By Sarina Wijts, CVPM, CVT, CVBL
The first quarter of the year has come to end. You feel like things went well and cannot wait to hear about the outcome. The accountant sends over the quarter review and alerts the owner to the fact that your net profit is down by 3%. The owner asks you to start an investigation to decipher the cause and how to rectify this deficit before the end of the second quarter. Where do you start?
You wrack your brain on what data you would like to collect and conclude that numbers speak truth, you will need to review the practices financial statements. You ask the accountant to send you some information, pull up the profit and loss statement and see a literal sea of numbers. It is so intimidating. Your first instinct was right, numbers speak truth, but how do we learn to READ numbers?
Before we begin our READ - ing session, there will be a few questions to consider. First, which accounting system are you using (Cash vs Accrual Accounting)? Second, how is the Chart of Accounts organized in your Accounting Software? And third, how will you utilize industry benchmarks?
Cash vs Accrual Accounting- Which is recommended?
Cash-based Accounting is when income is recorded when the cash is received, not when the services are performed. Expenses are recorded when the practice makes the payment, not when the expense is incurred.
Accrual-based Accounting is when income is recorded when the service is performed, not when the client ultimately pays for those services. Expenses are recorded when incurred, even if the client still owes the vendor.
Many accountants recommend cash basis for income tax purposes but that is based on the theory that clients owe more to the practice than the practice owes to its vendors. If you require client payment at the time services are rendered (which is recommended) that will not be the case. Therefore, accrual accounting is recommended as the preferred method for the veterinary industry. It will give you an accurate depiction of how the practice stands relevant to revenue and expense ratios at any given point in time.
It is very important to know which method you use, because you may be getting incomplete information if your financial statements are prepared on a cash basis.
Chart of Accounts – Comparing Apples to Apples
The backbone of any good financial management system is going to be your profit and loss statement and therefore your chart of accounts. We will need to ensure that we set up this system to correlate with the available industry benchmarks to compare apples to apples and help us interpret our businesses financial standing.
You will want to break out your profit and loss statement into 5 key categories – Revenue, Cost of Goods Sold (COGS), Compensation, and Operations expense with 2 subcategories for Facility and Admin. It will be organized to first list Revenue streams, remove the expense categories, and then at the end show the businesses profit. If you need to implement a system, there are standardized chart of accounts published for you. You will simply need to adopt the items that your practice will use day to day.
Benchmarking- What does it mean?
Industry benchmarks have become much more prevalent over the last 10 years and they are items which have been collected and reported through published works like the Well Management Practice Reports, the Veterinary Fee Reference and Financial and Productivity Pulsepoints from AAHA.
Benchmarks are created by compiling data from practices across the US and therefore show the averages that can be expected in median form. The way I like to look at this data is as a recommendation and then we can extrapolate the best recipe to fit your practice. These numbers can help us identify opportunities in revenue streams and expense management. Items that may cause variation would be demographics, type of practice, business structure, and the size of the practice.
OK, we have identified our accounting method, verified that our Profit and Loss Statement is organized appropriately, and we understand what benchmarking does. So, let us dive into the details and make some cents out of these practice numbers!
Learning how to read words is conquered in our early childhood years, but the only time that we learn to READ numbers is through extensive education. Here is an acronym that will help us walk through the story that our profit and loss is telling us.
R – Revenue Review
E – Expense Review
A – Adjustments
D – Drive Change
To truly evaluate our revenue, we will first compare our current revenue to previous year trends, then to industry benchmarks. Looking at 3 years’ worth of data will help us gauge growth trends, which are recommended to be 10% growth year over year. When we pull these numbers, we see that each year has grown at a steady rate.
Then we need to evaluate our revenue generation in comparison to benchmarks per FTE DVM and per revenue stream. Those seem to match up as well. So, we are not experiencing a negative trend in revenue.
That means that now we need to turn to our expense review. This is the key to good financial management; we need to control our spending to maximize our net profit. This is also where our Chart of Accounts really comes into play too.
We need to visualize the percent of revenue that is going into each category, COGS, Compensation and Facility/Admin. Our goal is to hit the 20% rule- think of a pie cut into 5 slices. One slice will go to COGS (20%), another to staff compensation (20%), then DVM compensation (20%), one to facility/admin (20%), and we save the last piece for tomorrow (net profit-20%).
This is where we identify the cause of our 3% loss in net profit, our COGS are at 25%!
Now that we have identified the deficit, we need to talk about the adjustments that will need to be made to change the outcome of the second quarter. We set a goal of 22% in the next 90 days and a goal of 20% thereafter.
Now we need to “grab the bull by the horns” per se and drive the change or create our action plan. Cost of Goods sold is a common overage and we decide to utilize a weekly inventory budget, remove any commodity products, and review pricing. We will monitor the impact on a bi-weekly basis during our leadership team meetings.
The items that were put into place cause us to reach a 21% COGS by the end of the year and finish up with an increase in our net profit! The owner is ecstatic. All in all, we learn that numbers are telling a story and if we listen to what they have to say (by monitoring them) we can change our future, make cents of our practice finance and come out ahead in the end. Happy READ – ing!