Understanding Expenses

Roger P. Levin, DDS

Dr. Barnes* was young dentist who wanted to have the best practice possible. He recently purchased a practice from an older dentist. Dr. Barnes wanted to immediately put his stamp on the practice. He invested heavily in the latest technologies. He had the practice remodeled and redecorated at considerable expense. He added two operatories. He believed his practice was ready to take off in the coming year.

As a new practice owner, he had to borrow heavily to finance all the improvements. He didn’t like the idea of owing so much money to the bank, but he considered everything he was doing as a necessary investment in the practice. He thought that his high-tech, refurbished practice would immediately attract scores of new patients. Unfortunately, that didn’t happen. In fact, he lost some patients because they were more comfortable with the older dentist. His overhead percentage soon ballooned to 86%. Some weeks he could barely pay his bills. It seemed like he was working for the bank—not himself. His cash flow was severely constricted. He had little to invest in retirement planning. He felt he was one crisis away from bankruptcy.

Dr. Barnes’ situation is not uncommon. Many young dentists and quite a few established doctors incur moderate to serious financial problems due to high overhead.

UNDERSTANDING FIXED EXPENSES

Expenses are a necessary part of operating a dental practice, but high expenses can have devastating consequences, including bankruptcy. Controlling overhead is critical to achieving profitability. To manage their practices successfully, dentists must recognize that not all overhead is created equal. Based on normal accounting methods, there are two types of overhead—fixed and variable. Fixed overhead are expenses that will be incurred whether the practice is producing or not. Examples of fixed overhead include rent, mortgage, labor costs, utilities, and insurance. Fixed expenses are always present and do not rise or fall based on the level of production.

Fixed expenses are often the area that has the greatest impact on practice profitability. While most dentists have a reasonable understanding of their fixed expenses, the classic example of a young dentist over-purchasing and ending up in trouble, as in Dr. Barnes’ case, is usually due to fixed expenses. Examples of high fixed expenses include operating an office with too many operatories with a rent that is too high and purchasing technologies that do not provide a quick enough return on investment (ROI).

Fixed expenses need to be established based on where the practice is presently with an educated prediction of future growth. Preparation and research are necessary tools that can help a practice better anticipate future needs. If the dentist underestimates growth, the practice may not have enough space, facilities, or resources to grow. If the doctor overestimates, the practice may not have enough collections to pay bills and could find itself in difficult financial straits. Before undertaking major expenses, dentists need to do the appropriate research that helps them make the right practice investment decisions. Consulting with advisors or outside experts is prudent before undertaking a practice expansion or other major practice decisions.

UNDERSTANDING VARIABLE EXPENSES

Variable expenses are the good expenses. They are usually paid only when production takes place. Examples include supplies, materials, laboratory work, and part-time staff members who work on an as-needed basis. Rising variable expenses are typically a good sign because they do not occur unless production rises as well. Whether expenses are fixed or variable, they must be controlled to ensure proper practice growth and profitability.

Although they are usually a good sign, variable expenses can still have a significant impact on practice profitability. While they do not occur unless production takes place, it is possible for the variable expense to be greater than necessary. Such a scenario would include laboratory remakes and the patient returning for several appointments. Many people see variable expenses as always good, but there can be a negative aspect as well if these expenses are overpriced.

The main reason to incur expenses is either to produce dentistry or to invest in the future. Each type of expense should occur at the lowest (or a reasonable) level to achieve profit goals set by the doctor for the practice.

Comparative Budgeting

Every dentist should take the time to understand how his/her practice ranks in comparison to industry averages. The American Dental Association regularly publishes surveys of general and specialty practices that feature a plethora of practice financial information, including overhead. For management clients, Levin Group uses both national overhead averages and its own research to provide benchmarks for various expense categories. Comparative budgeting will allow you to assess whether expenses are being properly allocated, where expenses should be increased or decreased, and how these expenses compare to national averages.

Comparative budgeting is also an excellent way to understand whether the practice’s expenses are within acceptable ranges. If the overhead is too high, then the practice needs to understand why certain expenses are higher than others. Frequently, higher-than-normal expenses are often due to the practice under-producing rather than outright waste. When faced with high overhead, many practices spend a great deal of time searching for waste instead of focusing on ways to increase production that drive down the overhead percentage.

UNDERSTANDING INVESTMENT

In addition to normal accounting methods, there is a third type of expense—investment. For example, many dentists become excited and motivated to have the latest and greatest item. In some cases, these are very positive investments for the practice. Other times, these purchases are a unnecessary or are not a right fit for the practice. How many of you own products or materials that you have not used since you bought them?

