I’ve been working my dental practice for several years now, and I’m just not making the money I would like to make. What should I be looking at in terms of my income and expenses, and how can I trim overhead to take home more money?
To answer this question, let’s turn to some quick and basic fundamentals of good business management and learn how to measure practice profitability. But before we do, a small but direct disclaimer: The author is not an accountant, and is not a tax advisor. This article is not meant to provide tax advice or accounting advice. It is meant to shed light on the concept of identifying cost centers and ways in which a dental practice may improve profit.
Many dentists are not skilled in reading a Profit and Loss Statement, similarly called an Income Statement, because their time and energy is often put forth in learning to become excellent clinicians. This could be construed as a fault of the dental schools, but is it really? Some would argue that dental schools are credentialed to teach dentists in the healing arts, not business management. I concur.
On the other hand, in the real world dentists in the private sector are privy to educational courses beyond dental school in business management, but how many attend? Management consultants, like yours truly, have the information and skills to teach dentists about overhead control and profitability, but how many contact a consultant and make an investment in their business education? This article will help clarify overhead control and profitability, and at least provide help to those who seek answers.
Many dentists use overhead as a measure of proficiency in business. True, low overhead yields good profit, and proficiency in this area is a measurement of business success. But overhead is commonly misconstrued, in that it may not be measured consistently across all practices. Here is a good way to consider measuring office overhead so that the office’s ability to generate profit is enhanced.
The Net Operating Overhead for a practice is derived from the Profit and Loss Statement, or Income Statement, by calculating all operating expenses and dividing it into the practice’s income. The result is in the form of a percentage, usually less than 100%; if it’s more, we need to talk!
The first step is to have an accountant prepare a Profit and Loss Statement, or generate a P&L from an in house accounting program such as Quicken or QuickBooks. Use the feature if it’s available, that calculates expenses as a percentage of income. This will come in very handy later.
The next step is to identify expenses not included in operating overhead. These expenses occur in the P&L but are not part of operating the business, per se. Expenses such as doctor compensation and his or her payroll taxes, interest paid, depreciation, amortization and taxes. In addition, any discretionary expenditures taken on the doctor’s behalf not related to practice operations must be included, such as automobile expense, life insurance premiums paid, medical insurance for the owner, disability insurance premiums, and so on. Again, these expenses are not related to operating the dental practice and are part of the owner’s benefit.
Adding all of the above mentioned expenses would help arrive at a number that represents operating income. The difference between this number and the total collections is the operating overhead. Divide the operating overhead dollar amount into the total income dollar amount of the practice and voila! Overhead Percentage!
Here’s an example. Our fictitious dental practice collects $1,000,000 in our make believe year. Doctor’s compensation and payroll taxes are $230,000, Interest Expense is $25,000, Depreciation is $15,000, Amortization is $10,000, Taxes are $5000, Life Insurance premium is $7500, and Automobile Expenses are $7500. Total non-operating expenses and doctor’s compensation: $300,000. The difference between $300,000 and $1,000,000 is $700,000. $700,000 divided by $1,000,000 is 70%.
Is that good? Bad? Okay? So-So?
Since a large pool of comparable data is not available to measure against the “averages”, it isn’t possible to say 70% is good, bad or otherwise. It’s relative to the income needs and financial plan of the owner.
Clearly, 30% operational profit on $1,000,000 in sales would satisfy a good portion of working dentists in the marketplace. What’s important here is that we now know how to calculate net operating overhead. Take that one step further and begin to study the key cost centers of a dental practice, make budget decisions, and set goals that will decrease overhead and increase profit going forward.
To control overhead and increase profit, I suggest concentrating on four major cost centers of the practice and their target levels to ensure overhead is managed. The percentages are related to income (collections) rather than production. This discussion is focused on general restorative dental practices, not specialty practices such as pediatric dentistry, oral surgery, endodontics, periodontics, prosthodontics, and orthodontics.
Rent/Mortgage: 5-7%; with a target of 5%
The Rent/Mortgage line item in a Profit and Loss Statement is an excellent indication of practice performance against rent expense. If Rent/Mortgage is above the 7% range, the facility is either too large, rent is too expensive, or the office is not generating enough income to support the occupancy payment. The ideal target is 5%. If the rent is below 5%, more often than not this shows an excellent use of facility resources.
