How a credit line can be a lifeline for your practice

Because your practice's cash flow is threatened by an array of economic realities, from reduced Medicare reimbursements to higher technology costs, most financial experts agree that a solid line of credit is an essential tool to have. But where should you start?

First of all, a credit line can be defined as an available amount of money that can be tapped at the borrower’s discretion, says Michael La Penna, principal of the La Penna Group Inc., Grand Rapids, Michigan.

Generally, if you are looking to finance big-ticket items, you will want to seek out a business line of credit. If, on the other hand, you wish to fund smaller business purchases such as office supplies, you will want a revolving line of credit, such as a credit card. When you use either will depend in part on your preferences. Some practices establish a line of credit, or revolving credit, for emergencies, and others regularly use one or the other types of lines.

“A credit line is an open access resource to a physician practice that can be used on an episodic basis. It’s generally in place for private physician practices, and it is a useful tool for any business that has a cash flow that can be irregular or cyclical,” La Penna adds. “It should never be used for standard financing. Generally, the size [of the line] is a function that is determined by business planning and business trends. It’s generally agreed on between the bank and the practice. It’s at a variable [floating] interest rate, and it is re-qualified annually.” More on the appropriate amount of credit to seek later.

THE RIGHT STRATEGY?

So how can a solo or small practice determine whether opening a credit line is the right strategy?

Marc Lion CPA, CFP, founding member of Lion and Co. CPAs LLP in Syosset, New York, says a credit line is a good resource to have all of the time, especially now, when interest rates are extremely low.

“I usually advise my clients, ‘Even if you don’t need a [credit line] today, let’s go ahead and apply for something just so you will have it,’ ” he says, adding that despite the low interest rates, he has not seen an influx of physicians seeking counsel regarding credit-line implementation.

Lion, who oversees his firm’s healthcare advisory group, working with providers on tax, personal finance, and practice management issues, says practices should aim for an interest rate one or two points above the prime rate, a commonly used benchmark easily obtained online. He’s also the outgoing president of the National CPA Health Care Advisors Association.

CREDIT COVERAGE

If you commit to applying for a line of credit, it’s important to calculate the proper amount to establish and maintain. Barry Oliver, CPA, CPS, of Thomas, Wirig & Co., advises to base the size of a credit line on the necessity of the practice-and then some.

The need for credit is likely to be greater in newer, seasonal, and transitioning practices, which are more likely to have uneven cash flows, as well as in practices adding a partner, staff member, or location or merging with another practice. Regardless, La Penna says, “Doctors should have a realistic assessment of their actual ‘in the door’ cash and be able to predict how and when they can...pay down the line.”

Oliver, an editorial consultant to Medical Economics, says, “In today’s environment, many doctors will take more than they need, because credit lines don’t come as easy as they once did.” For physicians, outstanding student loan debt may complicate matters, La Penna notes.

A practice’s legal structure may necessitate a credit line, Oliver says. “Many C-corporations will need one immediately following their year-end so they can make their payroll in the first part of the year,” he adds.

Lion recommends to his clients that they maintain a credit line of avt least $100,000, although he says a larger line of $250,000 can cover most budgetary goals, including expansion plans, significant equipment upgrades, or even buying out a partner. The respective amount of credit needed also will depend on the size of the practice and specialty, he adds.

Cash flow needs and trends within the practice will dictate additional factors to consider, Le Penna says.

“A practice with seasonal trends may require a more robust line of credit,” he says.

“Consultation with a banker or a financial consultant over the practice performance is the first step. Traditionally, banks will look at [accounts receivable (AR)] and approve some line of credit that is a function of the existing AR-like one half of the AR or some other ratio that is standard within their reference set.”

Lion recommends that physicians maintain credit lines regardless of their practices’ financial health, in case situations should arise that interrupt practice cash flow. He points to the effect that Superstorm Sandy had on medical practices in New York and New Jersey this past October.

“Some specialists have big war chests. Family practitioners? Not so much,” he says. “All the insurance companies have to do is jam you up 3 or 4 weeks and all of the sudden, you are falling behind and now you are in a cash crunch. That’s where the credit line comes into play.”

SHOP AROUND

The experts who spoke with Medical Economics recommend shopping around, because the marketplace is competitive.

Lion includes credit card companies, banks, and financial services firms in his list of credit line providers. Financial services firm often charge more interest compared with regular banks but often can process a credit line request more rapidly-saving time but not necessarily money, he adds.

La Penna advises limiting your choices, however. “The only option that should be considered should be a credit line with a bank that handles the practice assets and checking and banking services,” he says. “Credit cards are too expensive and should never be used. Financial services companies charge too much.”

Other factors to consider when shopping for credit, according to La Penna, include terms that define your ability to change any aspect of the credit agreement, and the structure and nature of the security for any credit or loan as related to guarantees for the credit line.

Lion says that national or regional banks are granting credit according to stricter underwriting standards that dictate how banks and other financial institution assess the eligibility of a customer for a credit line. The more stringent underwriting guidelines stem from the financial incidents of a few years ago, when the nation’s banking system came under intense scrutiny, he adds.

“Key factors that contributed to the rise in product and portfolio credit risk were the weakening economy, rising energy costs, turbulence in the secondary credit markets, the downturn in the housing market, and the anticipated impact of relaxed underwriting standards over the past few years on payment performance,” La Penna says.

During the business underwriting process, the institution evaluates the financial information provided by the practice, including analyzing the practice’s balance sheet of tangible net worth, the ratio of debt to worth (leverage), and available liquidity (current ratio). The more solid a practice’s balance sheet, the more likely the institution will grant a line of credit.

