How much is too much?

Nov. 1, 2004
The building contractor who recently built my new office often brings prospective client doctors to see it and talk to me about the building process.

Dr. Michael Gradeless

The building contractor who recently built my new office often brings prospective client doctors to see it and talk to me about the building process. Recently, I talked to a dentist who was located next to my optometrist. We had never met and he had no idea that I was intimately aware of the demographics of his area nor that I had peeked in the windows of his office while he was closed. Yes, we do this everywhere! Let me explain.

When I say "we," I am referring to myself and my wife, the self-proclaimed office manager from Hell. Kathryn has an MBA and manages my practice so well that I look like I know what I'm doing. Wherever we go, if there is any interesting looking dental office, we must go look. We have stolen many great ideas just by looking in windows.

This doctor was planning to remodel and expand his office and he asked me a very good question: "With the increases in rent costs, construction loans, and equipment costs, how do I know how much is too much?"

This is a question you should ask yourself every time you incur expenses that will increase your overhead. Most doctors assume that if they pay $1,000 a month on a loan for new equipment, they must simply increase their production by $1,000 a month. This is unfortunately incorrect. Here is a way to calculate the increased production needed to pay for a new purchase.

First, ignore all tax benefits and calculate a payment to amortize your purchase over five years. A good sales representative will always point out the tax savings from depreciation allowances. These savings are real and you should still ignore them when calculating needed cash flow. These tax savings do not improve your monthly cash flow because you will not realize the savings until April 15 of the next year. If, because of the depreciation allowance, you find you have actually overpaid your taxes, you usually don't receive a refund check from the IRS. Instead, the money is credited against your quarterly tax deposits. The credit is real, but you can't write a check with it. A five-year amortization of expansion costs is standard in most businesses. If you are paying cash for your purchase, you still must pay yourself back, and five years is a good turn-around time.

There are many expenses in our practice that can be expressed as a percentage of gross production. For your cash-flow projection, use numbers from your practice. For this example, I will use some average figures for five areas of the practice where your expenses will increase as your production goes up.

1)Lab fees: 10 percent. Laboratory expenses range from 8 to 15 percent, based upon the number of crowns and bridges you do.
2)Supplies: 5 percent. Another variable expense.
3)Doctor's pay: 35 percent. You must add this in as well. A new expense of $1,000 monthly for six years is $60,000. Are you willing to do that much dentistry for no pay?
4)Staff expense: 20 percent. Staff expenses increase every year and are approaching 30 percent in some practices.
5)Collection loss: 3 percent. A well-run practice can reduce this to near zero.

If we use our example of $1,000 per month, we must now produce enough dentistry to pay these five variable expenses first and then have $1,000 left. To obtain this new cash-flow number, you must divide 1,000 by the percentage remaining after these expenses have been deducted. In this example, it requires $3,704 in increased cash flow to pay a $1,000 expense. This is a fairly astonishing number to most people. If you understand how to calculate this, you can avoid getting yourself into serious trouble.

The original question was not just how much extra do I have to produce, but how much is too much? To answer this question, you need to know your monthly production for the last 12 months. Find your monthly average production and also average your best three months. If your top three-month average production is greater than your average production plus the increased cash flow required, you should be able to afford your purchase.

In our example, if your average monthly production is $40,000, the new production goal is $43,704. If your best three months last year averaged $46,000, then you can afford this without making major system changes in the practice or decreasing your income.

Dr. Michael Gradeless, a 1980 graduate of Indiana University, practices preventive dentistry in Indianapolis with an emphasis on cosmetics and implants. He is an adjunct faculty member at Indiana University, where he teaches the Pride Institute university curriculum of dental management. He also is the editor for the Indiana Dental Association. Contact him at (317) 841-3130 or e-mail to [email protected].

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