Blog: 8 common cash flow pitfalls to avoid: Part I

Michael A. Kling, OD

The views expressed here belong to the author. They do not necessarily represent the views of Optometry Times or MultiMedia Healthcare.

If an OD has survived in business for more than six years, he has accomplished something that 60 percent of all other business owners have not. According to the Bureau of Labor Statistics, only 40 percent of all businesses survive beyond six years.¹

However, what is often not discussed is the financial struggle that these remaining 40 percent-the “survivors”-endure while running their businesses.

According to the Small Business Administration (SBA), the most common causes of business failure include inadequate leadership, poor cash flow, lack of appropriate marketing, and insufficient capital reserves (such as an emergency fund).² In reality, businesses simply run out of money.

Previously by Dr. Kling: Blog: Put profit first in your practice

While these may be the symptoms for some owners, the real problem is a lack of business acumen for most OD practice owners. Most ODs started their businesses with plenty of ambition, high hopes, and big plans for their practices.

Yet they lack the basic business skills required to develop and execute a well-thought-out business plan. They simply were not trained in the intricacies of managing a small business. And this often results in significant challenges for business, with inadequate cash flow representing one of the greatest threats.

Why cash flow matters
Cash is the lifeblood of business. It is the fuel that propels owners toward a healthy and profitable practice. Without it, they cannot pay the bills, staff, and themselves, or invest for future growth.

Achieving good cash flow is simply collecting money faster than spending it. And that can be difficult in an industry such as health care, in which we often deliver the care before we get paid. Compare that to most other businesses-which collect money first, then deliver the product or service.

Think about the last time you purchased a new set of car tires. You likely did not drive off the lot with those flashy new treads without paying for them. And the tire shop owner certainly did not have to wait 30 to 60 days to get paid.

Related: Lower your financial risk

Cashflow pitfalls
As a business coach, I have had the opportunity to analyze many practices.

The most common question I get is:

“Mick, I’m working hard, yet there’s hardly ever enough money to pay the bills. Where is all the money going?”

In fact, most practice owners struggle at some time with making payroll, covering rent, compensating themselves a decent wage, and servicing the debt on the practice.

Eight common cashflow pitfalls can occur in business. Avoiding them can significantly stabilize, strengthen, and even increase the value of a business.

These include:
• Declining practice ruloevenue
• Cost of goods sold (COGS) too high (usually frame expenses)
• Overcompensated staff
• Excessive rent relative to the size of the practice
• Lack of internal spending controls
• Owner’s compensation too high
• Too much debt
• Lack of capital reserves (emergency fund)

Alone, each of these factors can result in significant cash flow problems. But when more than one act in unison on a business, the owners are in for a wild ride.

In this first of two installments, we will discuss the first four cash flow pitfalls and provide strategies to avoid being in the dreaded cash flow pinch.

Also by Dr. Kling: Blog: How to calculate your compensation as a practice owner 

Pitfall 1. Declining practice revenue
Revenue drives business. And without it, well, there is no business. All businesses occasionally experience a slowdown in income. This can occur for a number of reasons-some of which are within our control and others that may not be.

The most common causes of decreased revenue include:
• Seasonality of the business
• A short month, resulting in fewer clinic days (February, for instance)
• Too many doctor days away for the practice (vacation or work-related, such as conferences)
• Too few exams performed
• Poor productivity per exam (unable to sell enough)
• Poor collection practices (not collecting copays at the time of service, ordering contact lenses without requiring upfront payment, or violating policy of collecting 100 percent payment at time of eyewear order)

So, how does an OD avoid, or at least minimize, the impact of the inevitable slowdown? Have a plan. An OD should know exactly how much he expects to collect each month based on a growth percentage over the same month last year.

Related: Boost sales per patient 

Once the target has been determined, focus the team’s energy for hitting that target. If it is a short month, plan for it. If an OD plans on taking the family to Hawaii for a week, it is important that he build that into his monthly projections.

The key to maintaining revenue is a full schedule, and that is the result of an effective recall system. When the schedule is full, we often step off the gas of recall. When the practice is busy, the system falls to the wayside and gets neglected until the schedule slows again. Then we panic. Our recall system is our pipeline to drive future patients into the practice. When we tap the brakes on this important operational process, we often find ourselves with a light schedule and reducing practice income.

Sometimes we just do not do a good job selling. Everything from second-pair eyewear sales to contact lens annual supplies to referring to our dry eye clinic. Each patient encounter is an opportunity to drive revenue. When we lose focus on the importance of maximizing each patient encounter, we negatively impact the amount of money rolling into your practice.

Finally, even with a full schedule, we often just don’t do a good job collecting money from our patients and insurance companies. We may forget to collect vision plan copayments, order products without requiring upfront payment, submit vision and medical insurance claims too slowly, or have poor follow through on denied claims. Remember, all of these practices significantly reduce the amount of income for the practice.

Related: How to see 50 patients a day at your practice

Pitfall 2. Cost of goods too high
Cost of goods sold (COGS) include what we pay for frames, lenses, contact lenses, and other retail products such as nutraceuticals, dry eye products, or accessories.

Fortunately, most of these larger expenses (ophthalmic lenses and contact lenses) are considered variable costs. That means an OD incurs a cost only once he has sold something.

