So you want to improve the profits that come out of your dental lab but not exactly sure how? Well, that’s no surprise. In fact many lab owners I know are great technically but are not exactly sure about how to look at the financials in a way to actually grow their labs profits
Here are the levers of profitability in your lab and how to use them to find problems, identify areas for improvement and grow profitability.
There are really only three ways to improve profits in your lab; your levers of profitability; growing sales, improving gross margin and reducing fixed expenses. I’m going to give an overview of each.
Let’s start with a basic understanding of your labs financials to put us all on the same page. Your lab sales come in on the top of your P&L statement. From those sales we reduce the cost of goods sold, otherwise known as COGS. These are the expenses that go directly into making the product and are direct labor, direct materials and direct supplies. These are almost always variable in nature meaning the more work you do the higher the dollar amount will be, however the percentage stays the same.
Direct labor: $230,000 23%
Direct materials: $190,000 19%
Direct supplies: $35,000 3.5%
Total COGS: $455,000 45%
Now if your sales were to go to $2,000,000, your costs might look like this (assuming no change in your product mix)
Direct labor: $460,000 23%
Direct materials: $380,000 19%
Direct supplies: $70,000 3.5%
Total COGS: $910,000 45%
Notice that while your sales doubled, your expenses doubled with them as your direct labor, direct materials and direct supplies doubled to manufacture the additional product. However this doubling in COGS did not result in doubling of your percentage.
What’s the takeaway here? The percentage of your total COGS is how many cents on the dollar it costs you to make your products. So, in the above example, whether your lab makes $1MM or $2MM of product, it still costs $0.45 on each dollar in costs. The remainder of this number is your gross profit, which, in this example is $0.55 on each dollar. So you have $545,000 in gross profit at $1MM in sales and $1,090,000 in gross profit on $2MM in sales.
This gross profit is the money that is then used to pay your labs fixed expenses, which we will talk about in the next part of this article. What’s important to know about the gross profit, is that if you can improve your costs in making the products, say from $0.45 to $0.40, you would have five more cents on the dollar of sales to contribute towards your fixed expenses. If your lab is already profitable, that means for the lab doing $1MM a year in sales, you just increased your profit by $50,000; an increase of $100,000 for a lab doing $2MM in sales. That’s a lot of additional profit for a five cent reduction in your labs COGS. Thus gross margin as one of your levers to improve profitability in your lab. Conversely if your costs go up just five cents on the dollar, that same $1MM would be losing an additional $50,000 per year or losing $100,000 on $2MM per year.
Next month we will discuss the next of the remaining two levers of profitability in your lab. Subscribe to get notified or make sure to revisit our page often.
This is why understanding your financials is a critical part of being able to control your business. The first step in using your financials this way is to make sure your financials are accurate; meaning your expenses are all properly classified. From there, you can easily see your percentages, understand your costs to make your product and improve your gross margin. We have a great program to show your accounting person which expenses go where and how to set up your financials so you can use them as a management tool to start understanding and improving your labs profitability. Call or email to learn more about getting our Financials as a Management Tool program for your lab.
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