Balance Sheets Income statements, and Statements of Cash Flow.pdf

The State of Statements:Balance Sheets, Income Statementsand Statements of Cash FlowRobert M. Traynor, Ed.D., MBACEO/AudiologistAudiology Associates, Inc.Johnstown, ColoradoRobert G. Glaser, Ph.D.CEO/AudiologistAudiology Associates of Dayton, IncDayton, OhioIntroductionFor most audiologists the patient is foremost in mind as weprovide hearing care services. Successful practitioners know thatwhen their practice is centered on their patient’s welfare, successwill usually follow. Probably the greatest responsibility of thepatient-centric practitioner is to be in business next year when thepatient needs things that are warranty items,or other services thatmay be of benefit to them. There are many stories of highly suc-Continued On Next PageFEEDBACK • VOLUME 19, NUMBER 3 • FALL 20087

Feature The State of Statementscessful practices that did not survive for onereason or another. These failures are mostcommonly related to poor managementpractices and less likely due to the qualityof the clinical care provided.Historically, academic programs preparingaudiologists for clinical work haveeither not addressed issues of managing apractice as a business entity or have offeredlimited information as a part of a courserather than offering an entire course inpractice management. Contemporary programsare offering comprehensive coursesin practice management, increasing thelikelihood for not only surviving the firstfew years of practice but optimizing thechances for success in the hard fought worldof today’s health care market place. Whenentering independent, private practice,audiologists must be well prepared toaddress the multi-faceted challenge that ispractice management. They must have theessential tools needed to monitor, manageand maintain their business to profitability.Thus,to be a good manager,clinicians musthave the capability to digest informationabout the financial performance of thepractice and develop the background totranslate that information into decisionsthat move the practice toward profitability.Although it is not necessary to obtain anMBA in order to know how to run yourpractice or an audiology profit center withina hospital, educational, or other institutionalsetting, courses in businessmanagement, accounting and finance aresubstantially beneficial and readily availableat most local community colleges. Thesecourses offer the practitioner greater insightinto the management of their practice andgives them the power to interpret the relevantbusiness variables. The following discussionis an attempt to orient clinicians tothe basics of the Balance Sheet, IncomeStatement and, probably most important,the Statement of Cash Flows.Financial StatementsMost of us use the services of anaccountant to prepare reports and to assistus in the interpretation of the informationthey contain. Traynor (2008) suggests thatpractitioners should have knowledge ofthe vocabulary and language of accountingto effectively communicate with the8 FEEDBACK • VOLUME 19, NUMBER 3 • FALL 2008accounting (and bookkeeping) professionalswho manage their practice and protecttheir assets. Although it is the bookkeeperor office manager in the practice thatenters the day-to- day financial data, it isthe accountant who prepares financialreports that will assist the practice owneror manager in making evidence-baseddecisions regarding the success or failure ofdaily operations, a specific procedure, or anew market offering. These reports arefundamental to understanding the reasonsfor positive or negative changes in the bottom-lineperformance of the practice.Such accounting reports are preparedaccording to internationally acceptedaccounting rules called the GenerallyAccepted Accounting Principles (GAAP),a universal method of valuing profit andmeasuring assets and liabilities. Althoughthey vary slightly from one country toanother, GAAP rules are used to conductaccounting in all businesses. GAAPdescribes how transactions for costs, profit,inventory, sales and other businessspecifics are recorded and facilitates a comparisonof one business to another sincebusinesses all use these same proceduresfor accounting. While the role of anaccountant in the practice will vary fromone practice to another, his or her professionalassistance, counsel and guidance ofthese practitioners is essential to both thelong and short term success of the practice.There are two primary objectives ofevery business, including audiology practices;profitability and solvency. Unless apractice can produce satisfactory earningsand pay its obligations in a timely manner,all other objectives will never be realizedbecause the practice will not survive.Financial statements that reflect a practice’ssolvency (the Balance Sheet), its profitability(the Income Statement) and a viewof its financial health (the Statement ofCash Flows) provide the practitioner substantiveinformation upon which to makewell informed decisions about the operationsof the practice. These financial statementsare so important that bankers andother lenders depend on them to supporttheir decisions to grant credit opportunities.Bankers and lenders know that financialstatements are the bases of thecalculations for business ratios that offerimportant,informative metrics about activity,liquidity, and leverage (debt) of thepractice.Balance SheetThe Balance Sheet contains the elementalfiscal components of the practice;information about assets, liabilities andowner’s equity. It presents a snapshot of thefinancial condition of the practice at a specificmoment in time, usually at the closeof an accounting period such as the end ofthe month, quarter, or year (Brealey et al,2002). Businesstown.com (2003a) indicatesthat the purpose of the balance sheetis to quickly review view the financialstrength and capabilities of the business aswell as answer important questions such as:• Is the business in a position to expand?