How to Interpret & Utilize P&L Statements
By Ryan Lindgren, VP Acquisitions and Development
Dental schools really don’t educate dentists on how to successfully build practices, let alone interpret financial statements to capitalize opportunities and minimize loses. Most dentists go into dentistry because of their passion for the artistry and patient care. It’s important to remember that at its core – every dental practice is a small business. And to run a profitable practice, dentists need to know how to interpret their profit and loss (P&L) statements. Over the past 10 years, I’ve met with hundreds of dentists who didn’t understand, let alone look at, their P&L statements. While that might seem understandable because dentists are only productive when seeing patients – it’s neither prudent nor advisable. Understanding P&L statements helps dentists not only maximize cash flow – it also helps maximize dental practice sale value.
All P&L statements are based on one formula – Revenue – Expenses = Profit. It’s really that simple! Income is typically shown at the top of the statement, with expenses below, and profit is shown at the bottom. While there may be various subtotals on the statement, the basic formula will always be the same.
Optimize Practice Accounting
Most dentists use accountants or bookkeepers to track their practice expenses (in QuickBooks or similar accounting programs). Either way, you should receive a monthly P&L statement. If your accountant specializes in dental practices, you should also receive data on industry norms for expenses in your area.
TIP #1: Use an accountant that specializes in dental practices. Visit the Academy of Dental CPA’s website to find one close to you!
Dental practice accountants compile their client’s financials into summary data so you can compare your practice against others and understand how & where to improve cash flow. Comparative practice data is one of the most important ways to effectively monitor expenses!
Interpret P&L Statements
The sample P&L statement (to the right) shows income on top and expenses below. Practice expenses are grouped into four key categories – Staff, Variable, Administrative/Fixed, and Occupancy. Every dentist should carefully review and manage each of these four practice expenses.
TIP #2: Pay close attention to the percentage of total income next to each expense line item. These percentages show how a practice is operating vs. industry norms.
The most important line items (typically the largest) are highlighted in light blue. For the purposes of this article, the sample P&L statement categorizes expenses based on practice importance vs. what’s typically shown in a QuickBooks statement.
Staff expenses are the single largest expense of any dental practice. It’s also the one expense dentists can control the most – yet don’t! To adequately manage total staff expense requires a keen understanding of how your practice compares to area practices and industry standards. If your total staff expense exceeds 28% of income, that’s well above industry norms and requires re-evaluation of staffing and/or salaries.
TIP #3: Tie staff salaries and/or bonuses to total practice income. When income is up – bonuses go up. When income drops – bonuses go down.
Pay close attention to dental lab and dental supplies percentage of income. These costs vary based on production. But it’s common to see these expenses rise well over the 14% industry norm. It can happen for a variety of reasons – most commonly from not monitoring suppliers cost over time. Dental suppliers and, to a lesser extent, dental labs have become commodities businesses. That’s why you should constantly be looking for the lowest prices. And here’s where “great” supplier rep relationships might help you negotiate better rates.
TIP #4: Maximize practice leverage for supplier costs savings. Remember 80% of all dental products have minimal differences.
Administrative & Fixed Expenses
Most administrative expenses are fixed or change minimally. What’s important is how administrative cost totals change over time. Annually review administrative costs in comparison to same expense categories over the previous five years. One expense item that should be managed and negotiated on a yearly basis is merchant fees. This is one of the largest expense line items of any dental practice. And it’s also rarely reviewed or re-negotiated. Many dental practices have merchant fees upwards of 4-5% because they opted to process credit cards through services provided within their practice management systems or other “easy to use systems.” Carefully weigh the cost/benefits of using credit card management systems because costs add-up and eat into profits as a practice grows.
TIP #5: If merchant fees are > 2.5% of credit card income – you’re paying higher than market rates for these services.
Occupancy costs are rarely reviewed or re-evaluated by dentists until it’s time to sell their practice. It goes without saying – there are many financially sound reasons to buy rental property (i.e. practice building). Yet the decision to invest into real estate should always be made separate from running a successful dental practice. An important metric to consider before buying property is the percent of total occupancy costs vs. income. The industry average is 3%-5%, so you are in the risk area with anything over 6%. If it’s over 8% you could be in trouble as your occupancy cost is reducing the value of your dental practice. Many dentists buy or build an office with too much space thinking it will be used in the future. There’s a high risk the space will be unused and they’re left paying for more real estate than needed.
TIP #6: Don’t build or buy into expensive office space when an efficient/rented office serves the needs of your practice.
The ultimate value of a dental practice is based on how well it manages cash flow. Managing and maximizing cash flow starts with your ability to understand and thoroughly review monthly P&L statements. By doing so – it ensures you’ll have the needed cash flow to meet retirement goals and get the best possible price when it’s time to sell your dental practice.