Financial Ratio Liquidity Analysis for Medical Accounts Receivable

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Understanding Vital Balance Sheet and Income Statement Components

By Dr. David Edward Marcinko; MBA, CMP™

By Dr. Gary L. Bode; MSA, CPA, CMP™ [Hon]

Dr. Gary L. Bode CPA MSAFinancial ratios are derived from components of the balance sheet and income statement. These short and long-term financial ratio values are “benchmarked” to values obtained in medical practice management surveys that become industry standards. Often they become de facto economic indicators of entity viability, and should be monitored by all financial executives regularly.

Defining Terms

One of the most useful liquidity ratiosrelated to ARs is the current ratio. It is mathematically defined as: current assets/current liabilities. The current ratio is important since it measures short-term solvency, or the daily bill-paying ability of a medical practice, clinic  or hospital; etc.  Current assets include cash on hand (COH), and cash in checking accounts, money market accounts, money market deposit accounts, US Treasury bills, inventory, pre-paid expenses, and the percentage of ARs that can be reasonably expected to be collected. Current liabilitiesare notes payable within one year. This ratio should be at least 1, or preferably in the range of about 1.2 to 1.8 for medical practices.

Other Ratios

The quick ratiois similar to the current ratio. However, unlike the current ratio, the quick ratio does not include money tied up in inventory, since rapid conversion to cash might not be possible in an economic emergency. A reasonable quick ratio would be 1.0 – 1.3 for a hospital, since this ratio is a more stringent indicator of liquidity than the current ratio.

Assessment

A point of emphasis in the case of both the current ratio and the quick ratio is that higher is not necessarily better. Higher ratios denote a greater capacity to pay bills as they come due, but they also indicate that the entity has more cash tied up in assets that have a relatively low rate of earnings. Hence, there is an optimum range for both ratios: they should be neither too low nor too high.

Conclusion

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4 Responses

  1. Gary,

    Recently, some practices were selling out to Public Practice Management Companies (PPMC) or other buyers.

    However, many of those transactions have soured since the PPMCs or other network models were not able to generate the earnings Wall Street or some other market force wanted to see.

    Many of those same practices are now being bought back by the same physicians that sold out several years earlier. If an entity is being bought back and accounts receivable is being purchased, be careful not to pick this item up as income twice. The costs can be immense to the practice or other business unit.

    The CPA

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  2. Quantitative Business Ratios

    There are many quantitative business ratios. While controlling expenses, focusing on revenue and making smart decisions on what assets to purchase or to get rid of are quantitative components of ROI; practice owners should not forget to also fucus on the qualitative components of ROI.

    An effective, efficient, and profitable business must clearly articulate its mission, invest in quality and appropriate technology, train and properly rewards people, insure organization structure supports mission accomplishment, and ensure leaders know where they are leading those being led.

    Leroy Howard MA CMP™ candidate
    http://www.CertifiedMedicalPlanner.org
    http://www.amazon.com/Dictionary-Health-Economics-Finance-Marcinko/dp/0826102549/ref=sr_1_6?ie=UTF8&s=books&qid=1254413315&sr=1-6

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  3. QUICK RATIO

    I’m glad you included the quick ratio. I definitely feel it is the more accurate indicator of ability for a practice to cover short term liabilities. Also, payables that are 6-12 months out (assuming it’s coming from patients) will likely go to collections or be sold to a collection agency.

    JOE

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  4. Aged Accounts Receivable (A/R)

    The A/R report summarizes your practice’s lifeblood: the potential revenue from payers and patients for services you’ve rendered. That’s right: potential – because any number of things can hinder (or halt) payment to your bank account. And that’s precisely why physicians must review their A/R on a monthly basis.

    Start with “Days in A/R,” which indicates the average number of days it takes to collect on an account. [Total A/R ÷ (annual gross charges ÷ 365)]. “Days” of 30 or less is good. “Days” of 50 or more is not so good. And look at the percentage of total A/R in each aging category. More than 10 percent to15 percent in the 120+ days indicates a problem.

    If the indicators signal trouble, analyze further. For instance, review A/R by individual payer to determine if specific companies are slow to pay, and identify why by analyzing explanation of benefits (EOB) for denial patterns such as noncovered service, applied to deductible, patient ineligible, or wrong modifier. If necessary, modify your operations or train staff accordingly to minimize denials.

    JOE

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