This article is part two of a five part series on how to increase practice profitability and manage overhead. To view part one, click here.
In last week’s article, we covered lowering overhead by realizing your collections potential and thereby increasing revenues.
In this week’s article, we’ll cover overhead and expense basics, including general overhead categories, along with suggested percentages for each. We’ll also detail common overhead trouble spots.
What’s Your Overhead?
Normally, the small business or practice owner thinks of their overhead in monthly terms – i.e., “My overhead is $30,000 per month.” We usually arrive at this figure by asking our accountant for a Profit and Loss statement or getting the same or similar report from our financial software.
Then using what was collected the past month, we calculate a rough estimate of profit, “We collected $50,000 and my overhead is $30,000 so my profit is around $20,000.”
Often, these rough calculations are way off the mark.
Calculating Your Overhead
Technically, your overhead will fluctuate (to some degree) month to month. Here are a few things to keep in mind:
1) You have fixed and variable expenses. More on this later, but for now, the variables are primarily dependent on how much you produce or collect. The more you produce or collect, the higher your variables go. So, if you’re estimating an overhead figure, you could get pretty close as long as that figure was based on a certain production and collection figure. For example, someone’s overhead is $40,000 as long as they are collecting and producing $70,000. If they produce $100,000, the overhead for that month would go up (due to more lab, supplies, additional staff or hours, etc.).
2) Basing projected expenses off of what you’ve already spent in the past can be a major error. Sure, using your Profit and Loss statement for the 1st Quarter could help you figure your monthly overhead out. But, what if you overspent in certain areas? Let’s say your assistant went wild with supplies and over-ordered? If you used this information, you’d project too high of an overhead figure into the future for dental supplies. So, while past expenses are helpful to determine future expense, they are not the final word. Don’t blindly transfer your P&L information to an overhead sheet and think it’s all nicely taped. Ensure the amounts you’ve been spending are the amounts you should be spending, which leads us to the next point.
3) Financial planning for a business should be done in this sequence:
1. Earn money.
2. Determine/plan how you are going to spend this money or which expenses you’re comfortable incurring.
3. Incur expense. You’re planning AHEAD.
How it’s usually done is:
1. Incur expense
2. Get money
3. Pay bills
4. Now figure out what you spent on what.
The earlier sequence is planning. The latter sequence is reacting. You wouldn’t go on a trip with no idea as to where you were going. Similarly, you’d want to plan what you were going to spend money on before you spent it. We’ll get into this more as the newsletters continue, but for now let’s use the dental supply example. Do you have a budget? If your assistant orders does he or she know how much they can spend per month? Or, do they just order whatever they want or think you need and you pay the bill? Maybe they have to exceed their budget one month – do you find this out before or after the money’s been spent? I think you see what I’m getting at.
4) Last point: Weekly and monthly expenses are usually added in to someone’s overhead figure. What about expenses that are less frequent? Malpractice and other insurances, major maintenance and repairs (i.e., replacing a compressor) and some tax bills are not paid on a monthly basis. But, they add up. Technically, even if they’re not paid on a monthly basis, it should be built into your overhead and expense figure and this money should be set aside for when the bill is due. For example, if your malpractice is $4,800 per year, $400 per month should be built into your overhead to cover this when the bill comes due. This deserves attention – I’ve seen plenty of doctors who thought their monthly overhead was 40K find out it was actually 45 or 50K when you factor these expenses into the mix.
The MGE Overhead and Expense sheet covers just about every category of expense. (For a copy of this Overhead and Expense sheet, click here.) It has two parts: The Worksheet where you figure out all of the expenses for each category and the Summary Sheet, where you bring it all forward and come up with a final overhead figure. The break down of categories with some explanation follows:
RENT & MORTGAGE EXPENSE
This would include any rent and association dues (if you’re in an office condo, etc.) that you might pay on a monthly basis. If your office owns the building itself, which I’ve found to be rare, you’d include the mortgage expense in here. If you own the building and rent it to the practice, you’d include your rent – not the mortgage – since you as the landlord pay the mortgage.
LOANS & LINES OF CREDIT
Again, self-explanatory. If you’re newer in practice and your loan payment will graduate higher in the years to come, keep in mind that you’ll need to adjust this category.
We include this category if you’re carrying any credit card balances. With clients, we work to get these retired quickly through increased profitability. Nonetheless, you have to service the debt whether you like it or not. If you use your credit cards for supplies or lab and pay them off every month, these would be lab and supply expenses respectively (which are covered later), not credit card expenses. This category is here just in case you’re carrying balances.
Accountant, hazardous waste disposal, janitorial services, etc.
COMMUNICATION & PHONE
Self-explanatory. However, if your yellow page ad is included in your phone bill, break the amount off for the ad and include under advertising.
Are all self-explanatory.
This would include employee compensation, along with any employer related payroll tax or unemployment contributions.
Any advertising – mail, billboards, TV, radio, etc.
PR & PROMOTION
Birthday cards, sponsorship of local organizations, etc.
This is primarily office supplies.
BANK & CREDIT CARD CHARGES
We added this category in the event that a business is behind on bills. If this is the case, we’d want to ensure that this was factored into overhead to ensure that the office catches up to where they should be quickly.
The catch all! If we’ve forgotten anything, here’s where you’d add it.
Using the categories above, we’ve calculated some projected percentages. These percentages were calculated with a solo GP who’s been in practice for at least seven years. These are NOT written in stone and can fluctuate due to a number of factors (more doctors, newer in practice, etc.) that I’ll detail afterwards.
