located. Building: the physical structure of the company’s operations. Machinery and Equipment: include operating machinery (MRI), vehicles, computers, copy machines, etc. Accumulated Depreciation: accumulated depreciation is the total depreciation for a fixed asset that has been charged to expense since that asset was acquired and made available for use. 20

B/S Assets: Long-term Investments Long-Term Investments & Intangibles are assets acquired by the company to provide long-term benefits to the company. They include: Long-term notes receivable owed to the company (from customers or others). Investments in stock of other companies: held for expectation of dividends and/or stock price increase. 21

Dallas Hospital Organization Dallas Hospital Organization (DHO) purchased equipment on January 1, 2015 for $290,000 with an expected scrap value of $30,000 and estimated useful life of five years. Using straight line depreciation, what is the depreciation expense for 2015 What is the accumulated depreciation after 2016? After three years, DHO decides to sell the equipment for $130,000 what is the gain or loss on the sale? 22

B/S Liabilities: Current Liabilities Current Liabilities are obligations expected to be paid (or services expected to be performed) within the next year or operating cycle. The elimination of current liabilities requires the use of current assets (most commonly cash). Examples include: Accounts payable Wages payable Interest payable Short-term notes payable Current maturities of long-term debt Deferred (unearned) revenues 23

B/S Liabilities: Long-term Liabilities Long-Term Liabilities are obligations expected to require payments beyond the current year. Examples of long-term liabilities include: Notes payable: amounts owed to banks and other creditors beyond the current year. Mortgage payable: amounts owed to mortgage company beyond the current year. Bonds payable: amounts owed to investors holding bond investments issued by the company, where payments of principal and interest are beyond the current year. 24

Let’s Discuss the Following Balance Sheets Hill Physicians Medical Group, Inc. Deaconess Health System 25

Cash Flow Business Activities & Purpose Business activities (CASH FLOW ) are reflected in financial statements; business activities include: Operating Activities – selling goods and services. Investing Activities – acquisition and sale of productive assets. Financing Activities – issue and retirement/repayment of liabilities and equity. A Statement of Cash Flows: shows the relationship of net income to changes in cash balances & helps to predict future cash flows. evaluates how management generates and uses cash. determines a company’s ability to pay present and future obligations, including debts when they are due. 26

Typical Activities Affecting Cash Cash Inflows Operating Activities net income depreciation reduction in current assets increase in current liabilities Investing Activities sale of long-term securities sale of property, plant & equipment Financing Activities borrowing from banks and other creditors charitable contributions Cash Outflows Operating Activities operating loss increase in current assets decrease current liabilities Investing Activities purchase of long-term securities purchase of property, plant and equipment Financing Activities loan repayments long-term debt repayments dividend payments (for-profit Hospitals) 27

Lets Discuss the Following Cash Flow Statements Hill Physicians Medical Group, Inc. Deaconess Health System 28

Order of Battle Understanding the concept of Generally Accepted Accounting Principles and Financial Reports. Understanding the difference between Cash and Accrual basis of Accounting. 3. Reviewing and analyzing the Financial Statements; Income Statement Balance Sheet Cash Flow 4. Ratio Analysis DuPont Analysis Liquidity Profitability Asset Management Debt Management 29

Du Pont Analysis Du Pont analysis summarizes and highlights a business’s financial condition. It is based on the fact that ROE can be expressed as the product of three ratios: Total margin (expense control) Total asset turnover (asset utilization) Equity multiplier (debt utilization) 30

x x = ROE TA DuPont Model Example Equity x x = ROE Multiplier Total Margin TA Turnover x x = ROE TA TE NI Rev Rev TA 2012: 2.22% x 0.73 x 1.50 = 2.43% 2013: 7.30% x 0.78 x 1.41 = 7.98% Ind. Avg.: 5.00% x 0.97 x 1.73 = 8.39% What does it all mean? 31

DuPont Analysis for: Hill Physicians Medical Group, Inc. 2016 & 2015 Deaconess Health System 32

Interpretation of Financial Statements Liquidity Profitability Debt Management Asset Management 33

Comparisons Within the Industry Financial accounting numbers can also be made more meaningful if they are compared to those of similar hospitals. Comparison of financial accounting numbers with hospital averages is also helpful. 34

Liquidity Ratios Liquidity Ratios are ratios that come off the Balance Sheet and hence measure the liquidity of the company at a particular time. These ratios are important in measuring the ability of a company to meet both its short term and long term obligations. 35

