Managing Cash Flow

It’s not enough to make more than you spend—practices must also keep a close eye on cash flow.

Managing Cash Flow

Managing cash flow is a challenge for all small-business owners. But with proper planning and insight, cash flow crunches can be avoided. Cash flow planning—or forecasting—starts with a budget. A surprising number of practices do not work with budgets, perhaps because the idea of creating one can seem overly complex. Yet budgeting does not need to be an extensive process. Existing practices can look at their historical data and use that to make a simple projection of revenue and expenses.

Most expenses are known—or fixed—and therefore easier to project. These include rent, salaries, malpractice insurance and website costs. Other expenses are variable based on production and sales. These include inventory such as fillers, sutures and equipment disposables. Forecasting revenue is naturally more difficult than determining fixed costs. A simple rule of thumb is to under-project revenue and over-project expenses. This conservative approach leads to far fewer headaches in managing cash flow.

Creating a Cash Flow Budget

A cash flow budget begins with projected revenue. An established practice can look back two or three years to get the best estimate of how it will perform going forward. All things being equal, it is advisable to project income at 5% to 10% less than the previous year. If the previous year was a “banner year,” average the prior three years to project revenue. For physicians starting out in private practice, it is prudent to seek outside assistance from advisors with experience in your specialty when anticipating costs and revenue.

Next, the practice must project expenses—start with last year’s figures and determine if they should be adjusted. For example, salaries are based on the projected number of staff and include the cost of benefits; therefore, practitioners should watch for increases in health insurance as those expenses generally increase annually. Rent, on the other hand, should be a known number.

Variable expenses are tied to projected sales. Again, look at the practice’s historical data for guidance. One strategy is to multiply the cost of a product by the projected number of units sold; another method to determine projected cost is to multiply the revenue by the markup amount. For example, if skincare products are marked up 50%, then multiply the projected revenue by 50% to estimate the cost. Don’t forget to budget for planned, non-recurring expenses such as equipment purchases, upgrading the computer system and/or new carpet for the office.

Preparing for Gaps in Cash Flow

Anticipated seasonal variances must also be factored into the budget. Therefore, preparing a monthly budget is wise. If August is historically the practice’s slow month in terms of revenue, a natural cash flow deficiency may occur. With proper planning, cash can be held back each month to prepare for more cash-lite months.

One mistake physicians often make is bonusing out all of the cash to themselves. To build a cash reserve, start by not distributing all the cash to the owner(s). A prudent approach to physician bonuses is to take revenue minus expenses, less a cash reserve. The reserve needed will vary from practice to practice but, generally speaking, one month’s expenses in reserves is safe.

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If employees are paid every other week (i.e., bi-weekly), a three-pay-period month can cripple the practice’s cash flow for that month. This should be taken into account when preparing the budget. If possible, move to a semi-monthly payroll (twice per month) to even out cash flow. Semi-monthly payroll periods end on a specific day of the month (e.g., the 5th and 20th, or the 1st and 15th). Not all states permit semi-monthly payroll, and managing overtime is more challenging with this schedule. Overtime is calculated based on one work week. Therefore, when a semi-monthly payroll ends before a work week ends, it will require a more complex calculation of overtime. As long as the practice has a mechanism to track overtime accurately, then a semi-monthly payroll is feasible.

Excess inventory of skincare products can also create cash flow woes. Special deals, such as “Buy two and get one free,” are attractive incentives that often lead practices to stock up—but if the inventory isn’t moving, then the practice has sunk cash into products that aren’t generating revenue. Practitioners might be offered a “smoking deal” on injectables if purchased in bulk, but the real question is, “Will I reasonably be able to use the injectables before their expiration date, and do I have the cash flow to purchase these large quantities at once?” How much inventory to purchase at once is dictated by how quickly the inventory will sell. In general, maintaining smaller amounts of inventory is wise. Shipping terms, including cost and delivery time, must also be factored into the decision of how much inventory to purchase.

It is tempting to pay bills when the invoices arrive, however, savvy cash flow managers will wait until an invoice is due before departing with cash. Practices can also take advantageof common payment terms—such as Net 20 and Net 30—that are often available or negotiable via vendors. The key is to align the practice’s payment terms with its expected cash flow cycle—or how long it takes for payment to be received for services rendered. Days in accounts receivable is a common metric used to align payment terms.

Another strategy to conserve cash on hand is to use a corporate credit card to pay for expenses. The advantages are that the owner can make one monthly payment for practice expenses while accumulating points that can be used to fund staff outings, staff and physician travel, and other expenses. One aesthetic practice was able to fund a family vacation for the owners using points on the corporate credit card. As always, consult an accountant regarding the tax implications of such transactions.

Maintaining a line of credit is a practical solution to managing unexpected cash flow shortages. Establishing a line of credit when times are good is advisable since banks are more willing to lend when the practice can show strong financial performance. If a practice opens a line of credit, payback—including principal and interest—must be included in the monthly budget, if it’s needed.

Managing cash flow is achievable with proper planning that includes savings and backup strategies for unexpected shortages. Practices that take the time to create a cash flow plan will benefit from less stress and better financing options.

Cheyenne Brinson, MBA, CPA, is a practice management consultant and speaker with KarenZupko & Associates, Inc., a medical practice consultancy based
in Chicago.

Image copyright Getty Images.

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