As dental groups are starting to see some semblance of normalcy (at least relative to 2020), they are reporting year-end financial figures, while also getting resolution on Paycheck Protection Program (PPP) forgiveness.

Financial Experts Have Spotted a 2020 Trend

While a large focus will be on the ultimate profitability for the year, part of the balance sheet is catching the eye of the financial professionals and executives. Specifically, the cash balance at the end of the year is higher than expected relative to the profitability of the year. 

Although we’re conditioned to think that having too much cash is a good thing, it’s important that organizations dedicate time to understand why their cash balance may differ from their expectations and be intentional with how they treat any excesses.

What Caused This?

There are likely multiple factors that could have contributed to an organization having excess cash at the end of the year:

• Did the company receive funding through the CARES Act Provider Relief Fund?
• Did the company receive funding through the Paycheck Protection Program (PPP)?
• Did the company receive additional funding through other SBA or local relief funds?
• Did the company furlough workers while offices were closed or at reduced operations? 
• Were pre-existing debt payments deferred for any given time throughout the year?
• Were distributions temporarily halted during 2020 due to uncertainty?
• Did owners and/or leadership reduce their compensation to help cash flow?
• Was any rent forgiven?
• Were any other employee benefits suspended or cancelled?

Any combination of these factors listed likely resulted in a higher cash position despite what was likely a decrease in financial performance from normal operating results. For example, the Cares Act Provider Relief Funding was a grant that was intended to replace revenues, but comes with none of the variable costs that would have come with typical revenue. 

Similarly, PPP funding allowed organizations to operate for two and a half months with minimal out of pocket payroll. Depending on how productive the organization was upon reopening, it could have led to a very profitable period that more than offset any closed or reduced capacity period.  

These huge cash inflows, combined with any reduced rent payments, deferred debt payments, or other reduction of cash outflows, would naturally lead to “excess” cash.  While this is a more comfortable and safe position to be in after the uncertainty of 2020, with interest rates near zero, excess cash in the bank has zero financial return and it is important that organizations efficiently utilize their capital position.  

So how do you determine how much is “excess cash”? 

The key is to define what the ideal cash balance is for your organization. It’s common for dental groups to have the expectation that last month’s production will come through in the current month so that you always have a month of float. This amount depends on the organization’s insurance and private payor mix, collection policies, financial arrangements, etc. 

In economic crises like the one just experienced, those dollars dry up quickly as there are no promises they will be paid, and often there are expenses related to those collections. Therefore, many organizations are no longer treating receivables as a safety reserve and are instead focusing on cash (or access to cash) as representative of their available “working capital”. 

In looking at an ideal cash balance, many organizations include their available access to cash through a line of credit, or similar arrangement at a financial institution so that they can avoid keeping too much cash in the business and draw on the line of credit if needed. 

A Cash Rule of Thumb

Each organization has different risk tolerances based off of profitability levels, number of offices, ownership structure, and overall theory on cash management and debt. However, a common rule of thumb is to have 2-3 months of fixed expenses available in cash (or line of credit). 

Many organizations also factor in some variable costs as well, particularly wages and what is necessary to keep all people, leases, and equipment in place so that business is able to function. This rule of thumb might have changed for an organization just from this last year! 

How to Make the Best Use of Excess Cash

Once the target cash is defined, the excess can also be defined, which leads to the key question: What do we do with this money? In answering this question, your organization should ponder the following:

• What are the current debt balances of the company and at what interest rates? Should those with high interest rates be paid off or paid down? Does it make sense to keep a higher cash balance in place on those with a very low interest rate (e.g. SBA loans) as an extra “war chest”?
• Are there any capital expenditure needs that could be funded by this excess cash?  
• Are their acquisition opportunities where it makes sense to use the cash to offset some of what would be raised from ownership or borrowed from the bank?
• Did the owners forgo distributions in 2020 that would now be appropriate to distribute? At the outset of the crisis, did any owners draw from their retirement accounts to fund temporary cash shortfalls that need to be repaid? What will the ultimate tax liability to the owners be? The PPP forgiveness is effectively tax-free, but as it stands as of January 2021, grants received through the Cares Act Provider Relief Fund are in fact taxable.  
• What benefits structurally changed in 2020, such as retirement contributions, that need to be reinstated to remain competitive, and at what cost?

There is no one-size-fits-all answer. All organizations, their structures, and their ownership differ due to different histories and experiences, but taking a strategic approach to the organization’s current cash situation is an important reset from 2020’s reactionary approach. 

What will you do to set the organization on solid financial footing moving forward?

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