By: Drew Hinrichs, CPA, CEO of Engage Advisors
Buying a practice is one of the most important decisions a dentist will make in their career.
A successful outcome depends on many factors but one of the most essential is correctly assessing the value of the practice you intend to buy. The problem is that figuring out the true value of a practice can be confusing and there isn’t one methodology everyone agrees with. That’s one reason why I recommend working with an experienced dental CPA.
- Establish Your Financial Priorities
While there are qualitative considerations that shouldn’t be overlooked, let’s focus on some of the quantitative factors that go into assessing the value of a practice. But first, you should establish a few quantitative priorities of your own by answering these questions:
- How quickly do you want to pay off your student loans?
- How much do you want to earn?
- At what age do you hope to retire?
Any practice you consider will need to have the collections and profitability to support your goals for debt repayment, retirement savings, and lifestyle. Keep those benchmarks in mind as you begin your search.
- Numbers to Look at When Assessing Practice Value
- Collections is the amount of revenue that comes into the office. It includes all the insurance and patient payments that have been generated by the practice’s production. This number is important because it affects cash flow, profitability, and factors into things like how much overhead you can afford. There also needs to be enough money coming into the practice to justify the responsibilities you’ll be taking on as an owner.
- Profit is the income remaining after all operating and other expenses have been paid. Dental practices in the U.S. have an average profit margin of about 40% so anything below that could be a sign of problems. But profitability can be a difficult number to determine.
- Overhead includes all the expenses related to running the practice. The total amount of overhead should not exceed 60% of collections. Within that number, let’s look at some specific categories.
- Employee Expense Ratio: Employees comprise the largest single practice expense. It includes salary, payroll taxes and employee benefits. A well-run dental practice should maintain employee expenses of about 25-28% of collections.
- Lab Fees & Dental Supplies Ratio: The combined ratio of lab fees and dental supplies should be about 10-14% of collections. This number will vary depending on the type of practice, with orthodontists spending more on supplies and pediatric dentists less on lab fees.
- Rent: This number is highly variable because real estate prices range so widely. What’s important to know is that rent is a fixed cost, so if you start out with high rent, you’ll be stuck with it. It’s very unlikely the cost will come down, so you need to make sure the location is worth it and that it adds value to the practice.
- Cash Flow – You’ll probably need a good dental CPA to do the necessary analysis, but getting this information is worth the effort. If collections, profit margin, and overhead costs all look good, projecting cash flow tells you whether you can make the business work given your personal expenses. Factor in your income, plus other expenses such as your disability, business overhead and life insurance, and account for your savings and debt repayment plans. Then see if the cash flow projections still look good.
- Beware of the Delta Deficit
There are several hidden factors that can undermine the value of a practice. Take for example, the Delta Deficit, named for the lower reimbursements dental providers will receive as Delta Dental phases out its Premier Network and replaces it with Delta PPO, which pays 15-25% less. Delta is forcing practices to make the switch whenever they change or update contracts, which happens when there’s a change in ownership. If you buy a practice where collections are based on Delta Premier, the valuation needs to reflect the lower reimbursement the new owner will receive from Delta PPO.
Working with a dental broker you trust is the surest way to get an accurate dental practice valuation. If you are thinking about buying a practice schedule a call with our team at Engage Advisors. We can help you make a successful transition into ownership.