Profitability Advice from a Dental-Specific CPA – Episode 147

When’s the last time you gave your practice a financial x-ray? Would an expert accountant find any hidden problems? Morgan Hamon, founder of HDA Accounting Group, is Reese’s guest on this episode of Dentist Money™. By focusing his firm’s tax, accounting, and consulting services solely on dentists, Morgan has gathered valuable benchmarking data to measure key performance indicators of a dental practice. During this interview, he shares his thoughts on profitability improvement and overhead management. He also discusses if and when it’s time to invest in more growth.

Podcast Transcript

Reese Harper: Welcome to the Dentist Money™ Show, where we help dentists make smart financial decisions. I’m your host, Reese Harper, recording in studio today with a special guest who has just flown in from the great state of Colorado, the home state of my Denver Broncos, Morgan Hamon. Morgan, welcome to the show.

Morgan Hamon: Thanks for having me!

Reese Harper: I’m kind of excited about my Broncos this year. They just beat the Raiders on Sunday!

Morgan Hamon: It’s looking a little better than last year, for sure.

Reese Harper: Yeah, I’m stoked! I’ve grown up in Idaho and now Utah, and I don’t really have a professional football team, and so John Elway was my second father. I just have never met him in person. He was a father figure for me in my youth (laughs).

Morgan Hamon: Well, Denver bleeds orange and blue, so there is a lot of excitement so far this year.

Reese Harper: When I first went to Denver, I saw the stallion at the airport; there’s a giant horse there.

Morgan Hamon: Yeah, it’s disturbing (laughs).

Reese Harper: If you’ve never been to the Denver airport, there is this giant raging stallion there with glowing eyes! It’s crazy. And I thought it was sweet, but it’s kind of like, “what?” It kind of catches you off guard. It’s an international airport, you know. So, there was a rumor that I heard that the guy that built this horse, or who made it, like… I don’t know if this is true, and I might be slaughtering the story. But I heard he was making this horse, and it tipped over, or something happened, and it killed him! Is this true?

Morgan Hamon: (laughs) I have no idea.

Reese Harper: I heard that for some reason! The artist was making this horse, and at the end of the project, the horse killed the artist! This could be a rumor, but I heard that from a couple people. So, any podcast listeners who know the story about the Denver horse, you let us know, because I would still like to know the truth behind it.

Morgan Hamon: It’s slightly disturbing, that horse.

Reese Harper: Well, Morgan has been on the show before, and you’ve all heard his background at this point, and I guess I want to start off just outlining what we’re going to cover today a little bit. We’ve planned a great show. What we’re going to do is, we’re going to start by kind of walking through a typical practice review that Morgan might go through to analyze the financials of a dental practice from his perspective. Now, Morgan works with hundreds of practices in almost every state in the country, and he has a lot of perspective in looking at profitability, and overhead, and key practice performance statistics, from a cash flow perspective, and staff costing, and a bunch of different things. So, we are going to go through a typical practice review and look at maybe what a struggling practice might look like, or a practice that is underperforming, and then one that is really healthy and succeeding, and kind of talk through that a little bit. Morgan, how about you start us off and kind of give it maybe any additional context you might want to give to what we’re going to cover.

Morgan Hamon: No, that’s good. And what I thought we’d do is just walk through, basically looking at the financials. And if I were to make an analogy, if you have good reports and you know how to interpret those or have someone walking you through those, the financial data is like the x-ray image. So, when I’m having a client meeting, I look at the image, if you will, and we’ll diagnose, and then there’s a treatment plan. And any time I’m visiting with one of our clients, I always want to finish up that interaction with an action item or two that can put some money in their pocket. If we’re going to look at a set of financial data and diagnose if the practice is healthy or not, where I start is revenue and profit margin. And just to be clear, as a CPA, I’m thinking in terms of profit margin, and a lot of dentists think in terms of overhead, and it’s the same number. A 35% margin is a 65% overhead. What we’re talking about there is the return for the owner.

Reese Harper: Yeah, can we pause there just a second? Because a lot of people tell me, “I run my practice at a 65% overhead,” and a lot of people say, “I run it at a 35% profit margin.” Now, how are most people referring to their numbers? Do they talk about it in terms of overhead, or do they talk about it in terms of profit?

Morgan Hamon: If they’re talking with me, we talk in terms of profit margin. With their buddies, they might think in terms of overhead.

Reese Harper: Okay. So you’re saying that the overhead conversation—because I feel like that’s a really uncommon way to talk about financials.

Morgan Hamon: I do too.

Reese Harper: Because I’m not used to hearing that. And until I got into the dental space, I had never heard someone say, “I run my business at an x% overhead.”

