How to Drive Two Trains at Once
Three ways advanced KPIs and analytics can help HME providers increase their profitability.
- By Michael Scarsella
- Mar 01, 2019
At a time when many home medical equipment (HME) providers need to keep track of every penny passing in and out of their doors, many still don’t take the time to understand their numbers and struggle with knowing how to increase profitability. Running an HME business without utilizing data and analytics is akin to driving a car using only your rear view and side mirrors. You can see where you are and where you’ve been, but it’s extremely difficult to see where you’re headed.
For the better part of six years, I have spent many of my days walking in and out of home medical equipment stores across the country. I am on the road just about every other week visiting an average of 12 stores per trip. That totals out to more than 1,800 store visits during my short tenure in the home medical equipment industry.
I know what you are thinking: what a romantic way to make a living. True. My stories are a hit at cocktail parties. It doesn’t get much better than mid-level chain hotels and eating alone, but I love it.
I love what I do because each stop involves a conversation. A connection. A story. Every dealer is working hard to figure it out and improve. I enjoy being a small part of that. I enjoy being a passing visitor who learns from one stop how to better help at the next. I enjoy discovering the problem and working with new people to find a solution.
The Value of a Good P&L Statement
One of the biggest problems I have encountered in recent years is the difficulty in separating true cash retail from the third-party billing side of an operation. Both segments have distinctly different cost structures, cash flow mechanics, sales processes, and marketing needs. Each segment requires a clearly defined and unique value chain in order to maximize both top line sales and net profit. Most of the time, I find the managers, owners and operators of many HME provider businesses treating the two segments as one, leading to mediocrity or worse — especially on the retail side.
To drive these two trains at one time, each business must run on separate tracks, and management must fully understand each business both for what it is, and for what it can become. The starting point for this process is the profit and loss statement (the P&L). A reliable and accurate P&L stands as the starting line for all strategic business planning. The P&L is void of emotion and reveals where a business truly is. It allows management to zero in on problem areas and enhance the areas positive performance. The P&L is the baseline for goal-setting and future performance measurement.
In just about every case, the P&L generated by the HME providers businesses that I work with is all-encompassing. In other words, it includes all business units and segments in the line items and totals.
While this is excellent for evaluating the overall health of the business, it proves difficult to make specific and informed decisions at the operational level. A handful of dealers have invested in the point of sale and accounting systems that allow them to produce segment specific financial statements, but this is typically not the norm. The average dealer needs to take the time to peel back the layers to separate revenue streams and expenses to align them with the business segments they drive.
How P&Ls Can Help in the Real World
The power of a good P&L can truly be transformational. Since my background is dominated by retail, my work with customers has focused heavily on store layouts, merchandising, marketing, advertising, and retail-specific performance metrics. I often counseled dealers that these discussions needed to begin with a detailed P&L analysis.
However, I quickly found that most dealers had neither the time, nor confidence to tackle the task. I started providing guidance and walking through the process with a few owners who were willing to share their financials with me. We took their overall P&L and carved out segment P&L’s for cash, Medicare, and private payor insurance, and the results were more eye-opening than I expected.
For example, one dealer was contemplating closing his doors, but the analysis revealed he was much healthier than he thought. He simply needed specific effort to improve his cash flow. By using the carved-out P&Ls we were able to identify some cash-raising opportunities and implement a few inventory and purchasing controls to keep things in check.
Another partner dealer realized his cash sales were heavily contributing to his net profit, but he was under-spending on marketing specific to his cash division. The cash flow analysis showed he could afford to significantly increase his spend in this highly profitable segment. Conversely, the analysis showed a deep net loss in the Medicare segment solidifying the dealer’s deci-sion to avoid getting too caught up in the latest CMS changes and Any Willing Provider status.
These are two examples of dealers that can make better, more specific deci-sions about their businesses simply by giving themselves the most accurate information with which to start.
Building a Powerful P&L
So how do you develop a P&L with that level of strategic value? The process is not terribly difficult, but it can take some time. It involves digging into your accounting system and running some key reports, reviewing full company financials including the cash flow statement and balance sheet, and making some educated assumptions in a few areas where the delineation between segments is not hard and fast.
Building segmented financials that operate within a margin of error in the 5 percent range will still prove invaluable in your strategic decision-making process. The management of any HME provider can and should continuously adjust your assumptions as its knowledge base and analysis deepens during multiple iterations of the separation process.
We start with identifying the primary segments of your business: Medicare, Medicaid, insurance, hospice, retail sales, home modification, etc. I suggest starting with these somewhat broad buckets and then choosing which ones you would like to drill further into. The hospice profit and loss, for example, could then be separated into individual contracts to reveal the cost and profitability of each.
Once you have identified the segments, pick the one you most want to separate first. This is an easier process to manage initially if you have a singular focus. After completing the first separation, the other segments fall into place more quickly. For the purpose of this article, we will zero in on producing a cash retail P&L.
Example: The Cash Retail P&L
We are going to follow the elements of a traditional profit and loss, so we start with sales/revenue. Hopefully, you have an accounting system that will allow you to quickly generate the dollar volume and percentage of sales generated through cash retail.
