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Key Strategies For Reducing Office Overhead

Can a group purchasing organization rein in your supply costs? Do you need a different perspective on your P&L statement? How are your collection practices? Answering these questions and more, this author discusses proactive approaches to reduce overhead costs and improve the financial viability of your practice.

We have all heard, “It’s not how much you make that counts, it’s how much you keep.” Although top line revenue for today’s typical podiatry practice is relatively high, the portion that we keep—profit—continues to shrink. This is partially a result of lower fees. However, doctors today are facing an even bigger challenge: high patient volumes coupled with more complex business operations. This combination can generate overly high costs, resulting in too much of a doctor’s hard-earned revenue going toward ever increasing overhead rather than higher compensation.  

Controlling overhead is something that should be on every practice’s “to-do” list. When overhead is controlled, a larger portion of revenue ends up as profit. Unlike other “profit-building strategies,” money saved through lowering overhead drops directly to the bottom line. Enhancing profit through cost control requires no increase in volume nor does it require negotiation of higher fees, making the outcome a win-win-win for patients, doctors and payers alike.

What does the typical practice manager do when overhead becomes disproportionately high? He or she first turns to cutting costs. However, while it makes sense to cut unnecessary costs, it makes no sense to cut anything beyond “the fat.” Since practices often have little “fat” to cut, a focus on controlling overhead, rather than simply cutting costs, is what can lead to greater profit without undermining opportunities for increasing quality or growth.

Cost control is as much about having the right “mindset” as it is about honing one’s management skills. A mindset open to new ideas, innovation and change is the prerequisite for cost control. It is important to understand that controlling costs is not about being “cheap” or arbitrarily cutting expenses by predetermined percentages. We achieve prosperity not simply by cutting costs but by making smart investments in one’s practice while taking on no unnecessary expenses, ones that neither improve quality nor add value for patients. One of my favorite business axioms is: “A company cannot cut its way into prosperity.” Again, simply cutting costs is not the answer. A more effective focus—one on controlling costs—requires strategies that go beyond cost-cutting across the board.

When told that their practice overhead ratios are too high, most doctors begin by looking for the “easiest” solution: “Where can I cut costs?” If a doctor sees that his or her practice overhead ratio is 70 percent of revenue, the doctor recognizes that he or she is keeping only 30 percent of income generated, and immediately jumps to “let’s cut costs.” Cost-cutting is always an option. However, before going down this path, a doctor should first do a more in-depth analysis. There are a number of alternate strategic options for reducing one’s overhead ratio without decreasing quality.  

What To Look For In Profit And Loss Statements

When planning cost cutting, doctors typically begin by analyzing the profit and loss (P&L) statements from their CPAs. These documents usually contain more than 30 expense categories arranged in alphabetical order. At the bottom of the P&L chart, all costs (including fixed, variable, non-operational, and even personal ones) are added together into a final number labeled “total expenses.”

As a starting point for accurate cost analysis, it is best to first ...

(1) Enter this P&L data into an electronic spreadsheet (see “An Alphabetical P&L Listing” at right).

(2) Use the “sort” feature on the spreadsheet to rank the cost categories, rearranging them from an alphabetical order to one sorted from highest to lowest cost while also combining similar categories such as “payroll taxes” with “wages” and “business supplies” with “medical supplies” (see “A Closer Look At A P&L In The Pareto Format” at right).

(3) Eliminate non-operational and personal expenses (i.e., depreciation and pension contributions) that have no bearing on operations.

(4) Arrange the most costly 15 categories in a Pareto graph (see “Assessing The Highest Costs In A Pareto Graph at right). Note how this graph gives a clear visualization of cost distribution. This Pareto format separates the “trivial many” from the “vital few” expenses and quickly draws focus to the left side of the graph, which has the 20 percent of categories that drive 80 percent of the expenses. The good news is that the categories in this 20 percent are all under the doctor’s direct control. The bad news is that the top two expense categories, wages and rent, are the ones most difficult to “control” because they are in operational areas that may require major change. This is something to which we have a natural resistance.

A practice needs to get the most it can from these 20 percent of expenses that account for 80 percent of costs. It is important to note that the two highest costs in this example, “wages” and “rent,” are both relatively fixed while the third and fourth highest, “supplies” and “billing service,” are variable. This distinction is important to keep in mind. As volume grows, a practice wants to keep its fixed costs as stable as possible. If these costs are kept constant and shared by more doctors (i.e., associates, mergers, etc.), the relative cost of these expenses, per doctor, will decrease. This scenario offers leverage for reducing the overhead ratio and thereby increasing a practice’s bottom line.

