Episode 115 Transcript – Important Differences Between Cash Flow and Profit in Optometry Practices

[00:00:04] Hey, everybody. Welcome back to The Optometry Money Podcast, where we’re helping ODS all over the country make better and better decisions around their money, their careers, and their practices. I am your host, Evon Mendrin, Certified Financial Planner(TM) professional and owner of Optometry Wealth Advisors, an independent financial planning firm, just for optometrists nationwide.

[00:00:26] And thank you so much for listening.

[00:00:27] Really appreciate your time and attention today. And today’s episode. I’m going to talk a little bit about cashflow when I want to have a conversation on cashflow. Specifically within your optometry practice. And I’ve been fortunate to dive into the financials of practices in working with clients and having conversations with clients about their financials. working together with some phenomenal accountants and tax pros and CFO level experts in optometry practice financials.

[00:00:56] And. We’re review these for a variety of reasons for projecting out the year for tax purposes. For weather, new expenses or. New team members should be added to the practice or whether the owner can afford to distribute more to themselves or decisions on what to do next with extra cashflow, pay down debt, invest, et cetera. And throughout the conversations were usually talking about the differences between profit, as it shows up on the P and L the profit and loss. Versus the actual net cashflow the practice. What are the actual dollars flowing through and out of the business? And it’s this difference between profit and cashflow that I just want to mention and talk a little bit about today. And why it’s so important. So with that said, let’s go ahead and dive in.

[00:01:44] The Three Financial Statements

[00:01:44] And within any business, there are three main financial statements. most of my clients, actually, in fact, all of my clients use QuickBooks online. And so we’ll go into QuickBooks, go to the report section. And you’re going to see three, you’re going to see a whole list of reports, but there are three primary financial statements in any practice.

[00:02:03] It’s going to be the balance sheet. Which shows you at a specific point in time. What is the financial health of the business? What are the assets that the business owns? what are the liabilities of the business and what is the owner’s equity of the business ?there’s the profit and loss also known as the income statement. and then the statement of cash flows, which also shows you the activity over a period of time. And. All of them are important.

[00:02:30] Though the most commonly known statement is the profit and loss or income statement.

[00:02:34] And understandably, so most owners want to know what they’re earning from the business. And the profit and loss shows the revenue. Hopefully broken down so you can track different sources of revenue that are important to your practice. It’s going to show the different expenses in the business from cost of goods sold. which is a direct cost to the business for you to provide services. it’s going to show non-OD staff, OD compensation, if you have associate doctors, your owner’s compensation, which should include your wages and, employment taxes, benefits attributed to you. Occupancy costs, marketing costs and everything in between. And then subtracting those out. You get the profit or loss if it’s negative. The profit or loss. of the business during that time period. Showing the economic value that the business created for you the owner, right?

[00:03:28] What’s left for you as the owner, after everything is paid for.

[00:03:32] Differences Between Profit and Cash Flow

[00:03:33] but there can be important differences between the profit that’s on the P and L the net income number that’s on the PNL versus the actual cashflow of the business. And some examples are, you know, for example, your accounting method can determine that quite a bit.

[00:03:49] If you’re using an accrual accounting method, you are, recognizing or seeing income show up on the profit and loss as you’re providing services, meaning as the, the income is earned instead of when that cashflow comes in Same thing with expenses. Or cash based accounting, where you’re not seeing that show up on your financial statements until the revenue shows up in your bank account.

[00:04:12] Or when you actually pay for expenses or when you swipe that credit card. Most practices are going to be using from what I see, cash basis accounting, simply because it’s, it’s simpler, it’s more straightforward. Although some may use accrual and I’ve heard it argued that accrual can be a more accurate representation of what’s going on in the practice.

[00:04:31] But. The accounting method, whether it’s accrual basis or cash basis can determine quite a bit on that front.

[00:04:38] another big one is debt payments. If your practice has debt, only the interest portion of those debt payments show up as a deductible business expense on the profit and loss, at least it should.

[00:04:51] It should only show up there. The principal portion of those payments is not a business expense. You’re, you’re just paying principle back to the, uh, to the lender. Those principle portions show up elsewhere in the financials. So if you’re only looking at the P and L you’re going to see a smaller expense for that debt, because it’s only going to be the interest. but the actual principle portions of that are dollars leaving your bank account.

