Physician practice owners need to review key financial data points regularly
Key takeaways:
- Owners can use the balance sheet to get a picture of the ability of the practice to repay what it owes in the short term.
- Working capital is another indicator of the practice’s ability to pay its debts.
A physician practice owner’s week is spent seeing and caring for patients and managing the day-to-day issues of the practice.
For many owners, this leaves little time for one of the key aspects of successfully running a health care business: reviewing and analyzing the practice’s financial data. While it is easy to get caught up in all the other aspects of running the business, physician owners cannot afford to ignore the important symptoms that the financial statements reveal about the health of the practice.
In this article, we focus on some of the key data points that should be regularly reviewed.
While physician owners often focus on the practice income statement to evaluate a practice’s health, many of the key indicators of business sustainability are actually found within the balance sheet. The income statement — or profit and loss statement — shows the income and expense over a period of time. Meanwhile the balance sheet is a snapshot of what the practice owns and owes on a particular date. Each of these statements, along with a cash flow statement, will provide the owners with important pieces of analytical data that can be used to more efficiently run the practice.
Balance sheet
The balance sheet will show us the cash on hand and the net worth of the practice. Owners can use the balance sheet to get a picture of the ability of the practice to repay what it owes in the short term. The current ratio or the quick ratio can be used for this measurement. If the practice does not carry inventory, then the current and the quick ratio are the same. Current assets (cash, cash equivalents, receivables, inventory) are divided by current liabilities (accounts payable, notes payable due within the year, interest, wages, takes and retirement plan payables). A ratio of greater than 1 indicates that the practice has more current assets than current liabilities, indicating the ability to pay its debts within a year. The quick ratio subtracts inventories out of current assets and then divides by current liabilities. Depending on how quick inventory moves, this may be a better indicator of the liquid assets of the practice that can be used to pay debts.
Working capital — determined by subtracting current liabilities from current assets — is another indicator of the practice’s ability to pay its debts. A positive working capital indicates an ability to pay bills. The larger the working capital, the better a practice is able to sustain during a downturn in revenue. Owners should determine the level of working capital they wish to maintain in the practice as a step in determining any owner profit or bonus distributions.
Accounts receivable, accounts payable
The balance sheet will show the practice owner the amount of money owed to the practice (receivables) and the amount owed by the practice (payables). But the astute owner needs to dig a little further to get key receivables and payables data. Days in Accounts Receivable (A/R) measures the amount of time it takes to turn a receivable into cash and is calculated by dividing the accounts receivable balance by revenue (from the income statement) and then multiplying by the number of days in the period.
For example, if the owner is looking at the year-end financial statement, he or she would multiply by 365. The average days in receivable will be another indicator of the ability to pay what is owed in the short term. It is also important to look at the Days in A/R by payer to know how quickly insurance reimbursements are coming in as opposed to patient and other payments.
Days in Accounts Payable (A/P) is a measure of the length of time it takes the practice to pay its bills. It is calculated by taking the accounts payable balance divided by the cost of sales (from the income statement) divided by the number of days in the period reflected by the income statement (365 for an annual statement). While the Days in A/P may be less important for the practice owner than the Days in A/R, it is helpful to know whether the Days in A/P changes significantly from period to period. The owner will want to ensure the practice isn’t incurring fees for late payments but also that it isn’t using cash too quickly by paying bills early.
Income statement
Analyzing the practice income statement can perhaps best be done by looking at a comparison to a prior period. This will help the owner see trends of increasing or decreasing revenues and expenses to ensure she has an understanding as to why those trends occurred. An income statement review will also allow the owner to review variable costs vs. fixed costs as well as non-cash expenses — important items to be aware of when considering things such as current ratio and working capital.
Another key piece of data the owner will find within the income statement is the practice’s operating margin. This is calculated by dividing operating income by net patient revenue. The operating margin tells the owner what portion of the revenue is left after the costs related to patient care to cover fixed expenses of the practice such as rent and insurance, building maintenance, utilities, and office expenses.
Cash flow statement
The cash flow statement summarizes the practice’s cash receipts and payments for the period from operations, financing and investing. A review of the cash flow statement could aid in spotting any irregular cash flows as well as ensuring there is enough cash on hand to fund operations.
Conclusion
Utilizing the financial statements as practice management tools will aid in making the practice owner better able to evaluate the practice, make needed changes and increase financial efficiencies. Being an astute business owner is an important step in increasing wealth and keeping more of what you earn.
For more information:
Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or by ebook download by texting HEALIO to 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.
David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group www.ojmgroup.com, where Carole C. Foos, CPA, is a partner and tax consultant. You should seek professional tax and legal advice before implementing any strategy discussed herein. Mandell and Foos can be reached at mandell@ojmgroup.com or 877-656-4362.
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