Understanding Overhead in Dental Practices

So too many people in dental practice management are talking about overhead. They're talking about EBITDA, they're talking about take home pay, but none of them are actually talking about the same thing. So in today's episode, I want to dive into the math. I want to dive into the assumptions. I want to make sure that you know exactly what overhead really is, exactly what EBITDA is, exactly what take home pay should be. How is it calculated? What do you need to think about? And ultimately, what should those percentages look like? That's what we're talking about in today's episode of the Dental CEO Podcast.

All right. So on the surface, this might seem like a kind of simple conversation. What's overhead? Don't you all know what overhead is? But no, what I'm seeing in looking at other consultants, looking at accounting firms, talking to dentists, it's all over the place. People don't even understand how to calculate it and they don't understand what a top performing practice should be looking like. So I find this episode to be a very important episode to kind of reset all of us, to align us, to almost calibrate us into knowing exactly what this is and what it should look like. So let's start here with the simple kind of concept of overhead. Overhead represents all of the reasonable costs. Another way of saying it may be the mandatory costs that we have to run the practice without though having the cost of doctors. So we're going to look at all of our costs, but we're going to remove the fully loaded cost of doctors.

So what did we spend on everything else other than doctor's salary or doctor insurance, doctor taxes? Let's take that away. That's not part of overhead. It's all the other expenses. Well, it's not all the other expenses. It's the mandatory expenses. So that means non-discretionary expenses, like mandatory expenses, rent, right? It's utilities, it's security service, it's janitorial, it's staff payroll costs and taxes and so forth. What are the discretionary expenses that should not be included in overhead? And by the way, they shouldn't be included in EBITDA either. So I'm going to list these out for you. And ideally on your profit and loss statement, the expenses I'm listing out should be in their own discretionary category so that it's easy for you as a CEO every month to see what your overhead was, what your EBITDA was, what the take-home pay looked like. The discretionary expenses need to have their own category.

So here are the discretionary expenses, the expenses that aren't mandatory to run the practice. If I bought your practice, I wouldn't have to pay these expenses to keep it running. Charity is one of them. Money you give away is a discretionary expense. That should be taken out of overhead. That should be what we call an add-back, meaning it's a cost you had, but you got to add that back because that was really take home pay that you decided to give away. It wasn't a cost needed to run the practice. You didn't have to give the Boy Scouts of America $2,000 to run this practice every year. So it's a discretionary expense. We add that back. Charity. Another one, meals and entertainment. You going out and having a business dinner where you talk to your lab guy for five minutes about dentistry and then you enjoy a high-end stake.

Yeah, you're running that through your company so that you have some tax benefits. You're writing that expense off. But if I bought your practice, I would not have to go on a monthly dinner with the lab guy to eat steak to run your practice. That's an add-back. So meals and entertainment's an add-back. Vehicle is an add-back. You don't need that car paid for to treat patients. Also, travel and continuing education or add-backs. Even consulting expenses. Those are one-time things that if I bought your practice, I wouldn't have to pay for consulting every year to run it. That's an add-back. And the kind of retirement things you might be doing, these are optional things that a different owner wouldn't do. Those are all things that you, in a discretionary way, are deciding to spend money on in your company to either have tax benefits or to give more to people than you're required.

And those are all add-backs or discretionary. So to calculate your overhead, you're going to look at all of your expenses and then you're going to add back charity, meals, vehicle, entertainment, travel, CE, consulting, retirement. You're going to add back the discretionary stuff. You're also going to add back the doctor pay stuff. We said that, right? Overhead doesn't include doctor pay. So anything you paid any of the doctors, all the doctors, your associates, the owner, doctor, you add that back. That doesn't become a cost in the overhead calculation. And finally, you're going to add back the loan and tax expenses. You might see that on your P&L as depreciation or interest. You're going to add that back. Once you've added all of that back, what you're left with are the daily operating costs required to run the practice that don't include doctor costs. That's overhead. All right?

