March 2010
Were You Scared By The Recession? Recovery May Be The Real Monster
By Karen Simmons, CPA
Abstract:
We all hope for smooth sailing out of a difficult 2009. Most days the Dow is back above 10,000, job losses are slowing, home prices are stabilizing and most importantly patient visits are picking up. Wait! Before you celebrate take a look at what recovery may mean for you.
During the recession the government pumped huge amounts of money into the system in order to rescue the banks. Historically this type of action would cause us to leave the recession and enter an inflationary cycle during the vigorous recovery. However, this recession is proving to not be typical. The consumer has been affected through their home values, retirement portfolios, employment and of course cash flow. Prior to the beginning of the recession many consumers were highly leveraged, making the impact of the rapid decline in home values much more severe. All indications are that this recovery will be sluggish, a gradual climb up hill rather than a fast ascent to prior highs. So what does this mean for the veterinarian?Lending
In spite of the vast sums put into the banks by the government, banks have mostly kept this money in their reserves rather than resuming lending. Veterinarians who seek funds for new construction or start-up practices are facing much more stringent lending standards. Rather than simply looking at whether the project cash flows, many banks are emphasizing reserve requirements. If a loan doesn’t meet the bank’s requirements, for example 20 percent equity, the bank cannot make the loan. Consequently, even with lower interest rates, business owners find it challenging to get financing.
Rigorous lending requirements don’t only impact business owners seeking funds for expansion, they also affect owners who need to refinance with local banks. Most commercial property loans are amortized over a 20-25 year period, but require a payoff at 5-7 years. Therefore the owner needs to refinance at the end of the loan term (5-7 years). In the past refinancing has been automatic for the majority of owners. Often the existing lender would simply re-write the loan, or in some cases the owner would shop the loan seeking better terms. In the new lending environment, many banks require an updated appraisal. If the property value has fallen or does not meet the reserve requirement, the bank will not write the loan. This is occurring even for good customers, who are current on their loans and can show positive cash flow.
Veterinary-specific lenders continue to provide financing for strong borrowers, and have somewhat filled the gap left by conventional lenders who have tightened their underwriting. They provide financing based on the cash flow instead of the more typical asset based lending. As such, they have continued to provide financing for acquisitions, remodeling and expansions, plus refinancing current loans. It is worth noting that they are paying attention to the practice's near-term revenue trends. While they will provide loans, declining revenues can lead a lender to be more conservative in the amount they are willing to lend a practice.
Consumer Confidence
Although much improved over a year ago, consumer confidence is not continuing to show improvement. Consumer confidence is the degree of optimism that consumers feel about the overall economy and about their personal financial situation. It is measured by two instruments, the Consumer Confidence Index and the Survey of Consumers. According to Richard Curtin, the Survey of Consumers Chief Economist, “Consumers continued to judge their income and job prospects less favorably than any other time in the more than sixty year history of the surveys.i” People don’t expect their income to grow or the unemployment situation to improve in the near future. Consumer confidence is critical for recovery. Because of the prolonged period of uncertainty, people are focusing on increasing savings, reducing debt and living more frugally. Additionally clients in many areas still directly feel the repercussions of the housing crisis and unemployment. As with all areas of spending, consumers are going to analyze more critically the choices they make including their spending on veterinary care.
The Survey of Consumers forecasts consumer spending will rise just 1.8 percent in 2010ii. With consumer spending expected to remain relatively flat, it is likely that any increase in veterinary gross revenues are going to be small. The flat revenue growth many veterinarians experienced in 2009 may repeat in 2010. Rather than just monitoring gross, veterinary practices should identify other metrics that indicate performance. Consider tracking statistics related to client base such as client acquisition & attrition and the frequency of client visits. Although average transaction charge may not be increasing dramatically, by focusing on developing their client base, practices can remain stable or even show growth.
Inflation
Finally, be aware of inflation. Typically a recovery period involves some inflationary trends in which interest rates and prices rise more quickly than income. This causes a decline in earning power. Since interest rates are expected to remain low through 2010, most economists don’t consider inflation an imminent threat. Even so, be aware that it could creep in and impact your expenses as your suppliers and vendors pass on their inflationary impact to you.
Conclusion
In 2009 many practices adjusted their expenses, reduced payroll and trimmed inventory levels. Out of necessity most practices are running more efficiently than they were in prior years. As the recovery stretches out, this new frugality may start to impose a psychological burden on you and your staff. You’ve already done the initial pruning, you may next need to look for opportunities to really fine tune. Take some time with the staff to reevaluate work flow, expenses and inventory. Are there areas you can improve with the new staffing levels? Did any cost control measures get missed in the first round? Also tie some rewards to efficient performance. If you have not already implemented a budget, it is more important than ever to do so now and to begin monitoring it weekly or monthly. A budget poises you to make adjustments as the situation changes.
Expect a long, slow and challenging recovery. Clients, staff and owners all experienced consequences of the recession. Consumer spending patterns may be indelibly changed. As the recovery draws out at a snail’s pace you may find that being thrifty and financially vigilant can be fatiguing. Try to alleviate this by focusing your practice on some of the non-financial joys of veterinary medicine.
Author Biography
Karen Simmons, CPA is the owner of Pathfinder Business Analysis, LLC. She focuses her practice on financial consulting to enable veterinarians to manage their practices profitably. Her website is www.PathFinderVet.com.
i "Improvement in Consumer Confidence Ends", University of Michigan Survey of Consumers, February 26, 2010
ii "Improvement in Consumer Confidence Ends", University of Michigan Survey of Consumers, February 26, 2010
Questions or comments? E-mail EconNews@VetPartners.org.
VetPartners is a professional organization consisting of members who consult to the veterinary profession and whose mission is to promote excellence and ethics in veterinary consulting and advising through continuing education, communication, collaboration, and collegiality and to establish and improve business practices and standards. For more information visit www.VetPartners.org
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