The number everyone in the practice quotes is 42 percent. The year-end report says 61 percent. Nobody has stolen anything, no expense has been misposted, and both figures were computed correctly. They are answers to different questions, and no one in the room knows which question was asked. That is how overhead disputes start—not with fraud, but with two partners using the same word to mean two different computations, and each of them budgeting a career around it.
So begin where the arguments begin: overhead is not a self-defining term, and three computations are in circulation. The first divides all expenses by all revenue. It is the general-business convention and what most accountants produce unprompted, and it is close to useless in a physician practice, because provider compensation—the largest item on the expense side—is not a cost of production at all. It is the residual that production exists to generate. Under this method a practice that pays its owners well scores worse than an identical practice that underpays them, which is a measurement system rewarding the wrong behavior.
The second computation removes provider compensation and asks the better question: what does it cost to run the practice before the clinicians are paid? It fails on a distortion specific to pediatrics. Vaccine products can represent 15 to 25 percent of a pediatric practice’s total expenses. A practice with a large private vaccine program carries enormous vaccine expense and enormous vaccine revenue; a heavily Vaccines for Children practice carries neither. The second method makes the first practice look expensive and the second look lean when their actual cost of operating may be identical.
The third removes the distortion on both sides of the fraction—provider compensation and vaccine drug expense out of the numerator, vaccine drug revenue out of the denominator—leaving the controllable cost of caring for a child expressed against the revenue that care generates. It is the method PMI uses, and it produces a number a practice can compare against something: roughly 60 percent, with 58 to 65 percent the typical pediatric band. Name the method in the agreement, and the 42-versus-61 conversation cannot happen again.
The definitions inside the method matter as much as the method. Non-provider clinical staff stay in the overhead figure, because nurses and medical assistants are the cost of providing care, which is exactly what the rate exists to measure. Vaccine-adjacent supplies stay in, because syringes are not serum. Vaccine administration revenue stays in, because administration is a service the practice’s staff performs. One-time extraordinary items—a records-system conversion, a legal settlement, a retention bonus round—get flagged and excluded with a note, because a ratio that governs hiring and compensation cannot be held hostage by a single unusual quarter. And owner distributions and income taxes are never operating expenses.
Now the allocation, which is a separate decision from the computation and the one that moves individual partners’ money. Four methods are in general use, and each of them is defensible in the right circumstances. Direct assignment charges a cost to the partner who incurred it—her dues, her continuing education, her individually elected insurance. Equal split charges every partner the same dollars. Pro rata to revenue or collections charges each partner in proportion to what she produced. Hybrid allocation routes each category by what actually drives the cost: fixed capacity costs split evenly or by scheduled sessions, variable costs by volume, individual costs directly.
The reason the choice generates so much heat is that each method quietly picks a winner, and neither of the simple methods is neutral. Equal split fits costs driven by capacity—the room, the assigned medical assistant, the slot on the schedule—which each partner occupies whether or not she fills it. Applied to costs that plainly track volume, such as supplies, billing fees, and clearinghouse charges, it asks the higher producer to carry a colleague’s consumption. Pro rata to revenue reverses the injury: it charges the busiest partner twice the rent for the same room. The honest resolution is not to pick a side but to allocate each category by its own cost driver and to write down which category goes which way.
One worked audit shows what the choice is worth in dollars. An advanced practice provider at Acme Pediatrics appeared, on the practice’s own reports, to be losing money—and the report was arithmetically correct. Her contract’s per-capita clause charged her one full head of her site’s fixed expenses, a fifth of everything at a five-clinician office, in a year when she was 0.8 of an FTE and generated 14 percent of that office’s visits. The equally shared pool included the site’s entire vaccine purchase line, roughly $266,000, of which perhaps $31,000 traced to her panel. Recomputed under the practice’s own published rules—revenue at actual attribution including the incident-to work billed under supervising physicians, overhead at the practice rate applied against her revenue, vaccine held in its own lane, and supervision priced explicitly at $9,600 for the year—her true margin was positive $38,700. Two allocation methods, one clinician, opposite conclusions about whether the role should exist.
The same practice learned the transparency lesson the other way around. A physician’s productivity bonus computed to $1,364 on $462,000 of collections, because $455,180 of allocated expenses had consumed the rest. The allocation was legal and arithmetically correct. It was also indefensible in a conference room, because it had been set “in the employer’s discretion” by an administrator no longer employed there, using a percentage nobody could reconstruct. Any allocation that cannot be rebuilt from the practice’s published overhead rate and applied identically to every clinician will eventually fail that test.
Which makes the governance provisions short and non-negotiable. Define the overhead components in the agreement. Name the computation method and the allocation method for each category. Require any change in methodology to be approved by vote, on notice, with the effect on each partner modeled before the vote rather than discovered after it. Disclose the allocation annually with a worked example attached, so a partner can trace one dollar from the income statement to her own statement. And give every partner a standing right to audit the allocation, at practice expense where the examination finds a material error. Article 10 covers the reporting rights those provisions sit inside.
Red flags. An overhead methodology nobody can name, decided annually by whoever prepares the reports. Personal expenses buried in the shared pool. No audit right. A methodology changed without a vote, or changed by degrees without a notice. And equal-split allocation applied to costs that plainly track volume, so a high producer carries a colleague’s supplies and billing fees without ever being told that is the arrangement.
Overhead disputes almost never start as theft. They start as an assumption two partners each made privately, in different directions, about a number nobody ever wrote down.
Three computations circulate. Dividing all expenses by all revenue treats provider compensation as a cost of production, which it is not. Removing provider compensation asks a better question but distorts pediatrics, where vaccine products can be 15 to 25 percent of total expenses. The third method removes provider compensation and vaccine drug expense and revenue from both sides of the fraction.
Computed on the third method—provider compensation and vaccine drug expense out of the numerator, vaccine drug revenue out of the denominator—the rate runs roughly 60 percent, with 58 to 65 percent the typical pediatric band. Naming the method in the agreement is what makes the figure comparable and prevents partners from quoting two correct but incompatible numbers.
Neither simple method is neutral. Equal split fits capacity-driven costs, such as the room and the assigned medical assistant, but applied to supplies, billing fees, and clearinghouse charges it asks the higher producer to carry a colleague’s consumption. Pro rata to revenue reverses the injury by charging the busiest partner twice the rent for the same room. Hybrid allocation routes each category by its own cost driver.
The Partnership Agreement Analyzer scores an existing agreement against the framework this series is built on — or schedule a discovery call to work through it with PMI. The full framework, with the arithmetic, lives in the textbook Pediatric Practice Management: The Fundamentals.