Use pro forma analysis to make better practice decisions
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“The only function of economic forecasting is to make astrology look respectable.”
– John Kenneth Galbraith
“Forecasting is simply not a strength of the species; we are much better with tools and narrative storytelling.”
– Barry Ritholtz
Last month we covered things to consider when writing and using a long-term strategic business plan. Because such plans are more often “A-B-C” words on a page rather than objective, accountable numbers (which are as important in business as medicine), let’s get more granular this month and discuss the “1-2-3s” of business planning.
Practice owners have two common starting points for such planning.
The first is long-range, advance planning from a blank page. Let’s say you have a two-surgeon practice with one office, performing 1,000 cases per year. Day-to-day operations are well ordered; profits are strong. Now, as partners, you and your colleague are asking, “Where should we go from here?” There might be numerous options:
- Remain status quo.
- Reduce work hours and trim practice scale to improve work-life balance.
- Add one or more optometrists along with optical dispensing.
- Admit a new partner-track associate MD.
- Open a satellite office.
- Add medical retinal services.
Each of these options can be modeled using a simple pro forma tool (from the Latin, “for the sake of form”). A pro forma is a disciplined method of calculating expected financial results using assumptions and projections.
The second common kind of planning analysis arises in response to unexpected opportunities. Let’s imagine the same two-surgeon practice. Along comes a third surgeon, newly graduated, who says, “I grew up around here and would like to practice locally with you if you’re looking for a new associate.”
In either case, pro forma forecasting treatment is essential. Here is a simplified workup for the second case of hiring a new provider.
As a first step, it is important to prepare a set of assumptions, which might look something like:
- The young doctor is going to join us fully credentialed in July, or “month 1.”
- The practice is busy now but not quite overflowing; some of the founding doctors’ patients might be transferred to the young doctor (but will not represent much in the way of new revenue to the practice), so to be conservative, we will assume the new doctor starts with 50 patients in month 1 and grows their practice by 50 additional patients each month after that, topping out at 500 visits per month in month 10.
- The average collections for each patient visit will be $200 (inclusive of professional fees, testing and surgical fees).
- The practice will be paid for the new doctor’s services in the month after the services are rendered.
- Many practice expenses will remain fixed, but incremental practice operational costs will rise at a base level of $5,000 per month plus an amount equal to 35% of the new doctor’s collections.
- The young doctor will be compensated at the greater of $360,000 per year ($30,000 per month) or 35% of personal collections.
- The two senior doctors will continue to work full time as they have been.
- Last, we need to define how we are going to interpret the pro forma and use it to make the hire/no-hire decision with this young doctor. It is agreed that owner-MD compensation per hour worked will be the chief performance measure — it has to increase for this to be a good business decision — and we do not want to risk any more than $200,000 with this investment.
With these assumptions in hand, one can readily prepare a month-by-month Excel spreadsheet showing incremental collections, incremental costs and incremental losses or profits. Such pro forma workups typically show that successful new business activities lead to a transient near-term loss before eventually breaking even and becoming profitable. A pro forma can help you make go/no-go decisions and also help you understand advance capital resources that might be needed to carry near-term losses.
The table below is an example based on the above assumptions about hiring a new doctor.
Again, remember that this is a highly simplified example. Your own setting is likely to be more complex. Even so, we can point out several insights from this simple workup:
- Each owner’s income per hour is cut sharply within the early months of the new MD’s arrival.
- If things go according to forecast, this owner pay cut goes away by month 7, after which the owners get a material pay raise going forward.
- If year 2 goes as well as the end of year 1, the owners will enjoy a roughly 30% pay raise in the new doctor’s second employment year.
- Finally, this workup shows that the peak negative cumulative cash flow to the partner MDs is reached in month 7, with owner losses (compared with baseline) of only around $139,000.
- Because this owner income loss is less that the $200,000 limit stipulated in the assumptions set, and because the owner MDs get a material pay raise if everything works out as portrayed in the pro forma, there is a strong business case for hiring this new MD.
- Of course, practical considerations will still apply: Does the new MD possess the skills and personality to fit in with the current owners? Will the practice leaders be able to integrate the new provider? Can the practice increase marketing efforts sufficiently to fill another full-time MD’s schedule? If our forecast is wrong, do we, as partners, have sufficient alignment and risk tolerance to manage the resulting difficulty?
With this as a basic “expected case” template, you can use Excel to create various “what if?” scenarios. What if the new doctor gets off to a slower start? What if we need to outfit two new exam rooms before they start? What is our worst-case exposure if the new doctor fails to thrive and ends up leaving after a few months?
Pro formas like this have many other uses in your practice:
- Will a new service line be profitable?
- Will a new piece of capital equipment be cost-effective?
- Will opening or closing a satellite office be accretive to owner income?
- What will be the effect of a provider going to part time?
- What will be the effect of a fee change for elective services?
A final thought: Remember that we do not want to gather information (business or clinical) that is not going to be useful for making decisions. We do not write down whether a cataract patient’s favorite color is blue or red because it has no bearing on patient care or outcomes. In the same way, whenever generating a pro forma or other analysis, always ask, “How will this data be used to make decisions?” Do not get lost in the weeds of excessive analysis or overthinking.
- For more information:
- John B. Pinto is president of J. Pinto & Associates, Inc., an ophthalmic practice management consulting firm established in 1979. He is the country’s most published author on ophthalmology management topics, including John Pinto’s Little Green Book of Ophthalmology: Strategies, Tips, and Pearls to Help You Grow and Manage a Practice of Distinction, UP: Taking Ophthalmic Administrators and Their Management Teams to the Next Level of Skill, Performance, and Career Satisfaction (with Corinne Wohl), Simple: The Inner Game of Ophthalmic Practice Success, and Ophthalmic Leadership: A Practical Guide for Physicians, Administrators, and Teams. He can be reached at 619-223-2233; email: pintoinc@aol.com; website: www.pintoinc.com.
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