Finance: Using Income Statements as Business Tools

Quick: What was your practice’s overhead last quarter? Last year?

If you don’t know the answer … Congratulations! While many practices fixate on overhead, you’ll find that a well-designed income statement is a much more powerful tool for keeping tabs on practice performance, regardless of the size or specialty of your group.

“We don’t really talk about overhead much,” says William M. Edsel, CEO of the 30-physician Pinehurst Surgical Clinic in North Carolina. “Unless someone asks for it, I don’t produce overhead data on income statements because in a way it’s a false term.”

When physicians at Valley Medical Center in Lewiston, Idaho, gather for monthly budget sessions, they focus on revenue and expense trends. Bill England, a family physician and the practice’s president, says doctors at the multispecialty practice also watch for hiccups in patient charges and deviations - almost anything but overhead ratios.

“We look at previous quarters and previous years and ask, ‘What are we spending, and what’s happening with our volume?’” says England, who also runs the practice’s urgent-care clinic.

Knowing how to read financial statements and understanding the information within them is often the difference between prosperity and just getting by.

Financial Statements 101

The three financial statements commonly used to monitor an organization’s financial health are:

• The income statement, which lists revenue, expenses, and net income or loss for a specified time;

• The cash flow statement, which tracks cash flowing in and out of the practice for day-to-day operations; and

• The balance sheet, which indicates the organization’s degree of solvency and the owners’ equity by subtracting liabilities from total assets.

Of the three, the income statement is your most adept and flexible device for monitoring your practice’s financial health, which is the reason most practices review these statements at least quarterly, often monthly. In addition to reporting patient income, outside revenue sources, and overhead (office and medical expenses), these statements can break out physician compensation and benefits as an expense category and even list the costs for various medical departments, service lines, or ancillaries. Practices that pay physicians based entirely on their production will record each physician’s expenses and revenues on these statements.

England explains, “Practice finances may be more complex to track than your household income, but they are every bit as important to me, especially when my name is sitting there along with my partners’ names on the practice’s mortgage and notes.”

Yet overhead ratio - the percentage of total revenue consumed by operating expenses - has traditionally been Topic A when physicians discuss practice performance.

Edsel warns that overhead is a tricky and often misleading yardstick. For one thing, the overhead rates among specialties - Pinehurst boasts 15 surgical departments ranging from allergy and immunology to urology - vary widely. They also are of little use when comparing physician productivity or pinpointing where the practice may be leaking money.

More important, focusing on overhead doesn’t always get to the most important financial question for physicians, namely: “Are we making money?”

“You can have a practice that’s barely making ends meet but has a nice-sounding, low overhead percentage,” Edsel says. But would you rather be part of a practice with a 30 percent overhead rate producing $100,000 in total revenue per physician or one with a 50 percent overhead rate producing $200,000 per physician?

“I’d much rather hear physicians asking each other, ‘What are you producing per RVU [relative value unit]?’ or ‘What’s your expense per RVU?’” Edsel adds. Those answers and more can be found on a well-designed income statement.

Detective work

So what is a well-designed income statement? Pretty much whatever you want it to be.

“The [income statement] - what’s on it and what isn’t - tells you something about the practice and its issues,” observes Rosemarie Nelson, a Syracuse, N.Y.-based consultant for the Medical Group Management Association (MGMA). “You can start with a standard format, but you should also highlight line items where you want people to pay attention, because there could be a problem or you anticipate some changes.”

Worried you’re spending too much on staffing? Keep an eye on the statement’s entries for nonphysician salaries and benefits, often listed under “operating expenses” on many statements. At the same time, monitor quarter-to-quarter fluctuations in the gross charges obtained from patient services under the revenue heading.

Also, ask your manager to display on your monthly report some data about patient volume during the period. That way you can compare monthly or quarterly staffing costs and patient revenue entries with patient charges or CPT codes billed per physician. Then look at what happened last year during the same quarter for those items. Are your volume figures stagnant or dropping? Perhaps overstaffing isn’t the problem. You may need more staff on board to help your physicians see more patients per day or to perform more procedures.

An income statement augmented by a footnote or by extra details for a few quarters can reveal expense problems that may be caused by just one or two physicians. That’s why Lucien W. Roberts, MHA, administrator of Neurological Associates Inc. in Richmond, Va., says income statements have two purposes: to help physician owners tend to their fiduciary responsibilities and to produce desired behaviors.

“I don’t believe in hiding stuff,” Roberts says. “The numbers are what they are, and I show it to them because my job is to help them make money, which I can do by relying on the doctors’ natural competitive instincts.”

Roberts says a few footnotes could help. If, for example, he noticed the line for discretionary expenses, which is where his practice lists outsourced transcription costs, was consistently too high, he would take action. Breaking out those transcription costs by physician for a few months in a row could lead to productive changes.

“If Dr. Brown is spending three times what everyone else spends on dictation, then some peer-to-peer help to cut that verbosity could save a few thousand dollars for everyone else,” Roberts says. “But if Dr. White is spending half of what everyone spends on dictation, maybe he’s under-documenting, which could give us serious compliance and liability exposure.”

