Dental practice accounting: What the income statement reveals about your dental practice
The income statement is the cornerstone of the financial statement world. Everyone in business relies on it. It goes by several names, including income statement, earnings statement, statement of revenue, and profit and loss statement (P&L).
The income statement provides valuable insight into a practice's performance and operations. It allows the owner to analyze the efficiency of the practice's financial management through a precise focus on revenue and expenses. Finally, it identifies underperforming sectors of the practice to analyze its performance relative to its industry peers. In this third article of our series, you’ll get to know the income statement, which is key to improving and growing your business.
Part 1 of this series: Why financial statements are the key to growing your practice and your wealth
Part 2 of this series: How the balance sheet can help you build a better practice
Income statement components
The income statement is a multi-component financial statement. It has three main sections, and each section has a different purpose. Let’s take a close look at each income statement section.
Revenue or gross income section: The top section presents a list of services or products your practice offers, allowing you to see how much revenue each one generated in the current period. A company's revenue (gross income) is equal to its total revenue over a set period, such as a week, month, quarter, or year.
Also known as a top line, this section allows you to see a list of income sources, starting with sales of dental services and products. You'll also see any passive income, such as investment income. In total, it shows you how much money your practice generated during the given period from various sources of Income.
Finally, this section must show enough detail so you can see what offerings in your practice are doing best. This can help you spot trends and identify opportunities.
Cost of goods sold and expenses section: The second section of the income statement shows how the money is flowing out. You'll see all costs and expenses, a list of everything your business spent money on, from labor to lease to dental supplies and everything in between.
This section usually has two main subsections that identify the cost of goods sold (COGS) and expenses. While the COGS identifies the costs directly related to income generation, such as labor and materials, the expenses subsection is not directly related to the generation of income, such as insurance and utilities. It’s frequently called and classified as indirect costs. The expenses section allows you to focus on nonclinical-related expenses such as office leases, utilities, telephone, insurance, and similar items.
In an optimal case scenario, this section should be customized to your needs so you can see your biggest expenses, such as staff wages, dental supplies, and lab costs, near the top.
The difference between the revenue and COGS is called gross profit. In contrast, the difference between the revenue, COGS, and expenses is called net operating income. This leads us to the third and perhaps most important part of the P&L, the bottom line.
Income section—net income: Finally, we arrive at the bottom line. While it might be detailed further for taxes, it should show the income your practice generated. This is the income less the expenses. Like any other business owner, we hope this number is positive. The end of the statement, the bottom line, shows how much is left over. This is your net income, the amount of money that you must pay taxes on.
The net income is important because it presents you with a final verdict on the performance of the practice. Additionally, it allows you to calculate the practice's net profit margin and assess the portion of every dollar of revenue retained in profit for each accounting period.
The bottom line
Now you know if you're making money and how much. The good news is that the income statement does not stop here. It goes further when it’s optimized and used to its fullest. Its true power is in the financial analysis that’s based on identifying the trends and comparing the values. This analysis allows you to answer these questions:
- How is your practice doing compared to the last month/quarter/year?
- Are there line items that show significant percentage changes?
- What areas of practice performance require your attention?
- Where are opportunities to increase profit?
- What can be done to increase revenue or cut costs?
A properly prepared income statement helps you answer these questions and provide clarity to your analysis of your practice's financial performance. The income statement can also help you make short- and long-term decisions. Can you afford to hire an additional staff member? Is it time to upgrade your equipment? Do you need to do some tax planning to avoid a large tax bill at the end of the year? These items become apparent when you have the facts from the income statement.
Design is key
With any financial statement, design is critical. This becomes more apparent with the income statement. You should customize your format to your business. You may only get a fraction of the information you need if you do not customize. You want to ensure your P & L breaks out the detail you need and puts your biggest expenses in plain sight.
If you have only a summary income statement, you won’t see where you can improve or what costs are rising, or which of your services has momentum, which might prompt you to allocate more resources to what’s working well.
That’s why you want an income statement that shows you enough detail because you don’t want to have to dig for it.
Snapshot in time
The income statement is all about time. While you'll want to run an income statement for each quarter and year end, it's also wise to monitor it monthly. Then you can more closely monitor business progress. Remember, the income statement is compiled at the end of each financial period that’s important to you and your business. Since a cash budget of the practice is solely affected by the timing of cash receipts and payments, timely preparation and analysis of the income statement is crucial. There are telltale signs that will help you spot problems and opportunities early. Income statements tell you what you need so you can evaluate and correct before it’s too late.
The longer you stay in practice, the more you'll learn about running it successfully. You can get industry benchmarks to compare your firm's performance to other dental practices. Benchmarking is one of the most powerful ways to use your income statement. It's also a must when considering selling, as potential buyers will compare your practice with peers.
You’ll want to refer to your financial statement frequently. Look at it monthly so you can spot trends in sales and expenses. Design is critical. You should be using a format that’s standard for the dental industry. If you aren't, stop right now and put that on your to-do list. This will enable you to compare your practice to industry benchmarks so you can monitor progress. With today's technology, it's not hard to make the change. Once you do, you’ll have more visibility and control over your practice than ever before.
Editor's note: This article appeared in the June 2023 print edition of Dental Economics magazine. Dentists in North America are eligible for a complimentary print subscription. Sign up here.
