How is Your Practice’s Financial Health?Mark OppermanCVPM
Dr. Jones has owned the XYZ Animal Hospital for 15 years and the practice has always done well. It normally enjoyed a 12-15% increase in income per year. However, this year, things do not seem to be going as well. Dr. Jones is not quite sure what is going on but the balance in the check book is lower than it has ever been and he even had to hold his personal paycheck this week in order to make payroll. Dr. Jones has noticed that business is slower wonders what he needs to do to turn things around and get the practice back on track. Let’s see if we can help Dr. Jones analyze what the problem is and take some steps to correct it.
How is your practice doing financially?
Let’s begin our investigation of what is going on in Dr. Jones’s practice by looking at the financial aspects. Until now, Dr. Jones really hasn’t paid attention to his financial statements or any of the reports coming from his veterinary software program. Why should he when things were going well? But now he needs to find out why he can’t pay his bills.
Overall, the most important financial factor is Dr. Jones' net income. Is he up, down or unchanged from last year? In his review, Dr. Jones discovers that his gross income is down while his expenses are up – so of course net income is plummeting.
What has caused this and what should he look at next? Basically, there are two expense areas that we can control within the practice. These are payroll expense and inventory.
It is generally accepted that payroll costs should run between 18-22% of your gross income. Payroll costs are gross payroll for your support staff (NOT doctors’ or owners’ compensation) and include payroll taxes but no other benefits. There are many possible reasons for high payroll expense. One of the most common is that your team is not properly scheduled. You might have too many people at some times of the day and too few people at other times of the day, but not the proper people at the proper time. I think it is fair to say that, in most veterinary practices, the team’s schedule is determined by the team members themselves. Instead, your team schedule should be determined by your practice’s office hour and surgery schedule. When creating your schedule, look at when you have doctors scheduled for office hours and surgery, and then superimpose your team schedule on it. As an example, if Dr. Jones is scheduled for office hours, then you will need a receptionist, an exam room assistant and a technician. If you have another doctor scheduled for surgery, you will need another technician, a veterinary assistant and maybe another receptionist. The idea is that the doctor’s needs should drive the team schedule.
The second most common reason why support staff costs may be too high is overtime. Overtime is a killer and, in most cases, unnecessary. In fact, I often find that the people who are receiving the most overtime compensation are the least deserving of it and may actually “pad the clock.” Overtime should be kept to less than 1% of your total payroll. Many times you can hire another person for what you are paying in overtime costs. Try not to schedule full time employees for more than 38 hours – this creates a two-hour buffer for them to work without running into overtime.
A Another reason why support staff costs could be out of line might be lack of employee training or effective utilization. Have your employees been trained so that they are able to do some income-producing activities? The more competent your employees, the more responsibilities they can take on and the more they can leverage the doctors within the practice. Hiring licensed veterinary technicians, trained assistants and developing an environment of quality and excellence where education and continuing education is valued can pay off significantly for the practice.
Another reason why your support costs might be out of line could be a factor of income. In other words, you may not be charging enough for your services or not effectively capturing fees. Your fee schedule might need to be updated, your discounting policy might need to be reviewed, or you might have some severe “holes in your bucket” that allow fees to escape. You might have an internal control problem where services are being rendered but not charged for. Lastly, there is the possibility that your support staff costs might be out of line due to embezzlement occurring within your practice. Studies have found that one out of ten veterinary practices are embezzled from every year and, to be considered embezzlement, the amount must be over $10,000 a year. Hopefully, this is not the case in your practice, but it is a possibility, so proper controls need put in place to help insure that you are not that one in ten.
In Dr. Jones’ review of his financial statements, he discovered that his support staff costs were running 23% of gross. He also noted that two of his employees were getting over 5 hours a week in overtime – which he calculated was costing him almost $4,000 a year.
He also realized that he had not increased his fees in the past two years and this may be a causative problem as well. Dr. Jones also found that his inventory costs seemed high and, in fact, they were 19% of his gross income.
