One important aspect of business is understanding financial statements. All physicians practicing medicine should be familiar with three fundamental financial statements. Understanding these three statements is essential to planning for and managing a practice, department, or organization. Planning uses estimates to project how these statements could look in the future. For management purposes, these statements are used to monitor how the practice, department, or organization is operating financially by reviewing historical data.
One issue you will always have to deal with is financing your practice, department, or organization. Almost all of finance and accounting deals with three fundamental financial statements: the income statement (also know as a profit and loss statement), the balance sheet, and a cash flow statement. Accounting basically reports on past transactions by putting them into these three statements.
The income statement, historical or projected, shows financial performance over a given period of time, a month, quarter, or year. The income statement starts with revenues (reimbursement for services) and the direct costs associated with those revenues. Subtracting direct costs from revenues gives you your gross margin. Gross margin can be expressed in dollars or as a percent. Gross margin is used for comparing your practice or department to industry standards or to other similar practices or departments. Bankers and financial analysts expect it see it.
Once you know your gross margin, you subtract expenses, including any interest and taxes. This step gives you “the bottom line;” i.e., your profit. For planning purposes, you can only construct a projected income statement since you do not know your future revenues. As such, you make your best guess as to what your monthly totals will be for revenues, direct costs and expenses.
A balance sheet is a statement of financial position at a specified moment in time, for instance at the end of the month or at the end of the year. It shows assets, liabilities, and capital. Assets include cash, money owed to as well as property and equipment (computers, furniture, instruments, etc.) owned. Liabilities are debts: money owed to others and loans to be paid. Capital is the money invested in the practice, department, or organization, which usually includes any initial investments and retained earnings. Recent earnings are usually included in capital, so they provide a link back to the income statement. The balance sheet represents what your assets, liabilities, and capital are at specific time in the past. For planning purposes, the balance sheet is a projection of what those items could be at some specified time in the future. The essential equation for the balance sheet is that assets must always be equal to the sum of liabilities and capital. If that is not the case, there is no balance and something is awry.
The last financial statement is the cash flow statement. The cash flow statement uses information from both the income statement and the balance sheet and ties them together. A cash flow statement can be either historical or projected just like the income statement and balance sheet. It displays the money coming in and money going out, month by month, and the cash balance. The reason this statement is so vital is that the income statement does not necessarily reflect all the money. For example, you may have seen patients who you have not billed yet. In addition, the balance sheet might not reflect all the money either. You could have loan repayments, new loans, new investments, and/or buying assets, none of which show up on the income statement. The cash flow statement neatly ties the other two statements together.
In summary, when you are dealing with the business aspects of medicine, you cannot plan or manage effectively without these three financial statements. Understanding these statements and being able to construct them is absolutely essential. If you, as a physician, want to have a financially sound practice, department, or organization, clinical knowledge is not enough; fundamental business knowledge is crucial. Without this knowledge, your ability to make financial business decisions is significantly compromised.