[00:05:16] So those aren’t going to be accounted for there. you also may see non-cash expenses on the profit and loss, like depreciation or amortization. It’s possible with the way depreciation is taken for tax purposes that it doesn’t align with the actual cashflow of buying the equipment. So you’ll see those expenses, which reduced profit But they’re not actual dollars leaving your bank account, leaving the business. even the use of credit cards can shift the cashflow from one month to the next, because you, you buy the expense and recognize it in one month, but the actual cash to pay off the credit card may not happen until the next.

[00:05:56] So that can cause some differences. If you’re looking at a really short time period, like month to month or quarter to quarter.

[00:06:01] So those are some of the most common ones I see. And for both accounting and tax purposes, you might see differences between the two. Depending on how you manage the finances. You can even find yourself in a position where you have a profitable year, but without enough cash to pay the tax next April.

[00:06:19] So when you’re trying to make decisions in the business of when to spend money, how to spend money, when to save it, when to distribute it to yourself, Whether you need to increase your wage and what that does to the practice. You’d want to have a better feel for the actual cashflow, the business. Not only what’s on the profit and loss, but what, what dollars are actually coming into your practice? And what dollars are actually going out. So, where do you find that?

[00:06:45] Right. If it’s not a perfect picture on the profit and loss, where do you find that?

[00:06:50] Exploring the Statement of Cash Flows

[00:06:50] Well, I like to go to the statement of cash flows. And this is probably the least known financial statement. But the statement of cashflow shows you. The actual flow of dollars into and out of your business over a given time period, whether it’s one month, a whole year quarterly.rolling 12 months, whatever it is. As well as the categories or sources of that cashflow.

[00:07:17] And the statement of cashflow breaks down cashflow into three sources or categories. And it shows you cashflow from the operations of the business operating activities. Meaning what cash comes in and out of the business for actually doing the stuff of the business, providing optometric care. Selling the products that you sell, frames, lenses, things like that. It’s actually doing the business stuff. And for those of you using QuickBooks. The way this is put together is, is that it starts off with your net income. Which you would find on the P and L and it adds back or subtracts non-cash adjustments to get to the actual cashflow from your operations.

[00:08:00] So how much cashflow is your business creating or losing from doing the actual operations of the business? That’s number one. Number two is it’ll show you the cashflow from investing activities. Which shows you the dollars you spend buying longterm assets of the business, like equipment. Or dollars you receive from selling those assets of the business. That type of investment activity in the business is going to show up there. And then lastly, cash flow from financing activities. Financing activities in the business, meaning dollars related to raising capital for the business.

[00:08:36] So if you borrow money, Those dollars that you borrow are going to show up here in the financing activity section as a positive. If you or another owner contributes money into the business, it’s going to show up there. On the other hand, if you make loan payments, this is where those principal portions of the loan payments show up. In the financing activities of the statement of cash flows.

[00:08:59] And this is also where distribution to owners show up. So any money to, or from a lenders or owners is going to show up in the section. So. You can see the cashflow story broken down between the operations, your investment in the business and, financing activities to raise dollars or payback, lenders, things like that. So importantly, the statement of cashflow explains the changes in your cash account on the balance sheet. So if you pull up two balance sheets, one from one period of time, another, from another period of time, There might be differences in the cash.

[00:09:36] And so you might be wondering, well, why did the cash change while your statement of cashflow is going to describe why exactly the cash changed in that balance sheet in your business. If your cash goes up or down from one period to the next, the statement of cash flows tells you why that happened and where the cash came from or went to.

[00:09:53] All of these statements are, are bound together. They’re tied in together. And so looking at these categories, you can see the story of the business through cash coming in and out and where it comes from. You know, for example, you can see, did your business have a positive. Net cash flow in general. For the time period or looking at, you know, maybe you’re looking at it over the course of a year.

[00:10:16] Hey, what happened over the last 12 months? Did my business provide cash to me. And so you can see if that happened and where exactly that cash is coming from. Is it coming from operations actually providing services to patients? Is it coming from borrowing or lending?

[00:10:32] Is it coming from you as an owner, adding dollars to the business? Where’s that coming from? You can look at, did it have positive operating cashflow, meaning are you actually bringing in dollars from the work of the business? And this is really the lifeblood of your business, right? Your ability to provide care to patients and provide products to patients that are going to benefit the health of their eyes and their eyesight. Is this work that you’re doing, bringing in cash. Is it stuck in accounts receivables.

