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Once you know how to read it, your balance sheet will tell you volumes about the financial health of your practice .
F. Michael Arnow, CPA, CFP, MBA, and George C. Xakellis, Jr. MD, MBA
Every physician practicing today should know how to read basic financial statements, starting with a balance sheet. Why? To begin with, it will equip you to sit down with your bookkeeper, accountant, administrator or chief financial officer and discuss finances in a way that demonstrates that you understand the bottom line. And, if you find yourself in negotiations, whether for a raise or the sale of your practice, a healthy understanding of the numbers will empower you. After all, banks use financial statements to decide whether to lend your practice money; hospitals review them to determine whether they want to purchase your practice and how much they’re willing to pay for it; and your employer (if you’re employed) uses them to calculate the organization’s profitability and, in effect, to determine how much money is available for your raise. Why should you be the only one who doesn’t know what is going on?
A little knowledge of accounting will help you better understand the information your accountant, administrator or banker provides and will empower you to act on that information.
A balance sheet is a financial snapshot. It summarizes the financial status of an organization at a given point in time.
A balance sheet shows the assets of a practice and the extent to which those assets were financed with borrowed money and with the owners’ money.
What is a balance sheet?A balance sheet shows what your practice owns (in accounting terms, your assets ), what it owes (your liabilities ) and what you have put in it based on your original costs (your net equity. or fund balances if your practice is a nonprofit organization). It also gives you an indication of your practice’s ability to pay its bills (your liquidity ) and its ability to weather an economic downturn or finance growth (your solvency ). Key points to remember are these:
A balance sheet balances. That is, the total of what a practice owns (its assets) equals the combined total of what it owes and what the owners have invested in it (liabilities plus equity).
A balance sheet is a snapshot. It provides you with a picture of the financial health of your practice or organization on a certain date. By comparing snapshots, you can assess where you are in relation to where you want to be and take corrective action if necessary.
The balance sheet actually combines two financial snapshots of the Hometown Family Medical Group – one taken on Dec. 31, 1999, and one taken exactly a year later. Notice that the information is presented on a per-FTE
(full-time equivalent) physician basis. This facilitates comparison of practices of different sizes. Like most balance sheets, this one is organized according to generally accepted accounting principles (GAAP; the accounting profession’s “rule book” for preparing financial statements). Assets (i.e. the group’s resources) are listed at the top, with liabilities and equity below. Note that the “Total assets” line in each snapshot equals the “Total liabilities & equity” line. That’s because of where assets come from: Assets financed with the group’s own money are considered equity while assets financed using other means (e.g. bank loans) are called liabilities.
According to GAAP, assets are listed on a balance sheet in liquidation order, with the most liquid asset (cash) appearing first. Typical assets of a practice (in liquidation order) include:
Current assets. These are anything owned by the practice that could be sold or converted into cash within one year. This includes cash on hand and in bank accounts, accounts receivable (minus the accounts you’re unlikely to collect) and prepaid expenses, such as insurance and inventory (e.g. office and medical supplies). Notice that inventory isn’t listed on the sample balance sheet. In most cases, practices do not have enough tangible investment in inventory to merit its inclusion. An exception would be a practice that also runs its own pharmacy. In this case, inventory would include the cost of medication on hand to be sold.
Long-term assets. These are anything with a useful life that extends beyond one year, including property that the practice owns or leases (e.g. buildings, office furniture, computers and medical equipment) less accumulated depreciation (i.e. the cost of the item spread over the years of its estimated useful life). Net long-term assets are long-term assets minus accumulated depreciation.
Other assets. These include such things as investments and security deposits for rent.
Total assets. Current assets plus long-term assets equals total assets. Like assets, liabilities are listed as current or long term :
Current liabilities. These are anything that must be paid within the next 12 months, including accounts payable, wages payable and payroll taxes payable.
Long-term debt. This is anything due over a period of many years (generally more than eight), including the mortgage on your building and loan payments.
The final major element of the balance sheet is equity. Generally, equity includes assets financed by a practice’s owners or net profit that’s retained in the business. In a nonprofit organization, equity is referred to as “fund balances.”
The fundamental equation embodied by the balance sheet is this:
Assets = Liabilities + Equity
If that seems counterintuitive at first, think of it in a slightly different form: The equity in a practice equals the assets of the practice minus what the practice owes.
The balance sheet for your practice may be more complex to look at than our example, but you’ll see that it embodies the same principles – with one possible exception: If your balance sheet does not list accounts receivable as an asset, chances are that your practice uses what’s called cash-based accounting. (See “Cash-based vs. accrual-based accounting.” )