Morgan Hamon: Right. Conceptually, it’s the same number. So, I always try and be very clear. When I’m talking 35% margin, that is 65% overhead, and we’re referencing the exact same thing. You know, what is there for the owner?

Reese Harper: So when you talk about profit, is it healthy—to keep the math simple, let’s say that you have 50% overhead and 50% profit, okay? Inside of that profit number, though, there’s the dentist’s compensation, and then there’s what is really profit, right? True profit would be like if you stepped away and you plugged in an associate, what is left over. If you were talking in real business lingo out there when they look at that kind of stuff. Is it healthy to look at it all-inclusive? I mean for most owner-operators, it probably is. You just look at it all-inclusive, and it’s less complicated, right?

Morgan Hamon: Right. So, profit margin is what the practice produces before the owner gets their hands on it. And so that does not include the owner compensation. It is the economic profit. And we talked earlier about how that does not include depreciation, amortization, those non-cash deductions, which are a great deal on the taxes, but not indicative of how the practice is performing.

Reese Harper: Okay, so you’re saying, we have to add those back in.

Morgan Hamon: I add those back in. So, the way I look at profit margin—and this provides consistency across the board when we’re comparing practice-to-practice or practice against industry average—as I said, it’s the true economic profit. What did we collect? What were our actual operating expenses that we actually paid for? And now, how much is available for the owner?

Reese Harper: To do whatever he wants with it.

Morgan Hamon: Yeah, you can do whatever he wants You could pay down additional debt; you could make some capital investments in the practice; you could distribute it and take it home.

Reese Harper: Great. So, do you right off the interest expense on debt?

Morgan Hamon: Yes. Interest expense is always included in the margin/overhead. The portion of the check that pays down principal is non-deductible. And that’s a substantial number. So if somebody, at the end of the year, I tell them, “hey, congratulations! Your practice made 400 grand,” they’re not going to feel that 400 grand in the bank, because their debt service may have been $60,000 that year, and they do not get to deduct that, and they unfortunately owe tax on that money as well, so…

Reese Harper: Yeah, it makes sense.

Morgan Hamon: But when we talk in terms of, let’s measure how a performance is doing, I look at that pure profit margin. And that is, is there an adequate return for all this risk that we took to start this business, or buy the business, and as we all know who own businesses the trials and tribulations for owning a business and caring for that business, there must be an adequate return. If a practice is starting out day one on a startup, I can tell you the, what we call the break-even point, or the minimum cost just to be open, it’s going to be somewhere around 25,000. So, if you’re only collecting 30,000 per month, you’re going to have a positive margin, but it’s not going to be industry standard. In my opinion, a practice needs about 50k per month to have what I consider the industry standard margin of 35%. So, you have to take that into consideration. If we look at a margin and it’s 20%, initially I would think that’s a little low. But if we’re at month four on the startup, and we’re collecting 35k, that’s actually pretty good. So, it always has to be in context.

Reese Harper: So, let me ask a question on this. So, if industry standard is 35% generally, if you’re saying that you see that as a minimum level of—

Morgan Hamon: Single owner-operator.

Reese Harper: Single owner-operator, right? Now, if I can go get an associate job and get paid 30% of production, then you’re saying that owning the practice itself is paying me 5% more. Now, there is hygiene production that I wouldn’t get paid on if I were an associate, right? So that increases the value. Even though it’s just 5% more, it’s not just 5% more, because it’s 5% of the entire practice collections, which include hygiene. So, that’s not bad! I mean, that’s still a worthwhile venture. You get down to that 30% range, and it might start getting close to where you could be making the same as an associate, but not necessarily, because you’re still getting a percentage of hygiene production on that.

Morgan Hamon: Correct. And, you know, 35% is the average. Now, with that average, that includes everything. That’s the startups, the under-performing, the rock stars, so…

Reese Harper: What would be a target for you?

Morgan Hamon: A target? 40%-45%. We have a large number of our clients in that range, and so we’re realizing that the 45% margin, that’s way more than you’re going to make as an associate.

Reese Harper: Keep in mind, that’s an additional 15% on the entire block. I mean, the economic value was completely worth that risk that you took, and the endeavor. How many practices do you see getting into that 50% margin range, in your book?

Morgan Hamon: 50% is tough. And we have some, certainly.

Reese Harper: But you’d say it would be less than 10%?

Morgan Hamon: Yes. I would say 10% or less that are 50 or more.

Reese Harper: But it wouldn’t be like—in your case, you have a lot of practices. I mean, you’d say it would surprise you if it was like one or two percent. It’s probably not that small.

Morgan Hamon: No, I mean, I would say 10% would be a good way to quantify that.

Reese Harper: So, it is a really successful point, an achievable point.

