Focus on Cash Flow, Not Profit in Medicine

 

Cash flow timing problem in medicine

I’ve learned a lot from this class called Short-Term Financial Management, which is basically an accounting class. The most important point is that profit is completely different than cash flow in medicine.

Your medical practice could run a profit every day and still go bankrupt simply from day-to-day operations because of the timing problem with cash flow in medicine. I am not talking about a major lawsuit from a patient or an investigation into your practice by Medicare. This refers only to regular operations.

Let me introduce some accounting into your life. I won’t go too in depth because no one really likes accounting… (But it’s one of the most useful things you can study in school.) If you don’t understand the Financial Statements Overview section, you are probably in the majority, and the section below it will go through the main points.


Financial Statements Overview

There are 3 main financial statements. Here are 2 of them:

1) Income statement: This document shows how much “profit” aka “net income” you made. For a private practice or hospital includes:

  • Revenue
    • services rendered to patients
    • from equipment
  • Expenses
    • salaries to employees
    • property rent and utilities
    • equipment costs
    • supplies
    • depreciation
  • Taxes
    • payroll taxes (social security and Medicare taxes=to what employees pay)
    • property taxes
    • taxes on profit differ between private practice partnerships, non-profit hospitals, and for-profit hospitals

Analysis

The profit/net income earned = Revenue – Expenses and Taxes.

What is revenue though? Unlike what you probably think, revenue is not the money coming into your practice. Revenue is simply what you bill for your services. It is money or “cash” that you should get at some point. Basically, you could run a profit every day, but not have had any actual dollars come into your practice or hospital.


 

2) Cash flow statement: this document shows the actual money that you got during the period by making adjustments to net income. Here is what is included in just the operating cash flow side:

  • Starting net income
  • Operating cash flow adjustments
    • depreciation expense
    • change in accounts receivable (A/R)
      • bills to insurance, government, patients
    • change in accounts payable (A/P)
      • bills from medical equipment suppliers
    • change in accrual expenses
      • salaries to employees

Analysis

Operating cash flow (actual money brought in) = net income + depreciation expense – increase in A/R + increase in A/P + increase in accruals

The point of a cash flow statement is to start with net income or profit from the income and adjust it to show the actual money that came into your practice or hospital. ¬†I’ve got a few confusing terms in there, so I’ll explain.

Starting net income is the net income or profit from the income statement above. Depreciation expense on your equipment etc. is like depreciation on your car. It’s not a cash outflow, but it subtracts from profit, so it’s added back in. I imagine a private practice wouldn’t worry about this but a hospital definitely would.

A/R or accounts receivable is the money that you billed for but have not collected. Billing goes to insurance companies, patients, and Medicare/Medicaid. The reason an increase is subtracted from net income is because there is no actual cash inflow, yet it added to your profit. It can take very long for the money to actually come in (see below.) A/R is the main reason for the cash flow in medicine problem and why cash, not profit should be your focus.

A/P or accounts payable is the money that you have pledged to pay but have not sent the money for. Think medical equipment or supplies, which you usually don’t pay for right away. It is added back in to profit because it was subtracted in the income statement, but is not actually a decrease in cash yet.

Accrual expenses are expenses that slowly build up over time but are not paid for yet. The best and most commonly used one is salaries. Your employees may have worked for 3 days and you owe them all of those wages, but they won’t be paid until every other Friday. Once again, this decreases profit, but it is not a decrease in cash yet, so add it back in.


Financial Statements Takeaway

A private practice or hospital can be profitable every day (seen from the income statement) but be in serious financial distress because of the timing of its cash inflows and outflows, which are unrelated to the net income timing.


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The Main Cash Flow in Medicine Problem: Delayed Reimbursement 

The main problem with cash flow in medicine is that with insurance/government/patient reimbursement cash flow is significantly delayed. According to my dad, his practice collects on about half of their billing within a month. Most of the rest is collected within 3 months and a small portion could take up to a year to collect!

Your rent and utilities still need to be paid every month and employees still need to be paid every other week, but your cash inflow is very irregular. Even if you have a hefty profit every day on your income statement like an independent free-standing ER will have, you could have no real money to pay your obligations when due.


Recommendations 

The business world is very different than personal finance. In personal finance, it is always recommended to pay off debt immediately; however, in business it is often recommended to pay off your obligations as late as possible within a contract. One of the main differences is that as soon as an individual purchases or “invoices” something, it has to be paid for. If not, then it is paid for through credit card debt that charges you interest per day. In business, on the other hand, major purchases are rarely paid for when invoiced. If a “net 90” contract is stipulated (meaning you have 90 days to pay), then there is no interest charged per day for paying on day 90.

To Hospitals

There is little that can be done to collect faster on your billings to patients, insurance companies, and Medicare/Medicaid; however, the timing of your cash outflows can be adjusted. Negotiate payables terms with medical equipment suppliers so that you pay as late as possible without actually paying late.

When a major piece of medical equipment is ordered, you won’t pay for it right when ordered or even when delivered. If given net 3o terms, there is no reason to pay on any day before day 30 unless there is a slight cash discount for paying early (look at it case-by-case.)

For one, your cash inflows are very delayed, so you want your cash outflows to be delayed as well. A second reason is that there is an opportunity cost of paying cash early. Cash can be invested in highly liquid securities, such as a 10-year U.S. treasury that might pay 2.2% yearly (or .183% monthly) on your cash. A hospital negotiating net 90 terms for a $3M MRI machine will result in saving $16,500 as well as helping out with the cash timing problem

To Private Practices

Once again, there isn’t much that can be done to collect on billings faster. You’re really at the mercy of insurers and the government. You can still delay payments though.

Like I mentioned above, terms can be negotiated with new medical equipment suppliers to pay later than the invoice date. You should always do this. This will alleviate the cash timing problem. My dad’s practice doesn’t invest their short-term cash, so it may not be common outside of large companies. Thus, there may be no opportunity cost of paying early but it will still create cash flow timing problems.

According to CFO.com, you should approach different suppliers differently. Some are crucial too your business, but there might be negotiating room with others.


Conclusion

Focus on cash flow in medicine. Profit can be very deceiving. It can show that your hospital or practice is thriving when it can actually be on the verge of bankruptcy because of cash issues. Always keep an eye on cash flow and delay payments to suppliers whenever possible without incurring a late fee.


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