Playing the percentages

Let's return to our story that began in this column in the May issue.

Our practice owner, Dr. Gene Moss, had just made a difficult decision. The practice was not doing well, so he would have to reduce his associate's pay percentage if their working relationship was to continue.

His associate, Ben Collier (our hero), had taken the news stoically, but after much thought decided to call Lou Swinney (our dark-caped villain) and have lunch.

(Note: Any comparison Mr. Swinney may have to any actual sales rep, living or dead, is purely coincidental.)

At the restaurant

Dr. Ben Collier eased patiently into a parking spot not far from the front door.

A moment later, Lou Swinney wheeled into the lot, just missing a small SUV parked between him and Ben's black Subaru station wagon.

"Hey, Doc! It's good to see you!" Lou bellowed over the SUV.

Ben grinned and sauntered along at the proper angle in order to meet Lou at the door.

After they were seated, Lou started the conversation.

"Dr. Collier, you mentioned over the phone that you wanted to start your own practice."

"Yeah," Ben replied sheepishly. "I've been thinking about it lot lately!"

"How come?" Lou probed.

"Well, really I need to make a little more money, and I think that owning a business is probably the way to go."

Lou came half out of his chair and circled his right arm in a huge loop. "You got that right!"

Ben blushed a little.

He knew this middle-aged-man's body language in front of potential clients was a bit awkward.

Ben wasn't being totally truthful, but decided Lou didn't need to know everything.

Lou continued. "I have all kinds of contacts. We can set you up and things will be just peachy."

Just then the waitress brought some water, but the two men didn't seem to notice.

"What do I need to start a practice?"

"Just give me a list of the toys and drugs you want, and I will take care of the rest."

"What about paying for all that?"

"I dunno. We can work out something. Our company can carry you for a few months, and then you can work something out with the bank."

"What about start-up costs?"

"It will be easy. Just talk to a banker. They want to lend money to a fence post these days. You should be able to get all the dough you want," Lou opined.

At Fibbs & O'Brian Accounting

Gene Moss sat upright and stiff. In front of him sat Gilbert O'Brian.

"Welcome back to our office. You called and were concerned. How can we help you?"

Gene's neck muscles tensed.

He began to speak somewhat timidly.

"Gil, I'm lookin' at these financial statements, and I need to know something."

"Shoot!" came the quick reply.

"Well I am looking at these asset numbers, and you say I have all this money and that I have to pay my taxes based on this money, but – darn it – I don't have that kind of money right now in the bank."

"Well, that is what they all say," Gilbert said in a clipped voice that belied his northeastern background. Gil also gave a dry, hesitant laugh that seemed to catch in his throat.

He went on.

"The truth is, the paper accounting and the bank statements are not always the same."

"Huh?"

"Well, it's a little complicated. Let's just say it all evens out in the end."

Gene swirled his eyes almost imperceptibly, then quickly changed tactics.

"And another thing. I have been paying my associate on percentage. When I look at these statements, and you factor in my supposed return on investment, it looks like he is making more money in this practice than I am."

"Well let's see," Gil mumbled as he rummaged through the file. "Yes, your draw is less but you have more inventory this year and thus more taxable income."

Gil mumbled some more to no one in particular.

"The net income for the business is about 7 percent," Gil announced and then mumbled a bit more.

"Your draw is more than your associate's pay, but not by much. Your percentage pay based on your tax return is approximately 10 percent of the gross, but that's a paper figure. I really don't know what you have in the bank at this moment."

Gene sat there and just looked at Gil, not fully comprehending what to say.

Gil swallowed and finally said, "Well I mostly do taxes. If you really want to dig deeper into this, you may want to talk to Bernie Switzer in our firm. He is more of a cost accountant."

Eleven months later, at Collier Veterinary Medical Center

Ben Collier walked into his new office to call an Internet pharmacy for one of his patients. He glanced at the desk. He noticed that his wife apparently had brought in the mail. The pile was bigger than usual. His wife, who had been paying the bills, left a post-it note on top that simply stated: "Help!"

