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December 2023
Profit Checkup: What Are You Missing?
As we move towards the end of the year, Karen E. Felsted, CPA, MS, DVM, CVPM, CVA, says it’s a good time to start thinking about the financial health of your practice and what changes you want to make for 2024.
Check in with Your Finances in Advance of the New Year
There are many data points that could be reviewed to actually assess the financial health of your practice, but the most important starting point is the practice’s operating profit margin.
As we move toward the end of the year, it’s a good time to start thinking about the financial health of your practice and what changes you want to make for 2024.
Clean Up Your Numbers
Veterinary teams take great pains to make sure the results they get from diagnostic testing are accurate; if they aren’t, then any subsequent decisions made about the pet’s care won’t be right either. The concept is the same with management analysis. The result of any kind of analysis, including the profit calculation that follows, is only going to be as good as the quality of the data that went into it: garbage in = garbage out. If you’re not sure you have good quality input, here are some of the things to look for.
Check up with your accountant or a veterinary financial advisor to make sure you are recording transactions properly. One of the most common errors in practice financial statements is how payroll is recorded. Payroll is often incorrectly recorded on a “net” basis rather than a “gross” basis, and this will totally distort any analysis you try to do regarding compensation and benefits. Gross payroll is the full amount an employee earns; for example, 80 hours X $20/hour = $1,600.
Net payroll is the bottom-line amount actually paid the employee on their check after taxes, benefits, and other deductions are made. The employee with a gross payroll of $1,600 may only receive $1,032 after taxes and their share of benefits are deducted. Obviously, if you look at total net payroll as a percentage of gross revenue, it may look like your practice has significantly less payroll expense than other practices, when in fact your payroll expense may be similar to or much higher than other practices if you had only been looking at the right numbers!
Other common mistakes seen in a practice profit and loss statement include treating loan principle payments or shareholder dividends as an expense and not consistently using the same categories for the same kinds of expenses. This consistency is important; for example, if a practice started out by recording the purchase of pet food in the “Drugs and Medical Supplies” expense account and then later switched it to the “Dietary Product” expense account, then these numbers will not be comparable before and after the change and the trends analysis and related conclusions may be inaccurate.
Check up with your accountant or a veterinary financial advisor to make sure you are recording transactions properly.
In order to achieve this comparability, it is important to carefully set up the accounting system and define calculations precisely. Sometimes it will be necessary for a change to be made in order to improve the accounting system. This is acceptable; just remember that in the month of the change, some comparability will be lost. This comparability will be regained as time goes on and more data is added.
Make Your P&L Easy to Read and Easy to Use
The profit and loss (P&L) statement is meant to be a summary document. It should give you a high-level overview of how well the practice is doing from a revenue and expense perspective. It is not meant to include every possible piece of information ever needed for the analysis of the practice.
In order to compare the practice with outside benchmarking studies and to get the most meaningful analysis internally, the accounts used in the P&L should be those generally used by the veterinary profession. An excellent source is the American Animal Hospital Association/Veterinary Study Group’s Chart of Accounts designed specifically for veterinary practices. This publication includes descriptions of the specific accounts and the types of transactions that should be recorded in each.
Very few practices will need every account included in this list; however, this Chart of Accounts is an excellent starting point. Ask yourself if particular info really has to be broken out in detail on the P&L before including it. For example, is it essential to have all 40 of the revenue categories on your P&L? No! A revenue by category report is readily available in every practice management information system when needed, so just use three to four revenue categories on the P&L. (Remember: it’s meant to be a summary!)
The same concept applies to expenses. Travel expense is a very small expense in almost every practice. It makes much more sense to have just one account (travel and lodging expense) for the expenditures rather than breaking them out into air fare, lodging, parking, transportation, tolls, and so on. If you ever need that level of detail, it is readily accessible from your accounting software.
The profit and loss statement shouldn’t be more than one or one-and-a-half pages long and should show expenses grouped into sections by type. Common sections include cost of goods sold/cost of professional services, compensation and benefits, revenue collection costs, facility and equipment expense, administrative expense, and other income/expense.
Anything longer or more complex than what is described here will make it impossible to get a good quality, high-level understanding of how the practice is doing. The point of the P&L will be lost.
Profit Calculation
There are many data points that could be reviewed to actually assess the financial health of your practice, but the most important starting point is the practice’s operating profit margin. This figure represents the gold standard measure of a practice’s financial success, and profits are a significant driver of cash flow and practice value. Unfortunately, most practices don’t really know how profitable they are. The only bottom-line number they look at is their net income, and this is not the same; in fact, net income can be very different from true operating profit and lead the management team down the wrong road.
