The receivables of a practice are the engine that drives the legal and logistical details of how physicians come into a group and how they leave. Understanding the methods of valuation of accounts receivable (AR), therefore, is critical to any practice.

As background, it is suggested that the reader refer to articles in two previous issues of Decisions in Axis Imaging News [1, 2] that discuss issues concerning accounts receivable benchmarking and how AR influences a new or departing physician’s financial relationship with his or her colleagues. This article will have two parts. The first will show how valuation is made easier by the more advanced receivable systems. The second will discuss methods that statistically estimate a value, necessitated by the older system’s more primitive reporting features.

The following exhibits will help you understand both the differences between the reports of the two types of systems and the internal dynamics of receivable processing.

Every system on the market is able to produce a summary page like Exhibit 1, with detailed backup reports that list the individual dollar amounts of the debits and credits by reason and/or payor classification. All systems have been able to produce an aging report, listed by payor, which tells you how long the ending balance has been outstanding.

This is the exact same information, now reorganized by the month-of-service of the charges. In other words, the database is compiling the linked credits that pertain to the charges stemming from clinical services in each month from January 1999 to May 2000. The report you are looking at is a month-to-date summary. There would also be one in the same format that is year-to-date. That one reveals the cumulative cash and noncash credits linked to the monthly charges. The beginning balances will always be zero; the ending balances will be the same as the month-to-date report.

Valuation: New Database Features

Assume that a new doctor has joined the group or a senior member is departing. The transition date is June 2000. The receivables are factored into the structure of the relationship with either doctor, discussed in detail in a previous article.1 Because this practice is using a system that compiles information by month-of-service, it is no longer necessary to estimate the value of the receivable as of May 31, 2000. All the advisors/managers of the practice have to do is track the cash and refunds attributed to services rendered through May 31, 2000. Approximately 75% of the cash income will flow to the practice in the 5 months following the transition date, and an estimated 98% will be collected after 12 months.

The documents that describe the relationship between the new or departing physician, and the legal entity, would use a monthly compensation level in the first 5 months after transition that approximates 70% to 80% of the receivable value. Language would stipulate a final settlement amount to the parties after 12 months equal to actual collections minus the cumulative amounts already paid.

Assigning a True Value to Accounts Receivable

Part 2

Valuation: Old Technology

Unfortunately, there are still many systems in the market that do not have the database compilation features just described. It is necessary to estimate the cash value of the accounts receivable based on statistical calculation of collection ratio and probability factors on liquidation of accounts older than 180 days. Let us start the discussion by going back to Exhibit 1 and examining the relationship between cash and charges: (95,000 – 1,000) / 250,000 = 37.5%. This calculation is valid only if every month’s receipts and charges were identical. The reality is that monthly charges and cash receipts fluctuate, each for different sets of reasons. There is virtually no relationship between cash deposits in a month and new charges. The method of computing a valid ratio is to use forward rolling average or weighting techniques that consider the timing between charges first billed and the flow of cash in subsequent cycles. Exhibit 3 helps you understand this concept.

After a gross ratio is computed, the next step is to apply it to a gross receivable value. Is the value listed in the exhibits equal to that number? The answer is no for two basic reasons:

1. Not all charges attributed to dates before May 31 have been captured.
2. The balances over 181 days have high bad debt and write-off potential.

Even a medium-size practice will have thousands of outstanding accounts. These accounts pertain to patients covered by hundreds of payors. Every payor has a different fee schedule and set of payment guidelines. All of this implies that delays will occur for both valid and invalid reasons. A list of these reasons would consume another article!

Even if a practice auditor reviewed every unpaid account, and was armed with the payor fee schedule, the best they would be able to come up with is the probable cash value of the account if everything goes perfectly. The fact that an account is over 180 days old means that something is not perfect. Exhibit 2 is simplified for illustration. Besides self-pay balances, the list probably includes Payor 1 to Payor 100. Drawing upon the data in the first three exhibits allows the construction of an exhibit where we assume that the rolling average collection ratio is 37.5%.

