Threshold of profit
It is vital to have access to up-to-date financial data, know your practice’s cost structure and the basics of business analysis. But how do you work out your breakeven level and, in practical terms, what are its implications?
You need to know your costs – the fixed and variable overheads – and your practice income. You also need to know the level of activity in terms of how many hours you work in a given period.
Since most practices do not have access to up-to-date financial data, gather your cost and income details from the latest profit and loss statement prepared by your accountant. Your annual accounts will show your practice revenue, costs and profit/loss for the period concerned.
To carry out a breakeven analysis, you need to distinguish between the variable and fixed costs in the annual accounts. Variable costs, as the term suggests, are those that vary with the level of activity – materials, laboratory expenses, associate fees and so on. Fixed costs are those that do not vary, such as rent, rates and salaries.
When you have identified these costs, you then need to find out the level of activity in terms of how many hours you worked during the period concerned. You can obtain this from the practice’s manually kept records or management software system.
To show how to compute your breakeven point, here are some hypothetical figures. Let’s assume the level of activity during the last accounting period was 1,500 hours, and that practice turnover was £250,000. Divide the turnover by the hours and you get an average hourly revenue of about £167.
If we assume your practice’s variable/direct costs were £60,000 for the period, then on the basis of the above level of activity your average hourly variable cost is £40. We can now work out your hourly contribution. This is the amount of money available, once you have met all your direct expenses, to pay all your fixed overheads, such as staff salaries, rent and so on.
If your total contribution is more than your fixed overheads, then your practice will have made a profit, and vice versa. It is calculated by deducting the hourly variable/direct cost from your hourly revenue. With the above assumptions and data, this is £167 minus £40, giving £127.
Now, if we assume that your total fixed costs were £90,000 for the above period, we can first verify the profit for the period. At the above level of activity and hours, your total contribution for the period will be £190,500 – that is, 1,500 hours @ £127 an hour.
If you now deduct your fixed costs for the period from the total contribution, it will give you your profit for the period, which is £100,500 – £190,500 minus £90,000. This should agree with the profit figure in your latest accounts, but this is subject to any rounding-off errors.
In this example, the practice concerned has made a profit. But the crucial question is what is the breakeven level of activity and the breakeven revenue for the practice? In other words, what is the minimum revenue needed to avert a loss.
The breakeven level of activity can be calculated by dividing the total fixed costs by the hourly contribution. In our example, if we divide £90,000 by £127 an hour, it gives us a figure of nearly 709 hours.
As you know, at breakeven level the practice owner will make neither a profit nor a loss. This can be cross-checked. For example, the breakeven revenue is £118,236 – that is, the breakeven level of activity (708 hours) multiplied by the average hourly revenue (£167). If you now deduct the variable costs (£40/hour multiplied by 708 hours) from the breakeven revenue, it gives you the total contribution, which is £89,916 – £118,236 minus £28,320.
At breakeven level, the total contribution should be adequate to pay all your fixed costs. In our example, the fixed costs are £90,000. So, if you ignore the rounding-off errors, the practice’s breakeven level of activity is 708 hours and its breakeven revenue is £118,236.
So, how can you use the breakeven analysis at a practical level? As we’ve seen, you can influence your practice’s profitability by reducing your costs and/or increasing your revenue. So, you should now ask yourself the following:
• What are your practice’s sources of income?
• Has the income risen at all this year?
• Is it possible to raise the income further?
• To raise the income what options do I have?
• Is my fee list up to date?
• Is my advertising effective?
• How satisfied am I with my costs management?
• Can I cut costs further?
• What are my cost reduction strategies?
• Can I use a budget to control the practice costs?
So, in order to manage your costs and revenue better, it is important to know your practice’s breakeven level of activity and revenue. This will give you an indication of the level of activity at which you should breakeven – and, importantly, the amount of revenue and level of activity you need to generate to achieve your target net profit for a given period.
By lowering the breakeven level through the above steps, practice owners who are satisfied with the current level of profits could work fewer hours and still enjoy the same level of profit. Alternatively, practice owners who want to increase their profits could stick to working the same number of hours to generate more profits.
But to carry out a breakeven analysis and manage your costs and revenue efficiently, you should have regular access to up-to-date financial data. The availability of this data has always been an issue in dentistry, and limited access to it has led to many UK dentists being unaware of their practice’s performance until the annual accounts are prepared for tax purposes. Unfortunately, most UK dentists do not have much control over their practice finances.
•Make sure you have regular access to up-to-date financial data
• It is important to know your practice breakeven level of activity and revenue
• Look at the options of raising income – is your fee list up to date? Is your advertising effective enough?
• Consider cutting costs further, perhaps by adopting a fresh budget.