By the Numbers: How to Use Them & Improve Them
Posted Apr 28, 2011 in Management
Profit is the driving force behind any business. It isn't just what is left over at the end of the month or the end of the year; profit is something for which you must plan. "If you aren't making a profit or don't know where you stand, there is no satisfaction in running a business. That's when laboratory owners tend to get resentful about the industry," says Dennis Carreon, CDT, owner, Naturalistic Ceramics, a five-person laboratory in Long Beach, CA.
Many lab owners pay all their bills and then consider what's left as profit. This is not a systematic approach. "Every laboratory owner should have a sense of his monthly sales, expenses and a specific amount of profit he wants to make," says Ron Ferguson, partner, Ferguson Crown and Bridge, Chesapeake, Virginia. "The first check we write each month is our profit check because we have a clear sense of our profit margin."
If you don't know what to do with your financial reports or you aren't tracking changes in the numbers over time, it's difficult—if not impossible—to know the financial status of your business. Operating a laboratory is like playing a ball game—financial data is the scoreboard that tells if you're winning or losing.
If you are confused by accounting terminology or intimidated by the financial reports you receive from your accountant or bookkeeper, you aren't alone. Many successful laboratory owners admit that getting a handle on the financial aspects of their business took some time.
Some laboratory owners feel they can keep track of their businesses in their heads. However, getting the numbers out of your head onto a piece of paper gives you more control over your business. Greater control means you have a better sense of expenses, productivity, revenue and profit.
Rather than waiting for your accountant to tell you that you have a problem, financial reports put you in a position to take action—cutting costs, increasing production or increasing sales, for example—before it's too late. In other words, taking an organized approach to the finances of your business enables you to pinpoint your strengths and weaknesses and provides you with valuable marketing and customer service tools.
A balance sheet and an income statement are the two standard financial reports you'll receive from your accountant. The balance sheet—comprised of assets, liabilities and the owner's equity—provides a snapshot of the overall financial condition of your laboratory at any given time. (See Your balance sheet below for further information.)
The income statement—also called the profit and loss report, P&L report, or operations statement—is a summary of your income and expenses and determines your profit or loss during a particular period. It is used to quickly pinpoint changes in sales, remakes and costs and determine income tax liability.
When analyzing the income statement, it's important to look at the percentages rather than the dollar figures. Dollars will change from period to period but the goal is to achieve or maintain consistent percentages. By comparing current and past percentages you can determine where costs are increasing or decreasing in relation to all expenses.
There are some standard industry percentages that laboratory owners strive for:
Direct labor and benefits should be between 30-35% of sales; if you combine all labor and benefits, this percentage might go up to 50%. Obviously, the extensiveness of your benefits package can affect your labor percentage.
Material percentages are usually between 8-15%; this may vary depending on the size of the laboratory. "A larger laboratory may have a lower material percentage because it has more buying power than a smaller lab," says Jim Gorgol, CDT, owner, Distinctive Dental Studio, Naperville, Illinois.
But—and this is an important but—percentages can vary depending on how you keep your books and allocate expenses. For example, if you work at the bench, the time you spend fabricating restorations should be a direct labor cost, whereas your "non-producing" time should be a general and administrative expense. "If an owner is looking at a 33% percent labor figure but that doesn't include his time spent at the bench, it's not an accurate percentage," explains Dave Brown, vice president of finance and chief financial officer of National Dentex, headquartered in Wayland, Massachusetts.
"You should think of your time at the bench in terms of replacement cost—what would you have to pay someone else to do the work you are doing," says Brown. By keeping a timecard or a log for several days or a week you can approximate a percentage of time you spend at the bench vs. managing the business and allocate your labor cost appropriately.
The point is to use percentages as a guide. If you are trying to compare yourself to another laboratory, you have to be sure that you are both handling your finances in a similar manner; otherwise the comparison can be misleading.
Ideally, you are receiving a monthly income statement that compares current and past data. "I request my financial reports by the 10th of the month," says Carreon. "If you are getting reports quarterly or semi-annually, you are fooling yourself. The sooner you receive the information, the sooner you can react to problems or identify success."
The first section tells you the amount of revenue you've generated, minus any credits or discounts, and the costs directly associated with producing those restorations, such as technical labor and materials. You want to look at your gross profit percentage, the last line under revenues and cost of sales (Click here for an example of an income statement).
According to industry standards, a 40-48% gross profit margin is indicative of a well-run laboratory. "The gross profit figure is meaningful because if it drops five or 10% from one month to the next, it's your first sign that either labor or material costs are too high or sales are too low," says Carreon.
