Dr. X-Ray: Does it make financial sense in your practice? (Proceedings)

Three factors are essential to the practice of quality medicine and surgery:

• A doctor with a high level of knowledge and skills in veterinary medicine

• An appropriate range of high-quality equipment for both diagnostics and treatment

• An appropriate range of safe and effective therapeutic agents

If any one of these factors is missing or of substandard quality, patient care will suffer.

In this seminar, the second factor, equipment (specifically digital radiography) will be discussed. Unfortunately, equipment usually can't be purchased JUST because it contributes to high-quality care. It must also pay for itself. There isn't any question that digital radiography contributes to high quality care. There also isn't any question that, on the surface, it costs more. However, because the technology is different, there are cost savings from the change that will offset the additional equipment costs. All of these factors must be included in the analysis to determine if this new technology is right for your practice.

As with any equipment purchase, it is first necessary to understand what the goal of the acquisition is in YOUR practice. Will the new equipment improve patient care? For example, the purchase of digital radiography may allow for more accurate diagnoses. Will the new equipment lower the operating costs related to the provision of services? The use of digital radiography may improve staff efficiency and lower staff costs because there are less retakes necessary and no time is needed to develop the radiographs. Will the new equipment increase revenues? Client perception of the digital technology plus better quality images may let you charge more than for conventional radiographs. Often, more than one of these goals is met with the acquisition of a single piece of equipment.

There are many considerations, financial and managerial, associated with planning and implementing the purchase of new equipment. The decision to purchase some capital assets may be an easy one—for example, it may be clear that the practice needs a new anesthetic machine and even though this is a long term asset, its cost is not too great and the practice already uses this type of equipment daily therefore the decision is clear cut. The purchase of more expensive assets and those not previously used in the practice, however, requires more planning and forethought than does the purchase of equipment or supplies with a much shorter life.

There are a number of capital budgeting techniques that are extremely useful in analyzing the purchase of new equipment. These techniques can be used in contemplating the purchase of just one asset or in comparing the benefits of two different purchases (for example, computed radiography vs CCD digital systems.)

As with any analysis, good data is critical to good results. A number of variables will be used in these calculations such as the cost of the equipment, the additional annual costs associated with the asset (such as a service contract or supplies), the expected cost savings to be obtained from usage or the anticipated increase in revenues. If these items are not accurately estimated, the results of the acquisition analysis may be erroneous. For example, cost of equipment does not just include the sticker price. Other components of cost include tax, installation, training, and interest costs if the asset is financed.

Some of the more commonly used financial techniques are payback period analysis, net present value calculations, and breakeven analysis.

The payback period is the number of years necessary to breakeven on the purchase of the asset. After this point, the practice will start to realize a profit on the acquisition assuming the figures used in the analysis are accurate and reality conforms to the assumptions made in the analysis.

The payback period is calculated as:

Total purchase price

Annual net income (i.e. revenue minus operating costs for a year)

The payback period is not the only tool that should be used in analyzing an asset purchase. Acquisitions with the shortest payback period may not be the ones that are ultimately the most profitable to the practice. It is also important to remember that the time value of money has not been factored into this calculation.

Net present value (NPV) analysis estimates the total cash outflows involved with the purchase of an asset compared to the total inflows. A positive outcome equals a profitable purchase. NPV analysis also incorporates the time value of money into the calculations.

The difference in value depends on the interest rate used in the calculation. Differences get larger with higher interest rates and longer payback periods.

While this calculation gives more accurate information, it is also more difficult to do and many small business owners will enlist the aid of their accountant or financial advisor in performing this calculation.

This analysis could be performed over the full expected life of the equipment in order to estimate the total profitability. If this were done, any amounts expected to be realized from the sale of the equipment at the end of its life should be recognized as an inflow and any costs of disposal should be recognized as an outflow. This is a useful calculation when comparing the potential profitability of two or more pieces of equipment.

Breakeven analysis is also a very useful tool for studying the relationships between revenues, fixed costs, and variable costs. It is particularly helpful in analyzing the consequences of starting or expanding a business or when acquiring significant pieces of new equipment.

The breakeven point is the level of sales that will just cover all costs, both fixed and variable. Variable costs are those that fluctuate directly with revenue. For example, variable costs in a veterinary practice would include anesthesia, drugs and supplies. If no patients are seen, none of these items are used and there is no associated cost.

Fixed costs are those that do not fluctuate with revenue over some range of this revenue. For example, the rent paid to lease the building a veterinary practice is located in is a fixed cost. Even if no clients come in the door and no revenue is generated by the practice, the business still has to pay rent. Very few fixed costs, however, are fixed forever over the life of the business. A 2-exam room veterinary hospital may spend $1500/month in rent payments for the facility. This amount will be the same whether the practice generates $300,000 or $600,000 in revenue per year. There will come a point; however, at which the building is simply too small to accommodate any more clients or any more revenue growth. In order to continue growing the business, facility expansion will have to occur and this cost will increase. Rent is a fixed cost over a very wide range of revenue (in this case from $0 to perhaps $900,000) but at some point the cost will change. It is important recognize that if there were no fixed costs, there would be no breakeven point. A practice would have no costs if it had no revenue.

Some costs that don't fluctuate directly with revenue but must be increased over shorter ranges of revenue than an item like rent are often called semi-variable costs—staff salaries would be an example in a veterinary clinic.

At the breakeven point:

Revenue = fixed costs plus variable costs

or

Revenue = total costs

While breakeven analysis is very useful in understanding the relationships between transaction volume, prices and costs, it does have some weaknesses. As with all analyses, reasonable estimates are essential. The linear assumptions made may not hold true in all cases; for example, as the volume of transactions increases, variable costs may increase or decrease on a per unit basis.

Tax effects and alternative financing can be included for even more precise analysis, but those calculations are beyond the scope of this document.