Think of a break-even analysis as a little like a depth finder on a boat—it tells you how close you are to running aground. Put another way; it shows you how far the revenues of the practice you are considering purchasing can drop before it hits rock-bottom. In this case, rock-bottom is the moment net revenues only cover the practice’s expenses. Depth finders help mariners navigate away from dangerous waters; the break-even analysis will help you do the same, even before you get in the boat!
First, you need to ask: What is the break-even revenue, and how do I calculate it? Break-even revenue means that the revenue generated by the clinic matches that of the fixed and variable expenses.
Fixed expenses are those that don’t change when revenues increase or decrease. Let’s assume, based on the valuation report of the target clinic, you determine that the annual fixed expenses are $450,000. In this case, costs are $250,000 for clinic overhead, $80,000 for servicing the purchase loan, and a minimum of $120,000 for your living expenses.
The variable expenses are 15% of revenues and consist of dental supplies and lab fees which are 7% and 8% of revenues, respectively. The remaining 85% of revenues contribute to paying for the fixed expenses. Accountants call the 85% the “Contribution Margin Percentage”.
To calculate the break-even revenue, divide the fixed expenses by the Contribution Margin Percentage. Break-even point = fixed expenses ÷ Contribution Margin Percentage.
In the above example: Break-even point = $450,000 ÷ 0.85 = $529,412
If the clinic brings in $530,000 in revenues, it pays for all the running costs, but there is virtually zero profit. In this case, where do you find the funds to upgrade the website, replace dental equipment, or take an extra draw to take your family on a Disney Caribbean cruise?
In dollars and cents, the break-even analysis provides the answer to whether or not you should consider buying the clinic. Unless future income projections indicate a substantial increase in revenues, the break-even analysis above shows that you should move on to the next purchase opportunity.
The break-even calculation is essential when shopping for a dental practice and as a monthly management tool to monitor profitability. Like the depth-sounder mentioned earlier, it can alert you if you get too close to rock-bottom so you can take immediate corrective action.