The operating profit is the difference between the operating revenues and expenses of a practice. Operating revenue and expenses include only items normally and necessarily seen in the day-to-day operations of the practice such as fees for professional services and drugs and medical supplies expense. These items should be stated at fair market value rates. For ease of comparison with other practices, the profit margin is generally stated as a percentage—this is calculated as practice profits divided by gross revenue. Some of the items that must be calculated differently to determine operating profit versus taxable income or net income include practice owner payments, facility and equipment rent (if these items are owned by the practice owner and leased to the practice), services provided by family members to the practice, and personal expenses paid by the practice. Additionally, items such as depreciation, amortization, interest expense, and interest income are removed entirely from the calculation of profit, although they would appropriately be included in a net income or taxable income calculation.
Note, the term “EBITDA” or “adjusted EBITDA” is also used regularly and represents a very similar concept. EBITDA is an accounting term that stands for “earnings before interest, taxes, depreciation, and amortization.” The same adjustments that are made to calculate profitability must be made to determine a meaningful EBITDA number. An EBITDA calculation made without adjustments is pointless. The one difference often seen between an adjusted EBITDA number and an operating profit figure is related to equipment purchase. An operating profit calculation generally includes a deduction for average annual equipment purchase, whereas an EBITDA calculation does not.
Calculating the true operating profits of a practice is not a simple task, but an excellent resource to get you started is a booklet titled “The No-Lo Practice: Avoiding a Practice Worth Less,” available from vetpartners.org /practice-valuation-resources. VetPartners is a professional association of various kinds of business consultants and advisors who regularly work with veterinary practices. A veterinary financial consultant can also help you calculate this figure or refine your initial calculation.
Using the Data
If the practice’s profits aren’t at the desired level, what can be done about it? A lack of profitability comes from revenues that are too low, expenses that are too high, or a combination of the two. Understanding not only the profitability of the practice but the kinds of factors that lead to this state is critical. Until the practice has an idea of the root causes of the problem, it is difficult to determine what the correct solution is.
Just looking at one data point, such as total revenue for a particular year, is usually not very helpful. The following types of data comparisons are most commonly seen and offer greater insights, including comparisons between practices or from one period to the next:
- Trends analysis within a particular practice (for example, a particular month is compared to the prior month or the same month in the previous year)
- Comparison of the practice’s metrics to published studies of these metrics within the veterinary industry
- Ratio analysis (for example, an expense is calculated as a percentage of total gross revenue)
- Analysis on a full-time-equivalent doctor or nondoctor staff basis
- Comparison of budgeted numbers with actual results
No comparisons are perfect; for example, activity in the practice may be cyclical and comparison of one period with another may show changes related to normal cyclicality rather than any improvements the practice has put in place. Different numbers of workdays in one period versus another can also impact the comparison. Regardless, internal trending is very helpful in understanding how well the practice is doing.
A lack of profitability comes from revenues that are too low, expenses that are too high, or a combination of the two.
Key factors to consider when performing comparisons to published data include:
- How old is the data?
- Is the data meant to represent an average practice or “best practices”?
- Is the data reliable?
- Are the figures in the study calculated in the same fashion as in the practice?
No study will be perfectly comparable to all practices, but it is still possible to get valuable information to help operate the business more effectively. It simply means these comparisons must be used with caution and as one tool in running the business, not as the final word about how well a practice is doing.
Once the causes of a problem have been determined, specific action must be decided upon to correct a trend or improve operations. Finally, a practice should perform follow-up analysis to ensure the action decided upon is actually occurring and having the desired effect.
There are many outstanding management resources available to practitioners from organizations such as AAHA (aaha.org), VetPartners (vetpartners.org), the AVMA (avma.org), and the American Association of Feline Practitioners (AAFP) (catvets.com). Working with a financial advisor or practice consultant may help in not only gaining a greater understanding of the issues impacting profitability but in identifying and implementing solutions. VetPartners can help in locating an appropriate individual. Many continuing education events and veterinary publications also cover management topics that are useful in improving profitability.
Karen E. Felsted, CPA, MS, CVPM, is owner of PantheraT, a management consulting firm that works exclusively with veterinary practices and with companies in the animal health world that provide pharmaceuticals, dietary products, and business services to veterinary practices. |
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