If it is not completely automated, you can work backward from the more clearly defined segments. Your accounting system likely denotes payer sources and contracts so through the process of elimination you can work toward a non-third-party payer number. You can also use the sales history of non-coded products to ensure you do not miss any cash sales in your analysis.
From sales/revenue, we move on to cost of goods sold (COGS). Again, most accounting software programs will make this isolating this number relatively easy. You can use the sales breakout I described in the previous step to focus in on the landed purchase cost of the products driving the newly formed top line number.
It is important to accurately drill down on this number, because the segment percentage will likely differ from that of the top line sales breakdown. For example, COGS for cash retail will likely be a smaller percentage of the top line than the COGS for the Medicare or private payer insurance segment.
With sales/revenue and COGS complete, you have your first look at the carved-out cash retail gross margin (GM). This is the first opportunity for a quick comparative. How does the cash retail GM measure up against the GM from your HME provider business as a whole? It is likely that the cash retail GM is significantly higher than the blended GM for the entire operation. When you go through this exercise for each segment, the variability in the GM for each division will be a strong indicator of how each segment of your business either contributes to or detracts from your company.
In my opinion, gross margin is the primary metric as it drives so many other metrics and is integral in all decisions. Regarding the cash retail business, it is important to compare your GM to the market place. Too high and your sell-through will be sluggish. Too low and you are leaving money on the table. This first look at your cash retail GM will tell you a good deal about your pricing and purchasing habits.
Totaling Your Expenses
We have broken out sales and COGS to derive our retail segment’s gross margin, the next step is to dive into the expenses. You will have a line item expense section of your general P&L to serve as your guide. The process is simply to go line by line and determine what portion of each expense can be directly tied to the cash retail business.
In a handful of cases, this can be cut and dry, but most line items will take some work. In many cases, assumptions will be required, and an acceptable starting point is to use the same percentage from the first step’s sales/revenue breakout.
The largest expense for nearly every HME provider business involves people. Salaries, wages, benefits, and taxes generally dominate the expense section of a P&L. This section is also somewhat easy to break out by segment. By separating your team into billers, floor salespeople, outside sales reps, techs, management and warehouse personnel, you can begin to separate the costs associated with each.
Ask yourself, “If I went all cash retail, which employees would I not need any longer?” The cost of those employees should be carved out completely from the new cash retail expense line. Conversely, ask yourself, “If I went straight third-party pay, who would I lose?” The cost for those employees should be fully loaded into the new expense line. The remaining employees likely wear many hats so using the sales percentage breakdown is a solid starting point.
The next expense line to take your time with is marketing and advertising. This is an important category to try and get as specific as possible because the cash retail segment has dramatically different marketing needs than other segments. The budget for marketing will be higher for cash retail than for the billing side of a business. More planning and thought will be required when building this budget so clearly knowing the separation of the spend is vital to measuring the return on investment of your marketing expenses.
Breaking out the utilities requires a look at your physical location. What percentage of operation is dedicated to billing only? Is the showroom section more heavily focused on cash sales? Costs associated with accreditation, education, contracts, and certain fees are usually quick exclusions from the cash retail side of things, since they are related to funded income. Vehicles, building maintenance, postage, travel, supplies and other expenses simply involve a detailed look at the general ledger.
I recommend a quick first pass to find anything clearly cash retail-specific or not and then apply the sales percentage to the balance remaining.
The Bottom Line
When all the expense line items are adjusted and in place, you can plug them in for your finished cash retail P&L. Your new sales/revenue, COGS, GM, and expense section will reveal a new Net Profit bottom line. How does the cash retail Net Profit compare to the Net Profit of the whole business? What is the cash retail business’ contribution percentage to the company’s total Net Profit? Is it more than the percentage of total sales/revenue?
In addition to the high-level metrics of gross margin and Net Profit, the new P&L allows you to dig deeper when measuring performance. More granular financial metrics such as break even, gross margin return on investment (GMROI), inventory turn times, dollars per square foot, marketing as a percentage of revenue, average ticket, and cost per customer all paint a more detailed picture when viewed through the segment P&L.
Now you have results. The result of these metrics is the ability to make better and more specifically informed decisions about how to run your HME business. The result is to set better goals and better track progress toward their attainment. The result, ultimately, is maximizing your returns with more money staying in your pocket.
The biggest challenge to taking this detailed approach to managing your business is finding the time. As I work with HME provider businesses across the country, their stores are always buzzing with activity. Patients and consumers are flowing in and out. Deliveries are being planned, pulled and loaded. Claims are being billed, chased and defended.
Rarely do I find a dealer with more time on his hands than he knows what to do with. Also rare is to find an HME provider whose business is simple and straightforward.
So, when you combine the complexity of each HME provider business with the lack of time, the challenges of charting a path, setting goals, and measuring progress become massive. But the provider owners, operators and managers who make the time and take the time to meet this challenge, end up driving their two trains better and farther than the rest.
This article originally appeared in the March 2019 issue of HME Business.