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Overhead – Friend or Foe? by Roger K. Hill, MSK

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The very word "overhead" brings fear and dread to most doctors' hearts. It is universally viewed as the impediment between top-line income and bottom-line profit, something never really tamed, simply an ongoing battle.

It does not have to be this way. Viewed from the proper perspective, it can be a useful tool in 1) the delivery of care to patients, 2) providing an income and 3) building wealth.

We need to consider the true purpose of overhead. The purpose of overhead is to generate income. Consider this: Even a doctor with the most excellent clinical skills and an endless stream of patients will never realize the potential without spending money on overhead. Imagine arriving at your office on Monday morning to find a full schedule awaiting you. However, the office is dark and the staff are missing. All the potential for success exists, but it cannot be achieved without spending money on overhead - in this case, staff salaries.

Another way to view overhead is that it is the mirror image of profitability. In other words, all of the income received by a practice will ultimately be divisible into one of the following categories: normalized overhead or profit items/benefits. The sum of the two (whether expressed in dollars or percentages) equals all of the income.

We will discuss the concept of profitability and its relationship to overhead, but before getting to that, it is necessary to define the term "normalized overhead." Normalized overhead is the amount of money that must be spent in order to generate the income before there is any financial benefit available to the doctor (in the form of salary, pension contribution, discretionary expenses, debt services, etc.).

Doctors often believe their normalized overhead is a higher percentage than is actually the case. Normalized overhead does include staff salaries, rent, dental supplies, laboratory expenses (such as Invisalign aligners and retainers), utilities and similar items. It does not include the previously mentioned doctor benefit items. Some perspective on the major components of overhead will be instructive.

Our transactions database indicates the following cardinal overhead indices for orthodontic practices.

1. Staff Salaries - 18-22 percent
This category excludes compensation paid to any doctor (whether owner or associate), family members not actively employed in the practice and other personnel not actively working in the practice but who may be paid a salary for discretionary reasons. You might be surprised to find that if you look at the staff salaries (as a percentage of revenue) for each of the past few years, and exclude the categories listed previously, your staff salaries will likely fall within this range. If they do not, you might want to consider the reasons for this variance.

2. Rent - 5-7 percent
This range excludes utilities, property taxes, insurance, facility repairs and any one-time (non-reoccurring) items. Bear in mind that if you own the facility in which you operate, the rent needs to be adjusted to fair market rental rate instead of what you might be paying yourself for tax-driven reasons. Fair market rental rate is the rate at which the facility would lease to an unrelated tenant, and should be comparable to lease costs for similar facilities in the area.

3. Dental Supplies - 6-10 percent
This range includes items such as archwires, brackets and other consumable supplies. There is considerable variability (thus the wider range of 4 percent) due to the variation in cost for different bracket types, such as self-ligating brackets (which are typically more expensive than others). The dental supplies category usually does not include the cost for aligners associated with products such as Invisalign.

4. Laboratory Expense - 4-8 percent
This range will vary depending on the amount of Invisalign production; with more Invisalign production, there is greater laboratory expense.

5. Advertising/Marketing - 2-4 percent
This will generally be a higher percentage in a practice's early years, or in the beginning phase of developing a marketing program. Later, it will usually subside to the lower end of the range. Nonetheless, this is a job never finished, and should be considered an ongoing and necessary expense.

6. Total Overhead - 47-62 percent
The average (mean) overhead rate from our transactions database is 54.60 percent with the first standard deviation ranging from 47.10 percent to 62.09 percent. Remember the definition of normalized overhead and the excluded items

To this point, we have been discussing the purpose of overhead and typical indices. Let's turn our attention to managing the overhead and the benefits to be realized.

From the standpoint of day-to-day operations, suppose we have two practices, each with an income of $1 million. One practice has a 50 percent overhead rate, and the other has a 55 percent overhead rate. This is a difference of $50,000 per year, or just over $4,000 per month. Over the course of a 25-year career (assuming a maximum tax rate of 40 percent), the difference in accumulated after-tax earnings is $750,000. This assumes the worst; that none of this amount is sheltered in a qualified pension plan and there is no growth on potential investment. In short, it is additional after-tax income potentially available, depending on management of the overhead.

If the pre-tax amount ($1,250,000) were contributed to a qualified pension plan on a monthly basis over the same 25 years and grew at a modest rate of 6 percent, the accumulated wealth is nearly $2.9 million. For most of us, this is enough to make a difference.

Let's look at it from another standpoint. The impact on practice value of a lower overhead rate is additive to these cash flow benefits. Before we begin this discussion, we need to acknowledge one more cardinal point: Everything else held constant, the higher the profitability the higher the value.

That same $50,000 difference in annual overhead will not increase the practice value by $150,000 to perhaps $200,000. Instead, the lower overhead will increase the practice value by approximately $250,000. Again, remember that this positive benefit is additive to the wealth accumulation illustrated above. The sum of these benefits is more than $3.1 million, all for the sake of finding a way to be more efficient by $4,000 per month. Almost every practice can accomplish this goal.

On an allied note, even though this is not strictly an overhead item, we would be remiss if we did not acknowledge that regular fee increases can make a positive impact on income. For example, with our same $1 million practice, a 1 percent fee increase each year produces an accumulated difference of approximately $3.2 million in practice income over the course of 25 years. With a 3 percent increase, the difference is approximately $11.4 percent, and with a 5 percent increase, the difference is approximately $22.7 percent.

Managing or controlling the overhead could be stated as a never-ending task. It can also be stated as a never-ending source of financial benefits. It all depends on how it is viewed.

Fully exhausting all of the aspects of overhead is well beyond the size of this article, but there is one more area that is often overlooked, and yet deserves our attention. That is, overhead can be viewed as a way to answer any number of how-to questions. For example, suppose you are considering bringing an associate into your practice, and you want to know the minimum increase in income needed to offset the additional overhead and compensation for the associate. The formula for determining the breakeven point (BEP) is as follows:

$ Total New Fixed Costs
1.0 - Variable Costs (VC) % 		= $ BEP

Assuming the associate hopes to earn $150,000 pre-tax income, that an additional clinical assistant will be needed (at $35,000), and that variable costs (dental supplies and lab expenses) are a combined 15 percent, the practice needs to add approximately $217,650 per year, or $18,100 per month. With this construct, you can easily substitute different variables and determine how much additional revenue is required.

There are numerous other ways in which overhead can be used as a tool to justify or determine the benefit of other expenditures, such as new capital purchases or the acquisition of a nearby practice to be combined with your own. Many times when a nearby practice is acquired and moved into your facility, the savings on fixed overhead costs no longer being duplicated will finance most (or in some instances, all) of the acquisition cost. Though it might sound counter-intuitive, the post-acquisition overhead rate is lower than the rate for either practice prior to the acquisition. This provides both the cash flow and increased practice value benefits detailed earlier.

Viewed properly and managed well, overhead can be your ally and route to significant additional financial benefit.

Author's Bio
Roger K. Hill provides transition planning for practice sales, partnerships (buy-in/buy-out), practice mergers, associateships/compensation analysis and financial forecasting (proforma) through Roger K. Hill & Company, a member of The McGill & Hill Group, LLC. For more information, visit www.mcgillhillgroup.com.
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October 2025
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