Inventory is the second expense area that we can control and which has a significant impact on the practice’s bottom line. In a recent survey, the top 50 CEO’s of Fortune 500 companies were asked what one thing they would do during a recession to “recession proof” their business. The overwhelming response was “reduce my inventory.” Inventory is an expense, not an investment. After all, what inventory item have you ever purchased that actually appreciated in value? So, when Dr. Jones found his inventory was 19% of his gross income, he knew he had a problem. Inventory as a percentage of gross in a veterinary hospital should be 16%-18%. What would cause this number to be high and out of line? Let’s find out.
The number one reason why inventory costs would be high in a veterinary practice is shelf life. Shelf life is measured from the time a product enters the practice until the time it is used or sold. What is the optimum shelf life for any product coming into your practice? The technical answer is a minute or even a second! You only want in your practice what you are going to use that day. Of course, this is not practical in a veterinary hospital, so the realistic answer is one to two months. Almost nothing should come into your practice and sit on the shelf for longer than a month or two. There are certainly exceptions to this. Food, for instance, should turn over even quicker (a week or two) and there are some products you might need to have just for the sake of quality medicine or surgery that will not be used or sold in this specified time. But, for the most part, you want to see items used or sold within a month or two of stocking them. For this reason, you should set your inventory reorder point at a 15- to 30-day supply and your re-order quantity would be the same amount. Let’s say you use, on average, four boxes of 3cc 22X1 syringes a month in your practice. You should set your reorder point in the computer at two to four boxes, so when you get down to this number, the item will come up on your reorder report. At this time, you will have a 15- to 30-day supply left and another two to four boxes will be ordered. If the order arrives the next day, you will then have a one- to two-month supply. Now, I know what you are thinking—why have a month’s supply on hand? Well, there is something called the cost of ordering. Every time you order something, an employee must place the order for that item, when it comes in, an employee has to unpack it and enter it in the computer. The bookkeeper has to post and then pay the invoice, etc. These are all called costs of ordering. These costs of ordering need to be offset by the fact that inventory ties up your money. As I said before, inventory is not an investment; there is no inventory item that you will purchase that will appreciate in value. So your money is tied up, not making you any interest, just sitting there. This tying up of your money must be offset by the cost of ordering to determine the ideal shelf life. In fact, there is a formula called the economic order quantity formula that does just that. The formula basically indicates you should have a shelf life of one to two months.
The second reason why your inventory costs might be out of line is duplicity of product. How many different lines of flea control products, ear cleaners, food or other products do you maintain in your practice? This is all costing you money and tying up your revenue in products. If you are selling these products within the one- to two-month shelf life, then you don’t have a problem. But, if the duplicity of products is causing that product or others to sit on the shelf for longer than two months, then you do have a problem. A great way to find out for sure is to use what is known as the red dot idea. Have one of your assistants place a red dot on all your inventory items and 30 days later, count how many items still have red dots on them. Then count the red dots again at 60 days or 90 days. You may be amazed to find that you are seeing red dots for many months to come. The truth is, all those items with red dots should have been used or sold with 60 days of placing the red dots on them.
Your inventory costs might also be out of line due to a factor of income. If you have not raised your fees while your other costs have gone up, it might make this expense seem out of line. Are you charging for all your services? A recent study indicated that the average full-time veterinarian “gives away” $64,050 per year. In other words, services were provided, but no income was received. This might have been because the doctor purposely decided not to charge for the service, the fee was discounted, or someone forgot to charge, but the bottom line was that the service WAS rendered and no income was received.
It is also possible that your inventory costs might be out of line because embezzlement is occurring within your practice. In doing monthly reviews with our clients, we always compare income to expenses. So, for example, compare your cost of food against the income received. If your normal markup is 34%, add that to your costs and see how that compares to your income. Many times, the results will surprise you and may open your eyes to a potential problem occurring within your practice.
