Chances are pretty good that your collection rates are too low and your overhead too high for comfort. These are common problems that plague family practices today. Unfortunately, these problems are particularly difficult to solve because of another problem: Chances are almost as good that you don't know much more about the financial state of your practice than the collection rate and overhead. And if that's all you know, you don't know enough.

Although we've come to depend on these figures as our yardstick for measuring the financial success of medical practices, today's environment requires a more sophisticated approach. It also requires that you, the physician, understand your practice's key financial data and be able to answer the 10 questions posed in this article.

The root of the problem

The financial squeeze physicians have been feeling is usually attributed to managed care, which (at least according to the stereotype) starts out as discounted fee for service and evolves into capitation. Capitation, which pays physicians a set fee per patient per month regardless of the actual cost of services, is often viewed as the fundamental source of the problem. In reality, though, discounted fee for service, not capitation, has inflicted the real damage, especially to family physicians and other primary care physicians. Discounted fee for service increases a practice's administrative burden and reduces payment for services without changing incentives or giving physicians and patients an opportunity to benefit from truly managed care. If a practice absorbs the discount and does not somehow reduce its overhead, the net effect of the discount is magnified in the bottom line. (See “The danger of discounted fee for service.”) This very real loss in income isn't obvious at first, however, because most physicians simply work longer and harder, thus mitigating the loss to some degree.

Over time, overhead continues to increase due to higher payroll costs, supplies, rent and other expenses. In addition, since more staff time is directed to administrative chores, we often see weaker customer service, which can also affect the bottom line. Although some individual physicians report no income decline over the last several years (often because they have increased the volume of patients and services), various data show substantial income erosion in competitive markets, often as much as 30 percent over the last three years. This forces physicians to become proactive in managing practice costs.

But before you can begin to control practice costs, you have to become acquainted with your practice's financial data, both revenue and costs. Without this understanding, you cannot spot problems, establish reasonable expectations or make wise financial decisions.

Revenue data

To have a complete picture of your practice's revenue, all revenue (including co-payments) must be tracked, and it must be tracked by payer. Periodically, you should analyze your revenue data and answer the following questions:

1. What are the practice's total charges, receipts, discounts and write-offs (i.e., bad debt)? In other words, how much money is the practice bringing in and how much should it be bringing in? Your total charges should represent the amount you would charge under your usual fee schedule, so make sure your billing staff is not discounting charges before entering them into the system. Instead, have them enter discounts (contractual and voluntary adjustments) separately. Your receipts (or collections) should include all monies actually realized by the practice, including payments from third parties, co-payments, other payments from patients and capitation payments.

These data will help you calculate important measures such as your gross collection rate (receipts ÷ charges), which tells you what percentage of your production is contributing to the bottom line, and your net collection rate(receipts ÷ (charges - discounts and write-offs)).

This tells you what percentage of your adjusted production is contributing to the bottom line.

2. What are the practice's charges, receipts, discounts and write-offs by payer? These data will help you understand how much revenue each payer represents for your practice. When you also factor in the cost data for each payer (described later), you'll be able to determine the profitability of each of your contracts. This will give you better leverage for negotiating and will help you determine whether to continue a particular contract. If you have a busy practice, why keep business that represents a poor return? If a certain health plan contract is not contributing to the bottom line, there may be reasons to continue it, but first approach it as a profit-and-loss issue. [See “Find Out How Much Your Plans Are Really Paying You,” November/December 1998.]

3. What are the practice's charges, receipts and discounts by ancillary service? If your practice provides ancillary services such as radiology, you should carefully track the charges (or billings) generated for that service, as well as how much the practice actually collects for the service. By comparing and monitoring these data on an ongoing basis, you will be able to determine whether the provision of individual ancillary services is financially warranted.

4. How old are your accounts receivable (A/R)? Your computer system should be able to compute this fairly easily, sorting accounts into those 30, 60 and 90 days past due. If you also track this data by payer, you'll be able to see when unpaid balances are creeping higher and can stop the problem early. Generally speaking, less than 15 percent of your A/R should be more than 90 days old. If you see an increase in the age of your accounts, investigate. Sometimes, payers will delay their payments when they are experiencing cash-flow problems, which may mean much bigger troubles down the road.

