1. Balance Sheets and Ratio Analysis N287E Spring 2006 Joanne Spetz 5 April 2006

2. Administrative news Our classroom is now C701, except… April 26, either U506 or the Bailey Lounge May 10, HSW 303 Next week – guest lecturers Do the reading in advance!

3. What did we do last time? Defined “health economics” Defined “utility” Graphed indifference curves Talked about marginal costs and marginal benefits Learned the supply and demand magic

4. What did we do last time? Defined “perfect competition” Learned why perfect competition does not exist in health care Talked about nursing shortages Short-term supply and demand Long-term supply and demand

5. Questions for you… Is there an economic case for addressing nursing shortages? Do you think Huston 2003 makes the case well? Why or why not? What are the costs to our economy of nursing shortages? Rivers et al., 2005, recommends Magnet Certification as a key strategy. Do you agree?

6. Questions for you… Do you think the model proposed by Spetz & Given (2003) is adequate? What issues did they ignore in their analysis?

7. And on with the show… How do we assess the financial impact of anything on health care?

8. How do we assess whether firms are profitable? Profitability has many components Immediate profit Investments that lead to future profits In health care many firms are not-for- profit Religious and not-for-profit hospitals Community clinics

9. Firms keep records of financial information Most financial information is available to the public For-profit firms must share information if they are publicly held (stocks) Not-for-profit firms have an obligation to the public and must have information available Some states require reporting

10. What financial information do we want? Financial sheets Balance sheet Statement of revenues and expenses Statement of cash flows Statement of change sin fund balances or net assets Plus… footnotes to all these

11. Firms report financial data in standard way Financial sheets contain information about firm financial performance For most companies, these data are available to the public There are many accounting tricks to make these sheets “look good”

12. Balance Sheets The Balance Sheet provides the present value of the firm Two sections: Assets Current liabilities and equity Assets = liabilities + equity Equity (roughly) measures the value of the company Equity = Assets - liabilities

13. Types of assets Current assets (cash, securities, etc.)

14. Types of assets Limited-use assets

15. Types of assets Property, plant, and equipment (PPE) Note PPE is depreciated to get net PPE

16. Types of assets Investments, other assets

17. Types of assets Intangible assets Very hard to value There are some strong rules about valuation

18. Types of assets (restricted funds) Specific purpose funds

19. Types of assets (restricted funds) Plant replacement & expansion funds

20. Types of assets (restricted funds) Endowment

21. Types of liabilities Current liabilities

22. Types of liabilities Deferred credits

23. Types of liabilities Long-term debt

24. Types of liabilities (restricted funds) Money due to the restricted funds Specific purpose funds Plant replacement & expansion Endowment funds

25. Components of equity Non-profit (fund balance) For-profit Stock Capital Retained earnings

26. Statement of Revenues and Expenses Presents the year’s earnings Presents the year’s expenses Calculates the income or loss from operations

27. Components of statement of income Operating revenues Deductions from revenue Operating expenses Taxes Non-operating revenues Non-operating expenses

28. Operating revenues Money the firm receives

29. Deductions from revenues Particularly relevant for health care…

30. Operating expenses What does it cost to run the business?

31. Taxes Only if you’re a for-profit company

32. Non-operating revenue Revenue that isn’t connected to your line of business

33. Non-operating expenses Costs that aren’t associated with your production

34. Add it all up and you get… Net income

35. It can be important to adjust for inflation Inflation can increase value of assets Inflation can decrease cost of debts Inflation increases cost of future investment

36. To deal with future costs… Future costs come from: Inflation Investments Firms must have increases in their assets Assets = liabilities + net assets Asset increases come from increases in  Debt  Equity

37. Ways to measure growth Growth Rate in Equity (GRIE) GRIE=  equity =net incomex  equity equityequitynet inc. = return on equity = (net income/equity) reported income index (net income/  equity)

38. How to interpret GRIE… If a firm has no equity source other than net income No endowment No government transfers …then the reported income index = 1 GRIE is sometimes called Return on Equity (ROE)

39. To break down ROE more… ROE=net op income+net nonop income revenue xrevenuexassets assetsequity

40. To go farther than this… Ratio analysis Liquidity ratios – ability of firm to meet short-term financial obligations Capital structure ratios – quality of capital of firm Activity ratios – revenues and expenses Profitability ratios – revenues vs. expenses Other ratios

41. We can benchmark ratios Ratios get compared to national or regional averages/medians Different ratio goals for different industries In your problem set you will be computing ratios