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HomemibusinessFinancial Statements 101 Basics for Practice Success

Financial Statements 101 Basics for Practice Success

You could easily be mistaken for thinking financial statements are just for accountants, however the truth is, they’re also critical to your practice success. To provide continued patient care you need to maintain a profitable practice, and the best way to do that is to maintain a scorecard that shows how well your practice is performing financially.

All too often we’ve seen practice owners gauge the financial performance of their practice based on their ‘cash at bank’ position. But this is not a true indicator of how well a business is performing, as it fails to take account of numerous other factors, including capital expenditure, Government grants/support (e.g. JobKeeper), increased sales and decreased GP margins, and excessive wages costs that are not commensurate with increased turnover, to name a few.

Preparing accurate financial statements on a timely basis (usually monthly) is critical to monitoring the financial performance of your practice. By reviewing them against, inter alia, budget, prior years’ results and KPIs, you’re able to identify what you’re doing well and what you’re not, and make changes as required to keep your practice on track for success.

CLEARING COMMON MISCONCEPTIONS

You may ask, “Don’t we just do all that at tax time, when we sign what the accountant puts under our noses?”. If you do, you’re doing it wrong.

If you’re waiting for that once-a-year meeting with your accountant (often six to nine months after the end of the financial year) to find out you’ve made a profit and how much tax you owe, you’re really not watching your business closely enough. By then, the damage is potentially done. Underperforming practices and lack of corrective action(s) could cost you a loss of gross margin, sales volumes, market share, or a blow out in expenses and/or staff turnover.

Management Accounts vs. Annual Financial Statements 

Monthly management accounts (your monthly profit and loss statement and balance sheet), produced from accounting software such as MYOB or Xero, show the financial results for the month just passed, and should be compared to budget to identify any significant (>10%) deviations. This will allow you to ask why the deviation happened, and then take corrective action.

Management accounts are generally used by managers inside the organisation to help make well-informed business decisions. Annual financial statements, on the other hand, are often used to provide financial information to parties outside the practice (such as banks when we’re applying for finance).

Both sets of financial reports will have:

  1. The Balance Sheet 

This is essentially a statement of position (or snapshot), at a given point in time (often 30 June, which is the end of the financial year). It tables the assets (things you own) less the liabilities (things you owe) to equate to the shareholder’s equity (or net worth) of the business.

  1. The Profit & Loss Statement 

This shows the profit (or loss) your business has made for a specified period, usually for a month that has just transpired, or for the full financial year. It’s calculated by starting with your sales, then deducting your cost of goods sold (COGS) to give your gross profit (GP). From there, your expenses (fixed and variable) are deducted from the GP to arrive at your net profit (NP).

INTERPRETING FINANCIAL STATEMENTS

Your financials are the window to seeing just how well your practice is performing financially. The top five things to take away from your practice financials include:

  1. Current Ratio 

This essentially measures the ‘solvency’ of your practice, and is calculated by taking your current assets (things that can be converted to cash within one year, such as stock and debtors) and dividing this by your current liabilities (bills that are expected to be paid within one year). A ratio of less than 1.0 suggests the practice has more debt to repay in the coming year than it has assets to meet those debts. This is a critical ratio, and should be highly respected.

  1. Gross Profit Ratio 

This relates to the profit directly generated from consultations and sales of product. As mentioned above, it is computed by dividing your GP by total sales revenue. GP ratios differ by practice, based on the level (standard or quality of stock) you carry, your pricing, and your cost of product/consultation time. As a general guide, GP percentages of 70 – 80% would be the norm for an Australian practice (again, this varies between individual practices). GP can be increased by reducing your COGS, which may include pursuing higher discounts on inventory, reviewing freight costs and tying salaries to the number of patients seen. Minimising stock theft and remakes can also assist here.

  1. Net Profit Ratio 

This is the NP (bottom line profit, after all expenses) expressed as a % of your sales. It’s important because it helps you monitor the net return from every dollar sold, and is a key measure of practice profitability.

  1. Average Stock Aging 

Average age of inventory indicates the average number of days it takes for a practice to sell its inventory balance, and can help you decide, for instance, on the number of frames you need to hold in your inventory. It’s calculated by dividing the average inventory balance by the COGS and multiplying it by 365. It’s an important ratio to monitor, as it helps correct pricing, identify marketing strategies (e.g. discounts and promotions) and detect stock obsolescence.

A stock turn of three times per annum is considered average, but may be higher in larger practices. This number can help you decide on the number of frames you need in your inventory, as well as help determine optimal inventory ‘mix’.

  1. Staffing Costs 

This is usually the largest variable (controllable) expense of any practice. Our team members (I prefer ‘team’ over the use of ‘employee’ – there’s a big difference here) are our biggest asset, and if we get the wrong team on board, with a wage bill not generating sufficient sales revenue, this can make or break a practice. You can expect your employment costs (including salaries/ wages, superannuation, bonuses, training, uniforms and incidentals) to sit at around 15–35% of total sales revenue.

NOTES TO THE FINANCIAL STATEMENTS

The profit and loss statement and balance sheet don’t provide all the information you need to know. The accompanying ‘notes to financial statements’ provide a better understanding to help properly evaluate the practice’s performance and financial position. Further details around key items, such as the level of inventory held, receivables, fixed assets, current payables (creditors), lease commitments and financial liabilities to the banks, are all set out in the notes – they tell a story, and it’s important to read this detail.

OTHER KEY PERFORMANCE INDICATORS

There are many, many other key performance indicators (KPIs) that you should be watching closely to ensure the growth and success of your practice, and not all of these come from your financial statements. Perhaps we’ll cover these off in another article, but some to keep an eye on include:

– Total number of patient visits – this can be used to track daily or monthly visits, and number of patients seen by the optometrist/dispenser,

– Total number of new patients per month – used to help track practice growth,

– Cancelled (or ‘no-show’) appointments – if this is increasing, you need to ask why?, and

– Debtors (receivables) and creditors (payables) aging – this helps manage your cash flow if receivables are ‘blowing out’ to 60 and 90 days to collect. Prompt payment discounts for creditors who within 30 days can help (some suppliers offer this).

CONCLUSION

In short, you simply must review your monthly management accounts, as well as your annual financial statements, on a regular basis. Think of maximising the financial performance of your practice in terms of a ‘leaky bucket’ – you want to maintain the profit (volume of water coming into your bucket) by maximising your sales and GP margin, while minimising your expenses (holes letting the water out)…and you need to keep a close ‘eye’ on it…

Paul McKinley is the Managing Director and resident Chartered Accountant of Optometry Finance Australia, an independent finance broker that works with optometrists Australia-wide. With over 30 years relevant commercial experience in the finance, automotive and accounting industries, Mr McKinley specialises in commercial funding with a strong focus on personalised client service and retention. Visit optometryfinance.com.au.