Role of financial ratios
The reported financial statements do not give an in depth analysis of the strengths and weaknesses of the company. Therefore, it is necessary to carry out an in depth analysis of the financial analysis of the financial statements so as to have a better view of the company. Further, analysis of the company helps in making informed decision. Ratio analysis breaks down the financial data into various components for better understanding of the financial strengths and weaknesses of the company. Some of the common categories of ratios are the liquidity ratios, profitability, leverage ratios and efficiency.
These ratios measures different attributes in the financial health of a company. The role of the various categories of financial ratios will be discussed for ratios will be discussed using financial data for Kindred Healthcare (Abdullah & Ismail, 2008).
Kindred healthcare, established in 1985, is based in the United States. It has outlets in 2,203 locations through subsidiaries. Also, the health care has 116 transitional care hospitals. Further, the center has six inpatient rehabilitation hospitals, 223 nursing and rehabilitation centers. The health center employs about 77,800 workers. It is a public company that is listed on the New York Stock Exchange market. Besides, it is a component of fortune 500.
Liquidity ratios show the capability of the entity offset current liabilities using liquidity assets. It is necessary to maintain optimal liquidity ratios since either low of very high ratios are not favorable. The table presented below shows the liquidity ratios of the company.
The liquidity ratios for the company were fairly high. The current ratio increased from 1.35 times in 2010 to 1.52 times in 2012. The ideal rate for current ratio is 2:1. Similarly, quick ratio increased from 1.24 times in 2010 to 1.42 times in 2012. The values are higher than the ideal rate which is 1:1. The ratios indicate the liquidity position of the company is growing stronger.
Profitability ratios give an indication of the earning capacity of an entity. The ratios measure the effectiveness of a company in meeting the profit objectives both in the long run and short run. The table presented below shows the profitability ratios of the company.
|Return on Assets %||2.59||-1.65||-0.96|
|Return on Equity %||5.65||-4.61||-3.17|
|Return on Invested Capital %||4.15||-5.93||-3.85|
|Net profit %||1.3||-0.97||-0.65|
|Gross profit margin %||34.7||33.8||33.6|
The profitability of the company declined by a large margin between 2009 and 2010. Return on equity declined from 5.65% in 2010 to (3.17%) in 2012. The industry average for return on equity is 34.56%. This implies that the return on equity for the health center was way below the performance when compared with the peers in the industry. Similarly, the return on assets declined from 2.59% in 2010 to (0.96%) in 2012.
The average for the industry is 28%. The gross profit margin for the company declined from 34.7% in 2010 to 33.6% in 2012. The industry average for gross profit margin was 47%. Further, the net profit margin for the company was 1.3% in 2010 to (0.65%) in 2012. The industry average for net profit margin is 8.9%. It can be observed that the profitability ratios for the company were quite low and negative in 2011 and 2012.
Besides, all the ratios were lower than the industry averages by a large margin. It can be deduced that the company is experiencing difficulties in managing resources. The management of the health center can improve on profitability by reviewing its pricing strategy. The price charged for products and services offered should adequately cover the cost operating the health center. Further, the management should control the cost of operation. For the company to earn profits, then costs should be minimized Zeller & Stanko, 2010).
Efficiency ratios focus on the internal operations of the company. These ratios show the level of activity in a company. It measures the productivity in allocation of resources with an aim of maximizing output and income from the resources available.
|Days Sales Outstanding||52.03||53.76||60.03|
|Cash Conversion Cycle||33.51||37||43.83|
|Fixed Assets Turnover||5.3||5.65||5.61|
The efficiency ratios improved by a small margin over the three year period. The inventory turnover increased from 122.15 times in 2010 to 130.1 times in 2012. Also, payables period declined from 21.5 times in 2010 to 19.1 times in 2012. Further, fixed asset turnover increased from 5.3 times in 2010 to 5.61 times in 2012. Further, the ratios were fairly close to the industry average.
A company’s leverage is explained by the amount of debt financing it holds. The ratios are vital since they show the extent of exposure of equity financing. A commonly used ratio is the debt to equity ratio. When analyzing debt ratios, it is important to also evaluate the ability of the organization to pay borrowing costs (Olson & Zoubi, 2008). The table presented below shows the financial leverage of the company (Ledama & Sorensen, 2009).
|Financial Leverage (Average)||2.27||3.21||3.37|
The leverage of the company increased from 2.27 times in 2010 to 3.37 times in 2012. It implies that the amount of debt in the capital structure increased by a large margin. The company needs to reduce the amount of debt in the capital structure so as to reduce leverage. This will help in attracting potential shareholders.
Abdullah, A. & Ismail, N. (2008). Disclosure of voluntary accounting ratios by Malaysian listed companies. Journal of Financial Reporting and Accounting, 6(1), 1 – 20.
Ledama, R. & Sorensen, R. (2009). Accounting for health care outcomes: implications for intensive care unit practice and performance. The Royal Society of Medicine Journals, 43(3), 97 – 102.
Olson, D. & Zoubi, R. (2008). Using accounting ratios to distinguish between Islamic and Conventional Banks in the GCC region. The International Journal of Accounting, 43(1), 45 – 46.
Zeller, T. & Stanko, B. (2010). The arrival of a new GAAP: international financial reporting standards. Journal of Business & Economics Research, 25(3), 28 – 64.