Key Strategies For Protecting A/R Accounts

By David Edward Marcinko, MBA, CFP©, CMP©

Whether they are due from patients, insurance companies, HMOs, Medicare, Medicaid or other third-party payers, accounts receivable (A/R) are the lifeblood of any medical practice. Unfortunately, it is not unusual for a podiatry practice to wait six, nine, 12 months or longer for payment. In fact, older A/R are often written off or charged back as bad debt expenses and never collected at all. Also keep in mind that A/R are often the biggest practice asset to protect against creditors or adverse legal judgements. A judgement creditor pursuing you for a claim may pursue the assets of your practice and A/R and cash are the most vulnerable assets. A/R are as good as cash to a creditor, who usually only has to seize them and wait no more than a few months to collect them. It is no wonder healthcare administrators like Rachel Pentin-Maki, RN, MHA, of West Palm Beach, Florida, feel the cash flow stream that A/R represent is an important practice asset that must be constantly monitored and protected much like any other valuable asset. Given the potential implications of lost A/R revenue on both the immediate cash flow and long-term survival of your practice, let’s take a closer look at managing these accounts and an array of strategies for protecting A/R from creditors. Taking A Proactive Approach To Monitoring A/R Typically, bad debt control occurs because doctors are too busy treating patients and/or their front office staff does not have or follow a written formal system of A/R control. Here are some questions you need to ask yourself. • Is there an A/R policy in place for the collection of self-pay accounts (de minimus/maximus amounts, APR, terms, penalties, etc.)? • Do employees receive proper A/R, bad debt and follow-up training within legal guidelines? • Are A/R exceptions approved by you or your office manager, or do they require individual scrutiny? • Are A/R policies in place for hardship cases, pro-bono work, co-pay waivers, discounts and no-charge cases? Are collection procedures within legal guidelines? • Are A/R policies in place for past due notices, the amount of telephone calls one should make, when to turn accounts over to collection agencies and when to turn accounts over to a small claims court, etc.? • Are guidelines in place for hospital consultations, unpaid claims, refiling of claims, appealing claims, etc.? • Are office A/R policies periodically revised and reviewed with employee input? • Does you agree with and support the current A/R guidelines in your practice? Why It Pays To Incorporate Your Practice Developing a proactive mindset to maintaining A/R accounts and preventing them from getting too far behind is commendable. However, it’s also important to look at long-term asset protection strategies as well. With this in mind, let’s take a closer look at what incorporating your practice can do for you. In medicine, certain types of property can’t be conveniently held outside of a practice’s business entity. However, far too many podiatrists are solo, unincorporated practitioners. This is especially the case in the industrialized Northeast, in states such as Maryland, Pennsylvania, New Jersey and Delaware. Nevertheless, assets, like accounts receivable, may cause tax and accounting difficulties unless one maintains these assets in corporate form. See “A Guide To Common Corporate Entities” below. If a podiatry practice becomes a corporation, it could be an Inc., Corp., P.A. or P.C., depending on the state in which the practice entity is organized. In addition, almost every state has enacted legislation to create limited liability entities, such as LLPs and LLCs that provide the liability protection afforded a corporation while having the attributes of a partnership. These entities are popular with physicians because they allow much flexibility with regard to buy-ins and buyouts, and in the allocation of practice income and practice deductions. However, if you have significant value in your A/R accounts, one strategy for protecting them is to create liens, secured by a loan against the A/Rs that will have priority over subsequent creditors. For example, podiatrists can make loans to the corporation for working capital or other needs. The loan proceeds are not taxable income to the practice and the interest payments on the loan are tax-deductible, making the effective cost of the loan considerably lower. In today’s low-interest climate, the effective interest rate can be as low as 3 to 5 percent. This security interest is called an UCC-1 filing under the provisions of the Uniform Commercial Code (UCC). The hoped for result of this UCC-1 filing is that accounts receivable will be protected. A judgment creditor would find that the equity in these assets is subject to the superior claim of the practice doctors and cannot be used to satisfy a judgment. Cash in a corporate podiatry practice is even more valuable and vulnerable than A/R accounts so there