Occasionally owners will ask us about using an accrual method of accounting versus cash basis. If your eyes are already glazing over, I understand. But let’s get technical anyway, starting with the difference between cash basis and accrual basis.
What do you mean, there’s more than one way to do accounting?
The main question different accounting methods address is “When does the business recognize or book revenue or an expense?” For example, let’s say I had a recent comprehensive eye exam on July 15. I used my VCP benefits to order a pair of glasses, and I paid $550 out of pocket on the 15th for the exam, photos, and my portion of the glasses. My VCP’s reimbursement for my exam and materials will show up in four to six weeks. The practice also re-ordered the frame and the VCP presumably paid for the lenses; the bill for the frame will also be due in five to eight weeks.
- On a cash basis, revenues and expenses are recognized on the date they hit bank accounts. This means that technically there is no inventory on the balance sheet in cash-basis accounting since anytime you buy a frame for your boards or stock contact lenses, they are “expensed” on the P&L on the date you pay for them. In my hypothetical exam, my out-of-pocket payment hits the day of my exam, my VCP’s portion hits the day it clears the bank, and the frame cost hits the day the practice pays that bill.
- On an accrual basis, revenue and expense are tied back to the date the “sale” took place. Sounds simple, right? Let’s think about what that means for my hypothetical visit. My out-of-pocket payment hits the day of my visit. Easy. The practice now needs to pull out the portion of the VCP reimbursement for my visit that was just for my visit and tie it back to the day I came in. If the practice sells my frame off its board, they have to move the cost of that frame from inventory to Cost of Goods Sold. This means they need to have listed each frame on the boards in inventory and linked the wholesale cost of the frames to my visit. And then there’s another question: should you book the revenue from your lens reimbursement and take the charge-off in the Cost of Goods Sold?
Can You Reliably Generate Accrual-Level Data?
Before I dismiss accrual accounting, let me say we would love to do it. For the precision it can provide to decision-making (How profitable is XYZ VCP? Are Saturdays profitable?), accrual is a great way to do accounting. It can be abused (we’ve seen people make up their write-offs to get to the revenue & profit they want), but accrual accounting offers real advantages.
If you have the systems and data to do it.
And that’s the issue with accrual. Most practices don’t have the A/R (accounts receivable) systems to line out the net revenue for each patient tied back to the day of their visit. Basically, no practices accrue their inventory and have the tracking to pull through an accurate frame cost when they sell eyewear. A/P (accounts payable) is also an issue for accruing financials.
Cash Basis Isn’t Without Benefit
So, if accrual is better, why not force a bunch of independent optometry practices to build out the systems to accrue? Well, cash-basis accounting isn’t without its merits.
For one, it’s simple. Book revenue when it comes in. Book expenses when money goes out. There is a delay between an event (like a patient visit leading to sales) and money moving in and out of the practice; we simply book the money when it goes in or out.
Cash basis is less likely to be abused or result in fictions around revenues or write-offs. It mirrors cash flow much more closely because there’s no guessing about future revenue or moving expenses from today to the past.
Time Smooths Insights
To close this out, let me quickly touch on benchmarking. A key advantage of accrual accounting over cash accounting is the precision of marrying expenses to the revenue that drove them. There is nothing cash basis can do to overcome that.
Unless you let time be your friend. Our optometry practice financial benchmarks are generated on a trailing 12-month basis. By looking back at a full year of patients, income, and bills, most of the noise from cash basis will be smoothed out. Trailing-twelve also has the advantage of taking out seasonality concerns; all seasons are always incorporated in the reporting.
Accurate. Timely. Meaningful…Simple.
If you want to enjoy accurate, timely, and meaningful financial statements and reports, contact us today. We have also prioritized making things simple for practice owners. Cash-basis accounting minimizes the input we need from our clients (note: minimal is not the same as zero), allowing us to quickly and vastly increase the data set feeding into our benchmarks.
If you’re looking to reduce your workload and/or increase your insights into your practice, we are here to help. We’d welcome the chance to improve your business intelligence while freeing up your time.