Morgan Hamon: It’s attainable. I would not necessarily say that’s a make it or break it, like, “I won’t feel like I’m successful until I have a 50% margin,” because it’s tough.

Reese Harper: Well, and a lot of people, to get to that margin level, they might have to be smaller than—if you’re really big at that margin level, you’ve done an amazing job. But it might be better to be at a 40% margin and have a larger amount of collections.

Morgan Hamon: Right, and it depends. I get asked this question, like, “what’s the common thread? Is it a geographic area?” And I personally think it has a lot to do with the dentist themselves, what type of producer they are. I think it has a lot to do with their internal operations. If they’re scheduled, and they’re busy all day, and how well they produce. The clients that realize that 50%, I know that they’re super star producers, and they run a very tight ship. For example, there is likely not holes in the schedule. I mean, they know how to make it happen.

Reese Harper: Interesting. So, that’s revenue and profitability. What’s the next thing you are kind of looking for?

Morgan Hamon: So first thing, I look at the profit margin, compare that against revenue, and what I’m trying to decide is, is this profit margin acceptable? Let’s say it’s not acceptable. Let’s say it’s a single owner-operator practice, they’re collecting something like 65,000 a month—so it’s not a huge practice, but there’s definitely potential to have a very nice living with 65,000 per month. And let’s say the profit margin is like 25%. That’s a problem. That is not an adequate return. And so, there are two things that can be happening. We can either be overspending or under-collecting. I mean, it’s that simple. And I think the default assumption is we’re overspending, and that may be. So, the next thing that I’ll look at is what I call our benchmarks. Let’s look at all our pertinent expense categories and see if those are running higher than normal. And if they are, that could explain it. And I’ll try and work backwards. If the target is 35 and we’re 25, we’re missing 10%. So, it is obvious that 10% is going somewhere. Maybe staff costs are through the roof; maybe the supply costs are.

Reese Harper: Okay, so I have a good practice on the benchmark analysis, and you have one that is more struggling. Let’s talk about some of these categories a little bit and understand maybe—if we’re going to go look at costs, let’s start with that, and just say where these ranges would need to be.

Morgan Hamon: Mhmm. So, you know, we’ll start with the three that we refer to as variable costs, because these costs are going to vary with the amount of dentistry that you do. Those are your dental supplies, lab fees, and what we call ortho implant supplies. So, the dental supplies, that is one that can creep up, I think; about 6% of collections of collections is pretty normal. And this is one of the few benchmarks where it’s consistent regardless. Big practice, small practice, old practice, new practice. About 6% clinical supplies is a pretty good target. Lab fees can depend on the practice. If they have a lot of cases, a lot of times, you have to front those costs. And so if I see high lab fees, I’m not as concerned, because that’s likely going to result into some nice collections down the road. And same thing with ortho implant supplies. So, the clinical supplies is one thing we can see that can push a little bit high. But that’s not going to make or break a practice, typically. Now, staff cost. We have to quantify this: we’re talking non-doctor staff. So, admin staff, assistant, hygienist, payroll taxes, payroll service fees. If they’re outsourcing to eAssist or DSC to help with collections, I include that in staff costs. It’s like a replacement person. It’s your out-the-door cost. The sweet spot, in my opinion, is kind of low to mid 20 percentile to keep things healthy. Now, that is one of your biggest line items; it’s the biggest expense. And that is one that, unfortunately, is one that often probably gets high. And I think it’s high on both the sample reports I brought.

Reese Harper: Now, just pausing on that a little bit, what has been your experience with—like, do you notice a big difference in staff costs for people who are outsourcing to a group like eAssist versus doing internally? What do you typically notice?

Morgan Hamon: If they decide they need help, and then they outsource, but then they don’t make staff adjustments, it’s just going to push the cost up.

Reese Harper: And do you see that reflected in a lot of people’s financials?

Morgan Hamon: Yes, because while they want it done correctly and reliably, they don’t necessarily want to go let somebody go. But if you’re going to hire someone to do it, and they’re sitting in a different office, you can’t keep paying the person sitting in your office. So, you can’t double up.

Reese Harper: Yeah. I think that’s the hard part. I feel like a lot of times, I’ve seen it actually relieve anxiety and stress from the doctor, right? And some people may choose to just do that to have less stress in their life. And they hope that they will be able to take their existing staff and just fill them with new responsibilities. Maybe a marketing responsibility, or something else. Typically, what I see is there isn’t staff reduction, like you said, and then there’s also not a clear replacement job for that staff person to go implement, and so rather than filling their time with additional marketing and growing collections like you intended, it kind of just— this has been my experience, at least, and I think we’ve all seen this, that people tend to do as much work as they are asked to do. It’s amazing how two people in eight hours a day can do very different volumes of work.

