Fee-setting: A look at margins

Editor's Note: This is the second in a two-part series about fee-setting. This month, Dr. Heinke provides insight into pricing professional services, capturing charges, collecting fees and a new financial tool: The balancing scorecard.

Professional services

When it comes to setting fees for professional services, we prefer a bottom-up approach that first targets the profit margin we're looking for and then uses existing expense projections to set the required gross income we want the practice to generate.

For instance, if practice expenses (not including capital expenditures for new equipment or for debt retirement) are budgeted at $1.2 million, and target profit is 15 percent of revenue, then the desired level of revenue will be $1.2 million divided by 85 percent, or $1.412 million.

Next, we would evaluate the average percentage of fee increase needed, assuming no change in volume. If the current year will total $1.31 million, then gross income is expected to grow $102,000 ($1.412 million – $1.310 million). The change is 7.86 percent ($102,000 divided by $1.31 million), and this is the baseline target for fee increases if volume isn't expected to change.

Volume is a combination of the number of new clients gained in excess of the clients lost, plus increased transactions per client. Compliance studies predict that a large potential for increased transactional volume per client exists through better goal-setting, measuring and tracking financial numbers, and client communication.

The next step is structuring fees through departmentalization. In the past, vaccinations and office calls typically subsidized "losing" activities in the practice, such as sterilization surgeries and hospitalization. However, protocol changes and increased competition for vaccinations require practices to spread fees more evenly over all services. In the new model, fees have a more direct correlation to the cost of providing those services.

Departmentalization of the main segments of hospital activities requires recognition of the disparate levels of labor required in different departments. The five main segments most typically budgeted include outpatient services, laboratory, surgery, hospitalization and boarding and grooming. The trickiest area of cost assignment in these areas is labor. Although difficult to track, labor is the most costly expense, averaging 38 percent to 48 percent of gross income.

Simplified time and motion studies can be conducted, though achieving employee compliance can be a challenge. Your employees, over two to three days, every six minutes (10 times per hour), will write down what they did in that time. After assessing where their time is spent, you can allocate dollar amounts to the work of the appropriate department based on that employee's hourly rate.

With multiple doctors, different practice styles may dictate novel ways of allocating labor costs. It is critical to recognize time spent on follow-up calls and phone consultations with clients. Consider this simple example: A doctor with an annual compensation package of $80,000 works 40 hours per week, 50 weeks per year. We estimate that she must generate $400,000 of services in the practice to earn this level of salary, to cover overhead expenses, support staff wages and to earn a profit.- Assuming that the veterinarian is a productive generator of income in each of the 2,000 hours she works during the year, she must make $200 dollars per hour for the practice.

If she is only productively creating income 50 percent of the time, she must generate $400 per hour during those hours. Average DVM time spent on justifiably chargeable services such as client consultations about hospitalized pets, surgical procedures and lab results must be factored into the calculation of fees for those services.

Total overhead costs in the form of utilities, management costs, insurance, etc., can be obtained from your practice's financial records. Use the AAHA chart of accounts and consistent coding of expenses to ensure you achieve an accurate assessment of overhead costs.

Total overhead can be allocated to each department equally or on some other basis, such as percentage of total invoices generated and square footage utilization.

Supply costs — anesthetics, intravenous catheters, fluids, laboratory reagents, etc. — can often be assigned to specific departments. Full deployment of a well-organized chart of accounts, with or without departmentalization, will show the approximate cost of each department.

Once all costs have been identified and assigned to departments, they are totaled for each department:

Allocated labor cost + Allocated overhead + Specifically assigned costs = Total cost for each department

This total cost is divided by the total number of invoices for the department to determine an average cost that must be met. Management sets a desired profit margin, say 20 percent. Total costs divided by the sum of 100 percent less the desired profit margin results in desired revenue budgeted for the department. For example:

Estimated costs $500,00 ÷ Profit margin (100% – 20%) = Revenue $625,000

Knowledge of the distribution and average number of specific procedures within the department can be used to set fees for those procedures. You can use computer histories of service codes and the number of times they were used in the last year. With an overall understanding of the costs associated with a single department and a goal for the revenue to be generated by that area, you'll develop a more educated approach to assigning fees.

