William Litt

As buyers of big-ticket items, physicians have been in the eye of what consultant Robert James Cimasi calls an "almost perfect storm" during the past several years. Great commercial forces -- low interest rates, abundant medical real estate, and investments required by HIPAA -- seemed to align to make 2003 a very good time for practices to invest in themselves.

And 2004 looks to be much the same. As a result, quite a few practices are facing expensive decisions to invest in property and upgrade their practice's technology. According to some experts, low interest rates and a surfeit of supply mean that if physicians are not pondering such purchases, they should be.

Yet some troublesome details typically remain even after the decision is made. Chief among them, of course, is how to finance capital investments, especially medical equipment and real estate. Should physicians lease or buy? Does renting provide a better return on investment than buying?

The answers, unfortunately, are not clear-cut. "There's no one right answer for all practices," says Mike Andersen, senior vice president of Commons Medical, an Orlando, Fla., firm that works with practices to develop both leased and acquired space. "There are a lot of pros and cons to leasing and buying."

Many of the pros and cons, moreover, rest not only on each practice's financial condition, but on its expectations for the future. Not all the factors can be reduced to numbers. "Every physician has a threshold [for] what the minimum internal rate of return is on this stuff," says Cimasi, who is president of Health Capital Consultants in St. Louis. "That's easy to quantify, but taken together with other factors it's a complex set of circumstances that they need to consider."

At first blush, the math is simple. "First you compare what it would cost if [you] were to lease with what it will cost to buy," says Paul Angotti, president of Management Design LLC, a medical practice financial consultancy in Monument, Colo. Those costs should include interest payments and depreciation expenses.

After comparing how many dollars would go out the door under a lease to how many would go out under a straight purchase plan, the next step is to add or subtract the tax consequences.

With leases, each monthly payment is an expense that can be subtracted from the practice's taxable income each time you make that payment. When you purchase items that are going to last longer than a year, on the other hand, the amount you deduct usually would not be the amount of your monthly payment. Instead, it would be how much the property depreciates, the amount you spend to maintain or improve it, and (sometimes) the interest payments you make. 

The Internal Revenue Service allows you to decide whether you think you'll be using the new equipment for three, five, or seven years. Depending on what you decide, you can write off up to one-third, one-fifth, or one-seventh of these total "amortization and depreciation" expenses each year.

Yet there are still other factors to consider in deciding whether to lease or buy. When they buy, for example, practices can immediately write off up to $100,000 in office equipment a year, notes Brent Meyer, a partner at Physicians Accounting Management in Encino, Calif.  The rest would be depreciated over the five- to seven-year life of the equipment. 

In Meyer's view, that often makes purchasing the best choice. "I would say that probably 90 percent of my clients will purchase their equipment," he says, "and the 10 percent who don't purchase ... are leasing equipment that is very expensive." They either did not have the cash to make a sizeable down payment, or they were getting high-tech equipment that would be obsolete by the time they paid it off in a few years.

"They don't mind just leasing the equipment, knowing at the end [of the lease] they just give it back because they're going to end up getting new equipment anyway," says Meyer.

Cimasi agrees that each decision ultimately depends on each practice's particular condition and need. "It has a lot to do with cash flow," he says. Leasing makes sense "if you can set up a lease where you can conserve capital, and you get lower monthly payments and avoid the technical risks of obsolescence."

Then there is a series of maddeningly subjective, educated guesses that need to go into each lease-versus-buy decision.

How long a piece of equipment or even a building will hold its value is often strictly in the eye of the beholder.

"There's a difference between the functional life of a piece of equipment and its market life," Angotti points out. A technologically obsolete imaging device might still work -- producing value for the practice -- long after faster, better devices are out in the market. Some physicians might not mind purchasing and holding it for as long as possible; others may worry that competitors soon will be using newer devices to take images faster, more cheaply and probably more profitably in the future. For them, leasing would be a better choice.

When it comes to real estate, "the biggest point in the [lease or buy] issue is estimating the value of the building 10 years down the road," Angotti says. A typical mortgage on medical office space will go 10 years, with a balloon payment at the end. A balloon payment is the amount you still owe for the property after making all your payments. Practices can either pay it all at once or, if you and the property qualify for a new loan, refinance it by borrowing the remaining amount as a new mortgage. 

