Chris Barrow’s Blog

Dear Dentist: Let’s start this conversation with a quick recap of the first three steps we discussed

In Step 1 we looked at creating a personal budget – hopefully you have worked out how much money your business has to produce to give you a financially stress-free lifestyle, for both the present and future.

In Step 2 we began looking at your financial practice data from the last 3 years, based the profit and loss statements and other historical documents produced by your accountant. At this stage, we looked at the figures on a surface level to get an idea of the trends for the past 3 years and pinpoint any changes.

The big question is – does your business actually produce enough money to give you the lifestyle that you want and deserve?

In Step 3 we started to look at the other fee earners in your business – the associate dentists and dental hygienists. The key here is to think about what they really bring to your business financially. Do they actually make you money? If not, how can you improve the situation?

In Step 4 we are going to take a deeper look at the concepts of profit and cash flow, and give you some tips on how to manage your business finances more effectively and prevent the dreaded cash flow crisis.

Dear Coach:

There are a lot of misconceptions about what profit actually is – can you clarify this for me?

Dear Dentist:

Simplistically, profit is what is left after subtracting all the costs of doing business over a period of time. However, it is important to understand the various terms associated with profit, and what they specifically mean to your business.

Gross (or margin) profit is what is left after subtracting all the costs associated with your sales.

Here is the example of an an associate:

Now, we need to take the overhead (or fixed costs) from the gross profit in order to come up with the net or operating profit for the business.

It is the net profit that you pay tax on, and what is left is then available for you to take out of the business for yourself, or use to pay off business debt, future investment in your business, etc.

Dear Coach:

How do we use these numbers to establish a budget for our business?

Dear Dentist:

The key is to keep track of the numbers on a monthly basis. Most dentists employ a book keeper or accountant who gathers all the bills and mysteriously produces a set of accounts at the end of the year – these will breakdown how much profit the business made and how much tax you have to pay.

Unfortunately, these accounts are not a lot of use in ensuring your practice is profitable on a day to day, or month to month basis. The information you receive from your accountant comes too late. It would be like driving a car where all but the rear windows were blacked out, and all you could see is what has already passed.

Dear Coach:

So how do you keep track of your budget on a monthly basis?

Dear Dentist:

By creating a set of management accounts for each month. These accounts will show how your business is doing in all departments – sales, variable expenses, gross profit, overheads and net profit.

With the car analogy, these accounts would act like your instruments or gauges – keeping track of how fast you are going, how much fuel is left, etc. Monthly management accounts are vital to keeping your business on track.

Dear Coach:

How does cash flow fit into all of this? What is the distinction between profit and cash flow?

Dear Dentist:

All businesses need to understand the difference between profit and cash flow. With the car analogy, cash flow would be how much fuel you have, or your level of fuel consumption. When driving a car, you need to think ahead to ensure the have enough fuel to get to your destination – the same theory applies to cash flow in any small business.

Essentially, cash flow is more important than profit – without a steady cash flow, your business will be in trouble. Profit refers to how much money is coming into your business, and cash flow refers to when the money is coming in.

Here’s an example:

To keep it simple, let’s say your business is buying apples from farmers, then transporting them elsewhere and selling them at a higher rate.

You have £1,000 in your bank account to buy £1,000 worth of green apples from Farmer Giles. You pay him cash, then drive to the market and sell the apples to the public, and make a total of £2,000.

The good news is that you have made £1,000 gross profit, and now have £2,000 in your bank account. But of course, this £1,000 is not completely yours – you need to consider all the expenses associated with the sales: the travel costs, the fuel and maintenance of your lorry, the bank charges, etc.

If you are thinking ahead, you know that the whole £1,000 is not yours to spend on whatever you want .This is why management accounts are vital for effective planning.

In terms of cash flow, let’s say you buy another £1,000 of green apples the next week and go to the supermarket to sell them. But this time, you do not get paid right away – the vendor promises to pay you in 30 days, but doesn’t, so you chase him every week and he finally agrees to pay in 90 days.

So, for 90 days, you can’t do business – you have no money to buy the apples. So how do you make living? How do you pay your bills? This is an example of a cash flow crisis.

In this simplistic example, you can see that the timing of when you get the money is very important, even more so than profit itself. In fact, the fastest killer of businesses is lack of cash to pay their bills – this is a cash flow problem.

Dear Coach:

So how do I keep from getting into a cash flow crisis?

Dear Dentist:

This is where the concept of cash flow projections and planning, combined with regular management accounts, keeps a business on track and ready to take avoiding action if a problem arises.

Measuring how much money we need with a cash flow forecast is the key to preventing a crisis. This will allow you to see were the tight spots will occur, and if necessary, go to the bank and arrange to borrow money ahead of time, rather than working from a crisis mode. And of course, once you have started to make surplus profits, you can immediately pay back the bank.

Management accounts can also be used to measure the trends in key performance indicators, or the main sources of income in your business. They also allow you to look at how to produce and keep more of the money that passes through your business (i.e. increase the profitability).

Dear Coach:

Where does this fit as far as running a dental practice in 2005?

Dear Dentist:

It is not unusual for dentists to be in an overdraft situation, and keeping track of both your cash flow and profit on a monthly basis is crucial to getting out of the red. It really boils down to setting a budget and sticking to it. If you decide to buy a new piece of equipment, really think about how long it will take to pay for itself. If you can’t justify the expenditure, don’t buy it.

You also need to look at how you can accelerate the cash flow into your business. Create some incentives to make sure you can get the money up front. For example, you can offer patients incentives, whether it’s a discount or additional product or service, to pay for the larger procedures up front.

Obviously, there’s no such thing as a free lunch, so if you’re going to offer a 5 percent discount, put up your prices immediately across the board.

Summary/Key Points

What is Profit?

Simplistically, the total sales of a business minus the cost of the sales equal the profit. But, businesses need to be familiar with the different types of profit and what they mean.

Gross (or margin) profit is what is left after subtracting all the costs associated with your sales. So for dentists, this would include the associates cut, lab fees, materials, etc.

Net or operating profit comes from taking the overhead (or fixed costs) from the gross profit. And, what is left is then available for you to take out of the business.

Monthly Management Accounts

Monthly management accounts will show how your business is doing in all departments – sales, variable expenses, gross profit, overheads and net profit. It is essential to keep track of all these factors on a monthly basis in order to ensure your business remains profitable.

The Importance of Cash Flow

Profit refers to the amount of money that comes into a business, and cash flow refers to how often the money comes in. In order to be able to pay the bills, businesses need to keep an eye on when the income is coming, and be prepared to deal with times of low cash flow.