Should a medical practice use cash or accrual accounting?

For tax purposes, most independent practices are better off on the cash basis. For running the practice, you also want to see accrual numbers. These two goals don’t conflict, and many practices use both.

Cash basis records income when money reaches the bank and expenses when you pay them. The IRS allows it for businesses whose average annual gross receipts over the prior three years fall under a threshold of about $31 to $32 million, adjusted for inflation each year. That covers nearly every independent practice. It’s simpler to keep, and you only pay tax on money you’ve actually collected. That matters when insurance payers take 30 to 90 days to pay a claim.

The problem is what cash basis leaves out. Say a practice has a heavy December, but most of those claims pay in January. On a cash basis, December looks weak and January looks strong, and neither month is accurate. Bills work the same way. A supply order or malpractice premium that hasn’t been paid yet doesn’t show up, so profit looks higher than it really is.

Prepaid revenue is the reverse problem. Direct primary care and concierge practices often collect annual memberships up front. Med spas sell treatment packages. On a cash basis, all of that counts as income the day it’s collected, even though you still owe months of care or several treatments. A January full of annual renewals can make the practice look far more profitable than it is. Owners sometimes hire or spend based on that number and then come up short later in the year.

Accrual reporting shows the full picture. It shows what payers and patients owe you, what you owe vendors, and how much prepaid revenue you haven’t earned yet. That view becomes important at certain moments. A new partner buying in, a bank reviewing a loan for equipment or a building, or a buyer valuing the practice will all want to know what’s owed to the practice and what the practice owes. Partners splitting profits also need numbers that reflect the work actually done in a given period.

The practical approach is to file your return on the cash basis and have your bookkeeper produce accrual-style reports each month. QuickBooks Online can run a profit and loss report either way. Insurance receivables usually live in your billing system rather than your books, though, so someone has to pull the aging report each month and check that reported collections actually reached the bank. We build that check into our monthly bookkeeping for practices that bill insurance.

Changing your tax accounting method later requires filing Form 3115 with the IRS, so it’s worth choosing on purpose rather than by default. Our enrolled agents provide tax services for physicians and practice owners. They can look at your payer mix, membership revenue, and future plans and tell you which setup makes sense for your practice.