While our modern world can sometimes seem overwhelming and complex, there are still some beautifully simple spots to happen across. Like most things in the American healthcare system, accounting for healthcare providers is as clear as day.
Ha ha – just kidding!
Healthcare accounting is like everything else in the sector – confusing, bureaucratic, and riddled with nonsense. Imagine someone gave the IRS the job of writing a medical textbook. Now have that book published only in Sanskrit. Now replace the pages with, I don’t know, moth wings.
Although the whole field is specialty unto itself, today we’re going to focus in on one small part that affects many small providers – choosing an accounting system. From the very start, you can make this small change and set yourself up for big success down the line.
The value of getting paid
In the world of accounting, you have a couple of options when it comes to recognizing revenue and costs. I know you want to learn about healthcare transactions, but let’s start with some simpler businesses to illustrate the difference between cash and accrual accounting.
Pretend you own a simple and pleasant toy store, instead of a place where people go to not die.
You start the day with a $50 asset in hand and, therefore, on your balance sheet (a toy car, let’s say) and $0 in revenue. When someone comes in to buy the toy car, they give you $50 and take the toy. Now you’ve got no car and $50. So this is easy. As soon as you sell the toy, the asset is gone, the cash appears, and your revenue goes from $0 to $50.
Now, imagine a slightly different scenario. You’re a plumber. You spend the morning fixing a leaky pipe for a customer, charging them $50. There are some cost concerns, but let’s assume it’s really just a loose pipe that can be fixed with a wrench. Now, you’ve spent the time to fix the pipe and given them a bill for $50. You don’t have any money, but you have a cost – your time.
If we recognized revenue like the toy store owner, we wouldn’t have any revenue until the bill was paid. The problem is, we have a cost that should be linked to revenue. What can we do?
Accrual accounting
The toy store is using cash-basis accounting, sometimes just called cash accounting. Just as the name implies, cash accounting is a basically a history of your business as told by the cash you’ve taken in. Five dollars walks in the door and goes on the sheet. You buy a stamp and its cost goes down in the ledger. Cash accounting is like a more complex bank account statement – if it says $567, then you have $567.
Accrual accounting is the other option – technically, there are some more flavors out there, but cash and accrual are the biggies. Accrual accounting attempts to match all of your costs to your revenue. It does this by recording revenue when you’ve earned it – because there was a cost to earning it – not when you get paid for it.
As a plumber, then, you spend three hours fixing the pipe. To account for that cost, you need to have some revenue to show for it. This matching principle is the driver behind most of what happens in accrual basis accounting.
Accrual accounting is considered a much better accounting system for demonstrating what’s actually happening in a business, in terms of activity. The trade-off for this insight is complexity. Accrual basis accounting spawns extra accounting buckets, like accounts payable and accounts receivable, to capture the details of revenue.
Cash accounting, on the other hand, is simple and clear. Get a dollar, write down a dollar.
Both systems also use their fundamental premises to define themselves, which means expenses are recorded in the same way. In cash accounting, you’ll record an expense when you put the money down for it. In accrual, you record an expense when a service is performed, not when you pay for it.
Healthcare accounting basics
Chances are, you’ll be using an accrual accounting system in your practice. Here’s an example explaining why:
You cut Tom open and jiggle his organ around. You bill Tom $67 million. In an accrual accounting system, you now add $67 million in revenue to your books. In a cash system, you wouldn’t count the money until you were actually paid.
The difference matters for two reasons. First, you’re probably obligated to use accrual accounting for reporting or tax purposes. This isn’t always the case, but beyond a certain size, it’s almost guaranteed. Second, as we covered previously, accrual accounting gives you a better picture of what your business is doing.
Imagine you used cash accounting instead. Tom – and Jerry and Martha and Bill – would all wait until the last minute to pay – lazy gits. That means that you might provide their services in the first quarter, but not get paid until the second.
For future planning, you would look back and think that the second quarter was really busy – just look at all the money you brought in. In reality, the busy quarter was Q1. Accrual accounting captures that distinction.
Accrual accounting software
Most accounting software options make accrual accounting the default. This is because accrual accounting is the industry standard and because, if you practice accrual accounting, you can generate a cash accounting report, but not vice versa.
Since accrual is the standard, you can choose from almost any option in Capterra’s accounting software directory to manage your practice. As always, you’ll want to work with your accountant to pick the right solution.
The big names – QuickBooks, Xero, Wave, Sage, etc. – all use accrual accounting. The one exception is FreshBooks, which is really more of a bookkeeping software anyways. You can find plenty of reviews on software’s Capterra listings to get a better feel for their pros and cons.
You can also head over to our finance blog for more tips on running a profitable business, or swing by our medical software blog for industry specific insights.
Header by Rachel Wille