When it comes to increasing the bottom line of your Profit and Loss (P&L) statement, you have options. You can take the approach of focusing on expense management, or you can focus on increasing revenue. Which do you choose?
Trick question; you don’t. Both have an impact on your bottom line. The correct question to ask is which should you focus on first? Let’s look at two scenarios.
Scenario 1: Jack decides to increase profitability using the revenue approach
Jack manages a $2 million-a-year practice that is currently operating at 7% net profitability (bottom line). He wants to boost his net profit by increasing the clinic’s revenue. Currently, for every additional dollar in revenue he brings in, he gains 7¢ in net profit based on his bottom line. Jack has bigger goals though.
Ultimately, he wants to operate at 15% net profitability, which he is far from achieving. In this scenario, if he wants to increase his net profitability from $140,000 a year (7% of $2 million) to $300,000 (15% of $2 million) he will need to increase his revenue by $2.3 million, at 7% net profit.
Scenario 2: Jack decides to increase profitability using the expense management approach
Jack manages a $2 million-a-year practice that is currently operating at 7% net profitability (bottom line). Rather than focusing on revenue, he wants to increase his net profit by focusing on expense management.
Looking at his P&L, he notices that his cost of goods sold (COGS) are currently at 28%, and that his total payroll, including all staff, benefits and taxes, is at 48%. Given industry standards, Jack sees that he should be able to reduce his COGS to somewhere between 21-23%, and total payroll to around 43%.
If he manages to achieve this, he’ll be able to add 10-12% to his net profit. Even without increasing revenue, he’ll be boosting his total net profit up to somewhere between $340,000 – $380,000.
What should Jack do?
As we learned in scenario 2, Jack’s expense management system is essentially broken. If he leaves his system as it is and focuses solely on increasing revenue, he’ll continue to earn just 7¢ of net profit for every dollar of revenue he brings in. If, however, he focuses on fixing his system before increasing revenue, he will have a much larger impact on the financial health of his practice.
By undertaking scenario 2 before he undertakes scenario 1, Jack will add short-term profit to his practice and maximize his long-term revenue increase. Once the expense management issues outlined in scenario 1 are under control, he’ll be able to add 17¢ in net profit for every dollar of revenue.
In short, while you do have options when it comes to increasing profitability, these options deliver very different outcomes. You can:
- Drive more revenue into a broken expense management system, and get less out of it; or
- Fix your expense management system prior to driving more revenue into it, and get more out of it.
I think we can all agree that Jack needs to go with option 2.
3 ways to get a better handle on your cost of goods sold (COGS)
When looking at expense management, [bctt tweet=”COGS and payroll tend to be the culprits of most under-performing systems.”] Given these are typically the two highest expenses in a practice, they can be a little challenging to manage. Of the two, the easier one to tackle is COGS.
[bctt tweet=”What should you look at if your COGS are higher than 21% (industry standard)?”] I’m glad you asked. You need to consider these questions:
- Do you have a monthly budget for ordering?If not, you need one. Take the previous month’s revenue and multiply it by 0.21. There’s your 21% budget.
- How much product do you order at any given time?Most managers respond to this question with, “I don’t know, but I know how much we go through,” but you should know. The answer should be a month- to a month-and-a-half’s worth of product. If you have two- to three-months plus of product sitting on your shelves, you’re potentially looking at upwards of $30,000+ of excess inventory. In Jack’s practice, this would add 1.5% (excess inventory divided by revenue) to his bottom line.
- Are your codes set up appropriately? Is your pricing accurate?“Yes, I increase my prices as they go up from the manufacturers/distributors,” you may say. That’s great, but it doesn’t mean your codes are correct. From setting up appropriate minimum fees to incorporating injection and prescription fees into your practice codes, take the time to get your set up right.
Are you ready to drive more revenue into your system?
My suggestion is to wait until you’re able to check all three boxes above as only then can you be sure you have an effective inventory management system in place and are maximizing your COGS.
Want to monitor the impact of your pricing adjustments and see just how much your revenue-generating initiatives are bringing in? Check out the VetSuccess Practice Overview Report. It delivers incredible insights into the economic health of your veterinary practice.
Brandon Hess, CVPM is an Associate Consultant with Tassava Consulting and a founding member of the Southwestern Ohio Veterinary Management Association. He can be reached at [email protected].