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Finance: Drowning in Red Ink?


Most businesses need some debt to fuel growth. But how do you know if you've taken on too much? And what can you do when you're struggling to make payments? We've got some answers.

Neither a lender nor a borrower be? Sound advice in the Elizabethan era perhaps, but in a modern business climate, no way. Debt is often the fuel for growth. What matters, experts say, isn't whether your practice has some debt - nor even how much it has - it's whether you've accepted your fiscal obligations strategically.

And of course, whether you can pay it back.

"Debt is a good and sound business concept because it is the key to growth," says Marshall Maglothin, MBA, president of Blue Oak Consulting in Holden, Maine. "Physician practices have to grow because they have competition just like any other business."

But what if your practice's debts are piling up faster than you can pay them back? Rather than swearing off debt or looking for ways to bail out, experts recommend you focus on carefully monitoring your practice's performance; find ways to generate more revenue; reexamine your borrowing sources; and try to renegotiate with lenders.

Physician practices get in financial trouble for a myriad of reasons, but experts say that physicians themselves can be the biggest culprits by not adjusting their pay when cash begins to run short.

"The small-business owner is the last to get paid, but many times I see doctors who won't change their lifestyles," says James P. Sacher, CPA, a partner with the Cleveland-based financial consultants Skoda, Minotti and Co.

Matthew Baker, executive director of Maryland Brain and Spine Associates in Annapolis, adds, "Everyone understands you have to pay your bills, but when you own a business your salary is a discretionary expense - you take the risk and hope to get rewarded for taking it."


A practice that continually comes up short on cash may have one or more of the following problems:

  • Physicians taking out too much compensation;

  • Physicians taking too much time off;

  • Financial mismanagement or fraud; and

  • Cash-flow expectations not adjusted for rising costs or changes in payer reimbursements.

Understanding your financial statements is vital. But they may not tell the whole story if your practice continues to lose money month after month, says Sacher.

Even careful, regular scrutiny of your practice's financial statements may fail to alert you to your real debt situation. You know there's money in the bank, but "You have to be asking, how does that money get in the bank?" says Sacher. "Maybe it's because you have a line of credit that you keep drawing on."

Borrowing to make payroll is OK once in a while. If you pay staff every other week, there will be two months of the year in which you will have to fund three pay periods. Quarterly malpractice insurance payments, physician vacations or illnesses, and bonus distributions in December - often the slowest month for charges - can also cause cash to run short the following month, Sacher says.

But frequent dips into your credit line to meet payroll or other expenses such as loan payments is a sure danger sign. Getting turned down for a loan by your regular commercial bank is also a red flag indicating you're in too deep.

Sacher and other experts recommend tracking your practice's cash flow by monitoring your gross and net charges and incoming cash on a weekly basis. Comparing each week to the same week of the previous year can help you spot negative cash flow trends.


But surely there's a handy benchmark you can apply to help you determine the "correct" amount of debt you should have, isn't there? Some debt-to-income ratio you can plug in to know how you're doing? Unfortunately, no. The great variety of different types of medical practices and individual situations makes most debt ratios meaningless.

"I don't encourage external benchmarking for debt financing because you may limit yourself and end up being too conservative if you are in a growing practice," Maglothin advises.

Each practice's financial needs are different. A newly formed group of three orthopedic surgeons in their mid-30s might have good reason to take on more debt than a similarly sized orthopedic surgery group across the street in which the physicians are in their late 50s. The older physicians may be working at peak productivity with no plans to expand, while the younger surgeons may have substantial plans for their practice's growth - and profits.

Individual practice culture also can make it difficult to determine the "right" amount of debt you should carry. Even personal and professional aspirations can come into play, says Deanna Willis, a family physician and MBA who splits her time between office practice and management duties at Indiana University Medical Group in Indianapolis.

"You may want to branch out professionally, get into something new because you are bored, or want to use some of those skills you were trained in," Willis says. "And it may be that borrowing to expand that service or buy the new equipment and accepting whatever ROI [return on investment] for it is what you have to do to get to that goal."

So rather than searching for benchmarks, develop your own practice debt plan. Maglothin says you can get started on your plan by checking whether your costs are outpacing your expenses - and then determine why.


Before seeking forgiveness from lenders or planning to spend 80 hours a week at the office, Sacher and others recommend combing through your accounts receivable (A/R).

"If you haven't done a good job of managing accounts receivable, there's probably a lot of money to be found there," Sacher says. Turning those accounts over to a collection agency and paying the commission isn't the best idea, at least not when they're still relatively young. Instead, assign your best employee to work the patient and payer accounts relentlessly.

But don't overvalue A/R, especially accounts that are more than 180 days old. Time limits imposed by Medicare and many other payers can make older accounts uncollectible.

Short of a complete top-to-bottom operational overhaul, many practices can speed up some of the cash flow needed to relieve their debt by merely capturing more charges, reworking denied claims, and collecting their copayments and cash more diligently.


Sometimes practices use the wrong loan for the wrong purpose. For example, they might dip into a line of credit to fund new equipment when a secured loan would have been more affordable. Perhaps that new computer hardware that will be obsolete in four or five years should have been leased instead of purchased.