Morgan Hamon: They look busy (laughs).

Reese Harper: Yeah, everyone looks busy! (laughs) yeah.

Morgan Hamon: A couple of things with staff costs. If staff costs are high, I’d say the majority of the time, the solution is growth rather than cutting. And if I see staff costs high, I always ask the question, “what’s your gut feel on staff? Are you about right? Are you overstaffed?” Or even, “do you feel understaffed?” Usually, the answer is, “I feel about right, or even a little understaffed,” which means we just need to grow. The other thing with staff costs is, revenue, even though everyone will have up and down months along the way, it’s generally a linear—if a practice is growing, it’s a pretty linear curve. Staff costs grow in steps. You can’t hire half a person, or a third a person. So, you’re going to be behind, feeling shorthanded. We’re going to add somebody, but maybe we don’t have full work to support that, but you have to do it to grow. I picture staff costs growing like a stair step, and you lay that over the top of a linear growth curve, and you’re going to go between having really awesome staff costs and high staff costs until you grow into those and come back down. But hands down, I think the solution for high staff costs most of the time is growth.

Reese Harper: I think it’s just really important to view the business in the way you’re describing, which is, view staff costs a growth engine. We don’t want to have excessive costs, especially if you cannot grow anymore. If you can’t grow any more, and you’ve seen that plateau for several years, and you’ve done all you can to expand, then we maybe start cutting costs, but don’t let that be your first place. I have had many conversations where the client calls and wants to get me to second their gut feeling about letting someone go, because they feel like their overhead is too high, and I just say, “man, you’re a year-and-a-half into this. You’re so close. This associate is—” and where you’re probably seeing this often, and where I see it often, we’re talking a lot about the associate hire here, too. And hygiene and front. And that associate hire is usually a pretty big step, and one that takes production away from the doctor. It makes everything feel tight.

Morgan Hamon: Well an associate, I mean, that is definitely what we have on our benchmark analysis. And that completely changes the picture and the practice. And so, if we’re talking about bringing an associate on, or we have a client that joins us that has associates, I mean, it’s really important for me to have a good understanding of what the roll is. Because it changes the goal posts, if you will, for profit margin. It changes how we think about this practice.

Reese Harper: Totally. And you don’t lump that into regular staff costs, right?

Morgan Hamon: Oh, absolutely not. Absolutely not. Staff costs, that is people that are not doctors. And hands down, I think the fix for high staff costs is growth. We have to grow our way into more income; we don’t necessarily cut our way.

Reese Harper: Well I didn’t want to skip past rent and marketing, but…

Morgan Hamon: Okay, rent and marketing. Well you might say, “why are we benchmarking rent?” because you can’t really do anything about rent. Maybe once every five years, you know? But I think that rent tells me two things. One is, does the overhead structure of the practice fit how much rent they’re collecting? And rent usually comes out around 5. So, that really quickly gives me an idea of overall overhead, but I think rent and marketing are related. Because if you have the really sweet spot on the corner with terrific visibility, it probably costs more, but you don’t have to send out so many post cards or do so much marketing. So, you can get away with a little less marketing. If you’re in the internal medical office building, and nobody can see you, it may be cheaper, but you really have to hammer the marketing, so you’re going to have a higher marketing. So, I look at both of those, and honestly, we’ll combine them to determine if we think the expense structure is about right.

Reese Harper: Yeah, that’s interesting! I think that’s good insight. Do you have conversations with—I mean, what do you do when people have building payments? So they bought the building, and they’re renting it from themselves. Which one are you going to include as the actual cost? Because they might pay themselves a disproportionately high rent, or a disproportionately low rent.

Morgan Hamon: Yeah. So, we advise to just pay the market rent. Because typically what we’ve seen is they’ll finance the building, and they need that rent to service the debt in their real estate holding company. So, when someone owns their building, we see very minimal impact on the practice financials. Because they’re still paying a third party for rent, but they happen to be a third part. And it has a minimal effect on the overall tax situation.

Reese Harper: So the number that you’ll use is the rent payment. See, and I think that’s effective—that’s the right way to look at it, because a lot of times, people will buy a building, they’ll put a big down payment towards it, maybe they’ll put the loan on a 20 or 25-year term, and it does make the payment a little lower than rent would be. And they feel like that’s a huge win when sometimes, it’s like—in my experience, at least, you just parked a bunch of cash in this building, and that cash is not growing or doing anything for you, and you’re just subsidizing your rent by owning this thing and having a bunch of equity in it that’s not growing. And I’m not saying it’s a bad thing to do. Man, if you have the chance to buy the building and it’s the perfect location and the best visibility, why not, right?

