What Net Income Really
Your net income may be higher than you
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)
know your 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
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