Ben sorted the mail into various piles — bills, offers and trade magazines. He now was sidetracked from his original mission and started opening and compiling duns.

"Drat, some of these are second notices."

One was from the bank.

"I have been working my backside off. There has to be money in the account."

Just then Danielle popped into the office. Just out of high school, she was one of Ben's two new hires.

"Excuse me, Dr. Collier. There is an Acme Drug Co. on the line that would like to talk to you!"

Ben smiled and fumbled for the phone.

"That must be Lou getting a price for that automatic processor he promised," he thought as he picked up the phone.

"Hello, Dr. Collier, this is billing. I am sorry to bother you, but our records indicate that you are 90 days behind on the drug-and-equipment portion of your original 'new account' agreement. If you can send us $500 today, we'll be able to ship your latest order by Monday."

Ben was incredulous. The insulin for Mrs. Dollins' cat was in that order, and she needed it by tomorrow.

"Didn't my wife just send you $2,800?"

"Oh, yes, and we thank you. However, that check didn't quite clear the 90-day cut-off on our billing cycle. One of your invoices will cycle into the 120-day period this cycle as well."

Ben was trapped and really couldn't call his wife right now. There were three clients waiting and Mrs. Sanders was waiting for her call-back concerning the Internet pharmacy item.

"OK, let me get back with you."

He looked at the phone and thought to himself, "You know, I haven't seen crazy Lou in a good while. Is he layin' low till I pay this bill?"

He looked at the ceiling. Is this what owning a business is like?

Ben walked up front.

"Danielle, can you call Dr. Moss' office and see if they can lend us some PZI insulin?"

Three years later

The Collier Veterinary Medical Center has grown in three years. The gross income leveled off some after a huge growth spurt in the first 18 months. Ben is overworked and grumpy, but manages to pay the bills for the most part. He had a short vacation last year to visit relatives. He reasoned that he couldn't take another vacation, at least in the near future, because the gross plummeted while he was out of the office.

Today he had taken a few hours off to talk to his accountant. In his own mind, he was barely breaking even, yet was making pretty hefty quarterly tax payments to the IRS. He wanted to know what was going wrong.

Ben looked at his tax synopsis from the accountant. On a small white sheet of paper in the front of his tax forms he could read how his taxes compared with last year and his effective tax rate.

He could see that, since he started his own practice, he was paying what to him was a huge percentage of his income to the government — even with tax write-offs. He winced when he realized how much Social Security he had to pay in. As business owner, he now had to pay the whole percentage by himself.

Ben looked up at his accountant, Walter Hampton, and asked, "Am I supposed to be happy?"

"There are some bright spots," Walter said with a jaunty smile.

"You had some pretty good deductions because of the interest you're paying to your bank and to some of your drug companies. We were able to write off a substantial amount on your equipment purchases via Section 179."

"Yes, you say I made all this money and owe a lot of tax, but I don't have any of the money you say I do."

"Everybody says the same thing." Walter laughed dryly as he leaned over and sipped some Java from a small cup. After a small pause to reload his thoughts and after another lingering sip, he looked over his glasses and remarked:

"Your drug inventory was up this year. The IRS considers that income."

"But I still owe a lot of money for those drugs."

"You are on the accrual system of accounting."

"You mean the cruel system."

Walter smiled.

Ben sat back in the big black chair and muttered to himself.

"Big percentage to the IRS, big percentage to Social Security, big percentage to supplies, little percentage to me!"

"Watch your expenses, Dr. Collier," Walt said as he rose and extended his hand.

Ben Collier stood up, offered a limp mitt to the accountant and quietly left the room and the building in a stupor.

Ben flopped into the front seat of his car and announced to the windshield: "Twenty two percent at Gene's clinic is looking pretty good right now!"

The downside

Hello, are there any problems with production pay?

Yes, and here are just a few of them:

• Production and money mentality. Who will give tours to the Brownie troop?

