As anyone who runs a medical practice, a dental practice or any sort of small business knows, profitability is important but cash flow is key.
Medical and dental practices exist in an arena where receivables can be an issue, especially when insurance or governmental reimbursement comes into play. A practice that looks profitable may or may not have a healthy cash flow based upon the length of time its accounts receivable is outstanding.
Here are some liquidity ratios that practice owners and managers should monitor to ensure that they have sufficient liquid assets to cover normal business expenses as well as your short-term physician debts and the unexpected expenses that invariably arise.
The current ratio is simply calculated as your practice’s current assets divided by the current liabilities.
Current assets are those that could reasonably be converted to cash within one year. These include items such as:
- Net accounts receivable
Current liabilities are those that must be paid within the next year. These typically include items like:
- Accounts payable
- Notes payable due within a year
- Interest payable
- Wages payable
- Taxes payable
A current ratio of less than one indicates that your practice has more debts due over the next twelve months than assets that could be converted to cash.
The quick ratio, also known as the acid test ratio, is similar to the current ratio in many respects. The calculation is the same except that inventories are excluded from current assets. For businesses that do not hold inventories, or hold minimal amounts, this may be a better indicator.
Accounts receivable days outstanding
The days outstanding for your practice’s accounts receivable is an indication of how quickly your patients are paying you. Depending upon the nature of your practice and your patients, some may pay you when service is rendered, some may submit the bill to their insurance company and some may come from governmental payers such as Medicare and Medicaid.
In terms of payments from third-party payers you have some control by having your staff follow-up to ensure claims have been received. A key thing to monitor on your accounts receivable is the trend. Is the level of days outstanding staying relatively constant? Is it increasing? Decreasing?
If the days outstanding is increasing this is a red flag that needs investigation. Are certain third-party payers lengthening the time they take to pay claims? Perhaps you or your staff need to follow-up with these third-party payers on a regular basis. Would it make sense to make other payment arrangements with some clients to increase cash flow?
Make no mistake, if this statistic increases drastically it is akin to slowing the flow of the life blood of your business, cash flow. If your practice operates on an accrual based-accounting system, you could find yourself being very profitable but starved for cash.
The actual calculation is to take the current accounts receivable balance divided by your annual revenue and multiply this number by 365.
Operating margin is what is left over after deducting the variable costs of producing goods, in this case providing the services you provide to your patients. Your main variable expense will be the cost of the salaries of your office staff and perhaps yourselves. There may be other consumable-type expenses included here as well.
The residual is operating margin or operating profit. Operating margin is expressed as a percentage and is calculated by dividing operating profit into revenue.
Operating profit is an important number in that this is what is left to cover your fixed costs
Working capital is another measure of liquidity. This is calculated by subtracting your practice’s current liabilities from your current assets. The larger the number the greater your cushion against a downturn in revenue. Bankers Healthcare Group offers working capital loans for doctors to help provide this cushion.
Days in accounts payable
This is similar to the aging calculation for accounts receivable. This is calculated by dividing your accounts payable by your annual cost of sales (this will generally be wages plus consumable items used directly in the generation of revenue) times 365.
This is a very useful ratio in a couple of ways. Paying bills too early can be a poor use of your cash and cause a cash crunch under certain circumstances.
Stretching your payments out past the terms given on the invoices is also a bad sign. This might say to outsiders that your practice is having cash flow issues or at least that you are someone that they might not want to do business with.
Cash flow is king
Profitability is very important in any business, whether a medical or dental practice or a widget manufacturer. Long-term, if a business is not bringing in more revenue that its expenses it will likely go out of business.
That said, cash flow is the lifeblood of any practice. If your practice uses the accrual accounting method, you could easily show a profit but be starved for cash.
It is important to be sufficiently capitalized from the outset to ensure that your practice has sufficient working capital for startup expenses and to meet payroll until the revenue starts rolling in. Beyond that, however, managing your cash flow is critical to your success and your survival. As mentioned previously, your accounts receivable may get stretched due to the vagaries of dealing with various third-party payers among other reasons.
No matter how busy you are with patients, if cash is coming in too slowly compared with your outflows this is a problem. This can result in you borrowing more money than you’d like or worse it could put you out of business.
Using ratios as a tool
The financial ratios discussed above are a great place to start in monitoring the liquidity of your practice. If you have a qualified financial person in your practice this is something they can set-up. If you are smaller, then perhaps your outside accountant can help with this. They may also be able suggest other ratios and indicators to help monitor the financial health of your practice as well. Tools like financial ratios can provide a quick means to monitor the financial performance of your practice.
The views, advice, and opinions expressed in this article are solely those of the original authors and do not necessarily reflect the view of Banker Healthcare Group, LLC its affiliates, or its employees.