How to diagnose cash flow problems in your practice

Cash is the lifeblood of your practice. Recognizing how much money you have and where it is going is key to the survival of any business. It doesn't matter if you're running a multi-specialty clinic or a lemonade stand. The ability to predict and deal with cash shortfalls is critical to your practice’s longevity. Your understanding begins with three important financial reports.

Three reports you should be looking at

The income statement is the first report you will want to examine. This report shows the cash generated from your practice’s core business operations. Avoid focusing on the bottom-line figure, the net income. Instead, take time to review every line item on the income statement. A thorough review will provide a greater understanding of how your business works.

The balance sheet is the second report you will want to review regularly. This report shows what you own, what you owe, and the difference between the two. Watch your assets and liabilities closely. Look for changes in either and investigate to make sure they make sense.

The final report is the cash flow statement. This report shows how cash moves throughout the company. It’s helpful for identifying cash sinkholes and revealing sources of cash you might not be aware of. Remember, the money you borrow doesn’t appear on the income statement, but it appears on the balance sheet and the cash flow statement.

Most physicians I work with are familiar with the income statement. They know this report shows how much money they have earned, paid, and have left at the end of the day. What physicians rarely realize, however, is this report only shows you cash from the core operations of your business. The balance sheet is a mystery to most, and many have never heard of the cash flow statement.

It’s important to always follow the money, so invest time now learning how the business works to help the business run better in the future.

Metrics give you insight

Using data on the financial report, we can gain insight into any cash flow problem that might be lurking around the corner. Just as ratios and other metrics can help with the diagnosis and monitoring of a disease and its therapy in clinical care, financial metrics and ratios can help physician owners determine the health of their businesses.                                                                               

Following and trending metrics will reveal the cash position of your business and warn you about potential troubles should a hiccup arise in your cash receipts. Here are four tools that will help you identify when you might be running low on cash.

Working capital is a simple calculation that gives you an idea of your cash cushion. Working capital is calculated by subtracting the current liabilities from the current assets, both of which are found on the balance sheet. This remainder represents how much you have to fall back on if your practice’s cash flow is halted. A larger number means you have a thicker cushion while a smaller one suggests you might want to establish a line of credit. A negative number means you’re in trouble and might be living on a line of credit.

Operating income is the net collections minus the cost of the services provided and the associated overhead. This shows you how well your core business functions earn revenue in excess of their expenses. Considering this metric is one Wall Street investors use to determine the value of a company, it should be one you use, too.

Current ratio is similar to working capital as it is an indicator of your ability to pay your bills on time. It’s calculated by dividing the current assets by the current liabilities. These figures are found on the balance sheet. A ratio that is greater than 1.0 is desired, but it should ideally be closer to 2.0. A larger number means you have more capital available.

Cash flows to current liabilities uses numbers from both the income statement and the balance sheet. The operating income is divided by the current liabilities and yields a number that is hopefully greater than 1.0. This ratio tells you whether the core functions of your business are bringing in enough cash to cover your bills. If it is below 1.0, you are not earning enough money to pay your liabilities.

David J. Norris, MD, MBA, is a practicing anesthesiologist in Wichita, Kan. He is the author of The Financially Intelligent Physician: What They Didn’t Teach You in Medical School and a frequent speaker on physician finances. Read more about David at davidnorrismdmba.com.