Let's discuss the common sources of borrowing, and which are appropriate for your different business needs:

Lines of credit. Tapping into this source of short-term funds can be justified in emergencies, such as when an illness sidelines a physician for several weeks. Credit lines also come in handy for practices organized as corporations that routinely empty accounts at year's end to award bonuses to owner-shareholders. This helps avoid corporate earnings taxes, but it also means the practice starts the following month with no money in the bank.

Expect to pledge a portion of your A/R as security, but don't pledge a larger-than-necessary amount of collateral for a line of credit.

"Always negotiate," Maglothin urges. "You don't want your entire A/R - say it's $1 million - tied up as security for just a $50,000 line of credit."

Credit lines appear as debt obligations on your credit report and can reduce your practice's credit worthiness for other loans. Maglothin suggests obtaining just enough of this short-term borrowing capacity to cover half your practice's operating budget for a typical six-week period.

Secured commercial loans. Secured commercial loans usually carry the lowest interest rates and are appropriate for medium- and long-term investments. Use fixed-rate, fixed-term loans for items that will produce revenue, even if the project has to remain in red ink for the first several months. Expect to put up collateral, often a portion of your A/R or some equipment. Also expect banks to ask for personal guarantees, especially if your practice already has a lot of debt, questionable credit, or is a startup.

The prospect of providing personal guarantees sounds scary, but it shouldn't be if the expenditure is for a reasonable risk and the practice is well run, Maglothin says.

Still, guarantees can get sticky when a bank asks some partners to pledge more than others. Maglothin says to be wary of contract language that puts one partner on the hook for the full loan amount. Banks may demand that senior partners pledge more. Older physicians may resent this - but they might not realize that their younger partners are generating increased patient flow and charges that will make the venture profitable, says Maglothin.

However, always beware the three words "joint and several" within loan contracts. The phrase means a lender can go after just one loan signatory for the full amount of the loan, letting the others off the hook entirely. In other words, a 60-year-old senior physician may lose his second home on the shore while a 30-year-old physician gets to keep her old Honda. Established, deep-pocketed physicians are more attractive targets for lenders even without such language - and they should probably expect to be liable for a larger percentage of a loan. But the "joint and several" language suggests the bank can go after the senior doc exclusively.

Maglothin says he frequently sees the phrase buried in loan contracts. What to do? "Tell them to take it out and usually they will," he says. "The bank is just trying to get a little extra insurance."

Internal resources. You and your partners may be good sources for low-interest loans. Personal assets can be loaned to a practice at a lower interest rate than bank loans carry. There's no collateral, and the loan doesn't show up on your practice's credit report.

Internal borrowing - that is, an unsecured loan - is not uncommon. Baker says they can be useful to finance new ventures when a practice is already extended, interest rates are too high, or the physicians decline to pledge any more personal wealth to banks as loan collateral.

The catch? You and your partners take all of the risk. If no one else will loan your practice money, why should you?

Maglothin advises keeping such a transaction at an arm's length by drawing up a formal loan document with an interest rate and clear payment terms.

"Avoid handshake agreements," Maglothin says. "What if each partner gives the group $100,000 on sketchy terms and one of the partners dies the next month? The surviving spouse needs the money, but who knows where it went and when he or she will get it. It can get very messy."

Your building. If you own your building, it may make sense in some cases to tap into that real estate equity. Baker says that option is best reserved for opportunities that can create new value, and it is definitely not a wise idea for paying off day-to-day debts.

Sacher agrees: "If you don't solve the underlying problem causing you to run short of cash, then it will just come back and you'll have to take even more money out of your building or real estate," he says. "The first step is to solve the problem, then go back to figure out how to patch the hole."

Other loan sources. Public financing isn't just for luring the big-box super center to town. Sacher says the federal Small Business Administration is often overlooked as a source of funds. Though these loans may require a bit more paperwork and must be applied for via local banks, they are especially useful when a major equipment purchase or new construction can create additional jobs.

Sacher says to look at state incentives: "In Ohio, if you create five new jobs, the state will loan you $25,000 per new job in a low-interest, short-term loan. Other states and communities might have those types of loans, too."

Finally, if you are expanding or starting a new practice in a rural area where physicians are in short supply, you may be able to qualify for low-interest loans from your local hospital under certain safe harbors from the Stark regulations.


A few additional options exist for raising quick cash, or for avoiding personal responsibility for a loan default. Unfortunately, experts consider none of these good ideas, and some say they are downright ineffective. A few examples:

Factoring. Factoring - selling your uncollected A/R for cash - is never cheap. In fact, it may be your most expensive option for raising money.

Factoring companies will pay you cash up-front in exchange for your A/R - typically at 75 percent of its value. The factor keeps what it collects but also subtracts interest and fees on late or unpaid accounts. Most factors accept only your most collectible A/R - that is, accounts less than 90 days old and owed by insurance companies, not patients, and definitely not Medicare, which prohibits factoring.

But for practices with questionable credit, giving up 20 percent to 30 percent (or more) of the return on their most collectible claims in exchange for seemingly quick and easy cash up-front may sound too tempting to pass up.

