Medical practices boost cash flow through factoring

The practice, also called factoring, offers several types of advantages, particularly for physicians working to establish – or re-establish – private practices.

It wasn’t too many years ago that hospitals set a trend of purchasing medical practices. The theory was that not only would the hospitals benefit by an influx of referrals, the physicians would not have the headache of managing their practices and therefore would earn more and work less. Unfortunately, this rosy scenario has not always worked out and, as a result, many doctors are terminating their contracts with the hospitals. This has forced many physicians to re-establish their practices.

For most doctors, maintaining a customer base isn’t a problem, as most patients will follow their doctors back into private practice. The main issue is practice management, in general, and financing, in particular.

Although the physician may have no trouble getting financing for capital expenditures, an ongoing problem is how to pay expenses and overhead incurred during the 60 to 90 days it takes to get paid from third-party payers, primarily the insurance companies.

Even the most efficiently run practices need short-term working capital as their businesses grow, and as a result of this need, health care financing companies have sprung up to provide medical receivables funding.

Even though the largest asset of most providers is their accounts receivable, most banks won’t lend money based on them. Loan officers often lack the specialized knowledge of the health care claim billing and collection process. Because there can be a significant difference between the expected amount to be paid versus the face amount of the billings, banks are leery of using medical receivables as collateral. In a medical factoring situation, the funding company purchases the outstanding receivables of the practice, thereby assuming an ownership position in the receivables. Because the ownership of the receivable has changed, the practice also passes along the credit risk to the funding source.

There are other advantages beyond passing on the risk:

• There is no monthly debt service because the funding is not a loan.

• Factoring medical receivables is an off-balance-sheet transaction, since the practice is selling an asset.

• The selling practice can receive fresh cash weekly, thus providing a manageable flow of funds.

• Because the only asset that is encumbered is the receivables, the health care provider can pursue other types of financing concurrently.

• Factor fees tend to be much less than paying a billing company.

• No personal guarantees are required. The factoring company is more interested in the credit of the payer.

The funding process

There are several steps involved with medical receivables factoring.

First, the provider completes a client application and submits it to the funding source along with a due diligence fee. The due diligence fee helps the funding source defray costs of researching and analyzing the practice’s billing methods and procedures and verify that the net collectible billing is accurately reflected on the firm’s books.

Next, the funding source sends out a letter of intent, which specifies what can be done for the health care provider. After receipt of the signed letter of intent, the funding source draws up a purchase and sales contract for the client. This contract specifies the fees to be charged and the advance rate to the provider.

The funding source performs final due diligence and provides reports to the client’s management as to the integrity of the billing and collection system.

Then, the funding company advances a percentage – generally 70 percent to 80 percent – of the net collectible receivable to the client practice’s bank account.

When the invoice is paid to the factoring company, the remaining amount (invoice total less the advance and the factor fee) is wired to the customer’s account.

The factoring of medical receivables is relatively new but rapidly growing. It can provide much-needed working capital to providers for meeting expenses, making investments, growing the practice and taking advantage of early payment discounts.

Kent Harlan, CPA, is owner of Ozarks Capital Funding. He can be reached at kenth@ocflink.com.