Cash basis accounting might seem simpler for small medical practices, but its limitations become clear as a practice grows. When a practice surpasses a few hundred thousand dollars in annual revenue, the disconnect between when services are delivered and when payments are received makes accurate financial reporting extremely challenging.

Revenue Recognition: The Key Issue

The fundamental flaw in cash accounting for medical practices lies in revenue recognition timing. Due to insurance billing cycles, there can be significant delays between providing care and collecting payment. Under cash accounting, a $50,000 service rendered in April might not appear as revenue until May, June, or even later. Additionally, the amount collected from insurers often differs from the initial bill due to contractual adjustments.

Cash accounting only reveals current month deposits, which could easily be for services provided in previous months. This makes assessing the actual operational performance for any given month nearly impossible.

Expense Recognition: The Mismatch Continues

The expense side of cash accounting is equally problematic. While expenses like rent and subscriptions are generally consistent, payroll – the largest expense – fluctuates significantly due to bi-weekly processing.

Some months will see two payroll cycles, while others will see three. This variability distorts expense comparisons from month to month, rendering cash-basis analysis misleading.

Impact on Profit and Loss (P&L) Analysis

Due to the timing discrepancies in both revenue and expense recognition, cash accounting makes it virtually impossible to accurately assess monthly performance metrics like operating margins. Attempts to match revenues with expenses become guesswork at best.

Conclusion

For medical practices exceeding $1-2 million in annual revenue, switching to accrual accounting is highly recommended. Although more complex, accrual accounting aligns revenues with the period when services were provided and smooths out payroll expenses. This enables far more accurate analysis of monthly operations and margins.

For a rapidly growing practice focused on optimization, the transition to accrual accounting provides the clear, accurate financial data needed to make informed decisions and operate at peak efficiency. The benefits gained far outweigh any additional accounting complexity.

Ready to gain deeper insights into your medical practice’s financial performance? 

FinSource specializes in helping healthcare organizations transition to accrual accounting and optimize their financial reporting. Contact us today for a consultation to discover how we can support your growth and success.