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The modern laboratory is big business. Often lost in the myriad of machines, testing, and laboratory results is the financial know-how and savvy needed to direct a pathology laboratory. This review of basic financial terms is applicable to any well-run business. One approach is called the cash flow-production cycle.

Cash Flow-Production Cycle
Balance Sheet
Debt and Equity
Operating Statement

Valuation of a Company

Laboratory Financial Reimbursement


NET INCOME (Profit or Contribution) Adding the above categories




Assets that a company has at its disposal that can be easily converted into cash within one operating cycle-an operating cycle is the time that it takes to sell a product and collect cash from the sale, usually 60-180 days

There are five main of current assets:

Cash and Equivalents
Short and Long Term Investments
Accounts Receivable
Prepaid Expenses

Cash and Equivalents
Completely liquid assets
Short and Long Term Investments

Money that cannot be immediately liquefied without some effort, but hopefully earns a higher return than cash by itself

Cash and investments that give shares immediate value and could be distributed to shareholders with minimal effort

Accounts Receivable (A/R)

Money that is currently owed to a company by its customers

Product has been delivered but has not been paid for yet

Companies routinely buy goods and services from other companies using credit and A/R is almost always turned into cash within a short amount of time

If receivables are up more than revenues, you know that a lot of the sales for that particular quarter have not been paid for yet

Allowance for doubtful accounts or bad debt

Net accounts receivable, which is equal to total accounts receivable, minus an estimate for amounts the company believes it will never collect

When a company makes a sale, it often doesn't receive the cash immediately, so while the revenue is recognized on the income statement, the amount of the sale also appears on the balance sheet as an accounts receivable

It is an estimate since no one knows exactly what percentage of accounts receivable will be impossible to collect. Thus this number may vary and in turn, may allow manipulation of the true earnings


Components and finished products that a company has currently stockpiled to sell to customers

Inventories are a dubious asset in most cases since:
Accounting systems (FIFO and LIFO) may overstate the value
Inventories tie up capital

Prepaid Expenses

Expenditures that the company has already paid to its suppliers

Can be a lump sum or a credit

These bills will not have to be paid in the future, and more of the revenues for that particular quarter will flow to the bottom line and become liquid assets


This is what a company currently owes to its suppliers and creditors

These are short-term debts that normally require that the company convert some of its current assets into cash in order to pay them off

These are all bills that are due in less than a year. As well as simply being a bill that needs to be paid, liabilities are also a source of assets. Any money that a company pulls out of its line of credit or gains the use of because it pushes out its accounts payable is an asset that can be used to grow the business

Accounts Payable
Accrued Expenses
Income Tax Payable
Short-Term Notes Payable
Portion of Long-Term Debt Payable

Accounts Payable

Money that the company currently owes to its suppliers, its partners and its employees

Basic costs of doing business that a company that has not paid off yet

Accrued Expenses

Expenses are bills that have not yet been paid

Usually marketing and distribution expenses that are billed on a set schedule and have not yet come due

Income Tax Payable

Income tax a company accrues over the year that it does not have to pay yet according to various federal, state and local tax schedule

Short-Term Notes Payable
Amount that a company has drawn off from its line of credit from a bank or other financial institution that needs to be repaid within the next 12 months
Portion of Long-Term Debt Payable
Debt come due with the year



These are assets that cannot be easily turned into cash or liabilities that will not come due for more than a year

Five main categories:
Total Assets
Long-Term Notes Payable Stockholder's/Shareholder's Equity
Capital Stock
Retained Earnings

Total Assets

Assets that are not liquid, but that are kept on a company's books for accounting purposes

The main component is plants, property and equipment and encompasses any land, buildings, vehicles and equipment that a company has bought in order to operate its business

Much of this is actually subject to depreciation for tax purposes, meaning that the stated value of the total assets and the actual value or price paid might be very different

Long-Term Notes Payable Stockholder's/Shareholder's Equity

Long-Term Liabilities are loans that are not due for more than a year

Normally loans from banks or other financial institutions that are secured by various assets on the balance sheet, such as inventories

