The annual audit for healthcare companies is similar to an annual physical. Just as a physician checks vitals to ensure a body’s systems are working properly, the audit seeks independent verification that a company’s financial statements are accurate, and its reporting systems are on solid footing, while also identifying potential issues.
In this post, I am focusing on accounts receivable valuation because it is typically one of the largest and most important pieces of a healthcare company’s financial statement audit. Accounts receivable valuation is also where most of the risk resides due to the subjectivity of the estimates and the fact that there are several ways to perform the valuation. Without adequate preparation and internal analysis, valuation concerns will be prevalent with your auditors.
Completing an internal review of your accounts receivable prior to the year-end audit, with a few key points in mind, is a proactive effort that will have many benefits when the auditors walk in the door. Generally, LBMC considers the six high-level analyses listed below when evaluating the reasonableness of accounts receivable valuation during an audit. Considering these analyses and looking through the lens of an auditor will save a lot a time and minimize the possibility of an audit adjustment.
1. Contractual allowances
Ensure contractual allowances are based on supporting reports by financial class. Generally, these reports should be based on three- or six-month transactions on fully adjudicated claims. This hindsight analysis supports recent contractual adjustment percentages that should be applied to gross receivable balances at year-end.
2. Bad debt allowance
Consider how much of your high-risk accounts receivable are covered by your bad debt allowance. For example, the bad debt allowance covers 100% of all self-pay (and any other high-risk balances) over 60, 90, or 120 days, depending on your company’s collection history of these receivables.
3. Interim cash receipts
Review your cash receipts based on the service date prior to the date under audit. For example, if your year-end audit is 12/31/18, consider reviewing cash receipts 10/1/18 – 12/31/18 on dates of service 9/30/18 and prior. This will give you an idea of expected collections trends for a three-month period. For a 12/31 audit, your auditor will likely review collections through February or March of the subsequent year. Performing this analysis on 9/30 accounts receivable will give you an idea of what to expect.
Perform a year hindsight cash collections analysis on accounts receivable. Compare the total cash receipts 1/1/18 – 12/31/18 on dates of service 12/31/17 and prior to the 12/31/17 net accounts receivable balance. Completing a full year hindsight of cash collections based on service date is ideal when it comes to assessing how well cash collections match the estimated receivables that will be audited.
5. Net revenue to cash
Ensure that monthly net revenue to cash is close to 100%. Generally, this analysis (commonly referred to as a “cash goals” analysis) is considered on a one-month or two-month lag, depending on the turn of your accounts receivable. For example, if you generally expect to receive most collections within 60 days, you would compare January revenue to March collections, February revenue to April collections, and so on. This is a good month to month analysis as well as a full year review and ideally, should approximate 100%—assuming there is no triggering event that would cause collections to increase or decrease significantly in a given month.
Review month to month and year over year metrics, such as the following:
- Total allowances as a percentage of gross accounts receivable
- Contractual allowances as a percentage of gross accounts receivable
- Bad debt allowances as a percentage of gross accounts receivable
- Aging bucket analysis
- Accounts receivable turnover
- Days in net accounts receivable
- Days in gross accounts receivable
- Bad debt expense as a percentage of gross revenue
- Bad debt expense as a percentage net revenue
By considering these analyses with your year-end financial review, you’ll be well prepared for the audit from an accounts receivable valuation standpoint. If you have any questions or would like to discuss further details on these analyses, we will be happy to assist.
For more information on ensuring your accounts receivable are audit ready, contact Meredith Douglas, LBMC Shareholder, Audit and Advisory at firstname.lastname@example.org or 615.309.2220.