In most medical practices, there comes a time when immediate access to credit is beneficial − and occasionally, essential.
Securing a traditional loan through banks and lending institutions can be a lengthy process, depending on a variety of business criteria. Establishing a line of credit makes access easier to preapproved funding that is ready when needed.
Working with a bank or lending institution familiar with the medical industry, a practice can establish a line of credit (also called a revolving line of credit) to be available for short-term use in the event of seasonal opportunities and temporary working capital needs. This might include buying supplies in bulk for special periodic needs, such as ordering vaccines in late summer for flu season. A line of credit can also be available to cover short-term office operating expenses that need to be paid prior to actually collecting account receivable funds. It is important to align the loan and the terms associated with it for its ultimate purpose.
Lines of credit are typically one to two year terms. Interest payments on the advanced balance are paid monthly or quarterly. Principal payments should also be made to “revolve” the line. Bankers expect the loan to have a “rest” (a time when there is no outstanding balance), of at least 30 days a year.
A line of credit should not, however, be confused with a traditional term loan. You and your banker should review the line’s use on at least an annual basis. Lines of credit that have a perpetual advanced balance throughout the term, are considered “evergreen”. This usually means the funds were not used for temporary cash needs and have become permanent working capital. These balances will need to refinanced off the line of credit and in to a term loan with a three to four year repayment period.
The clean line of credit can then be started again for another term.
For most medical practices, especially those that do not own their own building, the biggest asset available to serve as collateral in securing a line of credit is its accounts receivable. Among the factors lenders will consider in establishing a borrowing base is overall credit history of the practice, a review of the accounts receivable aging report, and the efficiency of the practice’s billing and collections process − whether the function is handled in-house or by an outside billing company. When gathering this information for the meeting with your bank, remember that for HIPAA reasons, patient names should not be on the AR report. A summary by major payer provides the information a banker to assess the rate and timing of collections.
The first questions your banker should ask when given an AR Aging Report are to clarify if the report reflects gross or net accounts. Gross billings are what are actually billed. Net billings have been discounted for contractual adjustments and more closely reflect what the practice actually expects to collect. If the report has gross billings, there are additional steps the banker will use to estimate the net numbers. Lenders familiar with the medical profession understand the national average for receiving payment from insurance companies is 45-60 days. In most cases, the focus will be on accounts of 90 days or less. Accounts beyond 90 days are less preferred collateral as accounts become more difficult to collect as they age.
Lenders will assess the receivables and establish an amount available for lines of credit, often based on 80 percent of the allowable receivables. For example, a practice that averages $500,000 in qualifying accounts receivable could receive a line of credit up to $400,000 based on their overall credit worthiness. Once the line is in place, monthly or quarterly reporting to the bank will consist of the practice’s financial statements in addition to an AR aging report and a “Borrowing Base Certificate”, which calculates the AR collateral value and compares it to the line balance.
The right sized line of credit is important, too. In many cases the fees associated with establishing a line of credit are minimal. On larger lines of credit, “unused fees” may be assessed to offset the costs incurred to have the line available. Financial institutions offering lines of credit are obligating themselves to have funding available on the line, whether it is used or not.
Establishing a line of credit for a medical practice is a safeguard in the event it is needed. Used properly, it can allow a medical practice to smooth out its cash flow and fund short-term cash needs - but it can lead to repercussions if misused.
Check with your banker or financial advisors to determine if establishing a line of credit makes sense for your practice.