• Can the business easily withstand thenormal financial ebbs and flows of revenuesand expenses?• Or should the business take immediatesteps to strengthen cash reserves?The balance sheet gets its name from thefact that the two sides of the statement

Feature The State of StatementsTable 2: Income Statement (Traynor, 2008)10 FEEDBACK • VOLUME 19, NUMBER 3 • FALL 2008how efficiently the business is operating.In accounting, the practice’s profitabilityis measured by comparing the revenues generatedin a given period with the expensesincurred to produce those revenues. Thedifference between the revenue generatedand the expenses created during the generationof the revenue is the profit (or loss) ofthe practice. In an Audiology practice,revenuesare defined as the inflow of revenuefrom providing patient care or the dispensingof products.Expenses can be consideredthe sacrifices made or the costs incurred toproduce these revenues. If revenues exceedexpenses,net earnings result while if expensesexceed net revenue, a loss is recorded.As with other financial statements, theIncome Statement, presented in table 2,may be prepared for any financial reportingperiod and is used to track revenues andexpenses critically important in assessingthe operating performance of the practice.Businesstown.com (2003b) suggests thatmanagers can use income statements to findareas of the practice that are over or underbudget and identify specific areas of unexpectedexpenditures. Additionally, theIncome Statement tracks the increase ordecrease in product returns; cost of goodssold as a percentage of sales and presentssome indication of the extent of the practices’income tax liability. Since it is veryimportant to format an Income Statementappropriate to the type of business beingconducted, the structure of income statementsmay vary from one practice to another.In audiology the format may dependupon the mix of business conducted in diagnostics,hearing products, and rehabilitativeservices.Net sales on the Income Statement consistof sales figures representing the actualrevenue generated by the business.Marshall(2004) states that the Net Sales entry on theIncome Statement represents the totalamount of all sales less product returns andsales discounts. Directly below the NetSales in Table 2, is the Cost Of Goods Sold(COGS). COGS are costs directly associatedwith making and/or acquiring theproducts.These costs include the acquisitionof products, such as hearing aids or assistivedevices provided by outside suppliers. Ifhearing instrument are repaired or manufacturedby the practice, COGS could alsobe materials, parts, and internal expensesrelated to the manufacturing or repairprocess, such as faceplates, shells, microphones,receivers, and components.Net Profit, sometimes called gross profit,is derived by subtracting the cost of goodssold from net sales. This net profit, however,does not include any operating, interest,or income tax expenses. Just below the NetProfit entry in Table 2 is a category forSelling and General AdministrativeExpenses. This subcategory is described byTracy (2001) and Marshall (2004) as a broadìcatch-allî category for all expenses exceptthose reported elsewhere in the IncomeStatement. Examples of selling and generaladministrative expenses that are recordedhere are legal expenses, the owner’s salary,advertising, travel and entertainment, andother similar costs.The actual income fromoperations, sometimes called EarningsBefore Interest and Taxes (EBIT) is the resultof deducting the Selling and GeneralAdministrative Expenses from the NetProfit. The earnings Before Interest andTaxes (EBIT) are the net revenue generatedby the practice. Interest expenses andtaxes are subtracted to arrive at the NetIncome (or Loss).Statements of Cash FlowStatements of Cash Flow reflect the cashposition of the practice as well as thesources and uses of cash in the practiceduring a specified business cycle. It presentshow cash flows in and out of the practice.Monthly cash flow statements areuseful but quarterly statements of cash floware essential to provide a look at trendsthat might be developing in the overallcash-flow picture of the business. Profit andcash-flow are intimately related. A practicecan be highly profitable yet on the verge ofbankruptcy if the profits are sequestered,forexample in the Accounts Receivable—highprofit, low cash flow. This situation results inlimited cash to pay the practitioner,employeesand/or to service the accounts payable.Conversely,if there is substantial cash inflowto a practice but excessive overhead costs thatare strangling profitability, financial difficultieswill ensue—low profit,high cash flow. Thisis a situation where in the practice owner hasoverextended available resources with illconceivedequipment purchases,exceptionalleasehold costs, or extraneous staff salariesand other questionable business decisions.To illustrate how cash flows in and out of thepractice, Marshall (2004) indicates that theStatements of Cash Flow are used to identifythe sources and uses of cash over time andContinued On Page 26