Let us focus on the variable costs that increase or decrease as volume fluctuates. These are the only costs that should increase along with higher volume, in either patients or in numbers of procedures. Our strategy is to decrease the ratio of these costs, which will increase the marginal profit of each new dollar collected. An estimated 16.1 percent of the practice revenue in this example goes toward variable costs ([$42,200 + $60,926] ÷ $640,286 = 16.1 percent). This means that if fixed costs remain fixed, each “new” dollar collected over and above the 2018 revenue of $640,286 will have a marginal profit of 83.9 percent (100 percent - 16.11 percent = 83.9 percent), which is much greater than the practice’s gross profit margin of 20.8 percent (based on the $507,129 in total expenses listed on the P&L (100 percent - [$507,129/$640,286] = 20.8 percent).

It may not be obvious to a doctor looking at the 20.8 percent profit margin derived from the P&L that he or she has an opportunity to capture 83.9 percent of all new dollars collected. Again, this opportunity to capture significant marginal increase in profit from new dollars billed can be achieved by increasing the patient and/or procedure volume, and spreading this new volume over stable fixed costs.

Relative Cost Cutting And Reducing The Average Cost Per Patient

When overhead costs are way out of line, cutting those costs definitely becomes a consideration. However, the first cost cutting opportunity to be recognized before haphazardly jumping into direct cutting of total practice expenses is relative cost cutting. The focus of relative cost cutting is on increasing prosperity.

One way to achieve this is through cutting the average cost per patient. I use the term “relative” for the type of “cost cutting” we seek because, as volume increases, the average cost per patient should actually decline even as total overhead costs increase. To calculate the cost per patient, one can use numbers from the P&L and patient volume data from the appointment schedule. Assuming 6,000 patient visits in 2018 for this practice, that year’s average cost per patient was $84.52 ($507,129/6,000 = $84.52). One can reduce this average cost through greater efficiency, internal growth (perhaps by adding associates) and/or practice mergers. All of these enable a practice to spread a greater volume of patients and services over relatively stable fixed costs. The result of this relative cost cutting is a higher marginal profit.

Obviously, running a practice at a significantly lower cost per patient makes sense in any economic environment. As a practice grows in volume or doctors merge to form a group practice, new opportunities to share overhead will emerge, and the cost per patient will continue to drop as long as fixed costs are kept “fixed.” Given that many doctors practice solo or in groups of two or three, this opportunity to add doctors (or merge practices) is open to many and this strategy can lead to greater prosperity regardless of what type of health care reform is adopted in the future.

Facing The Truth About Collections

Another “relative” cost cutting tool that can reduce the overhead ratio is increasing the collection ratio. After completing patient visits, focus on capturing a greater percentage of the charges for those visits. First, you must establish an accurate overhead ratio for your practice. Using the numbers in this example’s P&L provides an overhead ratio of 79.2 percent ($507,129/$640,286 = 79.2 percent).

This, however, is not actually an accurate ratio because non-operational expenses have been included in calculating the overhead. To achieve an accurate ratio, subtract anything non-operational from the overhead. Non-operational expenses include the $38,205 pension contribution, the $11,080 in depreciation and the $12,450 in travel and entertainment. A revised calculation reflects actual overhead. Total operational expenses are now $445,394 ($507,192 - [$38,205 + $11,080 + $12,450] = $445,394). Using this number, we can calculate a more accurate overhead ratio. The new ratio improves to 69.6 percent ($445,394/$640,286 = 69.6 percent). Recognize, however, that no matter how good your ratio might be, it can always be improved upon because no practice collects 100 percent of what is allowable.

Since most practices charge two to three times the fees they expect to collect, staff often have no idea when they have collected 100 percent of the charges that will actually be allowed. Frequently, even allowable charges go uncollected. Due to high volume and complex billing requirements, staff may not obtain prior authorizations or, because of the difficulty in keeping up with new charges, they may be quick to adjust off remaining balances, or not follow up on underpayments.

Due to such issues, many of the practices I have seen have inefficient billing processes or are outsourcing to billing services. These practices have collection ratios that are easily 8 percent lower than the rates they could reasonably expect to achieve. If this example practice had been billing at the rate of 2.5 times the Medicare rate (which many do), at their collection ratio, they would have had to have billed over $1.6 million to collect this $640,286. If, with a more efficient billing system, this practice had captured 8 percent more of this $1.6 million in billings, the result would have been another $128,000 in collections. Adding this “lost revenue” to $640,286 changes the total revenue to $768,286, dropping the overhead ratio from 69.6 percent to 58.0 percent ($445,394/$768,286 = 58.0 percent) without cutting treatment quality or expenses. Whether you are using a billing service or doing your billing “in-house,” it is important that you keep operations “tight” and closely monitor the entire process.