are at least two basic options. First, one can make the loan proceeds a taxable distribution to the doctors. This makes it tax deductible to the practice. The second option is to fund a non-qualified or qualified retirement plan. This A/R protection is usually funded by life insurance that secures and protects the A/R loan and policy from creditors. Tax qualified retirement plans are protected by federal and state law. While non-qualified retirement plans are usually not protected by federal law, they are often protected by state law. Using your life insurance to help fund a retirement plan and crediting it with 4 percent or more tax-free interest can actually generate money. After a number of years, one can use tax-free policy loans to pay back the A/R loan principal. The cash value remaining in the policies is virtually free money earned through interest rate arbitrage and will be available as tax-free loans for retirement or disability income, etc. What You Should Know About The Multiple Corporation Strategy Under the multiple corporation strategy, a single corporation may own and operate several podiatric medical clinics in different locations. If something happens at one of the clinics that leads to potential liability, having each practice set up as its own corporation would isolate and protect the A/R of the other successful clinics from the potential liability claim of the one practice. In another example, a podiatrist may have three offices in different locations, but they are all held in one corporation. When business at one location slows down substantially, that clinic may become a financial drain on the others, absorbing all of the available cash in the company. Eventually, the corporation has to file for bankruptcy, wiping out all of the equity that had been built up. In order to avoid this possible scenario, one should ensure that each office is incorporated separately. Therefore, if one location falters, it will not drag down the others. A judgment creditor of one corporation would not be able to reach the A/R accounts and assets of the other companies. This strategy is also useful for podiatrists who provide different high-risk podiatric medical services like diabetic wound care, osteomyelitis infection management, etc. These practices face enormous potential liability and whenever a particular specialized service is deemed too risky, using multiple corporations is an effective technique for insulating each separated high-risk service from liability caused by another. What About Insurance For A/R Accounts? Credit insurance is an asset protection plan for A/R that minimizes your exposure to a large or unexpected loss. It ensures that your podiatry practice will get paid despite intervening economic events, industry competitive factors, changes in business cycles or overambitious managed care expansion. It can protect all your A/R accounts or a set of designated accounts. This insurance can even be set up to protect one or two large HMO contracts since uncomfortable levels accounting for greater than 15 to 25 percent of practice A/R accounts may occur given the continuation of healthcare insurance mergers, acquisitions and consolidations. Disclosure of credit insurance in financial reports can inform bankers and prospective investors that an effective strategy is in place to manage receivable risks. However, just as you would compare and contrast most insurance policies, be sure to compare and evaluate credit insurance policies on premiums, fees, deductibles, co-insurance payment, policy limits and maximum payment terms (if any). Keep in mind that premium rates are based on A/R aging schedules, the spread of intrinsic medical specialty risk versus systemic healthcare industry risks, HMO/MCO insurer corporate credit risks and your own previous personal and/or practice credit risks. The cost of credit insurance is low, typically a small fraction of one percent and it is payable monthly, quarterly or annually. For example, a large West Coast podiatry practice felt credit insurance was important due to a recent rash of insolvent HMOs in the area, but found that it was not cost efficient to insure all of its accounts receivable. When the practice reviewed its A/R aging schedule and list of managed care contracts, it determined that only five or six accounts were large enough (collectively accounting for greater than 68 percent of all A/R) to be considered for credit insurance. The solution was key account A/R coverage for “at-risk” A/R accounts, while the practice remained responsible for the remaining accounts. The key account policy was obtained without a deductible, with the insurer approving all the A/R contract limits. Subsequent assumption of a policy deductible reduced costs even further for the podiatry practice. Using An Accounts Receivable Financing Strategy A/R financing occurs when a loan is received against practice A/R that is not taxable until it is paid to the doctor. In turn, payment to the doctor is a deduction to the practice (S-Corp, limited partnership, or LLC). For example, if the practice receives a loan and pays $25,000 to each doctor, each doctor would have to report $25,000 of taxable income to the IRS. The practice might be able to report an operating loss on the loan for the distribution and each doctor would get an offsetting $25,000 K-1 deduction or reduction. The “cost” of this transaction is interest on the loan that must be paid back. Today, some insurance companies will finance A/R if the practice uses the loan to purchase life insurance and pledges the policy as secondary collateral. Financially, this strategy may allow the proceeds to work in a tax-deferred manner with interest rate arbitrage potential. After a decade or two, each doctor is allowed a tax-free loan from the policy to pay back his or her share of the A/R loan. The remaining insurance policy’s cash value may be available through tax-free loans to the doctor (if not a modified endowment contract (MEC)) and the death benefit remains. If one uses this approach correctly, this strategy will protect A/R accounts from creditors and may increase after-tax retirement income by a nominal amount. However, former financial advisor Hope Rachel Hetico, RN, MHA, says it is important to exercise caution when pursing this strategy since “this concept is new to the industry.” She notes that insurers haven’t had extensive claims experience with this approach and “commissions on this type of insurance product are hefty and not always transparent to the doctor.” Should You Consider An A/R Factoring Strategy? A/R factoring occurs when a podiatry practice sells its A/R accounts to a third party. The proceeds are given to each doctor to hold in a personally owned and asset-protected account. This does result in tax liability to the doctor for receiving the payment from the practice and one must continually use this maneuver in order to deplete A/R. A drawback of this strategy is greatly reduced A/R value and more robust collection policies than you might pursue, especially when it comes to collecting for “at-risk” care. Be aware that these more aggressive collection policies may aggravate those who are receiving at-risk care from you and accordingly may lead to increased liability claims. Therefore, this can potentially be an expensive strategy for protecting your A/R accounts. Currently, some third party benefits companies may purchase your A/R accounts for almost the same amount as you might collect if you collect the money for them. The practice will collect the funds from the benefits company and use the proceeds to operate the practice. This approach protects the A/R accounts since the practice does not “own” the accounts. Then the company invests the after-tax profits into an investment account for each doctor. This money is invested on an after-tax basis so all proceeds to the doctor in retirement would be tax-free. Usually this strategy increases the retirement income of the doctor while reducing current tax liabilities and protecting A/R from creditors. For example, a podiatry practice has $500,000 in A/R accounts from a third-party payer that historically pays 96 percent of the claims in 60 days. A benefits company has offered the practice $475,000 for the A/R accounts. If the practice can earn 6 percent on excess cash, should it sell these A/R accounts? No. The benefit is less than the cost. The cost is $475,312 and the benefit is $475,000, calculated in this manner: $500,000 (.96)/1+[1+(.04/365)*60] = $476,864. Should You Leverage Your A/R Accounts? Accounts receivable leveraging is a complex method to protect these accounts in such a way that makes more retirement money available to you. It can provide protection for your family in case of death or serve as a way to buy out older doctors. Although this option is attractive, one must invest A/R loan funds in a way that both protects your assets and allows the money to grow in a tax-advantaged manner without exposure to the practice’s creditors. According to David B. Mandell, JD, MBA and Christopher R. Jarvis, MBA, accounts receivable leveraging (financing) works something like this: a podiatry practice and doctor use A/R loan proceeds to invest in an LLC that also uses after-tax dollars. (The LLC must be created with a legitimate business purpose, not just for owning life insurance.) The LLC buys a life insurance policy on the doctor. If actuarial assumptions are correct and the policy is properly substantiated, there is no taxable transfer of value between the practice and the physician. Under the LLC agreement, the doctor owns cash value position in the life insurance policy and the practice owns the death benefit. If the doctor retires, the LLC takes a loan from the policy and pays the principal amount of the loan back to the practice and pays off the A/R lender. The doctor owns the remaining cash balance in the policy through the LLC. He or she can then take tax-free loans from the policy, paying throughout retirement. The practice gets the death