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Why you should have the right information, in the right format at the right time: To avert a potential disaster

Excerpt from “Navigating the business of optometry” by Chris Faul

Having the right information available at the right time, but in a format that you, the optometrist can comfortably relate to, is the key to taking charge of the financial management of your business. Not having your finger on the pulse of the practice can result in a potentially disastrous financial situation, as will be shown below.

The stock-take

A regular and accurate stock-take is essential for verifying the accuracy of the physical stockholding. The stock variance figure is the difference between the physical stock and the figure represented in the accounting. It is made up of items, such as shrinkage (theft), breakage and promotions. This figure is a cost to the business and should be included in the cost of sales figure. This in turn allows one to present an accurate gross profit percentage – an essential management tool.

It is good to know the monthly stock-take variance. Should there be a shrinkage problem, it is best to know the extent of it on a monthly basis, as opposed to receiving a big surprise at year-end. The conventional system was to do a stock-take at year-end only. This is seriously outdated and bad business practice. Just imagine what can go wrong with stock in twelve months.

Gross profit percentage (GP%)

Gross profit is the rand value of the difference between what you pay for goods and what you sell them for. The GP% is a representation of the gross profit as a percentage of turnover.

This percentage is key to managing the business. The easiest way to improve a business is to improve the gross profit, but it is also the easiest way to mess it up, if the gross profit percentage (GP%) is not controlled in a proactive way. Post mortems are useless.

Practice management software must allow for daily management of the GP%. It is surprising how often the GP% is misunderstood; yet it is so important.

The formula is as follows:
Gross profit (mark-up) ÷ the selling price × 100 = GP%
or
Cost price ÷ selling price × 100 = cost of sales percentage

The sum of the two will always add up to 100. For example, if the GP% is 65 percent, the cost of sales percentage is 35 percent. Note that the GP% can only be influenced by factors that can affect the cost of goods, or what they are sold for. For example, rent or telephone has no impact on the GP%.

The GP% is a great management tool. In the Cape winelands, one often sees roses planted among the grape vines. This is because the roses provide early warning signals of diseases that can affect the vines. The GP% can do the same for a business. It can warn the owner that any of the factors mentioned above are having a negative effect on net profit.

Knowing the industry benchmark for GP% can be an effective way of measuring business performance. Optometrists should achieve a GP% of 65 percent. High-performance practices can post a GP% as high as 70 percent. Once a GP% lags below the benchmark, it is essential that you immediately establish the cause and manage it on a weekly basis.

Avoid poor buying

There are three things that can drive down the price of frames. The size of the order, terms of payment and out-of-date styles. Those styles that are outdated are often discounted, but are best left alone. However, every effort must be made to capitalise on volume and cash buying. Impulsive buying in the absence of a clear strategy is probably the biggest threat to the GP%. Discounts will be forfeited by placing small orders from just about every sales representative who knocks on the door.

The income statement as a management tool

Management accounts should be available for scrutiny by the 10th of the new month. The strength of the income statement as a management tool lies in the comparison it allows one to make against the forecast. This is a true measure of the practice’s financial performance.

The variance column on the income statement immediately shows which line items require attention. The astute manager will use this information to fix these problems.

The Mini Income Statement

  • Turnover
  • Cost of sales
  • Gross Profit %
  • Expenses:
  • Salaries
  • Rent
  • Finance charges
  • Other
  • Net Profit

The mini income statement summarises the whole income statement in nine item lines. Provided one knows what these percentages should look like over a period of time, the mini income statement becomes a one-minute check on the pulse of the practice.

Expenses shown as “other” in the mini income statement must be, and can be, 10 percent or less. If not, it will be reflected in, for example, an out-of-control telephone account. This can easily be tracked in the variance column and further investigation will always reveal the cause.

The primary issue is the net profit. The owner should be very clear about what the year-to-date net profit should be. If the net profit does not meet expectations, the mini income statement will give an immediate indication of where to start looking for the problem.

Salaries and rent are the two biggest items under expenses. The salaries item, as a percentage of turnover, reveals whether one is over- or under-staffed. Past experience and records should show what turnover is possible with a certain number of workers.

All of these percentages should be taken in the context of the turnover. A really bad month will throw everything out of kilter, but the reason will obviously be the low turnover that messes up the percentages. Before a new staff appointment is made, it would be prudent to check on the salary percentage.

Although the rent is, by and large, beyond one’s control, it helps to keep it fresh in one’s mind. However, if it is getting out of control as a percentage of turnover, there is a case to be made with the landlord, especially when backed up with good financial reports.

