MARKET VALUE RATIOS, COMMON SIZE 13 ANALYSIS, AND PERCENTAGE C ANGE ANALYSIS

MARKET VALUE RATIOS, COMMON SIZE 13
ANALYSIS, AND PERCENTAGE C ANGE
ANALYSIS
Supplement Learning Objectives
After studying this chapter supplement, readers should be able to
• describe the purpose and use of two market value ratios, and
• apply common size and percentage change analyses to assess
financial condition.
Market Value Ratios
In addition to the financial ratios discussed thus far, another group of financial
ratios focus on stockholder metrics. For investor-owned firms with publicly
traded stock, ratios that relate the firm’s stock price to its earnings and book value
per share can be developed. Such market value ratios give managers an indication
of what investors think of the firm’s past performance and future prospects. If the
firm’s liquidity, asset management, debt management, and profitability ratios are
all good, its stock price (and hence market value ratios) will be high.
Price/Earnings Ratio
For investor-owned firms, the price/earnings (P/E) ratio shows how much
common stock investors are willing to pay per dollar of reported profits. Suppose that the stock of General Home Care, an investor-owned home health
care business, sells for $28.50, while the firm had 2018 earnings per share
(EPS) of $2.20. Its P/E ratio would be 13.0:
Key Equation S13.1: P/E Ratio
Price per share $28.50 P/E ratio = = = 13.0.
Earnings per share $2.20
Peer group average = 15.2.
13-2 Gapenski’s Understanding Healthcare Financial Management Chapter 13 Supplement
P/E ratios are higher for firms with high growth prospects, other
things held constant, but they are lower for riskier firms. General’s P/E ratio
is slightly below the average of other investor-owned home health care businesses, which suggests that the business is regarded as somewhat riskier than
most, as having poorer growth prospects, or both.
arket/Book Ratio
The ratio of a stock’s market price to its book value is another indication of
how investors regard the firm. Firms with relatively high rates of return on
equity generally sell at higher multiples of book value than those with low
returns. General Home Care reported $80 million in total equity on its
2018 balance sheet, and the firm had five million shares outstanding, so its
book value per share is $80/5 = $16.00. By dividing the price per share by
the book value per share, we determine that the market/book (M/B) ratio
is 1.8:
Investors are willing to pay slightly less for each dollar of General
Home Care’s book value than for that of an average home health care
business.
Key Equation S13.2: arket/Book Ratio
Price per share $28.50 M/B ratio = = = 1.8.
Book value per share $16.00
Peer group average 2 = .1.
SELF-TEST
QUESTION 1. What are two ratios that measure market value?
Common Size Analysis
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There are analytical techniques other than ratio analysis that are used to
interpret financial statements. In common size analysis, all income statement
items are divided by total revenues, and all balance sheet items are divided
by total assets. Thus, a common size income statement shows each item
as a percentage of revenues, and a common size balance sheet shows each
account as a percentage of total assets. The significant advantage of common
size statements is that they facilitate comparisons of income statements and
balance sheets over time and across firms because they compensate for scale
(size) differentials.
Chap te r 1 3 Supplemen t : Ma r ke t Value Ra tios . . . 13-3
Exhibit S13.1 contains Bayside’s common size income statement for
2018, along with the common size statement for its peer group. An analysis of
the common size statements shows few significant differences between Bayside
and its peer group. Perhaps the most important difference is that Bayside’s
operating income is well above average while its nonoperating income is well
below average. Although having a higher income from core operations is good,
Bayside’s managers should examine its contributions and endowments to see if
better management could result in higher nonoperating income. Additionally, a
lower percentage of Bayside’s revenue comes from capitated contracts and other
patient-related sources than is true of the average hospital.
Exhibit S13.2 contains Bayside’s common size balance sheet for 2018
along with peer group average data. Three striking differences are revealed:
(1) Bayside’s current assets are significantly lower than the average, (2) its net
property and equipment are significantly higher, and (3) it uses far less debt
financing than the average hospital uses.
SELF-TEST
1. How are common size statements created? QUESTIONS
2. What advantage do common size statements have over regular
statements when conducting a financial statement analysis?
Chapter 13 Supplement
EXHIBIT S13.1
Bayside
Memorial
Hospital:
Common Size
Income
Statement
for 2018
Bayside Peer Group verage
Patient service revenue 93.3% 90.4%
Less: Provision for bad debts .9 3.o
Net patient service revenue 90.4% 87.4%
Premium revenue 4.6 7.
Other revenue 3. .4
Total operating revenues 98. % 97.0%
Expenses:
Nursing services 51.1% 50.7%
Dietary services 4.8 4.7
General services 11.6 11.5
Administrative services 10.0 10.
Employee health and welfare 9.0 9.
Malpractice insurance 1. 1.0
Depreciation 3.6 3.0
Interest expense 1.4 1.9
Total expenses 9 .5% 9 . %
Operating income 5.7% 4.8%
Nonoperating income 1.8 3.0
Net income 7.5% 5.0%
Note: This ta le contains inconsistencies ecause values are rounded to the nearest tenth of a
percent.
