Financial Statements for Physician Leaders, Part II: The Balance Sheet
Last month, we covered the statement of operations, or as it is more commonly known, the profit and loss (P and L) or income statement. This month, we will cover the balance sheet. This financial statement demonstrates an organization’s financial position at a specific point in time and presents a “snapshot” using the accounting equation:
Assets = Liabilities + Equity
Assets are economic resources that an organization relies on to provide services to its customers, and liabilities are economic obligations or debts to creditors. In a for-profit organization, equity represents economic obligations to investors or stockholders, whereas in a nonprofit setting, equity is called net assets and represents the difference between total assets and total liabilities. Net assets represent a combination of retained earnings or funds left over after dividends are paid to stockholders and the amount of investment or donations/funds that are provided to a for-profit or nonprofit entity, respectively. In a nonprofit organization, funds are divided into unrestricted, semi-restricted, or restricted categories based upon whether donors or grantors want the organization to utilize funds for a specific reason or leave it up to senior management to decide.
The balance sheet is arranged with assets on the left hand side and liabilities and equity/net assets on the right as follows:
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Current Assets: Cash Current Liabilities: Accounts payable
Short-term investments Accrued expenses payable
Net accounts receivable Deferred revenues
Inventory
Pre-paid expenses
Total current assets: Total current liabilities:
Long-term Assets: Long-term investments Long-term liabilities:
Plant and equipment
Less accumulated depreciation
Net plant and equipment TOTAL LIABILITIES:
NET ASSETS (Unrestricted + temporarily
Restricted + restricted funds) or EQUITY (total
common stock – dividends payout = retained
earnings)
TOTAL ASSETS = TOTAL LIABILITIES + NET ASSETS OR SHARE HOLDER’S EQUITY
You will notice that assets and liabilities are divided into current assets or liabilities (those that have a life under one year) and long-term assets/liabilities (those that last for more than one year). A “year” may be a calendar year or a fiscal year, which is 365 days from the beginning of one budgetary cycle to the next and often begins/ends at a time of year when revenues and expenses are stable enough to be predictable. Another pattern is that both assets and liabilities are placed in order of liquidity (the ability to convert an asset or liability into cash) with the most liquid asset/liability at the top and the least liquid at the bottom.
Definitions of typical line items are as follows:
Current assets:
- Cash = cash
- Temporary or short-term investments are securities or other investments that mature in under a year
- Net accounts receivables are money owed for services minus allowances for contractual allowances (the difference between what you charge and what a third party payer has agreed to pay you), charity care (money you don’t expect to receive), bad debt (money you expect to receive but don’t)
- Inventory includes the cost of food, drugs, equipment, and supplies purchased but not yet used
- Pre-paid expenses are expenditures made for goods and services (e.g. insurance) not yet used
Long-term assets:
- Long-term investments are corporate bonds or securities that the organization intends to hold for more than one year
- Net plant and equipment is the purchase value of land, buildings, and equipment minus a calculated percentage of the value that is subtracted as an expense over time (depreciated) in either a consistent (line depreciation) or accelerated (accelerated depreciation) way
Current and long-term assets are added together to make total assets, which according to the accountant’s formula, must equal total liabilities plus net assets or equity.
Current liabilities:
- Accounts payable are amounts the organization owes to creditors or suppliers for merchandise and services purchased.
- Accrued expenses payable are obligations (accrued wages, etc.) that the organization owes its employees.
- Deferred revenue is revenue received by the organization prior to providing a service and represents a pre-paid expense to the creditor. An example of this would be capitated revenues paid by a third-party payer, such as a managed care organization or patients prior to receiving services.
Long-term liabilities are economic obligations due in more than one year. Again, short-term and long-term liabilities are added to determine total liabilities.
As mentioned, in for-profit entities, stockholders’ equity equals the amount of outstanding stock held by investors minus dividend payout plus retained earnings, whereas in nonprofit entities, net assets (the difference between total assets and total liabilities) is the sum of non-restricted, semi-restricted, and restricted donations, and retained earnings.
What are the strengths and weaknesses of the balance sheet?
The strength lies in its clarity and ability to create a simplified view of the total financial condition of an organization summarizing the key assets, liabilities, and net assets or equity. It is simple to read and provides a good view of summary information at a given point in time.
The weakness is that it doesn’t show the financial condition of the organization over time, including cyclical fluctuations and variability in financial performance. Most importantly, it fails to show the organization’s cash position, which may be a critical determinant to the overall solvency of the organization and its ability to meet its debts. When healthcare services are provided, it may be weeks or months before cash is received (if ever) and this can have an enormous impact on the organization’s ability to reinvest in capital and equipment to continue to provide up-to-date services with up-to-date technology and equipment.
This critical determinant will be covered next month with the most important financial statement of all: the statement of cash flows.
Jon Burroughs is senior consultant and director of education services with The Greeley Company, a division of HCPro, Inc., located in Danvers, MA.