Demystifying financial statements
Episode 9: Demystifying Financial Statements
So, each month you attend your board meeting, or you meet with your bookkeeper and somewhere along the line, someone hands you a whole bunch of reports with numbers on them. In our second episode, we started to talk about those in reviewing the Language of Finance. In our third episode, we broke down the Profit & Loss Statement a bit more in reviewing how to create a Budget.
Today, we’re going to delve a bit deeper into the financial reports you’re likely to see, and why they’re important. Sometimes the scariest thing about finances is not knowing where you are. Is your practice doing okay? Are you well compensated in relation to your peers? Are your practice expenses in line with the rest of the industry? All of these questions are easy to answer when you have good data.
The two most common and useful reports are the Balance Sheet and the Profit and Loss (or Income) Statement. The Balance Sheet is a listing of your assets (what you have – think cash in your business checking account, equipment in your clinic), and your liabilities (what you owe – think credit card balances, loans). The Balance Sheet is a listing of those, and it is a snapshot in time. It shows the balance in all accounts as of any given day. We usually run these every few months, and they should be reviewed every 6 months as you’re getting a handle on things, and every year thereafter. You can use this series of snapshots to track your financial progress over time. Make sure things are moving in the right direction (like loan balances going down if you’re making regular payments) and that the accounts all look current, and you know what they are. Ask questions about any that are unfamiliar.
If you have an individual financial planner, he or she may have prepared one of these for you personally. In that case, the difference between your assets and your liabilities is your net worth. In a business sense, that’s called “Owner’s Equity” or just “Equity.”
As we discussed in Episode 3, your Profit and Loss Statement (P&L) or Income Statement is a great document for understanding what’s happened over a period of time, and for tracking performance. I recommend running this once a month, and reviewing it against your budget, as we discussed in Episode 3. To review, the Income Statement is a detail of all of the income that came in during the time period, and all of the expenses you incurred in that same time period. The amount left over is called “net income” and in most private practices is the amount that gets split up between the owners. In your personal finances, this is what’s left over in your checking account at the end of the month, ostensibly available for investment or paying down debt, or to fund that trip to Italy you’ve been contemplating.
The practice expenses are also frequently called “overhead” and can be calculated as a percentage of net revenue. This allows you to understand what percentage of your net revenue is paid out to operate your clinic before you pay yourself. Most groups range between 35-65% overhead with primary care groups being at the higher end of the spectrum. If your overhead is higher than 55-60%, don’t despair. There is likely a lot of room for improvement! We’ll cover all of that in our next episode, which will be entirely devoted to overhead.
There are many finance and accounting terms that appear on your financial reports, many of which get thrown around and are largely misunderstood. Let’s clear some of that up:
Gross Revenue or Gross Income, also sometimes called Top Line Revenue, is how much cash landed in your bank account. Plain and simple.
Gross Charges are something else entirely – that’s what got billed to the insurance companies and patients. Depending upon your conversion factor, which is the amount your billing system bills out for each Relative Value Unit (RVU). DO NOT expect to collect this much money – you won’t. As we discussed in Episode 5, you will always collect a percentage of your Gross Charges, never 100%. This is called your Gross Collections Percentage, and we’ll have more on that in an upcoming episode.
Net Revenue – this is Gross Revenue less refunds issued to insurance companies and patients.
Total Expenses – this is all of the money that left the bank account to pay for staff, rent, medical supplies, and any other expense to run the clinic. This DOES NOT include compensation for the physicians.
Net Income or Bottom Line or Bottom-Line Income – this is Net Revenue less all expenses paid to run the clinic, before the doctors are paid.
Overhead Percentage – this is VERY FREQUENTLY miscalculated or misquoted. The CORRECT way to calculate it is:
Overhead Percentage =
This is also the source of huge bragging rights if your percentage is low (<50%). If that’s true for you, brag on! Again, more on that in our next episode.
Now that we’ve got those terms sorted out a bit better, we should discuss the third report that makes up the triad of a formal set of Financial Reports, which is the Statement of Cash Flows. This report shows the sources and uses of cash, and also helps groups that run their financial reports on an accrual basis.
Typically, larger and more sophisticated medical groups operate on the accrual method of accounting, and smaller groups use cash basis financials. It’s important to know which method your group uses, so if you don’t know, please ask. Sometimes, it’s written at the bottom of the report in the fine print.
If your group uses Cash Basis Accounting, this means that cash is recognized and booked into the accounting system when it is received. So, if you saw 400 patients in January, and got paid $58,000 for that work, but the money didn’t come in from insurance companies until February, the income would be recognized in February, NOT January. That’s when the cash arrived in the bank account, and that’s when it’s entered into the accounting system and recognized as income. Similarly, if you paid medical malpractice premiums of $9,000 for the first quarter of the year in February, that expense would be recognized and booked in February, because that’s when the cash left the bank account.
Larger groups sometimes use accrual basis accounting, which attempts to spread income and expenses over the appropriate time period. In the above example in an accrual system, the $58,000 in revenue created in January would be booked in January instead of February. It would be booked when created, not when the cash actually came in. This is an attempt to smooth the financials. With the medical malpractice premium, $3,000 of expense would be booked into each of January, February and March, as that’s the time period that the expense was covering. Again, this acts to smooth the financials and lets you have a picture that matches expense to revenue created in the period, not reflective of when it was actually received or paid. This accounting method is much more sophisticated, and I generally don’t recommend it for groups of less than 20 or 25 physicians. It requires members of your executive team who are financial experts, and who can manage cash flow separate and apart from these statements.
Again, if you’re unsure as to which method your group uses, ask. This will make a huge difference and will give you great insight into what you’re reading.
That’s a bit of a deeper dive on your financials – again, if all of this is still feeling foreign to you, run through the earlier episodes again, and then set some time to sit down with your bookkeeper, manager or accountant to go over the financials and so that you can ask your questions. I’ve seen some groups set up learning sessions with their accountants, so that all of the partners can review the statements and be educated together. It’s fun to create a space where “dumb questions” are welcome so that you remove the stigma, and you can get to a space where everyone can comfortably ask questions, and no one feels like the should already know all of it. Most physicians aren’t that familiar, but as I said in the first podcast of this series, many are pretending that they do. Be the courageous one and ask the questions everyone else has, but no one is asking aloud. Your partners will thank you for it later!
Join me for our next episode, where we’ll turn our focus to Overhead – or, in other words, where did all the money go?
