Article Date: 6/1/2006

Analyze the impact a change in staff or location might have on your income.
JERRY HAYES, O.D.

I recently gave a talk in Phoenix on one of your favorite topics, practice overhead ratios. As often happens, an O.D. came up after the lecture and pulled me off to the side for a private question.

Better or worse?

He was the senior doctor in a group that had just built a large, new office. So large, in fact, it was turning out to be more space — and expense — than the practice needed. Instead of spending the normal 6% of annual revenues on occupancy and 2% on equipment, this practice was spending 12% and 5%, respectively, in 2006.

Because the added expense was causing their income to suffer, this O.D. was looking for my support to help him justify the new overhead on the basis that the office was going to be a good real estate investment. My answer: That may be O.K., but only if all the O.D.s who will lose income share equally in the equity of the building.

This was a classic case of a group of sharp men and women getting caught up in the excitement of building a first-class facility without doing all their homework. I am sure they carefully selected the location and laid the floor plan out down to the last detail. But they failed to create what bankers call a "pro forma" income statement, something any qualified accountant can help you do.

A pro forma is nothing more than a good faith attempt to project how your net income will be affected when your revenue or expense picture changes. You can use a pro forma to help you analyze the impact of renting a more expensive office, leasing new equipment or even hiring more staff.

Creating a pro forma

Calculating how much your expenses will increase is generally easy to do. The real trick is deciding how much the investment will increase revenues over time. Despite the uncertainty, creating a pro forma is still an exercise you should undertake if your new expense is greater than 5% of your gross.

Look at it like this: Assume our friend had a \$2 million gross practice that was spending 6% (occupancy costs) + 2% (equipment) = 8%, before they built. If the new office increases that expense to 12% + 5% = 17% of gross, without a proportional increase in revenues, the practice's net income would decline by 17% - 8% = 9% x \$2M = \$180,000. Spread over four partners, that's a loss of \$45,000 per doctor per year. That would hurt!

Don't be too conservative

The primary job of a pro forma is to keep you as a practice owner from over committing yourself financially. But it can also protect you from being too conservative and not spending enough on your building, or buying less equipment than your reasonable future needs. How many times have we all looked back on a project and said, "Gee, I wish I had spent \$50,000 more and doubled the size of my frame area," to ourselves?

Deciding how aggressive to be when expanding your practice is like treating a patient with glaucoma. You need to gather all the information at your disposal before making a decision on how to proceed. And be sure to put financial data at the top of your list.

THE FOUNDER OF KNOWYOURSTAFF.COM AND HAYES CONSULTING, DR. HAYES IS A REGULAR CONTRIBUTOR TO OPTOMETRIC MANAGEMENT MAGAZINE. REACH HIM AT JHAYES@HAYESCONSULTING.COM.

Optometric Management, Issue: June 2006