Instrumentation in Dr. Kling’s office that is used during patients’ annual comprehensive exams. Dr. Kling offers key pointers for conducting a year-end review of debt management to improve how you handle debt going into the New Year.
Optometry practice debt management strategies
Part two of three-part series on conducting a year-end evaluation of your practice. Click HERE to read part one.
Mick Kling, OD
Nov. 20, 2024
In the first installment of “The Year-End Practice Checkup,” we explored strategies for analyzing our profit and loss statement, including tips for organizing the data, assessing our goals and obtaining insights for reducing operating expenses to boost profitability.
In this second installment, we will discuss the impact of debt on our practice, and determine how much debt service we can afford in the coming year.
The Impact of Practice Debt
Cash flow challenges are a common struggle for many optometric practices, often the result of too much debt.
As practitioners, we are naturally drawn to the latest technology. 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 our enthusiasm can sometimes lead to an over-investment in technology. Since we often borrow from a lender or leasing company, this can take a toll on our practice cash flow. And without a clear strategy for utilization, it’s easy to create a financial train wreck for the practice.
When considering investments that add debt to the practice, it’s important to evaluate every investment through the lens of cash flow improvement. Consider how any new investment will contribute to operational efficiency, patient care, or both.
Some investments, such as updating essential equipment or software, are necessary to maintain the normal operations of the practice. Others, like adopting advanced diagnostic tools, can enhance the patient experience and streamline workflows.
Making smart decisions about when and how much debt to take on will help ensure that every dollar spent on debt drives growth and profitability.
How Much Debt Do I Have?
A common question I hear is, “How much debt can I afford?” This answer depends on how well you are managing practice expenses and your existing debt levels.
Before making your next investment, assess your current debt situation by using this straightforward formula to evaluate its impact on your practice. This will help ensure you are making an informed and wise business decision.
First, begin by totaling all of your monthly debt payments (both principal and interest) and multiply by 12. This will give you the total you spend each year on debt repayment. Next, divide this number by your annual practice revenue. Finally, multiply the result by 100. This will tell you, as a percentage, how much of your revenue goes to service debt. That is, how many cents of every dollar are going to repay debt.
Example:
Let’s say you add up all of your monthly debt payments, which total $75,600 per year on your $1 million revenue generating practice.
Let’s now insert this information into our above formula:
$75,600 (Annual Debt Payments) / $1,000,000 (Practice Revenue) = 0.0756 * 100 = 7.56%
In this example, we can see our annual debt payments total $75,600. When we divide this by our $1 million revenue generating practice, we find 7.56 percent of our revenue is used for debt repayment. In other words, almost 8 cents of every dollar we collect is being used to repay debt.
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How Much Debt Can I Afford?
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.
You may recall in our last article, we discussed the impact of COGS (25-28 percent), staff wages (22-28 percent), occupancy costs (7-10 percent) and other operating expenses on the practice (10-12 percent), and the metrics which are found in most optometric practices.
Because of these known and predictable expenses, there is a finite limit to how much debt we can take on without impacting the owner’s compensation and return on investment of the practice. In a well-run practice, too much debt will begin to eat into the cash available to compensate the owner(s), and in cases where the practice’s expenses are not well controlled, high debt can be devastating to cash flow.
Getting Out of Debt
So, what do we do if we find ourselves with too much debt? There are really only two options: pay off the debt or grow the business. In either case, you will reduce the impact of debt repayment as a percentage of practice revenue. While growing your top-line revenue helps, reducing the debt burden is the fastest way to improve cash flow.
The first step toward getting out of debt requires you to commit to a debt freeze. That means no more borrowing. You simply can’t get out of debt by continuing to borrow. Instead, focus on paying down existing debts while maintaining essential core functions of your business. After halting all new debt, the next step is to actively reduce what you owe.
Radio host and financial advisor Dave Ramsey suggests an excellent strategy for eliminating debt.
First, make a list of all your debts starting with the lowest balances to the highest. Don’t worry about interest rates, simply list them in order, lowest balance to highest.
Make the minimum monthly payments on each debt you owe, aggressively putting anything extra each month toward the debt with the lowest balance.
Once the debt with the lowest balance is paid off, apply those proceeds (plus anything else you can afford) to the monthly payment of the debt with the second-lowest balance until this is paid off.
Continue this strategy until all of your debt is paid off. This highly effective strategy is called a “debt snowball” because once you get a few debts paid off, an increasingly larger payment will be made to the debts with the higher balances, and these will go quickly.
Conclusion
I frequently hear the phrase “business debt is good,” but have come to realize that’s not always true.
Investing in our practices often requires leveraging debt for essentials like real estate, office renovations, or new technology; however, the challenge arises when practice owners overspend beyond what the practice can afford.
As we approach the New Year, carefully consider every investment that involves debt, including how efficiency, productivity and, most importantly, cash flow will be affected.
By calculating what portion of your revenue is currently going to debt payments, you will gain clarity on what you can afford next year, helping ensure that each investment supports the financial health and long-term growth of your practice.
M
ick Kling, OD, is the president of Impact Leadership and the founder and CEO of Invision Optometry in San Diego, Calif. Dr. Kling is also the Practice Management and Transition Advisor for Vision Source. To contact him: dr.kling@invisioncare.com
