Back to basics

By Roger K. Hill, ASA, and John K. McGill, JD, CPA

“When you’re up to your elbows in alligators, it’s difficult to remember the original objective was to drain the swamp.” Likewise, it’s easy to lose sight of practice profitability — a fundamental factor greatly affecting both day-to-day operations and your future transition activities.

While it may sound overly simplistic, there are four overhead categories* every doctor should keep focused on to remain profitable. Let’s review them:

1. Staff salaries — This is often the largest overhead expense for a practice. This number does not include owner/associates, family members (unless they work in the practice), payroll taxes, benefits, or retirement plans.

Controlling salaries — GP offices should staff one FTE (full-time equivalent) employee per $170,000 of collections, and specialty offices one FTE per $200,000 of collections: the key is don’t overstaff. Pay staff hourly versus salary and use some part-time employees. Also, replace automatic raises with a bonus incentive plan based on collections.

2. Rent — This is your current rent/lease expense, or the fair market rental rate if you own your office building (adjust if you are paying yourself a higher/lower rate for tax-driven purposes).

Controlling rent — Rent for a GP office should not exceed 6% of collections (cost of land and building should not exceed 7%), and again, the key is don’t overbuild.

3. Dental supplies — This is all of the supplies used for treatment of patients.

Controlling supply costs — Put one staff member in charge of ordering supplies with a budget of no more than 6% of collections for a GP office (7% for orthodontists). Ask your current supplier for a volume or prepayment discount.

4. Laboratory — This is the amount paid to outside laboratories plus internal lab costs. For orthodontists, this also includes the cost of Invisalign items. Lab expenses should be no more than 7% of collections for GPs and 4.4% for orthodontists.

Controlling lab costs — Ask your current lab for a volume or prepayment discount. Shop different labs for quality at affordable rates.

Impact on your retirement nest egg

Let’s assume a practice is producing $1 million. Lowering overhead costs by $30,000 per year ($2,500 per month) can have a huge effect on retirement savings. If this $2,500 were used toward a pension contribution over a 30-year career (with a modest return of 5.0%), the difference would be nearly $2.1 million! This modest reduction in overhead can have a significant impact on your financial security.

Practice value

Another huge benefit of well-managed overhead is the increase in practice value. Assume there are two practices with incomes of $1 million per year. One has an overhead rate of 58%; the other has a rate of 61%. The effect on value is far greater than $1 of profit equaling $1 of value.

Keeping all factors constant, the difference is approximately $111,000. This means the value of the practice with an overhead rate of only 3% more ($30,000 per year) is reduced by a whopping 16%.

Some doctors may be thinking, rather than decreasing overhead, why not just increase income? In and of itself, it’s prudent to increase income. However, in order to achieve the same value with the same overhead rate, income would need to go up by almost 20%! This is not an efficient or easy path to higher profits and practice value reflecting your years of effort.

Both strategies (overhead control and increasing income) should be systematically pursued. There are many doctors whose practices are modest in size, where the pace is not frantic, and who have an exceptional retirement portfolio as a result of overhead control over the course of their careers. Remain focused and you’ll attain great results.

* For our recommended 2012 overhead percentages by specialty, access our sample article “Start Your 2012 Practice Budgeting Process Now” at www.mcgillhillgroup.com/sample_advisory.asp.

Roger Hill provides transition planning for practice sales, partnerships (buy-in/buy-out), practice mergers, associateships/compensation analysis, and financial forecasting (pro forma) through Roger K. Hill & Company, a member of McGill & Hill Group, LLC. John McGill provides tax and business planning exclusively for the dental profession, and publishes The McGill Advisory newsletter through John K. McGill & Company, Inc., a member of McGill & Hill Group, LLC. For more information, visit www.mcgillhillgroup.com.