The trick is in guessing whether the building will be worth more than the amount of the balloon payment when it comes due. If it is, it will be easy to refinance. If it is not, the physician may well end up making another sizeable cash payment in order to get a new loan for the remainder of the original purchase price.

"That's what people are banking on -- that property is always increasing in value," Meyer says. 

They are often correct. "Overall," Andersen observes, "medical buildings appreciate as fast as if not faster than others." Cimasi notes that, when buying a medical office building, you're also accumulating equity that you don't get when renting. Real estate often outperforms other kinds of investments, too. A stock that would generate as much cash as a building that has appreciated over 10 or 20 years would need to be distributing "a whole lot of dividends during that time." There are not many stocks that have done that recently, he says.

Yet owning medical real estate is not always a slam-dunk profit. There is genuine risk involved. 

"It's not always appreciating," Meyer maintains. "Property [value] goes in cycles just like the stock market does ... ." Timing matters. Buy at the top of the market just before one of the cyclical slumps, and it's eminently possible that the building won't fully regain its value by the time the balloon payment is due in 10 years.

Angotti is even more dubious about the wisdom of buying instead of leasing office space. "I've been doing this 21 years, and I can tell you medical office space does not appreciate like a house." Buyers often may devalue it because they will have to do a lot of renovation in order to accommodate their own specialty. "An orthopedic group may have to blacken an area. A family practice needs a casting room. Different specialties and kinds of practices all have different kinds of space configuration needs. That tends to deflate the value."

Medical office owners' properties can suffer in other ways that homeowners' properties do not. Often dependent on their proximity to hospitals, certain specialty practice space can lose value if, for example, the hospital downsizes, does away with its NICU, downgrades from a Level I to a Level III trauma center, or if it merges with another, Cimasi adds.

Angotti has "seen war stories where [a practice] is at the 10-year point, and each of the partners had to reach into their pocket and take out an eighth of a million dollars each because the building wasn't worth what they thought it would be."

"To be very, very conservative," he says, Angotti counsels his clients to figure the building will be worth only 80 percent of its original value in 10 years. If the deal does not look advantageous when it includes that assumption, it's probably best to keep leasing space.

Andersen and Cimasi generally use less conservative calculations. "In all cases, it is a case of trying to leverage your available capital," Cimasi advises. "The most optimal investment is to find a property that you're going to sell for more than what you paid for it." If you can't, buying probably is not a viable option.

Still other factors that don't fit into a neat mathematical equation need to go into any lease-versus-buy decision. The most important factor, Andersen points out, is to have a good idea of where the practice is heading. Do you plan to take on new partners, retire, grow, or merge with another practice during the time you'd be paying off the equipment or the building? 

For example, one of his clients, Asheville Cardiology in North Carolina, wants to be paperless in five to seven years. It thus needed space flexible enough to turn a chart room into a clinical pod, and needed financing that would allow the current chart room to pay for itself in five years.

Another client "in five years might want to add a partner or two, or at least PAs," he reports. Those kinds of considerations greatly influence the kinds of equipment, office space, and financing that would be best for the practice. 

In the end, the experts agree, deciding whether to lease or buy inevitably extends beyond financial statements, the educated guesses, the practice's likely development, and even the specifics of the deal to the individual physician's personal investment and risk tolerances. "Your personal risks, your financial comfort zone, how much aggravation do you want to deal with; all these are factors you want to consider," Cimasi says. 

This article originally appeared in the February 2004 issue of 

Articles

To Lease or to Buy?

Back in the late 1980s, Reed Tinsley was running an AMA business seminar for residents who were about to launch their practices. In those days, "doctors made a ton of money," Tinsley says. Managed care was still just distant thunder in many areas, and "the reimbursement system was structured in [physicians'] favor," he recalls.

Practice management was an afterthought, if that. Tinsley's audience, in short, could not have found a more boring subject than the one he was presenting. Management tools like practice financial statements were abstract, fussy things, best left to someone else. "Their eyes just glazed over," says Tinsley.

But the environment has changed. "We've gone from the days when a physician did billing and got paid for most of it to the days of a physician billing and getting paid for almost none of it," observes Martha Bethea, an Akron, Ohio-based CPA who works exclusively with medical practices.

