Basic Accounting & Financial Records/Financial Ratio Analysis
Terms
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For-Profit Organizations
1. Primary Purpose -
2. Examples in Pharmacy - -
1. To provide financial return on shareholder's investment
2. Community pharmacies, long-term care & home health care pharmacies, pharmaceutical industry, some hospitals -
Not-for-profit Organizations
1. Primary Purpose -
2. Examples in Pharmacy - -
1. Provide services to those that may not otherwise obtain them from a for-profit
2. Most hospitals, community health centers, government health care facilities, most academic institutions - Can a not-for-profit organization NOT earn a profit on their operations ove3r the long-term?
- NO - all organizations must bring in more than they spend to remain operating
- What do not-for-profit organizations do with their profits?
- Reinvest back into the organization; generally NOT taxed
- What can for-profit organizations do with their profits?
- Profits can be spent however owners see ift & generally are taxed
- Sales
- $ generated from prescriptions, OTCs, services, etc.
- Net Sales
- True amount of sales generated; total sales - (merchandise returned, refunds, deductions from TPs, discounts)
- Cost of Goods Sold (COGS)
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The amount of goods sold in a given time period in terms of their cost to the pharmacy
-sell a prescription, COGS is cost of drug - Gross Margin
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= Net sales - COGS
1. Money that can be used to cover operating expenses & provide a profit
2. Gross margins are under pressure in pharmacies - high cost of drugs & consumers wanting control of what they pay - Operating Expenses
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-Does NOT include the cost of drugs or other items that are sold
-Ex: wages, utilities, rent/mortgage, licenses/fees, supplies, equipment, depreciation - Depreciation
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-A method of calculating the expense of an asset over its entire useful life
-Usually only fixed assets - Methods of Depreciation
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1. Straight-line: initial value of asset/# of years it is used = depreciation/year
2. Accelerated - depreciates a lot in early years and less in later years (cars, computers) - How does depreciation show up on an income statement?
- It shows up on each year of the life of the asset, not all at once
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True/False:
Depreciation does NOT impact cash flow - TRUE
- Net Income Before Income Taxes aka "Net Profit Before Income Taxes"
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= Gross margin - operating expenses
-Businesses pay income taxes on this amount, the rest is spent at the discretion of the owners or reinvested inot the organization - Balance Sheet
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-Keeps track of what a business owns, owes, and investments
-Snapshot of a point in time - Types of Assets
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1. Current Assets
2. Fixed Assets
3. Intangible Assets - Current Assets
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-Assets that are cash, or can be turned into cash quickly
-Will be used up quickly (<1 year)
-Ex: accounts recievable (owed to pharm), drugs, supplies, cash/checking/savings/stocks/bonds - Fixed Assets
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-Will not be used w/in a 1 year period
-Assets that will be of use in the long term, not used up immediately
-Ex: equipment, furniture/fixture, computer hardware/software, buildings, land - Intangible Assets
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-Something of value to a business that is not tangible
-Very hard to place a $ value on
-Many lenders won't accept these assets when pharmacies are applying for loans/credit
-Ex: value of a brand name, value of a key employee, value of pharm. education/pharmacist license - Liabilities
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-What is owed by a business to others
-Current/Long-term - Current Liabilities
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-Amounts that are owed that are due in the short term (one year or less)
-Ex: accounts payable (drugs/supplies), accrued debts (to employees), current portion of long-term debt(portion of mortgage) - Long-term Liabilities
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-Owed at any given time but are not due w/in one year
-Ex: bank loan, mortgages - Net Worth
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"Equity" or "Owner's Equity"
= Assets - Liabilities
-Includes owner's original investment, subsequent investments, and any profits - The balance sheet MUST follow what equation?
- Total Assets = Total Liabilities + Net Worth
- Factors impacting financial performance monitored at individual pharmacies:
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a. Daily & weekly rx counts
b. Inventory levels & purchasing practices
c. % of prescriptions filled w/ generics
d. employee hours worked - including overtime
e. partial fill %
f. shrinkage: shoplifting, employee theft, lost/spoiled/unsalable goods - Financial Ratio Analysis
- A method examining the financial performance of a business using information from income statements & balance sheets to detect trends & problems
- Why use financial ratio analysis?
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1. Objective
2. Pinpoint areas where changes could improve financial performance.
3. Monitor changes that occur over time (trend analysis).
4. Compare financial performance of different pharmacies - Tests of Profitability
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1. Gross Margin %
2. Net Income % - Grose Margin Percentage
- Measures the profitability of a business BEFORE operating expenses are paid
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TRUE/FALSE:
Gross margin % is steady for pharmacies vary based on the type of operation. - FALSE: Gross margin % VARIES for pharmacies based on the type of operation.
- Regardless of the gross margin %, what ulitmately is important is that the gross margin dollars a pharmacy generates are high enough to __________________.
- cover their expenses and provide an adequate profit.
- As the % of prescriptions paid for by managed care plans has increased, gross margin percentage for pharmacies has __________.
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DECREASED
-volume purchased by managed care
-lack of bargaining power of pharmacies - How can pharmacies improve their gross margin?
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a. Lower cost of goods sold
b. Price products & services effectively
c. Encourage use of generic drugs when appropriate
d. Accept only favorable 3rd party contracts - Net Income Percentage (Net Profit Percentage)
- Examines a pharmacies profitability after all drug costs & operating espenses have been accounted for
- How can you improve net profit?
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a. Decrease operating expenses & COGS
b. Increase gross margin
c. Increase sales at a higher rate than your costs increase - Tests of Liquidity (2)
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1. Current Ratio (CR)
2. Quick Ratio (QR) - Tests of Liquidity Measures...
- ...a business's ability to convert its current assets into cash to pay its current liabilities.
- Current Ratio (CR)
- Compares current assets to current liabilities. Creditors look at this before deciding to exted a pharmacy credit.
- For most pharmacies, the current ratio should be between ___ and ___.
- 2 and 5
- If a pharmacy's current ratio falls below 2...
- it's a sign the pharmacy will not be able to pay its debts on time
- If a pharmacy's current ratio is above 5...
- they mat gave too much money invested in current assets
- Quick Ratio or "Acid Test"
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Similar to CR, but only considers assets that are cash or could be converted into cash quickly.
Signal of a pharmacy's ability to pay off bills quickly w/o selling inventory. -
TRUE/FALSE
Regarding Quick Ratio:
Inventory is considered an asset that can be turned into cash quickly -
FALSE
inventory is NOT an asset that can be turned into cash quickly - For pharmacies, the quick ratio should be between __ and __.
- 1 and 2
- Quick ratios above 2...
- pharmacy may not be allocating its assets efficiently
- Most effective way to improve the QR is to...
- decrease inventory as much as possible w/o sacrificing sales
- Tests of Solvency
- Describe a firm's overall ability to pay its legal debts over the long term.
- Debt
- -Funds lent to a business/individual
- Advantages of Debt
- Conveys no ownership/control to lender, so a business can keep all of its profits
- Disadvantages of Debt
- Increased financial risk, since a business & individuals are legally obligated to make payments on debt