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Practice Management: Look to Financial Statements Before You Leap

Donai, Jeremy J. PhD

doi: 10.1097/01.HJ.0000444139.39633.db
Article

Dr. Donai is visiting assistant professor at West Virginia University in Morgantown and former audiology clinic coordinator at Hendrick Medical Center in Abilene, TX.

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When making financial decisions for a practice, hearing healthcare managers should be guided by the business's present financial status as well as specific needs and future goals. Reading and interpreting financial data is critical to getting an accurate accounting of current conditions.

In this article, I'll review financial terminology and concepts pertinent to the operation of a hearing healthcare practice. The information is intended to serve as a starting point in understanding financial statements.

Generally, there are two methods used for healthcare accounting: cash accounting and accrual accounting.

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In cash accounting, revenue is reported when the cash for goods or services is received. In accrual accounting, on the other hand, revenue is recognized at the time a good or service is provided, regardless of whether or not payment has been received yet.

The accrual method is based on the matching principle, which has two components: 1) revenues must be matched with the accounting period in which the good or service was provided, and 2) expenses must be matched, to the extent possible, with the revenues to which they are related.

Here's an example: a practice receives and pays for a pair of hearing aids in one month. According to the accrual method, the revenue must be matched to the expense in that month, even if the hearing aids are fit and the practice is paid in a subsequent month.

It's suggested that the accrual method provides a more accurate accounting of an organization's use of resources than the cash method. (O'Neal TM. Basic guidelines: accounting for today's healthcare. In Piland NF, Glass KP, eds. Charts of Accounts for Healthcare Organizations. Englewood, CO: The Center for Research in Ambulatory Health Care Administration; 1999.)

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EYE ON TRENDS

One of the most important questions about any business is whether it's making money. The answer is summarized in the income statement.

The income statement lists income (revenue), costs (expenses), and the difference between the two—net income (i.e., profits) or losses—over a given period of time.

Revenue is income resulting from the provision of goods and services. In the case of hearing healthcare practices, the income statement includes, most often in a detailed manner, total revenues from patient services and merchandise sales.

Any revenue generated from investment activity is also reflected in the statement, categorized as nonoperational revenue.

Expenses are simply the costs associated with doing business. They can be divided into two types: fixed and variable.

Fixed expenses are those that stay constant over a given time period—a year, for example—such as rent for office space, which is not expected to change in the middle of a lease.

Conversely, variable expenses fluctuate over a given period. For instance, cost of goods sold (COGS) or the cost of goods to be sold, including hearing aids, batteries, and accessories, will change depending on the number of units purchased for sale.

Total expenses or total costs encompass all fixed costs plus all variable costs.

Net income is best defined as the residual income or earnings left after all bills associated with practice operation are paid. It's a measure of profitability equal to revenues minus expenses.

As it is the primary focus of the income statement and, typically, on the last line, net income is commonly referred to as “the bottom line.”

At a minimum, the income statement should be analyzed monthly to keep a vigilant watch for trends in financial performance.

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ON THE MARGIN

Net profit margin (NPM) is another means by which hearing healthcare managers can monitor cost containment. This profitability ratio provides information about a business's overall financial performance and ability to control expenses.

The measure is calculated by dividing net income (bottom line) by total revenues, then multiplying by 100.

Thus, if the net income is $50,000 and total revenue is $200,000, NPM is 25 percent. This figure suggests that $150,000 of revenue had to be used to pay expenses associated with practice operation.

If total revenue were the same but net income were $20,000, the profit margin would be 10 percent, suggesting the use of $180,000 in revenue to pay expenses.

Comparing multiple years of financial performance in terms of net profit margin can elucidate trends in the practice's profits above all expenditures. If profit margins decrease over time, the manager should examine revenues and expenses, reducing expenditures wherever possible.

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BREAKING EVEN

When considering the purchase of a new piece of diagnostic equipment, it would behoove the hearing healthcare manager to calculate the break-even point or break-even volume required to cover the costs associated with the purchase.

In this calculation, fixed costs are divided by the difference between unit price and unit variable cost.

Fixed costs are the total costs associated with the purchase of a piece of equipment, for example. The unit price is the price your patients are charged for a given good or service, and the unit variable cost is the cost of providing the good or service.

For example, say the total cost of purchasing a piece of equipment is $10,000, the unit price is $200, and the unit variable cost is $50. The break-even point (volume) is 67 units of the good or service. Units above the break-even point of 67 should garner profits for the practice.

Using a break-even analysis, the hearing healthcare manager can determine approximately how long, based on the current amount of services in that area (e.g., number of videonystagmography tests [VNGs] per week), it will take to recoup the expense of a given expenditure.

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IN AND OUT

Another crucial financial statement is the statement of cash flow, which describes the movement of cash from operations, investing, and financing activities in and out of the organization.

This statement should be monitored and analyzed frequently to determine if current cash flows are sufficient to pay practice expenses.

The cash flow statement typically is of interest to potential lenders and investors, as it reflects a practice's ability to meet financial obligations.

One particularly important piece of financial information that influences cash flow is accounts receivable. Accounts receivable refers to the amount of money owed to a practice for a good or service that has already been provided.

In an ideal situation, revenues would be received the day the good or service is provided. Given the widespread utilization of third-party payors, however, it is well recognized that the majority of payments in healthcare typically are not received on the day of service and are, therefore, categorized as accounts receivable.

The metric days in accounts receivable (days in AR) provides objective information on how effectively patient accounts receivable are managed.

I'm unaware of a hearing healthcare industry average for days in accounts receivable, but a general rule of thumb suggests 30 days to be excellent, 45 days to be acceptable, and over 60 days to be objectionable.

This metric is a must for frequent monitoring—weekly, if possible, or monthly, if not. To encourage efficient collection of balances, a hearing healthcare manager might consider offering a performance incentive to billing personnel.

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TAKING ACTION

Given the current situation in hearing healthcare of reductions in reimbursement and increases in costs, it is of paramount importance for managers to understand the contents of financial statements.

These metrics provide actionable information to aid managers in their decision-making processes, with the ultimate goal of increasing financial performance.

As the purpose of this document was to provide an introduction to financial statements, readers are encouraged to further investigate and increase their understanding of this important topic in practice management.

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Second of Three Parts

This article is the second installment in a three-part hearing healthcare practice management series by Dr. Donai. The first installment http://journals.lww.com/thehearingjournal/Fulltext/2013/11000/What_the_New_Hearing_Healthcare_Manager_Needs_to.7.aspx, published in the November issue, offered tips and tools for new managers, and the third will provide a guide on determining the financial health of a practice. Stay tuned to an upcoming issue for more advice on making the most of your hearing healthcare practice.

© 2014 by Lippincott Williams & Wilkins, Inc.