Stockholder's or Shareholder's Equity is composed of Capital Stock and Retained Earnings

Capital Stock

Capital stock is the par value of the stock issued that is recorded purely for accounting purposes and has no real relevance to the actual value of the company's stock

Capital in Excess of Stock is any additional cash that a company gets from issuing stock in excess of par value under certain financial conventions

Retained Earnings

The money that a company has earned, less any earnings that are paid out to shareholders in the form of dividends and stock buybacks

Measures the amount of capital a company has generated and is best used to determine what sorts of returns on capital a company has produced

If you add together capital stock and retained earnings, you get shareholder's equity, the amount of equity that shareholders currently have in the company



From Operations By type of payment agreement
By type of guarantor
Deductions from Revenues Charity discounts
3rd-party payer
Policy discounts
Administrative adjustments
Nonoperating revenues  
Net Revenue Sum of three previous categories


Current Ratio

A measure of how much liquidity a company has

Current assets divided by the current liabilities

As a general rule, a current ratio of 1.5 or greater is normally sufficient to meet near-term operating needs

A current ratio that is too high can suggest that a company is hoarding assets instead of using them to grow the busines-Certain industries have their own norms as far as which current ratios make sense and which do not

If a company has a lot of its liquid assets tied up in inventory, it is very dependent on the sale of that inventory to finance operations. If the company is not growing sales very quickly, this can force the company to issue stock or take on debt

Quick Ratio

Current assets minus inventories divided by current liabilities

This eliminates inventories out of the equation so one can check and see if a company has sufficient liquid assets to meet short-term operating needs

Most people look for a quick ratio in excess of 1.0 to ensure that there is enough cash on hand to pay the bills and keep on going

The quick ratio can also vary by industry, always compare this ratio to that of peers in the same industry in order to understand what it means in context

Cash ratio

Amount of cash that a company has divided by its current liabilities, not commonly used

Another method to compare various companies in the same industry with each other in order to figure out which one is better funded


Price-to-Book Ratio

Traditional book value is the shareholder's equity divided by the number of shares of stock outstanding

Price-to-book ratio may also use the aggregate market capitalization of the company divided by the current shareholder's equity

Enterprise Value may also be used which is market capitalization minus cash and equivalents plus debt

If it is below 1.0, then it means that the company is selling below book value and theoretically below its liquidation value

Days Sales Outstanding (DSO)

Current accounts receivable DSO =Sales for period divided by days in period

Sales for period A/R Turnover =Average A/R for period

Accounts Receivables Turnover (tells you is how many times in a year a company turns its accounts receivable, higher is better)

Allows insight into how well a company is managing their credit better and getting money in faster on their sales, a way of transforming the accounts receivable number into a handy metric that can be compared with other companies in the same industry to determine which player is managing its receivables collection better (Measure of how many days worth of sales the current accounts receivable (A/R) represents)

A company with a lower amount of days worth of sales outstanding is getting its cash back quicker and hopefully putting it immediately to use, getting an edge on the competition

This tells you roughly how many days worth of sales are outstanding and not paid for at any given time. As you might have expected, the lower this number is, the better it is for the company

Inventory Turnover

Cost of Goods Sold (COGS) for the past 12 months (second entry in the Consolidated Statement of Earnings right below the balance sheet)

Add up the last four quarters worth of COGS and then find out the current inventory level

Costs of Goods Sold Expense Inventory Turnover =Average inventory for period

It is desirable forcompany to turn its inventories as often as possible during the year in order to free up that working capital to do other things.

Inventory management actually is a bottleneck for growth if it is not efficient enough, tying up a lot of working capital


Working Capital

Current assets minus current liabilities and can be positive or negative

Expression of how much in liquid assets the company currently has to build its business, fund its growth, and produce shareholder value

Market Capitalization

Value of all the shares of stock currently outstanding plus any long-term debt or preferred shares that the company has issued

If you are dealing with a company where 10% or more of the capitalization is backed up with cash, you have a company that has ample funds to get itself going


Nonoperating Expenses
(Selling, General, and Administrative)
Personnel benefits
Material and supplies
Repairs and maintainence
Rental and depreciation
Professional fees
Communication expenses
Operating Expenses  
Indirect (Overhead expenses)
Personnel benefits
Material and supplies
Repairs and maintainence
Rental and depreciation
Professional fees
Communication expenses
Outside fees (Professional and lab)


Valuation of a Company

How does one value a company or a laboratory? Here is a basic overview.