There is another technique that offers somewhat more statistical precision but still does not make the valuation of old accounts any more accurate. The concept was discussed in a previous article. [1] Every major payor will have a fee schedule that, on a weighted basis, equals a percentage of a practice’s gross charge. If the practice auditor/manager compiles this information, they can apply the payor-specific ratios to the balances less than 91 days with confidence. The percentages beyond that aging begin to erode because there is something about the account population that requires further discounting. It is very difficult to even guess how much to adjust the maximum payor-specific ratios beyond 90 days.

The point with this method is that someone will have to do a great deal of research on a large number of payor classes to establish more precision than using the average collection ratio on the entire population.

The final step in computation is to consider what it costs to convert outstanding receivables to cash. This is generally easier when a practice uses an outside vendor because most contracts are based on a percentage of cash collected. The drafting of documents that outline the statistical methods described will be more complicated. They could site reference to specific reports produced by the receivable system, while acknowledging that the report, as of the transition date, does not include a level of unbilled charges. There should be discussion of methodology about calculation of a gross collection ratio on unbilled charges and accounts up to a certain age. The last point will address what to do about accounts beyond a certain age.

Assigning a True Value to Accounts Receivable

Part 3

Concluding Remarks

We have noted that practices that earmark receivables for a buy-in will generally distribute them to the senior members over 3 years, even though the cash value is collected in about 12 to 15 months. Most of this is done to keep income to the senior and junior members from spiking; otherwise there is no practical reason to do it that way.

Buy-outs generally provide for a distribution of a departing member’s share in the form of severance or salary continuation over a span of 6 months, more realistic when you consider the actual speed of liquidation.

The final point is a legal issue about accounts receivable distribution. Some attorneys are reluctant to draft documents that reference accounts receivable as a basis for compensation to a departing physician because there is a risk that the IRS will consider the transaction to be a nondeductible distribution of an asset. Yes, accounts receivable is an asset; in fact, the largest asset of any radiology practice. But it is also nothing more than deferred compensation. The IRS position stems from the different methodsof reporting operating results for tax purposes: accrual versus cash basis. The vast majority of radiology practices report results on a cash basis, and accounts receivable is not even listed on the balance sheet. If these same practices were to have reported results on an accrual basis, they would consider the cash value of each month’s charges as income, and the actual cash collections would be the liquidation of an asset: accounts receivable.

There is virtually no way to predict the risk that the IRS will review a buy-out transaction and the documents that describe the process, or what its position would be if it did so. My preference is to clearly outline the process because it is the intent of the parties to guarantee the fair distribution of the cash value of accounts receivable. If the language is kept vague, it has been our experience that the gap between amounts changing hands and the true value of the asset widens over time.

The improvements to computer and software technology make it possible to track finite universes of patient accounts, eliminating the need to estimate the cash value of a practice’s accounts receivable. Those practices not using vendors or internal systems with this capability still must rely on valuation techniques that are based on statistical computations of collection ratios and assignment of probability of collection to accounts over 180 days old. Even if a practice engaged a team of auditors to scrutinize every open account where the payor fee schedules are known, they will not compute the cash value accurately. There are too many variables, and accounting for them is not cost justified. The advantage of the new technology is that cash attributed to the accounts that are the basis for the buy-in/buy-out relationships can be accurately mapped.

James A. Kieffer, MBA, is president of a management consulting firm with an emphasis on radiology practice management and strategic planning.Email:[email protected]

References:

1. Kieffer JA. Deconstructing buy-in. Decisions in Axis Imaging News. 1999; 12(2):40-42.
2. Kieffer JA. AR revealed! Decisions in Axis Imaging News. 1999;12(3):65-71, 76.
3. Kieffer JA. AR revealed! Decisions in Axis Imaging News. 1999;12(3):65-71, 76.