Morgan Hamon: It can limit some uncertainties. There is going to be no rent escalations that you’re not wanting to do. A landlord could not choose not re-lease to you. And I would advise—I have this conversation quite often—I say buy a building if you want to own an investment in commercial real estate. It’s an appreciating asset. Own it for those reasons. Honestly, it has a very minimal impact on taxes, so, buy it because you want to be in the commercial market for real estate.

Reese Harper: Yeah, that’s good advice.

Morgan Hamon: The next is associate, and that is a big topic. I guess I’ll just take this from the topic. A question I get often is, when is a good time to maybe bring on an associate? And the practice has to be big enough to sustain that associate. In my opinion, that coincides with when a dentist is starting to kind of hit a wall. They’re working really hard, and they might be running out of time. So, it’s usually when the practice gets to about—you know, they’re somewhere around 1.3 to 1.5 million in collections per year. It’s usually about that time. So, the launching for an associate is, you have to have adequate revenue, enough patients to support, and you also need to have a very strong profit margin to start with. And by that, I’m talking for a single owner-operator practice, we need to be pulling down about a 45% margin I think. 40 to 45. Because the associate costs are going to come right off the top of that profit margin. In the example, I have typical associate costs for a full-time associate producing side by side with the owner. So the owner is not necessarily stepping back, but we’re bringing an associate, and we’re going to and capacity in the practice. More chairs, more time, open more days, et cetera. Those associate costs are going to be around 15%. And I have had the question, “well where does that number come from? Because I’m paying the associate around 30%.” Well, by the time you factor in what the owner is still bringing in plus hygiene, it’s going to average it out to the low to mid-teens. And that comes right off the profit margin. So if a practice had a 45% margin, brought on an associate, and is costing 15, they are now going to have a 30% margin. But they are getting 30% of 2.5 million dollars instead of 1.3. So, it’s still more money in the end. So, with that being said, if I see associate costs, now we have to adjust the goal post on profit margin. So, in the example I just described, if it’s a full-time associate working side-by-side with the owner—so, the owner is not trying to replace themselves, they are just trying to add capacity—the goal post for the profit margin is normally about 25-30. And in the example you had, that’s exactly what the situation is. But this practice is like a 32% margin, which I think is acceptable.

Reese Harper: Yeah. So ultimately, let’s say that my target, my average for associate costs is, you know, in that 15% kind of range. Does that decline the larger I get? Does that increase right at that first point that I hire that associate? And do these rules of thumb really—I guess, how many associates deep do these rules of thumb really even—

Morgan Hamon: So, the more associate you have, the less impact the owner’s production is going to contribute. So, the more the associate, that expense is going to come up to closer to maybe even 20. If I look at the numbers and I’m seeing like, 7% or 8% in associate costs, I’m thinking, we either have someone part time, or it’s someone right out of school, and they just don’t know how to produce well just yet. So, I ask a lot of questions about the associate when I see associate costs, because I have to understand that. Again, what we’re after is, is that profit margin acceptable for what the owner has invested in the business?

Reese Harper: It makes sense. What is the next item we’re talking about?

Morgan Hamon: So, the next item is what we refer to as discretionary. So these are business expenses we absolutely want to deduct for the owner, but they are owner related. It’s at the owner’s discretion when, where, and how much. CE and travel, auto expense, things that are related to—

Reese Harper: So, you put CE in there.

Morgan Hamon: Absolutely. And so, if someone is taking a bit implant course, we might see discretionary through the roof, but I’m cheering them on. I’m like, when you see high marketing or high discretionary due to CE, I view that as, we’re trading a little margin now for future growth. It’s an investment. Typically, a healthy level for those discretionary is usually a couple percent, unless we are seeing like, the big implant course. So, that’s the expense side. We had started this discussion like, so the profit margin is low. It’s like 25%. We can look here to see what is happening. If we’re seeing like 38% staff costs, well, that’s why your margin is low. That’s a short walk. But let’s shift gears here. And this is what I think is more often the case is that the practice is not necessarily overspending, but I think that they’re under collecting. And so, if I see a profit margin that is low, and expenses are elevated across the board, the next thing I’m looking at is collections. Like, are we collecting money, quite honestly. And the way that you analyze that is, you look at your AR aging. There are two things I look at with the AR aging: one is just the total amount of outstanding receivables. A healthy level is about one month’s worth of average production. So, say an office is producing on average about 80,000 per month. 80,000 in total receivables is normal. Now, there are some people that say up to a month and a half is normal too, but I don’t know. I guess I’m just a little bit more conservative. I’d rather see that money in a client’s pocket than in someone else’s. So, I look at the total amount. And then, you have to look at the composition of the again. That is current, 0-30 days, 31-60, 61-90, and 90+. The majority of the receivables should be current, and we should celebrate that. That’s terrific! We did that dentistry, and that is going to turn into collection. 31-60, maybe there are some insurance plans that are slow to pay, or patients slow to send in what they owe, depending on what the payment policy is at the practice. When we start getting 61-90, now we’re in the problem area, and definitely over 90+. But I also have to ask some questions when we’re analyzing this as well. We have to understand, does the practice allow for patient payment plans? So, if a practice is doing a lot of ortho or doing a lot of implants, those are big, expensive cases, and they might be allowed to pay over time, so it’s okay for them to have those receivables aged out. What I’m after when I’m looking at AR aging is, what has slipped through the cracks? If there is a problem in the collection process—so, say we have hired our collection person—and like we were talking about earlier, people look busy. They feel the day. And this has happened! I can think of at least three specific examples of when this has happened to clients where their person in charge of collections is having some personal crisis. They’re showing up to work, and they look like they’re working, but they’re not doing their job. And so, collections, isn’t happening. The production is happening, and everybody’s getting paid, all the employees, overhead is getting paid, but it’s not turning into a collection. If that’s happening, that will crush the profit margin. The owner will feel that in cash flow.

