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Establishing Best Practices for Extending Credit in Today's Economy, Part 2

Sept. 27, 2011
Dr. Bruce B. Baird discusses strategies to consider when developing your own patient credit program.

by Dr. Bruce B. Baird

In Part 1 of our series on “Establishing Best Practices for Extending Credit in Today's Economy,” we described how dental practices can extend credit via internally funded payment plans, including the value of developing a written plan and formalizing the credit process. In Part 2, we will discuss strategies to consider when developing your own patient credit program. This includes deciding which procedures or types of transactions to include in the program and what types of patients will be eligible for credit.Leveraged transactionsLeveraged transactions or procedures of all sizes are good candidates for selling on credit terms. Why? Because the fee you will charge for providing financing will be high compared to the hard cost you will actually incur to provide the service or procedure. Couple this with requiring a downpayment and/or charging interest over the term of the payment plan, and the lending risk can be minimized or eliminated as you grow your practice and generate a high level of wealth creation for you as the owner. Let’s look at an example from the dental market and also compare this to the results you obtain using outside third-party financing.Outside financing may seem attractive on the surface because the dentist gets paid immediately. If the need for immediate cash flow is critical, an outside financing program is an option that should be considered. However, dentists do take a discount on their fees and the lender will only approve certain patients. Also, only certain procedures are eligible for financing, often at less than 100 percent financing. As a result, the dentist's revenue potential from the highly leveraged procedure is severely limited because the outside finance company dictates who gets financed and how much is covered. Considering that highly leveraged procedures are a good way to grow a practice and create wealth for the dentist, outside financing is not the best option for achieving these goals.It's interesting that many dentists are willing to take, for example, a 10 percent discount on their fees, which happens to be a significant percentage of their profit (based on the national average overhead of 73 percent). This isn't generating wealth for them, but rather it is reducing profits. Using an outside finance source for a $10,000 procedure nets them $9,000. Performing three of these procedures costs a dentist $3,000 in discount fees, while netting $27,000 in cash. Now compare that to the dentist extending his own credit and charging interest over the term of the payment plan. Patient payments over 60 months with 18 percent interest would equal $15,236. One out of three could not make any payments. However, the revenue from two patients would equal $30,472, which is actually more than the dentist receives from the outside financing company for three patients. If all three patients pay off their payment plans, the dentist would receive $45,708, which is $18,708 more than he or she would receive from the outside finance company. If the dentist averages three procedures a month, he or she would generate approximately $225,000 in additional income compared to the 28 percent reduction in profit by using an outside finance company. Outstanding receivable balancesIn certain situations, extending payment terms to an outstanding receivable account is a more effective and less expensive option than sending the account to outside collections. This is called “soft collections.”In today’s economy, many patients want to pay their dental bill, but often lack the resources to make a single, large payment. Affordable monthly payments are an attractive option for these people. If sent to outside collections, the agency generally suggests a payment plan as a first option in the collections process. For this, the dental practice pays a 25 to 35 percent collections fee on what is collected. On the other hand, if the practice extends its own payment terms, it saves the collections fee while still receiving payments.For example, let’s assume 10 accounts — each with $3,000 balances — were sent to an outside collections agency. At best, the practice would net between $19,500 and $22,500 of the total $30,000 outstanding. Often, collections agencies only collect on 40 percent of the accounts worked, which further reduces the practice’s net to $7,800 to $9,000 of the $30,000 outstanding. This translates into 26 cents to 30 cents on the dollar being paid to the practice.Compare that to extending your own credit based on terms your patient can afford. You have two options for approaching this opportunity:1) Run credit checks on the account owner prior to extending terms.
2) Extend the same terms to everyone without credit checks.
If you run credit checks on accounts prior to extending terms, the terms offered can vary based on credit risk. This would include term and interest rate charged. If the situation doesn't warrant this approach, extending terms that cover the perceived risk for the entire pool of accounts may be a simpler and better way to go.Using our example, assume that standard terms are used that offer a six-month term and an 18 percent interest rate. If everyone pays, the practice receives the full $30,000 due, plus $1,595 in interest income. Comparing this to the outside collections option, the payments received from just three out of the 10 accounts is more than what would be received from a collections agency. That provides a 70 percent upside to the practice that extends its own credit terms. Further, if the accounts do default, the practice can still send those accounts to an outside collections agency.Strategies for assessing credit riskWhen it comes to deciding who is eligible for extended payment terms and who is not, the decision should be based on a defined business strategy for offering credit, and then on criteria that is consistently applied to all applicants.First, let’s discuss strategies for offering credit. A properly designed credit program serves a business purpose. This may be to stimulate sales, provide a financing option to customers, or to supplement an outside financing program. Within the context of the business purpose, a decision should be made regarding how much credit risk is acceptable.For example, if the dental practice’s purpose is to stimulate sales of a service, but stringent criteria are set for credit approval, the practice may find a higher than desired percentage of applicants is declined. On the other hand, setting more lenient credit criteria may result in higher missed payments and bad debt situations. That said, it may be acceptable if the service is highly leveraged in terms of cost of the sale, and the increased business volume generates additional profits that justify the bad debt dollar risk.Credit risk should be assessed based on the dental practice’s purpose and should be well understood prior to commencing the program. The practice should develop financial models around the program to establish performance benchmarks that are monitored. Adjustments should be made along the way if performance is deviating from the benchmarks, so that the business purpose is achieved as originally envisioned.The second aspect of assessing credit risk is the consistent application of credit criterion to all applicants. This seems like a simple concept, but unfortunately, one that is often not followed. This can be avoided by establishing clear, written credit criterion and a monitoring process to enforce policy compliance and external lending rules.Effective automation is keyExtending your own credit for leveraged services and receivable balances offers enticing advantages over outside financing or collections services. It eliminates error-prone manual processes and can significantly reduce the workload for existing staff. That said, trying to manage the process manually can substantially increase risk and place a large burden on existing staff. Using a software solution that automates the entire process lifecycle delivers significant benefits and can maximize results for a small dental practice with limited staff. Automation ensures consistency and can enforce best practices. It can go as far as to define the business rules for the credit-granting process so that the approval/denial tasks are executed consistently irrespective of the individual processing the application.One of the key aspects of the credit review and approval process is running credit and identity verifications on each applicant to obtain information regarding credit worthiness while verifying his or her identity. An integrated, real-time service should be a required feature of any automated lending system.Next month, in the final part of this series, we will cover “Best Practices for Handling Missed Payments and Defaults,” and “Using Automation to Take Best Practices to the Next Level.”
Dr. Bruce B. Baird is the CEO and Founder of Comprehensive Finance, a coaching program and online lending software platform for creating and managing in-house customer financing plans for small and mid-sized businesses. Visit his website at www.comprehensivefinance.com.