The interest and depreciation line in the mini income statement relates to repayable loans or an operating lease for, say, equipment. The repayments over time usually equal interest plus depreciation. Beware that this can be quite complex. When purchasing an item on lease, it is important to always bear in mind the impact on the income statement. The mini income statement will immediately reflect this position.

Repayable loans and leases will vary greatly from one practice to the next, depending on the gearing. This will usually be a heavier burden on new practices. Benchmarks will vary in terms of salaries, and in rent for mall practices to value mart practices and rural practices. Over time the numbers become significant to each individual practice.

Work out the average invoice per patient

This number is derived by dividing the monthly turnover by the number of transactions done over the same period. This is not the average cost of a pair of spectacles – this includes all transactions, big and small. Over time, it becomes a very useful indicator of how well the team is selling. For instance, the number may run at R1 000 for a practice. Should it drop suddenly, it is vital for the owner to know this and to find out why it has dropped. It may well be that a new dispenser is not selling many frames with new prescriptions. The average turnover per patient can also act as an incentive to all of the sellers in the practice. Raising it by a mere R100 can bring about surprising results to the bottom line.

Manage the remakes

From the writer’s experience over many years, remakes are acceptable at two percent of turnover in a practice with a cutting and fitting workshop. However, it remains one of the areas within the business that needs to be carefully monitored. Once again, there is very little to gain by having a retrospective discussion about the remake figures.

A report should be available to the owner on a weekly basis. A remake report should be detailed so that it can be tracked to the source.

REMAKE REPORT
Date  
Source For the month Year to date
Optometrist error    
Dispensing error    
Trial failure    
Patient rejection    
Reading add    
Orders error    
Supplier error    
Lab error    

No-shows

Patients who do not show up for their appointments must be seen as a loss to the practice. You have a choice: Ignore it and lose them, or put management systems in place to get them back. Two no-shows per day can add up to a huge amount over 12 months. By converting this potential loss into rands and showing it in monthly reports, you have a good incentive to turn the situation around. For example, one no-show per day (valued at, say, R3 000 turnover each) over a 26 working-day month will amount to staggering losses per year.

R3 000 × 26 days = R78 000 × 12 months = R936 000 potential loss in turnover per annum.

Disaster Report

The hypothetical scenario presented in the Disaster Report in Table 1 below, tells a scary story. Practice A has a turnover of R200 000 per month and makes a healthy profit of R50 000 (25 percent) per month. Practice B, doing the same turnover, runs into trouble because most of the issues discussed go wrong, all at the same time. It makes a net profit of R21 400 (11 percent).

A swing of R28 400 for the month can mean that, if left unchecked, the practice is R343 200 worse off at year-end. While it is unlikely that all of these things will go wrong every month and all at the same time, it certainly can happen some of the time. This clearly makes a case for monthly controls through accurate, real-time information.

It is so much easier to detect and eradicate problems if the system is geared to deal with them on a monthly and even weekly basis. Doing an annual audit. report after the horse has bolted, does not serve much purpose.

The above scenario shows that instead of posting a net profit of R600 000, profits were eroded to a mere R256 800 per annum. Converting a turnover to a maximum net profit requires control and up-to-date information. Two things are important: A bookkeeper who can set up the accounts and a software package that has the capability to provide the correct information with ease and simplicity. 

DISASTER REPORT
  Practice A Practice B
  Month Year % Month Year %
Turnover R200 000 R2 400 000   R200 000 R2 400 000  
No-shows       -R25 000 -R300 000 1/day
Average invoice (R100 short)       -R20 000 -R240 000 10%
Turnover after adjustments       R155 000 R1 860 000  
Cost of sales -R70 000 -R840 000 35% -R70 000 -R840 000 -35%
Remakes   R1 400 R16 800 0.7%
Stock variance   R10 000 R120 000 5.0%
Shrinkage   R5 000 R60 000 2.5%
Cost of sales after adjustments       -R53 600 -R643 200  
Gross profit R130 000 R1 560 000 65% R101 400 R1 216 800 51%
Expenses -R80 000 -R960 000 40% -R80 000 -R960 000 40%
Net profit R50 000 R600 000 25% R21 400 R256 800 11%
Notes
  # Per day Amount   Value
Inventory level       R200 000
No-shows 1 R1 000   25-day month
Average standard invoice   R1 000    
Remakes norm is 2%        

The above scenario shows that instead of posting a net profit of R600 000, profits were eroded to a mere R256 800 per annum.

Converting a turnover to a maximum net profit requires control and up-to-date information. Two things are important: A bookkeeper who can set up the accounts and a software package that has the capability to provide the correct information with ease and simplicity.

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