benefit when the doctor dies. This can be used as a buy-out. Be sure to consult with a tax attorney and healthcare accountant knowledgeable with this strategy to ensure it satisfies all state and federal deferred compensation laws, forfeiture risks and IRS Section §83 constructive receipt requirements. Weighing A/R Buy-In And Buy-Out Strategies Although this is not proactive in nature like the above strategies, it is important to have some idea of your A/R buy-out/buy-in strategy should the need arise. The obvious question that most doctors wonder about is the inclusion of A/R accounts in a practice “buy-out” situation. The short answer is “yes,” if they are structured in the form of deductible deferred compensation to the practice. This allows the practice to deduct payments on its federal income tax return since A/R accounts are really an income asset. On the other hand, as part of a buy-in strategy, one should not include the practice’s A/R since they only inflate the value of the practice and make the buy-in more expensive. Rather, they might be declared as a bonus to practice equity owners and paid out over time (two to four years) as regular overhead cost disbursements. In other words, all the new doctor actually purchases is the practice’s net fixed asset value and goodwill, which is reduced by any debt liabilities. Unfortunately, when determining the buy-in amount, the medical practice appraiser should realize that the new doctor is mostly concerned with a low dollar amount rather than what constitutes actual buy-in value. Since the valuation process is a complex one and a CPA may often not be in a position to perform fair-market value appraisals, one should seek out the services of an appraiser who is knowledgeable in your specific medical specialty. A Guide To Understanding Financial Ratio Analysis For A/R Accounts Financial ratios are figures or percentages derived from components of the balance sheet, representing the assets and liabilities of a medical practice at a specific point in time. These short- and long-term financial ratio values are benchmarked to values obtained in surveys that become industry standards. Often, they become economic indicators of practice viability and all physician executives should monitor them regularly. In the February 2004 issue of Podiatry Management, John V. Guiliana, DPM, MS, noted that the economics of an average podiatry practice look something like this: • Gross collection rate = 65 percent (collected revenue/gross billing) • Adjusted or net collection rate = 96 percent (collected revenue/ (gross billing - contractual adjustment) • Total accounts receivable = less than two months gross charges • Average time in accounts receivable = 50 days • Percentage accounts receivable over 90 days = less than 15 percent • Clean claims percentage (not rejected due to internal error) = 97 percent Since the size of a podiatry practice varies greatly from start-ups to behemoth multi-office groups, these numbers also vary. Even with their inherent limitations, the following ratios are hallmarks of interpreting the financial statements of a medical practice. These ratios are used in most banking, lending, sales, merger or acquisition transactions. In fact, Gary L. Bode, MSA, who is the CFO of a large healthcare system in North Carolina, believes one of the most useful liquidity ratios related to A/R is the current ratio. The current ratio is mathematically defined as current assets divided by current liabilities. It is important since it measures short-term solvency or the daily bill paying ability of the practice. Current assets include cash on hand and cash in checking accounts, money market accounts, money market deposit accounts, U.S. Treasury bills, inventory, pre-paid expenses and the percentage of accounts receivable you can reasonably expect to collect. Current liabilities are practice notes payable within one year. This ratio should be at least one or preferably in the range of about 1.3 to 1.7. The quick ratio is similar to the current ratio, but money tied up in equipment, inventory and instruments is not included as an asset since rapid conversion to cash might not be possible in an economic emergency. A reasonable quick ratio would be 1.0-1.3, as this ratio is a more stringent indicator of practice liquidity than the current ratio. What You Should Know About Buying Back Practices And A/R Accounts From Failed PPMCs A few years ago, some podiatry practices were sold to physician (public) practice management companies (PPMCs) or other corporate buyers. However, many of those transactions have soured since the PPMC business model failed and was not able to generate the earnings that Wall Street investors desired. Investors increasingly abandoned the industry as behemoths like MedPartners and PhyCor called off merger plans, and FPA Medical Management filed for Chapter 11 bankruptcy protection, in 1998. In fact, a more recent review of the Cain Brothers Index of publicly traded PPMCs revealed losses of up to 