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A balancing act

Use KPIs and financial smarts to drive your practice toward higher levels of profitability.

A balancing act
You need to strike a balance between having enough cash to pay your bills each month and meet unexpected expenses, but not having so much cash that you are not utilizing your assets effectively.

In case you missed my August/September article, “Uneasy Street,” I examined the difference between flying by the seat of our pants as practice owners versus leveraging financial statements and key performance indicators (KPIs) to make educated, intentional management decisions. For those readers ready for a structured, calculated management process and the benefits it brings, let’s pick up where we left off and dive into some of the tools at our disposal.

Balance Sheet

We hear a lot about P&Ls in veterinary medicine — I will address them later — but our balance sheets tend to not get as much attention. Balance sheets reveal assets, liabilities and equities. Assets, including categories like bank balances, inventory and equipment, are found at the top of the page and are listed in order of liquidity. Liabilities follow and include accounts payable, whether short term for bills from a vendor or long term like a mortgage or equipment lease. Equity is the last section and is a product of all assets minus all liabilities.

Balance sheets are useful because they allow us to calculate:

  • Current ratio and “days cash on hand” to evaluate your ability to meet financial obligations. Days cash on hand measures your ability to make payments when due by telling you the average number of days’ worth of expenses you can cover at any given point. You need to strike a balance between having enough cash to pay your bills each month and meet unexpected expenses, but not having so much cash that you are not utilizing your assets effectively. For example, you might want to invest extra cash in hiring another CVT, who will generate additional income, rather than letting the cash sit in your checking account.
  • Debt ratio and debt-to-equity ratio to evaluate how effectively you use credit to finance your operations.
  • Return on assets (ROA) to measure how productively you use your assets to generate revenue. It tells you how many cents of profit you generate with each dollar of assets. A higher ROA means your practice is more productive. To calculate ROA, divide net income by the value of your total assets.

Profit and Loss Statements (P&Ls)

One of my favorite workshops, whether the audience is composed of veterinary students or seasoned practice owners, is a P&L exercise. It starts by reviewing why profitability matters and then transitions into dissecting real hospital P&Ls to identify and calculate KPIs and what they tell us about the health of a clinic.

For those unfamiliar with P&Ls, as I was early in my career, in their simplest form they are an income statement categorizing a business’s revenue and expenses for a given period. As practice owners, we should be able to use P&Ls to:

  • Identify opportunities to generate profit by ethically increasing revenues and decreasing costs.
  • Complement our budget by highlighting areas where expenses need to be tightened or where additional spending might benefit the hospital.
  • Plan for profits, including supplies, capital investments and owner return on investment.

While each P&L line gives us something that could be of value, I tend to focus on these five primary P&L KPIs because they often represent the greatest opportunity for substantial improvement:

  • Gross revenue: The money our hospital brought in during a given period before any expenses are subtracted.
  • Net income: Our practices’ gross income minus expenses.
  • Payroll: All the costs of employing staff, such as wages, taxes, benefits, uniforms and continuing education.
  • Cost of professional services (also known as cost of goods sold, or COGS): All expenses associated with providing the services your practice offers. Expenses within the COGS category include professional services, pharmacy, laboratory, imaging and radiology, dentistry, ancillary products, and grooming and boarding.
  • Rent or mortgage: Does not include facility costs.

Upon identifying valuable KPIs on a P&L, we can begin to benchmark our numbers with national averages. The percentages below represent the share of gross revenue.

  • Gross revenue: The average full-time equivalent (FTE) veterinarian produces roughly $550,000 to $600,000 a year. In a three-FTE practice, I’d expect my doctor-driven gross revenue to be around $1.8 million.
  • Net income: 8 to 10 percent of gross revenue. Top-performing hospitals can see net income as high as 24 percent.
  • Total payroll: Non-DVM staff, 23.7 percent; DVM staff, 21 percent; taxes and benefits, 6.3 percent.
  • Cost of goods sold (COGS): 22.8 percent.
  • Real estate/rent: 4 to 6 percent if leasing or 8 to 10 percent if owning.

Key Performance Indicators

I often have practice owners look at national data and tell me why they can never achieve a profit margin of 20 percent or a COGS of 21 percent. They’ll blame their numbers on their rural location, practice size or client demographics.