Dr. Jones did some research and used the red dot idea. He was amazed how many items had red dots on them not only after two months but still, to this day, he has products with red dots on them. He reduced his shelf life and started to use bar code scanning and his veterinary software program to start to controlling his inventory. He also found many duplicate inventory items – product his associates had ordered which were still sitting on his shelf. So he instituted a new policy that he would have to approve the purchase of any new inventory items. Now his inventory is starting to fall into line.
Dr. Jones’ review of his financial statements also revealed that his income was actually flat for the year. This is the first time in 15 years that his income had not increased. Upon further investigation, he found that the number of invoices had gone down this year and the number of new clients seen had also decreased. This was quite disturbing to Dr. Jones and something he had not experienced before.
In a “healthy” practice, a full time veterinarian should generate about 3,200 professional transactions per year. These are transactions where the doctor is formally involved in the delivery of service. If you are looking at total transactions, we would expect around 5,000 invoices per full time veterinarian. Dr. Jones saw a decrease in both of these areas.
In looking at new clients, normally we would expect 20 to 25 new clients per full time veterinarian per year. Dr. Jones had slipped to an average of 15 new clients per full time doctor. What to do about this?
One of the first things I look at is the practice’s reminder system. How effective is it? Normally, we would expect to achieve 80- 85% effectiveness in our reminders. This means that, by the time you are done sending out all your reminders, 80-85% of those clients should have responded. If you find your effectiveness is not up to par, then look at how you are handling your reminders. I normally suggest a three-tier reminder system. The first reminder should be sent out a week or two before the pet is due. This reminder should consist of an email and a postcard. If the client does not respond, then send a follow-up reminder 30 days later in the form of an email and a tri-fold reminder letter. If the client still has not responded after another 30 days, send a final email and a past due reminder postcard. Three series of reminders is normally all I recommend. Further reminders might be viewed as harassment by your client. If a year goes by and the client still has not responded, a purging card or letter can be sent to the client to determine the status of the client and the pet. Another important aspect of your reminder system is to make sure your patients have a reminder set up in your veterinary software program. Run a report listing the patients you have seen in the past year that have no future reminders. You might be surprised at what you find. Many clients who brought in their pet for a skin problem, eye problem, or some other medical issue may not have given you preventative information or it may not have made it into the computer. This results in a patient that was seen yet is missing future reminders - and you are missing a major revenue source for your practice.
Dr. Jones had not increased his fee schedule in the past two years. The cost of materials continued to increase, he gave raises to his team, and rent and utilities went up, yet Dr. Jones did not adjust his fees. Shame on Dr. Jones! Your fee schedule needs to be increased at least double the cost of living ever year. Otherwise, you will always be playing the catch up game and experiencing a decrease in net, just as Dr. Jones has.
Dr. Jones’ new clients were down, but he was not doing anything to actively promote his practice and thus bring in more new clients. Dr. Jones did not have an up-to-date website. In fact, all he had was one single web page that the telephone company did for him. So Dr. Jones hired VetStreet to develop a new website and went even further – he developed an online store that would allow him to compete with internet pharmacies. He also decided to visit veterinary-related businesses in the area and tell them about his practice. He visited some boarding and grooming facilities and invited them to come and tour his practice. He also visited a large pet shop in the area. It just so happened that this pet shop was looking for a new veterinary hospital to work with. They developed a great relationship and Dr. Jones is seeing a significant increase in the number of new clients coming into his practice.
The Bottom Line
Dr. Jones had not stayed on top of his practice and its financial affairs. It wasn’t until the checkbook started to run dry that he became concerned. There are many practices that are experiencing a decrease in net income, flattening of their practice income, or worse. You can sit back and hope to ride it out or you can start to analyze the problem and respond to the challenges. There is no reason you can’t grow your practice and be profitable – it just may take a little more effort to accomplish this goal.