Financial Statement Analysis for HCA, Inc and Community Health Systems - Assignment Example

HCA & CHS: Preparing for the Financial Analysis Nanyail Smoke Post The purpose of this paper is to provide present to present the computations and insights for the final financial statement analysis for HCA, Inc. and Community Health Systems. This will help prospective investors willing to invest in the healthcare sector to evaluate the optimal organization to invest his capital. Both companies operate under the healthcare sector. In addition, the two organizations are public listed firms in New York Stock Exchange (NYSE). The computations were performed using Gibson (2013), supplemental Excel worksheet provided with the text.The financial data included in the worksheet were retrieved from the firm’s SEC filings for years 2008 to 2012. HCA & CHS: Preparing for the Financial Analysis There are many reasons for someone to explore a firm’s financial statements. Investors use it to explore potential returns on their capital investment, managers explore to assess performance, and the government reviews them for legal compliance. The final analysis for HCA & CHS will be presented from the prospective of the investor. In order for the investor to understand the return on an investment, he/she must examine the firm’s quality earnings. Quality earnings are different from profit. Profit could mean the firm is just breaking the even point that enables the firm from incurring losses. Maybe the profits are being absorbed by debt. Many firms hide debt in the financial statement notes. Consequently, investors willing to invest in a given organization should not evaluate the viability of the investment from the face value of the financial statements. Assessing a firm’s worth involves a deeper understanding of the firm and its industry. Ratio analyses are very useful in that understanding. In the next few pages, you will find a vertical ratio and horizontal analysis for subject firms. Reading the financials HCA’s financial data was easy to comprehend due to the concise and clear presentation of the consolidated statements. In addition, the accompanying financial notes helped in understanding the origin of the figures in the financial statements. Most of its financial data are easily translated into terminology used in the Excel template. The financial data of HCA was presented in the millions while Community Health Services was listed in the thousands. To make the two firms’ financial statements more comparable, Community Health Services numbers were divided by 1000 to convert it to millions. Cost of goods sold for the firms is actually labeled “Revenues before the provision for doubtful”. The healthcare industry has a large provision for doubtful accounts, primarily due to its payer mix. Each insurance provider has a set agreed upon amount for services rendered. Anything over that amount has to be written off. Prior to the year 2009 both HCA and Community Health Systems listed the item as an expense on the income statement. It is now included in the revenue section of the income statement. Another item worth mentioning is “Electronic health record incentive income” prior to 2010 where the income did not exist. They are funds received from the government to help the hospitals convert patient data to electronic database. Community Health Systems has more extraordinary and unusual items listed. It also seemed the majority of its facility, which HCA was investing in, was under construction. In fact, HCA’s fixed assets were almost equal to the accumulated depreciation value. As far as profits are concerned, HCA has recognized more revenue. Its gross profits have consistently been around 90%. However, the firm had negative equity. Five years ago, its equity ratio was –37.50 and was -29.71 for the most recent reporting year. Without a complete analysis, one would assume Community Health Systems is in a better financial position. Its long-term debt ratio is roughly 76% versus HCA’s roughly 98%. Conversely, Community has a higher interest expense, possibly associated with capital leases. During the preparation of the analysis, it was noticed that Community Health appeared to be selling off unprofitable operations. The final analysis should reveal the