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As the U.S. Small Business Administration (SBA) states, the most common causes of business failure in any industry are inadequate leadership, poor cash flow, lack of appropriate marketing, and insufficient capital reserves.1
In other words, businesses often run out of money.
In the first installment of common cash flow pitfalls-8 common cash flow pitfalls to avoid: Part I- we identified the first four pitfalls OD practices may face, as well as strategies to avoid being in the dread cash flow pinch.
The first four pitfalls included:
1. Declining revenue
2. Cost of goods too high
3. Overcompensated staff
4. Occupancy costs too high
In this second and final installment, we explore the remaining four pitfalls OD practices want to dodge.
Also by Dr. Kling: Blog: How to caluclate your compensation as a practice owner
Pitfall 5. Poor spending controls
Just about every practice has some form of wasteful spending. Although ODs would like to think they run lean operations, the fact is that most have buried expenses they are unaware of.
Reducing our operating expenses requires hard work, discipline, and commitment to running a business more profitably. An OD can achieve this by taking a hard look at every penny he spends to run the business.
He will likely find surprises: unnecessary expenses, wasteful spending, or overpaying for things that could be renegotiated for a better price.
Start by making a list of all expenses from the last year. This information can be found on the business’s profit and loss (P&L) statement or from the practice’s accountant.
Place a P next to all expenses that directly result in a profit.
Place an R by the expenses that could be renegotiated for a better price or replaced by another vendor (with the goal of saving money). Contact the practice’s vendors and have an honest conversation about the need to get the best price possible-otherwise, an OD should be prepared to move his business to the competition, if needed.
Finally, place a U next to all expenses that are unnecessary to running a profitable business. Cut these expenses out immediately. An OD could find himself saving a couple hundred dollars a month ($1,000 to $2,000 per year) on things that are not necessary to running a business.
This exercise will take time, but ODs could discover hundreds-if not thousands-of dollars of savings each year simply by challenging every single expense in their businesses.
Related: Know what practice metrics to measure
Pitfall 6. Excessive owner’s compensation
OD owners often take too much compensation out of their practices to meet personal lifestyle needs. This may not be in the form of a salary but by using the business bank account as a personal cash machine.
Pulling money out of the business indiscriminately or using the company credit card for trips to Costco, meals unrelated to business, family vacations disguised as continuing education, and jumbo packs of toilet paper that end up at home are common-they are nothing more than additional owner’s compensation.
These extra costs can place an additional burden on the business, making it difficult to meet other operating expenses such as cost of goods sold (COGS), employee salaries, and occupancy costs.
It is important to understand that there is a limit to what businesses can afford to pay employees. ODs paying themselves a “fair market wage” (what they would pay someone else to do the work they are doing) is important to maintaining the fiscal health of the practice.
Avoid the temptation of burying personal expenses in the business. Not only do practice owners run the risk of getting the attention of the Internal Revenue Service (IRS), but they also complicate their P&L statements, making them less useful for determining profitability in the practice.
If an OD is not sure what he can (and should) pay himself, he should contact his tax professional. That person should be able to help determine a reasonable compensation that won’t stress the business.
Related: Debt management tips for ODs
Pitfall 7. Too much debt
One of the greatest enemies of an OD practice is debt. The optometric profession has evolved over the last 20 years with new technology that allows ODs to provide a high level of patient care.
Unfortunately, new technology costs money. And it is easy to get tempted by all this new technology. When coupled with low interest rates, an OD can find herself caving to this temptation and slipping into more practice debt without considering the potential negative impact on the business.
When considering any new technology, ask these three questions:
• Will it improve cash flow?
• Does it improve efficiency in speeding up the exam process or making the diagnosis faster and easier?
• Is it good for the patient?
If all three of these criteria are met, an OD should likely to make the investment. If only two of these are met, he should still consider it-however, give it significant thought before making the commitment.
Always remember the potential impact on cash flow before investing in new technology in the practice. Making purchasing decisions based solely on improving patient care can put businesses in financial jeopardy.
Related: Why ODs should embrace new technologies in eye care
Pitfall 8. Lack of capital reserves (emergency fund)
Years ago, before I graduated from optometry school, an OD mentor told me “...the thing about optometry is, you’re only one month away from bankruptcy.”
Although it did not make sense at the time, it is now clear what he meant. Most ODs keep less than one month’s operating expenses in their business bank account at any given time. This could spell disaster in the event of an unforeseen event such as fire, flood, theft, or illness.
I learned this lesson the hard way.
A few years ago, I arrived at my office and noticed what appeared to be fogged windows in the entryway. As it turns out, a water pipe in one of the patient restrooms ruptured the night before and left 4 inches of standing water throughout the entire office.
Related: How private equity affects optometry
To make matters worse, we learned that the building contained asbestos and would require a major remediation. We closed the office for several weeks as the repairs occurred and made the best of the situation. Then came the battle with the insurance company.
While the repairs only took a few weeks, it took months before our practice saw the payout from the insurance company. Fortunately, I had previously established a line of credit (LOC) with a local bank. This allowed us to continue to pay our employees until we could reopen. While these events may seem unlikely, they can occur every day in businesses all over the country.
So, how much of ODs’ hard-earned capital should be set aside for emergencies? That depends on an OD’s risk tolerance and ability to access cash when needed.
A good rule of thumb is to set aside at least two months of operating expenses in an easily accessible cash reserve account. A banker once recommended to have between 5 to 7 percent of one year’s annual revenue in cash at any time.
That might seem like a lot, but this not only helps cover any unforeseen emergencies that may occur but also serves as a resource for an additional cash infusion should a practice experience a significant cash shortfall.
All practice owners experience tight cash flow at some point along their business journeys. Understanding the common pitfalls that can occur-and taking action to avoid them-will help alleviate the burden and stress of managing the cash in any practice.
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