In today’s environment of higher co-pays, higher deductibles and increased numbers of non-covered services, it is also important to become proficient at the process of collecting cash (i.e., co-pays, deductibles, and non-covered services) in a timely fashion. Significantly, cash is most collectible on the date of service and its collection rate drops steadily the longer cash remains in receivables. If you wait until insurance pays before sending the patient a bill for his or her portion of the payment, you will want to change your process because postponing collections significantly lowers overall collections.  

Errors that result in non-payment or denials also create delays in billing processes. These errors require time-consuming follow-up, which frequently falls victim to procrastination—getting set aside until “later”—often much later. Most of these errors are “simple” matters, either data entry errors made at a busy front desk when staff is distracted by phone calls and checking patients in, or “missing” billing information such as birth dates or insurance numbers. Each of these necessitates later follow-up. Doing things right the first time saves significant time. It is worth taking the time to improve any collection “glitch” because even small improvements in billing “timeliness” can have a large impact on the total revenue collected.

How To Save On Supply Costs

Saving on supply costs is a relatively “simple” matter to address because this requires no change in business operations. You need not buy lower quality products or cut your numbers of supplies. You can simply cut the costs of those supplies. Here you are cost-saving by controlling costs rather than cutting something out. There is considerable variation in the amount that each practice spends on supplies but for many, this number is large, especially for busy practices that stock durable medical equipment (DME) or sell supplies to patients. In the past, large medical groups have had an advantage negotiating fees with suppliers but now even small practices can garner sizable discounts by ordering from group purchasing organizations (GPOs).

When considering the option of ordering through a particular GPO, it is important first to ascertain that the GPO charges no joining fee (i.e., membership is free) and that discounts will be based on quality items as opposed to lesser substitutes. A podiatric-specific GPO can be a plus because it is likely to have more of the supplies and products that a DPM regularly uses. There are three significant financial benefits one can obtain through the use of a GPO: (1) the relative value of revenue enhancement to cost-cutting; (2) the often overlooked, yet magnified, impact of cost-cutting on net profit; and (3) the patient satisfaction and revenue enhancement a practice can achieve from offering supplies for sale on site.

Ordering from a GPO can save the average practice approximately 22 percent a year on supply costs. For example, a practice with supply costs of $80,926 ($60,926 medical supplies + $20,000 office supplies), a savings of 22 percent would equate to $17,804 a year. This amount will drop straight to the bottom line as profit. Compare this amount of savings with the equivalent number of bunionectomies that one would have to perform to capture the same amount in revenue. Assume that you will collect $950 in revenue from one Medicare bunionectomy. A doctor would need to perform 19 of these procedures with appropriate postoperative care to produce an amount equivalent to this $17,804.

Often, physicians evaluating the value of a “small” 22 percent savings on supplies do not fully understand the concept of profit and the amount of leverage that saving costs provides. Many believe that profit is simply the money “left over” after paying the overhead with their salaries being part of that “left over” money. In reality, profit is the money that is left over after paying the overhead with the physicians’ salaries being included in this overhead number. Doctors whose practices are incorporated have a better understanding of this concept because they are required to declare their salaries.

Profit is what is left over after paying all of the overhead, including all physician salaries. Profit is important to those looking to join a group and is what creates the value for ownership in a group. To determine the net profit for this practice, we would add the $61,735 in non-operational expenses to the $133,157 the P&L designated as net profit. This makes a total of $194,892. This figure still does not represent true profit because it includes the doctor’s salary, which one should consider part of the $507,129 in “expenses.”

To determine what the actual profit is (the amount left over after paying all expenses, including the salaries of employed doctors and owners), one would need to subtract a normalized DPM salary from the $194,892 profit. (Normalized salary is the amount that one would typically pay a DPM in this practice.) Say that we use $160,000 as the “normalized” salary for our example. In this case, what would then be left as actual profit is $34,892 ($194,892 - $160,000 = $34,892). If, by ordering from a GPO, this practice were able to save the previously calculated $17,804, the profit of $34,892 would be increased to $52,696 ($34,892 + $17,804). This “small” cost savings has great leverage on profit, increasing it 51 percent.

In Conclusion

If your practice’s expenses or overhead seem to be disproportionately high relative to revenue, utilize the strategies I have discussed in this article. Keep in mind that these strategies are not mutually exclusive and one can incorporate them simultaneously into an overall strategy, which will improve the economics of the practice by widening the margin between revenue and costs.

Instead of focusing solely on lowering your overhead by direct cost cutting, you can achieve greater prosperity through a focus on (1) lowering your cost per patient, (2) lowering your overhead ratio and (3) achieving a higher profit margin.

Dr. Hultman is the Executive Director of the California Podiatric Medical Association He is a consultant for Medical Business Advisors and the former CEO of Integrated Physician Systems (IPS). Dr. Hultman is the author of Reengineering the Medical Practice (1994) and The Medical Practitioner’s Survival Handbook (2013).

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By Jon A. Hultman, DPM, MBA, CVA
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