Accounting for Medical Practices: What Every Healthcare Provider Needs to Know

A dermatology practice in the Medical Center was preparing to open a second location in Sugar Land. The lead physician had been running the original office for six years with a bookkeeper who came in twice a month, a billing company that handled insurance claims, and a personal accountant who did the annual tax return.

None of them were talking to each other.

The bookkeeper recorded payments when they hit the bank account but didn’t track outstanding insurance claims. The billing company tracked claims but didn’t reconcile their numbers against the books. The accountant prepared the tax return based on whatever the bookkeeper provided, without visibility into the $180,000 in unpaid insurance receivables sitting in the billing system.

When the physician applied for a loan to finance the Sugar Land location, the bank wanted to see accounts receivable aging, net collection rates, and revenue per provider. The physician couldn’t produce any of those numbers without weeks of manual reconstruction.

Medical practice accounting isn’t just tracking income and expenses. It’s managing a revenue cycle that includes third-party payers, delayed reimbursements, contract-adjusted write-offs, and compliance requirements that don’t exist in other industries. Getting it wrong doesn’t just affect your books. It affects your ability to grow, your relationships with payers, and your exposure to audits.

The Revenue Cycle: Why Medical Revenue Is Different

Most businesses invoice a customer, the customer pays, and the revenue is recorded. Medical practices operate differently. The payment chain has multiple steps, and each step introduces delays, adjustments, and potential errors.

Step 1: Patient encounter. The provider sees the patient and documents the visit. The documentation determines the CPT codes (procedure codes) and ICD-10 codes (diagnosis codes) submitted on the claim.

Step 2: Charge capture. The encounter is translated into a bill. If the coding is wrong, the claim gets denied or underpaid. Under-coding leaves money on the table. Over-coding risks fraud allegations.

Step 3: Claim submission. The claim goes to the insurance company (or Medicare/Medicaid). Most practices use a clearinghouse as an intermediary to scrub claims for errors before submission.

Step 4: Adjudication. The payer processes the claim according to the contract terms. They determine the allowed amount, apply any deductible or copay, and issue an Explanation of Benefits (EOB) showing what they’ll pay, what the patient owes, and any adjustments.

Step 5: Payment posting. The insurance payment arrives (typically 14-45 days after submission). The payment must be posted against the specific claim, and the contractual adjustment (the difference between the billed amount and the allowed amount) must be written off.

Step 6: Patient billing. Whatever the insurance didn’t cover (copays, deductibles, coinsurance, non-covered services) gets billed to the patient. Patient collections are slower and less predictable than insurance payments.

Step 7: Denial management. Claims that get denied need to be investigated, corrected, and resubmitted. Common denial reasons: incorrect coding, missing prior authorization, timely filing deadlines missed, eligibility issues. Denied claims that don’t get worked are lost revenue.

From the accounting perspective, this cycle creates a specific challenge: revenue recognition. Under accrual accounting, you record revenue when you earn it (the patient encounter), not when you collect it (the insurance payment weeks later). But the amount you ultimately collect is almost always different from the amount you billed, because of contractual adjustments, denials, and uncollectable patient balances.

This is why medical practices need to track both gross charges (what you billed) and net revenue (what you actually collected after adjustments and write-offs). The difference is your contractual adjustment rate, and it’s a critical metric. If your practice bills $500,000 per month and collects $325,000, your collection rate is 65%. Knowing whether that 65% is normal for your payer mix or a sign of coding problems, underpayment, or denial issues requires tracking each payer’s performance separately.

Insurance Receivables: The Hidden Asset

Accounts receivable in a medical practice is dominated by insurance receivables: money the practice has earned but not yet collected from payers. This number can be enormous. A busy practice might have $200,000-$500,000 or more in outstanding insurance claims at any given time.

Aging matters. Insurance A/R should be broken down by age:

Aging Bucket	Target	Concern
0-30 days	50-60% of total A/R	Normal processing time
31-60 days	20-25%	Follow up on unpaid claims
61-90 days	10-15%	Active denial management needed
91-120 days	5-8%	Escalation required
120+ days	Under 5%	Likely uncollectable, write-off candidates

If more than 15-20% of your insurance A/R is over 90 days old, something is broken in your revenue cycle. Either claims aren’t being worked, denials aren’t being appealed, or your billing company isn’t following through.

That dermatology practice had $180,000 in receivables, but $60,000 of it was over 120 days. Much of that was unworkable. The bookkeeper had been recording the expected payments as if they’d come in. They didn’t, and the books showed more revenue than the practice actually collected.

Proper medical practice bookkeeping requires monthly reconciliation between the billing system and the accounting system. The total payments posted in the billing system should match the deposits in the bank account. The outstanding claims in the billing system should match the accounts receivable balance in the books. When these numbers don’t match, you’re either missing revenue or overstating it.

HIPAA and Financial Data

The Health Insurance Portability and Accountability Act (HIPAA) applies to financial records that contain Protected Health Information (PHI). This affects how you handle, store, and share financial data.

What counts as PHI in financial records:

• Patient names tied to services rendered or amounts billed
• Insurance claim details that identify patients
• Explanation of Benefits documents
• Patient payment records
• Collection agency files

What this means for your accounting:

• Your bookkeeper, accountant, and any outsourced financial service providers who access records containing PHI must sign a Business Associate Agreement (BAA)
• Financial data stored in cloud accounting software must be in a HIPAA-compliant environment (QuickBooks Online is NOT inherently HIPAA-compliant, though the financial data in it may not contain PHI if structured correctly)
• Emailing patient-level financial reports requires encryption
• Disposing of financial records containing PHI requires shredding or secure digital deletion

The practical approach: Structure your accounting system so that routine financial reports (P&L, balance sheet, cash flow) do not contain patient-identifiable information. Use patient account numbers instead of names in your billing system exports. Keep the detailed patient-level data in your HIPAA-compliant practice management system, and only transfer aggregate numbers (total charges, total payments, total adjustments by payer class) to your accounting software.

