Article Date: 9/1/2003

What Net Income Really Means
Your net income may be higher than you think.
By Jerry Hayes, O.D.

One of the most misunderstood terms in practice management is "net income." According to surveys by the American Optometric Association (AOA) and by my own consulting work with optometric clients, I can report with a high level of confidence that the average net income for private practice O.D.s is about 31% of their collected gross income. Do you know what that means?

Check out the numbers

In terms of simple math, if your practice grosses \$500,000 and you have overhead expenses of 69%, then your net is 31% (\$155,000). But your real net isn't what shows on your Profit & Loss statement or what you report on your federal tax return. That's because most practice owners deduct a number of expenses that would otherwise accrue as income if they were someone else's employees.

The result is, your Profit & Loss statement generally understates your true net income -- in some cases by a significant amount. Here's a typical example:

\$500,000 gross collected income

-\$345,000 practice expenses

= \$155,000 P&L profit

Now let's add back the deductible expenses that were either directly personal, such as the car and retirement contributions, plus some things that were done purely for tax reasons, such as overpaying a family member. Once we do that the real net of the practice is actually higher than the profit and loss statement shows.

\$155,000 previous total

+ \$3,000 auto expenses

+ \$6,000 O.D. retirement contributions

+ \$10,000 excess salary to family member

+ \$6,000 O.D. health insurance

= \$180,000 (the true net)

Keep in mind that at least three common situations affect net income. For example, when you buy something through your practice for personal use and deduct it, that artificially lowers your income.

On the other hand, if a family member performs real duties in your practice for which you don't compensate them fully, then your net will be inflated because you would have to pay a real employee if the relative left your practice.

The same situation applies if you own your building but don't pay yourself the fair market value for rent. This inflates your net because it would cost you more to practice in another location. I advise you to charge yourself market rates and book the profit under rental income.

The final analysis

It's important to understand what your real profits are for two reasons:

1. The true net of your practice affects how lenders view you as a credit risk, which in turn impacts virtually every business decision you make -- how much to spend on new equipment, when to build a new office and when to take in an associate.

2. When it comes time to appraise your practice for a possible sale or to negotiate a partnership, the higher the net, the higher the appraised value of your practice. In other words, all the things you did to intentionally lower your net will also cause your practice to appraise at a lower value.

In the final analysis, most O.D.'s net more than they realize. For business reasons, it's important to be able to identify and explain any discretionary expenses you run through your practice.

A frequent writer and speaker on practice management issues, Dr. Hayes is the founder and director of Hayes Consulting.  You can reach him at (800) 588-9636 or JHAYES@HAYESCONSULTING.NET.

Optometric Management, Issue: September 2003