The next section details your general and administrative (G&A) expenses, costs associated with operating your business but not directly related to producing restorations. This is another area where you should track percentages to see if expenses such as electricity, water, office supplies or health insurance are increasing.
The last line of the income statement is net income or loss, which shouldn't be confused with gross profit. Net income or loss is your bottom line—it tells you how much money you have either made or lost during that period. Again, the net income figure can change significantly depending on how you designate costs and the owner's salary and fringe benefits. For instance, if the owner is paying himself $90,000 a year and leases an expensive car, his net income may be low. If he pays himself less and has a more economical car, his net income will be higher.
The line items on your income statement should be tailored to your business. The more detailed you can make the income statement, the easier it is to identify cost overruns. For instance, rather than one line item for automobile expenses, you might want to break it down into three lines: maintenance, gas and insurance. Although this means more work for your accountant or bookkeeper, it simplifies things for you. "The less you lump items together, the more you'll understand about your business," explains Jerry Ragle, CDT, owner, Ragle Dental Laboratory, Inc., Champaign, Illinois.
You can also calculate your break-even point from your income statement. This enables you to determine your cash flow needs, the profitability of volume discounts and the effect of a price increase, specifically, how much business you can lose if you raise prices and still maintain the same profit level.
The important thing is to study the income statement, see where percentages have changed and determine what factors might have caused those changes. "If our net profit percentage is down, the first thing I look at is the gross profit percentage. If it is over 40%, then I know that our sales-to-labor cost and materials are in line. Then I look at G&A percentages to see what has increased," explains Ragle.
You also have to be aware of one-time or periodic expenses. For example, if you sponsor a free seminar for your dentist-clients, which will be allocated as a G&A expense, it could significantly affect your net profit for that period. Another example is real estate taxes that you might pay twice a year. Or, if you pay your employees on Fridays, you know that four months a year there will be five Fridays in the month instead of four, which will increase your labor costs for those periods. Being aware of these costs and knowing they are coming enables you to plan for them and save accordingly.
Inventory and equipment expenses are other areas to watch. "A small laboratory should only buy what it can use in six months to a year," says Manny Palgon, owner, Vortex Dental Lab, a three-person lab in Coral Gables, Florida. "And just because a new product comes on the market doesn't mean you have to jump on it immediately."
Financial reports: marketing tool
The balance sheet and income statement give you an overall picture of your business. For a more in-depth look, laboratory owners rely on more specific productivity, sales and collections reports. To take a systematic approach to your business, you need to know how much you are producing, how much—and what—you are selling and how much each customer owes you.
The decision to create these reports manually or by computer, or on a daily, weekly or monthly basis depends on the size of your operation and your needs. There are numerous computer software programs, both industry-specific and general, that can be very useful for analyzing sales, production, inventory and accounts receivable.
Laboratory owner Robert Wakitsch generates a weekly report of sales and labor costs per department. For him, the key number is income per labor hour that tells him whether or not the laboratory is being productive. To calculate this figure, he divides total sales by total number of production labor hours; this figure does not include non-productive labor hours. For example, if sales for the week are $22,975 and it took 409 production hours to fabricate those restorations, then his income per labor hour is $56.17.
"To achieve our sales goals, we try to shoot for $52 per labor hour. If we are over that number, we know sales are good and we haven't worked too much overtime; if we are under, sales are slow and/or overtime is high. We need to make adjustments if the figure continues to be out of line," explains Wakitsch, partner, Dental Craft Corporation in Ringwood, Illinois.
With sales reports, it's critical to look at both the sales per dentist and the product mix. "If a client has been sending you $1,000 per month and suddenly the product mix changes—for example, there is no veneer work—then you know he is sending his veneers elsewhere. By looking at product mix, it's a good telltale to see where clients might be changing services," says Carreon.
In addition to helping you internally, financial data offers you tools to help you better service your clients. For example, Wakitsch generates a monthly report of sales per client. If a customer's average sales per month has dramatically increased, he sends a thank-you note. If the number has decreased, he calls to find out if there is a problem.
At the end of the year, he creates a report of sales per client and breaks it down into 5% increments, ranking clients according to their sales figures. This tells him who are his top clients and how much each client brings in. "Sales reports give you the ability to react if there is a problem," says Wakitsch. "They tell us who we are servicing well and whom we need to service better. All the numbers bring you back to customer service."
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