3 Things to Fund Before You Take a Distribution

"How much can I take out of the practice?" It is the question every owner eventually asks, and the honest answer is that it is not a single number. It depends entirely on what the practice needs to keep in reserve before you touch anything.

Your bank balance is not your profit

Most owners answer the question by looking at the operating account. That balance is a snapshot of one moment, not a measure of how the business did, and it is holding a lot of money that already belongs to somebody else. The tax on this year's profit. Friday's payroll. The lab bill and the supply order that have not cleared. An insurance overpayment a carrier will claw back next quarter. None of that has left the account yet, so all of it still shows in the balance.

This is the same reason a bank balance is a poor stand-in for real books. It tells you what cleared, not what you earned or what you owe. Take distributions off that number and the pattern is predictable: money goes back into the practice a few weeks later, or a personal card covers a practice cost, or the quarterly estimate arrives and nothing is set aside for it.

Fund three reserves, in this order

The alternative is a waterfall. Three reserves get funded in sequence, and only what sits above all three is available to you. Operating reserve first, because a practice that cannot absorb a bad month makes bad decisions under pressure. Tax reserve second, because that money is not yours in any scenario. Capital reserve third, because the equipment you have already decided to buy is coming whether or not you funded it.

They also behave differently, which is worth knowing before you start. The operating reserve gets built to a target and then left alone. The tax reserve is funded continuously, every month, forever. The capital reserve rises and falls with your actual plans and drops toward zero when nothing is on the horizon. Work down the three, and what remains is a distribution you can take without wondering whether you just created a problem for March.

1. Operating reserve: three months of fixed overhead

This is the practice's runway. If collections dip, an associate leaves, or you are out for two weeks, this reserve covers the non-negotiable bills: rent, staff payroll, insurance premiums, and loan payments. Those hit whether patients show up or not.

Start by sizing it against fixed overhead. Leave your own pay out of the calculation, since in a real crunch the owner's check is the first one that pauses. Here is what that looks like for a practice running $1 million a year in net production, or roughly $83,000 a month:

Team payroll is the line that drives the answer, and healthy dental practices generally run it at 25% to 30% of net production, per Academy of Dental CPAs benchmarking. The rest of these figures are illustrative, so build the list off your own trailing twelve month P&L rather than borrowing mine. If you want a quick read on whether your own percentages are in range, our free Dental Practice Benchmark Scorecard checks them against healthy dental ranges in about two minutes.

Three months is the recommendation. Not one, and not "whatever feels comfortable." One month covers a bad stretch. Three months covers a bad stretch that arrives at the same time as something else, which is how these things actually happen. It is the difference between negotiating with a lender because you want to and negotiating because you have to.

Should supplies and lab be in there too?

The standard answer is no. Supplies and lab are variable costs, so when production falls they fall with it, and reserving for them ties up cash that could be working.

That answer assumes production stops. Real downturns are partial. If production drops by 40%, you still have 60% of it running, which means 60% of your supply and lab cost is still arriving, while every dollar of fixed overhead shows up untouched. There is also a tail. The crowns already at the lab get invoiced whether or not those patients come back, and the supply order you placed three weeks ago still clears. So there is a real gap the fixed-only number does not cover, and it is not imaginary money.

Covering it is simple, because supply cost tends to run 5% to 7% of net production and lab cost runs in the same band, which means they are roughly the same size. Take three months of whichever one you know off the top of your head:

Three months of one is the same as covering half of both, which is a reasonable read on a partial slowdown. That is the whole calculation.

Whether you need it depends on your case mix more than your temperament. A crown-and-bridge, implant, or ortho-heavy practice carries real money in cases already at the lab, and should add the buffer. A hygiene-heavy practice has very little in flight and can comfortably stay at the fixed-only number.

Three rules that make the reserve work

Keep it in a separate savings account linked to your operating account, so it is reachable the same day but not sitting in the balance you glance at every morning.

Build it to the target on a schedule, then stop. This one has two phases and they are different jobs. While you are building, it is a fixed monthly transfer like any other obligation. Once it is full, it is not a recurring cost at all, and the money that was funding it becomes distributable. After that you only top it back up if you tap it for a genuine emergency, and a slow month you saw coming is not one.

And do not count this cash when you calculate what is available to distribute. You own it, but like any other kind of insurance, its best use is peace of mind and a better night's sleep.

If your practice is new or newly acquired

Three months is the target for an established practice, and a practice in its first couple of years cannot conjure that out of nothing. So the target does not move. The timeline does.

