The biggest career decision you will make following your medical training and medical career management will likely be joining a medical practice. A practice is a small business and you will be entering the business of medicine. Very likely you will have business partners in this enterprise.
As with any investigation into a business’s financial health and stability, you must perform a rigorous analysis of the practice’s finances and business metrics.
Two key areas in which you, as a prospective partner, should concentrate your initial efforts when assessing the business fundamentals of a practice are revenue analysis and financial statements. In this, the second of two companion articles, we discuss what you should look for in a practice’s financial statements.
Financial statements are usually developed by an accountant and are produced on a routine basis, with monthly, quarterly and annual versions of each report. When assessing a practice, it is critical that you request, review and understand its financial reports before making a decision about joining.
These reports, alongside the revenue structures and metrics discussed in the companion article ? Practice Revenue Structure will provide you with a clear and detailed understanding of a practice’s overall financial health.
Here is a discussion of the standard financial reports generated by a typical healthcare practice.
Balance Sheet
The balance sheet contains information about the practice’s assets and liabilities.
Anything that a corporation owns that has economic value is an asset. Assets are acquired by a practice to add value the business. Assets can include cash, accounts receivable, real estate, equipment and machinery, and securities.
Liabilities are also recorded on the balance sheet, and include loans, accounts payable, mortgages, deferred revenues, and accrued expenses. For example, the unpaid value of a mortgage or outstanding monies owed to suppliers would be considered a liability. Current liabilities are debts payable within one year, while long-term liabilities are debts payable over a longer period.
Analysis of the balance sheet will reveal important information about the practice’s overall financial health and stability. It will provide you with a good understanding of investments that have been made as well as debts that must be paid off.
Careful reading of the balance sheet will indicate whether the group is borrowing to invest in the growth of the practice or simply borrowing to maintain a level of physician compensation not warranted based upon the group’s actual profitability.
Since you are considering becoming a shareholding partner in a practice, it is critical to determine what, if any, existing debt you may be expected to assume as a new partner. This is an important element to cover in negotiations – be sure to get professional advice if you’re uneasy or unclear about any proposed assumable debt for a new partner joining the practice.
Income Statement
The income statement provides a picture of the revenues, expenses, and net income of the practice group and is the single most important document to review and analyze as you assess a group’s financial condition.
You should request and review the year-end income statements for the practice’s previous 3 years of business operations. The most important point to determine is the trend in annual net income, whether it is increasing, decreasing or remaining flat.
Comparing two trends revenue growth and associated costs will help to give you a clear and informed view of the direction the practice is taking. Trends in practice expenses, in relation to changes in net revenue, directly impact net income. And net income is the business calculation that most directly translates into physician compensation.
A close reading of the income statement will also reveal the drivers of changes in the core business numbers. For example, has physician productivity changed or remained flat? Have reimbursement rates changed in any way to either positively or negatively affect the income statement?
To help you understand and analyze the information contained in these two financial reports, we will discuss several business and finance terms with which you must become familiar and comfortable: cost structure, break-even point, and profitability.
Cost Structure
There are two types of costs within any business fixed and variable. Oftentimes we refer to the total costs of an enterprise as “overhead”. For most healthcare practices, costs for rent, equipment leases, full-time staff salaries and professional liability insurance are relatively fixed, while variable costs move in relation to volume.
When a practice seeks to achieve and sustain long-term cost reduction and control, it will typically focus on reducing variable costs associated with its delivery of professional and technical services.
Understanding the differences between fixed and variable costs will help you determine what a change in the net revenue means for a practice and for physician income and, by extension, provide insight into the actual group expenses directly associated your first year of employment as a new physician.
Break-even Point and Profitability
Most physicians run a financial deficit during the start-up of their practice. How long the deficit runs depends on the amount of time required to reach the “break-even” point. Break-even is the point at which a physician’s cash collections equals total expenses. Beyond the break-even point lies profitability, if sustained.
Initial costs (in some cases one-time costs), associated with a new physician’s start-up may include items such as additional new equipment and furnishings, updated letterhead, brochures and related marketing collateral, salaries and benefits for additional staff, additional office space, and communications and information systems.
As a rule of thumb, in a specialty like ophthalmology, practice group overhead ranges between 40% and 60% of revenues. So, assuming an average of 50% overhead, collections for a new physician must equal twice the expenses related to the new physician in order to reach break-even.
Understanding the financial condition of the group will greatly assist you in estimating the costs associated with you, as a new physician, joining the practice ? and the likely impact on you as you face your first professional position in which you are no longer guaranteed a base salary.
So it’s important to look carefully at the existing partners in the practice to determine the length of time it took each of them to reach break-even and then profitability. This period is often referred to as the “ramp-up” time and clearly the shorter your ramp-up time, the sooner you will generate a profit for the group.
Confidentiality
If a medical practice has extended you an employment agreement or partnership offer, but is reluctant to share the types of financial information discussed here, you should offer to sign a confidentiality agreement, agreeing not share or disclose the information with any other parties beyond your financial advisor. The practice should understand that there is no other way for you to make an informed decision and recognize that it is protected by the confidentiality agreement.
If, for some reason, the group remains unwilling to share its financial data with you, it could be a red flag indicating there could be information the practice would rather not reveal, or that there is a general predisposition towards a lack of sharing openly and honestly among the partners.
Open, honest communication is critical to the success of any group practice and the earlier this is established, the better for all.