firm’s true level of debt. Since 2008, both firms have recognized a significant amount increase in their revenue. If the trend continues, both firms could recognize at least a 10% increase. The operation expenses seem to be following the same trend. However, more research may be needed to explore the difference in the firms’ cost of goods sold. HCA appears to be doing a better job at keeping its provisional bad debt down. Vertical and Horizontal Analysis of the HCA and CHS Financial Statements The vertical and horizontal analysis illustrates the financial trend of the two organizations over the last five years. This is significant in reflecting the financial growth of each firm to establish the most viable investment firm an investor should consider in investing his capital. Consequently, the financial statements of the two firms’ analysis using vertical and horizontal analysis below will be utilized in comparing and contrasting the financial strength and weakness of each firm. FinSAS Version 2008010211 Vertical Analysis Company: HCA, Inc. (All numbers in millions of US Dollars) Analyst: Nanyail Smoke Most Recent Year Available: 2012 Years Available for: Income Statement (1-5) 5 Balance Sheet (1-5) 5 = = = = = = INCOME STATEMENT 2012 2011 2010 2009 2008 - ---------- ---------- ---------- ---------- ---------- Net Sales 100.00% 100.00% 100.00% 100.00% 100.00% Less: Cost of Goods Sold 10.25% 8.69% 8.63% 10.90% 12.01% ---------- ---------- ---------- ---------- ---------- Gross Profit 89.75% 91.31% 91.37% 89.10% 87.99% Other Operating Revenue 0.91% 0.65% 0.00% 0.00% 0.00% Less: Operating Expenses 73.01% 74.11% 73.16% 71.71% 72.65% ---------- ---------- ---------- ---------- ---------- Operating Income 17.66% 17.85% 18.21% 17.39% 15.33% Less: Interest Expense 4.89% 6.27% 6.83% 6.61% 7.12% (no capitalized interest) Other Income (Expenses) -4.56% -4.51% -4.63% -4.74% -4.99% Unusual or Infreq. Item; Gain (Loss) -0.43% 3.08% -0.39% -0.19% 0.12% Equity in Earnings of Assoc.; Profit (Loss) 0.10% 0.79% 0.92% 0.82% 0.79% ---------- ---------- ---------- ---------- ---------- Income before Taxes 7.87% 10.95% 7.27% 6.66% 4.12% Less: Taxes Related to Operations 2.41% 2.21% 2.14% 2.09% 0.94% ---------- ---------- ---------- ---------- ---------- N.I. before Min. Ern. 5.45% 8.74% 5.13% 4.58% 3.18% Minority Share of Earnings (Loss) -1.09% -1.16% -1.19% -1.07% -0.81% ---------- ---------- ---------- ---------- ---------- N.I. before Nonrecurring Items 4.36% 7.58% 3.93% 3.51% 2.37% Oper. of Discontinued Segment; Income (Loss) 0.00% 0.00% 0.00% 0.00% 0.00% Disposal of Discont. Segment; Gain (Loss) 0.00% 0.00% 0.00% 0.00% 0.00% Extraordinary Item; Gain (Loss) 0.00% 0.00% 0.00% 0.00% 0.00% Cum. Effect of Acct Change; Gain (Loss) 0.00% 0.00% 0.00% 0.00% 0.00% ---------- ---------- ---------- ---------- ---------- Net Income (Loss) 4.36% 7.58% 3.93% 3.51% 2.37% = = = = = = BALANCE SHEET 2012 2011 2010 2009 2008 - --------- --------- --------- --------- --------- ASSETS Current Assets: Cash 2.51% 1.39% 1.72% 1.29% 1.92% Marketable Securities 0.00% 0.00% 0.00% 0.00% 0.00% Gross Receivables 16.64% 16.85% 16.07% 15.30% 15.57% Less: Allowance for Bad Debts 17.26% 15.27% 16.51% 20.14% 19.53% Net Trade Receivables Inventories 3.87% 3.92% 3.76% 3.32% 3.04% Prepaid Expenses 1.37% 2.21% 3.90% 4.94% 3.76% Other Current Assets 3.26% 2.52% 3.56% 2.40% 1.67% --------- --------- --------- --------- --------- Total Current Assets 27.65% 26.89% 29.01% 27.26% 25.95% Long-Term Assets: Net Tangible (Fixed) Assets (other than construction in progress) 101.80% 100.67% 104.66% 98.98% 93.46% Construction in Progress 3.38% 3.71% 2.84% 3.25% 4.21% Intangible Assets 19.73% 19.52% 11.29% 10.68% 10.63% Investments 2.20% 2.41% 6.33% 8.37% 9.32% Other Non-operating Assets -58.21% -56.66% -59.91% -54.88% -50.19% Other Operating Assets 3.45% 3.46% 5.77% 6.34% 6.61% --------- --------- --------- --------- --------- Total Long-Term Assets 72.35% 73.11% 70.99% 72.74% 74.05% Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% LIABILITIES AND EQUITY Current Liabilities: Accounts Payable 6.30% 5.94% 6.44% 6.05% 5.64% Short Term Loans 0.00% 0.00% 0.00% 0.00% 0.00% Current Maturity of L.t. Debt 5.11% 5.23% 2.48% 3.51% 1.66% Other Current Liabilities 10.58% 9.48% 8.97% 8.32% 