Many years ago when I went to Laville High School, my physics teacher, Mr. Butler, incessantly encouraged us to routinely check our work by performing “quick and dirty calculation.” In the quick and dirty calculation, you were to make an educated guess as to the approximate values of all variables (in easy-to-use round numbers) and see if your answer was still valid.
In the prospectus for the purchase of a dental practice, most dental practice brokers “forecast” the free cash flow available for the purchasing doctor. These figures are typically based on the selling doctor’s tax returns and, while there is no intention to mislead, the figures often are misleading. When you understand how to make quick and dirty forecasts, you can avoid the typical $75,000 mistake. This mistake comes about because the figures presented in the prospectus are not a forecast at all, but are usually derived from plugging the proposed debt service into the previous year’s profit and loss. Let’s look at a few areas where I believe you should forecast differently.
Assume we are looking at an average practice with gross collections of $450,000 and a taxable income of $135,000. If the selling doctor deducted $15,000 for depreciation and $15,000 for continuing-education expenses, the broker adds this $30,000 to the net profit and shows a free cash flow of $165,000.
The depreciation should absolutely be added back, but not the full amount of the continuing-education expenses. Clearly, you do not need to take expensive continuing- education vacations. At the same time, you must not allow the broker to forecast nothing for continuing education. State licensure requires you to complete accredited continuing education. If you expect to continue your education, you must forecast an expense. I recommend 50 percent of the selling doctor’s cost or, in this case, $7,500.
One of the most costly mistakes you can make is assuming your employee expenses will be the same as the previous year. Let’s assume the selling doctor gave everyone a raise at the end of the year. If six employees each received a $1 per hour raise, calculated on a 36-hour week, your yearly expense is increased by $11,232. You also will owe another $1,000 in taxes on the increased pay.
If you give these employees another raise after nine months, you increase your expenses by another $3,060. If you project raises, your employee expenses for the first year may be increased by $15,300. This is a very important issue, so be sure you ask when and how raises have been given in the practice.
Next, let’s look at advertising and promotional expenses. First, you know that all envelopes, letterhead, business cards, and brochures will need to be reprinted. Some may need to be redesigned. Secondly, your Yellow Pages ads may be more expensive. Consider running two ads the first year - one under your name and the other under the selling doctor’s name as “former practice of.”
Another consideration is other forms of advertising. The transitioning practice may have been stable for many years. Your added expenses must be covered by practice growth. An extra $10,000 would be a very minimal additional promotional expense for a new doctor.
The really big kahuna in any forecast is the gross production. It is generally very difficult for a purchasing doctor to duplicate the previous year’s results. The new dentist will almost never achieve the same level of treatment plan acceptance as the selling dentist. The selling doctor has years of experience in presenting comprehensive treatment plans and, more importantly, has an established relationship with the patients which translates into a feeling of trust.
Treatment plan acceptance is an ongoing problem, but there is always a loss of production that is simply based on the transition period. The selling doctor is winding things down and the new doctor is winding things up. When you are making a cash-flow projection, run multiple scenarios. It is very common for a transitioning practice to experience a 10 percent gross production decrease. That equates to $45,000 on a $450,000 practice.
Anyone who is good at math knows that we already are over $75,000, and we have only covered a few areas of dental practice. Before you purchase any practice, you should make multiple quick and dirty forecasts of cash flow. Look at the tax return and project future expenses for every area of the practice. In my high school physics class, it was amazing how close the quick and dirty calculations approximated the real answer. When you purchase a practice, work out your own forecast. You will find it will be surprisingly accurate.
Dr. Michael Gradeless, a 1980 graduate of Indiana University, practices preventive dentistry in Indianapolis with an emphasis on cosmetics and implants. He is an adjunct faculty member at Indiana University, where he teaches the Pride Institute university curriculum of dental management. He also is the editor for the Indiana Dental Association. Contact him at (317) 841-3130 or e-mail to [email protected].