AAHA Economic Bulletin

June 2009

Is Your Practice Financially Healthy?
David McCormick, MS
Dick Goebel, DVM

Abstract:

In order to continue to provide top level service and medical care, you must have a viable business. Understanding the financial health of your practice is paramount to managing and maintaining a successful operation. As the economy has slowed, and the news on television has become grim, you need to develop your plan for financial health.

Where to start? The first step in developing this plan is to understand what is to be measured (profit). The next step is to choose a method to measure your profit and answer the question: “Is your practice financially healthy?”

Understanding profitability

Many practice managers and owners tend to focus on the overt elements of practice health. This frequently includes: a solid client base, a good reputation, providing great service, having an effective team that enjoys working together, and so on. These are important elements but arguably the most important element is often overlooked: your practice’s financial health.

Your practice’s financial health provides the foundation for its future. A financially healthy practice can also better survive economically challenging times. Unfortunately, financial health is frequently ignored due to other day-to-day operations. It is also overlooked because assessing your practice’s financial health involves looking at your practice’s true profitability. This almost always involves more than just looking at the bottom line on your financial statements or tax return.

It is worth noting that “profitability” has a different meaning to a practice appraiser than it does to most owners and managers. DEFINITION: Profit represents the revenues remaining after paying all the customary and legitimate operating expenses of the practice, after paying a fair market rent (even if the practice owner also owns the real estate) and after fairly compensating the owner for his/her work as a veterinarian. The profit of the practice (also referred to as operating earnings or adjusted net earnings) is the owner’s return for owning and operating the business. For ease of comparison with other practices, the profit is generally stated as a percentage—this is calculated as practice profit divided by gross revenue (a.k.a. total sales).

The more profit a practice generates, the healthier the practice is financially. Profit provides for reinvestment in your facility appearance, upgrading the equipment, investing in your staff, and so on. Coincidentally, profit also drives the value of your practice. The more operating profit, the greater the practice’s value. Unfortunately, many practices provide owners with a good job and a comfortable living, but generate little true profit beyond the owner’s salary. In as much as these practices do not produce a fair and expected return on investment, they are of less value.

In the last few years, the number of practices with no or little profit has been increasing—to the point where the Veterinary Valuation Resource Council (VVRC) of VetPartners coined the term “No Lo” to describe these practices. The No Lo profit issue can hit the traditional, small, mom-and-pop practice as well as state-of-the-art practices with a large, attractive facility. The cash flow to the owner may appear strong, but that may not mean the practice has profits. In other words, thinking that your practice is healthy is not the same as actually knowing your practice’s financial health and its true profitability.

Look deeper

Determining the true profitability of your practice may not be as easy as looking at your financial reports. Usually your tax returns or profit and loss statements are developed with a focus on taxes rather than profits. This doesn’t mean those reports are improperly prepared; it simply means the reports were not designed for this purpose. Because practice owners and managers aren’t used to getting this kind of information, they generally don’t know the true profitability of their practice. Unfortunately for many owners, the first time they assess their true profitability is during their exit from ownership when it can be too late to make changes.

Fortunately, there are two ways for you to know your level of profit. The following two paths forward will help you diagnose your practice’s financial health and whether you have a profitability issue or not.

For the “Do-It-Yourself” folks, the VVRC has designed the No Lo Practice Worksheet to help practice owners and managers estimate the profitability of their practices. It can be found at this link.

This worksheet will help determine whether your practice profit is healthy or not. At the end of the worksheet, you will know where you fit in the five categories that range from severe threat of being a No Lo Practice to being a financially healthy practice with no profitability issues. Just as blood-work provides a baseline of what is happening under the skin of your patient, the No Lo Practice Worksheet provides the same for your practice. If you have already used the No Lo Practice Worksheet with your 2007 financial information, we recommend you do so again with your 2008 data. Tracking changes can help identify trends and thereby improve your practice's financial health. Every practice owner should review their practice’s profitability on an annual basis.
For a more formal assessment, you should have your practice appraised. The first step in the practice appraisal is a thorough assessment of the practice’s financial operation and the resulting operational profitability. This analysis is instrumental to the appraisal process and it is a powerful diagnostic tool for the financial health of the practice. If there are issues suppressing your profitability, they can usually be identified and a treatment plan initiated. Contact your veterinary practice appraiser. Tell them that you want your practice appraised – not because you are ready to exit, but because you want the appraisal for management and planning purposes.

In addition to assessing the true profit for your practice, it is also important to take the next step and plan for continuation of profit. Use a simple budgeting process to project revenue, forecast the expenses and thereby the profit. If the result is low, you can take action proactively to increase profit. A reasonable target, according to the VVRC, is in the 13 to 20 percent range. It is wise to have a target or goal for profit. After all, if you don’t know where you are going, any road will take you there.

In conclusion

It is important to regularly review and assess your practice’s financial health. Understanding the profitability of your practice and related factors is critical. Until you have an idea of the root causes of the problem, it is difficult to determine what the correct solution is. Working with the No Lo Practice Worksheet and/or a financial advisor or practice consultant is a step in the right direction. It may help you gain a greater understanding of the issues impacting your profitability. It can also help to identify and implement a treatment plan if needed.

This article is the second in a series of articles provided by AAHA and VetPartners. The next article in this series will provide guidance on identifying the opportunities that exist within your practice for continued improvements and growth.

David McCormick and Dick Goebel are veterinary practice appraisers and brokers with Simmons Mid-Atlantic and Simmons Great Lakes (www.simmonsinc.com). They are Charter Members and Past-Presidents of VetPartners, and members of the Veterinary Valuation Resource Council.

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

AAHA is the only organization that accredits animal hospitals throughout the U.S. and Canada. AAHA-accredited hospitals voluntarily choose to be evaluated on 900 quality standards that encompass all aspects of pet care — from patient care and pain management to team training and medical record keeping. Visit www.aahanet.org for more information.