Start with a floor: one month of fixed overhead before you take a single distribution. Below that line the practice cannot absorb a surprise, and taking money out is just borrowing from a problem you have not met yet. Reach one month first, then fund the remaining two on a schedule.

How fast depends on how you got here. A startup practice is ramping production from zero while carrying full overhead, so give yourself about 24 months from the day you opened. If you bought an operating practice, you inherited its production on day one, and 12 to 18 months is usually realistic. Divide the target by the months you are giving yourself and automate the transfer. For the practice above, $111,000 over 24 months is about $4,600 a month, or about $6,200 a month on an 18 month schedule.

Two traps catch new owners here. Working capital built into your practice loan is not a reserve. It is borrowed money with a payment attached, and drawing it down is not the same as funding anything. And the target moves as you grow. Add a chair, a hygienist, or an associate, and fixed overhead climbs, which means three months of it climbs too. Recalculate once a year so the reserve does not quietly fall behind the practice it is supposed to protect.

2. Tax reserve: fund the current quarter, continuously

Nearly every dental practice is an S-corp, and for an S-corp owner the pass-through income tax is the single largest cash obligation that has nothing to do with running the practice. Your W-2 withholding covers part of it. The K-1 income usually creates a gap on top of that, and the quarterly 1040-ES payments are what close it.

Here is how that gap actually shows up, and it is not at year end. It is a quarterly surprise from your accountant. An email arrives with a number and a due date, usually a week or two before the money has to be gone, and you go find it. Four times a year. The number is rarely wrong. It is just never expected, and that is the part you can fix.

Step one: call your accountant

This is a fifteen minute conversation and it is the highest-leverage part of the whole exercise, because your preparer already has the numbers that drive it. Ask three things:

• What was my effective tax rate on last year's return? Not my bracket, my effective rate.
• Do you expect this year to look materially different, and why?
• Based on where my profit is running, what should I be setting aside every month?

Most preparers will answer all three in one call, and that single conversation is what converts a quarterly scramble into a monthly transfer you never think about.

Step two: hold the money between the calls

Now you run it yourself. Take the effective rate from last year's completed return and apply it to year-to-date profit from the P&L to get your projected liability. Subtract the federal withholding already showing on your most recent paystub. What is left is the real gap the quarterly estimates have to cover, and that is the number that moves into a separate account each month.

Refresh the projection at least quarterly, and reset the rate each year once the prior return is finished. Profit moves, and a reserve built on last spring's numbers will be wrong by fall.

Then physically move the cash. A dedicated savings or money market account, not a mental note and not a line you promise yourself you will respect. The accrual entry on your books tracks the liability. The bank transfer is what actually enforces it. Those are two different things, and only one of them stops you from spending the money. Out of the operating account, off the first screen you look at, and there is no chance of counting the same dollar twice.

Put it somewhere that earns, since that cash may sit for up to three months before a payment is due. A high-yield business savings or money market account is the right home. The only constraint is that you can withdraw it on the due date without a penalty, which rules out anything with a term running past the deadline.

This is not tax advice, and your preparer sets your actual rate and your actual estimates. It is operational advice about where the money lives between the day you earn it and the day it is due, so the bill is never a surprise and never gets funded out of your personal savings. The IRS explains the mechanics and the due dates for estimated taxes.

One thing that sits outside the waterfall

If your practice is taxed as an S-corp, the IRS expects you to pay yourself a reasonable salary through payroll before you take distributions. Distributions are not a route around payroll taxes, and treating them that way is one of the more expensive mistakes an owner can make. Run the salary, let it clear payroll, and treat distributions as what comes after. Your preparer sets the split, and how owner pay differs from associate pay on the P&L is worth understanding before that conversation.

3. Capital reserve: what you are buying in the next 6 to 12 months

The third reserve is the one most owners skip, and it is the question a CFO asks before signing off on any distribution: what capital needs are coming in the next six to twelve months?

Dental capital is not small. A CBCT scanner runs $30,000 to $50,000. An operatory buildout can reach $75,000 to $150,000. A practice management conversion carries a deposit and a productivity dip on either side of it. These are knowable months ahead, which is exactly what makes them fundable.

This is not a vague rainy-day fund. It is tied to a specific, time-bound capital plan, and that distinction keeps the reserve honest in both directions. If you have a scanner slated for next spring, the reserve is real and it has a monthly number attached. If nothing is on the horizon, this bucket shrinks toward zero and that cash becomes distributable. Review it quarterly, alongside the tax projection, and adjust as plans firm up or fall off.

