By Eric C. Resnick, CPA

Published March 2008

Most medical practitioners are focused on providing professional services to their patients rather than the financial aspects of the practice. In reality, managing the operations of a medical practice is no different than running any other business. Any difference that does exist lies, not in the type of business, but in the mindset of the owners.

In most cases, medical professionals are not trained in business management. They receive little business education in medical school. Consequently, many doctors may feel less confident in dealing with business issues. In fact, in many cases what initially drew them to their profession may be a polar opposite to what draws others into the business world of manufacturing or other service-based businesses.

This does not mean that physicians cannot and/or should not understand the business side of their practice, but they need an experienced and qualified team to do so.

Some practitioners measure financial progress on two occasions: first, prior to year-end when attention turns to how much is owed in taxes and, secondly, if a paycheck is held because there is not enough cash flow to support the practice.

While planning for the final tax bill during the month or two prior to year-end is a crucial exercise, measuring financial progress throughout the year may alleviate the stress that emanates from this process.

Every business should set a budget at the beginning of the year and compare it against actual results throughout the year.

A budget is best prepared by someone with good financial experience. If the office manager is more suited to managing the practice and is limited in financial expertise to writing and posting checks, then an accountant should assist with the budget-preparation process. At first, a budget is based on the practice’s prior year results with adjustments for inflation. Next, take expected variables of the next year into account, such as changes in staffing levels and office space or purchases of equipment.

A budget achieves many goals. A budget can forewarn of any peaks and valleys in cash flow and provides time to address those valleys. The practice’s bank line-of-credit may need to be expanded in advance as the financing process requires time. Having a budget helps guide you in determining what a realistic amount of compensation is available for shareholders. Comparison between the actual and the budget also reveals anomalies in revenues and expenditures. A practice can take immediate action if it finds that there are significant variances from budget. The variance could result from embezzlement or poor internal controls (as well as pure economic changes). It is better to catch any irregularity right away before the culprit has left the practice or while the financial issue can be addressed.

Budgets should be compared to actual results at least once a month by the shareholders and company financial personnel.

A practice can have a sizable patient list, excellent facilities, staff and expertise, but without a reliable cash flow, it may have difficulty operating. There are a few simple formulas that are vital in assessing the strength of the practice’s cash flow. These ratios are also used by banks when determining strength of cash flow.

The current ratio is calculated as current assets divided by current liabilities. For a medical practice, current assets include primarily cash, collectible receivables and supplies; while current liabilities consist principally of payroll tax liabilities, accrued pension expense and notes that must be repaid within one year. This ratio is an indication of a practice’s ability to meet short-tem debt obligations; the higher the ratio, the more liquid the practice. A ratio of 1.2 to 1 or greater is ideal.

Turnover of receivables is another important indicator of cash flow. Of course, it is best to collect the co-pay up front and minimize receivables. The receivables from patients can be reduced by collecting patient fees during check in. The receivables turnover ratio is calculated as annualized revenue divided by the average receivable balance, net of adjustments. The higher the turnover, the better the cash flow. A practice should aim for turnover to approach 12.0 times per year, or in other words, not to exceed 30 days average receipt.

Insurance payments make up the largest portion of revenue, and for the most part, given strong billing controls, timing of payments cannot be controlled. Reduce billing disputes by submitting requests with proper coding and educate patients about what is and is not covered by their insurance.

An average reduction in receivables of $200,000 through improved collections saves a practice that utilizes a bank line-of-credit about $16,000 per year. This is more savings than if you hired a part-time employee to improve collections.

Most practices run profit and loss (income) statements on the modified cash basis as this is the preferred method to file business income taxes. Under the modified cash basis, revenue is recorded when cash is received and expense when cash is paid. A practice must take its receivables and payables into consideration when considering its profitability. Under the accrual method, revenue is recorded when the service is provided and expense when it is incurred. Practices should track profits using the accrual method simultaneous to the modified cash method as it more accurately reflects the true financial state of the business. By using the accrual method, net income reflects the volume of patients seen and the practice’s spending efficiencies, avoiding cash flow fluctuations that understate or overstate true net income due to timing of insurance payments.

Knowing the financial picture under the accrual method gives a prospective investor or purchaser of the practice a reasonable position to base its decision.

Once arriving at the overall operational picture, revenues and expenses should be compared to prior periods to see where inefficiencies in spending may have occurred. Expenses should not only be compared to budget and prior year, but they should be reviewed as a percentage of overall revenue.

If the practice grows, one would expect revenue and staffing to increase. In this case, one would want to see if payroll as a percentage of revenue is consistent between periods. An increase in payroll as a percentage of revenue indicates that the increase in patient volume did not warrant an increase in staffing from an economic standpoint.

Another valuable analytic is to calculate net revenue per patient visit. One would expect this ratio to increase at a rate commensurate to inflation or practice costs. If this ratio does not increase, costs may need to be cut to ensure owner compensation does not decrease. Otherwise, the number of patients seen would have to increase to keep up with costs; this results in more hours for the physician and the staff.

Most accounting software packages can be customized to illustrate expenses as a percentage of revenue in conjunction with the profit and loss statement.

"While it is always nice to work with people with whom you can be friends, it is more important to a practice, where the owner is not actively involved in the business side, to employ people who are knowledgeable, ethical, who stay current, especially in the financial and tax areas, and equally important, people who are willing to tell it like it is – who are not afraid of being replaced.", says Fred Theobald, a business coach at The Esus Group.

With a solid, qualified team, a well-monitored budget and the basic understanding of business ratios, a physician can very quickly and routinely know exactly where the business is, where it is going and what may need adjusting to improve the operation.

Eric C. Resnick, CPA is an associate at Margolis & Company P.C., a regional certified public accounting and business consulting firm.