ESTABLISH A RELATIONSHIP

When it comes to seeking a credit line for your practice, the experts advise taking the same action you would to position yourself well as a consumer: make sure your financial statements are in order, complete, accurate, and up-to-date. (See “Financial checklist.”) And approach establishing a line of credit with the same business acumen as any professional dealing, says Bruce Bagley, MD, interim president and chief executive officer of TransforMED, a wholly owned subsidiary of the American Academy of Family Physicians (AAFP).

Develop good rapport with your bank first, however.

“Probably the best advice is that a physician’s practice is no different than any small business in terms of cash flow and capital needs,” Bagley says. “They should have an established banking relationship that is responsive to business needs.”

Once you are on a solid footing with your bank, the groundwork for securing a line of credit is mostly done, according to La Penna.

“Processes for underwriting on all credit are more stringent, but a line of credit is typically constructed with a local bank that has a depository relationship with the practice [the practice is an ongoing client], and there may be many linkages,” La Penna says. “We do not see mature practices with local connections and solid business histories having a problem with accessing lines of credit.

“For the local physician practice and for other premium customers with solid business and revenue history, banks are eager to connect,” he continues. “One way to connect is at the point of deposits, and the other is to fulfill standard credit needs. Property loans, leases, lines of credit, etc., will never have lower standards in the future, but banks will be seeking the ‘right customers’ for their products, and many doctors would be considered [to be] in this category.”

Find independent banks in your area by using the bank locator tool from the Independent Banks of America at www.icba.org.

ALLY ORGANIZATIONS

Most physician organizations, such as the AAFP, have access to financial advisers that can assist with the questions a practice might have. Also, your local bank likely is connected with the medical community or works with many medical practices.

And government-backed organizations assist physician practices directly. One organization expanding its credit line offerings in the past few years, for instance, is the U.S. Small Business Administration (SBA).

Dianna Seaborn, SBA’s policy program chief of Basic 7(a) Loan Program, Office of Portfolio Management, says one successful program that the administration continues to expand is the CAPLine loan program, an umbrella program under which the SBA helps small businesses meet their short-term and cyclical working-capital needs.

“We do a reasonable number of medical practices, providing capital for equipment [and] capital for expansion of a building,” she says.

Seaborn says that the number of lending institutions nationwide that participate in CAPLine has grown incrementally, providing physician practices a wider canvas with which to take advantage of the loan program. (See “The CAPLine program.”) In fiscal year 2012, SBA’s loan programs posted the second-largest dollar volume ever, according to the agency’s annual report. The year was surpassed only by the 2011 fiscal year, which was greatly influenced by the loan incentives offered under the Small Business Jobs Act of 2010.

TO CLOSE OR NOT TO CLOSE?

In Lion’s opinion, if a practice is using a line of credit appropriately and for the purpose for which it was sought, then the credit line can remain open indefinitely. If a credit line is being used for purposes that aren’t appropriate, however, or if it hasn’t been tapped in more than 3 years, then the practice should consider closing it. For instance, he adds, “If the practice’s cash is not flowing sufficiently to pay the owners/partners, then it’s time to ‘check under the hood’ of the practice to identify where the profit leaks are.” The same advice holds true if you tire of paying annual fees for a line of credit that you’re not tapping into, Lion says.

As the borrower, when you close a line, you may be required to pay an “unused line fee,” often an annualized percentage fee on the money not withdrawn. You will pay interest, which can be written off on your taxes, only on amount of money actually withdrawn.

Weigh the act of closing a credit carefully, Oliver says.

“Because credit lines are difficult to come by, most [practices] won’t close [them] for fear of being denied if they apply for a new one,” he adds.

WHAT THE FUTURE HOLDS

According to La Penna, market-influenced changes in the healthcare industry will continue to trickle down to practicing solo and small-practice physicians, who, in turn, must remain flexible and aware so they can continue to keep their businesses operating in the black.

“Healthcare reform will change many local marketplaces, and referral sources will change as accountable care organizations and insurance exchanges mature,” he says. “These factors will cause uncertainty in some medical markets, and any doctor who is independent will have to be vigilant concerning how these factors might impact their business-and their access to credit.”

Financial checklist

If applying for a credit line, Marc Lion CPA, CFP, founding member of Lion and Co. CPAs LLP in Syosset, New York, recommends bringing these items with you:

• 2 years of personal tax returns;

• 2 years of business tax returns;

• financial statements for the current year;

• 3 months of current personal and business bank statements;

• 3 months of current brokerage statements (regular and retirement), if applicable;

• copies of 2 years of any K-1s that may appearing on the return on schedule E;  

• with respect to number 6, if any of the K-1s are related to businesses that a significant ownership position may exist, be prepared to provide 2 years of copies of those tax returns as well; and

• if a business owner, a letter from your certified public accountant indicating that if any funds from the business are to be used toward the purchase or the refinancing, it will not hurt business operations.

The CAPLine program

The U.S. Small Business Administration (SBA) continues to expand is the CAPLine loan program, an umbrella program under which it helps small businesses meet their short-term and cyclical working-capital needs. Key benefits of the program, according to the SBA:

• Small businesses can pledge accounts receivable, inventory, contracts, and purchase orders to secure an SBA revolving line of credit. For example, when fulfilling a purchase order request, that same order can be used as collateral to obtain an SBA-guaranteed line of credit to hire more workers and buy more materials.

• Small business subcontractors can obtain an SBA-guaranteed line of credit to finance their work on a contract with a federal prime contractor.

• The SBA no longer requires small-business owners without buildings or equipment to use their personal assets as collateral to secure working capital.

• Small businesses working on a contract that requires surety bonding can obtain an SBA-guaranteed line of credit.

• In addition, small businesses that use CAPLine can take advantage of an increased SBA 7(a) loan limit of $5 million, which went into effect with the Small Business Jobs Act of 2010.