8.80% --------- --------- --------- --------- --------- Total Current Liabilities 21.98% 20.65% 17.90% 17.87% 16.10% Long-Term Liabilities: Long-term Debt 97.93% 95.34% 115.85% 102.87% 109.49% Reserves 0.00% 0.00% 0.00% 0.00% 0.00% Deferred Liabilities 3.47% 3.69% 4.17% 4.38% 4.56% Minority Interest 0.00% 0.00% 0.00% 0.00% 0.00% Redeemable Preferred 0.00% 0.00% 0.00% 0.00% 0.00% Other Long-term Liabilities 6.33% 6.39% 6.74% 7.33% 7.34% --------- --------- --------- --------- --------- Total Long-term Liabilities 107.73% 105.43% 126.77% 114.58% 121.40% Total Liabilities 129.71% 126.08% 144.66% 132.45% 137.50% Shareholders Equity: Preferred Equity 0.00% 0.00% 0.59% 0.61% 0.64% Common Equity-incl. Ret. Ern. -29.71% -26.08% -45.25% -33.06% -38.14% --------- --------- --------- --------- --------- Total Equity -29.71% -26.08% -44.66% -32.45% -37.50% Total Liabilities and Equity 100.00% 100.00% 100.00% 100.00% 100.00% = = = = = = The vertical analysis of the two firms illustrated above depicts that HCA has a better financial performance and position to CHS. This is reflected by the income statement and balance sheet trend of each firm over the last five years. The income statement of the two firms demonstrates that HCA has been generating higher income from the net revenue it generates compared to CHS organization. This implies that the management of CHS has not been efficient in controlling the expenses incurred by the firm due to the low net income accumulated from the net revenue compared to the management of HCA firm (Warren, 2013). Consequently, investors investing in CHS have the potential of earning low returns compared to investors in HCA. Even though the net income proportion of CHS has been growing over the last five years compared to that of HCA, the percentage of net income in CHS is relatively low to maximize the wealth of investors. Accordingly, rational investors prospecting to invest in the healthcare sector should consider investing in HCA compared to CHS due to it high potential of expanding their wealth in future (Zelman, McCue, & Glick, 2009). However, the vertical analysis on the balance sheet of the two firms depicts that the financial position of CHS is relatively better compared to that of HCA. This is depicted by the capital structure of the two firms. The capital structure of HCA depicts that the firm is financed by debt in the last five years. This is due to the negative percentage of the equity financing in the vertical analysis in the last five years while the debt financing is over 100%. Accordingly, the ability of the firm in accessing debt financing to finance it future investment expansion that are essential in enhancing the earning of a firm are limited (Beyer, 2010). This means that CHS has a higher potential of expanding it investment in future to earn high revenue compared to HCA. Thus, the capital structure of the two firms illustrates that it is rational to invest in CHS. Similarly, the percentage of the current assets and current liabilities for the two firms reflects that it is rational to invest in CHS. This is because the margin between the current assets and current liabilities for CHS is high compared to that of HCA. Consequently, CHS has a better capability of offsetting it current liabilities compared to HCA that is essential in enabling a firm to acquire essential raw materials required in daily operations (Warren, 2013). This will enable CHS to operate smoothly to generate high revenue and attract patients compared to HCA. FinSAS Version 2008010211 Horizontal Analysis Company: HCA, Inc. (All numbers in millions of US Dollars) Analyst: Nanyail Smoke Most Recent Year Available: 2012 Years Available for: Income Statement (1-5) 5 Balance Sheet (1-5) 5 = = = = = = INCOME STATEMENT 2012 2011 2010 2009 2008 - ---------- ---------- ---------- ---------- ---------- Net Sales 129.64% 114.56% 108.14% 105.91% 100.00% Less: Cost of Goods Sold 110.59% 82.84% 77.68% 96.10% 100.00% ---------- ---------- ---------- ---------- ---------- Gross Profit 132.24% 118.89% 112.30% 107.25% 100.00% Other Operating Revenue #N/A #N/A #N/A #N/A #N/A Less: Operating Expenses 130.27% 116.86% 108.90% 104.54% 100.00% ---------- ---------- ---------- ---------- ---------- Operating Income 149.28% 133.37% 128.38% 