Consideration of Key Data for Arcadia

HCA 270 Financial matters for health care professionals By:

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Axia College of University of Phoenix May 10, 2009

Ratio Analysis between 2006 and 2005 Financial Statements, Part I

Current Ratio = Current Assets / Current Liabilities

2006: 1.81 2005: 2.16

What does this mean?

In 2006 Arcadia became less able to cover its current liabilities out of its current assets; this change indicates less liquidity, and may affect the extension of credit from prospective lenders.

Ratio Analysis, Part II

Inventory Turnover = Sales / Inventory = Net Patient Revenues / Inventory

2006: .74 2005: .61

What does this mean?

In 2006 Arcadia was able to move its inventory faster (turn it over more times over the year), which indicates better resource or sales use.

Ratio Analysis, Part II (Continued)

However

A hospital is a largely service-driven business, and therefore most of Net Patient Revenues will be due from services rendered, not inventory sold.1 Therefore, the inventory turnover ratio is not highly meaningful since the portion of Net Patient Revenues due to inventory sales cannot be disaggregated from total Net Patient Revenues.

Ratio Analysis, Part III

Total Asset Turnover Ratio = Sales / Net Total Assets

2006: .74 2005: .72

What does this mean?

This ratio is an indicator of Managements efficiency in using a companys net resources. The increase of this ratio may indicate increased Management efficiency.2

This indicator is mainly useful in comparison to industry ratios; in this case, competitors had a 2005 Total Asset Turnover Ratio of 1.01, which may mean one of two things for Arcadia: Arcadia is more capital-intensive than its competitors, or

Arcadias Management is comparably inefficient in its use of resources.

Overall Assessment from Analyzed Ratios, Part I

Between 2005 and 2006, the Hospitals liquidity decreased, as indicated by the drop in the Current Ratio. The Hospitals ability to more efficiently sell inventory may have increased, which, if true, is a positive indicator.

However, any conclusion from the Inventory Ratio is likely unfounded given the current level of information

Overall Assessment from Analyzed Ratios, Part II

The Hospitals Management has likely been slightly more efficient in its use of Total Net Assets. However, given the slight increase, the change could also simply be due to general economic factors. Compared to competitors, the Hospital may be underperforming.

Overall, Arcadia has improved modestly in some areas, but weakened in terms of overall liquidity.

Valuation of Arcadia, Part I

Rules of Thumb = Total Revenue x 2

2006: $1,344 million 2005: $1,136 million

Adjusted Book Value = Total Assets Total Liabilities

2006: $7,955 million 2005: $7,900 million

Valuation of Arcadia, Part II

Discounted Cash Flow, assuming cash flow of $655 million for both 2005 and 2006, for the following capitalization rates:

6%: $1,272 million 8%: $1,261 million 10%: $1,250 million 12%: $1,240 million

Valuation of Arcadia, Part II (Continued)

Since the $655 million per year cash flow may be assumed to continue for purposes of this calculation, and this calculation is viewed for each year on a two-year discounted basis, both 2005 and 2006 would result in the same valuation for each level of capitalization rate.

Comparison of Valuation Methods, Part I

The range of values span from $1,136 million to $7,900 million for 2005, and from $1,240 million to $7,955 million for 2006. Two of the valuation methods (Rules of Thumb and Discounted Cash Flow) place the value within almost $100 million of each another, which tends to lend credence to their results.

Comparison of Valuation Methods, Part II

The result for Adjusted Book Value that is well above $6.5 billion that of the other two methods, and has been generally deemed a very poor method of valuation compared to them.3

Therefore, the true value of the Hospital in an arms-length transaction would probably be somewhere between $1,136 million and $1,272 million for 2005, and between $1,240 and $1,344 million for 2006.

Consideration of Variances from Budgets

Revenue Variance

2006: ($28) million (i.e., negative) 2005: ($29) million (i.e., negative)

This outcome is not favorable, or what was expected. Why are both almost the same amount below budget for both years? Possible reasons include:

Low occupancy rates for beds than expected Lower-paying procedures across all beds on average A backup in paperwork necessary for billing and insurance reimbursement.

General Evaluation of Budget to Actual Result for Revenue

Managements expectations have not panned out by a significant margin each year. These expectations should likely be reevaluated.

Further Management research into the causes of this variance is warranted, as a consistently significantly inaccurate budget is not useful, and may indicate either poor expectations or problems within the Hospital that may be solved to bring actual results in line with budgeted expectations.

Assessment of the Hospitals Overall Health, Part I

Ratio Analysis yields a mixed result, but shows some areas of comparative weakness between 2005 and 2006. Weaker liquidity may be of some concern.

Three valuation methods provide a variety of possible business values for the hospital; however, the confluence of two methods reveals a likely value for each year. All three methods show an overall increase in business value from 2005 to 2006.

Assessment of the Hospitals Overall Health, Part II

Revenue Variances in terms of budget to actual has been unfavorable for both 2005 and 2006, and has remained almost the same amount below budget for both years.

This trend indicates a problem either with Managements expectations or an operational or fraud problem within the Hospital. Either way, research is prudent.

Citations

Steinberg, Samuel H., Ph.d (2006, November). How Does A Hospital Make Money? Retrieved 12 April 2009, from Physicians News Digest

: http://www.physiciansnews.com/business/1106steinberg.html Investopedia ULC (2008). Asset Turnover. Retrieved 12 April 2009, from Investopedia Web http:// www.investopedia.com/terms/a/assetturnover.asp

Biz-Zone Internet Group, Inc (2008). Valuation Formulas: Book Value & Liquidation Value. Retrieved 12, April 2009, from CanadaOneTM

http://www.canadaone.com/tools/buy_a_biz/section2e. html