Value_of_Ratio_Analysis_in_Decision-Making

Value of Ratio Analysis in Decision-Making The value of ratio analysis in decision making is unconscionable in an organization. Ratio analysis assists the organization in identifying investment opportunities, generate, and validate better ideas. It provides the organization measures to assess multifarious aspects of operational success or failure. Presented in this paper are: concept/purpose of ratio analysis, ratio analysis major groups, calculations/financial analysis of Patton-Fuller Community Hospital, and factors considered in analysis results interpretation. Concept/purpose of ratio analysis Ratio Analysis is a method of analyzing the financial condition and working performance of an organization based on ratios calculated from the line items found in the financial statements, a component of financial statement interpretation. Comparison yields insights into the organization’s financial success. Abraham (2006) stated, “The extent of financial performance by ratio analysis helps identify organizational strengths and weaknesses by identifying financial variances and focusing attention on issues of organizational importance” (p. 212). Ratios describe the various connections among accounts in the balance sheet and financial statement. Financial ratios save expected income. Financial statements use analysis of ratio information in generating estimates. They are significant to an organization’s finance status because they reflect the financial profile of the organization. Major Groups of Ratio Analysis Common size ratios compare financial statement numbers relative to the size of the organization. Cash ratio indicates the ability of the organization to meet liabilities and liquidity ratios. Current asset ratio indicates the efficiency of the organization’s ability to convert product/service to cash. A ratio of less than one suggests inability to meet obligation (Findler, 2011). Liquidity ratios compare the ability of the organization in meeting its obligations over the coming year. Quick ratios compare the organization’s capability to fulfill short- term obligations with liquid assets. Higher ratio represents better position of the organization. Current asset ratio (two is acceptable) measures the capability of the organization to pay liabilities due with assets that yield cash fastest (Pieterz, 2005-2011). Solvency ratio compares the ability of the organization to meet its long-term obligations. A high solvency ratio indicates a healthy organization, low indicates default, possible bankruptcy, liquidation, or restructure. Total debt to equity ratio measures the organization’s leverage. High ratios means creditors are supplying substantial portion of resources used by the organization, makes it difficult to borrow when needed. Interest coverage ratio determines the organization’s ability to pay current interest obligation. A ratio higher than one indicates ability to pay interest, below one indicates interest payments exceed earnings (Farlex, 2011). Efficiency ratio compares the relative efficiency of the organization’s use of resources. Day’s receivable indicates the length of time on average collect receivables, increased trend indicates deterioration. Revenue assets indicates amount of revenues generated by each dollar invested in assets. Profitability ratios compare the ability of the organization to generate relative profitability. Return on net assets is the organization’s profit of the year. Profit margin indicates earnings of every dollar, high margin is good. Ratio Calculations/Financial Analysis for Patton-Fuller Community Hospital 2009-2008 Common size: Cash= [Cash/Total Assets] 2009 22,995/588,767= .039= 3.9% 2008 41,851/548,353= .076=7.6% PFCH’s cash to total asset fell from 7.6% in 2008 to 3.9% in 2009, a downward trend; over time could attest the possibility that P-FCH cash may decrease. This indicates a need to improve/adjust operating activities to assist the organization have a sufficient cash to undertake. Current= [Current assets/Total assets] 2009 128,867/588,767= .22 2008 130,026/548,535= .24 PFCH’s current ratio is the same but less than one. P-FCH cannot turn service to cash. Liquidity: Quick ratio = [Cash+ Market securities+ accounts receivable/current liabilities] 2009 22,995+0+59,587/23,807= 3.47 2008 41,851+0+37,666/8,380= 9.49 PFCH’s quick ratio fell from 2008, warrants attention. Current ratio = [Current assets/current liabilities] 2009 128,867/23,807= 5.41 2008 130,026/8380= 15.5 PFCH’s is able to pay liabilities but current ratio in 2009 decreased from 2008. Management needs to address this huge decrease. Solvency: Total debt to equity= [Current liabilities+ Long Term debt/Net assets (Assets-Liabilities)] 2009 23,807+452,945/ (588,787- 462,153) 126,634= 3.76 2008 8,380+209,255/ (548,535- 213540) 334,995= .65 PFCH’s total debt to equity ratio has increase from 2008. Interest coverage= [Cash flow from operating activities+ Interest expense/Interest expense] 2009 23,979+ 13,797/13797= 2.74 2008 11,439+13,383/13383= 1.85 PFCH’s ratio increased in 2009, able to pay its interest obligation. Efficiency: Days receivables= [Accounts receivable/Patient revenue per day] 2009 59,787/1260 (459,900/365) = 46.6 2008 37,666/1146 (418,509/365) = 32.87 The 32.87 average days in 2008 is good result, the average 46.6 days in 2009 increase trend representing deterioration. Revenue assets= [Total revenue/total assets] 2009 462,982/588,767= .79 2008 421,314/548,535= .77 Minimal increase in 2009 is insignificant could be caused by slight increase in assets. Profitability Return on net asset: [Change in net assets/Net assetsx100] 2009 126,614/587,767x100= 21.5% 2008 335,085/548,535x100= 61% Return on net asset fell considerably in 2009. Profit margin= [Change in net assets/Total revenue x 100%] 2009 126,614/462,982x100= 27.7% 2008 335,085/421,314x100= 79.9% Profit margin fell off considerably in 2009 from 2008 representing a profitability decline. PFCH experienced significant events in 2009 as reflected in the financial statements. Return on investment income dropped due to decline in stock and real-estate markets. PFCH reassess its investment values and was stated as a one- time loss. Net patient increased slightly due to settlements from managed care contracts resulting to increased accounts receivable. Factors considered Ratio Analysis Results interpretation Ratios use numbers from financial statements. Generally Accepted Accounting Principles do not have standards in accounting methods, and valuation of assets (resulting to inconsistency). Trends considered in assessing the viability of a company. Ratio differs relative to sizes of organizations and industries, without comparisons they are insignificant. The essence of ratio analysis is to find two numbers that when compared yield some beneficial insights. Only a thorough review can provide information on which to base inferences.(Findler, 2011). Multiple ways of ratio interpretation of ratios exists. It is important to look at multifarious factors to determine the health of an organization (Accounting for management, 2011).