Whether you currently have a lab in place and operating within your eyecare practice or you are still in the decision-making phase, measuring cost effectiveness and profitability of the venture is an essential managerial task.
Let’s assume you are seriously considering whether or not to establish an in-house lab and you are performing the necessary due diligence required of such an investment. In this case, the saying, “Run the numbers before you run the lab,” is particularly meaningful.
Determining Financial Viability
As you contemplate your possible investment, there are additional decisions regarding the business model for the lab that need to be formulated and made part of your operating policies. These day-to-day operational routines are fundamental and necessary if you are to have a financial picture of the viability of your investment based upon operating costs, cost of goods sold, gross and net margins and inventory turnover rates.
Step 1) From an established “wholesale” price list, sell, at least on paper, the lab’s finished product to the dispensing portion of the practice. (Your dispensary is a customer to the lab.) You can use the price list from your full-service wholesale lab as a guide to format your lab’s pricing structure.
Step 2) Operate the lab under the same terms and conditions of sale and under identical policies covering returns, allowances and warranties that your current wholesale lab grants your practice now.
Step 3) Again, at least on paper, provide the dispensing customer the same prompt pay discount schedule based on volume you currently receive from your wholesale lab. This is necessary if you are to obtain a net sales figure for your monthly operating statements that is worth comparing to your anticipated investment.
Step 4) Come to a firm decision about which Rxs you will “farm-out” to a wholesale lab and at what price you will resell them to your dispensary. These Rxs fabricated and purchased from an outside lab will probably be based on your lab’s capability, Rx power requirements, lens materials or a combination of these or other prescription parameters. Note that these Rxs will be considered as purchases and obviously resold at reduced margins than Rxs your in-office lab fabricates and sells.
Step 5) Determine how to allocate operating expenses incurred by the practice. These expenses, such as electricity, water, heat and air conditioning, are sure to escalate due to the presence of the lab. Some businesses proportion such expenses based on square footage. For example, if the lab occupies 10 percent of the total practice space, then it incurs 10 percent of the operating expenses. It’s best to consult with your accountant of financial advisor on these matters.
To assist you in compiling a preview of the net effect of operating revenue and costs, you can use the sample operating statement below to construct a pro-forma statement of net operating profit/loss. Again, rely on your accountant for the best advice as to content, format and structure.
Even though you have by now worked your way through various elements to determine if an in-office lab is right for you, there still remains two additional pieces to this investment puzzle that should not be overlooked nor minimized in importance—calculating gross margins and opportunity costs.
Calculating Gross Margins
During the initial stages of investigating the feasibility of establishing a lab, you developed a 100 Rx statistical spreadsheet (This was explained in “Measuring the Effectiveness of Your In-Office Lab, Part 1, 20/20 November, 2003). Now you can insert projected gross and net sales revenue figures along with some operating costs into the sample P&L.
Calculate the following:
From your wholesale lab’s uncut price list, total your Rx lens purchases costs for those Rxs that would have to be ordered as uncuts from the wholesaler: progressive lenses, conventional bifocals and trifocals and single-vision lenses that are either out of foci range or made from lens materials you’ve decided not to inventory
From your wholesale lab’s “complete Rx” price list, total your purchasing costs for those Rxs that you have determined would have to be purchased as complete Rxs. This may include drill mounts, AR lenses, “specials” and other jobs.
Some Rxs can be filled with lenses from your projected stock lens inventory; total the costs of these lenses and calculate how much it will cost to replace them in the inventory.
(Note: At this point you have a fair estimate of the “purchases” element of the “cost of goods sold.”)
To arrive at a working figure for total cost of goods sold, add to your “purchases” figure an amount equal to 4 percent of that amount to cover the cost of lens production spoilage. Subtract any discounts earned from your vendors. (Actual production spoilage once the lab is running may be more or less than 4 percent, but this is a good number to begin working with.)
Using your in-office lab’s Rx price list, “sell” the Rxs from the spreadsheet to the office dispensary and register this total as gross sales. Subtract the “prompt pay discount” amount that you are allowing your in-house customer, and …
… the sales dollar value of the Rxs that would possibly be returned to the lab by the dispensary. To arrive at a fair estimate of the value of the returns and allowances, review the last statement from your wholesale lab for the dollar amount your office returned. Calculate this figure as a percent of your total Rx purchases, and apply this same percentage to the gross sales figure from above to arrive at a meaningful estimate for returns and allowances.
Remember, we are operating under the assumption that your in-office lab will grant the identical return and warranty policies and “terms of sale” policies you currently receive.
From gross sales less returns and allowances, and prompt pay discount we arrive at a net sales figure. Subtract from net sales the total cost of goods sold and you’ll have your gross margin amount.
Subtract the total of operating expenses as listed on the sample P&L to arrive at your net operating margin and subsequently subtract the total of general and administrative expenses from the net margin to arrive at a “net profit/loss from operations” figure.
Divide this net from operations amount by 100 (100 Rxs) to determine what a reasonable estimate of the dollar amount of the pre-tax earnings per Rx might be. Like estimates may be made for labor costs/Rx, material purchases/Rx, etc.
Compare this figure(s) with the pre-tax earnings per Rx currently realized from operating your dispensary without the presence of an in-office lab.
Calculating Opportunity Costs
The second of the two final pieces of the investment puzzle is something economists call “opportunity costs.” In his book, “Economics,” Paul Samuelson describes opportunity costs as those costs “… attributable to doing one thing rather than another … costs that stem from the foregone opportunities that have to be sacrificed in doing the first thing.”
In other words, by investing $40,000 or more in an in-office finishing laboratory, what amount of “value received” are you foregoing by not putting that same $40,000 into a professionallyproduced marketing plan for the practice or applying those dollars to professional sales training for the dispensing staff? Also, you may want to invest those dollars in updating the office, investing in formal education to upgrade the opticianry skills of the staff or other practice improvements.
A Worthwhile Process
Although the points raised and the exercises suggested in this two-part article may not be all-inclusive, they lay the foundation for making an informed and perhaps enlightened decision concerning the far-reaching effects of a major investment upon your practice and business. While these exercises require a considerable amount of time and effort, compare the time allotted for this process with the time (probably in terms of years) it would take to recoup any other $40,000 investment that has gone south because a sufficient amount of homework was deemed … “too time consuming.” Remember… run the numbers before you run the lab.