Every successful dental practice owner is familiar with their production and their profit. But if you’re playing the long game, how do you shore up your practice for prosperity through bull and bear markets? Beyond production, you need a strong understanding of your profit and loss statement as well as your balance sheet.
Five of the metrics derived from your financial statements can help you get a handle on the solvency of your practice. Once you understand what the metrics indicate and where your practice stands, the most important factor will be how your business is trending. These ratios can be included along with your financial reports at least quarterly, so you not only understand the impact of strategic decisions on your production but also the resilience and long-term solvency of your practice.
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Each metric has a standard range but never an “ideal” number. Why is this? Your specific targets will incorporate these four factors: risk tolerance, status of the economy, status of the dental industry, and your estimated years to retirement.1 Some may think that ratios on the safer side of the spectrum are better, but overly conservative numbers may mean you aren’t optimizing your practice for profitability. If you are unsure what targets align best with your objectives, speak with your CFO for guidance. If you are in a focus group, your fellow members can provide context for economic and industry statuses.
(Total liabilities divided by shareholder's equity)
This ratio helps you understand how much of the business is owed to creditors versus owned by shareholders. If your practice is just getting established and it’s full of new, financed equipment, imagine that your debt-to-equity ratio is 4.0. This would mean that for every dollar the practice shareholder has invested, creditors have invested four.
The most solvent practice has a low debt-to-equity ratio, as the practice owner would be de facto the majority shareholder—not the debtors—in case assets need to be liquidated for repayment. Your ideal debt-to-equity ratio will depend heavily on where you stand with the four factors mentioned above. It’s rare that a new dentist can purchase a practice without assuming a high debt-to-equity ratio; this scenario can be very strategic, as the new dentist likely has many years before retirement to invest in the equity of the practice.
What do you do if your debt-to-equity ratio is lower than you feel comfortable with? The quickest way to adjust this ratio is to bring in more shareholders. Everyone has had a DSO knock on their door, but that’s not your only option. You could consider offering an associate dentist a buy-in as a partner, but while this has many examples of success, debt is often what the average dentist turns to first. Bringing in additional shareholders comes with additional demands and divided profits. In the absence of investors, moving this ratio is a long-term game and one you need the guidance of a CFO on. Remember, safer is not always better if you’re building your practice, and self-funding might mean delaying retirement for decades.
(Current assets divided by current liabilities)This ratio is best considered as the practice’s ability to pay the bills. It compares the money you have and the money you expect in the next year with what you will owe in the next year. Maintaining sufficient liquidity is essential for a dental practice to remain resilient and solvent. If your ratio is 2.3, it means that you have $2.30 in things that are money or will be money in the next year for every $1.00 you’ll owe in the next year.
A higher ratio indicates a safer position, but that does not equate to a better position. A current ratio that is too high means you are utilizing your assets inefficiently. A common range for current ratio in a dental practice is about 1.8 to 2.0. There are valid reasons why yours might be higher or lower. A practice owner might be considering purchasing their location and have intel that a cash offer will mean a significantly reduced price. In this case, the current ratio of the practice will be quite high leading up to the purchase. Or perhaps the owner has financed a piece of equipment that industry data shows as decreased overhead and increased profitability within the same year of purchase.
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What to do if your current ratio is lower than you are comfortable with? Here’s an example: If you have $5 in cash and $4 of debt, paying off $1 of debt with your cash will increase your current ratio. In a real-life scenario, this can take place several ways: avoiding new debt and/or prioritizing payoff of current liabilities, increasing current assets (typically by increasing profitability), or refinancing current debt into long-term debt. This can be one of the easier ratios to change quickly; however, in an extreme case, using all your cash to pay off debt may leave you short in paying your operational expenses, such as payroll.
Accounts receivable days
(Total accounts receivable divided by total sales in period) times 365
This ratio could best be described as the number of days it takes after completing a dental procedure to receive money for it. It perfectly dovetails from the current ratio, where cash and accounts receivable are considered the same. However, employees do not want to be paid with IOUs on accounts receivable, and creditors will never accept accounts receivable in a 1:1 ratio with cash.
