To Buy or Not to Buy

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January/February 2003

By Charles Felder, MBA, PT, SCS, ATC, CSCS

Charles R. Felder, MBA, PT, SCS, ATC, CSCS

Physical therapy practices require a variety of equipment to operate effectively and efficiently. With the challenging health care market, many therapists are seeking additional revenue-enhancing options, particularly those that are cash-based. This often requires the addition of equipment or space. Making the decision to purchase additional equipment should be based on facts rather than intuition or a slick sales presentation. I like to categorize equipment into its functional area of use—professional equipment used for patient care only, exercise equipment used in patient care or for general exercise, and administrative equipment used to support the above activities. Before making the decision to add a piece of equipment, financial concerns, as well as several other questions, need to be considered.

FINANCIAL CONSIDERATIONS

Managers typically use two economic methods of evaluating the financial aspects of equipment purchases. The key factors are: how do assets (equipment, inventory, etc) relate to sales (revenue) and expenses (labor, supplies, etc).

Return on investment (ROI) is a very common assessment tool. ROI compares operating income to amount of investment required to produce it, usually over a specified reporting period such as quarterly or annually. A simple ROI is calculated by dividing the operating income by the cost of the investments.

Table 1. Simplified ROI calculation.

If the equipment would allow the addition of a fitness program to the clinic’s service offerings, resulting in new cash business, the manager should calculate the amount of the new sales, minus all expenses, and divide this by the cost of the operating asset. The example in Table 1 provides a simplified model.

A second concept is to calculate the payback period. How long will it take, at the expected operating income rate, to pay back the cost of the equipment? This requires estimating the operating income rate per unit of service or over a specified time, usually monthly. Divide the cost of the asset by the expected operating income rate to determine the payback in terms of units of service or time. For example, if you expect an additional $2 of operating income per visit, then the payback period for a $2,000 investment would be 1,000 visits. If there is an additional $100 per month in sales, with no increase in expenses, then the payback period would be 20 months. Make this calculation more accurate by including the interest, or time value of money, in the calculation. New equipment that costs $2,000 and is purchased on a 5-year loan with no down payment at 10% annual interest would have a total cost of $2,549.65. (See Table 2.)

Table 2. Top: Unit-based payback calculation. Bottom: Time-based payback calculation.

QUESTIONS TO CONSIDER

Is this equipment necessary for a need or a want?

The first step is determining why the equipment is necessary. Does it fill a need? For example, are you adding a fitness program but lack the appropriate equipment to adequately service the clients, or replacing business-critical equipment that is broken? Alternatively, you may want to have faster computers to improve the efficiency of your staff. This step is important since it will help you identify how the new equipment will provide a financial or performance return to the clinic. Filling a defined need places a greater priority on the decision. I believe that filling a want should provide a greater return on investment since the risk is higher. Higher risk should generate a higher reward to compensate for that risk.

What will I gain by having this equipment?

Determining what you can expect to receive from this investment may be very simple or relatively complex. Does having this equipment open a new market? If so, what is the potential of that market? Larger markets that are growing usually warrant increased investment. Adding balance training equipment may permit expansion into the fall prevention market that should grow as the population ages over the next decade.

If the equipment will provide an increase in an existing income source, or provide a new income source, the argument for purchasing the equipment is greater. The calculation also is simplified since one can easily compare the expected income to the cost of the equipment in a straightforward ROI calculation. Divide the expected revenue by the cost of the equipment. For example, if purchasing a new electrical stimulator means that you will now generate additional revenue, divide the cost of the equipment by the anticipated revenue. In this situation, you may not need to add in many other costs, but frequently it is necessary to consider additional labor or supply costs associated with use of the equipment.

In a more involved situation, the decision may not be based on a direct increase in sales, but rather a combination of improved sales and reduced expenses resulting in a higher operating income. Purchasing additional exercise equipment may permit more patients to be treated per unit of time, improving therapist productivity. Therefore, additional revenue is generated, while unit cost of services provided decreases, increasing overall operating income.

Purchasing a new computer and software program may reduce the time spent by personnel and have the side benefit of improving compliance. Here, savings are gained, and perhaps an increase in revenue secondary to more efficient claims processing. The time value of money may also need to be calculated if the payment cycle is reduced due to electronic claims processing with revenue arriving sooner and therefore able to be used earlier.

Often, having the equipment provides intangible rewards, such as an improvement in reputation, reduced stress, improved work flow, or similar concepts that are either impossible, or at least very difficult, to quantify. Considering intangible rewards is important in the decision-making process, but should not dominate it.

What is the downside of this purchase?

What will happen if you don’t purchase this equipment? There can be both economic and intangible factors contributing to the decision. An easily identifiable downside would be that the equipment is purchased and the increased revenue stream does not materialize, resulting in loss of the investment.

Perhaps not purchasing will not only forgo any increased sales, but could contribute to a loss of existing sales due to a change in referral patterns to someone who has the “newest and the best.” Do your best to quantify both aspects of this component as it could have a major impact on your decision.

Are there any underutilized pieces of equipment that could fill the identified need or want?

Is there anything existing in the clinic, or storage, that can fulfill the need or want? Perhaps the existing exercise bicycle could be used in the fitness program when not needed for traditional therapy uses. Maybe that older computer could be available for functional capacity testing, or work conditioning training.

How will this purchase affect other areas such as space, personnel, or supplies?

Where will the equipment be used and by whom? Will additional staff be necessary to use the equipment or instruct others? The equipment may improve the staff’s efficiency, thus increasing their productivity, which should also be included in the calculations.

Determine if the space requirements are appropriate for the expected return. If the equipment is a replacement, this step is relatively simple. In the case of new equipment, determine if any existing equipment will have to be moved or removed and what effect that will have on your work flow and revenue stream. New equipment that requires additional space must include the cost of that space in the ROI calculation.

Is the equipment planned for in the budget?

Have you prepared for this in advance, or is this a new concept? Will the budget be able to absorb the additional expense? If it is in the budget, or you make the calculations and decide that you should purchase, the next question is how to purchase.

When and how should I make the purchase?

Look for any special offerings by the manufacturer or distributor—this could be a significant source of savings. You are not likely to find seasonal sales, but any reduction in the cost of purchase can make a significant change in the ROI over the useful life of the equipment.

In many cases it will be best to pay cash since this reduces your total cost for the asset. You may earn a better return on your money if the ROI is high, than compared to investing in some other area, or just leaving the money in the bank. Use of financing will allow leveraging your funds and can produce a higher return since you risk only a small portion of your funds. The amount of debt carried by your practice is an individual decision based on the owners’ comfort level with debt. Leasing is another option and also allows you to leverage your funds, but typically you can reduce your overall costs by purchasing rather than leasing.

In making the final decision, plan well and consider the available options to make wise purchasing decisions that enhance your practice’s reputation and bottom line.

Charles R. Felder, MBA, PT, SCS, ATC, CSCS, is CEO of HCS Consulting. He can be reached by phone at (949) 280-3449 or email at cfelder@hcsconsulting.com. Free downloadable templates of the calculations used in this article are available at www.hcsconsulting.com

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January/February 2003