The only exception to this are frame purchases. And this is where ODs can really get themselves into trouble. While frame purchases are considered a “cost of good sold,” it is actually inventory. Investing in inventory is nothing more than converting capital (cash!) from a bank account into a product, in this case a frame on a shelf, that an OD hope to sell at a later date.

And every day that frame lives on the shelf is a day that cash is unavailable in an OD’s bank accounts. The goal should be to convert that frame back into cash as quickly as possible. ODs need that cash to pay operating expenses and themselves. The problem is, most do not have a plan for investing in their frame inventory. And they often delegate the task of purchasing to someone else (opticians) without guidance or parameters on how much to spend.

Related: 5 steps to maximize your optical profit

Assuming ophthalmic lenses and contact lenses are variable expenses-and an OD has done a good job negotiating the best prices with vendors-the percentage of revenue that these two expenses represent are somewhat fixed. In other words, if the OD is getting the best prices, that percentage will not change much.

If ODs sell more, their costs go up accordingly. Frame expenses, however, can occur independent of sales. For instance, a practice could experience a slow income month yet spend a fortune on frames.

This is where guardrails are needed to keep from flying off the track. I have found that if we keep our frame expenses below 10 percent of revenue, we can keep our overall COGS below the industry average of 28 percent. If we allow frame spending to creep higher than this, we are almost guaranteed to see our COGS get out of control.

My lead optician and I have devised a simple strategy of budgeting 8 to 9 percent of the average of the last two months of total practice revenue toward future frame purchases. This allows us a little wiggle room for the unexpected and gives my team clear guidance for investing in our frame inventory.

Related: Simple strategies for a success frame board management

Pitfall 3. Overcompensated staff
A business is nothing more than the people who work in it. Remove the people from any business, and all you have is an empty building with products and services unable to sell themselves. An OD’s people are his most important asset-investing in them is critical to success. However, there is a limit to how much businesses can afford to pay its people.

When too much capital is tied up in people, the economics of an optometry practice simply no longer work. And one of the most common causes of this is salary creep. Salary creep refers to legacy employees, those who have been with us for years, who may no longer be providing an appropriate return on our investment in them.

Almost every well-established practice has at least one legacy employee compensated at a rate outside of fair market value. It happens because we begin to base compensation on emotion rather than on our business’s needs.

“But Betty is so sweet and loyal. She’s been with me for 10 years, and she knows all of our patients by name.”

That may be true, but she is probably not worth $35 an hour!

Related: How staff can help differentiate your practice

Maintaining staff costs at or below 25percent of overall income is critical to ensuring that the math works. When people costs exceed this, it is difficult to run a profitable practice.

I have found that when the average hourly wage of all employees exceeds $18 an hour, it is practically impossible to keep payroll costs below 25 percent.

Take a minute to add up the hourly wages of all employees, increase that number by 10 percent to account for payroll taxes, then divide that number by total number of full-time equivalent (FTE) employees. (This assumes an OD’s practice is adequately staffed with one FTE per $150,000 of practice revenue).

If an OD has exceeded an $18 per hour average, he is likely having difficulty keeping his people costs below 25 percent of revenue.

And I will bet there are one or two legacy employees who are compensated at a rate pushing this average too high. An OD’s people are important. This isn’t to suggest that the team should not be compensated fairly. Just keep in mind that every dollar in a practice has a purpose, and the practice needs to keep people costs in line to maintain practice profitability.

Related: Know how to manage your staff

Pitfall 4. Occupancy costs too high
I recently saw a patient who works for the Jack in the Box restaurant chain. His job was to turn the majority of its locations into franchises. He once told me that the number one metric for determining if a new franchisee would succeed was the ability to keep occupancy costs around 7 to 8 percent of revenue.

Just like people costs, facility costs must be contained to ensure we do not find ourselves in a cash flow shortfall.

According to the Management and Business Academy (MBA) data, a typical optometry practice spends 7.1 percent³ on occupancy costs.

Related: Why ODs need a business strategy 

I have found there are often two scenarios that lead to overspending on office space.

The first is a smaller practice (less than $600,000 in annual revenue) in a strip mall setting. ODs often set up shop in local strip malls that command a higher retail rental rate. This often leads to occupancy costs exceeding 10 percent and-in some cases-more than 15 percent of revenue. When occupancy costs are this high, it makes it practically impossible to keep expenses in line.

The second scenario involves biting off more than an OD can chew when it comes to the size of a practice location. An example would be that same $600,000 practice leasing a 3,500 square-foot office building.

While nice to have, an OD probably does not need all that space to run the practice. (A similar situation is an entrepreneurial minded OD buying a building and overspending on renovations).

In both cases, the OD owner has taken on more occupancy costs than the business can afford.

We will discuss the remaining four cash flow pitfalls in the second installment: 8 common cash flow pitfalls to avoid: Part II.

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References:

1. U.S. Bureau of Labor Statistics. Survival of private sector establishments by opening year. Available at: https://www.bls.gov/bdm/us_age_naics_00_table7.txt. Accessed 6/26/19.
2. U.S. Small Business Administration. Market research and competitive analysis. Available at:
3. Essilor of America. Key Metrics: Assessing Optometric Practice Performance & Best Practices of Spectacle Lens Management Report. Available at: https://www.sba.gov/business-guide/plan-your-business/market-research-competitive-analysis. Accessed 6/26/19. https://ecpu.com/media//wysiwyg/docs/ECPU_MBA_KeyMetricsReport_2018.pdf.