The Basic Principles of Finance
All businesses, however large or small, require finance and as long as the business continues to trade this will always be the case. It is important to understand that all privately owned dental practices are businesses and, therefore, require to be financed. If the practice is the body, then finance is the blood supply and a healthy practice requires a healthy and balanced blood supply. Dental practices are financed from two sources: owners’ capital combined with an external source.
The owners of all dental practices finance the business, either in whole or in part. If there is no external borrowing, then that particular practice will be fully funded by its owners. The owners’ capital is normally a combination of monies originally put in to start or take over the individual practice, together with retained earnings (profits generated year on year but not drawn from the business). A well-run practice should show an increased retained capital investment from its owners.
One important aspect that is often overlooked is that the retained capital within the business should earn a better rate of return from the profits of the practice than would be obtained by placing those monies on deposit or in to an alternative investment elsewhere. This nature of return is known as the Internal Rate of Return (IRoR) and it is an important financial ratio. If the owner can achieve 5% on monies invested externally, then the IRoR should be in excess of this figure.
There are numerous ways in which a practice owner can finance the purchase or development of the individual practice, utilising outside money. In the vast majority of cases, practices are financed to some extent by external borrowing. If your borrowing is appropriately structured and for a specific purchase, it means that you are able to develop your individual business much faster than would be the case relying on your own finance resources. It is very important to bear in mind that all debt has ultimately to be repaid, together with the relevant interest, which is the reward to the external lender.
There are some golden rules when it comes to borrowing money for your practice.
Minimise non tax-deductible borrowing
In the vast majority of cases, domestic mortgage borrowing does not enjoy any tax relief whatsoever, since the demise of MIRAS. It is therefore essential to review all domestic mortgage loans on a regular basis: lump sum or enhanced monthly payments can make a dramatic difference to the term of the mortgage.
Ensure that the term of the finance arrangement is shorter than the life of the asset
As an example, it is self-defeating to finance computers or similar investment over periods of more than three years, as the depreciation rates of such equipment are extraordinarily high.
Do not be afraid to structure certain borrowings on a secured basis, if it provides a substantially better interest rate
It is understandable for an individual to be reticent to offer a Charge on their domestic or other property in favour of the lender. However, it should be understood that if money is borrowed lenders will always seek full repayment at the appropriate time – whether the loan is secured or not.
Take professional advice when signing any new agreement
Comparing APRs can often be very difficult and the devil can be in the detail. Ensure that you fully understand the commitment that you are entering into, particularly if there are any secondary periods or balloon rentals involved (a balloon rental is a deferred payment at the end of a finance lease, lease purchase, contract purchase or personal contract purchase).
Regularly review all finance arrangements
This is more essential now than ever before as the market becomes increasingly competitive. There is no law against talking with your lenders from time to time to ensure that you are still enjoying the most competitive products.
Repay all debt as soon as possible
Even if a loan is tax deductible, that does not mean it should not be repaid if surplus funds are available. If you enjoy tax relief at 40% this means that the remaining 60% of the interest charge is still financed by you and the cash flow burden of the loan repayments remains. It is therefore essential that all long-term loan commitments allow for early repayment of part or the entire loan without penalty.
Having established the rules, let us consider the different types of financing that are appropriate to modern dental practice.
In general terms, freehold property assets have an extremely long life and therefore can be financed over a long period of time – typically 20–25 years. The financing of such assets through individual pension arrangements has become increasingly popular over the last few years and can have significant tax benefits. However, personal circumstances will often dictate as to the best structure for such borrowings.
Fixed rates of interest on loans to buy property can be extremely advantageous and are normally arranged on a five- or ten-year basis by most of the main clearing banks. The right answer, of course, requires a very clear crystal ball, but fixing rates when the base rate is low can often be seen to be very sensible and years later, when rates have moved up again, you will have the satisfaction of still paying at the lower fixed rate. Such arrangements also have the benefit of allowing for accurate budgeting of your financial overheads over a reasonable period of time.
In certain circumstances it is quite acceptable to secure the lending required for the practice property – and indeed other assets, if appropriate – on the proprietors’ domestic residences if this provides a lower rate of interest, but once again professional advice is essential.
Good-quality equipment if well maintained should last at least ten years. Statistics indicate that on average dental surgeries in the UK are refurbished every fourteen years; many, of course, stay as they are for much longer. Practitioners do not appear to appreciate the benefits of regular re-equipping (a seven-year cycle would not be unreasonable) in terms of operating efficiency and modern presentation to your patient base. It is understood that new surgery investment (of the right quality) is not cheap, but there should be no difficulty in amortising the costs over a seven-year period. In fact, the vast majority of individual surgery investments are financed over a five-year term, either on a bank loan, lease purchase or finance lease arrangement.
The tax treatment of the finance lease is very different from that of the loan or lease purchase arrangement, in that the equipment is rented for a primary period and the rentals are charged against the trading income of the practice each year. If the lease is therefore for a primary period of five years, tax relief is given equally over this initial period. At the end of this primary term there is normally a peppercorn secondary rental paid to the finance house and the equipment is not normally ever owned by the practice (although you have the full benefit of the equipment financed in this way).
The bank loan or lease purchase agreement provides for an initial allowance of 40% of the cost (under current />