Two Secret (and Large) Costs of Prepayment Discounts versus Recurring Monthly Payments
PERSPECTIVE
Miles Bodzin
DC
It’s commonplace for chiropractors to offer discounts to patients willing to make a prepayment for services in advance. When surveyed, most chiropractors tell us they offer a 10 to 15% discount for payment in advance and commonly have patients prepay for six to 12 months of care. For illustration purposes, we’ll assume 10% is the most common discount provided, and we’ll use 12 months of service.
At first glance, a 10% discount for prepayment sounds quite reasonable. Get all your cash up front and only pay 10%. Seems like a pretty good deal, right? In practice, however, the cost of that capital is much more expensive than 10% in two critical ways. It’s imperative you understand that the discount is a “cost.”
SECRET COST #1: Prepayment Discounts Are High-Interest Loans
An essential aspect of understanding the real cost of discounts is to focus on the “cash difference” between the discounted prepayment received up front versus the cash the practice would have otherwise collected over time.
This “cash difference”—not the total prepayment amount—is the money that is effectively being “borrowed” from the patient. The money is considered “borrowed” because it is not yours until time has passed and services are rendered. In essence, you’re paying interest on this borrowed money in the form of your 10% prepayment discount.
From my own experience, I learned that the money patients prepay to us is “borrowed from the patient” in every sense of the word. Many years ago, I had three military families coming in for care who had each prepaid for their families. In one week, due to things out of their control, all three families had to move away, and I had the distinct honor of writing them each a refund check that week for nearly $10,000 total. Ouch!
Another way of thinking of the “cash difference” is that an annual prepayment accelerates one-twelfth (1/12) of the cash by 11 months, and one-twelfth (1/12) of the money
“In essence, you’re paying interest on this borrowed money in the form of your 10% prepayment discount. JJ
not at all. On average, payments are accelerated by five months. So, in actuality, the discount offered to the patient is an up-front interest payment for a five-month loan, not a 12-month loan.
By way of a simple example, let’s assume an annual chiropractic prepay agreement is $10,000, and you give your patients a 10% discount for a 12-month prepayment versus monthly payments. If the patient takes advantage of the discount, you will collect $9,000 at enrollment versus $833 at registration followed by 11 more equal payments.
As with most loans, the borrowed amount (principal) is significant at first, gets smaller each month, and
eventually goes negative the last month. When averaged that it’s about the same as borrowing all of the money (all the principal) for five months.
So, in actuality, the cost of the loan is $1,000 (the 10% prepayment discount), but the actual length of the loan is less than a year. To determine the real cost of a loan, you would have to calculate the internal rate of return (IRR), often what you see as the annual percentage rate (APR) on mortgage loans.
In this prepayment example, when you calculate the IRR, the effective rate of the borrowed cash is not $1,000/$ 10,000 or 10%. The IRR calculates as 24%! In other words, the actual cost or present value of the money being prepaid as compared to monthly payments is 24%.
In summary, you need to realize that the actual cost of the money you are “borrowing from your patient” is much higher than the percent discount you are giving the patient. Not to mention the risk of having to write refund checks when patients cease care.
SECRET COST #2: Impact of Prepayment Discounts on the Value of Your Practice
Practices, like other types of small businesses, are valued higher when there is recurring revenue. For example,
in the software industry, subscription-based companies are often valued twice as much as software companies that sell a perpetual license.
Although the chiropractic practices are not the same as software companies, the same idea holds true. The chiropractic practice with a business model based on subscription or recurring payments is more valuable than one that does not have recurring revenue.
One might assume two identical practices collecting the same amount of revenue would be valued nearly the same. However, if the first practice’s collections were primarily from annual prepayments, and the other’s collections were from monthly recurring revenue, the latter would be valued significantly more than the first.
A variety of reasons exist for when a buyer would be more interested and willing to pay more for a practice with recurring revenue than one without.
• Revenue and Cash Flow — The purchasing chiropractor can count on recurring income right from the start, allowing them to sleep a little easier knowing that they have the cash flow to cover immediate expenses of the practice.
• Predictability and Stability — Practices with recurring revenue are more predictable and stable.
The chiropractor can forecast revenue months in advance, allowing the doctor to plan for future growth and hire employees.
• Reduced Risk and Growth Potential — Recurring revenue minimizes the roller coaster ride of monthly income fluctuations. As a result, these practices are less risky and present more opportunities for growth.
• Allow for Vacations — Recurring revenue makes it easy for the purchasing doctor to go on vacation because income does not fluctuate as a result of the doctor being away.
• Easier to Get Loans — If and when a chiropractor seeks to get financing to expand or open additional clinics, banks are more likely to approve loans for higher amounts when they see projected future revenues from recurring payments.
With every patient who prepays, not only are you paying a much higher interest on the borrowed money (as discussed in Secret #1), but you also reduce the recurring revenue to the practice, which results in a reduced valuation to the practice.
In other words, prepayment discounts are nothing more than deductions from recurring revenue that destroy the value of your practice in the most direct possible way.
In conclusion, as a new practice, it may be wise for chiropractors to accept prepayments to increase capital because they may not be able to get their hands on money cheaper than the IRR from the prepayment discounts.
However, as your practice matures, the real cost of prepayment discounts, as outlined earlier, becomes a much more significant issue. The actual price of the discount is more like factoring than borrowing, which is very costly and not easy to isolate on your financial statements.
Those costs, however, pale in comparison to the negative valuation impact that will show up upon selling your practice or during the next time you’re looking for financing. Discounting for advance payments is a useful cash management tool available to all chiropractors. Just be aware of the real, secret, and substantial costs involved.
Dr. Miles Bodzin, founder and CEO of Cash Practice Systems, is a chiropractor who became known as “the king of patient retention. ” He’s appeared in the Wall Street Journal, on The Brian Tracy Show, contributed to ikwm a number one best-selling book with Steve Forbes titled SuccessOnomics, and speaks internationally on the topic of client retention. His company offers web-based software for chiropractors to implement his four-step process that results in increased patient retention. The Wellness Score System, Cash Plan Calculator System, Auto-Debit System, and Drip-Education Email Marketing System all work together to helpfree a doctor from the shackles of insurance dependence. Learn more at www.CashPractice.com or call 877-3-13-8950. To book Dr. Bodzin for interviews and speaking, call 877-343-8950, extension 201.
