Hows business? a colleague asks. I dont understand where all the money goes, you sadly reply. I have a good handle on the money that comes into my practice, but I dont have nearly as good a grasp on the money that goes out.

If you are unaware of how much money flows out of your practice and where it goes, you could find yourself in financial trouble.

Here, we will define each monetary aspect of your practice and what percentage of your gross should be accounted for, according to the current state of the optometric profession (i.e., the currently accepted norms).

We will also discuss how you can increase profits by sticking to the numbers.

Remember that these percentages are not necessarily how much you should consider spending. They are benchmarks. In other words, how much you choose to spend depends on your own personal situation.

Cost of Goods Sold
The cost of goods sold, or COGS, is usually the largest single revenue drain in most practices. As the name implies, COGS involves how much you initially pay for the materials you sell plus other expenses, such as the cost of office space used for your contact lens inventory. For example, if you sell a box of contact lenses that cost you $15, your COGS is more than $15.

For accounting purists and other number crunchers, this figure would be more than $15 because there are hidden COGS involvedsomething to keep in mind when managing this number.

One hidden cost: inventory-carrying costs. This is the sum of what you pay for materials, storage space costs, shrinkage costs (i.e., theft) and service costs, such as handling and insurance. For example, after you buy an eyeglass frame for $50 and place it in your dispensary, you will not accrue interest, dividends or any other buying power from that $50 for anything else. There is a loss of the time value of money associated with spending money on inventory. For a $50 frame, this loss is not much. But, for your entire office inventory, the numbers can add up.

Another hidden COGS can be found in your in-office lab. This includes more than the cost of lens blanks and tinting chemicals. Con-sider: When you send work to an outside lab, the lab builds its labor, space and technology costs, plus its profit margin, into what you pay for each order. When you fabricate the glasses yourself, be sure to factor in these costs as well as the cost of materials into your COGS.

Based on the current state of the profession, expect to spend 30% of your gross sales on COGS. Remem-ber, however, that this number can vary and that a higher COGS is not necessarily detrimental. For example, if your dispensary displays more expensive eyewear, your COGS may be higher than 30%. But, if you manage other areas of your practice well, your net income will be higher, too.

Labor Costs
When calculating your labor costs, include your employees salaries and benefits, such as financial bonuses, profit sharing, health insurance, etc.

This total labor cost number is typically around 20% of your grossagain, based on the current state of the profession. As with COGS, however, this number can vary greatly. Suppose, for example, you pay your employees $9.00 an hour, but you are thinking of moving your practice to a metropolis, such as New York City; you will have a hard time finding many qualified employees who will work for $9.00 an hour in New York City.

You might be tempted to increase net income by cutting staff costs. However, you might then find your practice UNDER-staffed.

In fact, the 20% benchmark should often be higher. Why? The highest-performing practices tend to have the highest, not the lowest, labor costs. The old adage, you get what you pay for, applies to hiring good employees. I often tell clients that a flourishing practice requires talented people in the trenchesthose individuals who have continual contact with your patients. Although talent costs money, it also earns money.

How much do you spend on marketing your practice, and how much revenue does your marketing generate? On initial meeting, most of the practices I consult with are spending about 2% of their gross revenues on marketing. This, in turn, generates anywhere from 5% to 20% of total gross revenues.

Even if you currently spend less than 2% of your gross on marketing, you dont necessarily need to spend more. The return on investment depends on the message, media, audience and timing. So, spending more does not equal earning more. In fact, spending more can mean earning less if your message is not well-crafted.

If your marketing efforts include advertising in the Yellow Pages, dont just lump this cost in with the phone bill; the money spent for this advertisement is part of your marketing expense. This is a very
common hidden marketing cost, so make sure you place this expense where it belongs: in this category.

How do you stick to the numbers when marketing and increase your profits? Thats a tough one. The short answer is to increase the efficacy of your marketing efforts. So, instead of generating $2 for every dollar you spend on marketing, try to generate $3. (For more on marketing, see Promote Your Practice More Effectively, August 2005.)

Pearls for Profits
To effectively manage your office by the numbers:

Print out your profit and loss statement each month. Break this down by the major categories discussed here. Compare this statement to the same month in the previous year to look for trends and to set internal benchmarks.

Be able to explain significant fluctuations in your profits. This comes from looking at the profit and loss statements. If you cant explain these fluctuations, you may not uncover costly problems.

If you had a significant decrease in office overhead expenses with a commensurate increase in sales the previous month, find out why and try to repeat it. Or, find out why your expenses, such as cost of goods and services and labor are much higher and attempt to get them under control next month.

