I Dealing with Dollars I
The Wealth-Finder Format Understanding and Controlling Your Practice Overhead
s your practice overhead too high? Do you know how to understand and control these costs? We have found that very few dentists have the tools necessary to address practice overhead issues and significantly affect results. This article will give you those tools, along with a brand new way to see and control practice financial outcomes. Dental financial statements typically are prepared on an “income-tax basis.” To control overhead, however, dentists need financial statements that are properly organized and that reflect cash flows in the practice. This is very different than most accountant-prepared formats. The confusion that exists in understanding dental practice overhead is primarily caused by the lack of a common language that every dentist can use for comparison purposes. When I read articles about dental practice overhead, I rarely know what type of overhead the author is talking about. Is depreciation included? What about equipment purchases? How is debt handled? Some practice operating statements are so detailed that they are three pages long, with dental supplies itemized in 10 different categories. How can dentists make meaningful decisions with that much detailed information? Let’s keep it simple so that we can see where problems exist. This simple template of overhead, called
Chart 1. The Wealth-Finder Format (ideal practice percentages)
Published with permission by the Academy of General Dentistry. © Copyright 2009 by the Academy of General Dentistry. All rights reserved.
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Category Ideal Percentage Revenue Production UCR 100.0% Adjustments and Refunds 2.0% Collections 98.0% Overhead Direct expense Staff expense 27.0% Lab expense 7.0% Dental supplies 6.0% Facility expense 6.0% Promotion 2.0% Total direct expense 48.0% Indirect expense Professional fees, insurance, continuing education, office supplies, etc. 8.0% Total Direct and Indirect Expense 56.0% Practice Operating Profit (POP) 42.0%
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the Wealth-Finder Format, represents ideal percentages in a general dental practice (Chart 1). Compare your actual numbers and percentages to this ideal to help you to quickly identify problem areas in your practice overhead. Note that several items have been excluded. There is no depreciation expense. Also, practice loans, leases, and interest expenses have been excluded, except for office facility mortgage payments. There are certain classes of overhead that are unrelated to practice overhead. At Hufford Financial, we call these classes the “Five Ls”: loan payments, levies (taxes), large purchases (equipment), lifestyle payments (doctor’s auto, insurance, relatives on payroll, and so forth), and legacy savings (doctor’s pension). If you mingle the Five Ls with normal practice overhead, it makes it impossible to understand the separate control issues associated with those items, as you will soon see.
The big picture In a solo general dental practice, the key profitability issues are revenue, overhead, associate expense, and practice operating profit (POP).
All overhead is driven by production at usual, customary, and reasonable (UCR) fees. Reducedfee arrangements significantly affect overhead percentages, since overhead is driven by production, not collections. For you to have all of the vital information about your overall fee relationships with your patients, your accountant must reflect production at UCR rates. Adjustments to UCR fees and patient refunds are reflected prior to collections. If overhead is compared to collections instead of production, valuable information about the source of overhead is lost. For instance, overhead will seem much too high in a dental practice where third-party payers reduce fee schedules. This isn’t an overhead problem, it’s a fee problem.
Two broad classes of overhead are important for comparison and control: direct and indirect. Direct overhead items are related to the direct production of dentistry. These items are staff, lab, dental supplies, facility, and promotion. Ideally, direct expenses will be 48 percent of production. Each one of the direct overhead categories contains all of the costs associated with it. For
instance, staff expense includes hygiene wages, staff wages, payroll taxes, fringe benefits, uniforms, and staff pension expense. It does not include relatives on payroll or payroll taxes. These are included below the line, illustrated later. Indirect overhead includes items indirectly related to the practice, such as bank service charges and computer expense. It does not include things that you do for yourself for income tax purposes, such as your medical insurance or your auto expense.
The sample overhead template does not reflect salaries and payroll taxes for associates paid in the practice. If you practice with an associate, you would add a separate overhead classification beneath “Indirect expense” for your associate.
The POP in a solo general practice should be 42 percent. We have discovered three primary reasons why dental practices don’t reflect a POP of 42 percent: 1. The productivity of the practice is impaired. 2. The dentist has practice management issues related to the appropriate fee structure, the mix of dental procedures, the flow of new patients, patient acceptance of optimal treatment, or reduced fee arrangements. 3. The facility expense is too high for the practice productivity. Ideally, facility costs in expensive locations should be reflected in the dentist’s fees—the cost of living in that area should correlate with higher fees. Marketing expenses also typically are higher in these areas.
The wide-screen view Most accountant-prepared statements combine all types of overhead in one income statement. This makes the management of overhead nearly impossible. For instance, if you are incorporated, your salary, payroll taxes, and pension benefits may be combined with those of your staff. There is no way to completely understand practice profitability unless tax-related decisions (owner-related overhead) are separated from other practice overhead. Likewise, practice loan payments and cash payments for large equipment purchases are not properly reflected in an accountant-prepared income statement to allow you to make knowledgeable management decisions about cash flow versus overhead. To fix this practice overhead versus owner overhead problem, we have moved owner-related overhead below the line—below POP. This portion of the Wealth-Finder Format is shown in Chart 2.
Personal and practice overhead differences We believe that overhead related to the owner—you—should be shown separately from practice overhead. Your overhead, as stated previously, should be shown below the line—below POP. The overhead decisions related to how you pay your practice loans, how you pay for large purchases, and whether you deduct your automobile in your practice or have a 401(k)
Chart 2. The Wealth-Finder Format (ideal owner-related percentages) Practice Operating Profit POP - Practice operating profit The Five Ls Loan and lease payments Principal and Interest expense Large purchases Levies (taxes) Lifestyle payments in practice Legacy savings Doctor’s pension Available to distribute
Ideal Percentage 42.0%
2.0% 0.0% 0.0% Situation dependent Situation dependent Situation dependent
plan are more closely related to income tax and wealth creation issues. These are very important issues and must be managed with a much different paradigm than practice overhead issues. You should be saving 20 percent of POP in either a practice pension plan or personal savings. If you are unable to do so every year, the problem is either above-the-line POP or below-the-line POP. Above-the-line POP problems are related to practice management issues. If the practice’s profitability is below 42 percent of production, the solution is related to learning proper practice management techniques. If POP is at 42 percent or above and you are unable to save 20 percent, you don’t have a practice overhead issue, you have a personal finance issue. Either your debt isn’t structured properly, your strategies for managing large equipment purchases are wrong, your lifestyle spending is too high, or your taxes are too high. Even though the expenditures show up in your practice income statement, none of these issues are related to overhead—they are related to personal finance.
“Where does all of my money go?” We think the main financial frustration of dentists can be summed up with this question: “Where does all my money go?” When a dentist states that overhead is too high, we believe that the real frustration is not necessarily due to high overhead, but to a lack of margin to save 20 percent. By having your accountant learn the Wealth-Finder Format of overhead, you will always know where your money goes and whether you have a practice management problem or a personal finance problem. We would be glad to provide your accountant with the Wealth-Finder Format to reconfigure your practice statements. For more information, visit our Web site at www.huffordfinancial.com. u Brian C. Hufford, CPA, CFP, is the CEO of Hufford Financial Advisors, LLC, an Indianapolis financial consulting firm that assists dental clients nationwide in achieving financial freedom. If you have a question for Mr. Hufford or a comment on this article, send an e-mail to email@example.com. Questions submitted may be featured in upcoming columns. May 2009 | www.agd.org | AGD Impact