The language of finance
Episode 2: The Language of Finance
Budget variances, debits, credits, Return on Investment, profit & loss, capital gains… so many finance terms, so little time! This episode is intended to begin to outline some of these terms, to give you some definitions and to begin to get you familiar with this whole new language. And, like learning any new language, it will all feel unfamiliar and awkward at first. Hang in there, maybe even replay this podcast a couple of times… you’ll get it! It just takes a little time and repetition.
First of all, we finance people like to talk about Financial Statements! Sometimes we just refer to them as “financials,” as in, “Send me over a copy of your financials.” What we mean are Financial Statements, and this consists of 3 different reports: First is your Profit & Loss Statement, also known as your Income Statement or your P&L, which reports activity over a period of time (usually a month).
Second is your Balance Sheet, which is a snapshot of your financial position at any given time. This outlines all of the things you own, otherwise known as assets and all of the things you owe, which we call liabilities. The difference between your total assets and total liabilities is considered equity or Owners’ Equity in a business. Usually, we review a Balance Sheet at the end of a month, a quarter, or a year.
The third report in the triad is your Statement of Cash Flows, which reports uses and sources of cash over a period of time – again, usually a month or a quarter or a year. I find these are most useful to larger groups with more sophisticated accounting and finance systems. We’ll go into these reports in more detail in an upcoming episode.
When you are contemplating adding something new to your business, whether it is a new service line, or a new piece of equipment, you’ll frequently hear businesspeople ask about the Return on Investment, or they’ll want to see a Break-Even analysis. In short, a Return on Investment is an algebra problem that holds time constant and seeks to answer the question of if you invest $X in something, what will you earn based on that investment after a fixed period of time, usually a year. So, as an example, if you invest $80,000 in a new ultrasound machine, and it earns you an additional $88,000 by the end of the first year, you have a 10% Return on Investment. Similarly, if you want to see a Break-Even analysis, you’re holding dollars constant and solving for time. So, if you make that $80,000 investment in the ultrasound machine, this analysis seeks to find out how long it will take for you to get your initial investment back out of it. In the above example, assuming the earnings come in evenly throughout the first year at $7,333.33 per month, the Break-Even analysis would show a break even at 10.9 months. So, you’d have your initial investment back out of it in slightly less than a year. We’ll also do a deeper dive on these two tools in future episodes, and you can find more information on pages 34-37 of my book.
We will focus on your Profit & Loss Statement, as it is extremely useful to you in managing your business. The basic formula is Revenue, which is money that came in from patient care and other activities, less Expenses, which money that went out for practice expenses, and the difference equals Net Income. This is the money you get to split up with your partners according to your physician compensation system. When you hear someone talking about your “bottom line” or “bottom line revenue,” they’re talking about the bottom line of your Profit & Loss statement. You can check that line to see how much money was left at the end of the day. Did you make a profit? Or did you operate at a loss?
Sometimes you’ll see something called Cost of Goods Sold on your Income Statement. This generally refers to the money that you paid for items that you resold in the clinic. For instance, if you sell small medical supplies, books or supplements over the counter, the amount of money you paid for those items before you resold them would be listed as Cost of Goods Sold. You can compare the revenue generated by selling them to the Cost of Goods Sold to determine if it’s profitable to have those items available for sale. We’ll cover more about retail components in medical practices in upcoming episodes.
Physician compensation is a huge topic that we’ll delve into in upcoming episodes too, but to begin to get you the terminology here, many physician comp systems seek to define Expenses, and they get categorized in lots of different ways. The first distinction for expenses is Fixed v. Variable. Fixed expenses are expenses that are the same amount each month. A great example of this is the rent expense that you pay for your office space. It does not change from month to month, and it is not impacted by the volume of patients you see. Variable expenses are those that fluctuate based on the volume of patients you are serving. A great example of that would be disposable medical supplies. In some cases, physician comp systems treat those differently when they are allocating expenses to physicians. Another way in which expenses are differentiated are Direct v. Indirect costs. Direct expenses are things which can be directly attributable to patient care, like medical supplies. Indirect expenses cannot be attributed to patient care directly, but are required to operate the practice, such as legal costs or marketing expenses.