Planning to finance it does not exempt you. Most lenders expect a down payment, and the practice needs cash flow margin during the ramp-up period while the new equipment is still learning to pay for itself. The note then becomes a fixed cost, which quietly raises the operating reserve you calculated in step one.

Fund it the same way as the tax reserve: a scheduled monthly transfer, not an intention. Skipping it does not make the equipment cheaper. It only decides how you will pay for it, and it decides badly, usually by financing something you could have bought outright, draining the operating reserve, or postponing a purchase the practice actually needed.

Everything above the waterline is yours

Now the math is short, and it is short because the work happened upstream. Start with the operating account balance. If you swept the tax money out when the books closed, you do not subtract it again here, because it already left. That is the entire payoff of physically moving it: the balance in front of you is honest, and every dollar in it has already cleared the tax question. Same for the operating reserve and the capital reserve, if you are holding them in their own accounts.

Subtract anything genuinely committed that has not yet cleared, a vendor deposit or an outstanding lab and supply bill, and what remains is your distribution. No guilt and no guesswork.

It is usually a less dramatic number than the balance you started with, and that is the correct outcome. Taking that amount is repeatable month after month. Taking the whole balance is how owners end up funding their own practice with personal money in the spring.

How to make this a five minute routine

None of this works if you do not know your real profit, and you cannot read profit off a bank balance. You read it off closed books: revenue recognized in the right month, expenses matched to it, the tax liability visible, everything reconciled. Once the books close on a fixed schedule, the whole waterfall becomes a short monthly pass. Confirm the operating reserve is intact, move the tax reserve, move the capital reserve, take the rest. Then once a quarter, refresh the tax projection and revisit the capital plan.

That is what timely monthly financials are actually for. They turn "how much can I take?" into a repeatable, numbers-driven answer that adjusts on its own as the underlying numbers change.

P.S. Reciprocity Accounting closes your books by the 10th, so every month you know exactly where your waterlines sit and what is above them. See how we can help your practice.

Frequently Asked Questions

Should my operating reserve include supplies and lab?

It can, and for some practices it should. The standard calculation uses fixed overhead only, on the logic that supplies and lab fall along with production. That holds if production stops, but real slowdowns are partial, and lab work already in progress gets invoiced regardless. Since supplies and lab each run about 5% to 7% of net production, adding three months of either one covers roughly half of both, which is a sensible buffer. Lab-heavy practices should add it. Hygiene-heavy practices generally do not need to.

If I already moved the tax money to a separate account, do I subtract it again before taking a distribution?

No. That is the whole reason to move it. The tax comes out once, when you sweep it after the monthly close. After that, the balance in your operating account is already net of tax, and subtracting it a second time would understate what you can take. One of the quiet benefits of physically moving the money is that the balance stops lying to you.

How much cash should a dental practice keep in the bank?

Three months of fixed overhead for the operating reserve, plus whatever the tax reserve and the capital plan require. Fixed overhead means rent, payroll, insurance, and loan payments. For a practice running $1 million a year in net production, that often lands near $37,000 a month, which puts the operating reserve at about $111,000, or about $126,000 if you add the supply and lab buffer.

My practice is new. What if I cannot fund three months yet?

The target stays at three months. The timeline flexes. Reach one month of fixed overhead before you take any distribution at all, then fund the remaining two on a schedule: roughly 24 months for a startup practice, or 12 to 18 months if you bought a practice that already had production. Set the monthly transfer and treat it like a loan payment. Working capital inside your practice loan does not count toward the reserve, because it is borrowed money with a payment attached.

How do I calculate my tax reserve?

Start with a call to your accountant and ask for your effective tax rate from last year's return, whether this year looks different, and what you should be setting aside monthly. Then apply that rate to your year-to-date profit, subtract the federal withholding showing on your most recent paystub, and move the difference into a separate account. Refresh quarterly and reset the rate each year when the new return is finished.

What if I have no equipment purchases planned?

Then the capital reserve shrinks toward zero and that cash is distributable. This reserve is tied to a specific, time-bound plan, not a general feeling that something might come up. That is what the operating reserve is for. Revisit the capital plan quarterly, because it changes.

What is the difference between owner pay and a distribution?

Owner pay is a salary that runs through payroll and carries payroll taxes. A distribution is a transfer of profit that does not. If your practice is an S-corp, the tax code expects a reasonable salary before distributions. If it is a sole proprietorship or a default LLC, your draws are distributions and there is no salary requirement, though you still owe self-employment tax on the profit.