Five Tips Every Therapist should Know about Practice Budgeting

Photo above by NEOM on Unsplash.

A solid budgeting strategy lays the groundwork for financial success, guiding decisions and ensuring stability. In this guide, we'll explore six key principles every therapist should understand about budgeting for their practice.

1. Practice budgeting doesn’t need to be a big, scary, overwhelming thing. Start simple!

Building a budget for your practice might sound like something overwhelming and scary. But like every element of your financial life, the key thing is not to get it perfect, but rather to make some progress. We all know progress is better than perfection, right?

A budget is really just a guess about how much income your practice will provide this year. That’s it - just a guess. And you can make that guess as complex or simple as suits you. More complexity isn’t necessarily useful or a good thing. Especially if you’re new to practice budgeting, I like the idea of starting as simple as possible.

What does simple budgeting look like? One idea is simply to look at last year's profit & loss statement and duplicate it. If you think this year is going to be slightly different, just make some small adjustments. If you think revenue will be higher, just bump it up a little bit. Lower? Just decrease that a bit.

And then think about your business expenses… are they likely to grow (or decline) as your revenue grows (or declines)? Or are your expenses pretty much fixed at a certain level and unlikely to change?

• If your expenses are fixed, just assume the dollar amount of expenses will remain the same. Subtract last year’s expenses from this year’s revenue guess and that’s your profit before taxes.
• If your expenses will grow or decline with your revenue, use a “margin percentage” to determine what your earnings for this year will be. To get that percentage divide last year’s profit by last year’s revenue. Then multiply that percentage by your guess for what this year’s revenue is going to be. Boom, that’s your estimate of profit before taxes.

If all these adjustments are sounding a bit much, that’s ok! Just make your best qualitative (e.g. math-free) guess of what this year might be and start there. That’s progress and SO much better than having no budget at all!

(If these profit & loss terms like revenue and net income are a bit confusing, click here to read my deep dive on understanding your practice P&L.)

And if you're new to private practice (and don’t have a P&L from last year to guide you), click here to get my Private Practice 101 toolkit, which includes some simple worksheets to help you think through and build your budget for your first year in business.

2. Your practice budget is a foundational element of your personal financial plan.

When your personal financial life depends on your earnings from private practice, there really can be no personal financial planning without a budget for your practice. We need to have an idea – even if it’s a very rough guess – of what your income will be for the year. This guess of your earnings combined with an understanding of what your personal financial needs are (e.g. a personal budget) dictates the most impactful financial plan strategies for you to prioritize.

Knowing how much to save, pick the right retirement plan, determining what type of investments are best suited for you, determining what insurance policies are best – all of these personal financial planning techniques depend on what your earnings picture looks like. That’s why I begin every financial planning engagement by helping clients define their practice earnings (and tax burden) for the next year.

Simply stated, no amount of personal financial planning will suffice if your practice doesn’t have a solid financial foundation. And a budget is how we ensure your practice has that solid foundation.

3. A “bottom-up” model can be a great complement to your simple budget, but often it isn’t necessary.

When it comes to preparing an estimate of your practice’s future earnings, there are two different approaches you can employ: top-down and bottom-up.

Neither approach is fundamentally better or worse. Rather they approach the same challenge from two different perspectives. And when attempting to predict an unknowable future, multiple perspectives can be helpful.

Top-down budgeting is the simple means of budgeting. It’s the method we discussed in the first tip above. This is almost always the right way to begin. I call this top-down because you look at things from a very high level, and then predict some of the details (found “down” the P&L statement) based on your birds-eye view.

The bottom-up method of budgeting takes the opposite approach. It starts in the nitty gritty details and then builds “up” the P&L from estimates of all those details. In this approach, you’d use estimates of the number of employees you have, their expected case loads over time and their compensation amounts. You’d look at the specific expenses you’d incur and estimate what level each of those expenses would be at in the future. You’d add up all these different estimates across the course of the year and create your budgeted P&L from those.

While bottom-up budgeting certainly has its place (primarily when you’re new to private practice or considering an expansion into group practice), it often isn’t necessary. The benefits of bottom-up budget often are not worth the effort. It can be a nice complement, but you don’t typically HAVE to do this style of budgeting.

I’d also caution that this detailed, bottoms-up budgeting often yields inaccurate and overly optimistic forecasts. We humans have a tendency to be a bit overconfident when building detailed budgets. So if you create your budget this way, I’d double check the profit margins you predict with your own recent financial results – or even industry standard margins (which you can find in the book Profit First for Therapists).

4. Budgeting helps you prepare for the unexpected, make the most of your savings and be prepared for taxes.

More than anything, a budget forces you to sit down and have a good think about what the full year is likely to look like in your practice. That will help you think through how much revenue is likely to come in over the course of the year, allowing you to periodically check in and see if you’re on the right trajectory.

You’ll also have thought through the different categories of expenses you’re likely to incur. That knowledge will allow you to better set aside funds for those expenses. It might also help convince you of the need to build up some emergency funds in your business – in case one day you’re suddenly unable to collect money for your services (looking at you, Change Healthcare).

When you have an idea of how much profit your practice will provide you, it also gives you a clearer picture of how much money you have to save. This allows you to lay the foundation for building the practice of consistently setting aside money for your future self. That might be through a retirement plan, but even setting aside money in a bank account is an amazing start. You can always decide to invest that money or contribute to a retirement plan down the road.

Last but certainly not least, having a budget will enable you to paint a clearer picture of what your total tax liability will be for the year. With a clear idea of your tax burden, you can consistently set aside the appropriate amount for your quarterly tax payments. And you can be panic-free next April when your tax return is due!

5. Update your budget a few times over the course of the year.

Because it’s just a guess, we know the budget isn’t going to be an exact forecast of the future, and that’s ok. It’s just a general guide, it’s going to be “wrong.”

That said, it usually makes sense to compare your actual financial results to your budget to see if you’re on or off track. There’s no shame in being off-track, it just means your best guess – your budget – needs to be adjusted a bit. Better to know now what’s happening than get caught unaware toward the end of the year!

I generally find checking in on your budget after the close of each quarter is a good practice. You can then extrapolate the year-to-date results to get a full-year estimate:

• Multiply Q1 results by 4 to get a full-year estimate.
• Multiple the total of Q1 & Q2 results by 2 to get a full-year estimate.
• Divide the total of Q1, Q2 & Q3 results by 0.75 to get a full-year estimate.

You can then compare the full-year estimate to your beginning budget, and decide what’s the best guess for the full-year based on what trends you’re noticing.

While that simple extrapolation method I outlined above isn’t perfect, I’ve found it’s often a pretty darn good guess at how the whole year will shake out.

That's a Wrap 🎬

That's it for this today's post. If I haven’t explained anything clearly, give me a shout!

I hope you found this useful! I really believe the practice of budgeting for your practice will help you feel in control of your finances and improve your financial results over time! Remember it’s often most difficult to get started, and gets easier as you learn. And also don’t forget to focus on progress rather than perfection!

If this all feels a bit much, give me a shout. I work one-on-one with therapists from all over the country and help them address issues just like these. Learn more about how I work on my services page.

Disclaimer

Turning Point is a registered investment advisor in the state of California. Please visit turningpointhq.com for important information and additional disclosures. This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes financial, legal or tax advice; a recommendation for purchase or sale of any security; or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Read the full Disclaimer here.