Buying New Equipment
Before you write the check, consider this information.
Jerry Hayes, O.D.
If you're a gadget lover, then it's a great time to be an optometrist because there's so much neat new equipment available. But before you buy any new "toys," consider how you're going to pay for them and how those payments will impact your practice profits and your cash flow.
Let's say that you're thinking about equipping a new lane to the tune of $30,000, and you want an opinion on how to proceed. Consider the following advice.
First, figure out how much you're spending on equipment now. In my experience, a comfortable level for "patient care" equipment is about 4% of your gross per year. Remember, we're talking about equipment in the patient care and examination category only. Depreciate lab equipment, such as edgers and dye units, under your cost of goods category, and business office equipment belongs under the category of general office overhead.
Next, look at the cost of the new equipment on an annualized basis. Have a salesperson give you a quote for monthly payments on a lease and multiply this by 12 months. Add that amount to what you're currently spending on equipment to arrive at the projected new total for your practice.
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For example, let's say that you're currently grossing $400,000 and spending $12,700, or 3.2% on equipment per year. The quote for a 5-year lease at 8% interest on that $30,000 for new equipment you want comes out to $7,300 per year. That's only 1.8% of your gross, which by itself is fine. However, when we add that to the old equipment you already have, the total is $12,700 plus $7,300, which equals $20,000. Twenty thousand dollars divided by $400,000 equals 5%, which I feel is a little high. This applies more to a stable, mature practice. A young, growing practice might have to exceed these ratios.
Should you lease or buy?
Now you should decide whether you want to lease or just make an outright purchase.
Buying. While it's nice to be debt free, I discourage my clients from paying cash for any purchase that totals more than 1% of their annual gross. If you have a $400,000 practice, then finance any capital equipment purchases that exceed $4,000 over the course of the year (again, don't confuse this with inventory and supplies you dispense to patients).
Leasing. With an operating lease (versus a capital lease, which is treated the same as a loan), your monthly payments will show up as an expense on your Profit &Loss (P&L) Statement over the term of the contract. In this case, your payments will equal your tax deduction because leases are treated as a regular expense. Now you know where you stand in terms of the economic impact on your practice.
If you borrow money, you can deduct up to $24,000 against your earned income in 2001, plus the interest you pay on a business loan. You can also depreciate the balance above $24,000. In plain language, depreciation is a non-cash expense that makes your profits look lower on paper than they really are, and thereby reduces the amount of income tax you owe.
On the other hand, principal payments are made in cash without showing up on your P&L. That's one reason why someone with a lot of loan payments feels like his checkbook never has as much money in it as his P&L indicates he should in the years after he takes the deduction on his purchase. It's called a cash flow crunch.
Deductions: lease vs. buy
Once you understand all of this you can make an intelligent decision on the best way to structure your payment. If your accountant advises you to buy rather than lease so you can take a large, one-time deduction, then it's going to have a funny impact on your P&L.
Here's what I mean: If your net is $100,000 and you take a $24,000 deduction, you're only going to pay taxes on $76,000. That's good because of the money you save that year, but your practice looks like it's earning less than it is.
If you leased the equipment under the same payment terms, the deduction would only be $7,300 per year. So if you leased, your P&L would show a net of $92,700 in 2001 (net of $100,000 minus payment of $7,300), compared to $76,000 if you bought. From the standpoint of production and profitability, these are both $92,700 net practices. The deduction allowances on an operating lease more accurately reflect the useful life of the equipment than the one-time, large deduction.
It's up to you
How much anyone should spend on equipment is a judgment call. I like to see doctors use loans or leases to manage their cash flow and set a budget of around 4% so they don't go overboard. Discuss major purchases with your tax advisor and evaluate the terms and structure of the payment before signing the dotted line.
A FREQUENT WRITER AND SPEAKER ON PRACTICE MANAGEMENT ISSUES, DR. HAYES IS THE FOUNDER AND DIRECTOR OF HAYES CONSULTING. CALL (800) 588-9636 IF YOU NEED HELP WITH YOUR PRACTICE.
Optometric Management, Issue: September 2001