Should a Physician Practice Use Cash Basis or Accrual Basis of Accounting?

Choosing the Right Accounting Method for Your Medical Practice

When managing the finances of a medical practice, one of the critical decisions to make is choosing between cash basis or accrual accounting. The right choice can significantly impact how you track revenues, manage expenses, and maintain the financial health of your practice. Understanding the nuances between these two methods—accrual accounting and cash accounting—is essential for proper medical office accounting and ensuring financial success. 

Cash Basis vs. Accrual Accounting: What’s the Difference?

Before diving into the pros and cons of each method, it's important to grasp the fundamental differences between the two: 

• Cash Basis Accounting: Revenues are recorded when cash is received, and expenses are recorded when payments are made. This approach gives a real-time snapshot of your cash flow, allowing you to understand how much money is coming in and going out at any given moment. 

• Accrual Accounting: In contrast, accrual accounting records revenues when they are earned (i.e., billed) and expenses when they are incurred. In other words, revenues and expenses are tracked based on obligations rather than actual cash movements. This method provides a clearer picture of financial performance over time but doesn’t always align with cash on hand. 

For many physician accounting needs, the accrual method offers a more comprehensive view of the practice’s financial health. 

Which Method is Best for Your Medical Practice?

The decision to choose cash basis or accrual accounting for your medical practice depends largely on how you intend to use your financial statements and your overall financial goals. Both methods have their merits, but in the healthcare sector, the cash method is often the industry standard. Here’s why: 

• Tracking Operations: Most medical office accounting professionals use cash-based financial statements to manage and track their operations. This is because they provide an easy, real-time picture of cash flow, which is critical for managing day-to-day expenses such as payroll, rent, and medical supplies. 

• Industry Benchmarks: Published statistics from reputable organizations like the Medical Group Management Association (MGMA) and the American Medical Association (AMA) typically present financial data on a cash basis. Medical practices often compare their performance to these benchmarks to understand how well they are doing compared to industry standards. 

• Practical Use: Cash basis accounting helps practices understand if their collections are in line with expectations and whether their overhead is manageable. For example, a practice can quickly determine if it’s on track by comparing its collections to expected cash flow benchmarks. 

However, if your practice needs to generate more detailed reports for external stakeholders, such as banks or investors, accrual accounting may be the better option. 

Why Accrual Accounting May Be Needed in Healthcare

While the cash method works well for operational purposes, there are instances when accrual accounting is more appropriate, especially for medical practices looking to grow or secure loans. Here's why: 

1. More Accurate Financial Insights: Because accrual accounting tracks revenue and expenses when they are earned or incurred, it offers a more accurate view of long-term financial performance. This can help practices manage their finances more effectively in the long run, especially if they offer services where payment is delayed or if they have large insurance receivables. 

1. Meeting Lending Requirements: Many banks and financial institutions require accrual-based financial statements when considering loan applications. This is because accrual accounting gives a clearer picture of the financial obligations and expected revenue of a practice, rather than just current cash on hand. 

1. Comprehensive Reports: Accrual accounting is especially useful for larger practices with complex financial structures. By understanding when services are billed and when expenses are due, practice managers can make better decisions about financial planning. 

Utilizing Financial Reports for Medical Practices

Regardless of the accounting method chosen, regularly reviewing financial reports is essential for ensuring that your practice remains profitable. Medical office accounting experts often recommend creating a Medical Practice Management Report that outlines key metrics such as production, collections, accounts receivable, and contractual adjustments. 

By analyzing these reports, physicians can monitor the practice's overall performance. If certain metrics, like the percentage of accounts receivable over 90 days or the collection percentage, fall outside industry benchmarks, it’s a red flag that something may need immediate attention. 

Benchmarking for Financial Success

Benchmarking is a critical tool in maintaining the financial health of any medical practice. To stay competitive, practices should regularly compare their financial performance to industry standards. Here are some key benchmarks that every medical office should monitor: 

• Overhead Costs: Overhead should typically be no more than 50% of collections. If overhead exceeds this percentage, it may indicate inefficiencies within the practice. 

• Receivables: A healthy practice should have no more than 15% of accounts receivable over 90 days old. If receivables are aging beyond this threshold, it may indicate issues with billing or collections. 

• Net Collections Percentage: Ideally, a practice should maintain a net collections percentage of 90% or higher. A drop in this percentage could signal problems with insurance claims or patient payments. 

By regularly reviewing these benchmarks, a practice can identify issues early and make necessary adjustments to maintain profitability. 

 The Role Reed Tinsley, CPA Consultant for Physicians

Whether a medical practice uses accrual accounting or the cash basis method, one thing is clear: proper financial management is essential to a practice's success. A CPA + medical practice management consultant for physicians, such as Reed Tinsley, can provide valuable insight and guidance, helping practices choose the right accounting method, monitor key benchmarks, and ensure long-term profitability. 

If you’re unsure which accounting method is right for your practice or if you need assistance in financial management, consult with a specialist in accounting for medical practices. Proper guidance will ensure that your financial statements align with both your short-term needs and long-term goals.