120.11% 100.00% Less: Interest Expense 88.97% 100.79% 103.76% 98.32% 100.00% (no capitalized interest) Other Income (Expenses) 118.57% 103.46% 100.35% 100.64% 100.00% Unusual or Infreq. Item; Gain (Loss) -484.85% 3036.36% -360.61% -175.76% 100.00% Equity in Earnings of Assoc.; Profit (Loss) 16.14% 115.70% 126.46% 110.31% 100.00% ---------- ---------- ---------- ---------- ---------- Income before Taxes 247.35% 304.36% 190.68% 171.11% 100.00% Less: Taxes Related to Operations 331.34% 268.28% 245.52% 233.96% 100.00% ---------- ---------- ---------- ---------- ---------- N.I. before Min. Ern. 222.39% 315.08% 174.39% 152.44% 100.00% Minority Share of Earnings (Loss) 175.11% 164.63% 159.83% 140.17% 100.00% ---------- ---------- ---------- ---------- ---------- N.I. before Nonrecurring Items 238.48% 366.27% 179.35% 156.61% 100.00% Oper. of Discontinued Segment; Income (Loss) #N/A #N/A #N/A #N/A #N/A Disposal of Discont. Segment; Gain (Loss) #N/A #N/A #N/A #N/A #N/A Extraordinary Item; Gain (Loss) #N/A #N/A #N/A #N/A #N/A Cum. Effect of Acct Change; Gain (Loss) #N/A #N/A #N/A #N/A #N/A ---------- ---------- ---------- ---------- ---------- Net Income (Loss) 238.48% 366.27% 179.35% 156.61% 100.00% = = = = = = BALANCE SHEET 2012 2011 2010 2009 2008 - ---------- ---------- ---------- ---------- ---------- ASSETS Current Assets: Cash 151.61% 80.22% 88.39% 67.10% 100.00% Marketable Securities #N/A #N/A #N/A #N/A #N/A Gross Receivables 123.60% 119.92% 101.38% 97.67% 100.00% Less: Allowance for Bad Debts 102.21% 86.61% 83.08% 102.51% 100.00% Net Trade Receivables #REF! #REF! #REF! #REF! #REF! Inventories 147.35% 143.01% 121.71% 108.82% 100.00% Prepaid Expenses 42.12% 64.99% 101.86% 130.42% 100.00% Other Current Assets 225.93% 167.65% 209.38% 142.96% 100.00% ---------- ---------- ---------- ---------- ---------- Total Current Assets 123.20% 114.79% 109.81% 104.38% 100.00% Long-Term Assets: Net Tangible (Fixed) Assets (other than construction in progress) 125.94% 119.33% 110.01% 105.26% 100.00% Construction in Progress 92.76% 97.55% 66.34% 76.71% 100.00% Intangible Assets 214.69% 203.53% 104.38% 99.88% 100.00% Investments 27.34% 28.67% 66.74% 89.18% 100.00% Other Nonoperating Assets 134.12% 125.08% 117.27% 108.67% 100.00% Other Operating Assets 60.34% 57.97% 85.74% 95.33% 100.00% ---------- ---------- ---------- ---------- ---------- Total Long-Term Assets 112.98% 109.38% 94.18% 97.64% 100.00% Total Assets 115.63% 110.78% 98.24% 99.39% 100.00% LIABILITIES AND EQUITY Current Liabilities: Accounts Payable 129.05% 116.57% 112.19% 106.57% 100.00% Short Term Loans #N/A #N/A #N/A #N/A #N/A Current Maturity of L.t. Debt 355.20% 348.27% 146.53% 209.41% 100.00% Other Current Liabilities 139.00% 119.38% 100.19% 93.96% 100.00% ---------- ---------- ---------- ---------- ---------- Total Current Liabilities 157.85% 142.05% 109.18% 110.31% 100.00% Long-Term Liabilities: Long-term Debt 103.42% 96.46% 103.94% 93.38% 100.00% Reserves #N/A #N/A #N/A #N/A #N/A Deferred Liabilities 87.82% 89.62% 89.80% 95.40% 100.00% Minority Interest #N/A #N/A #N/A #N/A #N/A Redeemable Preferred #N/A #N/A #N/A #N/A #N/A Other Long-term Liabilities 99.66% 96.52% 90.24% 99.21% 100.00% ---------- ---------- ---------- ---------- ---------- Total Long-term Liabilities 102.61% 96.21% 102.58% 93.80% 100.00% Total Liabilities 109.08% 101.58% 103.35% 95.74% 100.00% Shareholders Equity: Preferred Equity 0.00% 0.00% 90.97% 94.84% 100.00% Common Equity-incl. Ret. Ern. 90.08% 75.75% 116.57% 86.16% 100.00% ---------- ---------- ---------- ---------- ---------- Total Equity 91.61% 77.03% 117.00% 86.01% 100.00% Total Liabilities and Equity 115.63% 110.78% 98.24% 99.39% 100.00% = = = = = = The horizontal analysis of the two firms illustrated above depicts the trend of the financial items in the income statement and balance sheet over the last five years. This is critical in reflecting how each firm has been enhancing it operation efficiency to improve it financial performance and position. Accordingly, the horizontal analysis of the financial statements of the two firms reflects that HCA has improved it operation more compared to CHS firm. This is depicted by the movement of income statement and balance sheet elements in the last five years. The revenue generation of HCA in that last