In one of our recent posts, I talked about how finding the perfect dental practice is nearly impossible. It’s more important to look for practices with good numbers and even better potential. The problem is finding those practices and sorting out the “good” numbers from the not so good, and assessing the potential future performance of the practice with another dentist at the helm. Buying a practice can be scary and stressful because there are so many unknowns, even with the risk the vast majority of dental practices are solid investments.
A recent question by a potential buyer made this scenario quite real. What happened was this dentist was looking at a practice with average collections of around $800,000 for the previous three years. The dentists’ income was around $200,000, therefore, overhead appeared to be 75% with labor around 40%, both quite high which would chase away many potential buyers. The seller also worked about 25 hours each week. The practice had two hygienists, and between them had a seven-day hygiene schedule. Four operatories, good to great location near a major intersection, and one other dentist located up the street. The asking price for this practice was around $600,000, including accounts receivable. Something doesn’t seem right … right?
Not necessarily. I counseled the buying dentist not to run away just yet, because this could be one of those gold mines we hear about but don’t often see. My thinking was that the dentistry side could be under-producing. This has the effect of making overhead and labor look higher than it really is. Let me explain a little further.
With seven days of hygiene production, I would expect hygiene production to be at least $300,000-$350,000, meaning dentistry would need to produce at least $900,000 PLUS for a total production of over $1.2 million. Yet, the revenue was much less, at around $800,000. Sometimes, high overhead may simply be an indication of low revenue and easily resolved with appropriate production and collection levels. A practice with high overhead, like the one in this example, usually has a lower asking price because profits are lower, and hence, the value is lower for the buyer.
In my experience, these are some primary reasons why overhead in a dental practice can appear high when it actually isn’t. They are:
- Lower than normal doctor production comparted to hygiene production
- Excessive labor costs due to a generous seller paying for hours not worked, giving annual raises to long-term employees pricing them well above market or carrying an extra body because its easier than letting someone go
- Poor collection policies and/or little controls overspending
It could be that overhead seems high because the provider cut back to three or four days a week (like we have here), but fixed expenses like utilities, rent, and insurances won’t go down. Sometimes, an issue with high overhead is that the dentist doesn’t have proper controls in place and the staff members spend what every they deem appropriate without seller oversight.
High labor costs can come in the form of staff getting paid for more hours than they actually work, but more commonly I see the outgoing owner being very generous and paying above market rate. Another potential cause is the outgoing owner has been paying 100 percent of health insurance premiums for staff, plus some retirement contributions. All these things, while nice to offer, add up and they eat into the practice’s profits.
I also advised the dentist above to request copies of all W-2s for each year, then to break them down by department. For example, hygiene and assistant wages may be perfectly fine and the burden falls on the front desk/admin departments. The bottom line is to look at other statistics and numbers to find out why a practice has high overhead. Then, determine if it’s fixable. It usually is with the right guidance.
None of these things will be apparent without a deep dive into the financials and a better understanding of overall practice performance. For help sorting out the good practice acquisitions from the bad, contact the Dental CPAs team or me, at firstname.lastname@example.org.
ABOUT TIM LOTT
Tim provides consulting services to dental professionals and practices. He provides expertise in start-ups, mergers, transitions, tax and retirement planning, financing assistance and budgeting. Some of the specific areas of consulting are associate, partner, and shareholder arrangements; practice management, practice purchase, sales, buy-ins, and buy-outs and related tax issues.