Question

Explain how the below ratio could be affected if there was an increase in Publicly traded hospital costs or supply chain disruptions occurred for materials including equipment, medications and other supplies? And explain how these ratio can affect the Publicly traded hospital financial statement

Increase in costs

a. Debt service coverage ratio (Net Income/Debt Service)

b. Profit Margin Ratio (Net Income/Net Sales)

c. Return on Assets (Net Income/ total assets)

Supply chain disruptions

a. Current Ratio (Current Assets/Current Liabilities)

b. Inventory turnover (Net Sales/ Average Inventory)

c. Debt to total assets (debt/total assets)

d. Return on assets (Net Income/ total assets)

Answer 1

Increase in costs:

a. Debt service coverage ratio (Net Income/Debt Service):

The debt service coverage ratio is used to determine whether or not the company has enough cash flows to service its debt obligations.

This ratio can be used to analyze firms, projects, or individual borrowers. The numerator is the net operating income/operating profit, which is the portion of revenue that remains after deducting the cost of goods sold and other operating expenses, except interest payments and taxes.

The debt service coverage ratio is calculated as follows:

DSCR = Net Operating Income/Total Debt obligations.

Therefore, with an increase in hospital operating expenses, the value of the net operating income will register a decrease in the Profit and Loss statement. The DSCR also registers a decrease.

For an increase in accrued expenses, there is an increase in accounts payable in the balance sheet, and the amount of the expense also reduces the earnings of the company.

b. Profit Margin Ratio (Net Income/Net Sales)

The profit margin ratios are typically used by businesses and investors to measure the growth potential of the company, and how well the company is managed.

For intance, if a business has net sales worth $500,000 in a given fianncial year, and its operating expenses amount to a total of $300,000, then its profit margin will be:

Profit Margin    = 1 - ($300,000 / $500,000)

                               = 1- 0.6 = 0.4 or 40%

If the sales worth $500,000 remain constant, however, the expenses come down to $200,000, its profit margin would increase to {1 - $200,000/$500,000)} = 60%.

If the costs for generating the same sales further goes up to $350,000, the profit margin falls to {1 - $350,000/$500,000)} = 30%.

Therefore, an increase in costs will result in low net income or operating profits in the P/L statement, and subsequently, a low profit margin ratio.

Similarly, any accrued expenses will increase the accounts payable.

c. Return on Assets (Net Income/ total assets)

The return on assets is an important indicator of how well the company is using its assets to generate revenues. However, this differs depending on the nature of industry and scale of operations of the business.

If Company A has a net income of $100 million and assets of $500 million, and Company B has a net income of $800 million and assets of $500 million, then we can observe that Company A has a greater ROA (20%), as compared to Company B(16%). The value of assets are same for both companies, however, one has a lower net income and therefore, registers a low ROA.

An increase in hospital operating expenses will have the effect of reducing the net income figure in the P/L statements, and the profit margin ratio will also decrease.

Supply chain disruptions:

Supply chain disruptions may affect the income statements as well as the balance sheet of the company. This may result in stockouts, increase in storage and inventory costs, transportation costs, etc.

a. Current Ratio (Current Assets/Current Liabilities)

The current ratio is calculated as follows:

Current ratio = Current assets/current liabilities.

Current assets comprise cash and other near-liquid investments, accounts receivables and inventories; while current liabilities are mostly accounts payables.

Due to supply chain disruptions, the working capital component may be affected as there may be discrepancies due to the following reasons:

• Sourcing time
• Pricing changes
• Incorrect invoicing terms
• Order delays leading to stockouts

If supplies are not procured on time, it may lead to lost revenues due to high sourcing times and stockouts.

Depending on payment terms, there may huge amounts of cash advances paid for the supplies of equipment, and as a result, the value of current assets will decrease in the balance sheet.

Also, there will be a fall in revenues due to delays in sourcing which can impact the income statement of the company, and lead to a decrease in current ratio.

b. Inventory turnover (Net Sales/ Average Inventory)

Due to supply chain disruptions, there may be increased sourcing times and delivery times. Hence, this will lead to lost sales due to stockouts and low inventory.

As a result, the income statement registers a decrease in overall revenues, and the inventory items in the balance sheet also registers a decrease.

c. Debt to total assets (debt/total assets)

The level of debt may not change, however, inventory levels may register a decrease due to delayed sourcing and stockouts. Hence, the inventory registers a decrease in the balance sheet. The debt to total assets may go up in such cases.

d. Return on assets (Net Income/ total assets)

Normally, increases in the asset base can be considered positive as it indicates profitability and growth. But in the case of supply chain disruptions, it may mean lower asset turnover as there may be decreases in inventory in the balance sheet.

Subsequently, the net income may also decrease due to low sales of necessary medical supplies, affecting the profitability of the firm.