five years has been growing at a high margin compared to that of CHS as illustrated by the income statement analysis. Thus, the organization ability in penetrating the market to generate revenue is high compared to that of CHS. This means that HCA has a high potential of gaining a high market share that is critical in expanding the wealth of a firm. This will benefit it shareholders due to the high returns it will be able to accumulate through economies of scale. Similarly, the gross profit and net income of HCA has been growing at a higher margin compared to that of CHS. This is crucial in expanding the earning of the investors in future. The high net income and gross income in HCA compared to that of CHS means the dividend that investors of HCA will be receiving in future compared to shareholders of CHS will be higher. Consequently, it is rational for a prospecting investor willing to invest in the healthcare sector to invest in HCA compared to CHS Incorporation. However, the balance sheet analysis through horizontal analysis depicts that the financial position of CHS has been growing relatively higher compared to that of HCA. The horizontal analysis illustrates that the operation capacity of CHS has grown larger compared to HCA Incorporation. The capital structure of HCA has grown by 15.63% from 2008 while that of CHS has expanded by 44.33% as reflected in the horizontal analysis of the two firms’ balance sheet. This means that CHS has improved it operation capacity compared to that of HCA to enable it to serve it clients. Consequently, the firm will be able to generate high revenue in future due to it efficient operation capacity it has been investing in the last five years. This will boost it returns in future compared to HCA that has a lower operation capacity expansion. Thus, it is advisable for investors intending to invest in the healthcare sector to earn high returns in future to invest in CHS Incorporation. This will enable them to earn high returns in future due to the capacity investment the firm has been undertaking in the last five years compared to HCA Incorporation. Financial Ratios of HCA and CHS Analysis Financial ratios undertaken for the two firms are critical in comparing and contrasting the financial strength of the firms. This is due to the capacity of the financial ratios in depicting the financial performance and position of each of the analyzed firm. Consequently, the financial ratios undertaken will enable external users of financial information in understanding the financial strength of each firm. This will enable the external of the financial statements released in making informed decision in investing in any of the firm. Similarly, the management of the two organization will be able identify the weak areas that are derailing the growth and profitability of their firm. Thus, they will be able to cushion on financial trends that are endangering the capacity of the firm in expanding and increasing it profitability. The financial ratio analyses of the two firms have been undertaken through liquidity, solvency, profitability and investor analyses. The liquidity analysis illustrates the ability of the firms in meeting their current financial obligations. Consequently, the liquidity analysis fro the two firms in the last five years reflects that CHS has a better ability in meeting it current financial ability compared to HCA firm. This means CHS will be able to acquire raw materials from the suppliers at a credit easily compared to HCA. This will enable CHS to operate smoothly in it daily activities due to availability of essential goods and services from the providers on credit compared to HCA. Similarly, the solvency ratio that measures the ability of a firm in repaying it debts illustrates that CHS has a better financial capacity compared to HCA. This is depicted by the debt ratio and equity-debt ratio. The debt ratios for HCA firm in the last five years depicts that the firm has been acquiring it assets exclusively through debt financing. Similarly, the equity financing has been negative illustrating that the owners of the firm owes the firm finances. In contrast, the financing of CHS in acquiring it assets in the last years has been through both debt and equity financing. Even though the