Reese Harper: Big time. Yeah, I see that happening a lot. It’s a big issue. So, in your practice, I know you guys track total receivables. See, that’s reported to you from the person at the practice who is—

Morgan Hamon: So, what we ask for at the end of every month is, from their Dentrix or Open Dental, whatever they’re using, I want to know what the total production was last month, what the total collections was, and then send us your AR aging report. So, very very simple. It’s two reports.

Reese Harper: Yep. And so, if the average monthly production—let’s say average monthly production is 100,000, alright? And let’s say total receivables are 100,000. Then you feel like, “that practice is dialed in.”

Morgan Hamon: That practice is pretty dialed in, provided that you have to look at the aging composition too. Because if most of that 100k is 61-90 or over—

Reese Harper: That would be unlikely, but it’s possible.

Morgan Hamon: It’s unlikely, but there’s a problem in progress. It’s in process. So, think of AR aging as the canary in the coal mine. If we start seeing the 61-90 category growing, we have a problem. And so, what I’ll do when I have a phone call scheduled with a client is I’ll look at their AR aging, and then I’ll go look at our report from three months ago, just to see what is changing. Because what you just described, that is in process.

Reese Harper: So, what if I’m at $200,000 in receivables and $100,000 in production? What are you starting to smell in that scenario? You still want to look at my aging.

Morgan Hamon: I still want to look at the aging. And I guarantee, if we see that, we are going to see a big balance of 90+. And so, then we just have to have an understanding of the practice. Did they acquire this practice and that is just a bunch of junk? You know, maybe they bought some junky receivables. If it’s a practice that’s been around a while and they have just never cleared out the 90+, that could be it. What I’m really after—I’m looking for, do we have holes in our collection process? And I’ll recommend at least monthly for doctors to sit with their collection person and comb through that 61-90 and see what’s in there. This is how you break it down. I tell them, every month, have your person go into your Open Dental or your Dentrix and print out every patient balance that is, at this moment, in 61-90. Print it out. Now, get a highlighter. If they’re on an approved payment plan and they’re current, highlight it. They’re allowed to be here; we’re happy they’re here. Now it’s time to have your meeting, and sit down with them, and look at the report, and you’re going to go through and look at what’s not highlighted, and the question is, why is this here? Did this claim not get filed? Is it just a crappy insurance provider that’s slow to pay? Was somebody allowed to walk without paying per the office payment policy? You want to dial in, why are these here? And trust me, just from a leadership perspective, if your collection person knows that once a month, they have to sit down with you, and they’re going to highlight the payment plan, they’re not going to want to have a lot of things un-highlighted! It’s going motivation to have that happen. That’s how I think you boil this down to something that is actually doable. The 61-90 is a shorter list; it’s not a huge time requirement for the doctor. But they absolutely have to do it every month.

Reese Harper: Okay, you came up with something really helpful that I want to hit, too, that you called the owner scorecard. And that was kind of a recent addition to your reporting that for me is super helpful as a financial advisor, because I want to understand how much my clients are making (laughs), so that in advance of kind of the end of the year, we can make sure that we have the right retirement plan contributions made, bring the taxes down as low as we can, make the right debt reduction decisions, and just know how much cash flow we are going to be working with. And that’s really critical. I like the way you guys do this. Tell me a little bit about why—like, how did this come to be?

Morgan Hamon: Quantifying income. I get that question a lot, and particularly from the newer practice owners. Like, “what did I make last year?”

Reese Harper: And the more seasoned guys I think kind of have a ballpark, but they just care less because it’s enough. They’re fine! But that’s one of the things that is surprising, you know? “How much do I make?” is actually a really difficult question to answer.