95 percent as many other smaller entities collapsed ignominiously. The publicized financial difficulties of seemingly successful PPMCs are becoming more and more apparent as the recent accounting debacle at Health South continues to unwind. Today, many of these previously sold practices and their A/R accounts are being bought back by the same doctors that sold out years earlier. However, if one does consider buying back such an entity and its A/R accounts, one must be cautious not to pick this item up as income twice as the costs can be immense to the practice. For example, a podiatry practice purchased itself back from a PPMC. Part of the mandatory purchase price, approximately $300,000 (the approximate net realizable value of the A/R), was paid to the PPMC to buy back A/R generated by the doctors buying back their practice. Unfortunately, the office administrator unknowingly began recording the cash receipts specifically attributable to the purchased accounts receivable as patient fee income. If left uncorrected, this error could have incorrectly added $300,000 in income to this practice and cost it (a C Corporation) approximately $105,000 in additional income tax ($300,000 in fees x 35 percent tax rate). The error in the above example is that the PPMC must record the portion of the purchase price it received for the accounts receivable as patient fee income. The buyer practice has merely traded one asset, cash, for another asset, the medical A/R. When the practice collects these particular receivables, the credit is applied against the purchased A/R (an asset) instead of being applied against patient fees. In Conclusion Today, podiatrists must remain open to new ideas that identify and provide solutions to the contemporaneous problem of protecting their A/R accounts. When a solution is backed by an insurance policy, one must take particular care in evaluating the need and all associated costs. Although this emerging work is descriptive, it is not yet time tested since some of it aspires to be normative, as developing modern models of A/R protections hint that insurance may deserve a role in A/R protection for only the savviest of practitioners. A podiatry practice is unlike other non-medical businesses. Rather than extend customer credit terms to grow in a competitive environment, third-party medical payers are constantly seeking ways to delay, reduce or cancel payments to medical professionals. A/R accounts subsequently balloon and it often seems that doctors suffer A/R loss without recourse. It can get even worse as open-account patients and HMOs may file bankruptcy, run into cash flow problems, face adverse liability judgments, lack sufficient insurance protection themselves or fail to satisfy A/R for a variety of reasons. Hopefully, this review of A/R protection strategies along with the recommended guidance of a medically focused financial advisor will prove useful in protecting one of your practice’s most valuable assets. Dr. Marcinko is a licensed financial advisor, insurance agent, Certified Financial Planner© and Certified Medical Planner©. He is also the Academic Provost for, a practice enhancement resource center for physicians and their business consultants. The second edition of his book, The Business of Medical Practice, was just released by the Springer Publishing Company. For more info on the book, see or call (877) 687-7476. Dr. Marcinko can be reached at (770) 448-0769 (phone), (775) 361-8831 (fax) or via e-mail at Editor’s Note: Dr. Marcinko recently wrote the article, “How Shifts In Reimbursement Models Can Affect Liability Risk,” in the February 2004 issue of Podiatry Today. For other related articles, check out the archives at



Recommended Reading 1. Bode, GL: Economic Report Card for Physicians. In, Marcinko, DE (editor): The Business of Medical Practice (Advanced Profit Maximizing Skills for Savvy Doctors), 2nd edition. Springer Publishing, New York, NY, 2004. 2. Cook, G: Insurance Planning. Marcinko, DE (editor): Insurance Planning and Risk Management Handbook for Physicians and their Advisors. Jones and Bartlett Publishing. Sudbury, MA. 2004. 3. Gollier, C: Economics of Risk and Time. MIT Press, Boston, 2001. Hetico, HR and Marcinko, DE. Financial Statements and Medical Practice Benchmarking. In: Marcinko, DE (editor): Financial Planning for Physicians and Healthcare Professionals, 3rd edition. Aspen Publishing, New York, NY, 2003. 4. Jarvis, C and Mandell, D: Wealth Protection: Build and Preserve your Financial Fortress. John Wiley and Sons, New York, 2002. 5. Marcinko, DE (editor): Financial Planning Handbook for Physicians and their Advisors. Jones and Bartlett Publishing. Sudbury, MA. 2004, 6. Marcinko, DE (editor): Insurance Planning and Risk Management Handbook for Physicians and their Advisors. Jones and Bartlett Publishing. Sudbury, MA. 2004. 7. Marcinko, DE (editor): Financial Planner’s Library on CD-ROM, 4th edition. Aspen Publishing, New York, NY, 2003.


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