financing of acquiring assets through debt has been high in CHS, it is below a 100%. Consequently, the ability of the CHS in soliciting for debt financing it investment expansion at a low interest rate is high compared to HCA. This will hinder HCA in expanding it operation investment in future compared to CHS. Thus, CHS will be able to generate high revenue in future through it investment expansion compared to HCA. However, the interest earned ratio reflects that the ability of HCA in paying it interest amounts is relatively better than that of CHS. This will enable HCA to attract a low interest rate due to it low default risk compared to CHS. The profitability ratio that measures the ability of firm in giving returns to the investment illustrates that a rational investor should invest in CHS. This is depicted by the return on equity that shows the returns investors should expect from their capital investment. The return on equity for the two firms in the last five years reflects that investors in CHS should expect positive returns while investors of HCA should expect negative returns. Consequently, the profit the HCA will be making will not be enjoyed by the shareholders compared to shareholders of HCA. However, the profitability ratios illustrates that the management of HCA has been efficient in managing the resources and expenses of the organization. This is depicted by the high asset turnover ratio, returns on asset, gross profit margin and return on investment compared to that of CHS. Thus, the growth potential of HCA is relatively better than that of CHS in promoting the profitability of the firm. The investor analysis depicts that ability of the CHS in repaying it debts using tangible assets is better compared to that of HCA. Thus, investors willing to lend the two firms finance to expand their investment in future will consider lending to CHS. In addition, the interest rate that will be charged on CHS will be lower compared to HCA due to a low default risk. Conclusion and Recommendation The financial analysis that has been carried out in HCA and CHS is crucial in allowing investors prospecting to invest in the healthcare sector to identify the suitable firm. This is due to the financial analysis that has been conducted that demonstrates the financial performance and position in the last five years. The vertical and horizontal analyses are essential in demonstrating the financial trend of the firms in the last five years. Similarly, the financial ratios are crucial in reflecting the strength, weaknesses and opportunities of the firms that has the potential of affecting the wealth maximization of a shareholder in future. Consequently, the optimal decision for a prospecting investor in the healthcare sector through any of these two firms should invest in CHS Incorporation. This is due to the potential of the firm in expanding the earning of the investor in future compared to HCA. Even though HCA net income has been higher compared to that of CHS, the capital structure of the firm will hinder high returns for an investor in future. Indeed, investors investing in HCA will expect negative returns in future while those of CHS will earn positive returns. Furthermore, the potential of HCA in expanding it investment in future is hindered compared to CHS due to it capital structure. Consequently, rational investors should consider investing in CHS to HCA due to it positive financial promises in future. References Beyer, S. ( 2010). International Corporate Finance - Impact of financial ratios on long term credit ratings: Using the automotive examples of BMW Group, Daimler Group and Ford Motor Company. München: GRIN Verlag GmbH. Warren, C. S. (2013). Financial and managerial accounting. Cincinnati: South-Western. Zelman, W. N., McCue, M. J., & Glick, N. D. (2009). Financial management of health care organizations: An introduction to fundamental tools, concepts, and applications. San Francisco: Jossey-Bass. Community Health Systems (CHS). (2013). Sec filings and detailed financials. Retrieved from http://chs.net/investor/sec.html Gibson, C.H. (2013). Financial Reporting and Analysis 13th Edition. South-Western Cengage Learning. Mason, Ohio. HCA, Inc. (2013). Sec filing. 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