Assignment: Debt to Capitalization
Total margin is the excess of revenues over expenses divided by total operating revenue and reflects profits from both operations and nonoperations (typically investment income). Higher values indicate profitability.
• Return on Net Assets
Excess of revenues over expenses Net assets
Return on net assets (or equity for for-profit organizations) is the basic measure of profit in relationship to investment. Higher values reflect profitability.
Asset effIcIency rAtIos
Asset efficiency ratios reflect an organization’s ability to be efficient by measuring the relationship between revenue and assets. For purposes of these ratios, total revenue includes net nonoperating gains.
• Total Asset Turnover
Total operating revenue + Other income Total assets
Total asset turnover is the basic measure of how efficiently an organization is using its assets in relation to making revenue. Higher values usually indicate higher efficiency; however, older facilities with assets that are mostly depreciated may appear to be efficient because of a low numerator. W. Cleverley, J. Cleverley, and Song (2010) recommend calculating the age of plant ratio to determine whether efficiency or an older facility is causing a high total asset turnover ratio. The formula to determine the average age of a facility is
Current asset turnover measures how efficiently an organization is using its current assets in relation to generating revenue. Higher values indicate higher efficiency and can be obtained by increasing revenue proportionately more than current assets or decreasing current assets proportionately more than total revenue.
• Inventory Turnover
+Total operating revenues Other income Inventory
Inventory turnover measures the number of times an organization turns over its inventory rela- tive to total operating revenue and other income. Low values usually indicate overstocking
Capital structure ratios reflect the organization’s long-term liquidity by measuring a vari- ety of relationships to capital. Capital structure ratios are used by banks and bond rating agencies to determine creditworthiness.
• Net Asset Financing
×Net assets Total assets
Net asset financing (or equity financing for for-profit organizations) measures the relationship between assets owned by the organization (i.e., assets minus liabilities) and total assets. This ratio is nondirectional; higher values are usually preferable. However, high-performing hospitals use debt financing, which lowers this ratio, but not excessively.
• Long-Term Debt to Capitalization
+ ×Long-term debt
Long-term debt Net assets 100
Long-term debt to capitalization measures the relationship between long-term debt and assets owned by the organization. Lower values are preferable, whereas higher values imply a greater reliance on debt financing and may indicate a reduced ability to take on additional debt.
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