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What is your practice’s financial IQ?

By Sherry Migliore, MPA & Bonnie Meisel, CPA

Costs are up and revenue is down in many practices. Even so, many physicians and office administrators are reluctant to dig into the details of the problem and find solutions. If you are tired of the anxiety and unpredictability, buckle down and take a hard look at your numbers.

Physicians should perform routine financial checkups on their practices throughout the year. Just as they recommend preventative steps for their patients, so too should physicians follow a series of steps to prevent financial health problems in their practices.

Step One: Develop A Budget

Many medical practices do not develop annual budgets. Preparing a budget takes time and analysis. Is knowing your destiny worth it? Budget preparation requires an understanding of the type and amount of expenses that have been incurred by the practice historically. Budgeting also forces the practice to assess what impact current market indicators will have on future operations of the practice. For example, it is important to project the impact that increases in medical malpractice premiums will have on the financial operations of a practice, particularly on cash flow.

Physicians should assess where and why variances to a budget occurred. For example, did expenses for medical supplies increase because of increased usage, increased pricing, or a combination of both? If it is determined that it is a pricing issue, are there alternate vendors or more effective purchasing techniques that could be employed?

The budget is only useful if it is used periodically to assess actual results to expectations. This analysis should be performed monthly. Comparing actual against budgeted expenses on a monthly basis is a useful exercise, as is comparing current expenses against last year’s expenses for the same period.

Having a budget and using it as a management tool provides for proactive management of a practice’s finances. If you are developing a budget for the first time, don’t expect it to be perfect. Think of it as a work in progress and an investment in your financial future.

Step Two: Monitor Practice Overhead

Gaining an understanding of the practice’s overhead percentage is key to successful financial management. The practice’s financial statements should clearly differentiate physician expenses from other operating or overhead expenses. The ratio of operating expenses to net revenues (collections) is an important financial indicator.

Physicians should compare their practice overhead to other practices of the same specialty. There are a variety of surveys that can be used to benchmark overhead expenses. These include the Medical Group Management Association (MGMA) and the National Association of Healthcare Consultants (NAHC) surveys. Some of the specialty societies also collect this information.

An important component of monitoring overhead is a comparison of staffing level/expenses per full time equivalent (FTE) physician to other practices. Staffing levels vary significantly by specialty. For example, a 2001 Salary and Benefits Survey conducted by the Pennsylvania Medical Society reported an average of 5.75 staff per physician in ophthalmology practices. The same survey reported an average of 3.11 staff per physician in pediatrics practices. Both of these benchmarks were comparable to the averages reported in the MGMA and NAHC surveys.

Trending of overhead expenses should be also performed monthly and in comparison to previous years’ performance.

Step Three: Monitor Cash Flow

Many practices these days are experiencing difficulties with cash flow. Barring any unusual circumstances, shortages of cash are often an indicator of much more serious financial problems. Every aspect of the financial operations of a medical practice affect cash position. This includes, but is not limited to, physician productivity, fee schedules, billing, collections, expense management (particularly compensation and staffing levels), and purchasing activities.

The availability of cash can be particularly problematic at the beginning of the year because of the need to “zero out” the corporation’s books at the end of the year. Some practices place monies in reserve in anticipation of this. Physicians should work with their accountant to plan for this so the practice is not operating without adequate funds to start the year.

Generally, it is not advisable, nor should it be necessary, to utilize a line of credit to pay for the practice’s ongoing operating expenses. If a practice is using this strategy to fund operations, the line of credit should be used sparingly and on a very temporary basis. Otherwise, the problem is compounded and the practice will be in a vicious cycle of borrowing and incurring interest expense, which places further strains on cash.

Step Four: Monitor Accounts Receivable

Monitoring of accounts receivable (A/R) should be performed monthly, at minimum. The most successful practices review accounts receivable status on a weekly basis. The accounts receivable in the 0-30 day, 31-60 day, 61-90 day, and 91-120 day categories indicate how successful a practice is at getting paid for the services it provides. A general rule of thumb is the longer a claim is outstanding, the less likely it will be paid.

Aggressive management of A/R is key to a practice’s financial success. Again, there are benchmarks available for comparison purposes. Generally speaking, a practice should have less than 20 percent of its receivables in the over 90 day category. The use of electronic claims submission and electronic payment posting generally improves a practice’s A/R status.

Step Five: Monitor Collection Rates

There are two collection rates used to evaluate collection efforts: gross collection rate and net collection rate.

The gross collection rate is calculated by dividing total receipts by total charges. This indicates the percentage of total charges being collected. This ratio can vary from practice to practice based on payor mix and fee schedules. For example, a practice charges $100 for a service. In accordance with the practice’s contract, the insurer pays $50 for the service, yielding a 50 percent gross collection rate. However, if the practice charges $50 for the service, and is paid $50, the result is a 100 percent gross collection rate. Internal goals for gross collection rates should be established for each major payor based on the practice’s fee schedule.

The net collection rate shows how much a practice collects based on what is available to be collected. This ratio is calculated by dividing the sum of total receipts and total adjustments by total charges. As in the example above, the practice has a $100 charge and the insurer payment is $50. The adjustment amount for the practice’s charge is $50 and the net collection rate is 100 percent.

The net collection rate, which indicates how much of the practice’s collectible production is actually being deposited into the bank, should be as close to 100 percent as possible. This rate may vary somewhat due to timing of collections and adjustments from earlier time periods. The practice’s charges and payments can be obtained from its billing system.

Step Six: Know the Cost of Doing Business

A business cannot survive if the cost of producing a product or providing a service is greater than its selling price. A medical practice is no exception to this rule. If a physician knows how much it costs to provide services, he or she can make more fully informed practice decisions.

Conducting a relative value unit (RVU) analysis is a relativley easy way to determine the costs that go into each service provided by the practice. In order to perform the analysis, the following information is utilized:

• A report from the practice’s computer system listing total volume for each procedure performed (by CPT code), and total charges and payments received for a one-year time period. This information can be easily obtained from most practice management systems.

• The practice’s statement of income and expenses for the corresponding period of time.

Information from the practice’s statement of income and expenses is used to determine work, malpractice and practice cost components. This statement must identify separately all physician expenses such as salary and benefits, conferences and travel, automobile and any other expenses specifically related to the physicians. These expenses comprise the “work” component of the RVU analysis.

Additionally, the malpractice expense must be easily distinguishable from the practice’s other insurance-related expenses. Most practices capture this item separately for accounting purposes.

All other remaining expenses of the practice comprise the “practice cost” component.

Based on the RVUs for the procedures performed during the year, a conversion factor is calculated for each component of the analysis. These conversion factors are applied to each procedure in an effort to identify the per procedure cost.

It is preferable to utilize a full year’s worth of data to conduct an RVU analysis. The data from the practice should include all services provided during the year, including reimbursements received for these services.

A cost analysis by procedure can be used to:

• Make more informed decisions on types of services to offer.

• Decrease overhead by eliminating unprofitable services.

• Analyze capitated and global payment contracts.

• Negotiate higher payments for unique services provided by the practice.

• Market the practice’s most profitable services.

In conclusion, physicians who pay attention to their practice’s financial IQ will have a healthier practice overall. As noted by B. C. Forbes, “If you don’t drive your business, you will be driven out of business.”

Sherry Migliore, MPA, FACHE, is director of consulting for PMSCO Healthcare Consulting, and Bonnie Meisel, CPA, is director of finance at PMSCO, a subsidiary of the Pennsylvania Medical Society.

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