The Financial Fitness Test

It’s hard to believe the end of the year is just around the corner. This means preparing your corporate financial figures and gearing up for yet another tax season, making this a great time to speak to your CPA regarding the financial fitness of your practice. However, it is difficult for your CPA to comprehend the many nuances of your practice-management system or the industry-specific standards against which to measure your practice. The CPA’s expertise comes in reviewing deposits to the bank, measuring gross income for the year, and analyzing expenses to complete not only your tax return but also an analysis of the profitability of the practice. With some knowledge of your practice-management system, you can personally examine your patient accounting. The intent of this article is to encourage you to conduct an analysis of your practice’s financial fitness to determine if the accounting in your practice, or the management of production, can be improved.

We’ll begin the analysis of your practice by gathering the pertinent financial figures needed to assess the financial health of the practice. I will define production, collections, adjustments, and accounts receivable so that we are comparing the same figures, no matter which practice management system you are on.

Production

This is the gross total of all contracts put on the books plus all miscellaneous charges for a given time period. We will not use net production for our calculations, as an analysis of gross production accompanied by an analysis of your adjustments will provide a more educated assessment of the direction of production in the practice. Production should not include renegotiated contracts or any discounts, even treatment discounts; it should include all miscellaneous charges, although some of these are categorized as adjustments on certain practice-management systems. In other words, on some systems the production figure is very clear, while on other systems, you have to be a careful student to understand how your practice-management system has defined production, especially because your CPA will not be aware of the definitions that your practice-management system uses.

Collections

This is all payments to the practice minus refunds and payments posted in error. We will use net collections for our calculations. Most of the concerns with the accuracy of the collections figure come from posting procedures in the practice and refunds hidden as adjustments. Your CPA would be aware of this figure because CPAs use this figure on your tax returns, although there could be timing issues between your practice-management system and your bank statement, which is the CPA’s source document.

Adjustments

These include write-offs, discounts, transfer-outs, and miscellaneous adjustments. Adjustments can be distorted by posting to the wrong adjustment category, or by not being posted at all. You should be very careful to put adjustments in the proper category so that you can make management decisions regarding the volume of adjustments in your practice. Because adjustments reduce the potential collections of the practice, they should be scrutinized. This is an area of the practice your CPA might never review, yet it should be reviewed monthly either by you or your CPA.

Accounts Receivable

This is the total of all money owed to the practice, whether it is due currently or in the future, whether it is to be paid by patients or by insurance. We will exclude balances of less than $20 and all credit balances from this figure. Your CPA would be aware of this figure in your practice, although he or she would not be aware of the accuracy of this figure on a patient-by-patient basis. Chances are, your CPA knows this figure in total because they use it on your balance sheet.

Now that we have defined the figures to determine your financial fitness, let’s move on to how these figures will be used to calculate various ratios in the practice. We will look at ratios that are used to determine the success of orthodontic practices across the country, which will give the most insight regarding the financial fitness of your practice. We are looking at these ratios over an extended period of time; reviewing them on a monthly basis may give you skewed figures and poor comparisons:

Collection Ratio

Take the average of at least 6 months of collections and divide by the average of the same 6 months of production. The goal is to collect 95% to 97% of your production.

Should you fall short of this goal, look closely at the cash-flow components of patient delinquency, insurance delinquency, and financial arranging to see where improvements could be made.

Should you exceed this goal, examine your production levels over the last 18 months. Have they decreased? Could your financial arrangements be too restrictive?

Adjustment Ratio

Take the average of at least 6 months of adjustments and divide by the average of the same 6 months of production. The goal is to adjust no more than 5% of production off the books.

Should you fall short of this goal, there is a possibility that production is being put on the books at the net fee with no documentation of discounts.

Should you exceed the goal, it could be due to participation in insurance plans or other discount programs; however, you should carefully analyze each adjustment category to determine if you need to reduce adjustments, thereby increasing profitability.

As the orthodontist, you have ultimate decision-making power in this area, so make sure you are aware of the status of adjustments. Are patients receiving multiple discounts at the start of treatment? Are balances being reduced in error? Is it possible the adjustments are so excessive that you are working some days for free?

Receivables Ratio

Take the accounts receivable balance (adjusted for the credit balances and small balances) and divide by the average of at least 6 months of production.

The goal is to hold 4.5 to 5.0 times of your average monthly production in receivables.

Should you fall short of this goal, consider the possibility that your financial arrangements may be too restrictive to the point where production may be stifled.

If you exceed this goal, conduct an assessment of the cash flow components—patient delinquency, insurance delinquency, and financial arrangements—to determine where excess in these areas may be affecting both your collections figure and your receivables balance.

Having completed the calculations for determining your financial fitness, we can now move into an analysis of the cash-flow components to see how you may shift the above-mentioned ratios to a healthier position.

Patient Delinquency

This is the total number of patient accounts that are either 30, 60, or 90 days past due, divided by the total number of patient accounts with a positive contract balance.

The goal is to reduce delinquency to less than 10% of the total number of accounts. Do not include credit balances or insurance accounts in this calculation.

If your patient delinquency exceeds 10%, there are a few things to keep in mind. Remember that it takes time to reduce delinquency; a reduction of even 5% per quarter is considered effective. However, as you reduce patient delinquency, you also reduce your financial coordinator’s workload. With automated payments, delinquency rates have been automatically reduced by 3% to 5%. Remember, though, that automated payments are not guarantees, and without some type of very consistent collection activity, delinquency will still hover at 17% to 20%.

Insurance Delinquency

This is the same calculation as for patient delinquency, with the exception that only the insurance accounts are used. The other exception is that you should calculate the number of insurance accounts that are “paid ahead.” These accounts indicate that the insurance ledger is not set up properly, they distort the insurance delinquency rate, and they should be excluded from the calculation so that you get a cleaner picture of the delinquency rate on the insurance ledgers.

The goal is to attain an insurance delinquency rate of less than 5%. Insurance delinquency can be reduced very quickly—you can cut this delinquency in half in as little as 60 days. With electronic processing, insurance delinquency can even be reduced significantly within 30 days. It will, however, take a concentrated effort on the part of the insurance coordinator to keep payments coming in consistently.

Financial Arrangements

In this component, you should analyze the number of starts that are paid in full in a given month, the average down payment on starts for a month (excluding the paid-in-fulls), and the average length of the financial contract. Excluding the paid-in-fulls, you should conduct two analyses: one for insurance starts and one for noninsurance starts.

Unfortunately, there is not a computer system in the industry that calculates these figures automatically. You should set up some type of spreadsheet to track the results of the financial arrangements in your practice. Once you establish a method for calculating these figures, you will be in a position to determine how these financial arrangements not only affect cash flow, but also how they might potentially affect your case acceptance. You can then make management decisions regarding how to maximize both production and cash flow in the practice.

With the information outlined in this article, you can understand the definitions behind your financial health, calculate and analyze your financial ratios, and look into your cash flow components to improve collections. Following these steps should provide you with an idea of the financial fitness of your practice.

Keep in mind that your practice-management system and in-office policies will create variations that are hard to detail in an article. However, it is my hope that I have provided some tools to help you discern how financially fit—or unfit—your practice truly is.

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Jackie Shoemaker used her accounting degree from Miami University of Ohio with a Fortune 500 company before entering the orthodontic field 28 years ago. She specializes in the areas of patient accounting, accounts receivable control, and patient relations. She can be reached at .