Accounting Statements for Ophthalmology Practices

In this article, I will review some accounting principles and accounting statements that are useful for assessing the financial state of your ophthalmology practice. I will also review aspects of more traditional accounting and the reports that define the performance and financial condition of the “business” of your practice.

Deciding to use cash or accrual accounting is a topic that often generates debate between practice managers and accountants.

In cash accounting, income is recognized when it is received and expenses are recognized when they are paid.

In accrual accounting, income is recognized when it is earned and expenses are recognized when they are incurred.

For any medical practice, the major difference between cash accounting and accrual accounting is on the income side. In an accrual system, income is recognized when the clinical service is rendered. The value of the service is generally represented by the gross charges, which are then adjusted to the expected income. The inability to accurately predict the exact payment level from each insurer is the major factor that makes accrual accounting so difficult for medical practices to estimate.

In practices that are large enough to employ an accounting professional to keep the books, the accrual system is often used, with an adjustment to gross charges based on the collection ratio from the previous year. The flaw with this system is that there are not always accurate measurements to determine if the previous year's collections are optimal. For this reason, I recommend that most practices use the cash accounting method.

Financial Statements

There is no shortage of financial statements that accountants use to define a business. We will concentrate on four that I find the most useful. These are an income statement, a budget, a cash flow statement and a balance sheet.

In simple terms, an income statement is a report of the financial history of a business over a defined period. A balance sheet, on the other hand, is a snapshot of the financial status of the business at a moment in time. A budget is simply a projection or prediction of what the income statement will look like at some future point in time.

Income Statement

The income statement, sometimes called a statement of income and expenses, is a fairly straightforward report, with the top section of the report listing income by various categories, adjustments to the income (refunds, etc.) and the adjusted income.

The next section of the income statement lists expenses by category. These categories are generally defined by the practice’s general ledger categories. Whether the books are kept by hand or in a simple or complex accounting computer software package, expenses are sorted into categories that even a simple software program such as Quicken can track.

The format can be as simple as:

Note that this example is quite oversimplified. Your income statement would have a far more discrete set of expense categories, rather than $139,063 in “miscellaneous” expenses. The value in quarterly monitoring of the income statement is to assure that the total non-physician expenses (measured as a percentage of income) remains at an acceptable level compared both to previous quarters and national norms. It is also a way of comparing the actual income and expenses to the projections or the budget.

Budgeting

The income statement depicted above is a report of financial activity for the period Jan. 1, 2004 through June 30, 2004. Had budgeting taken place in December 2003, a projection of each “line item” in the income statement would have been entered. A similar income statement report with actual activity compared to budget would be as follows:

As illustrated by this statement, while the actual practice profit was $97,200, only $60,000 profit was projected in the budget, leaving $37,200 in profit above the budgeted amount.

I recommend that a budget be developed annually and monitored against actual performance. These projections are invaluable in making strategic financial decisions for the practice, including expanding services, adding a new provider or opening an additional office.

Cash Flow Statement

The cash flow statement is subtly different from that of the income statement. While the income statement reports on income received and expenses paid, the cash flow statement adds the beginning and ending cash balances. This report describes the liquidity of the business. A simplified example follows:

The above data illustrates positive cash flow, or an increase in the available cash at the end of the month, as compared to the beginning of the month. If the expenses for the month exceeded the opening cash balance and the income, the report would reflect a negative cash flow, as illustrated below.

Continuing months of negative cash flow will eventually leave the practice with insufficient cash to pay its expenses.

Balance Sheet

While the income statement presents a picture of financial activity over a period of time, the balance sheet is a snapshot of the financial status of the business at one point in time. Here is a listing of various categories of assets and liabilities:

With a balance sheet, the sum of liabilities and owners’ equity must always equal the total assets. There is always a claim against the assets, whether from creditors or owners of the organization.

If the practice has a lengthy and large list of liabilities, a negative amount may be reflected in the owners’ equity category. For instance, if a practice made a large investment in equipment and build-out for a refractive surgery or cosmetic center and that line of business was not generating significant income, the liabilities would be large, without the sufficient offset from accounts receivable or cash. Subsequently, the owners’ equity and the net worth of the business would reflect a negative figure.

It is important to remember that the balance sheet could show a very positive net worth, since there might be sufficient assets to provide a positive net worth for the practice, while the cash flow and income statements reflect monthly cash shortfalls, and therefore depict a negative cash flow.

This simple overview describes the reports that are most valuable for the practice. While the practice’s accountant will prepare these reports in most cases, it is critical that both the physician owner(s) and the practice manager review and understand how to interpret them.

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About the author: Ron Rosenberg is president of the Practice Management Resource Group, a health care consulting group that specializes in financial performance, computer system selection and business office management. The firm is headquartered in the San Francisco Bay area, with offices in Chicago, New York and Washington, DC. Ron authored the monthly newsletter Watching Your Bottom Line for the Academy from 1999 to 2002.