business advisor
Discretionary Cash Flow
After paying practice expenses, do you have enough left to live on?

If you are a regular reader of this column, you already know I think the financial picture of an optometrist who nets $150,000 on revenues of $500,000 (a net percentage of 30%) is generally stronger than someone who nets $150,000 on revenues of $600,000 (a net percentage of 25%).

Many practice owners don't understand why the net percentage matters as long as they net $150,000 (or whatever their dollar goal is). After all, isn't the bottom line what really counts? Yes, when talking about the financial side of your practice, profits are important. But so is something I call Discretionary Cash Flow, or DCF.

What is cash flow?

DCF is a term I use to refer to the cash you have left over each month after you pay all your practice expenses such as staff salaries, lab bills, equipment leases, insurance and utilities. Accountants call this free cash flow. In reality, it's neither free nor discretionary because it's the money you have to live on and use to pay taxes.

There is another term that describes cash flow in many practices: tight. The usual symptoms of tight cash flow are far less money in your checking account than your gross would indicate, a need to hold off paying your major lab bills until late in the month and trouble taking enough draw to pay your personal expenses.

Same net, different overhead

Let's look at a somewhat extreme comparison of two sample practices with the same net income to see how profitable practices get into a cash flow bind.

Dr. Redd grossed $900,000 and netted $180,000 (20%) in 2005. His nearby colleague, Dr. Green, grossed only $450,000, but she netted $180,000 (40%). Who do you think is more likely to have a tight cash flow?

On average, Dr Redd's revenues equal $900,000. Divide that by 12, and you get $75,000 per month. Therefore, his practice expenses were $60,000 per month (100% -20% = 80% x $75,000). That leaves $75,000 gross. If you subtract $60,000 in expenses, that equals $15,000 in DCF. That $15,000 is the cushion between all Dr. Redd's practice bills and what he can take out for himself each month. In this case, his ratio of DCF to monthly bills is 25% ($15,000/$60,000 = 25%).

Now let's do the same analysis on Dr. Green's finances. She grossed $450,000 over 12 months or $37,500 per month. Her average practice expenses were $22,500 per month (100% - 40% = 60% x $37,500). That leaves $37,500 gross. Subtracting $22,500 in expenses leaves her with $15,000, exactly the same as Dr. Redd. But here is the key difference: Her ratio of DCF to monthly bills is 45% ($15,000/$33,000 = 45%).

The main culprit

Tight cash flow can be caused by a number of reasons, including slow-paying insurance companies and excess inventory. But the main culprit in most practices is a net to gross ratio of 25% or less.

Can a high-volume, low-margin practice be profitable? Of course! It's a highly successful tactic used by many discount chains. But it's a much more difficult strategy for an independent O.D. to execute. That's because the lower the ratio of DCF to your monthly bills, the more time and financial expertise it takes to manage that type of practice. That means you can make your job as a practice manager much easier by keeping your net margins above 30%.

THE FOUNDER OF THE HAYES CENTER FOR PRACTICE EXCELLENCE AT SOUTHERN COLLEGE OF OPTOMETRY IN MEMPHIS, DR. HAYES IS A REGULAR CONTRIBUTOR TO OM. E-MAIL HIM AT JHAYES@HAYESCONSULTING.COM.