And that should be easily seen on your profit and loss statement if you can organize the P&L in the correct way. So again, overhead is all the expenses you have to run the company every day. These are mandatory expenses, not discretionary, but mandatory. And they don't include any doctor costs. None of the discretionary stuff we talked about that don't include loan payments or tax payments, depreciation, none of that. They're just the real ongoing daily costs required to run the company before you pay doctors anything. That's overhead. What should that be? In a healthy, solo dentist practice, overhead should be 50% or less. Let's let that sink in for a second because I hear time and time consultants saying overhead should be 65%. And I call bullshit on that. That is not a healthy margin. That is a practice that feels busy where you're cramming stuff in to try to make more money.

And at the end of the day, you just don't see this big payoff. That is an unhealthy model, 65% overhead. 50% overhead or less is healthy for a solo dentist practice. And I say the majority of my clients, by the way, that I coach one-on-one are near or exceeding that. 50% overhead. It's highly realistic to have that in today's environment. So overhead should be 50% or less if it's a single doctor practice. If it's multiple doctors, what should it be? Think about this. Overhead is all of our expenses before we pay any dentist anything. If we've got multiple dentists, we have more collections to pay that same rent. We have more collections for the janitorial service, more collections to help us pay that one office manager, more collections to pay the existing expenses. Now, sometimes when you have more doctors, you have more expenses, right?

You got more employees potentially, but some of your expenses don't go up just because you had an associate. So that means in a multi-doctor practice, our overhead percentage should actually be less than in a solo doctor practice. And I know most of us can understand that, that there's efficiencies when you have multiple dentists in one location. And so the healthy overhead number for a group practice should be 40% or less. Overhead. Remember, again, overhead is the mandatory daily expenses required to run the practice that does not include paying doctors or paying depreciation or interest or these discretionary things. So if we have a group practice, we should be at 40% overhead or less. If we've got a solo practice, we should be at 50% overhead or less. That's overhead. Now, let's go to the next number. Well, what is EBITDA? EBITDA stands for, as most of you know, earnings before interest, taxes, depreciation, and amateurization.

Calculating EBITDA

Okay. Earnings. What are earnings? We understand interest, right? That is the interest we pay on our loan. Taxes, we understand that. Depreciation is kind of this cost on paper that we don't necessarily incur that the equipment gets worth less every year. Amortization is kind of the long-term cost and effect of making our loan payments, but what is the E in EBITDA? Earnings. Earnings is, in a way, how much financial success we're generating. So how much money have we created net before we spent money on interest in taxes and depreciation and amortization? EBITDA. EBITDA's not the same thing as take home pay, although it's close. EBITDA is, in a way, the opposite of overhead, but after we pay doctors. So let me make this easier. We know what overhead is. Overhead is all of our costs without paying doctors, without paying depreciation or taxes or so forth.

EBITDA is the money left over from overhead, and then we're going to pay doctors. Let's say I had a million dollars collections and I had $450,000 of expenses or overhead without paying doctors anything. True overhead, 450,000, overhead out of a million collections. How much am I left with then? $550,000. And out of that $550,000 now, I need to take away paying doctors, and then I'm left with EBITDA. And I'm not going to take away how much we paid doctors. What I need to take away is the market rate for paying doctors. You see, sometimes we underpay ourselves as a doctor for tax purposes, or maybe we're overpaying ourselves. That is not going to manipulate my EBITDA number. EBITDA is calculated based on the appropriate market rate we should have paid the doctors. So I'm going to look at what the doctors produced and collected, and I'm going to take off the commission percentage and taxes and come up with this hypothetical market pay for those doctors in that year and that practice.