Get help. Hire a practice building consultant, financial advisor or accountant experienced in optometry to help you with this process.G.S.G.

Occupancy Costs
This category usually takes about 4% of the average practices gross income. Occupancy costs usually include rent, utilities and common area (the space shared by tenants in your building, the sidewalk in front of a strip shopping center location, etc.) and related maintenance charges.

A new practice will have a fixed occupancy cost but very little gross sales when the practice is started. So, this O.D.s occupancy cost will be higher than 4% of gross revenues. As gross revenues increase, however, this percentage should decrease. Of course, rent escalations built into most leases and increases in taxes will have some effect, but these should be negligible.

Unfortunately, there is no way to increase your profits by sticking to these numbers because once you sign the lease, youre locked in for the term of the lease. If you own your building, though, you might consider refinancing your mortgage to lower your monthly payment.

Technology and Equipment
Most of my clients spend about 5% of their gross revenues on technology and equipment. Thats too low. This 5% typically includes equipment leases or interest on equipment loans, computer upgrades and repair, and new software. But, this usually does not include an amount of money set aside to invest in new equipment that will help grow the practice.

I firmly believe in investing net income back into a practiceespecially when the practice is young. Investments, particularly those in technology or marketing, typically pay huge long-term dividends.

So, if you are a new practitioner, resist the temptation to take extra net dollars as personal compensation. Even if youve practiced for a long time, try to set aside income for ongoing investments in technology and equipment, especially since technology and equipment change rapidly. Also, high-tech equipment can impress patients, which in turn can lead to word-of-mouth referrals.

Aside from your salary and related personal compensation, every other monetary aspect of your practice not listed above goes into this remaining category. This category typically takes 10% of your total gross. It includes office supplies, postage, telephone costs (those not related to marketing), professional fees (e.g., your accountant and attorney) and professional dues.

Often overlooked, this category deserves close attention, as miscellaneous can sometimes turn into ridiculous. For example, Ive had clients whose employees spent inordinate amounts of money on toilet paper and pens, yet the doctor was unaware of this. By careful purchasing, price shopping and careful scrutiny of invoices, you can put an immediate end to this.

Your Personal Net
After youve accounted for all of the above categories, the last one to consider is your personal net income. This refers to the amount of money left over for you. You can reinvest this money back into your practice, or you can spend it on personal items that you will have to pay taxes on.

This number varies significantly and often depends on the age of the practice. It tends to be lower in new practices due to start-up costs. This number may also be lower in older practices in which the O.D. who owns the practice does not invest in new technology or marketing. Your personal net income can also vary by practice location (i.e., city, small town, state) and how well you manage the previous categories.

This category should also include any other items the practice pays foritems the practice would NOT pay if you were not self-employed. These include your health insurance, personal payroll taxes, retirement contributions, etc.

The only way to increase your personal net income is to increase gross revenues or decrease expenses in the other categories. I have seen net income among practice owners vary from as low as 10% in very young practices that continually reinvest in the practice to 45% in very lean and well-run practices.

The personal net category also includes what is perhaps the most overlooked, yet most important indicator, of a practices success. Namely, how hard do you want to work, and how much money do you want to make? This question seems straightforward, but the answer is greatly determined by how you ultimately configure and design your entire office philosophy, processes and systems.

For example, perhaps you work 40 hours a week with $500,000 in gross and 30% net ($150,000). Is your practice performing better or worse than one in which the doctor works 30 hours per week with $600,000 gross and 25% (also $150,000) net? Although the profit margin is less in the second practice, the doctor works less. This second practice probably has higher labor costs to allow the doctor to work fewer hours. This doctor probably decided that the time off is worth paying for and hired extra staff (or perhaps another doctor).

My point? Do not get so caught up in meeting percentages that you can no longer tell the forest from the trees. Keep your quality-of-life index in mind when deciding how many hours you work, how that relates to your personal net and how much you enjoy your practice.

Your practices stability depends on how well you keep tabs on the money that goes out of your practice. But, do not place too much emphasis on meeting the above percentages.

Remember that the percentages presented here reflect the current state of the optometric profession and are not absolute. Even if your numbers perfectly correlate with the norms for the rest of the profession, that does not guarantee that your practice will be healthy, well-run and profitable. Similarly, if your numbers are nowhere near the norms, that does not imply that you are managing your practice poorly.

Translation? How you manage your office by the numbers depends on your personal situation. But, stay on top of all of the money that goes out of your office lest you risk financial problems.

Dr. Gerber is the president and founder of The Power Practice, a practice management consulting company in Franklin Lakes, N.J.

Vol. No: 142:10Issue: 10/15/2005