Financial statements reveal business health

Financial statements provide information about the medical practice’s performance as a business.

There are several types of financial statements. Here are three important ones.

A balance sheet describes the practice’s financial condition as of a specific date, showing assets, liabilities and owner’s equity. The assets should equal (or balance) the liabilities plus owner’s equity. A balance sheet can be compared to a financial snapshot of the practice’s finances.

Assets can be current (something that can be liquidated within a year, like cash), fixed (not easily liquidated, like a building), or intangible (not physical, like copyrights). Goodwill also is an intangible asset but will likely be accounted for separately.

Liquidity refers to how quickly assets can be converted to cash. For example, liquidity could affect the practice’s ability to invest in costs associated with upcoming expansion without borrowing.

Liabilities are what the practice owes and can be current (due within one year or less, such as rent) or long-term (not due within one year, such as the mortgage on the practice’s office building).

The owner’s equity describes the extent to which assets exceed liabilities and may be referred to as “capital account” in unincorporated businesses.

The income statement describes income and expense (and resulting profit or loss) over a period of time. Income statements provide a different picture than does the balance sheet because it takes into account fluctuations in revenue and income.

The statement of cash flows, formerly called the statement of changes in financial position, is the difference between cash flowing in and cash flowing out of the practice. Cash flow problems can cause a business to fail. Practices that borrow too much and don’t get paid quickly enough have potential cash flow problems, especially if the bank declines to lend more money to help the practice ride out a period of slow income. The statement of cash flow can show the amount of cash generated from running the practice (operations), investments and financing, respectively.

Comparison of financial statements forms the basis for much financial analysis. There are four common ways such comparisons are made:

• Comparing performance over successive years
• Comparing performance with specific competitors’ performances
• Comparing with industry standards
• Comparing against a target set by the practice

Analysis of the numbers allows the medical practice to measure its success. Though most physicians do not have financial training, knowing how to analyze financial statements is important for forecasting per-partner income and spotting ways to make the practice more profitable.

For example, numbers can allow the medical practice to analyze the extent to which leverage, the ratio of associates to partners, is more or less profitable for the practice. Numbers, in the form of realization rates, can be used to reduce to dollars the effect of delay between the time work is performed and payment is received. The difference between being paid within 30 days of doing work compared to six months affects both profitability and cash flow.

Numbers also can help firms identify unprofitable areas of practice. If an unprofitable area is income per physician or per hours worked in a particular area, the practice may consciously decide whether to opt out of this area or whether to keep the less profitable practice area for other reasons – such as that it is a loss leader complementing other areas that are more profitable, or it has a stable and steady cash flow compared to other more profitable areas subject to fluctuation.

If income statements show a trend, such as a steady increase or decline in income in a practice area over a period of time, the trend may affect the practice’s strategy going forward, the manner of allocating personnel and the types of personnel recruited in the future.