Why is Incremental Revenue so Valuable?
My business is brokering dental practices. My objective is to help my clients maximize the return on their practice investment when they do sell. My blog posts are all about sharing skills and strategies that will ultimately maximize your cash flow and practice value – enjoy.
Before I can explain why incremental revenue is so valuable, you need to understand the definition of incremental revenue as it applies to the business of dentistry. Incremental revenue is the additional patient billings you charge above and beyond your regular billings. Incremental revenue is beneficial because adding it to your current gross does not increase your expenses proportionately. The effect is that a relatively large amount of the incremental revenue goes directly to increasing your net profit. As we will see, just a 15% increase in revenue will increase the profit by over 40%. The reason for this has to do with fixed and variable costs.
A fixed cost is a cost or expense that remains constant regardless of any increases and decreases in revenue. A variable cost is a cost or expense that increases and decreases as gross billings increase and decrease. Examples of fixed and variable costs are as follows:
In addition to fixed and variable costs, stepped costs act pretty much as fixed costs until they make a once in a while change, either up or down. The only example of a stepped cost in a dental office is staff costs. This cost stays pretty constant until you hire a new staff member; the staff costs jump by the cost of a new staff member and then remain fixed until you need to hire another new staff member. The following examples illustrate exactly how this works.
In this example, we have increased the gross revenue by 15%; however, many expenses have remained the same or increased only slightly, about 6.5%. The net result is that the net profit has increased by 40.6% – a 15% increase in the top line and a 40.6% increase in the bottom line (EBITDA).
If we look at the same scenario, however, we increase the gross by 35%, we get an even greater bottom-line increase.
In this case, a 35% increase in gross revenue increases the bottom line (EBITDA) by 94.2%. For all of this to occur, the only real assumption that we have to make is that you currently have a practice that is at least breaking even. This means that none of the incremental revenue you generate will be needed to cover your fixed overhead.
Suppose we assume that practice value is a function of EBITDA (which it is) and the current base multiple is 5.75 (Multiple times EBITDA equals value). In that case, the examples below illustrate the significant impact incremental revenue can have on practice value.
Both of these examples illustrate what a huge difference relatively small increases in incremental revenue can have on both your cash flow and the value of your practice. Looking through our blog posts, you will find information on where to look for incremental revenue and how to actualize it once you find it.
Closing Thoughts: After working exclusively with dentists for the last 40 years I know that every practice has some upside potential and in many cases lots of upside potential. The rewards for finding and collecting your low-hanging fruit can be huge. In my experience virtually any practice can easily increase its bottom line and value by at least 25%. Check back often because there will always be something of value here whether you are selling or not.
Written By: Derek Hill, CPA., CA., Broker of Record