Now, all sorts of dry business measurements -- revenues, expenses, financial ratios -- have become crucial not only to providing competent medical care, but to maintaining physicians' incomes. 

All those key elements, and the raw materials for gaining still more sophisticated insights into how the practice is doing, are in your financial statement -- which often remains stubbornly ignored.

"You'd be surprised at how many [physicians] don't look at them," Tinsley says. And he is adamant that this should change. "I don't care if it's a solo practice or one that has over 100 physicians, I tell people, 'You have to have a monthly management meeting, and the first item on the agenda should be the financial statements.'"

Kevin Kelleher, MD, who has a solo family practice outside Roanoke, Va., has learned to love his financial statements. He compares what he expected to take in and spend with what he actually took in and spent. "I look for spikes," he says. "If there's a blip in the graph, I know to ask what's going on."

Knowing what's going on is exactly the point. Financial statements guide physicians and their managers to ask the right questions, identify business issues, and cure fiscal woes. 

When people talk about financial statements, they are usually talking about two types of reports. One is the profit-and-loss statement, which details the practice's revenues and expenses during a certain period. The other is the balance sheet, which reports what the practice is worth by comparing all its assets to all its liabilities. Both are, as Kelleher attests, a practice's key diagnostic tools. There are also supporting documents that provide details about each line on these reports. 

Physicians who don't carefully read such fiscal outcomes measurements run risks much as they would in failing to read medical outcomes carefully. Tinsley recalls a gastroenterologist who didn't pay much attention to his monthly reports, and failed to discover that almost $1 million a year in billings were missing. "A million dollars!" Tinsley says in disbelief. 

A massive error like that has repercussions for the pay of everyone in the practice, especially the physicians. Most profit-and-loss statements start by reporting the practice's revenue and then subtracting its operating expenses (items like rent, phones, supplies, staff salaries, equipment loan and interest payments, health insurance, etc.) Using a percentage of the result, the practice's top financial person then calculates physicians' compensation. After subtracting compensation, the practice's profit figure appears at the bottom of the statement.

Generally, the top section of the profit-and-loss statement reports the practice's revenues. It is here that a physician learns not only how much money came in, but exactly where the money came from: insurance reimbursements, patient fees, research funds, even miscellaneous sources like rental income from sublet office space (see below). When income is more or less than expected, it's important to find out why. The problems may be short-term: staff vacations (so perhaps some payments weren't posted or the practice saw fewer-than-usual patients), a payment was late, an insurance company was switching to a new computer system. The problems may also be chronic: a payer changed its reimbursement policy, or a procedural glitch has stalled billing. 

"I look to see if revenues are increasing or declining," Bethea says. "If they're declining, is there a factor that would influence the decline? It may be a change in the number of physicians [at the practice] or that reimbursements were not what they should have been." 


Accountants can produce additional financial reports to help find out why revenues may be off. Using the clues in the financial statement, for example, Tinsley often will look to the coding report, which details how, when, and which procedures have been billed, and to whom. In his experience, it's more common to discover undercoding than overcoding problems. 

Bethea likes to have groups look at aging accounts by payer. That supporting report lists who -- insurance companies, Medicare, Medicaid, workers' compensation, and patients who have no insurance coverage -- owes the practice money, but is not paying in a timely way. It provides yet another possible explanation of why revenues in the financial statement may be off. It also helps direct the practice's collection efforts.

The expenses, which come next on the financial statement, are equally important to review. They help you  to see just where the practice's money is going.

In general, when Bethea looks at expenses, she wants to know "if they are reasonable for a practice this size."

"This area is always a work in progress," says Patty Royer, manager at Harbour Women's Health in Portsmouth, N.H. "The medical field changes so fast."

To stay on top of it, Royer carefully tracks both the number of patient visits each month and how much it should cost to serve them. She then cross-references those numbers to her financial statements as a way of tracking costs, which range from bank charges to salaries to imaging expenses. 

In plotting the first year of his practice, Kelleher says he did "an estimate of all the expenses I could think of, down to laundry." With each passing month, he used his statements to compare what he had spent on each item to what he'd budgeted for it. "I'm risk-averse. I needed that reassurance that I was on track." He was able to stay on course: his gross revenues were strong -- and he was only $700 off in his cost projections.

