The Challenges of Calculating Receivables For Medical Practices – A New Approach to Better, More Accurate Financial Statements
Accrual-based financial statements can be prepared for medical practices and, from a business point of view, it makes sense to do so. Even if the practice decides to stick with cash-based financial statements, they should consider this information when assessing the collectability of the receivables in order to capture a more accurate picture of their practice financials.
Gary Cavett’s article “The Challenges of Calculating Receivables for Medical Practices” was featured in the October 2015 issue of MDNEWS Minnesota, a magazine and network about + from + for physicians. You can also read his article online here.
Every industry has comparable revenues and expenses that determine what prices can be set for a business to create an expected profit margin. However, healthcare is different. A medical practice provides a service, but then has to wait to see what it will get paid.
While it is true that medical practices have the opportunity to somewhat negotiate fees with payers (insurance companies, for example), they are at the mercy of payers’ payment policies that are already in place.
The amount charged for services provided and the amount received are rarely the same, which creates a major issue for accountants trying to determine revenues based on the accrual method of accounting. Accountants are accustomed to booking revenue when earned, not to adjusting for potential differences between what a medical practice charges and what payers actually pay.
The Starting Point: RVUs and Conversion Factor Calculations
There are tens of thousands of procedures that can be billed for the services provided in a medical practice. Relative value units (RVUs) are used to quantify the acuity or complexity of care for each procedure. Billable procedures can be broken down into six distinct categories:
- Evaluation and Management
- HCPCS Level 2 and 3 Codes
RVUs were developed for Medicare in 1989 by a small group of physicians who were tasked with assigning a value to each medical service. Each year, these RVUs are adjusted as necessary and published by Medicare. Nearly all medical practices and payers in the U.S. use this RVU schedule for determining fees.
This is where the healthcare industry becomes simple — but complex — at the same time. Fees are based on a simple equation: RVUs times a Conversion Factor equals the Amount to be Paid (RVUs * CF = $).
Medicare and other payers establish their own conversion factor to identify what they will pay for each RVU. For 2015, Medicare pays $35.75 per RVU. Therefore, if a procedure has two RVUs assigned to it, the medical practice will be paid $71.50 for providing this service.
The Problem for Accountants: Conversion Factor Chaos
That sounds simple enough, so why all of the fuss? While Medicare uses one conversion factor for every procedure, many other payers use different conversion factors for each of the six classifications. In addition, other payers may not adopt the updated RVUs at the first of the year as does Medicare. In fact, they may change RVUs during the year and/or change conversion factors in the same year.
The current billing software used by most medical practices certainly helps with the evaluation of this process. Programs can generate reports that allow medical practices to determine what conversion factors are being used by individual payers and which year’s RVU schedule they are using. This collection percentage can then be applied to the receivable balance outstanding for each payer.
Charges, Adjustments and Collections
A word of caution, because here is where mistakes can be made. Most individuals who try to determine what percentage of a charge will be collected generate a report that shows charges, adjustments and collections. Charges are for one time period, while adjustments and collections relate to charges that are likely from a previous time period. Ignore the charges in this report. The adjustments and collections amounts are what need to be compared to determine the collection percentage. Simply add these together and divide collections by that total to get the collection percentage. Ideally, this is done by payer and, if possible, for each of the six procedure classifications.
Why It Matters for the Medical Practice
Being able to calculate the future collections of a medical practice is extremely important for many reasons, including:
- Preparing financial statements if using the accrual method
- To evaluate payer compliance with contracts
- To effectively negotiate future contracts with payers
- When a practice valuation is being done
- For preparing a budget or cash flow projections (both of which are good ideas for running an efficient business operation)
- To identify collateral when arranging for financing
Accrual-based financial statements can be prepared for medical practices and, from a business point of view, it makes sense to do so. The introduction of advanced software programs now available make this idea a feasible reality for all medical practices. Even if the practice decides to stick with cash-based financial statements, they should consider this information when assessing the collectability of the receivables in order to capture a more accurate picture of their practice financials.