Morgan Hamon: Right. If you ask anybody—like, my wife is a cardiac nurse, so, like, “what do you make?” They quote your gross—

Reese Harper: You see it on your paycheck every month.
Morgan Hamon: ‘This is what I make,” you know? Someone gets offered a job and it’s 80k, “well I make 80k,” right? We think of this as gross, and so that’s how we calculate it too. And it’s what I call your profit from operations. So, it’s the money you collected less your ordinary necessary operational business expenses, and that’s your profit. Now again, this is before the owner gets their hands on it. This is before we write off to depreciation, amortization, and those non-cash options. It’s what your practice produced—what you’re going to pay tax on before we do make those adjustments and write-offs. So, I now calculate that every month for our clients, so they can do, “so, this is what I made this year at this point in this year compared against last year.” But it’s that line item on the profit and loss. Your income from operations, that’s what you made.

Reese Harper: Yeah. So basically, you’re saying, “I want to know how much I’m making from my practice at this point in the year compared to where I was last year so that I can kind of get a sense of how we’re doing.” Now, you probably don’t beat yourself up over it too much early in the year, because people’s collections vary, and some months are not always the best months, but you get closer to the end of the year—especially even at the end of the year, it’s nice to look back and really understand that.

Morgan Hamon: Right. And so at this point in the year—we’re kind of mid-September, we’ve been delivering August reports, and so on my recent calls, we have eight months under our belt. And so, I can take that line item and essentially divide by eight times by twelve, and this is where I think we’re going to land, you know? And I am very forthright, like, “we don’t quite know what is going to happen these next four months…” but it gives us a zone—

Reese Harper: When do you start doing this—I don’t want to jump ahead to this next topic, but when do you start doing tax planning, really? To say, “I think you’re going to make more,” or “I think you’re going to be the same.”

Morgan Hamon: Early in the year, like, first quarter, or even second quarter… we need to have adequate tax deposits. And that is predicated on the prior year tax liability, okay? I mean, we can temper that with what’s going on in the current year. But you have to have a minimum amount on a deposit.

Reese Harper: So there is no analysis to really be done, though, that first quarter. You just have to pay what you need to pay—

Morgan Hamon: It’s very straightforward. And I don’t refer to those as like a tax estimate. It is purely a deposit. It is a deposit to protect the client against any under-deposit penalties that could result. We cannot do what I’ll call a projection or an estimate until—we need six months under our belt to have a reasonable idea of what’s going on.

Reese Harper: So typically do you change the deposit in the second quarter even, or is it like, that’s just the time where we’re starting to get analysis, and we’ll probably change it in the third or—

Morgan Hamon: Yeah, honestly, we’ll change it throughout the year depending on what’s happening. So, after the midpoint in the year, or what we’re delivering now is very detailed. It’s not just a coupon, like, “hey, send this in to make sure we’re covered.” Now we’re saying, “we have eight months of history, and we can assume the next four months will look similar to our eight months, and this is what we’re looking at.” I want to touch on a couple of points that I think will help the listeners understand a bit about tax planning. One is just a practical consideration. And I’ve heard this before from our clients, because we do the books for our practices. I’ve heard said, “well, you guys are doing my books every week, you should know my tax situation at all times,” and that’s not accurate. Just like a dental practice, there are different folks in not only our accounting firm, but in all accounting firms, there are different levels of folks. And so the employees doing the bookkeeping are generally not tax preparers. It’s a different skill set, and just a whole different category. So the tax planning, it’s complicated. It’s very highly skilled work. There are factors that go into the tax that a bookkeeper doesn’t know. Things like the spousal income, or maybe a loss carried forth from last year, things that can have a significant impact on the taxes. So just because somebody is doing your accounting on a monthly basis does not mean that the tax situation is always known. A qualified skilled tax reviewer has to go in there and pull a lot of data from multiple sources to really do that projection. So the bookkeepers don’t do taxes. I thought I might point that out. The other thing in the dental industry is it is complicated, because we have an industry where the revenue… frankly, it’s unknown. I mean, we can look at last year, and we can look at prior trends, but the fact is, nobody knows what’s going to happen. So, we’re trying to hit a moving target, which can be difficult. The other thing that can make tax planning more complicated specifically to the dental industry is there is a significant amount of capital purchases that will be written off with section 179 most likely. When you have a chair that’s ten grand, that has a big impact. If we contract that with my firm, accounting, the most expensive thing I have to buy is, say, my computer, and I have to go to BestBuy and drop $400 on a computer. It’s way different in the dental industry.

Reese Harper: And that’s because you’re buying a PC (laughs).