5. How frequently do you send out billings? And how much is billed? As a physician, you don't need to become a billing expert, but you must track the effectiveness of your billing staff, know how often billings go out and know how much is billed in each batch. The dollar amount of your billings should be fairly consistent from month to month, unless there have been special circumstances, such as vacations.

Some practices send out bills once a week, which increases the dollars in A/R and delays the receipt of payment. While once-a-week billing may make some sense in a manual system, there is no reason for such delays in a busy practice with a computerized system. You want your billings to go out quickly, thereby expediting collections.

Cost data

Before you can fully understand your cost data, you must develop some method for analyzing variances and putting the data in context. The best standard is a budget, although many practices measure variance against past performance. Other practices compare their performance to industry benchmarks, which can be problematic. (There are many different formulas for calculating costs and reporting data, so use caution and make sure you are comparing apples to apples. To prevent misunderstanding, a practice's leadership must identify which methodology it will use.) Serious efforts often use all of the above methods, since each offers a piece of the information you need.

When studying your costs, remember that there are two general categories: fixed or variable. Fixed costs remain the same regardless of volume. They include rent, insurance and utilities — costs you would want to spread over greater volume to reduce the bite. Variable costs, such as medical supplies, fluctuate with volume. Recognize, however, that variable costs vary differently. For example, medical supplies have a close relationship to volume, but staffing varies in steps. This is important to recognize in budgeting, as well as in developing strategy.

Your cost data should be collected and reported monthly and should enable you to answer these questions:

6. What are the fixed and variable costs per patient visit? This will help you understand what each visit costs the practice. If you know this, you can begin to determine how changes within the practice would impact the bottom line. For example, how would the cost per visit change if you increased volume? Could certain costs be reduced?

7. What does it cost to deliver various ancillary services? You need to know what an ancillary service, such as radiology, is costing your practice. Some of the costs will be clear, such as the price you pay for equipment rental. Other costs may not be as obvious or easy to calculate, such as staffing or office space, but you need to consider all of the costs associated with providing a particular service. If you routinely compare the costs for a given service against your net collections for that service, you can track whether it is contributing to the bottom line or whether it constitutes a drain.

8. What does it cost to deliver specialized services? If your practice offers weight-reduction programs, flex sigs or any specialized service, you need to know whether it is contributing to the bottom line. Although such specialized services may be fairly limited in your practice, you should analyze them as you do your ancillary services.

9. What does it cost to deliver services for each health plan population? If you have any risk contracts, this is especially critical. It will help you track whether the receipts from each health plan are sufficient to cover the cost of taking care of that population — and contribute to your take-home pay. Having good data in this area also improves negotiating leverage and, in some cases, may demonstrate that your practice is better off without that health plan.

10. What is the practice's overhead? You need to know how much of your practice's net revenue is going toward overhead, with a breakdown of the individual costs, such as non-physician salaries, supplies and rent (see “Overhead components.”) Once you see where your money is going, you can then look for opportunities to manage those costs. [For tips on cutting practice costs, look for the author's follow-up article 22 Tips for Improving Your Practice. See also “Practical Tips to Boost Your Efficiency and Cut Practice Costs,” October 1997, page 86.]

As indicated earlier, overhead costs vary considerably by practice, and with good reason. For example, nonphysician salaries and benefits average 31.7 percent of income. But in some areas, this rate would produce poor results. On average, according to Medical Group Management Association data, primary care practices use more than 4 FTEs per physician, but the more assertive primary care practices in California operate at 2.4 to 2.8 FTEs per physician. Practices in these markets might have a lower percentage for salaries and benefits but higher costs for rent and malpractice. Because of this, use caution in looking at published cost data and understand how the data were reported before you begin to make comparisons with your own practice.

The promise of reward

Managed care has fundamentally changed the practice of medicine, and, although many practices are feeling the financial squeeze, there is hope for the bottom line. If you are proactive, understand your data and learn how to manage costs and risk, it can even bring financial rewards.