"I've often thought of factoring as the death spiral - you're at the point now where there's nothing else to be done," Sacher says. "It could be very tempting to know you'll get a check, but it's generally the end of the road."

A factoring arrangement can take several weeks to set up while the factor combs through your A/R to find the choicest accounts. Because you will not have control over the tactics the factor uses to collect accounts, this can lead to patient relations problems.

Adds Maglothin, "Since banks are in the business of lending money, why wouldn't you use them whenever you can, instead of looking at the funky and expensive things that are out there?"

Selling charts. The intangible or "goodwill" value of a typical medical practice is nil for loan collateral. Medical records also have little or no value as commercial collateral.

"Physicians may have heard over the years that medical records are worth money, but nobody's paying anything for charts that would make much difference to your practice's debts," Sacher says. An unpublished IRS opinion estimates that charts are worth $12 to $22 dollars each at best. Sacher says his company's evaluations come up with similar values, or even less, depending on a practice's specialty.

Selling or merging. Thinking of selling your practice to evade a loan default or bankruptcy? Think again. In today's market, primary-care practices have very little value to buyers, and even specialty practices will have little value if they are too deeply indebted.

"If the practice is deep in debt then probably it isn't in the right market, wasn't run well, or the physicians were paying themselves too much, so who's going to be interested in buying that practice and taking on all of those problems?" Sacher asks.

Shutting down. Closing your practice altogether and going to work elsewhere is an option when the debt becomes too much to bear, Sacher says.

"You cut your expenses by closing your practice, somebody collects the rest of the A/R, and you get the debt paid down, but you are out of business," he says.

Chapter 11 bankruptcy. Filing for bankruptcy protection should be a last resort - and we do mean last.

"Bankruptcy is the last place you want to go because there's no good solution, it's really expensive, and you may have other options," says Sacher. "The best chapter 11 filing is the one that never happens."


If you're in a bind, you do have some less-drastic options that may be more effective. There are no magic solutions, but here are some things to try:

Negotiating better deals. You may have more negotiating power with your bank than you think. If you're struggling to make payments on a loan, there's always a chance your lender will be willing to work with you on renegotiating the loan's terms, or even refinancing. After all, your lender would much rather have you continue making payments than have you default on your loan. A lender will take your A/R - or your summer house - if it must. But what it really wants is your cash.

Of course, you can and should shop around for the best possible terms before you ever take on debt to begin with. Centralizing your practice's business at one bank rather than spreading it around town to get better loan rates may buy you a little leeway.

The first rule for obtaining better loan terms is to shop around. Interest rates, length of loans, personal guarantee requirements, collateral, and other terms are usually negotiable, says Baker.

"Compare loan fees along with other terms," he says, "it's amazing how competitive it can get." Once you find the lender with the best terms, call back the others you had approached and you may get a counter offer, says Baker.

Maglothin suggests asking lenders to keep your lines of credit open for two to three years and to have no renewal fees attached.

"I ran into a situation recently where a group had a half-million-dollar line of credit they weren't using, but when it expired the bank wanted a few hundred dollars to reactivate it," he says. "They said no way to the fees and the bank caved."

Playing with variables. If you've gotten into trouble after borrowing to finance a new service only to find it's underperforming your expectations, you may have to decide at some point whether to pour more money into it or just back out of it and any related loan obligations.

"It doesn't happen often, and it's a very dangerous place to be in, but maybe you've really underestimated the demand for the service or underestimated the amount of support staff it needed," says Willis.

She recommends looking carefully at variable costs associated with new ventures when they fail to produce enough income to pay back your loan. Hidden costs can emerge. For example, has locating your new dexi-scanner in a room at the back of your office meant that a medical assistant spends more time escorting patients back and forth? Maybe better signage could direct patients there on their own. Or maybe the machine could be moved to a more accessible location.

"The nice thing about variable costs is that you can manipulate them a bit, while the fixed costs are what they are and you're stuck with them for the most part," says Willis.

Still, if such tweaking fails to make a big difference, and if you can't boost payer support or patient volume enough to cover your loan costs, your choices become fewer. "One of the options is to ask, what if we sold the machine or the new clinic site or subleased it?" says Willis.

Baker says loan originators and leasing financing firms will sometimes extend the terms of a loan, but at a cost.


Go ahead and play Monday-morning quarterback with your loan decisions. Maglothin suggests asking: "What did we say we were borrowing this money for? Did we use it for that or something else? Was it a good investment? Why did we borrow instead of using cash? Did it turn out to be too much or not enough?"

Keep a master checklist that shows all of your loans, their terms, interest rates, and other details, including what loans were for. Check your list periodically. You may discover that a balloon payment is about to come due at the same time interest rates are making refinancing an affordable option.

Finally, be humble. "Remember that you are in a private business and that the marketplace doesn't care about your personal needs," says Maglothin.

Bob Redling is a freelance writer and a former editor of Physicians Practice. He can be reached via editor@physicianspractice.com.

This article originally appeared in the April 2006 issue of Physicians Practice.

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