How to calculate return on investment when buying or leasing equipment

Q: I am in a three-physician family practice, and my partners and I are debating whether to acquire laser equipment to offer certain cosmetic procedures to our patients. How do we calculate the return on our investment for acquiring the equipment? And are we better off purchasing or leasing?

A: The “lease or buy” question is one that medical practices often confront. Unfortunately, it does not have a clear-cut answer. Many banks are offering very low interest rates to physician practices for use in capital purchases, and equipment lease contracts tend to have higher  interest rates and additional fees. Also, most medical equipment purchases can take advantage of accelerated depreciation schedules that offer a tax advantage. A Section 179 expense deduction allows medical practices to deduct up to $500,00 of the purchase price of certain equipment during the tax year in which it was bought and placed in service, rather than depreciating the purchase over an extended period of time.

On the other hand, purchasing equipment requires predicting how long it can be used before it wears out or becomes obsolete. If you are predicting a short lifetime because of technology advances, a lease option may be attractive because they can upgrade or replace the equipment more easily.

What I find is that financially stable practices generally prefer to purchase equipment, and practices that are just getting by prefer to lease. I also find the practices that like the newest and greatest technologies often lease more often than they buy.

Calculating return on investment (ROI) means answering the question, “Am I making a profit on the services being rendered with the new piece of equipment?” Here is the typical ROI formulary:

The ROI Calculation

Gross revenues collected

Less: Financing costs (loan payments)

Less: Direct costs of operating the equipment

Less: Indirect costs of operating the equipment

Equals: Net profit (or loss)

I assume you’ve done your due diligence on potential utilization of this particular capital equipment.  I find that most practices are overly optimistic in their revenue projections,  so I suggest being very cautious in yours. Remember also that arriving at an accurate ROI requires determining the true cost of providing the additional service. This includes direct costs, such as disposables,  maintenance, technical support, rent (if additional space is required to house the equipment, etc.) and the indirect costs of rendering the service (allocated receptionist time, billing staff time, etc.)

In summary, make sure there is a market for whatever piece of equipment you intend to purchase or lease. Will there be sufficient patient volume to justify the acquisition and make a profit? If the answer is yes, prepare a financial proforma to get an idea of profit that can be generated by the new service(s). Due diligence is the difference between a good decision and financial trouble.

The answer to our reader’s question was provided by Reed Tinsley, CPA, an accountant and certified healthcare business consultant based in Houston, Texas. Send your practice management questions to medec@advanstar.com.