Incremental Revenue – A Series – Part 1
Incorporating Incremental Revenue (“IR)” into a dental practice significantly increases cash flow and practice value. This series of articles will be explaining how IR works, identifying the components of IR and uncovering the areas in a dental practice where IR exists. Our initial focus will be looking at what IR is, why you want it and how you can find it. We will also talk about the necessary components for taking full advantage of IR. The remainder of the series will explain how to find and incorporate IR into your practice.
Practice cash flow, net profit and value can all be significantly increased by adding a relatively small amount of IR to your practice. We will show how increasing your current gross by 15% can increase your Net Profit by over 40%. Increasing your IR by 15% will also increase the value of your practice by over 40%. If you are thinking of selling your practice, you need to understand IR and its effect on your practice.
Whether you plan to sell your practice and would like a higher sale price or would just like increased profit and cash flow, IR is likely your easiest way to accomplish both of those objectives. In case you are not familiar with IR, let us do a little review.
IR is the patient billings that you add to the fees you are already charging. They are billings that your practice charges that are in addition to your regular billings. They result for various reasons and from multiple sources, all of which we will be exploring over the next month or so.
The reason that IR is so beneficial is that adding it to your current gross does not proportionately increase your expenses. The effect is that a relatively large amount of the IR goes directly to increasing your net profit. As we will see, increasing your gross billings by 15% can increase your profit by over 40%. This is because most dental office expenses are fixed. That is, they do not change if the practice generates more (or less) revenue. If you add $200,000 of incremental revenue but only $75,000 of additional expense, 62.5% of the increase goes directly to the net profit. Under normal circumstances, only 20% to 25% of gross revenue goes to net profit (after paying all dentists as if they were associates).
To better understand this, let’s consider the nature of the most commonly used dental office expense categories.
Fixed Expenses: These expenses do not change with any increase or decrease in gross revenue – see the examples below.
Variable Expenses: These expenses increase and decrease proportionately with an increase in gross revenue – see the examples below.
Stepped Expenses: These have characteristics of both Fixed and Variable Expenses. They can remain Fixed and absorb a reasonable amount of increased gross revenue, but at some point, they take a “jump” one way or the other and then stay more or less Fixed until they need to make another jump. Staff costs are considered to be Stepped Expenses and are pretty much the only expense that acts in a stepped modality. Most offices tend to stretch their existing staff as revenues increase, thus working as a Fixed Expense until it is necessary to hire a new employee, in which case it acts as a variable cost.
The following are examples of the fixed, variable, and stepped expense types commonly found in a dental office:
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Applying Incremental Revenue
In general, as the following examples will show, adding a little IR creates a significant increase in the net profit. Unfortunately, the same math also applies when you have an incremental decrease in revenue, which will result in a substantial reduction in net profit. Those practices which have not been able to recover from COVID and are experiencing significant permanent drops in revenue have also experienced large value reductions. To illustrate this point, consider the effect on the net profit and value of a 15% increase, and a 15% decrease, in gross revenue.
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The first example shows the effect of adding incremental revenue equal to 15% of the initial gross. Gross revenue increased by $322,500, but expenses only increased by $105,300, including lab resulting in an increase in net profit (also known as EBITDA) of $217,200. The gross increased by 15% and the EBITDA increased by 40.6%.
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The second example shows the effect of incrementally losing revenue equal to 15% of the initial gross revenue. Gross revenue declined by $322,500; however, expenses only decreased by $105,300, including lab, resulting in a decrease in EBITDA of $217,200. The gross decreased by 15%, and the net profit or EBITDA decreased by 40.6%. In reality, an office would likely continue to keep its full complement of staff employed at least for some time during any “downturn,” which would result in an even more significant reduction of EBITDA than noted above.
Note 1: The ratio of Fixed and Variable costs will vary from practice to practice; however, we took the example above from an actual Hill Kindy client.
The Effect on Value
Practice value is a function of risk and EBITDA (Value = EBITDA X Risk), where risk is a multiple of EBITDA. Assuming the risk factor stays the same, then the EBITDA changes noted above will significantly affect the practice value.
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The examples above indicate that a relatively small increase or decrease in gross revenue can significantly affect the Net Profit (EBITDA) and thus practice value.
In summary, the nature of IR is that a relatively small increase in gross can create a rather considerable increase in net profit and practice value. The takeaway from the above examples is that the effect of positive or negative incremental revenue on Net Profit or EBITDA is huge. A little extra revenue can make a big difference to the bottom line and thus the value of the practice. Over the next month or so, we will examine how you can incrementally increase your gross revenues and enjoy the resulting benefits.
If you would like more about this or any other articles on this topic please contact Derek Hill at email@example.com. If you would like to receive a posting notice for all future articles on this topic or any others, please fill out the information below and click the submit button. For other articles by Derek Hill also visit the Hill Kindy website www.hillkindy.com.