In over your head with overhead

Dr Michael Sernik, January 2003 - You've been working hard all year, long days, few vacations, your revenue seems quite good but you don't see any significant growth in your savings. Sound familiar? As consultants we hear this all the time. Have a look at your % overhead. If it's 75% and you work 20 days per month, your 1st 15 days are just to cover your expenses! If you take 5 days off, you have to work the next 20 days before you make 1 cent. You could be creating a life where 'work' = worry + interruptions, and 'vacation'= worry without interruptions. How does this problem get so bad? Have you ever bought something and justified the purchase by "one more crown will cover it?" When you spend $1,000 and earn $1000, you have not broken even. You have lost money. Let's review a few terms:

• Revenue = everything you earn.
• Fixed expenses = expenses such as rent, leases, staff costs.
• % Overhead = Fixed Expenses/Revenue x 100
• Variable expenses = lab and supplies.

When you spend $1,000, you will need to earn $1,000 plus an amount to cover the variable expenses incurred in earning that $1,000. If the variable expenses are 18%, the amount you need to earn to cover that 18% is (1000/100-18) x 100. = $121.95. You now need to earn $1,000 + $121.95 = $1,121.95 to cover the expense. Yes you broke even, but you have begun the process of overhead creep. You have forgotten to factor in for profit. In the example above, if your %overhead=50% and if you spend $1,000, you need to earn $1,000 + the amount to cover the variable expense $121.95 + another $1,000 profit (to have a 50% overhead). That's a total of $2121.95! If you do not factor profits into the equation and keep repeating this 'break-even' policy a few more times you will break-even…. till you go broke! Many dentists have, over the years, made a continuous number of 'break-even' decisions without an understanding of the cumulative consequences.

Eventually they will find themselves working harder and harder just covering costs. The numbers are fascinating and frightening. An 80% overhead dentist doesn't begin to make 'take-home' money till Friday on a 5-day week. I believe a 50-55% overhead is desirable for most practices. To calculate the real cost of every new purchase you should follow some simple steps.

• Step 1. Calculate your current %overhead and decide what your desired %overhead should be. This will vary from practice to practice. Generally, if you are in a group practice, you will be sharing some overhead and be able to operate with a lower %overhead.
• Step 2. Control New Purchases. You should examine every expense based on the profits it can create. Look at all new purchases with a clear understanding of the real cost, not the 'break-even' cost. Develop strict criteria for purchases based on lowering your %overhead. Repeat the process for every new purchase to average down your current overhead. The creation of runaway overhead can take years to develop as the cumulative effects take over, so be prepared for the solution to take some time.
• Step 3. Boost Revenue. If your practice is suffering from a high overhead the quickest cure is to boost revenues without increasing fixed expenses. If a practice earns $500,000.00 on 200 clinical days, the hourly rate for an 8 hr day is $312.50/hr. Assume the variable expenses are 18% (18% x 500k=90k) If the Overhead is 70%, the profit=$150,000.00

Look what happens when we increase the revenues by 10%, 20% and by 40%.

A modest increase in revenue creates a dramatic increase in profit and as you can see, the %overhead is also favourably affected. While it may seem a daunting task to increase production by 40% it has been predictably achieved by practices around Australia*. By combining both methods it is possible to correct existing problems and prevent new ones. These methods will result in far more economic freedom and less stress for the Dentist and staff