Understanding the true cost of technology

When buying a new piece of equipment, investigate how best to invest to improve your efficiency

Purchases in the last five years of practice ownership should be based on needs. PHOTO COURTESY SIMMONS & ASSOCIATES
Purchases in the last five years of practice ownership should be based on needs.
Photo courtesy Simmons & Associates

As veterinary business appraisers and brokers, the authors of this article have encountered droves of young veterinarians reared on cutting-edge technology, hoping to equip their newly purchased clinics with blinking lights and high-resolution screens.

As such, it is not uncommon to see outgoing practice owners sink all their earnings into new gadgets just before they retire. These seasoned professionals hope their newly outfitted practices will bring in the tech-hungry millennial buyers. Unfortunately, what these individuals fail to realize is stuffing their facility full of new equipment can often have a negative effect on the value of the clinic.

Determine demand

The demand for more cutting-edge medical technology is a reality of the veterinary business. While these tools bring increased average expenses, the cost of falling too far behind might be greater than that of updating equipment.

The key is to think of buying equipment as an investment. You need to have the capital (cash) to make the investment; you also need a concrete plan, which allows you enough time to see a return on investment (ROI).

Let’s begins with the capital and time to return. It is inadvisable to invest in pricey equipment immediately after purchasing a practice. This is because, early on, your debt payments will take up a large part of your earnings.

Likewise, for a myriad of reasons, this investment should be avoided in the years leading up to retirement. This is because, when selling your practice, your equipment only has value in as much as it is producing earnings. Further, a practice sells free and clear of debt, which means the buyer does not take on your loans (rather, these are paid out of the closing proceeds).

Finally, keep in mind every dollar added to your earnings is worth up to $12 in practice value. If you sink a major share of your earnings into equipment and have not had enough time to see an ROI, the purchase might drag your practice down.

Thus, the ideal time to invest in equipment is after you have had time to understand the flow of your business and at least five years before you want to retire. Even if you are in the right career position to invest in equipment, you will still need to ensure it not only improves your quality of medicine, but is also a sound business decision.

To gain perspective and reduce the risk of making the wrong choice, it is advisable practice owners perform a full feasibility analysis to see if the equipment is worth the investment. A feasibility analysis is a tool used to gain perspective on a potential business decision. It helps figure out potential ROI, which is a major part of your feasibility analysis.

Evaluating

Before investing in new equipment, it is best to learn the health of your practice to see if you are in the position to invest.

When was the last time you had a management-based appraisal (MBA) done? A skilled valuator with understanding of the veterinary industry can point out profit centers and weaknesses in your practice. If you have kept up with the suggested MBA every three to five years, you can refer to the analysis to help understand the current health of your practice. If not, it is time to get one done to see if investment is possible, as lagging technology could be the least of your problems. Once you fully understand your practice’s health, you will be in a great position to make a plan to help ensure you will see an ROI on equipment.

If you can invest, start by estimating the actual cost of equipment. As an example, consider a $50,000 piece of equipment bought with a loan. Low interest rates will not last forever, so be conservative and consider a five-year loan with an 8.5 percent interest rate. This results in $11,550 in interest through the life of the loan.

In this example, assume the equipment will depreciate over five years. While it may retain some residual value and continued use, the rapid rate of technology growth renders a shorter useful life. You will be able to depreciate the equipment either in the first year, or through its estimated useful life. The tax savings from depreciation will be about 35 percent, bringing the cost down to $32,500. Adding the interest from the $50,000 loan brings your actual cost to $44,050.

Also, consider additional costs you might incur. Do you need to renovate or pay installation fees? You may need to hire new staff, as well as train your existing staff and, possibly, yourself to use the equipment.

After researching, assume you will have to invest an estimated $1,000 in installation and training. You might also consider the offered service plan for some equipment. Some practice owners never need to use these, while, other times, brand new digital X-rays fall apart in the first year. Paying $2,000 for an annual service plan is not bad compared to spending $50,000 on a new piece of equipment.

Including the installation costs, training, service plan, and the interest (less the tax savings), this initial investment is $47,050. With an estimate of the actual cost, you can start building an ROI calculation.

To determine your ROI, start with the annual cost, which is the actual cost divided by the useful life of the equipment. Over five years, this would be $9,410 (see Table 1).

Setting goals

Once you have annual cost, you will need to set a usage goal.

When purchasing a brand-new piece of equipment, try to estimate how much you may need to use it to see a return. If it is just an upgrade of existing equipment, such as going to your first digital X-ray, do not expect to achieve a huge initial usage jump. Instead, set a reasonable goal over several years (e.g. 200 uses).

Fixed cost per use is your annual cost divided by your number of uses. So, in this example, $9,410/200 = 47.05 (Table 1).

In addition to the fixed cost, the equipment will have some variable costs (i.e. personnel, materials). In Table 1, we assume minor materials costs of $2 and personnel costs of $20. This puts the total cost per use at $69.05.

Using the estimate of cost per use, apply a markup to set a potential price per use. Start with a 50 to 100 percent markup. (Remember: this equipment must pay for itself, pay you a return, account for variables you did not consider, and pay for the utilities and amount of space it takes up in your building.)

In Table 2, we start with a 50 percent markup, putting the price at $104 ($69.05 x 1.5). In Year Zero, total costs are listed an expense, with each subsequent year including the service plan as an expense.

Next, consider your number of uses. Do not assume you will hit your goal right away. In Table 2, we start with 75 uses, working up to 200 in the fourth year.

To determine revenue for each year, multiply your price minus your variable costs by your estimated usage for that year. Using Year One (Table 2) as an example, this would be: ($104 – $22) x 25 = $6,118.

For calculating gain in each year, start with the total initial cost as a negative in Year Zero. For each year, add the revenue minus the expense for that year to the previous year’s gain.

Continuing with the Year One example, this would be: $-47,050 + ($6,118 – $2,000) = $-42,932

With an estimated gain and cost, you can estimate your ROI (gain-cost/cost) by taking your average annual revenue and subtracting it from your average annual expense. This gives you the average annual gain ($12,644 – $11,410 = $1,234) (Table 3). Divide that number by average annual cost for your ROI estimate ($1,234/$11,410 = 10.82 percent).

In this example, the resulting ROI (10.8 percent) is great; however, before moving forward, a sensitivity analysis should be performed. To do so, change one variable at a time in the calculation and see how this changes the ROI. Adjusting the number of uses or the percentage markup could drastically change the outcome. (Per Table 4, changing the markup to 25 percent results in a considerable loss.)

 

Bang for your buck

There will always be a new piece of equipment available to revolutionize your practice. If you have the time, investigate how best to invest to improve your efficiency.

If your time until retirement is five years or less, it is probably best to let the next owner choose their own equipment. After all, the incoming veterinarian or practice owner might want a different brand, rendering your investment all for naught.

Lacking the newest technology will not impede the sale of your practice. Your equipment purchases in the last five years of ownership should be needs-based, not wants. Let the next owner decide what equipment they want for the practice.

Sean Coyle is president of Simmons & Associates Northeast. He holds a bachelor’s degree in economics from the Rochester Institute of Technology in Rochester, N.Y.

Jim Stephenson, DVM, CBA, is the owner of Simmons & Associates Northeast. He is a charter member of VetPartners, as well as a practice appraiser, ownership transition, and profitability consultant.

For more information, visit simmonsinc.com.

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