The Optometrist’s Guide to Business Financing
Chapter 3: When to Finance and Financial Terms
By: Dr. Aaron Neufeld (last updated: Sept 8, 2020)
Timing financing is a touchy and controversial subject. Modern culture has pushed financing and debt as a way to “have it all” when in reality you have nothing. The key to utilizing financing in order to run a profitable and successful business is to only use it when absolutely needed. Look at three factors, wherever you are looking to finance - whether it be a piece of equipment, working capital or an entire practice.
Liquidity describes the cash you have on hand that can instantly be used to cover a debt. If your liquidity is adequate, then a new purchase would be best done in full, rather than financed. However, if a full purchase risks illiquidity or a serious cash flow crunch, then financing is advisable.
So what specific liquidity numbers are we looking at? While each practice is unique, consider the “average” profitable practice that grosses $1 million annually and nets $300,000 after cost of goods and debts owed. A practice of this size would optimally keep a safe harbor of $50,000 cash reserve in case of a cash flow pinch. So when the owner looks at a new corneal topographer for $20,000, she must measure the numbers. If she can afford to use cash flow to purchase the topographer while still maintaining a $50,000 cash reserve then she should purchase the unit outright. If she cannot, she should finance.
Obviously, each practice owner will have different levels of debt aversion and different comfort levels for their cash flow. Our advice: stay out of extraneous debt whenever possible, especially if your liquidity affords you the luxury.
(2) Free Cash Flow
Positive cash flow is probably the most important part of a profitable business - essentially you always want to be making more money than you spend, enabling you to reap a profit. While financing may seem like a lucrative way of preserving your liquidity, it ultimately has to take a toll on something, and that something is cash flow.
When considering financing, calculate your monthly payment and map out your current average cash flow. How much will this financing expedition eat into your profits and potentially your own pay? If your financing prospect places you in a projected negative cash flow situation, then it is time to pump the brakes.
(3) Return on Investment
Every purchase for your practice should be an investment and should be looked at as an investment. While items in our personal life may be purchased for enjoyment or simply to have them, each item purchased for a practice must have a purpose that enables the practice to grow and become profitable.
That new fundus camera? It enables you to provide better eye care, generate revenue through medical billing and builds a deeper level of trust with your patients. The new chairs in your optical? They ensure a more comfortable experience when trying on glasses and help to psychologically ease a patient into buying a product. The new coffee maker? It keeps your staff energized and in a better state of mind to both help and sell to patients.
Before pulling the trigger and financing something for the office, map out a SWOT analysis. Under the Strengths category, make sure to list both tangible and intangible benefits of a potential purchase.
10 Must-Know Finance Terms
In the world of financing, terms are often used that can be confusing to someone that is not otherwise familiar with the lingo. This section serves to provide simple definitions for financing terms you may come across that have not already been mentioned in this chapter.
- Annual Percentage Rate (APR) - This basically gives you the true cost of your loan and reflects interest rate, fees and other charges within a year’s time period.
- Prime Rate - This is an interest rate determined by the banks that helps establish lending rates, credit card rates and home equity loans. The prime rate is based on the federal funds rate which is set by the Federal Reserve.
- Refinancing - This is the process of paying an existing loan with another loan with better terms (most likely a lower interest rate).
- Collateral - This is property or assets that the borrower pledges to a lender to protect the lender in case the borrower defaults on a loan.
- Origination Fee or “Points” - This is an upfront fee that some loans have tacked on that must be paid at the get-go. When using the term “points,” a point refers to 1% of the loan amount - so if you got a loan of $500,000 with 3 points, that would be a fee of $15,000 up front.
- Lien - This refers to the right to keep possession of property belonging to another person until a debt owed by that individual is discharged.
- Debt Consolidation - This is a form of refinancing debt where one large loan is taken to pay multiple smaller loans.
- Maturity Date - This is the time when both the principal and interest on a loan are due in full.
- Balloon Payment - This refers to a large payment that is due at the end of the loan term.
- Bootstrapping - This term refers to funding a startup with your own money and the revenue of the business, without any outside help.
Financing is an important tool that is often necessary to build a business, especially in its early stages. The problem with financing is that it is a double edged sword. It can easily place you in a spot of being over leveraged if not used correctly. The key to financing effectively lies in understanding underlying implications including terms and interest rates, and seeing if these cash eating components can be leveraged to ultimately create a profit producing investment.