BComm (Industrial Psychology)
Regardless of the type of veterinary practice, access to funds is the difference between a thriving business and one that has to close its doors.
Regardless of the type of veterinary practice, access to funds is the difference between a thriving business and one that has to close its doors. This access is particularly important in the short-term as it is required to pay practice expenses (salaries, electricity, etc) and suppliers (consumables and vet foods, etc).
Loans for short-term expenses can be difficult to obtain as banks and other institutions will want to see that the veterinary practice can repay the loan and, of course, if the business had the money available to repay the loan, it wouldn’t need to borrow the money in the first place!
So, if a short-term loan is going to be difficult to obtain, this means that cash will be required to pay for day-to-day activities. And the way that cash is obtained is from a business’s working capital.
Working Capital = Current Assets – Current Liabilities
Current assets are assets which can be turned into cash within 1 year.
The main current assets in a Vet Practice are typically:
- Stock / Inventory
- Debtors / Accounts Receivable
Current liabilities are liabilities which have to be paid within 1 year.
The main current liabilities in a Vet Practice are typically:
- Creditors / Accounts Payable
- Overdraft / Short-term loan
In other words, the main sources of working capital are current assets as these are the short-term assets that the practice can use to generate cash. However, the practice also has current liabilities and these have to be taken into account when calculating how much working capital the practice has at its disposal.
Examining the working capital position enables the practice to foresee any financial difficulties that may arise. Little working capital leads to financial pressure on a practice, increased borrowing (if lucky!), and late payments to suppliers resulting in a lower credit rating.
Analysing Working Capital
Not analysing working capital is the most common reason for businesses failing in South Africa. And the increasing trend for small animal practices selling pet foods and accessories is making them far more susceptible to the risky working capital.
Consider the following figures from a hypothetical start-up Veterinary business:
|From the Profit and Loss Statement:|
|Variable Expenses (Cost of Sales)||
|Fixed Expenses (Overheads)||
|From the Balance Sheet:|
|Debtors (Accounts Receivable)||
|Creditors (Accounts Payable)||
The profitability of the business seems pretty good and the current assets are significantly more than the current liabilities.
But before the working capital can be analysed meaningfully, three important key performance indicators (KPI’s) need to be calculated:
- Stock Days = Stock / Cost of sales x 365
= 80 / 120 x 365
= 243.33 days
In other words, once an item comes into the practice, it will take an average of 243 days before it can be charged for (surgical needles, gloves, etc, etc) or sold (pet food, etc, etc).
Naturally one wants the stock days to be as close to zero as possible – not only does a Vet practice need the money to pay to the owner, but expenses and creditors will need to be paid. If it takes 243 days to get money, it means that the practice will only get money after 8 months!
- Debtors Collection Period = Debtors / Sales x 365
= 50 / 200 x 365
= 91.25 days
In other words, once a service has been rendered or a product sold, it takes an average of 91.25 days to collect the money. This doesn’t exclude payments made immediately – it is an average of all sales.
Again, it is pretty obvious that the practice wants the money to come in as quickly as possible. If it takes 91 days, it means that the practice would not be able to pay, for example, salaries, for 3 months.
- Creditors Payment Period = Creditors / Cost of sales x 365
= 20 / 120 x 365
= 60.83 days
In other words, it takes an average of 60.83 days to pay all suppliers.
Analysis: I argue a lot with clients about this. In South Africa we have been raised to pay off debt as quickly as possible. And while this is a good strategy in one’s personal life, it is the opposite in a Vet Practice. The reasons for this will become clearer when we look at the Working Capital Cycle.
- The Working Capital Cycle
The Working Capital Cycle measures the relationship between trading cash inflows and trading cash outflows.
The KPI’s from the previous section create the Working Capital Cycle:
|DEBTORS COLLECTION PERIOD||91|
|CREDITORS PAYMENT PERIOD||60|
What this shows is that it will take an average of 243 days to sell an item or use a product in the rendering of a service.
It will take an average of a further 91 days to collect the money from the client, meaning that from when the practice has bought the stock, it will take a total of 334 days until money is collected.
However, the creditors only need to be paid after an average of 60 days. This means that the practice will have to find money 274 days before they receive it, in order to pay their creditors.
So how can this situation be improved? There are 3 approaches:
- Reduce stock levels
Compare the stock days at the various stock levels below:
|Stock = 80||Stock = 40||Stock = 20|
|Stock Days||= Stock x 365
Cost of Sales
|= Stock x 365
Cost of Sales
|= Stock x 365
Cost of Sales
|= 80 x 365
|= 40 x 365
|= 20 x 365
|= 243 days
|= 121 days
|= 61 days
By reducing stock to a quarter of its original level, the stock days have reduced from 243 days to 61 days, a far more manageable period.
Of course, the temptation is always to carry as much stock as possible, ensuring that the practice always has whatever a customer will want. But the bottom line is that by doing this, the practice is being put under additional unnecessary pressure.
- Reduce Debtors Collection Period
This can only be done in one of three ways – all of which vet practices know only too well:
- a) Don’t let the client out of the practice until they have paid.
- b) Don’t take on emergency client’s that clearly will not be able to pay.
- c) Follow a structured debt recovery system.
Of these, the one that I find most neglected is the debt recovery system; I strongly encourage practices to send the staff members responsible for collections on a debt collections course, and for a formal strategy to be implemented.
- Increase Creditors Payment Period
This refers to negotiating and re-negotiating terms with your suppliers. The longer the period you have to pay them, the less pressure your working capital will have.
Only in emergencies should you not meet payment deadlines, simply because this will incur penalties and will damage the relationship you have with your suppliers.
4. What Should the Working Capital Cycle be?
Traditionally the KPI’s for a Vet Practice are:
|DEBTORS COLLECTION PERIOD||5|
|CREDITORS PAYMENT PERIOD||30|
|0 days shortfall|
However, in our current economic climate, this is becoming increasingly difficult as debtors take longer to pay, creditors add pressure for payments and clients take a little longer to make decisions about none-essential treatments and products.
Vet Practices should:
1. Drop stock levels to the bare minimum. Arrange with suppliers better and faster delivery times. With the reduced prices in logistics, many suppliers should be able to deliver within 2-4 days, meaning that you don’t have to carry those items in stock.
2. Improve your collections process by making it formal and having a trained member of staff conducting all collections.
3. Try and negotiate better terms with suppliers.
Even if your Working Capital Cycle does not show a shortfall, or even if it shows a surplus, the Working Capital Cycle needs to be continuously improved as both a safety barrier against potential economic fluctuations and as an additional source of revenue by earning interest on the surplus.