Written by Valerie Connors Thursday, 30 June 2005 19:00
It’s been more than a year since you and the rest of the staff have received salary increases. The lunch conversations always seem to end up on that subject lately. You have a gut feeling that the financial status of the practice hasn’t changed much since last year, but you don’t have any actual facts to back it up. You heard someone mention that the practice made more than $800,000 in revenue last year, so it certainly sounds like it made money.
The doctors have agreed to sit down with the staff and the CPA to review last year’s financial statements and determine whether staff raises are going to be possible this year. The meeting is scheduled for tomorrow, and you decide it might be a good idea to get a basic understanding of what these financial statements are all about so you’ll be prepared to make your case. As we all know, financial reports aren’t exactly thrilling for the layperson to read. You make a mental note to have an extra cup of coffee tomorrow morning.
When the accountant appears with the financials in hand and deposits them on the conference table, don’t panic. There’s nothing to worry about. Armed with the following basic information about financial statements, you will be able to understand the terms and figures being presented and make constructive suggestions based on them. You will also have the tools you need for you and the rest of the staff to have a positive influence on this year’s financial outcome.
The term financial statement generally refers to the balance sheet, which reports information at a point in time, and the income statement, which is prepared for a period of time. We’ll start with the balance sheet.
The balance sheet has 3 parts: assets, liabilities, and capital (also referred to as owner’s equity). Simply put, assets are things you own, liabilities are other people’s claim on the things you own, and capital (or owner’s equity) is what’s left; it represents the value of the owner’s investment in the company. It’s called a balance sheet because of the following equation: assets = liabilities + capital. That’s the way the information is presented on the document. This equation can also be restated: assets – liabilities = capital, meaning that if you take what you have and subtract what you owe on it, what’s left is the value of your equity in the business. Let’s start with assets.
Assets are divided into 2 main categories: current assets are cash and other assets that will be converted to cash within a period of 1 year, and noncurrent assets (also referred to as fixed assets) are things like furniture, equipment, automobiles, buildings, and other nonliquid assets. Each category of fixed assets has an accompanying line for the accumulated depreciation of the asset since it was placed in use. The net of the 2 numbers represents the value of the asset at the point in time when the balance sheet was prepared. Some accountants record depreciation monthly, while others prefer to make a single entry at the end of the year. You may see another category of assets called other assets, which basically means anything that doesn’t fit into one of the other categories.
Liabilities are also divided into 2 main categories: current liabilities are debts that will be paid off within a year, and long-term liabilities are debts that will be paid off over more than a year.
|Table 1. Sample Dental Office Balance Sheet.
Daisy Dental Office
Capital (or owner’s equity) has categories that separate the original investment in the company from the profit (or loss) that the company has made since its inception. These may include the following: (1) capital, which represents the original investment in the company, (2) additional paid-in capital, which is additional capital that is investment in the company later, (3) retained earnings, which is the profit or loss the company has made from its inception until the last previous year, and (4) retained earnings current year, which is the profit or loss for the current year. This number will equal the year-to-date net income on the income statement. Table 1 is a sample dental office balance sheet.
Here are some points of interest on the balance sheet:
(1) Notice that the left side of the balance sheet and the right side of the balance sheet are equal. Hence the name balance sheet. This illustrates the equation assets = liabilities + capital (or owner’s equity).
(2) Current assets (cash) are used to service current liabilities. It’s best when the assets are greater than liabilities. See how easy this is?
The balance sheet is most useful for illustrating the solvency of a company. If a company has more liabilities than assets, there’s probably going to be trouble. Most people look at the balance sheet to see how much money they had in the bank on the day the report was prepared and call it good. Now that you know the basic theory behind the balance sheet, it should be more meaningful to you the next time you are presented with one.
The next report we’re going to look at is the income statement, also referred to as the P & L, or profit and loss statement. The income statement has 2 basic categories: income and expenses. Income minus expenses equals net income. You hope the net income is a positive number, which represents a profit. If net income is negative, you have a loss.
There are 2 ways of presenting income statement numbers: cash basis and accrual basis.
A cash basis income statement is just what it sounds like. All the income and expense figures are based on cash coming in and cash going out. In cash basis financial reporting, you recognize income when you receive payment for your work. In other words, payments from patients or from the insurance companies are recognized as income when the money is received and deposited in the bank. Expenses are recognized when the check is written to pay them. Cash coming in is income, and cash going out is expense.
Cash basis accounting is often used for tax purposes, and income tax is figured on the amount of cash you have at the end of the year. However, cash basis financial statements can be difficult to use as an operational management tool because of the fluctuation of income and expenses between months. For example, you may have paid an insurance premium for a 1-year period. Using cash basis reporting, you would have an expense for the full year’s premium during the month you made the payment, even though the cost of the premium should be spread out evenly over a 12-month period. On the income side, there may be large income fluctuation between months because you only recognize income when you receive payment, not when you do the billing. For these reasons, companies may prefer to use accrual basis financial statements during the year, but use a cash basis financial statement for tax purposes.
Accrual basis accounting attempts to match the income for a period with the expenses associated with generating that income. This shows a more realistic income and expense comparison from month to month, makes budgeting easier, and can be a useful management tool during the year. It’s not unusual for companies to use accrual basis accounting during the fiscal year and then have their accountant convert their income statement to cash basis at the end of the year for tax filing.
Table 2 is an example of an income statement that is cash basis, the more common practice in dental offices.
|Table 2. Cash Basis Income Statement.
Daisy Dental Office