While I recognize that different hospital models will have different KPIs, I challenge us to look at KPIs for our model and, if we’re not measuring up, to look for ways to improve. Maybe a 10 percent profit margin will never become 20 percent, but a move to 15 percent will mean big things for the hospital, staff and owner.

P&L KPIs are a product of other benchmarks we can use. Again, recognize that practice models and business philosophies are different.

For example, a high-volume practice might have a much lower ADT (average doctor transaction) than a low-volume, “high-touch” hospital, but the practice could have a similar profit margin as long as the patient volume makes up for the lower transactions. Similarly, even though the average practice brings in 24 new clients a month per FTE, a practice with high client turnover or a low bonding rate might need many more.

For an average small animal general practice focusing on “quality medicine,” I typically reference data from the American Animal Hospital Association’s Financial and Productivity Pulsepoints:

  • Annual revenue per full-time equivalent DVM: $530,805 to $574,639.
  • Average doctor transaction (ADT): $154
  • Average client transaction (ACT): $134
  • Active clients per year per FTE DVM: 1,837

Benchmarks give us something to compare to and maybe strive for, but not every hospital will have the same numbers given their specific model and location. I’ve yet to see a practice that didn’t improve its KPIs when the decision was made to practice thorough medicine, leverage the team and consciously manage expenses. Instead of looking at benchmarks as a competition or ignoring them because “we can’t do that here,” embrace them as an invitation to identify how to improve patient care, the client experience, the team leverage and management’s overall effectiveness.

Practice Information Management Software

My consulting team uses PIMS to review metrics like active clients, client retention and medical ratios. I noticed a decline in new client numbers at one hospital, and my team reported a similar trend at many of our client hospitals. This led us to leverage a client-retention report comparing the number of active clients, the number of new clients, and the percentages of clients lost and retained for different periods.

In our case, we shoot for a tenure of at least 6.3 years based on the formula “current year active client number minus current year new client number divided by previous year active client number equals client retention rate.”

If you run a similar report and don’t find agreeable numbers, ask these questions:

  • How can we improve the customer experience?
  • Are we using forward-booking?
  • How do we communicate with clients and at what frequency?
  • Is our practice growing sufficiently? (Last year, the average hospital grew gross revenue by 5.5 percent.)

Medical Ratios

Medical ratios, another KPI gleaned from PIMS, provide a reality check after a practice owner says, “We practice progressive, quality medicine.” Historically, how do we really know?

Sure, ADTs, ACTS and revenue are telling, but they’re big picture. When I hear veterinarians coaching others about medical ratios, they do it by encouraging other veterinarians to ask if they are providing the services and diagnostics necessary so that each patient who comes through the door is receiving the best care possible. In other words, are they doing everything they can to get a complete picture of the pet’s health?

Don’t get me wrong. I understand that not every client can afford, or even wants, “best medicine,” but if we don’t offer it, we’re doing that client and pet a disservice.

After sitting down with dozens of hospital owners, we elected to focus on four key ratios that we believe contribute to thorough, quality care: nutrition, laboratory, imaging and dentistry.

Ratios are defined as the amount of revenue generated in a particular veterinary service area divided by the opportunity (invoices) to provide that service. To keep the focus from being about money, because ratios are about quality of care and compliance, I recommend displaying ratios with only one digit to the right of the decimal and never with a dollar sign in front. For example, a ratio would never read “$10.50.” It would read “10.5.”

Within that definition, we look at these two types of ratios to capture the essence of quality medicine being a team effort:

  • Doctor opportunity, or doctor touch points with a patient. These include office visits for purposes such as medical appointments and rechecks as well as surgical and dental procedures.
  • Hospital opportunity, or nurse, grooming or boarding appointments.

I’ve seen ratios improve the quality of care in hospitals of all sizes. An added benefit in a multidoctor hospital is that they allow practice owners to eliminate the service gap between associates.

As veterinary professionals and practice owners, we have a choice to make: show up, practice medicine and let the chips fall as they may. Or, as one of the four hospital partners decided in the previous article, we can resolve that flying by the seat of our pants isn’t fair to our patients, clients, team and ourselves. When this happens, it’s time to ask this million-dollar question: “Now what?”

VetPartners member Stith Keiser is CEO of Blue Heron Consulting.