Morgan Hamon: I’m buying PC! That’s right. Artists use Mac, and accountants use PC. So, those two things make it complex to do that tax planning. And the reasonable expectations given those two factors is that effective tax planning will be close, but it will never nail it to zero. Particularly, our objective is to let all of our doctors know by the end of December honestly what we think the tax bill is for the current year, months in advance, just so there are no surprises. Nobody likes surprises. And I think we even like surprises probably less than the clients. We don’t want to call anybody and tell them they have to pay an amount they weren’t expecting. So, we try and get it very close, but it will never be zero. And nobody really wants to have to write a check; they definitely don’t want to have to write a big check. But on the same hand, nobody wants to give an interest-free loan to the IRS all year. So, we don’t want a huge amount of money back. We try and nail it down to where you might get a spall refund, or if we really killed it in December and did a little better than we thought, then you might owe a little bit. But we can try and get it with a very narrow window. Another factor to consider with tax planning—this is true with us, and I suspect it’s true with most CPA firms—is that there are a couple of assumptions. We assume that if we send somebody a coupon to pay first quarter or second quarter, and now it’s towards the end of the year, we are going to assume those payments were made. So, you may not want to, but if you get a tax payment to be sent in from your CPA, write the check. So, we assume that’s been done. Two ways tax deposits can be made: you can write the check if it’s just a voucher, or if they are an S corporation, there is owner salary. And often times, we will calculate withholding on that owner salary to satisfy that tax deposit requirement, so then vouchers are not necessary. It does not work with our real high-earning clients, because we’re setting that S corporation/owner salary at a reasonable level to achieve savings on the payroll taxes. And a lot of times, that withholding will make for a very modest paycheck, and we may have to supplement that with some vouchers. But if we recommend a payroll change, change in withholding, or a voucher, we go in with the assumption that when we FedEx that to their office that it’s going to happen. And that’s important too, because when we are doing end-of-the year fourth quarter, we’re looking at their liability less what they’ve paid in, so, we assume those have been paid.

Reese Harper: Cool. Well I think this is a great overview of tax forecasting, tax budgeting, and tax projection. We talked a lot about overhead, and some pretty insightful stuff there. I want to hit you with a lightning round here to finish off on a bunch of questions I haven’t told you about and see what your responses are. So, some of these questions are financial, and some of them are not financial. First question that I’ll start out with is a financial one, and it is, should I hire an associate or not? If someone just asks you, “should I hire an associate or not,” how do you respond to that?

Morgan Hamon: It depends on their goals. So, we have a number of clients, and they’ll get it dialed in. They have the lifestyle they want; they’re working; they have it so they’re three-and-a-half days a week; they have a young family. And if they’re happy with their income, then my goal there is to help them preserve their margin and make sure they’re where they want to be. If they just say, “well, should I hire an associate?” then I’ll ask them what their thoughts are. Do they want to get bigger and grow? If the goal is more money, then I would say yes, that needs to be in the plan. But we can’t do it too early. If the practice is kind of barely off the ground to support an owner-operator and you bring an associate in, it’s going to crush the practice. And that’s where that threshold I mentioned earlier—about 1.3-1.5 million with a strong margin of 40%-45%, and it is just really prime to bring on an associate. And then when you bring on that associate, the goal there—if the goal is to have higher earnings, we need to be expanding capacity and not necessarily replacing capacity.

Reese Harper: The next question is a non-financial one, which is, do I go to a Broncos game, or do I go and see the Nuggets play?

Morgan Hamon: Um, well I’ve never been to a Nuggets game. So if we could substitute Nuggets for Rockies, I’ll go to a Rockies game.

Reese Harper: Oh, okay! So you’re a baseball guy.

Morgan Hamon: Oddly enough, I don’t particularly care for baseball, but the games are so much fun to go to, and it’s very family-friendly. Like, you go to a Broncos game, and it’s a ruckus. And people have been drinking all afternoon… so, if I bring my kids to a Bronco game and they’re like, “I wanna go get a soda,” it’s like, “I’m going with you!” Where at the Rockies game, it’s like, “here’s some money! See you in a while,” you know? (laughs)

Reese Harper: Okay! I like it. Well, any parting words you want to leave with the audience today, Morgan? I just want to give you the last word.

Morgan Hamon: No, I mean, we had a great discussion! I really enjoyed it. It’s really rewarding to help these doctors to kind of shine a light on where the practice is. And again, my objective is to always have a few action items at the end of every interaction, you know, to put some more money in their pockets.

Reese Harper: Yeah. Well, thanks for all your hard work, and for all the effort you’re putting into helping people. This was a great conversation! I know we got a lot of great things here that we will be able to share with people. So, I’m looking forward to having you back on again!

Morgan Hamon: I enjoyed it! Thanks for having me.

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