Understanding Financials: Your Income Statement

The income statement is one of the financial statements which we as investors, managers, operators, and employees should all understand. Without a profitable business, we wouldn't be in business at all. The income statement shows us how our business is doing, and it shows us financial results over a period of time.

The basic format of an income statement is revenues on top, expenses listed next, and net income calculated on the bottom. The simple formula for the income statement is:

Revenues - Expenses = Net Income

It is also important to know that there are two different accounting methods that can significantly affect what is shown on your income statement. One accounting method, called Cash-Basis accounting, is purely based on the cash flows of the business. The revenues are the amount of cash you received during a specific time period, while the expenses are the amount of cash you paid during that same time period.

The other accounting method, called Accrual-Basis accounting, is based on the economic activity of the business. Revenues are recorded when they are earned, NOT when they are paid. Expenses are "matched up" with revenues so that the supplies, labor, and space needed to earn the revenues are recorded at the same time as the revenues are earned. Again, just like with revenues, expenses are recorded regardless of when the cash is actually paid for those expenses.

The two different accounting methods can produce two very different income statements for the same business covering the same period of time. This is especially true in the healthcare industry, where there is a delay of several weeks to several months between the date of service and the date payment is actually received on a performed case. Our recommended method is Accrual accounting, and your financials reflect the Accrual-Basis method.

The Revenues section of the income statement starts with Gross Revenue, which is the amount actually billed for cases performed during a specific time period. However, in our industry we all know that what we bill is almost never what we are going to collect. Net Revenue is essentially the money we believe the business will eventually collect on those performed cases.

The Expenses section of the income statement is typically divided into two types of expenses: Variable Expenses and Fixed Expenses. Variable Expenses change in proportion to the number of cases performed. For example, the more cases that are performed during a specific time period, the more medical supplies and the more nursing labor you will need in order to successfully complete those cases. As such, expenses for medical supplies and nursing labor are considered Variable Expenses. Fixed Expenses, on the other hand, do not change in proportion to the number of cases performed. Examples of Fixed Expenses are building rent and property insurance. These expenses would stay the same whether there was 1 case or 500 cases performed.

One line item on your income statement that may go unnoticed is the Contribution Profit (or the Contribution Margin). This figure is typically located in the middle of your income statement and separates the Variable Expenses from the Fixed Expenses. The Contribution Margin is the portion of your Net Revenue that contributes to offsetting the Fixed Expenses. The simple formula for the Contribution Margin is:

Net Revenues - Variable Expenses = Contribution Margin

Thus, the lower your Variable Expenses, the better your Contribution Margin will be. In other words, the better you can control the costs of medical supplies, pharmaceuticals, and staffing, the healthier your business becomes.

So, what should you look for when reviewing your income statement? Start by looking at the Monthly Trend Income Statement for your business. The Trend Income Statement will show you income statements for several months side-by-side. You will be able to notice trends, and you will be able to see which months were uncharacteristically above or below those trends. For example, your income statement shows $500, 000 in Net Revenues per month, but you only have Net Revenues of $375,000 in February. What happened to cause this decrease? Perhaps a couple of physicians went on vacation. Or perhaps the short month lead to fewer weekdays that were open for business.

It is also a good idea to calculate what percentage of Net Revenues each expense category is, especially for Variable Expenses. Again, Variable Expenses move in direct proportion to the number of cases performed. So, these percentages should remain fairly consistent. What percentage of your Net Revenues is spent on Direct Supplies each month? What if an increase in Direct Supplies Expense corresponded to a physician partner who began using an implant that cost twice as much as a similar implant used for the same type of surgery? What about Labor? Going back to our example in February, while Net Revenues decreased significantly, Labor Expense remained the same. As a result, the percentage of Labor Expense to Net Revenues was significantly higher in February than it was for all other months. Well, perhaps that "blip" is a signal that staffing didn't flex when cases decreased, so there were a few people without any work to do for a couple of days that month.

These numbers can lead to changes in your practices. If a lower cost implant can be used without losing quality, or a slow month happens in the future where staffing can be flexed, the business can save money from wasteful spending and instead distribute that money to its investors.

When you understand the income and expense components of the income statement, you can appreciate what makes your center profitable. This appreciation can help guide the decisions you make everyday, potentially saving money and increasing the financial health of the business.

View a sample income statement (pdf).

View a sample trend income statement (pdf).

Learn more about Regent Surgical Health. Contact Matt Lau at mlau@regentsurgicalhealth.com or (708) 498-4473.

Read more insight from Matt Lau and other members of the Regent Surgical Health leadership team:

- 10 of the Best Paying ASC Procedures

Maximize Reimbursement: 4 Strategies for Success

Maximizing Board Productivity

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