Accounts receivable days is a ratio where lower is more efficient. If you are a fee-for-service practice, your accounts receivable days is likely 0, as patients will pay for dental services on the same day. If you accept dental insurance, it reflects your efficiency in billing. Depending on the insurance companies you accept, your accounts receivable days may be hovering around 15 or 30. But again, looking back at the four factors, a fee-for-service practice will be much more affected by economic conditions than a practice that accepts insurance. To set your “ideal” accounts receivable days, bring in your CFO to help balance the targets for the factors involved.
What do you do after you’ve set a target to align the four factors, and you’re still high? Even without setting a target, what is considered a high number in any scenario? Anything over 60 to 90 days indicates an area of opportunity for increasing same-day patient payments and analyzing your percentage of first-time insurance claim acceptance. Dental office administrators should be collecting co-pays before patients leave the office on the day of treatment, and the insurance processor should have a 90% or higher rate of first-time claim acceptance. Failure on either of these parts results in a measurable increase in accounts receivable days.
(Total administrative expenses divided by total sales)
This ratio compares total sales with non-sales-related costs. Many clinics only look at this ratio in times of economic uncertainty, which can lead to massive cuts in administrative support and risk burnout of the remaining staff members who must pick up the pieces. As part of a long-term strategy, however, it can help illuminate inefficiencies and opportunities to streamline administrative practice functions.
The lower the administrative ratio, the more efficient the practice. An “ideal” ratio typically falls between 0.1 and 0.25. If you are not in a dental focus group, ask your CFO to set your target administrative ratio. If your ratio is 0.05, it may indicate that you are burning out your existing employees and risking high turnover (which has its own expensive costs), or you may simply be accounting expenses incorrectly. When would a ration of 0.30 be good? If you are planning on rapid growth, it may be strategic to build up your administrative team to support high-quality care before you increase production and add to your patient list.
What do you do if you realize your administrative ratio is too high? You can either build up your patient care team to fill the workload of existing administrative overhead (which is easier to stomach but more difficult to implement), or you’ll need to evaluate your workflows and reduce administrative overhead. While the administrative ratio is often considered last during prosperous times, it should be first in lean times. With regular monitoring, you can increase your profit in the former to strengthen your position in the latter.
Altman Z score
This is the most dynamic of all the ratios we’ve discussed. The Altman Z score is unique in that it combines elements from your profit and loss statement as well as your balance sheet. Since it combines many factors, I recommend entering your information in an investment calculator and having it calculate your Z score. This score was originally developed to help bankers predict the bankruptcy risk of a business for lending purposes. It is the most difficult to gamify and, therefore, one of the more reliable ratios in indicating practice solvency.
The higher your Z score, the more solvent your business is. A Z score above 5 is considered excellent, above 3 is considered safe, and 1.8 or lower is considered very risky. As with the other ratios, your practice’s trend will be most illuminating. In some cases it makes sense to strategically reduce your Z score. An example would be bringing on a practice manager whose value is in the longer-term effects of their work. The first year you will pay the practice manager’s salary, but the increase in efficiency and patient satisfaction will likely lag the expense. In this case, we would expect the Z score to trend downward for a given time while the practice manager is onboarding and implementing new processes; the trend should move upward once these changes have had time to take effect.
What can you do if your Z score is below your comfort zone? Take the issue to your focus group or CFO. Since the Z score is affected by all the other ratios, it can be increased in several ways. The best options for increasing your Z score will require a close analysis of your four factors.
The increasing concerns of economic uncertainty and recession give practice owners a chance to reflect on the solvency and resilience of their practices. No matter where your financial concerns fall, these ratios can help you look beyond your production and evaluate metrics associated with long-term sustainability of your practice.
Editor's note: This article appeared in the September 2023 print edition of Dental Economics magazine. Dentists in North America are eligible for a complimentary print subscription. Sign up here.
- Duryee DA, Bech TA. 60 Minute CFO: Bridging the Gap Between Business Owner, Banker, and CPA. Horizon Management Services; 2017:29-30.