Analyzing Financial Statements - Jones & Bartlett Learning

1 Chapter 10 Analyzing Financial StatementsLEARNING OBJECTIVESA fter studying this chapter, you should be able to do the following:1. Describe the balanced scorecard and dashboard Describe the four key elements of dashboard Explain what the most important measure of Financial success Explain what a health care firm s primary Financial objective should Describe the critical drivers of Financial Discuss relevant healthcare Financial performance Describe the hospital cost-index SCENARIOM ichael Dean has been recently appointed to the Board of Kenyon Medical Center, a 300-bed nonprofit community hospital. Mike is an attorney who specializes in labor law and is thefirm s primary litigation expert in this area.

2 He is reviewing the Financial information that wassent to him this morning in preparation for his first board meeting this evening. His total fi- nancial package includes 28 pages of Financial information consisting of current monthly in-come Statements , a balance sheet, and other monthly actual-to-budget comparisons ofperformance with some selected Financial ratios. Tonight s meeting is a critical one becausethe board s major item for discussion is related to a proposed bond issue to finance a majorhospital renovation. Mike recognizes that he has a fiduciary responsibility to protect the as-sets of the hospital and to ensure its continued Financial viability, but he does not know howto determine if the hospital can afford to take on this additional debt.

3 There is so much infor-mation and no apparent pattern as to what really is important. He is also concerned aboutassessing how the proposed financing would impact the hospital s Financial performance andthus, its ability to repay both interest and principal on the debt. He recently read a report on Dashboard Reporting and wonders if some structure like this would help him and otherboard members to get a better appreciation for the Financial performance of the 10/9/06 2:33 PM Page 201 The major purpose of this chapter is to introducesome analytical tools for evaluating the Financial con-dition of health care entities. Think for a moment howconfusing and difficult it would be, without a key, toreach any conclusions about Financial position fromany of the Financial Statements presented in Chapter your training is in business or finance, the state-ments may look like a mass of endless numbers withlittle meaning.

4 In short, there may be too much infor-mation in most Financial Statements to be digested eas-ily by a general-purpose the last 25 years, there has been an explosionin the adoption and integration of information technol-ogy for Financial reporting. Financial data are collected,analyzed, and distributed to decision makers in a moreaccurate and timely manner, and in greater quantitythan ever before. However, many people believe thatthe technology has not had a positive impact upon per-formance. While we have made important strides in thetechnology of information collection and distribution,we have failed to realize significant improvements inthe decision-making value of that accounts for the failure to take advantage ofinformation-technology advances?

5 We think the answeris very clear and is one that most executives wouldreadily acknowledge. We have been using the technol-ogy to rapidly deliver data (and more of it) to decision-makers, but we have ignored the issue of informationrelevance. As a result, we have in many cases simplyused technology to deliver irrelevant or inappropriatedata more quickly. Bad data delivered more quickly isnot likely to improve performance in either the shortrun or the long OBJECTIVE 1 Describe the balanced scorecard and dash-board concept of Balanced Scorecards developed byRobert Kaplan and David Norton represents an attemptto enhance the value of information and exploit the ca-pability of information technology to deliver true valueto decision makers.

6 Balanced scorecards, in theirstripped-down version, simply state that reporting shouldbe available on those key attributes affecting perfor-mance. More data are of little value if they do not pro-vide information to a decision maker that can be used toimprove the performance of the firm. Dashboard re-porting is a natural subset of balanced scorecards and isbeing increasingly used in almost all sectors of the econ-omy to keep managers focused on critical areas that willaffect overall firm 1988, one major company won a Vision Award is-sued by Business Finance for its dashboard reportingsystem. The company s present dashboard system isintranet-based and replaced the company s monthly200-page binder system that was sent to managers.

7 Themix of 16 Financial , operating, and human resourcemeasures is available online in a drill-down formatinto which managers can dig deeper if they desire. Thesystem is extremely easy to use and focuses on criticalperformance IS REQUIRED TO DEVELOP ANEFFECTIVE Financial REPORTINGSYSTEM? Learning OBJECTIVE 2 Describe the four key elements of dash-board that many health care providers are in-terested in developing a dashboard reporting systemfor key executives and board members, what needs tobe done? In general, four critical questions must beanswered: What is most important to the firm s success? What are the critical drivers that influence per-formance attainment?

8 What are the most relevant measures that reflectcritical driver relationships? What relevant benchmarking data are available toassess performance?In the remainder of this chapter, we will answer thefour questions above with respect to Financial perform-ance. We will then examine a specific hospital exampleto illustrate the definition and utilization of Financial in-dicators to assess Financial performance and to identifycritical opportunities for management ANALYZINGFINANCIALSTATEMENTS42368_CH10_2 01_228 10/9/06 2:33 PM Page 202 WHAT IS MOST IMPORTANT:SUSTAINABLE GROWTHU nderstanding Financial performance in any busi-ness requires some global or summary measure of fi- nancial success.

9 For many health care organizationexecutives, this measure is often the operating margin(operating income divided by revenues). We believethat this measure is wrong and can be misleading inmany situations. For example, low operating marginsmay not always be bad and high operating marginsmay not always be OBJECTIVE 3 Explain what the most important measureof Financial success should be the primary criterion for financialsuccess in health care organizations? We believe that afinancially successful organization is capable of gener-ating the resources needed to meet its mission. Thiscreates two immediate questions. First, what are re-sources?

10 Second, what level of resources is needed tofulfill the mission? Economic resources that are ownedor controlled by a business firm are referred to as assetsand would include such items as supplies, equipment,buildings, and other factors of production that must bepresent to produce health services. Human resourcesare not usually shown as assets because the firm doesnot own an individual, but human resources also are re-quired in the production of products or services. Re-sources or assets owned by a health care organizationare shown in its balance sheet, which provides a listingof its assets and the pattern of financing used to acquirethose assets.