Are you as profitable as you think? (Proceedings)

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Are you as profitable as you think? (Proceedings)

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Nov 01, 2009

The Brakke Management and Behavior Study empirically demonstrated the importance to practice owners of understanding the finances of their practices and how few owners really do. Bottom line: The majority of practice owners don't understand financial terms and those that do, make more money. Only half of the group understood "pre-tax profits" and "cash flow." Only 10-20% of the respondents could choose the correct definition of the other terms in a multiple choice format. And it makes a big difference in earnings—Male owners who answered three or more questions right had personal incomes of 7% greater than those who didn't—female owners who answered three or more questions right had incomes that were 19% higher than those who didn't

In addition to the obvious impact on current cash flow, profitability also is a critical determinant of practice value. Historically, practice owners have assumed (and with good reason) that when they decided to sell their practices there would be buyers ready to purchase them and willing to pay a good price. In other words, they have assumed there was value in these businesses that could be transferred to someone else. Of course, there have always been a few practices for which this assumption didn't hold true. A buyer couldn't be found or what buyers wanted to pay wasn't remotely what the seller thought the practice was worth. Typically these practices have been easy to identify and had several traits in common. They tended to be smaller practices with owners who had not focused much on the business side of things. Often the facility and equipment were old and the doctors hadn't kept up with the changes in medicine as much as perhaps they should have. These practices had little profit in them and, because the bulk of practice value is determined by profitability, the practices had little value. Fortunately there weren't too many of these practices.

However, in the last few years, the number of practices with no or little value has been increasing—to the point where the Veterinary Valuation Resource Council of VetPartners (formerly the Association of Veterinary Practice Management Consultants and Advisors) coined the term "No-LoSM practice" to describe these practices. More and more practices, when appraised, did not have the value that would normally have been expected. And, in almost all cases, the owners of these practices were totally unaware of the problem. Some of these practices had traits in common with the practices that have historically had little or no value. They were small practices with a low level of profitability and couldn't keep up with changing client demands regarding service, quality of medicine, advanced technology and improved facilities. The other practices with no or little value, however, were a surprising group. On the surface, these practices would appear to be doing very well. They are located in very attractive facilities, practice good medicine, have all the latest equipment and a large support staff, offer comparatively high compensation and benefits to their employees and, in the owners' eyes, cash flow is strong. However, practice value is largely based on profits and the very factors that make these practices look attractive on the surface are those that are reducing profitability.

Understanding the profitability of a practice is one of the most important concepts necessary to manage a veterinary hospital well. Profitability is the one single number which tells you how you are doing financially. Calculating the true operating profits of a practice is not a simple task. None of the standard financial or management reports a practice usually gets show this figure. Neither the taxable income from the tax return nor the net income from the profit and loss statement represents true profitability. This doesn't mean those reports are improperly prepared; it simply means the reports required by the IRS or accounting standards for small businesses weren't designed to determine profitability. No one report will give a practice all of the financial information it needs to make intelligent operating decisions; unfortunately, the report that seems to be prepared least often is the one that calculates true practice profitability. Because practice owners and managers aren't used to getting this kind of information, they generally don't know what the true profitability of their practice is. The first time many owners realize their true profitability is when their appraiser talks to them about it.