This hypothetical market rate, this hypothetical doctor cost is going to be taken out of that money leftover. And then I end up with EBITDA. So back to my example, we had a million collections, we had 450,000 of overhead, right? Well, let's do some math now. What if my doctor did 750 grand that year and I'm going to pay them 30% and of course I've got to pay taxes and benefits. And basically, I ended up with a market cost, a hypothetical market cost for that doctor of 250 grand. So let me write this down. So we had a million in collections. We had 450,000 in overhead, and we had 250,000 in this hypothetical doctor cost. So now what am I left with at the end? Well, a million minus my 450 overhead minus my 250 doctor cost. I'm left with $300,000 EBITDA. That is a 30% EBITDA margin. All right. Well, what's a good margin? What's a good percentage? In a solo doctor practice, a 30% EBITDA margin and up is good. In a group practice, we have a smaller percent because we've got to pay a lot of doctors. And many time in a group practice, not all of those doctors are high producers and we don't have the same types of success that we might have in a solo practice.

In a group practice, we need to be in the low to mid 20s in EBITDA percentage to be good. A lot of DSOs are in the teens. Some DSOs are in the single digits, but when you look at the healthy groups, they may not be the jumbo DSOs with all this corporate costs, but they're the healthy multi-location groups. They're typically in the low to mid 20 percentile range for EBITDA. So I know we're not all sitting down in front of a whiteboard right now and looking at the same thing and writing all the numbers. Some of you might be jogging or driving right now and you're not even watching this, but I'm going to restate it again because we need to be locked in on what this is. It's so important that we understand how to measure this and then how to compare ourselves to these standards. So overhead is all of our expenses without the discretionary stuff and without the loan and tax payments and without paying doctors anything. And in my example of a million dollar practice, we had 450,000 of overhead. Yeah, it's 45%. It's very healthy. Now, to calculate EBITDA, we're going to add this doctor expense to this problem. We're going to look at a hypothetical doctor expense, not what we actually paid doctors, but what we would have paid them had they made a market rate. Whether they're the owner or an associate, we're looking at all those doctor expenses. And in my example, we had $250,000 doctor expense because that doctor did about 700 grand that year, got paid 30% plus taxes and benefits. It netted a hypothetical cost of 250,000. When all the dust settled on that math, a million collections minus 450 overhead minus 250 doctor, we ended up with 300,000 in EBITDA.

I told you ideal percentages for a solo practice is a 30% EBITDA margin, 50% or less overhead. So the example I just did for you is the kind of healthy margins for a solo practice. I also told you for a group practice, we would like overhead of 40% or less and an EBITDA margin after paying all these doctors an EBITDA margin and the low to mid 20s to be healthy. And obviously if we can get higher than that, that'd be great. Okay, so that's overhead and that's EBITDA.

Owner and Office Take Home Pay

Well, what is take home pay? What's take home pay? Well, I've seen take home pay described in two different ways. You've got owner take home pay and you've got office take home pay. Let's start with office take home pay. Office take home pay is very simply the opposite of overhead. So if we had a million in collections and 450,000 in overhead, the office take home pay was the rest, 550.

The office take home pay number is not very important. It can be skewed and manipulated depending on your practice structure. It's just not something that we commonly talk about. People confuse that with owner take home pay. So you may not have ever heard office take home pay before. This might be the first time you're hearing that, but that is in essence what it is. It's the opposite of overhead. Sometimes the office take home pay is the same thing as owner take home pay. So let's talk about what is owner take home pay. This is what you're used to saying one dentite to another dentite. When we're talking dental business, we use a term like take home pay. We mean owner take home pay. Owner take home pay is all the money that's left over after our appropriate overhead. So back to the example, a million collections, 450,000 was appropriate overhead.