Many people purchase exercise bikes or other fitness equipment because they believe they are making a commitment to exercise. Often, after a brief period of initial use, these pieces of equipment sit unused in the laundry room or the basement. Some dentists have purchased the equivalent of exercise bikes for their practices. At the time, the piece of high-tech equipment seemed like a good addition to the practice, but then, for whatever reason (lack of training, compatibility issues with practice software, etc), the “exercise bike” is never used to its full potential. To avoid this scenario, practices can develop a multi-year practice investment plan. Issues to examine include:

• What technologies or products do you want to add to the practice?
• Does the facility need to be remodeled?
• Does the practice need to be physically expanded?
• Does the practice need another chair?
• Does the practice need another staff member?
• Are certain continuing education courses necessary to fully incorporate a new purchase into the dentist’s vision?

Once you have identified some potential practice investments, they should be put into a timeline based on purchase price, practice cash flow, ROI, and necessity.

One analysis tool that can help you determine whether to purchase an item is a 90-day study. Identify a new technology or product and over a 90-day period examine how often your practice would use it, if you had it. Once the study is complete, you can annualize the fees and costs derived from the product to see if there is a ROI and how soon that ROI will materialize. Practices that do this kind of preparation will be positioned to make better investment decisions for both the short- and long-term.

INCREASE PRODUCTION TO LOWER OVERHEAD PERCENTAGE

Any investment that covers its cost or increases profit within 12 months should be fully investigated. Many practices do not separate the concept of expense vs investment. Will a new technology or service provide a ROI within 12 months? Will the engagement of outside advisors or consultants provide long-term benefits?

For example, one service investment that often yields positive results is the addition of patient financing. While the practice may incur an initial minimal cost, it is a variable expense that only occurs when the practice provides treatment. Moreover, that cost is easily offset by the increase in production and profitability. Patient financing enables patients to accept treatment that they would have rejected due to financial reasons. The ability to pay is often the biggest hurdle for pa-tients to agree to treatment. Levin Group has studied the CareCredit® (CareCredit, Inc, Costa Mesa, CA) program in detail over the years and found that there is almost always a positive ROI if the product is used on a regular basis. Providing outside financing involves a minimal expense, but, more importantly, this service is a practice investment because it results in increased production.

DR. BARNES’ SITUATION

Dr. Barnes made several strategic errors. He greatly increased his fixed expenses based on unfounded assumptions of practice growth. He wanted to have the best of everything—new equipment, a larger facility, new furnishings, etc—even though he had to go deep into debt. He also lacked a plan to generate the production he anticipated.

Dr. Barnes was in dire straits. What could he do about his fixed expenses? He couldn’t return the high-tech equipment after he had used it for several months. It was the same case with the new furnishings. He also couldn’t “unbuild” two new operatories.

He had limited options. Most of them were not very appealing. He could file bankruptcy and close his practice. He could work at another practice on his day off or become an associate at another practice. If he could find another dentist or specialist, Dr. Barnes could rent out space in his office. This last option was the one he chose.

Within a year, Dr. Barnes’ overhead was significantly reduced. By sharing his office space, he was able to decrease his overhead percentage to 63%, allowing him to begin to increase his income and retirement savings. He developed a positive relationship with the other dentist and this situation has worked out reasonably well. The original problem was that Dr. Barnes did not understand the financial impact of his initial investment and what it would take to generate a proper ROI.

CONCLUSION

Practice expenses need to be looked at beyond traditional accounting methods. Fixed expenses are the expenses that often cause significant financial problems for practices when they are too high. Variable expenses are production-driven and usually a positive factor for the practice.

Re-evaluate all fixed expenses, variable expenses, and investments. Look for a balance between each of these categories. High fixed expenses, as in Dr. Barnes’ case, can undermine effective practice investment, create debilitating stress, and lead to potential bankruptcy. Variable expenses are usually a good indicator of practice production. Before making any significant practice investment, do your homework. Always consider what will happen when things don’t go as planned. Practices should have regular detailed conversations with accountants or consultants regarding these areas. Keep in mind that not all accountants are well versed in the nuances of practice investment and their effects on dental practice operations.

DISCLOSURE

The author has a corporate alliance with CareCredit.

*Dr. Barnes is a composite based on Levin Group’s 22-year experience of consulting to dentists.

Inside Dentistry readers are entitled to a no-cost phone consultation with a Levin Group Practice Development Specialist on “How To Best Control Practice Overhead.” Call 1-888-973-0000 to schedule a time for your call.

Roger P. Levin, DDS CEO, Levin Group, Inc. Owings Mills,Maryland