Feature The State of Statementsadjustments in practice operations for managementpurposes.Table 3: Statement of Cash Flows (Traynor, 2008)can be compared to the current period foranalysis. In Table 3, the cash flow statementis divided into three general sections, CashFlow From Operating Activities,Cash Flowfrom Investment Activities and Cash Flowfrom Financing Activities. The OperatingActivity section begins with the Net Income(taken from the Income Statement,Table 2)and includes all transactions and events thatare normally entered to determine the operatingincome. These entries include cashreceipts from selling goods or providing services,aswell as income earned as interest anddividends, if the practice has investments.Cash Flow From Operating Activities alsoincludes additions or deductions of itemsaffect cash such as depreciation, increase (ordecrease) in accounts receivable,merchandiseinventory and liabilities, resulting in theNet Cash used by Operating Activities. TheNet Amount of Cash Provided (or used) bypractice operating activities is the key figureon a Statement of Cash Flows. TheOperations Section is of the most interestsince it presents the specific areas of the practicewhere cash was consumed by the runningof the practice.The second section of a Statement of CashFlows reviews Income generated frominvesting activities. This section includestransactions and events involving the purchaseand sale of equipment,securities,land,buildings,and other assets not generally heldin the practice for resale. This area of thestatement also covers the making and collectingof loans, if the practice internallyfinances products and services these loans toconsumers internally.Investing Activities arenot classified as operating activities sincethey have an indirect relationship to the central,ongoing operation of the practice.Transactions within the third section recordCash Flows from Financing Activities anddeal with the flow of cash between the practice,theowners (stockholders),and creditorsas well as the cash proceeds from issuingcapital stock or bonds if applicable. Forexample,if there was a need to transfer profitfrom the practice to the owners or fromthe owners (or creditors) into the practice,it would be reflected in the Cash Flows fromFinancing Activities section. Careful reviewof the Statement of Cash Flows can offervaluable information to the practitioner as towhere the cash generated actually goes andpresents an invaluable opportunity to makeEpilogueAlthough these statements are extremelyuseful,as indicated by Freeman (2000),thesedata are simply numbers. To unlock the realinformation in these statements, it isnecessary to conduct liquidity, activity andleverage (debt) ratio calculations. Althoughthese can be conducted on all of the statements,the ratios of primary importanceare conducted on the balance sheet andincome statement data. These financialaccounting ratios can give the practitionerpowerful information about whether thereare adequate funds to pay the bills, howlong it takes to turn the accounts receivableand provide meaningful information as tothe debt of the practice. In the next issueof Feedback, the continuation of this topicwill discuss the calculation of some importantratios that can influence the managementof the practice as they are trackedfrom month to month, quarter to quarter,and year to year. ■Robert G. Glaser, Ph.D., FAAA, is the ownerof Audiology Associates of Dayton, Inc., a multi-office,independent practice providing a fullrange of audiologic, neurodiagnostic and hearingand balance rehabilitative services for children andadults. Dr. Glaser is widely known for his innovativebusiness approach to the profession throughwritings, presentations and seminars across thecountry. He is the principal owner of the AurisGroup, a practice management consulting firmserving health care practices and practitioners inaudiology,medicine and allied health care practices.Robert Traynor,Ed.D.,MBA is CEO and practicingaudiologist at Audiology at AudiologyAssociates,Inc.,Greeley and Johnstown,Coloradowith particular emphasis in amplification andoperative monitoring offering all general audiologicalservices to patients of all ages. An AssociateAffiliate Professor at the University of ColoradoHealth Sciences Center and the University ofNorthern Colorado,each academic session he continuesto teach doctoral level Audiology studentsas an Adjunct Professor of Audiology at theUniversity of Florida,Gainesville and the PCOSchool of Audiology in Elkins Park, PA. Apractice manager for over 35 years,Dr.Traynor haslectured on most aspects of the field of Audiologyin over 40 countries including the United States.26 FEEDBACK • VOLUME 19, NUMBER 3 • FALL 2008