Measuring practice value.

In my last column, we discussed the concepts of price and value. We defined price as the consideration (cash, note, barter, etc.) paid to acquire an asset, and value as the benefit (cash flow, enjoyment, etc.) received by the buyer of the asset. The importance of value to the buyer of a dental practice is emphasized, since value is the buyer’s actual takehome income. Our objective now is to learn how to recognize and measure value in practices. To this end, let’s examine two actual practices (see Table 1).

Most buyers would agree that Practice B is more desirable because the price is lower, the net income is higher, the price is a lower percentage of gross, and the percentage net is higher. Before deciding, though, let’s look at these two practices more closely (see Table 2).

We have just introduced an important new statistic — buyer net as a percentage of personal production. This percentage, along with the net income dollar amount, is the most important measure of practice value.

Buyers who overlook this essential statistic likely will prefer Practice B. Buyers examining this statistic likely will prefer Practice A with a 101 percent net as a percentage of personal production, compared to 35 % for Practice B.

Table 1
Practice A Practice B
Gross collections $654,643 $472,803
Practice price $425,000 $289,000
Price as a percentage of gross 65% 61%
Buyer net income after all expenses and debt service $121,910 $129,353
Buyer net as percentage of gross collections 19% 27%
Table 2
Practice A Practice B
Hygiene collections $170,879 $104,017
Seller (as post-sale associate to buyer) produced collections $363,327 $0
Buyer produced collections $120,437 $368,786
Buyer net income after all expenses and debt service $121,910 $129,353
Buyer net as a percentage of personal production 101% 35%

Additionally, Practice A’s first-year, accrued equity of $74,692, plus the buyer’s income of $121,910, yields a total benefit of $196,602 or 163 percent of personal production. Practice B’s comparable first-year equity of $51,105 and buyer’s income of $129,353 yields a total benefit of $180,458, which is 49 percent of personal production. Simply put, Practice B’s buyer will earn only onethird the value (income and equity) for a given amount of production as will Practice A’s buyer.

One reason for these differences is practice-overhead efficiency. Practice A’s three-year average-adjusted overhead expenses are 43 percent of gross, compared to 54 percent for Practice B. Practice A’s 11 percent higher efficiency results in a $72,000 higher net income for its owner, compared to an equal amount of work produced in Practice B.

The most impactful difference, however, is due to surplus earnings from income generated by hygienists and the seller working as a post-sale associate. Practice A’s income from these sources is $534,206. After paying seller and hygienist salaries of $198,116, Practice A has surplus earnings of $336,090, which pays the annual debt service of $116,263 with an additional $219,827 to apply to expenses. Practice B’s hygiene collections of $104,017, less hygiene salaries of $46,140, leave surplus earnings of $57,877, which cover 73 percent of the $79,549 debt service, with nothing left over for overhead.

The dramatic contrast of these actual practice opportunities underscores the importance of understanding and applying the statistic of buyer net as a percentage of personal production to measure practice value — an essential understanding for making well-informed, practice-purchase decisions.

Earl M. Douglas, DDS, MBA, is the founding president of American Dental Sales. He is president of Professional Practice Consultants, Ltd., and personally serves the Southeast and has affiliates nationwide. He can be reached at (770) 664-1982 or write to 11285 Elkins Road, F-4, Roswell, GA 30076. See ADS Classified ads for names and phone numbers of other ADS members.

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