Liquidity Ratios Current Ratio = Current Assets Current Liabilities Days Cash on Hand = Cash Operating Exp-Depreciation Expr Avg. Age of Plant = Accumulated Depreciation Depreciation Expense 36

Profitability Ratios These ratios are designed to measure a hospital’s earnings power, to generate funds for future reinvestment. Net income, the primary measure of the overall success of a hospital, is compared to other measures of financial activity or condition to assess performance as a percent of some level of activity or investment. 37

Profitability Ratios Deductible Ratio = Deductions Gross Patient Revenue Total Margins = Net Income Total Revenue Return on Assets = Net Income Total Assets Return on Equity = Net Income Total equity 38

Debt Management Ratios Debt Management Ratios attempt to measure the firm's use of Financial Leverage and ability to avoid financial distress in the long run. These ratios are also known as Long-Term Solvency Ratios. 39

Debt Management Ratios Debt Ratio = Total Debt Total Assets LT. Debt to Equity = LT. Debt Total Equity Times Interest Earned = NI + Interest Expr. Interest Expr. Cash Flow Coverage = NI + Interest Total Debt Payments 40

Asset Management Ratios Asset management ratios measure the ability of assets to generate revenues or earnings. They also compliment our liquidity ratios. 41

Asset Management Ratios Current Asset Turnover = Collections (Revenue) Current Assets Fixed Asset Turnover = Collections Fixed Assets Average Collection Period = Accts Receivable (Sales/365 Days) Average Payment Period = Accts Payable X 356 Purchases 42

Ratios & Calculations Ratio Calculation Current Ratio (L) Current Assets / Current Liabilities Days in Accounts Receivable (L) Net Accounts Receivable / Net patient Revenue per Day Days Cash on Hand (L) Cash / (Operating Expenses less Depreciation / 365) Total Margin (P) Excess of Revenues over Total Expenses / Total Revenue Return on Equity (P) Excess of Revenues over Total Expenses / Net Assets Average Age of Plant (AM) Accumulated Depreciation / Depreciation Expense Debt Financing Percent (DM) Total Liabilities / Total Assets Fixed Asset Turnover (AM) Total Revenue / Net Plant, Property & Equipment Long-Term Debt to Equity (DM) Total Long-Term Debt / Net Assets Cash Flow to Total Debt (DM) Excess of Revenues over Expenses + Depreciation / Total Long-Term Debt % Deductible (P) Total Patient Revenue – Net Patient Revenue / Total Patient Revenue (L) Liquidity (P) Profitability (AM) Asset Management (DM) Debt Management 43

Ratios & Descriptions Ratio Description 44 Current Ratio Measures the hospital’s ability to meet its current liabilities with cash generated by its current assets. A ratio of 1.0 or higher indicates that all current liabilities could be adequately covered by current liabilities. Days in Accounts Receivable Measures the average number of days in the collection period. A larger number of days represents cash that is unavailable for use in operations. Days Cash on Hand The number of days of expenses that the hospital can currently cover with its available cash. Total Margin Measures the overall profitability of the hospital using both operating and non-operating surplus (loss). Return on Equity Expression of net income relative to total equity. Average Age of Plant The average age of property, plant and equipment owned by the hospital. Debt Financing Percent Measures relationship of total debt to assets. Fixed Asset Turnover Provides an indication of the efficiency with which the hospital uses its fixed assets to generate revenues. Long-Term Debt to Equity Measures the hospitals debt burden and its ability for additional borrowing. Cash Flow to Total Debt The amount of cash flow available to service all debt. The lower the number, the higher the likelihood that the hospital will be unable to meet debt payments of interest and principal and the higher the likelihood of violating any debt covenants. % Deductible Measures the proportion of total patient charges that are given up in discounts and allowances. 44

Other Analytical Techniques In addition to ratio and Du Pont analyses, there are 3 other commonly used analytical techniques. In common size analysis, all income statement items and balance sheet accounts are expressed as percentages. The process of comparing a business’s ratios to selected standards is called benchmarking. In percentage change analysis, year-to-year changes in income statement items and balance sheet accounts are expressed as percentages. What is the value of these techniques? 45

Lets put Together Ratio Analysis for Hill Physicians Medical Group, Inc. Deaconess Health System 46

Healthcare Financial Detective You Decide 47

Van Nuys Community Hospital Assessing Hospital Performance 48

River Community Hospital Assessing Hospital Performance 49

Putting it All Together 50