Reading Financial Statements

October 1, 2003
William Litt

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

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."

Uncovering problems

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.

Reading section-by-section

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.

See what you spend

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.

Getting help

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 www.mgma.com).

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.

William Litt can be reached at editor@physicianspractice.com.

This article originally appeared in the October 2003 issue of Physicians Practice.