Optometric Management Tip # 172   -   Wednesday, May 04, 2005
Defining Your Expense Categories

I often write about increasing productivity and volume, but an equally important aspect of your profitability picture is the expense side of your income statement. If your practice grosses $700,000 per year, and you can cut your costs by just 2%, you will instantly give yourself a $14,000 raise without working any harder. Smart business owners know their expenses, they know the industry norms, and they set budgets based on this knowledge.

This week, Iíll review how to define your practice expense categories and next week Iíll write about ways to reduce them.

Jerry Hayes, O.D., a highly respected consultant and entrepreneur in our profession, has lead the way in analyzing expenses in optometric practice for many years. As a review, Iíll list the Hayes 7 Key Expense Categories and some of the statistical norms that go with them. The percentages of gross revenue shown below are my interpretations of the accepted norms in optometry, based on extensive data from Hayes Consulting and cross-referenced with AOA surveys. This is not necessarily what I recommend for your expenses, itís what I think currently exists on average.

The Hayes 7
▪ Cost of goods sold 30%
▪ Staff compensation 17%
▪ Occupancy 7%
▪ Marketing 3%
▪ Equipment 3%
▪ General office expense 7%
▪ Net 33%

Two Precautions

First, make sure you categorize your expenses properly, because if you define these categories differently than the statistical group, you arenít comparing apples to apples. Second, be careful to not over-generalize about the norms. The percentages listed above are averages and there is a range of acceptability. The numbers also must relate to your business goals. If you have a sound rationale for consciously choosing to spend more in an expense area, as a business investment, then go for it. The payroll category, for example, is a category that Iíve long advocated should be higher than the optometric norm. I place a very high value on customer service in my practice and I canít provide the kind of service I want with a lean staff, so Iím OK with a higher percentage there. I just have to make it up somewhere else Ė preferably not from the net category!

If you arenít using these seven expense categories, you should consider re-organizing your expenses into them. Many financial statements produced by accounting software like QuickBooks, or by CPAs, have so many categories that the expenses become hard to analyze. You lose sight of the big picture and itís hard to compare to industry norms. You may want to keep your detailed line item breakdowns for year-to-year tracking, but also reallocate them into the Hayes 7, for the big picture analysis.

Definitions and Reallocations

There are many nuances about how to categorize expenses. Some of what follows is simply convention and some is based on accounting principles. To give a true picture of your expenses and income, and to compare your percentages with the norms stated above, you will likely have to reallocate some expenses. This is simply moving them from one category to another.

Gross Ė This is not an expense, but we still need to define it because it can vary widely. Use only collected patient revenues that are actually deposited in the bank, otherwise called your true gross. Some practices write up usual and customary fees and call that the gross, but then take a huge write-off for insurance adjustments and discounts. For purposes of this expense analysis, use the true gross, not the inflated one.

Cost of goods sold Ė This is the only true variable cost in optometric practice, by accounting standards. It is the actual cost of frames, lenses, contact lenses, low vision aids, cases and other miscellaneous products that you sell. Also, add in the cost of any lab staff and lab equipment Ė see those categories for more on that.

Staff compensation Ė Include all costs associated with your staff, but do not include any compensation to doctors, even employed ones. You should include the cost of health insurance, other employment benefits, payroll taxes, supplied uniforms and continuing education courses. Do not include the payroll costs of staff members who make glasses in an in-office lab, however. This should be moved to the cost of goods sold category. If you have an employee who works part time in the lab and part time with patients, try to estimate the percentage and prorate the cost. If you have a family member who works for your practice, but does not take a salary, figure what the true value should be and deduct that amount from the net and place it in this category.

Occupancy Ė All the costs associated with your office facility. Include rent, utilities, janitorial, building maintenance costs, building insurance and real estate taxes. If you own your building, you should have the practice pay you rent. If you currently have the rent set at a very high figure, calculate the fair market value of what the rent should typically be for your space and move the excess rent to the net category. If you donít pay any rent because you own the building, figure the fair rent value, deduct it from the net and place it here.

Marketing Ė Advertising, newsletters and office brochures belong here, but not postage. Include yellow page ads, but not the phone bill.

Equipment Ė Do not include capital expenses or loan payments here, but do count interest on loans, equipment lease payments, service contracts, maintenance, and depreciation. Loan payments go into the net category. Do not include lab equipment costs (move to cost of goods) or business office equipment (move to general office expense).

General office expense Ė Any expense that was not counted above belongs here. Items of a personal nature that have been purchased through the practice should be reallocated to the net category. This might include auto expense, travel and entertainment, and many other possibilities.

Net Ė This includes all doctorís salaries and bonuses, doctorís employment benefits, plus any profit left in the practice.

Best wishes for continued success,

Neil B. Gailmard, OD, MBA, FAAO
Chief Optometric Editor, Optometric Management