Financial statements are a set of formal financial reports prepared from accounting records of the practice. The format of financial statements is somewhat standardized to assist you in understanding the information presented and to render this information useful.
Components of Financial Statements
The basic components of financial statements are:
- Accountant’s report
- Balance sheet
- Understanding Income Statement
- Statement of Changes in Financial Position
- Notes to Financial Statements
- Learn how Financial Statements can Help your Practice
The accountant’s report must precede any financial data. The report informs users of the financial statements about the degree of assurance given by the accountant. There are three different types of reports that can be issued:
- Auditor’s Report
- Highest level of assurance needed for public companies –many not-for-profit organizations and large corporations.
- Professional practices are not required to be audited by any government body or Legislation.
- Review Engagement Report
- Lower level of assurance than an audit, financial statements are prepared from client records but are subject to some analysis and enquiry.
- Usually required by lenders and prospective investors.
- Notice to Reader Report
- No assurance given.
- Financial statements have been compiled from information supplied by the client, with minimal analysis.
- Usually prepared for income tax filing purposes only and generally may be accepted by bankers or other lenders
Fees are commensurate with the degree of work performed and your accountant will generally recommend the most cost-effective engagement.
A balance sheet is a statement, at a particular point in time, of the financial position of your practice. It includes figures for the current fiscal year and comparatives for the previous fiscal year.
The basic formula for a balance sheet is: Assets = Liabilities + Practice Equity
Assets are items of value owned by the practice:
- Cash in the bank
- Investments such as bonds, term deposits, mutual funds
- Accounts receivable from patients
- Equipment and fixtures
Liabilities are amounts owed or obligations payable by the practice:
- Bank loan or line of credit
- Account payable to suppliers
- Credit card balances
- Capital losses
Practice Equity is the practitioner’s financial interest in its assets. When a practice is first established, the amount of your own funds contributed to the set-up and fixturing of the office is regarded as the equity or net worth. When the practice develops and becomes profitable you begin the process of building practice equity. As you draw cash out of the practice, the practice equity will decline.
The change in equity over a period of time is:
Equity balance, beginning of period
+ Net practice income for the period
+ Funds advanced by the practitioner in the period
– Funds withdrawn by the practitioner in the period
= Equity balance, end of period
Understanding Income Statement
Also known as the “income statement,” a statement of income and expenses summarizes the revenues earned and expenditures made for a stated period of time. The statement of income and expenses generally covers a full fiscal year and shows comparative figures for the previous fiscal year.
The basic formula for this statement is: Income – Expenses = Net Income for the period
Income is the amount earned by the practice in the year. Examples include:
- Professional fees billed: For accounting purposes, fees are recorded as income when they are billed, irrespective of when they are collected. Amounts not yet collected at the year end are shown in the balance sheet as “account receivable”.
- Investment income: This category includes interest dividends and capital gains earned on investments.
Expenses are amounts expended in the ongoing activities of the practice and are generally consumed within the year:
- Staff wages and benefits
- Associate and other fees
- Laboratory fees
- Supplies used in providing your services
- Repairs and maintenance
- Office expenses such as telephone, stationery, postage and printing
- Advertising, promotion and entertainment expenses
- Insurance premiums – office premises, business interruption (life and disability premiums are generally not included in the practice financial statements)
- Bank charges, interest on bank loans and line of credit
- Lease payments (operating leases)
- Depreciation of equipment and fixtures
Statement of Changes in Financial Position
This statement shows the change in the cash position of the practice over the year.
Notes to the Financial Statements
Notes to financial statements are standardized disclosure requirements and are meant to provide additional useful information to users of the statements. These notes are placed at the back of the statements so as not to obscure the actual figures reported. Financial statements, when used in conjunction with other financial reports (such as cash flow projections), will help you make informed decisions about your practice.
The value of any financial report for decision making is directly related to several factors:
The data used to compile financial statements is taken from the “books of account” for the practice. The data must be accurate, current and easy-to-read.
How can financial statements help your practice?
Your accountant can assist with your understanding of practice financial statements. If you wish to keep a close watch on practice financial operations, have your bookkeeper prepare these reports on a regular monthly basis (this is easy if you are using an accounting software package). Forward this information to your accountant and discuss it together.
Examples of how you may use your financial statements in practice decision-making include:
- Collection of accounts receivable: Compare the level of accounts receivable to fees billed. If accounts receivable is growing at a faster rate than fees, perhaps collection efforts should be reviewed and improved.
- Levels of expenses: Compare the level of supplies, various fees and staff wages as fees billed.
- How do these compare to industry averages (ask your accountant for more information)?
- Review purchasing and pricing procedures
- Review how supplies are being used in the office
- Level of repairs and maintenance expenses: Review office procedures for regular maintenance of equipment and facilities.
- Income tax payable: The practice’s financial statement does not show any income taxes. Rather, the net income shown in the statements will be reported in your personal income tax return. While this figure alone will not determine total tax liability, changes from one year to the next can help you estimate this amount.