A Medical Practice Must-Have: An Active Line of Credit

Every medical practice should have an active line of credit (LOC). An LOC can cushion the effect of revenue disruptions and large expenditures, whether expected or not. An active LOC functions as an insurance policy that disburses funds immediately upon the request of the borrower.

When is an LOC useful?
An LOC is useful any time there is a call for cash that the practice does not have on hand.

A revenue disruption is the most common example: the transition from one biller to another, the transition from one data format (5010) or coding set (ICD-10) to another, any disruption in practice operations (such as a natural disaster, physician injury or illness, EHR implementation), etc.

Major repair costs or purchases can require more funds than the practice has on hand. Using an LOC is appropriate if the practice can manage the expenditure over several months. It is also appropriate if the practice needs a temporary advance of funds while permanent financing is being arranged.

Estimated tax payments are another good application of an LOC, particularly in September when the estimated payment is due before the end of the period to which it applies.

How does an LOC work?
An LOC is a loan, very similar to a credit card. Any institution issuing a credit card evaluates the borrower's creditworthiness. It then agrees to make funds available to the borrower, up to a predetermined amount. There may be an annual fee, although the borrower is charged interest only on the amount of money actually advanced and outstanding.

An LOC works the same way, with a few exceptions. There is not a credit card; the funds are advanced to the borrower's operating/checking account instead of to a merchant; and the borrower must request the transfer of funds each time, although sometimes the funds are transferred automatically to cover an overdraft.

Unlike a credit card the LOC delivers money, which has no limit on where it can be spent. It would not be possible to use a credit card for payroll. Another advantage to the LOC is that the interest rate is generally much lower than that of a credit card.

What does an LOC cost and how do you get one?
The terms of an LOC can vary widely, depending upon the financial institution and the depth of the practice's relationship with it. In general, there are two components to the cost: annual fee and interest on the unpaid balance.

The annual fee is intended to cover the bank's costs in setting up the loan and reserving the money to fund the full amount of the LOC. A common fee is 1 percent of the maximum amount of the loan. It is, therefore, important that the practice requests the probable amount needed plus a generous cushion, and no more.

The interest rate is usually a floating rate, pegged to prime or LIBOR. Interest charges apply only to the outstanding balance of the loan, e.g., the money the bank has advanced to the practice. Any interest charges are usually to be paid in the month after they are incurred. Partners will almost always be asked to personally guarantee the loan.

A financial institution will usually ask for two years of income tax returns for the practice and the partners, and current financial statements. The bank will also want to look at the practice's cash flow and accounts receivable. The purpose in reviewing these documents is to gauge the capacity of the practice and the partners to repay any funds advanced.

The process of gathering information and underwriting the LOC takes about two weeks. That is why it is so important to have the loan in place before needing the funds.

What an LOC is not
An LOC is not a long-term loan or source of capital. Evidence that the loan is not being used inappropriately is the common requirement that the balance of the LOC be brought to zero for at least 30 days each year. If the bank sees that the balance never goes below a certain amount, it will want to roll that amount into a fixed-term loan or revoke the LOC.

Every medical practice should have an active line of credit to guarantee that its needs for cash are met, even in the face of unexpected events and disruptions.