Many good businesses have been undone by cash flow problems. For any potential practice owner, it is important they understand cash flow before embarking on ownership.
At its core, cash flow is defined as the amount of money going into and out of your business at a given time. When there is more money coming in than going out you have positive cash flow and vice-versa for negative cash flow. It’s application to service businesses such as dentists is somewhat different compared to product based businesses.
Typically, the average product based business will purchase products to on sell. They will purchase these products before being able to sell them. Many suppliers may not offer payment terms to new businesses and payment may be due on purchase of the products. It may take time to on sell these products and receive money to cover the initial purchase. In the meantime, the business has to pay staff, rent, utilities etc. Some of these businesses will have no additional cash or capital reserves and will rely on the products being sold to meet their payment obligations. If the products take too long to sell or do not sell the business will run into cash flow problems. That is, they do not have enough cash to meet their payment obligations. Essentially, it is a timing problem. The business may have been profitable on paper with the goods being sold for much more than they were purchased for and any associated expenses. However, a slow month with sales lacking can quickly become a large cash flow problem and lead to insolvency.
In a service business such as dentistry this timing problem is less likely. The reason is that our cost of goods (composites, bonds, gloves etc.) are much lower than our sales income. Consumables typically make up 5-10% of the total business turnover. Further, our suppliers usually afford us 30day payment terms, even to start-ups. Dental practices usually have very little bad debtors and most do not offer in house payment plans to patients. As such, we receive income immediately after a service or procedure is performed.
Nonetheless, perhaps the most important aspect of cash flow in dentistry relates to servicing debt obligations. That is, when one is purchasing a dental practice and looking at its profit and loss statement they may see a certain profit amount. This profit amount does not consider debt repayments. A dental practice may be making $150,000 in profit. However, they may have borrowed 1 Million to purchase the practice and the bank may ask them to repay say $200,000 per year (these are just made up numbers for the purposes of this article). The owner will need to put in $50,000 per year into the business to repay the debt. Hence, even though the business may be profitable the owner will be considered to be in a negative cash flow position. Yes, they will be paying down the debt but they do need to account for this negative cash flow and if they’re willing to put money into the business. Depending on how long the debt is taken over this may go on for many years until it is repaid. This is the reason that many practice owners say the first few years of ownership is the toughest as they are probably not increasing profit substantially and still need to meet their debt obligations. As the profit increases and/or the debt is repaid cash flow becomes much better.
For any associate looking to start-up or purchase a practice it is important to do this cash flow analysis prior to committing to ownership. Your financier will be able to indicate the repayment amounts and combined with the current profitability when purchasing a practice or a predicted profitability for a start-up you will be able to see how much (if any) you will need to put into the business from your own personal cash to sustain it.
Cash flow analysis is also important for current owners to plan and forecast. Whether it’s purchasing a new piece of equipment or expanding the clinic, a proper cash flow analysis is imperative. Once the numbers are visualised the decision typically reveals itself.
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We’re holding our 3rd Dental Practice Owners Conference (DPOC2023) in October this year. This is the premier event for practice owners and not to be missed. We have an amazing line up of speakers as well as spectacular events planned. There will also be a trade show with exhibitors from the major dental companies present providing conference only specials. The learning and networking opportunities will be immense. Please see the link below for more information.
Also, our next practice ownership seminar is coming up in Brisbane on the 18th and 19th August 2023. This seminar has sold out in previous years – please register ASAP to avoid missing out.
We also offer expert guidance in various areas of practice ownership. Please see the below link for more information.