That means 550,000 was left over for this owner dentist to take home. This solo dentist who happened to be the owner, the owner take home pay was the opposite of overhead in that example. Now, what if you're the owner of a group practice? How do we calculate take home pay then? Well, take home pay is calculated in that scenario as your EBITDA plus your hypothetical market pay for you being the dentist. That's really the cleanest way to calculate this take home pay, the owner take home pay. Owner take home pay. And if you're writing notes, now would be the time to write it. Owner take home pay is your EBITDA plus the hypothetical market rate you would've paid yourself, the owner, as a working dentist. So if you didn't work as a dentist at all, your take owner take home pay is your EBITDA. Or if you did work as a dentist, then obviously the hypothetical market rate you would've paid yourself for that dentistry you did as an owner, plus the organization's EBITDA ends up being what you take home.

And obviously, if you have one location or multiple locations, one doctor, lots of doctors or a massive group, that take home pay percentage, that margin changes. And there's no standard approach to measuring your take home pay versus anyone else's because there are so many different models and scenarios and setups. So in measuring percentages for health, it really is the first two numbers I said. What's the office overhead and what is the organization's EBITDA? Again, the overhead, we want 50% or less for a solo doctor, 40% or less for a group practice.

EBITDA, we want 30% for a solo doctor or more, and we want in the low to mid 20s for a group practice or more. If you find yourself not hitting those margins, then let's figure out why. Right now, let's figure out why. Why? If Scott says the overhead's supposed to be less than 50%, but my overhead is 65%, why do I have that difference? An uninformed dentist would say, "Oh, I need more new patients. I need to generate more collections. That's going to solve my overhead problem." And they're not necessarily always wrong. Sometimes that is the solution, but many times it's not. When you find yourself with overhead higher than this goal of 50%, for example, chances are you're overspending somewhere. You're spending away that profitability or EBITDA or take home pay you deserved. Chances are that's the issue. And common areas where we spend that away are supplies, lab, merchant fees, staff costs is the biggest one.

We usually find that overspend. And then there's a basket of small miscellaneous things that you could see, overspending on IT support, overspending on accounting services, having software programs you're paying for that you're not fully utilizing appropriately. Lots of little kind of cuts that can make you bleed out are in those categories. But the common ones are supplies, lab, merchant fees, and staff costs. Those four almost consistently across the board are areas where there's overspend if your overhead is not healthy. That's almost always the situation. But I did say sometimes your overhead's not a healthy number because you're just not producing and collecting enough. A great kind of way to figure out if that might be the case is to look at what you spend on rent. So on one extreme, we have a brand new startup practice. They're paying a market rate for rent. Let's just say it's a hundred grand a year. We know that rent is typically going to be 5% or less of your collections when you are mature, fully mature, 5% or less. So we can kind of back into something here. We can do the math and we could say, okay, well, if rent's supposed to be 5% of collections and I'm paying a hundred grand, that means I need a $2 million collection practice per year to justify the rents to make that 5%.

And if I have a startup that's paying 100 grand a year in rent, I'm not collecting two million yet. I'm not big enough yet to have easy health when it comes to my overhead because right off the bat, my rent's 15% because I just haven't grown big enough yet. We haven't grown big enough for our big rent britches, would be the analogy. So that's one little spot to look at in the P&L to try to get an understanding. Are we big enough to have ideal overhead or are we still kind of immature in our growth? Do we need to produce or collect more to have this overhead? I see that maybe nine times out of 10, a practice is big enough to have healthy overhead. Maybe one time out of 10, they're not, and it's obvious. So when you look at your numbers, assuming you're not paying something weird for rent, assuming you're paying a normal market rate, if you see your rent in the single digit percentages, you're probably big enough to have healthy overhead in your practice.

Don't think that the problem is that you don't produce enough or collect enough. You're probably big enough today to have healthy overhead. But if your rent is a market rate, but it's falling in the double digits, you're probably early on in your growth. And while you still need to have healthy overhead for that phase of your growth, you may not hit like 50% or less overhead because you just aren't big enough yet to fit into that model, to fit into that ratio. So again, nine times out of 10, when I'm looking at P&Ls and coaching people, they are plenty big enough to have healthy overhead. It is an expense issue. And it's an issue that they, many times they don't even believe that that's the issue. They don't think they overspend on supplies. They don't think they overspend on lab. Sometimes they think they overspend on people, but they don't want to let anyone go.

