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Lower your overhead with zero-based budgeting

Nov. 1, 2010
Consultant David Smith discusses zero-based budgeting and tells you how to implement it in your practice.

by David Smith

For more on this topic, go to www.dentaleconomics.com and search using the following key words: overhead, budgeting, zero-based budgeting, dental practice expenses.

"If you would be wealthy, think of saving as well as getting." - Benjamin Franklin (1706 - 1790)

As Benjamin Franklin reminds us from the mid 1700s, budgeting your expenses is an essential component in managing your internal controls and ensuring that your practice remains financially healthy. Zero-based budgeting can be an innovative approach to your expense budget that can dramatically increase your profitability.

Traditional incremental budgeting

In traditional incremental budgeting, expenses are determined as a factor of last year's budget or set at a particular ratio of income. However, some drawbacks to incremental budgeting are that it assumes that expense histories or expense-to-revenue ratios are always correct, what has already been spent is automatically sanctioned, and it encourages spending up to budget. In addition, there are few incentives to develop new ideas and limited incentives to reduce costs or measure effectiveness. In short, the problem with taking the same approach every year to our expense budget is that we tend to get the same results.

Zero-based budgeting

Zero-based budgeting (ZBB), which first gained widespread notoriety in 1977 when then-President Jimmy Carter announced that he was implementing ZBB into the federal budgeting process, does not take into account previous levels of expenditure or ratios to income levels. Rather, ZBB sets all expense items at a budget of zero dollars. Therefore, any dollar spent is a dollar over budget.

ZBB requires that justification be provided as to why any expense helps your practice achieve its goals. It also requires an examination into any alternative, less expensive means to achieve those same objectives.

The advantages of this approach are that it can help identify and eliminate wasteful expenses, encourage managers to look more critically at the way in which services are provided, and encourage them to seek more a cost-effective means to provide those services.

Dr. G. and ZBB

Here is an example of incremental budgeting vs. ZBB. In Dr. G.'s office, a general practitioner located in Tucson, Ariz., lab bills did indeed fall within what many consultants consider to be the healthy range of about 9% of collections.

However, Dr. G.'s practice is heavily hygiene-driven and not very many crown and bridge procedures are performed, so his lab bills are actually out of proportion to what he produces in those procedures.

Since it was determined that his lab expenses fell within the healthy ranges of his total collections and were incrementally about the same amount he spent every year, neither Dr. G nor his CPA recognized the opportunity to lower practice overhead.

When Dr. G. took a ZBB approach to his budget, he set out to examine his lab bill expense and explore cheaper alternatives. With a little research, he discovered another lab that produced comparable quality, but at 70% of his former costs, saving his practice more than $14,650 per year.

Dr. A. and ZBB

ZBB dictates that supplier contracts be renegotiated for better rates, and rotating debt be transferred to a card with a lower interest rate. A fixed cost is only considered fixed once that cost can be justified and alternatives explored. Many landlords are not open to lease renegotiations, even in this environment of plummeting real estate values and increased vacancy rates.

But after implementing ZBB, Dr. A. in Brentwood, Calif., refused to accept that his rent was a fixed cost until he had the opportunity to make a case to his landlord regarding a rent reduction. As a result, Dr. A. now pays $500 less per month in rent than he did prior to his implementation of ZBB.

Analysis and alternatives

ZBB dictates that the same analysis be applied to every expense line item on your profit and loss (P&L) statement. Even expense items for which there are no other suppliers should be examined. There is probably only one power company in your area, so finding a competitor in your area with lower energy rates doesn't seem likely.

However, in seeking alternatives to your energy expense, perhaps some simple things such as replacing lightbulbs with low-energy bulbs, making it a point to turn off the lights in any room not in use, and unplugging some devices at the end of the day could produce an alternative to the energy expense you are now paying.

Dr. N. and ZBB

Don't forget to include your team when implementing ZBB. I know of many offices that successfully form committees around their work centers to explore ways to reduce costs.

Dr. N.'s front office found a great way to consolidate their practice's stationery printer with their office supply vendor, and also implemented the use of refurbished toner cartridges, thereby saving the practice a substantial percentage off their office supplies budget - a budget previously considered healthy due to its incremental ratio to collections.

Implementing ZBB

To implement ZBB into your practice, first set the budget for every expense on your P&L statement to zero dollars. Then, for each expense line item, closely examine the following questions:

  • How does this expense contribute to the goals of your practice, and is the contribution it makes important enough to justify it?
  • Are there less costly ways to achieve the same objectives?
  • Where would this expense fall if your expenses were listed by order of importance?
  • What would happen if the expense was not incurred at all?

One major drawback to ZBB is that it can be quite time-consuming and exhaustive to review your expenses line item by line item, explore alternatives, and justify the dollar amount spent on each expense. Perhaps this is a budgeting exercise you will find most useful once every three years. However, regardless of the frequency with which you perform ZBB, the rewards for this exhaustive exercise could be a much reduced overhead, leading to substantially improved profitability.

J. David Smith is a practice-management advisor at Wells Fargo Practice Finance (formerly Matsco). With more than 10 years of experience in health care, David helps clients analyze data in order to evaluate and improve their processes and make sound business decisions that lead to improved practice profitability. He can be reached at (888) 937-2321, [email protected], or wellsfargo.com/practicefinance.

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