Dr. Kling’s practice, Invision Optometry in San Diego, Calif. Dr. Kling says there is a way to measure, rather than just guess, whether you have a healthy practice.
Quantifying how healthy your practice is.
By Mick Kling, OD
March 20, 2024
Do you have a healthy practice? How can you tell? Here are measures you can use to evaluate how healthy your practice actually is.
Liquidity
In the summer after my first year of optometry school, I worked in the office of an OD friend of my parents.
Growing up in Arkansas, I always loved the way he could impart southern wisdom in a way that really stuck with me. One day, while I was toiling away in his lab, he popped his head in and said, “you know the thing about optometry…. you’re always one month away from bankruptcy.” At the time, his comment didn’t mean much to me, but years later, it became abundantly clear what he meant.
In accounting, Liquidity is the word that accountants often use to describe cash. And most optometrists keep very little cash set aside in the event of an emergency. We witnessed this first hand when COVID hit, as we saw many ODs struggle to financially survive, often with less than one month’s worth of operating expenses in reserve. Measuring your liquidity, or how much cash you have for unforeseen events, is an important measure of a healthy practice.
So, how much cash should we keep in reserve? Ask any banker, and they will likely tell you between 7-10 percent of one year’s revenue. For a $1 million practice, that’s between $70,000-$100,000 in cash reserves. While that may seem like a lot, consider that between 40-50 percent of practice revenue is consumed by fixed expenses such as payroll, rent and other operating expenses, and 10 percent in cash represents only about 2-3 months worth of operating expenses.
If you are operating without a financial safety net, the first step toward establishing a healthy practice is to start building your cash reserves with a target of 7-10 percent of your practice revenue. Once you accomplish this, you can rest easier knowing you will have a better chance of surviving the next big financial challenge.
Solvency
A great thing about optometry is the abundance of great technology available to care for our patients. Whether that be automated phoropters, retinal imaging equipment, or the latest anterior segment cameras, these tools allow us to provide an extremely high level of care. Unfortunately, this technology comes at a cost to the practice. And since we often borrow from a lender or leasing company to acquire the technology, this can take a toll on our practice cash flow.
One of the most common causes of poor cash flow is too much debt. And one of the most common questions I hear is “how much debt can I afford?” In business finance, Solvency refers to a business’s ability to pay its bills, especially its long-term debt. Determining how much debt you can afford is critical when considering any new investment.
Fortunately, there’s a simple formula to determine the impact debt is having on your practice, and also help determine if it’s wise to make that next investment in your practice:
Total Annual Debt Payments (P+I) / Total Practice Revenue =
% Revenue Consumed by Debt
By totaling all your debt payments (both principal and interest) in a year and dividing it by your practice’s annual revenue, you can easily see what portion of your revenue is consumed by debt payments. As a general rule, healthy practices allocate less than 5 percent of practice revenue to debt payments. Practices with 5-10 percent of revenue going to service debt can create significant cash flow problems, and those with more than 10 percent of revenue going to debt are often experiencing serious financial challenges.
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So, before making that next technology investment, take a moment to think about your own solvency, and calculate what portion of your revenue is going to debt payments. This will help you better understand if you will be able to cover your debt obligations.
Operating Efficiency
If you become familiar with reading and understanding your profit and loss (P&L) statement (which I highly recommend!), you’ve likely noticed how it neatly represents both the income and expenses of your practice.
In a typical P&L statement, what’s left over after deducting your expenses (COGS, people, place and everything else) from your income for any given period is called your net operating income. This is sometimes referred to as “practice net,” expressed as a value before taking into consideration any compensation of the doctor-owner (either W-2 wage or distributions), associate doctor compensation and principal payments on any debt you may have.
Operating Efficiency (OE) of your practice can easily be calculated by dividing your Net Operating Income (“Practice Net”) by your total Revenue.
Net Operating Income / Total Practice Revenue = % Operating Efficiency
A well-run optometric practice should enjoy a net operating income (operating efficiency) of at least 25 percent, or more, of collected revenue. A practice with a net operating income of less than 25 percent most likely has operating efficiencies. Said more plainly…. is spending too much to operate the practice.
Common culprits include COGS and/or non-OD staff wages that are too high, poor control of general overhead expenses (marketing, insurance, office supplies, etc.) and running too many personal expenses through the practice.
By routinely measuring your OE for any given period, you can easily determine how well you are controlling your expenses relative to your income. Any “red flags” can easily be spotted (such as COGS too high) and corrective measures can be taken. Since your OE is directly tied to profitability, it’s important to consistently monitor this important measure over time.
Profitability
The fourth and final measure of a healthy practice is Profitability. In this context, we are referring to the profit left over after ALL expenses are paid, including a fair market wage to the doctors, both owners and associates. It’s probably not surprising that measuring profitability is quite important, since profit is required for long-term sustainability and directly related to our ability to reinvest back into our businesses.
Measuring net profit margins both in dollars and as a percent of revenue is important to understanding how we are managing our expenses, including doctor wages. A well-run optometry practice will see 10 percent or more in profit each year (after all expenses, including OD wages).
Profitability can be calculated by dividing your practice profit by your total Revenue.
Practice Profit (After all expenses INCLUDING OD Compensation) / Total Practice Revenue =
% Practice Profitability
It’s important to remember that the profit reflected on a P&L statement does not include two critical variables that impact cash flow: principal payments on debt and owner’s distribution or draw. Both of these expenses can have a significant impact on the cash flow of the practice. Because of this, a healthy profit does not guarantee strong cash flow. So remember, just like the other measures we’ve discussed, profitability tells us something specific (and important) about the practice, but may not be telling the entire story.
I encourage you to take time to start tracking these four key measures in your own practice: Liquidity, Solvency, Operating Efficiency and Profitability. If you’re not sure how or where to begin, create a simple spreadsheet based on the principles we’ve discussed here to track these key variables or ask your CPA to help you pull together the information.
M
ick Kling, OD, is the president of Impact Leadership and the founder and CEO of Invision Optometry in San Diego, Calif. To contact him: dr.kling@invisioncare.com
Thrilled to announce that Dr. Mick Kling will be contributing monthly columns to Review of Optometric Business. Mick and I lecture together for the “Business of Optometry,” fondly known as BOO. Mick brings unique insights to the table that I believe is unmatched by any other optometrist or consultant in our industry. With a track record of assisting numerous financially challenged optometrists in navigating their finances and facilitating dozens of practice buy-sell transactions, his expertise is unique.–ROB Professional Editor Laurie Sorrenson, OD