Monitor results on a monthly basis and adjust fees to cover department costs. If the profit margin has narrowed or disappeared in a particular area, don't neglect to examine the associated costs. Are costs increasing due to waste, excess staffing or extraneous and unused inventory?

In the final analysis, finding out the cost of procedures through departmentalization must be tempered with the knowledge of what the veterinary market will bear and the comfort levels of doctors and staff. Costing provides a basis for proactively setting profit margin goals for each department. With the help of departmentalized costs and budgeting for desired revenue, a hospital manager can begin to see the big picture and plan for profits, rather than just blindly reacting to inadequate cash reserves.

Capturing what is earned and collected

Internal procedures for capturing charges and collecting fees can help you reach those budgeted revenue projections. Scheduled specific actions during the year help doctors and staff achieve productivity goals. Repetitive employee coaching, instruction and encouragement should be part of the scheduled practice activity. Frank discussion with all veterinarians and staff members about the fairness of fees and the importance of charging for the work done are key. For all staff, but particularly support personnel, emphasize that fair fees result in appropriate, professional animal care and personal financial success.

In veterinary medicine today, a doctor must abandon the unintended charitable mentality, generate an income to feed his her family, cover practice overhead, and pay employees a living wage. This only happens if doctors charge appropriately for their work.

After your analysis of the practice's costs and fees, determine which aspects of the organization are weakest. Each of these weak links in the chain represent a priority for practice management.

The next business-school resource is an excellent tool for rounding out a detailed tactical plan for strengthening your weakest links.

Balanced scorecard

In the early 1990s, Harvard Business School's Robert Kaplan and David Norton developed an innovative planning tool called the "balanced scorecard."

The balanced scorecard is a perfect prescription for a healthy veterinary practice. The balanced scorecard approach helps you define specific critical success factors and what to measure to track progress.

As both a management and measurement system, the balanced scorecard helps clarify the practice's vision and strategy (both of which can feel a little ethereal) and translate them into action. It helps to "balance" the purely financial perspective expounded by practice management literature, consultants and organizations.

The scorecard tool provides feedback from both internal practice processes and external outcomes to continuously improve strategic performance and results. When fully deployed, the balanced scorecard transforms strategic planning from an academic exercise into your practice's daily management regimen.

The balanced scorecard can help you improve patient care, client service and employee satisfaction. We have modified Kaplan's model for use in veterinary practice as the Patient Care Scorecard (PCS).

The PCS recognizes the financial measures that assure an adequate economic base to drive excellent veterinary care. Like the balanced scorecard, the PCS helps guide and measure the practice's progress in providing value through investment in patients, clients, employees, supplies, processes and technology.

The PCS can help you evaluate your practice from four perspectives and develop metrics and collect and analyze data to understand:

> the patient care perspective

> the client perspective

> the learning and growth perspective

> and the financial perspective.

Use the PCS template (Table 1 above) to think more about how the balanced scorecard will work in your practice. You can see how critical success factors can evolved into specifically stated goals for each quadrant of the scorecard.

Table 1: Patient Care Scorecard

The financial dashboard

Strapped for time, many practice owners develop systems that help them see the forest for the trees. Executive summary graphs that depict practice key performance indicator trends are popularly labeled "financial dashboards."

Perhaps an even better name is the "CEO's dashboard," because many critical measurements defined by your balanced scorecard will not be financial-based, even though they drive financial results.

In an ideal world, your practice software would automatically pop key indicators up on your PDA every day. In reality, most of us compile the numbers ourselves or assign key personnel to gather the data for us and present it in a summarized format.

The CEO dashboard will rotate some indicators over time, depending on different needs.

For example, if your practice's accounts receivable are well managed at less than 35 days to average collection, you may decide to remove that gauge and add one for inventory turns, because cost controls for drug and supply inventories has become a primary focus.

The practice balance sheet, with its well-organized presentation of assets and liabilities, is a good resource for designing your financial dashboard. Highlight the items on it that you believe you need to see every day. Perhaps you choose cash balance, average days in accounts receivable and outstanding vendor accounts payable.

You may choose additional metrics such as gross receipts and total payroll dollars expended.

Dr. Heinke is owner of Marsha L. Heinke, CPA, Inc. and can be reached at (440) 926-3800 or via e-mail at MHeinke@VPMP.net