[00:11:03] And do you have billing issues is too much inventory being purchased and not being sold. Right. Those are things you’d want to dive into. And so, and, and. And how does that operating cashflow compared to the operating profit on the profit and loss? in their book managing by the numbers, Chuck Kramer and Ron Rizzuto I have helpful tests to sort of help you review the health of your operating cashflow.

[00:11:28] Once you get beyond the cold start phase, because in those early years, in those early days after cold start, I mean, you’re, you’re just trying to get revenue in and keep expenses paid. Right? So most of that cashflow is probably going to come from financing activities, right.

[00:11:41] That, that practice loan and. And the operating cashflow that comes from that. it’s not until you get out of that cold start phase and more into the growth phase where you start to see operating profit turned positive, and you can start to self sustain and start to pay yourself an income and even see additional cashflow from there. So once you get beyond that cold start phase. they provide four I think, helpful tests to give you some thoughts around is my operating cashflow specifically relatively healthy.

[00:12:11] And number one is, is the operating cashflow positive, right? This essentially has to happen. This is the lifeblood of the business. And if you’re past that cold start phase and you’re not seeing positive operating cashflow. You need to find out why and fast. number two. Is the operating cashflow greater than net profit. In most cases, it should.

[00:12:33] It should be greater than the profit on the profit and loss because that net income, that profit. We’ll often include in those non-cash expenses like depreciation and amortization. And so in those cases where you do see those on the profit and loss, you want to know whether that operating income is higher than the net profit.

[00:12:53] And if not, why.number three, is it greater than fixed asset investment and meaning, are you creating enough cashflow from your operations to cover your investments into assets of the business, to purchasing equipment, to building out a new lane, whatever it may be. or are you having to rely on financing and you may use other people’s money in that might be perfectly prudent, right?

[00:13:18] The. The, That might be perfectly prudent. I mean, you’re essentially just bringing forward future earnings into the current year and you’re planning to get a higher return on those dollars than the interest. So that may perfectly make sense, but I think it’s helpful to see, are you even able to fund that with your own operating cashflow? Or are you forced to rely on outside financing?

[00:13:38] And then number four finally is operating cashflow trending in the same direction as net profit. And I really liked this one. So if you look at the last few years, What’s the trend. Are your, is your net income and operating cashflow heading in the same direction? If profits going up, all operating cashflow is going down, something’s going on.

[00:14:00] Is that revenue cycle management taking too long to get that cashflow in. Or are you buying too much inventory more than you can sell in a reasonable timeframe.

[00:14:08] And I think those are fourr just kind of helpful things for you to keep in mind, as you’re looking at your own financials saying, Hey, Am I meeting some of these tests.

[00:14:16] Are there any, you know, is there anything I need to look into and I think just having a curious mentality as you kind of look through these. bits of information. Is is helpful. Ask yourself, why are things happening? Why are things changing and kind of get to the bottom of it? It helps you to know when adjustments need to be made. It also helps, you know, when to lean into something because it’s working really well.

[00:14:38] You know, some other things we’ll see from the statement of cash flows.

[00:14:40] Again, if you purchased assets like equipment, You can see where that money came from. Did you have enough operating cashflow? Where did it come from? Lending?

[00:14:48] And then importantly, you can see how much, how much money is going to paid back the principal of your debts, and importantly, You as the owner, are you distributing too much or is there room to distribute more? Are you causing negative cashflow with the amount of debt your practices taking on or the amounts that you’re distributing to yourself as the owner, even when there might be positive net income. So those are some things that you can see as stories that you can learn about as you look through these financial statements.

[00:15:15] And so when you’re making decisions in your business, and this is really the conclusion here, right? When you’re making decisions in your business, trying to project out numbers forward, thinking about how to use your dollars, new staff or hiring a new OD or a new lane build-out or equipment purchases or distributions to yourself. Look, not only at your profit and loss, your income statement, which is really important. But also at the other things that take dollars from your business, actual cashflow, that don’t show up well on the profit and loss. Things like principal payments on debt or planned regular distributions to shareholders or things that came up unexpectedly that. You weren’t even aware that you’re distributing to yourself or personal expenses that were being paid for and company credit cards that you weren’t really keeping track of.

