Financial statements.

Three financial statements form the basis for tracking the financial status of your practice: the balance sheet, the income statement, and the cash flow statement.

The balance sheet is a listing of your practice's assets and claims against those assets at any given time. It is based on the following model:

ASSETS = LIABILITIES + OWNER'S EQUITY 

Owner's equity is that part of the assets that exceeds liabilities. Owner's equity includes retained earnings, but in private medical corporations, retained earnings are usually distributed to the owner each year to avoid double taxation.

Balance sheets must always balance. In order to factor in the declining value of equipment over time, depreciation is used in balance sheets. It appears as a negative value under assets, indicating that the full value of the assets is being reduced by the amount of depreciation.

Income statements show a comparison of the wealth generated by the organization and the expenses incurred as a result of generating that wealth during a specific time. They are based on the following model:

INCOME = REVENUES - EXPENSES

Balance sheets and income statements are examples of accrual-based accounting. In a cash-based accounting system, revenues are recorded when they are received and expenses are recorded when they are paid. Therefore, if cash disbursements precede or lag behind cash collections, a determination of your current profit or loss position cannot be made.

Cash flow statements provide an analysis of cash receipts and cash disbursements over a given time. Cash flow statements are important in determining your financial status, because your practice can have wealth but lack cash when bills need to be paid. Therefore, your practice needs both cash-based and accrual-based information. Cash is used to pay bills; accrual-based accounting is used to make decisions.

Dr. Isenberg is an otolaryngologist in private practice in Indianapolis; [e-mail]