You’ll also hear businesspeople use the term “capital” when talking about finances. Sometimes people use it simply as a synonym for “money”. As in, we’ll need to raise some “capital” for that purchase. This can also be used to differentiate capital expenses from routine expenses. The phrase “Capital expenses” usually refers to larger purchases, such as exam tables or other new pieces of equipment. Those can also be referred to as “capital expenditures.” By contrast, “Operating expenses” are more routine expenses like medical supplies or staff costs.
Budgets are one of my favorite financial topics, and we have devoted the entire next episode to them, so I won’t spend a lot of time on them here. Suffice to say, there are typically two different kinds: Capital Budgets and Operating Budgets. As you might guess, capital budgets are for larger and longer-term purchases, and operating budgets are for ongoing use. The power of a budget is in analyzing “Budget to Actual” or budget variances. This is a fancy way of asking where did your business perform differently than you expected?
After that, Episode 4 will be all about your Revenue Cycle, and I’ve invited industry experts Kem Tolliver and Shawntea Gordon to join me. These ladies have literally written the book on Revenue Cycle as published by the Medical Group Management Association, and I am excited to talk with them about how to break it all down for you.
By way of a brief introduction, we begin at the beginning of your Revenue Cycle. You see a patient, and you select a CPT code, like a 99213. This is where your Gross Charges for that visit are derived. Your billing system multiplies the relative value units for that CPT code times the retail value in your fee schedule, and this creates a claim that goes out to the insurance company for payment. After some period of time, your claim is adjudicated by the insurance company, and they send you a payment for some portion of your gross charges. This can also be referred to as your receipts. They will only send you a portion of what you billed, as the rest will be split into two different pieces. First, the patients usually have a responsibility to pay part of it – if they have a copayment, or coinsurance or a deductible amount to meet. The other part will be Adjustments or Contractual Adjustments that your billing team will enter into your billing system. This is because your group has contracted with the insurance company for a certain rate of reimbursement per RVU, which is typically less than what is reflected in your fee schedule. The revenue cycle for medical practices is a bit counterintuitive at times, and we will spend quite a bit more time on a deeper dive of your revenue cycle. Please don’t worry if these terms are unfamiliar. We will continue to review them, as I’m really committed that you understand your revenue cycle completely!
Once your claims have all gone out, we now need to keep track of what amounts people owe you so we can follow up on it to assure that you get paid. We call this pot of money that people owe you “Accounts Receivable” and we generally report them back to you in the form of a report that we call the Accounts Receivable Aging. This shows how much money is owed to you and from whom. It shows you how “old” the money is – which means how long it has been since you rendered the service to the patient. As you might imagine, we like to manage Accounts Receivable so that the money is young – you have the highest probability of collecting it shortly after you rendered the service. Unlike wine, accounts receivable don’t age well.
When you have accounts that are not being paid, most practices then utilize the services of a Collections Agency to send patient accounts to collections. We’ll talk more about this, and how to manage the monies patients haven’t paid, or “Bad Debt” in future episodes.
If your head is now spinning, you can replay this podcast again – each time, a little more will sink in! I promise. You can also find a complete Glossary of Terms in the back of my book, Physician Heal Thy Financial Self. A quick review of that will help to cement more of these as you’re learning.
In my 30 years of running medical practices, I’ve learned a lot about business, and a lot about what we haven’t taught you about business. As I said in my inaugural podcast, this series is intended a gift back to a community that has been good to me for 30 years.
Remember, this podcast is for you. My goal is to give you bite-sized, digestible pieces of knowledge culled from the last 30 years spent working in the business of medicine. My commitment is to bring you resources, experts and answers so that you can achieve mastery over the financial and business aspects of your practice. Together, we can fill in that educational gap.
You can find more information online at MedicalMoneyMattersPodcast.com and I welcome you to tune into the next episode of this podcast, where we will talk All Things Budgets. We’ll cover why you’d want one, how to create them, and how to analyze them to assure that your practice is on track financially.
For more detail on any of this, you can purchase a copy of my book, Physician Heal Thy Financial Self, which is available on Amazon. You can subscribe to the Medical Money Matters Toolkit here.
As I like to close out these podcasts, congratulations on taking the next step in your professional development, and for making the commitment to learn about the financial and business aspects of your practice. I look forward to being on this journey with you, and send you my heartfelt gratitude for all that you do for your patients all day, every day every day.
