A key component of physician practice financial management is understanding the distinction between long-term and short-term debt.
Understanding the differences between the two, and how each can be used to support your practice, can improve the long-term viability of your business income – not just your practice income.
The Difference Between Long-term and Short-term Debt
Short-term debt, also known as working capital financing, is a loan taken to cover temporary cash flow needs or finance day-to-day operations. This type of debt typically has a repayment period of one year or less, but in medical practices typically covers expenses of a few weeks to a few months. Examples of short-term debt in medical practices include operating lines of credit and credit cards. The funds are typically used to cover costs between the dates that insurance claims are paid.
Long-term debt, on the other hand, is used to finance larger investments, such as purchasing new equipment, expanding your practice, major renovations, or acquiring another medical practice. Long-term debt usually has a repayment period of more than one year and can include mortgages, term loans, and leases.
When to Use Short-term Debt
Short-term debt is ideal for addressing immediate financial needs, such as covering payroll, purchasing supplies, or managing seasonal fluctuations in cash flow. It can be useful for maintaining liquidity and avoiding cash flow issues that could disrupt your practice's operations.
However, it's essential to manage short-term debt responsibly. Relying too heavily on short-term financing can result in not quickly and clearly seeing a decline in your revenue or receivables, over-using this type of lending can make it more challenging to obtain long-term financing in the future, and of course, when there’s an unforeseen expense you may not have the cash to cover.
When to Use Long-term Debt
Long-term debt is best suited for financing significant investments or growth initiatives that will generate returns over an extended period. The longer repayment terms and interest rates associated with long-term debt may make it a more cost-effective financing option for larger projects. For example, your $150,000 imaging machine would be too expensive to buy outright, but a financing option that costs $1,500 / month is much easier to afford over the short term, as long as your overhead fees more than cover the increased monthly costs. In scenarios like these, it’s important to recognize the opportunity cost of the interest payments vs the revenue-generating opportunity that comes from the long-term debt use of funds.
Before taking on long-term debt, carefully assess the potential return on investment (ROI) and ensure that the project will generate enough revenue to cover the debt repayments comfortably., considering interest rates against the value the funds offer is the key point in both situations
As an Ontario physician, understanding the differences between long-term and short-term debt is crucial for managing your practice's finances effectively. By using short-term debt responsibly for immediate needs and leveraging long-term debt for growth initiatives, you can optimize your practice's financial health and set yourself up for long-term success. However, with both situations, considering interest rates against the value the funds offer is really the key point. It’s important to remember that banks, lenders and vendors are all in business like you are. The costs of their services must be considered, as yours should be as well, for you to make the most informed decision about if – and when – debt can be used to your best advantage.