Medical practices face cash squeeze despite growth

A medical practice can collect more money than it did the previous year, have a full schedule, and still struggle to pay its staff. The initial reaction is to look for a problem, such as a payer denying claims or a staff member overspending.

However, the issue is often not that something is broken, but rather that the money is not arriving on the schedule the practice needs. Three lines on a profit and loss statement can explain most of the gap.

For example, consider a practice with three physicians, monthly collections of nearly $300,000, and operating expenses of $186,000 before owner compensation. The overhead ratio is 62 percent, meaning 38 cents of every dollar collected is available before owner pay.

If collections decrease to $255,000 in a given month, the overhead ratio increases to 73 percent, leaving only 27 cents of every dollar collected available before owner pay. This change is not due to increased spending, but rather decreased collections.

Understanding Overhead

Overhead is often viewed as a fixed dollar figure, but it is actually a ratio of expenses to collections. When collections decrease, the overhead ratio increases, even if expenses remain the same.

In the example practice, the overhead ratio increased by 11 percentage points due to a decrease in collections, not an increase in expenses.

The Delayed Statement

The second item that can explain a cash squeeze is the delay between when work is done and when money is received. This delay can cause a strong production month to appear as a weak one on a cash basis statement, and a slow month to appear comfortable.

For example, if a practice has 46 days in accounts receivable, it takes approximately six and a half weeks for money to travel from the date of service to the bank. This means that September’s deposits are mostly from July and August.

Understanding the delay and the basis of the financial statement is essential to accurately interpreting the practice’s financial performance. It is vital to consider the time it takes for money to be received after a service is provided.

Owner Compensation

The third line that can explain a cash squeeze is owner compensation. Owner draws are often set once and left unchanged, even as collections and expenses fluctuate.

In the example practice, the owner draws were set at $25,000 per physician per month, totaling $75,000, during a quarter when collections averaged $320,000. However, when collections decreased to $255,000, the practice was left with only $69,000 before owner pay, resulting in a $6,000 shortfall.

This shortfall is often covered quietly, such as by using a line of credit or postponing a hire. However, it is essential to review and adjust owner compensation regularly to ensure it is aligned with the practice’s financial performance.

This does not require a different accounting system or elaborate reports, as the necessary information is already available on the monthly statement.

Ryan Joneson, founder of GlassJar, which makes accounting software for small businesses, writes about reading financial statements for people who did not train in accounting. He provides guidance on how to interpret financial statements to make informed decisions.