For more established operations, Tinsley compares each of the expense categories not only to a practice's budget, but to what the practice spent on those same items during the prior month, the same month of the prior year, and the current year-to-date versus last year-to-date. "I'm looking for spikes in overhead," he explains.

Among the most important overhead expenses is debt. While debt payments may look small on a monthly basis, repaying the loans the practice took out to buy equipment or pay salaries when there wasn't quite enough cash on hand one week can mount up quickly. 

"I tell people that the only debt that better show up [on the statement] is strategic debt," says Tinsley. That's money borrowed for a strategic business reason, like purchasing computer or medical equipment. "If I see a line of credit on there that's used to pay off old expenses, that's a big red flag. A lot of people don't look at that, and that's why a lot of medical practices are in financial distress."

Also important: accounts payable. These are amounts owed to lenders, vendors, suppliers -- anyone from whom the practice has bought something (supplies, printing, etc.) and not yet paid. And even though you may have someone on staff dedicated to paying these debts, "an office clerk may have a drawer full of unpaid bills," Bethea says. "That's never a good sign."

Such bills often do not show up on most practices' profit-and-loss statements. Why? Most medical practice CPAs use a "cash basis" method to count money. The only expenses they show are those for which someone actually wrote a check. When something is bought on credit, it won't show up as an expense for a month or two, until the first payment is made. As a result, the practice's expenses may appear to be lower than they actually are. So both Tinsley and Bethea run an accounts payable report, another of the important supporting statements.

Despite the financial statements' importance, most physicians learn to read them on the fly. 


"[Physicians] get zero business training," Tinsley says. Family practice physicians may get a little training in medical school or residency as a requirement of the residency review board, but for the most part, they are cast into the commercial healthcare marketplace without a clue.

But many still resist getting involved in the business end. "The skills that make a physician a good physician are not necessarily the skills that make a physician good with business," Bethea points out.
Royer, whose three-physician practice also has three midwives and a nurse practitioner, hired a Medical Group Management Association (MGMA) consultant to teach her how to set up her financial statements. The practice also has a CPA to help Royer analyze them on a monthly basis. "My organization is also a big proponent of education," she says. It regularly sends her to practice management conferences that, in turn, often include using accounting controls like financial statements. 

Kelleher had "not a bit" of business background when he started his own practice. After medical school, he entered the "protected environment" of a 16-doctor multispecialty practice, where the office staff tended to all things financial. It was only after that group "went south" in 2001 that he confronted the need to manage a practice and tend to its financial health for the first time.

He found he liked doing it. With a financial adviser's help, he set up a budget and his own accounts in Quickbooks, an off-the-shelf small business accounting software program. "The hardest thing was setting it up. Once you do, then it's a breeze," he says. Kelleher takes about three hours every two weeks to pay bills, do payroll, and analyze his financial statements. "I love the graph on income versus expenses. It's a mindset, I think. We have a mental block against talking about financial things," he says.

Once they get over the block, sophisticated physicians and practice managers will use their statements to do more than just track revenues and expenses, find operational mistakes, and calculate compensation. For example, they can use them to compare their practices to other, similar practices. 

Tinsley, for one, looks first at the ratio of revenues to operating expenses on a statement. If he finds operating expenses exceed a certain percentage of receipts, he knows it is time to find out why. 

"On the expense side," Bethea explains, "I'm looking at the expenses both in dollar amount and as a percentage of revenues."
There are standard financial ratios for every size and kind of practice that tell how much each should be taking in and spending on all the items on its financial statements. "It really varies from specialty to specialty," Bethea says. An average three-physician internal medicine practice in the upper Midwest, for example, might spend a certain percentage of its income on office support. A fiscally successful three-provider allergy practice in the same area, in turn, may spend less (or even more) on the same thing. Your practice's accountant can get these ratios for you. The MGMA also publishes an annual survey that includes typical revenues and expenses for specialty practices (visit 

Despite their importance to the financial health of the practice, Tinsley believes that most statements still go unread. "The majority [of physicians] still have their heads in the sand." 

But the value of reading them is clear and simple. "It tells you how your practice is doing," Tinsley says. 

This article originally appeared in the October 2003 issue of 

Learn why and how to read a financial statement about your practice

Author | William Litt

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