[00:16:05] Those are all really important for you to have a better idea of what’s really available to you. In the practice and what’s really available to put, to use in the practice. If you choose to use it.

[00:16:15] A Framework for Deciding What to Do Next With Extra Cash

[00:16:15] And then lastly, once you have a better understanding of cashflow, you can start to use a framework for what to do next with your dollars.

[00:16:23] And there’s a lot of ways too think about how to use extra cashflow in the business. There’s I mean, there’s several frameworks out there. I’m a big fan of frameworks for decision making like this. I like to keep it simple. And I think one simple framework that I look for. and deciding what to do with cashflow once your operating expenses are paid for in the practice is from the book, Simple Numbers, Straight Talk, Big Profits by Greg Crabtree. And in the book, Greg talks about this, this framework, where as you look at your numbers, I understand that once the regular expenses are paid for ruts, the regular operating expenses are paid for. There are four things that will demand money from your business. And he calls them four forces of cashflow, but number one, taxes, you need to be able to set aside dollars to cover quarterly estimated tax payments.

[00:17:15] If you’re making those estimated tax payments. number two debt payments, right? So you need to make sure that you have enough cash in order to cover debt payments, or pay down lines of credit things like that. Number three, your business itself needs cash, right? So do you have enough cash in the business? To create a reasonable cash buffer in the business, not too much, but also not too little.

[00:17:38] And I would add to also prepare for upcoming planned investments in the practice. Right? If you, if you know, you’re going to spend some dollars on something coming up. You know, build that into there as well. And then finally you, as the owner is the last thing that’s going to demand dollars from the business meeting. Once you’ve tackled these other things, taxes, debt payments, appropriate cash amount, cash buffer in the practice. This is where, you know, what’s available for you to put, to use for yourself in some way. Paying down debt. Investing making profit sharing contributions. Investing in other things invest in experiences and time with the family, things like that. That’s how you kind of have some confidence that you have cash available to you and you’re not going to distribute too much. Or you’re also not distributing too little, keeping too much cash in the business unnecessarily. And you can do, this is something you can do quarterly, right?

[00:18:28] You don’t have to do this every month. You can look at it quarterly and make a decision like that. So, I think that’s a really great framework, but overall I think the conclusion here is that. As you look at the financials of the business and I hope you do. Keep in mind, not only the revenue and expenses that show up on the, on the net profit, but also keep in mind other cashflow items that show up elsewhere in your financials.

[00:18:51] And one last thing I’ll say is that the only possible way that you can look at this and make decisions in the business regarding your cashflow and your finances are if you have clean, Accurate, timely financials. Meaning someone is doing the bookkeeping in a timely fashion, And accurately, in an appropriate manner.

[00:19:14] And. I’ve seen a lot of books done both by professional bookkeepers, that know Optometry really well. And also DIY. And I would Almost broadly, generally recommend, please hire a bookkeeper to take that burden off your shoulders. There are some great ones that I know that work only within eyecare within Optometry. And do a phenomenal job and your role as the owner. Your skill is owner.

[00:19:41] Your time is owner should not go, in my opinion, into the arranging of these numbers, into doing the actual bookkeeping. Your time as owner is best spent reviewing, projecting, analyzing, and decision-making. And those are things that are done after the bookkeeping is done. So that’s where I think your time is best spent.

[00:20:02] That’s where I think your insights and energy and decisions are best made, but none of this is possible without clean, accurate bookkeeping. That’s done on a regular basis.

[00:20:12] So with that in mind, hopefully this conversation was just helpful to help you think more about the sources of cashflow in the business and, then making decisions around cashflow in the business.

[00:20:23] If you have any questions, please reach out to me. podcast@optometrywealth.Com. Or if you have other ideas or questions that you want to have on future episodes, please reach out as well. Would love to hear that. And if you are on the way to, or already at vision expo west in Vegas, hopefully you’re having safe travels.

[00:20:42] I will be there as well this week. So if you’re going to be there, Hey, let me know. Would love to connect with you. hear your thoughts around the podcast and around other topics and just what you think about this cashflow conversation as a whole. So. hopefully we can connect there.

[00:20:55] We will catch you on the next episode. In the meantime, take care.