Updating Your Financial System to Match Your Practice Growth
Financial reporting must evolve to ensure sound and efficient decision-making
By Rachel Siltman
When you opened your physical therapy private practice, you used a particular set of financial tools, and they’ve served you well up until this point. But if you’re finding that your financial system is no longer serving your practice’s needs, that system may need to evolve to incorporate new tools and strategy as your business grows. The processes and reporting systems utilized to get a private practice started will need to be modified and updated to ensure continued financial success.
UTILIZE SIMPLIFIED FINANCIAL REPORTING
A key accounting principle that applies regardless of business cycle or size is the need for simplified financial reporting. Many owners have an overly complex chart of accounts that detracts from the intended usefulness of a profit and loss statement (P&L). Consider working with your accountant or bookkeeper to eliminate subaccounts that do not either add value to your business or help you achieve your tax goals. The concept that less is more definitely applies, and most owners can limit their chart of accounts to no more than 50-60 lines of data.
An additional step is to create and use a monthly business summary that provides critical information for making key business decisions. Consider using a P&L summary to benchmark monthly performance using historical and current financial data (Figure 1).
The simplified report translates data into an insight-filled resource helpful for making everyday business decisions based on key financial trends. It also highlights variances requiring action. After all, you can’t improve performance without an understanding of the driving factors behind strong (or poor) financial trends. A summary that outlines profitability and labor as a percentage of revenue, for example, may highlight the opportunity to shift staff and ultimately improve efficiency and meet patient demand.
Another perk of simplified financial summaries is the ability to marry financial performance to operations metrics. Focusing on key financial and operational ratios can be instrumental to assessing performance against benchmarks and budgets. Revenue per visit, total labor cost per visit, and net operating income per visit are examples of ratios that paint a broad but important picture of financial and operational performance. Operational metrics, such as new patients, patient visits, visits per new patient, and procedures per visit, can add value as well. A deeper dive may be required to investigate shifts in the trend or unexpected variances, but a high-level snapshot ensures the primary drivers of the business are on track.
EVALUATE FINANCIAL RATIOS FOR STRATEGIC DECISIONS
Consider for a moment checking the final score of a sporting event. Knowing the Los Angeles Rams scored 23 points in the Super Bowl doesn’t indicate whether they won unless you also know that the Bengals scored 20 points. You need both scores for comparison to tell the whole story. The same goes for the financials in a physical therapy practice. Consider a clinic with $150,000 of annual net income. With that number in isolation, the health of the practice simply cannot be evaluated. Knowing that $150,000 of net income represents a 20% profit margin (with profit as a percentage of revenue) tells a more complete story.
In my experience, profit margins for healthy physical therapy practices average 18-20% of revenue. Armed with this information, an owner knows $150,000 is a sign of health in a practice with three physical therapists and $750,000 in annual revenue, as this represents a 20% profit margin. The same $150,000, however, would be concerning for practice with eight physical terapists and $2 million in revenue, which would indicate a 7.5% profit margin.
Evaluating financial ratios as a percentage of revenue provides a more complete picture of performance (Figure 2). Approach benchmarks with caution. Financial benchmarks provide useful guideposts but may not account for regional payer rates, billing rules, or your exact payer mix. As your practice grows, it is important to establish applicable targets that are most appropriate for your practice.
Caution should also be exercised when evaluating marketing as a percentage of revenue. Knowing a practice spends 5% of revenue on marketing is again no better than knowing that the Los Angeles Rams scored 23 points. Spending 5% on marketing is a great investment if the practice is growing by 10% each year. However, spending 5% on marking is likely a poor investment if the practice is not experiencing any new patient growth.
The goal of assessing ratios is to create a sound business that has enough money left over to invest in improving the business, create a reasonable return for the owner, weather any unpredicted storms, and invest in growth that allows the business to expand its impact on the community it serves.
LEVERAGE ACCRUAL-BASED ACCOUNTING PRINCIPLES TO HELP WITH BUSINESS DECISIONS
While cash accounting makes sense for most physical therapy practices, understanding and leveraging accrual-based accounting principles can assist with business decisions in several specific situations. The basic difference between cash-based accounting and accrual-based accounting comes down to timing. With cash-based accounting, revenue is recorded when it is received. With accrual-based accounting, revenue is recorded when it is earned. For example, with cash-based accounting, the revenue from a visit completed in June would not be recorded until it is received in July. With accrual-based accounting, the revenue anticipated for the June visit is recorded in June.
Opening a new clinic or assessing performance for a fast-growing clinic are examples where cash-based accounting will often lead to the appearance of lower than actual net revenue per visit and lower profitability due to timing of insurance payments. In both cases, using expected net revenue per visit in place of actual collections can assist in making key business decisions.
Accrual-based accounting provides a more accurate picture of the practice’s profitability and financial health. The downside of accrual-based accounting is that it requires a more complex system and potentially makes it more difficult to track cash flow.
Cash-based accounting simplifies the bookkeeping process and more accurately reflects cash flow. The downside of cash-based accounting is the difficulty of interpreting frequent fluctuations and reported revenue. As a practice grows to more than $5 million in revenue, owners may find value in running simple comparison reports to maximize the advantages of both.
TAKE FINANCIALLY SOUND ACTION
Regardless of size, software, and accounting practices, private practice owners can utilize simplified financial summaries to make sound business decisions. Below are key steps to assist with making necessary changes:
- Work with your accountant and/or bookkeeper to simplify your P&L’s chart of accounts.
- Create a simple business summary to assist in evaluation of key financial ratios.
- Leverage this summary monthly to make key decisions on staffing and the right time to open new clinics.
- Leverage the benefits of both cash- and accrual-based accounting to inform decisions on distribution, beefing up cash reserves, and ensuring access to financing when necessary.
- Celebrate the successes that have gotten you to this point AND implement necessary changes to help guide your business to future growth and success.
Rachel Siltman serves as the director of finance & marketing analytics at 8150 Advisors. Rachel can be reached at rachel@8150advisors.com.