Everybody needs a yellow brick road

Jan. 1, 2008
Can you see Emerald City in the distance? How do you get there? I remember feeling frustrated early in my business career about “where has all my money gone?”

by Brian Hufford, CPA, CFP

Can you see Emerald City in the distance? How do you get there? I remember feeling frustrated early in my business career about “where has all my money gone?” It seemed I just couldn’t get on a path to create wealth in line with the income that I was earning. I also noticed that tracking cash flow seemed to be difficult with such moving targets as large equipment purchases, overhead, taxes, spending at home, and getting out of debt. I needed a yellow brick road. Perhaps you need one, too.

I decided that creating a cash flow operating statement for my business was my yellow brick road solution to show where my money was going. In this way, I could always see what was happening to my cash. This cash flow statement is significantly different from a normal accountant-style income statement that you likely already receive. Perhaps you can have your accountant make these changes so that you will always know where your money goes. Here’s how to properly classify cash overhead for your dental practice.

To properly see and control cash expenditures, you need two elements. You need to properly categorize overhead, and you need an ideal target for each class. You need a “goal-and-control” process. In dentistry, there are three broad classes of overhead. I call these direct overhead, indirect overhead, and financing overhead.

Ideally, in a general dentistry practice, direct overhead consumes 47 percent of cash flow. Direct overhead consists of costs: staff, lab, dental supplies, facility, and marketing.

For direct overhead, ask your accountant to group your cash flow operating statement into these categories. For instance, under staff costs, group staff wages, payroll taxes, insurance and fringe benefits, uniforms, employee retirement plan costs, etc. The “ideal” percentages for each of the five direct overhead categories are staff (27 percent), lab (7 percent), dental supplies (6 percent), facility (5 percent), and marketing (2 percent). The sum of the percentages for these classes equal the 47 percent of cash flow mentioned earlier.

In a general dentistry practice, indirect overhead should consume 8 percent of cash flow. Indirect overhead includes accounting fees, continuing education, office supplies, insurance, telephone, etc. Have your accountant reorganize your chart of accounts to classify indirect overhead items so that you are able to see if your cash overhead items in the indirect category exceed the 8 percent ideal amount.

Financing overhead should account for 5 percent of cash flow. Financing overhead comprises equipment or large items. Loan receipts and loan payments, including principal and interest, are subtracted from this. Financing overhead calls for net cash outgo to be categorized for capital expenditures and debt.

On traditional accountant-style income statements, principal payments and cash paid for capital expenditures are not shown. Instead, equipment purchased and debt transactions are shown on the balance sheet while the noncash items of depreciation and interest expense are shown on the income statement. While great for tax purposes, this format makes it impossible to see where all your money has gone.

The three broad classes of overhead classification are direct (47 percent), indirect (8 percent), and financing (5 percent) for a total of 60 percent. With this information, you can see monthly if you are on the right path to the Emerald City as you compare your actual numbers to these target percentages.

Total collections minus direct, indirect, and financing overhead equals the practice operating profit. This amount should total 40 percent. Expenses for the dentist or relatives of the dentist employed in the practice should be categorized in practice operating profit under owner’s compensation.

These include such items as the dentist’s salary, spouse’s salary, payroll taxes for the dentist or spouse, auto expenses, owner’s fringe benefits, etc. It is important to separate owner’s benefits from practice overhead to see what is really going on in the practice.

Your yellow brick road is a detailed understanding of where cash flow goes in your dental practice and comparing those numbers to “ideal percentages.” Now, about those lions, tigers, and bears. Oh my!

Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. The company is recognized as the only strategic alliance partner for financial planning services for the Academy of General Dentistry. Contact Hufford at (888) 470-3064, or at [email protected].

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