In order to reduce this cost center, or reduce the percentage of the cost relative to income, one may have to re-negotiate a lease or improve income. More often than not, leases are locked in for a period and the alternative is to focus on increasing income. To do this, improve communication skills in order to boost case acceptance and increase productivity by having patients better understand their dental conditions and the benefits of proper treatment. Keep in mind, case acceptance is also related to the practice’s ability to help patients understand that the decision to undergo treatment for diagnosed conditions is theirs to make. Ultimately, improved productivity will increase income and bring this line item into a healthy range.
Laboratory: 8-12%; with a target of 10%
On the whole, it is a sign of fiscal success if actual costs are contained below a specific target. This is not true with Laboratory expenses. If this expense item is below the target of 10%, it is an indication that perhaps not enough laboratory related dental services are being delivered. On rare occasion, a low lab expense in a practice that is producing well may indicate a below market fee for lab related work is being paid for good profit.
Increasing this cost center depends on how well the office can increase case acceptance where lab related work is focused. That’s not to say, “Go sell more crowns!” Rather, improve productivity by following the suggestions previously stated.
Dental Supplies: 5-7, with a target of 5%
This expense should not waver. Be sure, however, that the expense entails only disposable dental supplies and materials. Keep equipment purchases separate since they are not usable disposable supplies, per se. Often times, including equipment purchases such as handpieces or other small equipment purchases will boost this category out of the healthy range. Understandably so, a business owner may want to deduct the expense of small equipment expenses during the year purchased, rather than depreciate the expense over several years. Just the same, if the expense is over 5%, it most likely means supply-ordering and inventory systems are inefficient.
If you find your systems are inefficient, integrate a Dental Supply Cost Containment program by setting a budget for dental supply ordering and establish a tracking mechanism to monitor expenditures monthly. Have the person who is responsible for ordering supplies in the office manage ordering so that they do not exceed the budget. For example, in our $1,000,000 practice, if the goal is to keep supplies at 5% of income, then the office would not want to spend more than $50,000 a year in disposable supplies and materials. On a monthly basis, keep track of ordering and attempt not to spend more than $4200 per month for supplies.
Remember not to be penny-wise and pound-foolish. If towards the end of the month materials are needed for scheduled production, such as impression material for a large crown and bridge case, then order what is needed so as not to run out.
Payroll/Staff Salaries: 25%; Employee Benefits: 5%
This line item is critical simply because of the size of the expense item. A quality team can be well compensated. It is not unheard of to pay team members well and maintain the expense in a healthy range.
Administrative and clinical staff may be allocated 12-16%. The remaining 9-13% could be salary for hygiene. Payroll taxes and cash paid benefits, such as bonus and paid time off are included in these numbers.
There is a saying in dentistry: “You’ll never get rich on the money you aren’t paying your team.” But the income of the practice must be able to support a well-paid team of people that produces results and appropriate net income for the doctor.
In some cases, a high salary percentage may be the result of over-staffing in certain departments. For instance, a practice with one doctor may employ two full-time hygienists and not produce enough revenue to offset hygiene salaries. And, a practice may employ extra front office to handle a high traffic of low-revenue insurance patients, there again perhaps not generating enough revenue to offset the cost.
Employee Benefits, such as medical insurance premiums, retirement contribution, profit sharing, continuing education, are separate and could range from 1-3% depending on the practice.
To keep payroll at a healthy level, make sure the team is well-educated in patient services, well paid for their excellent work, and track the income and expense results periodically to be sure revenue is supporting the salaries paid to your great dental staff!
The total of these four cost centers is 43% to 56% (when including employee benefits). Consider that there could be another 25 or so remaining cost centers in a dental practice that will make up anywhere from 10% to 25% of income. These include Advertising, Credit Card Fees, Bank Charges, Professional Development, Dues & Subscriptions, Legal Fees, Accounting, Consulting, Office Supplies, Postage, Repairs & Maintenance, Computer, Internet, Utilities, Meals & Entertainment, Collection Expense, Interest, License & Permits, Printing, Gifts, Medical Waste, and Storage. One can see how confusing this exercise is when each of these expense items is tracked regularly.
It is prudent to establish a budget for each of the rest of the expense categories, but first control the four major areas discussed in this article. Once a practice has the four major areas under control, the rest of the expenses can be evaluated individually to see if work must be addressed in other areas of the practice.
Be Proactive in planning for profit by examining the Profit and Loss Statement for the practice. The end result will be reduced overhead and increase income. Ultimately, this exercise will help create a more profitable and enjoyable practice!