EXPENSE CATEGORY ESTIMATED PERCENTAGE
Rent and Mortgage Expense 4-5%
Lease Expenses **
Loans and Lines of Credit **
Credit Cards **
Outside Services 1.65%
Communication & Phone .6%
Dues & Licensing **
Payroll Expense 22.5% (1)
Advertising 3-5% (2)
Continuing Education 1-5%
Office Expense 1.25%
Dental Supplies 6-7%
Lab Expenses 8-10%
TOTAL 50.6 -60.6%
GROSS PROFIT 39.4 – 49.4%
** = not listed as a regular expense, or amount less than .3 percent.
(1) – Does not include doctor or associate pay.
(2) – Marketing budget can be higher depending on the doctor’s desire for new patients or expansion.
Now, as I said earlier, this is not written in stone. Percentages could be higher.
If a practice is newer, it’ll be carrying more leases, loans, etc. If there are multiple doctors, the profit will be lower (as you’re paying additional doctors) but you should be more than making this up in volume. There are a number of other variables, most of which I’ll cover through the balance of my newsletter series. For now though, we have a start.
Fixed versus Variable
Defining which expenses are fixed and which are variable depends in a large part on who you’re talking to. I’m giving you my view on this. Whether you use it or not is up to you (this is why I have
that cool disclaimer).
Using the categories above, you could say that the following expenses are for the most part fixed. They don’t change or they change very infrequently (i.e., every year). It’s a good idea to periodically review these categories (possibly quarterly or at least semi-annually) as phone plans & loan payments might change and some insurances adjust more frequently than annually, etc.
1. Rent and Mortgage Expense
2. Lease Expenses
3. Loans and Lines of Credit
5. Outside Services (accountant, etc.)
7. Communication & Phone
8. Dues & Licensing
These expenses can change month to month. Some like lab and supplies are tied to office productivity. Others (like CE) are tied to how much and what type you’re utilizing. Regardless, we’ve listed these expenses as “variable” which could:
a. Drastically fluctuate on a monthly basis.
b. Change (as a percentage of expense) very quickly (i.e., you could sign up for a new marketing plan and this could impact your overhead within 30 days).
1. Payroll Expense
3. Continuing Education
4. Office Expense
5. Dental Supplies
6. Lab Expenses
Even though these expenses are variable, they could still fit within the percentage framework as listed above.
Working with a Basic Overhead Figure and Variable Expenses
So, how do we put all of this together to work and manage with?
Well, here’s what you could do:
1. Work out what your average collections and production have been for the past three to six months. Now, I’m assuming there are not huge swings here on a month-month basis (i.e., 25% or more).
2. Now work out your current overhead. You can use the categories above. Ensure you include the monthly amount for expenses that are paid quarterly, semi-annually and annually (insurances, etc.).
3. #2 above would be your overhead more or less when you are producing and collecting what you determined in #1.
In other words, if you work out your average monthly collections at $60,000 and your average overhead/expense is $40,000, we would say that at $60,000 your overhead is $40,000 or 67%. Now of course as explained in our last newsletter, if you were to produce/collect more, this number might go up, but the percentage would go down.
Getting back to this example, you’d be pretty set saying that your overhead was “$40,000,” as long as your collections average $60,000.
Now, let’s say you’re humming at the overhead and collections levels listed above. You haven’t added any expenses particularly; you’re staffed the same and all budgeted areas are operating at about the same level. Then, out-of-the blue, you have an incredible month and produce and collect $100,000. How would you account for the increase in variable expenses?
A simple rule of thumb would be to set-aside 30% of your increase towards variable expenses. It might be more than you need, but if you had a choice between having too much money or too little, which would you choose?
Working the numbers using our example above, it would go like this:
We’ve collected $60,000 on average (some months a little higher and some a little lower), with an overhead of $40,000. We have a big month and collect $100,000, which is $40,000 above average. We take 30% of the $40,000, or $12,000 ($40,000 x 30%) and keep that aside to cover additional expenses incurred this month (lab, supplies, etc.). So, instead of our usual $40,000 to pay bills with, we have $52,000 ($40,000 plus the $12,000 for variables).
We may use less, but again, isn’t it better to have that problem than setting aside too little?
Now, we collected an additional $40,000. We have the $12,000 for variables, leaving $28,000 left over, which is for the most part profit. What do you do with that? Well, this is where you talk to your accountant.
Now, what if this increase is not just a “flash in the pan,” but a more regular thing? Well, good news – you’re expanding. As your office expands, you’d want to review your overhead more frequently to adjust categories as more productivity will usually bring at least some additional expense.
MGE clients expand pretty fast. As such, we place our Financial Planning Seminar early on in our Executive training.
We have a basic idea now on overhead. I thank you for reading and hope I haven’t driven you into the unconsciousness of boredom with all of this numbers talk!
Let’s preview a bit of next week and look at the overhead areas that cause the most trouble – our overhead “hot spots.” From my experience, these categories (in the order of priority) tend to be most problematic:
2. Advertising and PR
4. Credit Cards
5. Supplies (Dental and Office)
While other categories could cause issues in individual situations (i.e., your rent is too high), I’ve found 1-6 above to be the most common overhead trouble points.
You’ll notice payroll is #1. It’s also (if you look at percentages chart above) the expense that eats up the highest percentage. Managed well it’s still a quarter of your expense.
Next week’s issue will be completely devoted to this subject and what causes it to go higher than it should. We’ll visit the subjects of efficiency, whether you’re paying too much for certain positions and how to get this category under control.
Next article in this series: Managing Your Overhead and Profitability, Part III – Payroll Expense in a Dental Practice
Jeffrey Blumberg provides this general dental practice management advice to furnish you with suggestions of actions that have been shown to have potential to help you improve your practice. Neither MGE nor Mr. Blumberg may be held liable for adverse actions resulting from your implementation of these suggestions, which are provided only as examples of topics covered by the MGE program.