Take Steps Toward a Healthier Practice

BY SANDRA E. D. MCGRAW, ESQ., M.B.A. AND MARK E. KROPIEWNICKI, ESQ., LL.M.

As a practice owner, you know you should monitor your financial statements, but what exactly are you looking for, and what information are you learning from this exercise?

Financial statements and other reports can be deceptive, even when you know what you are doing. In our experience, when most ophthalmologists track charges, collections and/or overhead, all they are really doing is seeing that these figures do not appear to be out of line. If any of these numbers do appear out of line, the practice might attempt to make some adjustments, which essentially amounts to maintaining the status quo. In this article, we will provide several practical examples that illustrate why relying on numbers alone is not enough to truly determine the health of your practice finances. Once you understand the business realities that lie behind these numbers, you can better manage the practice to benefit the bottom line.

Cash Balances Can Be Deceiving

Consider this example: Suppose you pay yourself $20,000 more this year than last year and you ended the year with the same amount of cash in the practice checking account. How is your business doing? Better? Not necessarily. What if the practice accounts payable (what you owe vendors), increased by the same $20,000? Then you are behind. You incurred roughly an additional $8,000 in personal income tax to pay yourself a net of $12,000, and you still owe $20,000 to your vendors! This scenario is easily possible and the dollar amount of accounts payable can be hundreds of thousands of dollars, given the cost of some of the expensive drugs routinely administered in various ophthalmology practices.

A similar result can occur if you pay yourself a year-end bonus on December 31 but staff payroll is due on January 2. Again, you start out the new year in arrears.

Suppose you pay yourself the same $20,000 more this year than last year, your accounts payable have not changed, and you are up to date in what you owe. Do you have a more valuable practice? Not if the practice's collectible accounts receivable have shrunk by $20,000 or more.

The Effects of a Medicare Cut

Consider what would happen if you have been told that there is going to be a 10% cut in Medicare payments. You want to know how this will affect your bottom line. That will depend on a number of factors, the first of which is the percent of collections that Medicare represents in your practice and the second of which is your current overhead rate.

Let's assume that Medicare accounts for 50% of your collections and that your overhead is 60% of your gross collections. Let's further assume that you cannot alter your practice in any way to change your patient or service demographics in the upcoming year. The impact on your bottom line is that instead of receiving $0.40 for every $1.00 collected, you would now receive only $0.35 ($1.00 - 0.05 ($1.00 × 50% × 10%) = .$0.95 - 0.60 = $0.35) for every $1.00 collected. Since you have to work just as hard, see the same patients and render the same services, you now earn less for it, and, unless you work harder, you will have a 12.5% reduction in your bottom line.

Lower Expenses or Increase Income?

Would you rather have 1% more gross income or 1% less overhead? Most everyone would rather have 1% less overhead because they believe the saving would provide a greater benefit to the bottom line. However, at some point, decreasing overhead is no longer feasible. Most practices understand that there is a minimum required operational staffing and overhead, and that if they have automated where they can to reduce error and costs, they are better off increasing income.

Because most ophthalmology practice overhead is fixed, if the practice can see more patients without materially increasing staff time, then that increase in income will drop to the bottom line. This is why efficient practices (those that see more patients per hour) usually have overall lower overhead ratios. On the other hand, some practices that have much higher incomes (more than $1 million per ophthalmologist) than their peers often also have much higher personnel costs (approximately 28%+ rather than the average 22% to 25%), while the fixed costs remain in line or are lower than average as a percent of gross income. This higher personnel investment is usually a function of those practices understanding how to leverage their staff to be efficient. So, in such cases, looking at staff costs alone without understanding how staff efficiency impacts gross collections would be a mistake.

Avoidable Borrowing

Another area where practices get ahead of themselves is with continually accruing (i.e., getting a deduction on the practice's income statement and tax return without actually paying the contribution) their retirement plan contribution each year. Unfortunately, many practices don't even recognize that they are actually borrowing from the retirement plan when they accrue that plan contribution each year. When asked whether they have any liabilities, they often answer "no," not realizing that the annual retirement plan accrual is really a form of borrowing (without interest) from the retirement plan that creates an often significant short-term liability that the practice owes each year.

This accrual happens because many practices usually end up their tax year by paying out most of their profits as bonuses and distributions to their owner. At the same time, they usually accrue (again, get a deduction on the practice's income statement and tax return without actually paying the contribution) the retirement contributions for themselves and their staff. That accrual of the retirement plan contribution is really a form of short-term borrowing because the practice has to actually pay off that accrual by the time it files the practice's federal income tax return in the next year. This accrual buys the practice entity at least 2 ½ months (and longer if an extension of time to file the applicable entity tax return is filed) in which to make that payment.

Why do practices do this? The reason is usually to maintain the practice's cash flow. When the practice pays distributions or bonuses to its owners at the end of the year, there is very little cash left in the practice and the practice uses the accrual (borrowing) of the retirement plan contribution to maintain its cash flow in the beginning of the next year. The better approach would be to have the total amount of profits available for distribution or payment of bonuses at the end of the year split between paying the bonuses/distributions and paying the retirement plan contribution. Unfortunately, once a practice gets in the habit of doing this it becomes difficult to get out of this trap.

Overall practice financial condition can change significantly based on these credit functions — what people owe you, what you owe others and how and when you repay those obligations. Additionally, while some figures are very important, it is also important to know how the numbers work in conjunction with others. For example, collecting more money is usually good, but if the practice is not replenishing its accounts receivable, it may be slowly going out of business. OM

Mark Kropiewnicki and Sandra E.D. McGraw are principal consultants with The Health Care Group, Inc. and principal attorneys with Health Care Law Associates, P.C., both based in Plymouth Meeting, Pa. 610-828-3888. They regularly advise ophthalmologists and their practices on an array of business, financial, legal, strategic and operational issues, including new doctor employment, income division, buy-in and pay-out arrangements. Contact them at smcgraw@healthcaregroup.com; mkrop@healthcaregroup.com