Question:
Is there any merit to performing a cash flow analysis to help determine the value of a dental practice?
WILLIAM L. OWENS, MBA
The short answer is "yes." Doing a cash flow analysis must be part of the valuation process. It helps to flush out issues and gives the prospective buyer and lender some reasonable projections of income.
The value of a dental practice starts with revenue collected. Gross production less adjustments should match collections, which should match bank deposits. Once revenue has been confirmed and compared, then the valuation switches to tier two: equipment (new or old), location (good or not so good), goodwill (solid or still growing), and cash flow (or overhead).
For the single location and single dentist owner, cash is king. Understanding cash flow starts with overhead costs. Overhead can be grouped this way: the people (variable), the space (fixed), the supplies and lab (variable), the support (mostly fixed), and doctor-related items (variable and fixed, depending on the doctor).
Three of these can affect value:
1. People-This is part of the goodwill asset. It is difficult to turn over an entire team upon purchase. Are they paid too much? Many retiring doctors have overpaid team members on staff.
2. Space-What kind of lease are you walking into? What part of town are you moving to? What kind of space are you taking on?
3. Supplies and lab-These are the biggest expenses for a practice behind people costs, yet they can be the most easily changed over a short period of time.
Keep in mind that not every practice has an associate, a loan payment, a doctor's spouse and/or children on the payroll, a group health insurance plan, or a retirement plan. All of these cash outlays have different tax implications, but that is a different topic.
Tom Snyder, DMD, MBA
Performing a cash flow analysis is a very critical component in the purchase of any dental practice. Although a cash flow analysis per se is not a proper valuation method, it can help determine if the purchase price that you are considering for a practice is worth the investment that you'll be making. Many practice brokers will provide a purchaser with a cash flow analysis to help support the practice value they prepared.
A properly designed cash flow analysis takes into account any "add backs" to net profit, as well as adjustments to various practice operating expenses that may appear to be overstated or understated. Thus, you can get an accurate forecast of the available funds needed to pay practice operating expenses and service your debt, as well as provide you with a reasonable income to meet your financial needs.
In fact, all lenders prepare an internal cash flow analysis as part of their underwriting process to assist them in determining whether the stated sale price is one that the bank can support. If you are purchasing a practice where additional equipment or technology must be immediately purchased, the cash flow analysis can assist in ascertaining if these additional assets can be financed at the outset.
When reviewing any cash flow analysis, you must be wary of the assumptions that are being made. For example, if the cash flow is prepared to illustrate a three- to five-year period, what are the projected rates of growth of collections for each partner? Is the inflation rate being applied to future operating expenses realistic? Since most cash flow analyses are a projection of future performance, these assumptions become important, so make sure they are realistic. Most CPAs who advise dentists on practice acquisitions will provide a well-designed cash flow analysis as part of their service.
William L. Owens, MBA, cofounded Owens & Bondell PLLC, which has been helping dentists for almost 40 years. For the past 16 years they have been a contributing member of the Academy of Dental CPAs, the premier group of dental specific-CPAs across the county. Learn more at obcpas.com.
Tom Snyder, DMD, MBA, is the director of transition services for Henry Schein Professional Practice Transitions. He can be reached at (800) 988-5674 or [email protected].