• Some owners are surprised to learn that some veterinarians don't increase production as much as they had thought or hoped.

• Competition for high-end cases (this can be a significant issue in some practices).

• Owners and associates whining over what is or is not included in production.

• Who gets credit for refills and prescription diets?

• Free exams are a valid marketing tool for some practices, if money is paid to associates. Is this fair?

• What about vacation time?

• Who gets credit for continuing Dr. A's patients when Doctor A is off?

• How much do you pay an associate for the care of staff pets?

• How do you pay associates when a practice generates significant account receivables?

There are many known solutions to these problems, but why create problems where none existed before? (See sidebar) This is again upside-down management. Keeping it simple is imperative but hard to do as your practice grows in size and complexity.

What we are doing wrong

We are teaching our young associates that production and remuneration are endpoints in private practice. Additionally, increasing individual production creates an unnecessarily competitive atmosphere. This divides rather than instills a team spirit so vital to our practices.

I am sure others will ostracize me in the consulting community for these views. But I sincerely believe that percentage pay has opened a can of worms. For the present, most associates in suburban settings are satisfied with this arrangement. Over the long term, practice managers will have more problems with it. In rural areas where low-average median incomes predominate, adequate associate pay is unlikely with percentage pay.

What does the future hold?

Will our associates become independent contractors in the eyes the IRS and move about from one practice to another with their own equipment and share expenses and risk with the owners of the practices they serve? I think not. They couldn't afford to if one considers the current situation. It also means they would have to run a business, something many are loath to do.

Will owners continue to pay a high percentage of associate production in order to keep someone on staff to avoid burnout themselves? Yes, in the short term. In the long term, who knows?

Do not get me wrong. Associates and owners are mostly underpaid. That is not in dispute. Percentage pay, however, is an unbalanced business model as expenses expand.

This is a prediction. As the cost of providing veterinary care expands on every front, all my consulting friends will start stirring a big black pot of "new" ideas.

Then, when the time comes, a "magic" lower associate pay percentage "standard' will pop out of the stew and we will start the cycle all over again — unhappy associates and more veterinary clinics.

David M. Lane DVM, MS

Dr. Lane is a graduate of the University of Illinois. He owns and manages two practices in southern Illinois. Dr. Lane completed a master's degree in agricultural economics in 1996. He is a speaker and author of numerous practice management articles. Dr. Lane also offers a broad range of consulting services and can be reached at david.lane@mchsi.com

Is the management upside down?

If you go on VIN, you will see dozens of posts and links trying to define what production pay is and how to pay it. Unfortunately, it is a constantly moving target. The current thinking is this:

Total pay is 25 percent, including benefits. The usual periodic pay is 19 percent to 23 percent of production, and thus the remainder occurs in benefits. These numbers have been shrinking mysteriously over the past few years as expenses have galloped along unabated.

In the end, all owners and employees are paid on percentage:

Employees paid on a percentage of production get a pay raise not only when prices go up (and/or when they are more productive), but also receive an increasingly greater portion of the net income if price increases cannot keep pace with inflation or expenses. Somewhere out there, net income would disappear and the business would cease.

Employees paid on salary receive some percentage of the net income. This is the standard approach. It relies on periodic reviews and wage adjustments. If the practice is participating in open-book management, these employees easily can justify fair and sometimes substantial wage increases.

Is the owner on percentage? You bet....

As an owner, add up your draws against the business, add (or subtract) changes in cash in the bank, then add any phantom income that is left over according to your financial statements (only your accountant knows for sure). Take this number and divide by the gross for the practice, and you get a theoretical percentage income from the practice.* Alternatively you can simply take your taxable income from the practice and divide by the gross and get another similar percentage. (Caution: Do not reveal this to your spouse.)

In practice, after accounting for return on management, return on risk and then return on investment, a large percentage (Did I use the word percentage again? Gasp!) of today's practice owners are making less as a practicing veterinarian than the associates they hire.

This cannot continue for long.

In other words, this is upside-down management.

*Depreciation not withstanding