Increase Your Practice’s Chances for Credit Approval
Published: Wednesday, September 19th 2012
The financial crisis has affected even the most creditworthy of medical practices.
While banks are still actively lending to medical practices and continue to view them as good credit risks, in recent years, the government’s Office of the Controller of the Currency — the agency responsible for regulating the banking industry — has increased capital requirements for banks as well as its oversight of the banking industry. This in turn has put pressure on banks to tighten their credit standards and toughen their underwriting process.
Underwriters are now doing a more comprehensive review of the underlying collateral and cash flow of their borrowers, the two primary factors in the loan approval process; they have no choice but to “dot every ‘i’ and cross every ‘t.’” While this may be frustrating for practice owners, it is a reality of today’s credit market.
There are steps that medical practices can take to reach the higher standards of lenders and increase their chances of credit approval.
Substantiating collateral value
Accounts receivable (A/R) is typically the most liquid collateral in a medical practice and, therefore, the asset that lender’s are most willing to lend against. That being said, A/R may also be the most difficult to value. A practice’s A/R is recorded at standard rates and until payment is received from third-party payers A/R is generally not reduced, or contractually adjusted, to its net realizable or collectable value.
Considering that the amount a practice can borrow depends, to a great extent, on the value of its A/R, being able to calculate and substantiate this value to a lender means maximizing the amount a practice can borrow. For this reason, a practice should be able to readily provide lenders with analyses that substantiate the practice’s historical collection rate, payer mix and patient bad debt write-offs. Being able to provide these types of analyses may require a practice to upgrade its billing or practice management software.
Medical practices historically draw out much of their profits in any given year. In the past this was not necessarily a problem, but this may no longer be the case considering today’s credit climate.
If a lender has concerns that a practice’s cash flow may be insufficient to cover its debt service, the lender may build safeguards that protect the bank into the loan agreements. This is accomplished by requiring practices to meet certain financial loan covenants, typically at year-end, as a way for the lender to monitor the financial strength of the practice. Examples of such covenants include debt service coverage ratios, debt to equity (leverage) ratios and minimum net worth requirements.
If covenants are not met, then the borrower will be in default of its loan and the lender can take certain actions to cure the default. The most severe of which would be to demand immediate repayment of the debt.
Upgrades in financial reporting
Being able to demonstrate a practice’s financial strength and its ability to repay debt will give a practice the greatest opportunity for a credit approval and maximize the amount it can borrow. For this reason alone, a medical practice may need to improve its financial reporting. In fact, more lenders are now requiring practices to provide financial statements, not just the practice’s tax return. This is where the quality of the financial statements and the level of assurance provided by the outside certified public accountant (CPA) becomes important.
In some cases, the lender requires that financial statements be prepared using generally accepted accounting principles, a basis of accounting that generally provides more accurate and comprehensive reporting than the simpler cash or tax basis of accounting. The lender may also require that the practice’s CPA firm opines on the financial statements.
Depending on the size of the credit facility, the lender may require that financial statements be reviewed or audited, which provides greater assurances from the CPA firm than compiled financial statements. These upgrades in financial reporting are all costs that will have to be born by the practice.
If there are concerns as to whether the underlying collateral and cash flow of the practice can support the debt, a financial forecast may need to be prepared.
A properly prepared forecast, which typically includes profit and loss statements, cash flow statements and balance sheets, gives the lender a “roadmap” as to how the practice will repay its debt, as well as the financial position of the practice over a period of time. The forecast will also provide the necessary financial data to calculate the financial loan covenants that the bank may include as part of their loan agreement.
In the end, a forecast may reveal that the practice does not have adequate collateral and/or cash flow to support the debt. This may be an indication that the bank may require the owners of the practice to contribute additional cash to the practice or provide additional outside collateral, such as outside real estate or investments.
Working with lenders
Understanding that lenders are being held to higher underwriting standards, it behooves medical practices to take the necessary steps that will allow them to meet these new standards. The practice may incur additional costs to implement these steps. However, they are necessary steps if the practice seeks to increase its chances for a credit approval, to maximize the amount it can borrow and, ultimately, to achieve its long-term goals.
Lee Ferber, CPA, is a senior member in GMSL’s Health Care Group, a division of Gettry Marcus Stern & Lehrer CPA P.C., a New York-based accounting and consulting firm. Mr. Ferber specializes in new group formations, mergers and acquisitions, partner/shareholder agreements, succession planning, physician-hospital arrangements and developing physician compensation models. He can be reached at (516) 364-3390 ext. 206, or via email at firstname.lastname@example.org.
Mr. Ferber is a proud member of the National CPA Health Care Advisors Association. The HCAA is a nationwide network of CPA firms devoted to serving the healthcare industry. Members provide solutions to the accounting and financial needs of physicians and physician groups. For more information contact the HCAA at email@example.com.