SDS Manager: Do you understand the dynamics of cash flow?
Do you understand the dynamics of cash flow?
By Stephen W. Earnhart, MS
President and CEO
Earnhart & Associates, Dallas
When we start a new business or invest in a going concern, most of us do so in anticipation of some reward for our efforts. Personal satisfaction and the knowledge that we are doing something that is meaningful are important.
The key to continuing those efforts usually involves some profits (cash).
Many of the individuals I meet with do not understand the way the finances of a surgery center work. Let’s discuss.
How many times have you heard your surgeons say, "We are busting our butts, but not making any money"? You wonder, how can that be? Actually, there are many surgery centers that are making a profit, but no cash. The average surgery center costs about $4.5 million to develop the operating entity; add on a chunk more if you buy the building. This includes startup cost, improvements to the existing space, equipment, and money on hand to pay the expenses until you start doing cases and getting reimbursement.
Most investors do not pay all that money up front in cash; they leverage it with some debt financing, i.e., bank loans or equity loans. I don’t like equity loans with which they get money from noncontributing individuals, the so-called passive investor. But regardless of how the investors get the money, much of it must be in the form of cash. We recommend about half of it be in cash.
A serious problem we encounter is that groups of surgeons build a center and put up only a small amount of cash (usually a loan from a bank), and they essentially charge the rest. Those charges, not unlike credit cards, require payments on a monthly basis. This "debt service" is usually the first bill that is paid each month. The rationale is that once the business gets going, the flow of cash through the business will pay for all the expenses and cover the debt service of the loans, and whatever is left over is profit. That profit is then divided among the investors (and of course, the staff!), and everyone is happy with the flow of cash.
Unfortunately, many physician groups put down the minimum amount of cash to get started, and subsequently, all their profits go to paying the debt. It’s like only paying the minimum on your credit card: You never will get out of debt. Physicians obtain loans for the equipment, the leasehold improvements, lines of credit, etc. So while your surgery center may make lots of money on the profit and loss statement, all the cash goes to service the debt. To make matters worse, your surgery center essentially is making money as an investment, and the investors still have to pay taxes on that "income." However, the cash flowing through the business never gets past debt service, so the investors have to take money out of their pockets to pay taxes on the profits they never received cash for in the first place.
At some point in time, that debt service will go away, and that cash will become available to give out to the investors. But that process can take many years, and there are a score of surgery center investors who retire before getting out what they put in. Proper planning capitalization minimizes that risk, but surgery centers are a risky business even today.
There is no other way but to accept that investment in any new business is always a risk, but the best way to help the business grow is to provide as much capital as possible in the form of cash and not debt. With the lower interest rates available today, refinancing existing debt is a great option to consider. If you want to help the center increase cash flow, focus on reducing personnel cost and supply cost. Those two items generally make up 60% of your monthly expenses. Then, once that cash starts to flow, get in line to get your share.
(Editor’s note: Contact Earnhart at 5905 Tree Shadow Place, Suite 1200, Dallas, TX 75252. E-mail: [email protected]. Web: www.earnhart.com. Earnhart & Associates is an ambulatory surgery consulting firm specializing in all aspects of surgery center development and management.)
When we start a new business or invest in a going concern, most of us do so in anticipation of some reward for our efforts. The key to continuing those efforts usually involves some profits (cash).
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