One of the most common questions we get at N/L Transitions is “What is my dental practice worth?” The answer is complicated and depends on so many factors, including many that are out of the dentist’s control. The simplest solution some use is to multiply the dentist’s net income by 1.5 times, or take the average of 70-80 percent of collections. Neither of these approaches accurately reflects dental practice purchase price.
However, there is a way you can determine a good portion of your dental practice’s asking price. Below, we outline the common process we use to evaluate a dental practice’s value.
The first step in analyzing a dental practice’s financial performance is understanding production. This is a good practice to do anyway, whether you’re planning to sell or not. To do this, we recommend doing the following steps:
- Conducting a production by provider spread
- Ensuring all procedures were reported correctly
- Performing a ratio analysis, such as doctor production to hygiene production and hygiene production to hygiene wages
- Separating production by owner and associates – specialists is key
- Looking for year-to-year trends – is hygiene production up, down, or the same?
- Investigating unusual procedures or unusual frequency of procedures
- Assessing the payor mix – for example, verifying FFS/PPO mix claims
Market Value Assessment
An independent valuation is crucial, and the valuation method you choose can have an impact on your asking price. Below we outline three common valuation methods used in dental transitions, plus how to determine furniture and equipment value.
Capitalization of Earnings
Using this method, you would determine practice value by calculating net present value of expected future profits or cash flows. Your dental broker arrives at a capitalized earnings estimate by dividing the practice’s future earnings by the capitalization rate. Capitalization rate is calculated based on the perceived risk of buying your practice. The dental industry capitalization rate is usually 25 to 31 percent.
Capitalization of Excess Earnings
A hybrid approach, this valuation method looks at a dental practice’s asset values and discounts expected cash flows. Practice value is determined using two capitalization rates on tangible assets and goodwill.
Multiple of Owner’s Income
As its name implies, this method ties the practice value to the dentist’s income. The last three years of earnings are used to calculate the practice’s profits, and the average multiple range is 1.0 – 1.75. Profits should be normalized to remove debt, expenses, and the owner’s compensation package.
Furniture and Equipment Value
Consider the age and useful life of the furniture or equipment. Value is assigned based on depreciated book value, replacement value, and economic useful life, which varies for different types of assets.
The calculated price is for tangible and intangible assets only, and the valuation is only part of the asking price. You need to also analyze your practice’s financial performance and calculate net cash flow.
Dental Practice Financial Performance
Next, you’ll want to know how your practice is performing. To figure this out, review the normalized cash flow reports, and calculate averages and percentages. Compare your results with industry benchmarks, and highlight any trends or variances. You’ll also want to consider the fair market value of doctors’ compensation and furniture and equipment (or other capital expenditures over five years).
Finally, use your practice’s cash flow to figure out your asking price.
Net Cash Flow
The last step is evaluating the net cash flow. We believe that profits drive value, not revenue; to find out what the calculated value is based on net cash flow, we generally follow this process.
Using a base number of the seller’s net income-per tax return, you want to add adjustments, like:
- Seller compensation, payroll taxes, retirement plan contributions, and fringe benefits
- Family payroll and taxes
- Depreciation and amortization
- Interest and/or lease expense
Then, we subtract the following adjustments:
- Normalized dentist compensation
- Dentist payroll taxes
- Front desk adjustment
- Fair market space rent
The result is the net cash flow. Multiple the capitalization rate by the net cash flow, and you have the calculated value.
In our next blog post, we’ll explore the other side of the dental transaction: beyond the price. There are several elements other than asking price that can be considered as part of overall practice value. Stay tuned!
In the meantime, if you have questions on a valuation report for your dental practice, contact Ellen today.