Financial ratios: Key indicators of practice success

As a healthcare provider, you may not spend much time on the financial side of your practice; that’s why you have hired a CPA. But you do need to understand key financial ratios to help you manage your financial status more effectively.

Three useful ratios are current ratio (measuring available cash), gross profit margin (measuring profitability), and days sales outstanding (measuring your ability to collect);

• Current ratio. This ratio compares current assets (those most quickly turned into cash) against current liabilities (bills and payments due soon).

It answers the question, “If I had to sell (liquidate) assets to pay bills, could I do it?”

Since you probably won’t get the full value on any asset except cash, a reasonable ratio is 2:1. That is, you should attempt to keep twice as much in current assets as you have in current liabilities.

• Gross profit margin. For a healthcare practice that isn’t selling products, this ratio indicates the relationship between sales and expenses.

Gross profit margin is calculated by subtracting deductible expenses from net collections (after write-offs and discounts) and dividing by gross collections. If your gross collections are $300,000 for the year, your expenses are $190,000 and you wrote off $30,000, your gross profit is ($270,000 less $190,000) divided by $300,000, or 26 percent.

• Days sales outstanding. This ratio is calculated by dividing total accounts receivable by revenue per day. The higher the average collection period, the less money you have for paying the bills. If your total receivables are $35,000 and your annual sales are $300,000, the calculation is $35,000 / ($300,000/360) or 42 days.

Keeping an eye on these ratios, and comparing current results to previous months and years presents you with a picture of how you are doing financially and whether you need to take action.