During my recent presentation on veterinary medicine compensation models, a Michigan State University student asked why 25% of production is used as a rule of thumb for compensation and benefits. “Why not a higher percentage?” he asked.
I explained that practice owners need to evaluate where gross profit is distributed among various expense categories (eg, Cost of Product Sold [COPS], Cost of Goods Sold [COGS], payroll, utilities, equipment). Most aim for a net income between 16%–18% of gross revenue, although the average practice nets closer to 10%.
Although the student’s question revolved around compensation, practice owners often use “rules of thumb” to make decisions, including not only payroll but also equipment purchases. With any practice investment, we must measure return on investment (ROI).
Another such rule I personally agree with is that we should not buy a piece of equipment we cannot pay off within a year. Anecdotally speaking, if we cannot pay off most pieces of equipment in that timetable, there is a lack of demand, under-usage by the team, or our price point is off.
Practices often invest excess earnings (ie, a percentage of net income) into the practice as new equipment, building renovations, marketing efforts, or team benefits, but it is important to know the ROI.
Many practice owners may be familiar with ROI but not know exactly what to do with it. ROI usually implies a financial return (ie, getting more financial benefit from an investment than that investment costs).
The ROI does not have to be short-term; for example, when repainting a practice, the cost of paint and labor is unlikely to result in direct financial ROI, but the expenditure is a good use of capital because the facilities will match the service and experience levels desired for clients.