Footnotes can explain major deviations in revenue such as a dramatic leap in patient receipts compared to the same quarter the previous year. “Maybe in the second quarter of 2005 you were down $80,000 because you had three physicians on extended sick leave at the same time, which means being up by $60,000 during the same quarter of 2006 with every physician working maybe wasn’t so great after all,” Roberts says.

Footnotes can also explain what’s behind unusual occurrences such as staffing costs significantly spiking one month. That could indicate a practice that pays employees biweekly issuing three paychecks two months out of the year. Or perhaps a semiannual billing for liability or business insurance hit that particular month.

Rather than perusing cash flow statements daily or weekly - which your office manager should be doing - you can find important clues to your practice’s current and future finances by following A/R trends, assuming you insist on listing them on your monthly income statements.

“If your A/R is cranking along, then your cash flow is OK,” Roberts says. “When there are wide swings in A/R performance from one month or one quarter to another, we drill down to the payer level to see if it’s them or something we’re doing, like not posting charges fast enough.”

Dips in A/R can come from many other sources, such as when physicians neglect to dictate notes for their hospital procedures or fail to complete necessary documentation for workers’ compensation services, he adds.

By using a consistent approach to tracking expenses, you should be able to “drill down” on almost any item in your income statement.

Suppose you spot a substantial increase in purchased drugs and supplies. Your accounting software system, working with your practice management system, should be able to pull up every operating expense and link it to the correct line on your income statement.

“You should be able to view every check and every invoice entered into the system for that particular account, so you could find out that maybe there was a 44 percent increase in infusion drugs from one vendor and you can see the impact of that one increase on your bottom line,” Roberts says.

What’s your ratio?

While some physicians may peruse their income statements just once or twice a year, savvy practice owners know to examine these statements monthly. But it is a challenge to hone in on the most important numbers and keep them in perspective.

That’s why medical practice administrators, CPAs, and physician leaders often expand their income statements by adding ratios to show physician productivity and A/R performance. They also add columns to show how the current period’s revenues and expenses compare with those of previous quarters and with spending projections. Each month, England and his fellow physicians at Valley Medical Clinic review:

• Physician and support staff cost per FTE physician;

• Average number of days that charges remain in A/R;

• Categories of aging A/R; and

• Collections, charges, and revenue indicators.

“You can get these concepts across better with charts and graphs instead of just columns of numbers,” says Nick Fabrizio, PhD, a senior consultant with MGMA. “The trick is to keep people focused on the major trends as opposed to minor monthly variations.”

Looks and timing are everything

Depending on the size of your practice, the number of services it offers, and what you think is worth tracking, your monthly income statement could end up several inches thick. Yet physicians at Valley Medical Center need just four pages to get a full view of their group’s monthly and quarterly performance. And that includes details about significant variances in spending from budget or changes in the owners’ equity. John Houser, the Idaho multispecialty practice’s CEO, prepares monthly summary reports and distributes them one week in advance of discussing them.

“It gives physicians time to ask me for more detail on an item, but usually at the meetings, we focus on any major variances from budget,” he says.

While overhead is not a vital topic at his practice, Houser says a glance at overhead ratio now and then can help assess the impact of major investments, especially those that are amortized and depreciated over several years, such as major software and hardware purchases.

Where to start

You can easily find income statement templates on the Internet. Professional versions of popular business software bookkeeping programs from Quicken, Peachtree, and Microsoft are good places to start because financial statements can be generated electronically from the data your staff enters. Due to the unique nature of CPT coding, medical charges, payer adjustments, and other aberrations of healthcare accounting, many practices rely on a practice management system or a billing vendor’s software to produce financial statements.

The goal is to be sure you can track expenses and revenues related to your unique structure. Although software packages may break these out, a better approach is to create expense categories that explain in more detail how your practice spends its cash. One often-used source for these general-ledger categories is the “Chart of Accounts for Health Care Organizations.” Published by MGMA, it breaks out the hundreds of expense and revenue categories unique to ambulatory healthcare operations. These can be added to almost any accounting software package’s list of categories.

In the end, buying software, hiring staff to enter numbers, and printing out reports monthly will do little good unless you know what you are looking at on your income statements.

“It’s always a challenge to accept this kind of fiduciary responsibility and spend an hour and a half every month - every week if the physician is on our executive committee,” Houser says. He routinely seeks out financial management education opportunities for his physicians and forwards magazine articles to them.

Adds England, “The key thing for us is that by reviewing and understanding these statements we are making sure our practice is financially strong so we know we’re going to be here five or 10 years from now, and likewise if we add a service or more physicians, we know if we are financially in a position to do that.”

Bob Redling has written on practice management topics for more than nine years. He has been practice management editor for Physicians Practice, Web content editor and senior writer for the Medical Group Management Association, and a speechwriter for the American Academy of Family Physicians. His work has been published in Physicians Practice and MGMA Connection. He also was a government affairs reporter for United Press International. He can be reached via editor@physicianspractice.com.
This article originally appeared in the September 2006 issue of Physicians Practice.