Written By: Karen E. Felsted, CPA, MS, DVM, CVPM, CVA
Many factors are essential to the practice of quality medicine and surgery; including an appropriate range of high-quality equipment for both diagnostics and treatment. The decision to purchase some pieces of equipment may be an easy one—for example, it may be clear that the practice needs a new anesthetic machine. Because the practice already uses this equipment on a daily basis and the cost isn’t too great, the decision is clear cut to replace the current unit. The purchase of more expensive assets or those not previously used in the practice, however, requires more planning and forethought than does the purchase of equipment or supplies with a much shorter life, lower cost and for which there is an undisputed need.
As with any equipment purchase, it is first necessary to understand what the goal of the acquisition is in YOUR practice. Two of the most common reasons for purchase are:
-The new equipment will improve patient care
-The new equipment will increase profits
We can assume that a practice won’t even consider the purchase of equipment if the answer to the first question above isn’t yes. This would appear to be an easy question to answer but it’s not always. For example, it’s generally agreed that ultrasound is a great diagnostic tool; thus purchasing an ultrasound unit should improve patient care. But this may not always be true. What if clients don’t want to pay for the cost of this new test and decline the recommendation? What if the doctors in the practice don’t have the skills to properly perform the imaging or interpret the results of what they see? In either of these cases, just owning an ultrasound won’t improve patient care.
A harder question is certainly if the new equipment will increase profits. When replacing a piece of equipment the practice uses regularly (for example, an anesthesia machine), the expectation usually isn’t that this will increase profits. The expectation is that the practice will continue to generate the profits that equipment already provides. It’s a different story, however, when the practice buys something it’s never had before—a digital x-ray, an ultrasound, or a laser—something that allows the practice to expand the services it already provides.
Net present value (NPV) analysis is an excellent tool to help in understanding the potential profitability of the purchase—this analysis estimates the total cash outflows involved with the purchase of an asset compared to the total inflows. A positive outcome equals a profitable purchase. NPV analysis also incorporates the time value of money into the calculations. While incorporating the time value of money gives more accurate information, it is also more difficult to do and many small business owners will enlist the aid of their accountant or financial advisor in performing this analysis.
This calculation should be be performed over the full expected life of the equipment in order to estimate the total profitability. Any amounts expected to be realized from the sale of the equipment at the end of its life should be recognized as an inflow and any costs of disposal should be recognized as an outflow. This is a particularly useful calculation when comparing the potential profitability of two or more pieces of equipment. It’s important to remember, however, when comparing the profitability between two choices that the timeframes must be similar for the results to be the most meaningful; $100,000 in lifetime profits from a piece of equipment with a five year life isn’t the same as $100,000 in lifetime profits from a piece of equipment with a ten year life.
As with any analysis, good data is critical to good results. A number of variables will be used in these calculations such as the cost of the equipment, the additional annual costs associated with the asset (such as a service contract or supplies), the expected cost savings to be obtained from usage or the anticipated increase in revenues. If these items are not accurately estimated, the results of the acquisition analysis may be erroneous. Some examples include:
– The cost of equipment does not just include the sticker price. Other components of cost include tax, installation, training, and interest costs if the asset is financed.
– One point that is always touted as an advantage of digital radiography is the ease of taking the images and the reduced staff time required. This is true but reduced time spend on imaging doesn’t always result in reduced costs. Unless the practice actually cuts back on the number of staff hours, there will be no reduced staff costs from purchasing this equipment. The staff may be available to do other work which can be advantageous but that is not the same as realizing a true cost savings.
– It’s easy to overestimate the additional revenue that the practice will bring in from the new services; one way to help get an accurate figure is to go back through a month’s work of cases and determine where the new service could have been used in place of what was otherwise done. Could an ultrasound have been done in-house instead of referring the client out? Could laser treatment have been performed? Of course, just because something is possible, doesn’t mean clients will accept it so those factors have to be taken into account as well. In the case of laser therapy, will the potential inconvenience of having to bring the pet into the practice multiple times reduce acceptance?
One final comment about the financial aspect of buying a new piece of equipment—just because the new item may not do much more than break-even financially, it doesn’t mean a practice has to forego purchase. However, the owner and manager need to understand the financial ramifications and not expect something that is not possible. In cases like this, the purchase is no different than if the practice owner chose to use his or her profits to purchase a boat. The purchase doesn’t necessarily add profits and value to the practice but it brings pleasure to the owner. This is only a bad thing if there was an expectation that things would be different financially. Pre-purchase financial analysis can go a long way in helping owners and managers manage their expectations and make a good decision.