Best Practices

Making Sense of Overhead Allocations

By Richard C. Koval, MPA, CMPE

Although much of the attention given income allocation formulas typically focuses on compensation, each option also comes with certain implications regarding the distribution of overhead to each owner. Understand-ing this aspect is critical to ensuring a fair and equitable approach to compensation shares. A distribution formula most often incorporates one of the following approaches.

Allocations of Net Income

This approach is based on practice revenue minus expenses. The resultant net income/profits are allocated to the owners. The three different types are:

► Pure Productivity. Also known as “eat what you kill,” this approach allocates net income based on each individual’s percentage of combined productivity. Accordingly, a 25% producer would take 25% of the practice’s total net income. Overhead is allocated by the same percentage as net income.

► Productivity/Equal. Hybrid structures typically use productivity as the main criterion for distribution with a lesser part of the net income pool distributed equally. Any equal allocation of net income serves to decrease the overhead percentage of a lower producer relative to the overhead percentage of a higher producer.

► Equal. A fully equal allocation means each individual receives the same compensation regardless of productivity. This method obviously works best where individual productivity is similar within the group. Again, to the extent any equal allocation of net income is used, the overhead percentage of a lower producer will be less than that of a higher producer.

Allocations of Expense

This approach uses individual revenue as a basis and assigns expense share with the resultant difference constituting the net income share.

► Individual Revenue/Expenses by Productivity. Each individual retains his or her own collections while overhead is allocated by each individual’s percentage of productivity. Overhead allocations are identical to the pure productivity net income allocation.

► Individual Revenue/Expenses by Use. This approach maintains individual collections while seeking to allocate expenses by each individual’s use of resources. Some expenses may be assigned directly (such as staff) while others may be designed by percentage or approximation (such as utilities). Overhead allocations can differ depending on the variables, but most of these formulas will decrease overhead percentages for higher producers and increase overhead percentages for lower producers.

► Individual Revenue/Expenses Equally. Again, each individual maintains his or her personal collections, but expenses are shared evenly. This approach is most viable where individual variations in expenses are minimal. Any equal allocation of expenses serves to increase the overhead percentage of a lower producer relative to a higher producer.

Revenue and Expense Allocation

Assigned shares of revenue and expense constitute the basis for this approach. The resultant difference constitutes the share of net income.

► Allocated Revenue and Expenses. This approach allocates both revenue and expenses based on a combination of equal and individual totals. In many cases, the outcomes are similar to those under allocations of net income, just computed differently. Due to the potential variability of the factors used in such formulas, overhead allocations also will vary and cannot be generalized.

In most instances, decisions about income allocation formulas will be based on a number of different factors with the resultant compensation being most prominent. However, if the group seeks to address more philosophical issues pertaining to the manner that overhead is shared, different formulas can address those concerns.

As with many issues within a group practice, the best answer will be a product of good faith negotiation among the owners. Group members also should not view the formula as etched in stone, because most practices will need to revise their allocation structures to some extent every few years as circumstances and objectives change. OM

Richard C. Koval, MPA, CMPE is a principal and senior consultant with BSM Consulting, in Incline Village, Nev., and Scottsdale, Ariz. More resources are available at www.BSMCafe.com.