Earnings per share (EPS)

Dividing the dollar amount of the earnings a company reports by the number of shares it currently has outstanding

P/E ratio P/E ratio takes the stock price and divides it by the last four quarters' worth of earnings (trailing P/E)
PEG ratio

Annualized rate of growth out to the furthest estimate and compares this with the current stock price

If a company is expected to grow at 10% a year over the next two years and has a P/E of 10, it will have a PEG of 1.0


Price to sales ratio

Current market capitalization of a company and divides it by the last 12 months trailing revenues

The market capitalization is the current market value of a company, arrived at by multiplying the current share price times the shares outstanding

You many want to addthe current long-term debt of the company to the total current market value of its stock to get the market capitalization

Market Capitalization = (Shares Outstanding * Current Share Price) + Current Long-term Debt

If a company has a low P/E but a high PSR, there may potentially be some one-time gains in the last four quarters that are pumping up earnings per share

New companies are often priced based on multiples of revenues and not multiples of earnings



Equity Everything that a company has if it were to suddenly stop selling products and stop making money tomorrow
Working capital

Subtract a company's current liabilities from its current assets

Working capital represents the funds that a company has ready access to for use in conducting its everyday business

Shareholder's equity Includes a company's liquid assets like cash, hard assets like real estate, as well as retained earnings
Book value and Price to Book ratio

Company's shareholder's equity and divide it by the current number of shares outstanding

Stock's current price and divide by the current book value=Price-to-book ratio.

Return on Equity (ROE) Measure of how much in earnings a company generates in four quarters compared to its shareholder's equity-measured as a percentage


Dividend Yield Percentage of a company's stock price that it pays out as dividends over the course of a year


Subscriber-based valuations

Companies that generate regular, monthly income through subscriptions

Calculate the average revenues per subscriber over their lifetime and then figure the value for the entire company based on this approach

Accounts-based valuation

In the healthcare informatics industry, companies are routinely acquired based on the value of their existing accounts

These acquisitions often completely ignore the past earnings or revenues of the company, instead focusing on what additional revenue could be conceivably generated from these new accounts



Estimating the Budgetary Impact of Setting the Medicare Clinical Laboratory Fee Schedule at the National Limitation Amount

Ronald L. Weiss, MD
David Sundwall, MD
and John M. Matsen, MD

Am J Clin Pathol 2002;117:791-796 Abstract quote

The Institute of Medicine (IOM) of the National Academy of Sciences was commissioned by Congress to study the current system for the payment of diagnostic clinical laboratory services provided to Medicare beneficiaries.

The current system was established in 1984 and has grown in complexity and is of diminishing contemporary relevance. The IOM recommended that a single, rational, national fee schedule be established and that it be initially based on the National Limitation Amount (NLA) currently mandated as the national fee cap. To estimate the potential budgetary impact of this recommendation, we merged the 1999 Part B Extract and Summary System and the 1999 Clinical Diagnostic Laboratory Fee Schedule (CLFS). By using an estimated 193 million allowed services from this data set and the current mean fee of $9.14 per test, current spending is approximately $1,768 million. The impact of raising the CLFS to the NLA will be approximately $1,792 million, or $9.26 per test.

The estimated cumulative budgetary effect, factoring in the current forecast for the Consumer Price Index, is an increase of approximately $993 million over 5 years and $2,359 million over 10 years.

Clinical Laboratory Management. 1997. Williams and Wilkins.
Analysis for Financial Management Sixth Edition. 2001 McGraw-Hill.

Commonly Used Terms

FIFO-First in, first out

GAAP-Generally accepted accounting principles

LIFO-Last in, first out

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Last Updated 8/15/2002

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