This creates a clean separation: your billing system is HIPAA-compliant and handles PHI. Your accounting system handles aggregate financial data without PHI. Your accountant works from the aggregate data without needing direct access to patient records.

Physician Compensation Models

For practices with multiple providers, the compensation model affects accounting complexity significantly.

Straight salary. Simplest from an accounting perspective. Each provider gets a fixed salary regardless of production. Payroll runs normally. The practice absorbs the variance between high-production and low-production months.

Production-based (eat what you kill). Each provider’s compensation is tied directly to their collections or charges. Accounting must track revenue by provider, apply the compensation formula, and calculate pay each period. This requires provider-level reporting in both the billing system and the accounting system.

Base salary plus production bonus. A hybrid where providers earn a guaranteed base and receive a bonus when their production exceeds a threshold. Accounting tracks the base salary through normal payroll and calculates the production component monthly or quarterly.

Equal share. All providers split net income equally (or by ownership percentage). Accounting must produce accurate net income figures before distributions, which requires all expenses to be properly recorded and allocated.

RVU-based. Compensation tied to Relative Value Units (a standardized measure of the work, practice expense, and malpractice cost of each procedure). More common in larger groups and hospital-employed practices. Requires tracking RVUs by provider from the billing system and applying the compensation formula.

Each model requires different accounting infrastructure. Production-based models need reliable, timely provider-level revenue reporting. If your accounting can’t tell you what Dr. Smith collected last month within 10 days of month-end, you can’t run a production-based compensation system.

Chart of Accounts for Medical Practices

A medical practice needs a chart of accounts that reflects its unique revenue and expense structure:

Revenue accounts:

• Patient service revenue (by payer class: commercial, Medicare, Medicaid, self-pay)
• Contractual adjustments (contra-revenue account)
• Bad debt / charity care write-offs
• Ancillary revenue (lab, imaging, procedures, if applicable)
• Other revenue (rental income from subleased space, speaking fees)

Cost of services:

• Provider compensation (doctors, NPs, PAs)
• Clinical staff wages (medical assistants, nurses)
• Medical supplies
• Lab and pathology costs
• Prescription drugs (if dispensing)

Operating expenses:

• Administrative staff wages
• Rent and facilities
• Medical malpractice insurance
• Health insurance and employee benefits
• Billing company fees (usually 4-8% of collections)
• EHR/practice management software
• Medical equipment depreciation
• Continuing medical education (CME)
• Licensing and credentialing
• Professional memberships

The key metric: Overhead rate (total operating expenses as a percentage of collections). A well-run specialty practice in Houston typically runs 55-65% overhead, meaning for every dollar collected, 55-65 cents goes to expenses and 35-45 cents flows to provider compensation and profit. Primary care practices often run higher overhead (60-70%) due to lower reimbursement rates.

Opening a Second Location: The Financial Planning

Coming back to that dermatology practice. Once the books were cleaned up and the receivables were properly reconciled, the physician could see the real financial picture:

Current location performance:

• Annual collections: $1.4 million
• Overhead rate: 58%
• Provider compensation: 35%
• Net profit: 7% ($98,000 available for reinvestment or additional owner compensation)

Second location projections:

• Buildout cost: $250,000
• Monthly fixed costs (rent, staff, equipment lease): $22,000
• Break-even collections: $52,000/month (based on 58% overhead assumption)
• Projected ramp-up to break-even: 8-12 months

The loan application now included real numbers backed by clean financial statements, proper receivables aging, payer mix analysis, and a financial model for the new location. The bank approved the loan.

None of this was possible with the disconnected bookkeeper-billing company-accountant arrangement. Integrating those functions, or at minimum creating reporting systems that connected them, was the first step.

Medical Practice Tax Considerations

Beyond the standard business tax issues, medical practices face specific tax situations:

Qualified retirement plans. Medical practices often set up 401(k) plans with employer matching or profit-sharing contributions. If you have both highly compensated employees (physicians earning over $155,000) and lower-paid staff, the plan must pass non-discrimination testing. A failed test can limit how much the physicians can contribute. Plan design matters, and getting it right requires coordination between your tax advisor, your retirement plan administrator, and your payroll provider.

Equipment depreciation. Medical equipment (imaging machines, lasers, diagnostic tools) often qualifies for Section 179 or bonus depreciation. A $120,000 laser purchased and placed in service before December 31st can potentially be fully deducted in the current tax year.

Research credits. Practices participating in clinical trials or developing new treatment protocols may qualify for the Research & Development tax credit. This is underused in smaller practices.

Entity structure. Many medical practices operate as Professional Associations (PAs) or Professional Limited Liability Companies (PLLCs) due to state licensing requirements. The tax treatment of these entities varies, and the choice between C-Corp and S-Corp taxation has significant implications for physician compensation planning.

Getting the Accounting Right

Medical practice accounting is more complex than most small business accounting, but it’s not mysterious. It requires systems that talk to each other, regular reconciliation between the billing and accounting platforms, provider-level reporting when compensation depends on it, and an accountant who understands the revenue cycle.

If your practice is growing, opening a new location, adding providers, or just struggling to understand where the money is going, the accounting infrastructure needs to match the clinical operation. Clean books aren’t a luxury. They’re the foundation for every financial decision.

We work with medical practices across the Houston area, from solo practitioners to multi-provider groups. If your bookkeeping and billing aren’t talking to each other, call us at (346) 389-5215 and let’s fix that before it costs you a loan approval or a misunderstood payer contract.

Have questions? Call us at (346) 389-5215 or visit our contact page to get started.