13-4 G apens ki’s Unde rs tanding Heal thca r e Financial Managemen t
EXHIBIT S13.2
Bayside
Memorial
Hospital:
Common Size
Balance Sheet
for 2018
Chapter 13 Supplement
Bayside Peer Group verage
Cash and equivalents 1.5% 3.7%
Short-term investments .6 .0
Accounts receivable 14.4 17.
Inventories .1 .5
Total current assets 0.6% 5.4%
Gross property and equipment 96.0% 90.1%
Accumulated depreciation 16.6 15.5
Net property and equipment 79.4% 74.6%
Total assets 100.0% 100.0%
Accounts payable 3.1% 3.9%
Accrued expenses 3.7 4.1
Notes payable .0 3.
Total current liabilities 8.8% 13.3%
Long-term debt 19.0% 36.5%
Capital lease obligations 1. 0.9
Total long-term liabilities 0. % 37.4%
Net assets (equity) 71.0% 49.3%
Total liabilities and net assets 100.0% 100.0%
Note: This ta le contains inconsistencies ecause values are rounded to the nearest tenth of a
percent.
Percentage Change Analysis
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Another technique frequently used when analyzing financial statements is
percentage change analysis. In this analysis, the percentage changes in the
individual items on the income statement and accounts on the balance sheet
over some period are calculated and compared. In this format, it is easy to see
which items are growing faster or slower than others and hence to see which
of them are under control and which are out of control.
To illustrate percentage change analysis, consider Bayside’s income
statements shown in exhibit S13.3, where the 2017 and 2018 items have
been converted into percentage changes. Note that Bayside’s net patient
service revenue grew at a 12.2 percent rate, while at the same time, nursing services expenses grew by only 2.7 percent. Conversely, dietary services
expenses grew at 15.0 percent. This information tells Bayside’s managers that
revenues associated with patients grew faster than nursing expenses (which
is a positive trend for the hospital), but dietary services expenses grew faster
than revenues (which is a negative trend). Other items on the income statement would be analyzed in a similar manner. Also, percentage change analysis
could be applied to balance sheet accounts in the same way as our income
statement illustration.
Chap te r 1 3 Supplemen t : Ma r ke t Value Ra tios . . . 13-5
EXHIBIT S13.3
Bayside
Memorial
Hospital
Statements
of Operations
(Income
Statements)
Years Ended
Decem er
31, 2018
and 2017 (in
thousands
of dollars)
with
Percentage
Changes
2018 2017
Percentage
Change
Revenues:
Patient service revenue $106,50 $ 95,398 11.6%
Less: Provision for bad debts 3,3 8 3,469 –4.1
Net patient service revenue $ 103,147 $ 91,9 9 1 . %
Premium revenue 5, 3 4,6 13.
Other revenue 3,644 6,014 –39.4
Total operating revenues $ 11 ,050 $10 ,565 9. %
Expenses:
Nursing services $ 58, 85 $ 56,75 .7%
Dietary services 5,4 4 4,718 15.0
General services 13,198 11,655 13.
Administrative services 11,4 7 11,585 –1.4
Employee health and welfare 10, 50 10,705 –4.
Malpractice insurance 1,3 0 1, 04 9.6
Depreciation 4,130 4,0 5 .6
Interest expense 1,54 1,5 1 1.4
Total expenses $105,576 $ 10 ,165 3.3%
Operating income $ 6,474 $ 400 1,518.5%
Nonoperating income ,098 1,995 5.
Net income $ 8,57 $ ,395 58.0%
Chapter 13 Supplement
The conclusions reached in a percentage change analysis, as well as in
a common size analysis, generally parallel those derived from ratio analysis.
However, occasionally, a serious deficiency is highlighted only by one of the
three analytical techniques, while the other two techniques fail to reveal the
deficiency. Thus, a thorough financial statement analysis includes a Du Pont
analysis to provide an overview and also includes ratio, common size, and
percentage change analyses.
SELF-TEST
1. What is percentage change analysis? QUESTIONS
2. Why is it useful?
3. Which analytical techniques should be used in a complete financial
statement analysis?
13-6 Gapenski’s Understanding Healthcare Financial Management Chapter 13 Supplement
Supplement Key Concepts
This chapter supplement contains some additional material on market
value ratios and on common size and percentage change analysis. Here
are its key concepts:
• Market value ratios give managers of for-profit businesses
an indication of what investors think of the firm’s past stock
performance and future prospects.
• In common size analysis, a business’s income statement and balance
sheet are expressed in percentages. This type of analysis facilitates
comparisons between firms of different sizes and for a single firm
over time.
• In percentage change analysis, the differences in income statement
items and balance sheet accounts over time are expressed in
percentages. In this way, it is easy to identify those items and
accounts that are growing appreciably faster or slower than average