Did you choose a career in medicine because you wanted to learn about accounts receivable, asset depreciation and cash accounting? Probably not. But an understanding of such concepts enables you to keep an eye on your practice’s financial health.

This quick overview describes the reports you need to be looking at, and explains how accounting in a physician’s practice differs from accounting in other businesses.

A Practice’s Financial Structure

The goal of accounting is to provide an accurate description of an entity’s financial status. It does this by compiling data, and those data fall into four categories—income, expenses, fixed assets and current assets.

Income includes fee-for-service income; capitated income; and income from your optical shop, cosmetic procedures and refractive surgery. Your “net fee income” is the money that comes in minus any money that you refunded when, for instance, a patient overpaid.

Expenses include nonphysician staff (e.g., compensation and benefits), office occupancy (e.g., rent, utilities and maintenance costs), insurance (e.g., malpractice, liability, employment and health insurance), advertising, telecommunications, office and medical supplies, and cost of goods sold (e.g., frames in your optical shop). These days, “goods sold” can include expensive items such as accommodating IOLs and drugs for retinal injections, and some practices have decided to move these dollar amounts out of the expenses category and include them as a negative figure in the income category.

Fixed assets include your medical equipment (e.g., lanes and diagnostic devices), office equipment (e.g., computers and photocopiers), furniture and inventory (e.g., frames and supplies).

Current assets include money in the bank and accounts receivable.

Two Accounting Methods

There are two principal methods of accounting to choose from. Many businesses opt for accrual accounting, but cash accounting is arguably more appropriate for most medical practices.

Cash accounting recognizes income when received and expenses when paid. Suppose, for instance, you provide an eye exam. If the patient pays the copay on the day of service, then it would be booked on the day of service; but the insurer’s portion of the payment wouldn’t be booked until it is received.

Accrual accounting recognizes income when earned and expenses when incurred. So when you provide the eye exam, the patient’s copay and the insurer’s payment would both be booked on the day of service. The challenge of this approach is that you can never be sure what each insurer is going to pay, so you have to estimate the payment that you expect to receive based on the previous year’s collections.

Cash vs. accrual accounting. In the wider world of business, many companies opt for accrual accounting because they believe it provides a more accurate representation of their business. But physicians don’t need to use their accounting statements to get a true handle on their practice’s financial status—they can use their practice management system instead.

Types of Accounting Statements

The income statement is a straightforward report of income and expenses over a specified time period (see box). It is worth monitoring your nonphysician expenses as a percentage of income. You’ll want to make sure that this percentage remains at an acceptable level compared with what you reported in previous quarters and with what other practices report.

I recommend that you develop an annual budget, with projections for each “line item” in your income statement. By comparing your income statements against what was projected, you’ll be able to spot overspending or income shortfalls early. These budget projections also are invaluable in making strategic financial decisions, such as expanding services or adding a new provider.

The cash-flow statement differs from the income statement in that it adds two figures—the cash balances for the start and the end of the time period. This shows whether your practice’s cash flow is positive or negative.

The balance sheet. While the income statement presents a picture of financial activity over a period of time, the balance sheet provides you with a snapshot of your practice at a particular point in time. It lists assets and liabilities.

Assets include cash in the bank, prepaid expenses, inventory of supplies, accounts receivable, property and equipment. I generally recommend that your real estate not be included here—it should be considered as a separate entity.

The practice’s liabilities include accounts payable (those bills that you haven’t paid yet), refunds that you owe patients, and any salaries, bonuses and commissions that are due to be paid.

The difference between the practice’s assets and its liabilities represents the owner’s equity, which can be positive or negative. If, for instance, a practice incurs a lengthy list of liabilities when it launches a refractive surgery center, its owner’s equity could be negative even though its monthly cash flow is positive.

Types of Financial Reports

Your practice management system may spit out a monthly batch of reports, but interpreting these can be time consuming. By pulling out the most relevant data and presenting it in an easily digestible way, the practice’s business manager can help its physicians get a clear picture of the practice’s finances. These reports fall into four categories.

Your productivity reports should be based on charges, and should compare one provider to another. If a practice has several physicians and several optometrists, putting them on two separate graphs makes it easier to compare relative productivity within each category.

Develop payer mix reports based on charges by type of payer (e.g., Medicare, PPO and HMO). If you find that your payer mix is changing over time, then you should try to determine what the reasons are and what the implications will be for your practice.

Your collection reports let you see the relationship between your charges and what you’re getting paid. Without knowing that, your financial planning will lack a firm foundation.

Your accounts receivable reports complement your collection performance reports by highlighting any areas where you may have collection problems. (See the April 2003 Practice Perfect—“Are You Collecting What’s Owed?”—at www.eyenetmagazine.org/archives.)

You should manage the business side of your practice by objectively assessing the metrics, and accounting is simply a way of showing those metrics.