They don't want to just go cut a bunch of people and they kind of use their assumptions and the way they look at their own practice and trap themselves into not doing anything about their overhead. Having healthy overhead is usually going to supplies, lab, and credit card fee, and in a very healthy way, making those appropriate, making those healthy. Then when you look at the team side of things, if that's unhealthy, we have to ask ourselves why. Are there things that we can do now to make it healthy or are we going to have to grow without hiring more people to finally get that category healthy? Sometimes we see people that are overpaid and we need to fix that. Sometimes we see an overtime issue. Everyone's getting overtime. We need to fix that. Sometimes we see that we're only using onsite employees at high incomes, high salaries without utilizing an offsite model that helps us control our costs.

Or we're only doing unassisted hygiene when we could do some assisted hygiene. Sometimes it's a model issue that results in that high cost, but that's usually where we're looking there. And then all the miscellaneous stuff, we need to be kind of like an inspector with a magnifying glass and look at every line item and find moments we can save money that don't do any sort of damage to the practice. It's that kind of look at things that are required to find these opportunities. So if you've got $2 million practice today, but you're running 65% overhead, you should be running less than 50% overhead. What does that mean for you? Every year you don't fix this. You are burning away at least another $300,000 in your own take-home pay. Just giving that to the universe, procrastinating, doing a deep dive, procrastinating, hiring a coach or a consultant to help you with this.

You're literally burning away 300 grand a year because you have decided to not yet address this issue. You're sticking your head in the sand and just telling yourself everything is as good as it can be. And if you just had more new patients, things could be better.That's not reality. When I work with people 101, I mean, we find hundreds of thousands of dollars usually immediately that can be fixed if we just make a few different decisions. So let's kind of sum this up. Overhead. Overhead are all of our mandatory ongoing operational expenses. They do not include paying doctors anything though. They don't include discretionary stuff like charity, meals, vehicle, entertainment, travel, CE, consulting, retirement. They don't include any loan or tax expenses, either like depreciation or interest. And when you calculate that up correctly, you should end up with overhead of less than 50% if you're solo practice, 40% or less if you've got a group practice.

Now, EBITDA, we start adding an expense back to this thing, or I should say that another way.

We incur an additional expense, and that expense is the market rate to pay our doctors for the work they did that year. What is that market rate? That looks at what they produced or collected, that gives them an appropriate commission, and it adds a tax cost to it as well. And then we can calculate EBITDA. So again, a million dollar practice, 45,000 overhead, and then another $250,000 in hypothetical doctor expenses gives us the EBITDA number 300 grand. EBITDA should be 30% or more for a solo practice. It should be in the low to mid 20s for a group practice. And by the way, as you all prop Probably know EBITDA, that number is what's going to determine how much your practice is worth and it's going to heavily impact how much loan money you can get qualified for to buy that practice or to build or buy the next practice.

So it's very important that we're calculating EBITDA correctly so that you can understand what your financial situation is when it comes to that practice or more practices. I hope this was helpful for some of you guys. Your P&L should be outlined to show this very easily. It should be easy to see every month. And if you calculate all of this soon and you realize that your numbers aren't as healthy as they should be, go look at your rent and go ask yourself, "Am I big enough to have healthy overhead? If the rent's a single digit, you're big enough to have healthy overhead." Then go look at your expenses and find ways to cut costs without hurting your practice. And if you need the help of a coach or consultant, holy cow, get one as soon as possible because every moment you wait is just a moment you're spending too much money in overhead.

All right, that is the end of this episode on the Dental CEO Podcast, Overhead, EBITDA, Take Home Pay. From here on out, we're all going to speak the same language. We're all calibrated. We're going to mean the same thing. I want to thank you guys for tuning in and I will see you next time on the Dental CEO Podcast.