When a potential buyer considers a specific dental practice, the buyer wants to know what his / her annual income potential might be, if the buyer reproduces the seller’s level of production and collection.
YOUR TAX RETURNS ARE NOT ENOUGH
Most sellers realize that they will need to give potential buyers copies of at least 3 years of their practices’ tax returns. However, tax returns only show buyers the sellers’ taxable income. They do not show buyers what their income potential might be after the sale. Buyers may have some expenses that the sellers didn’t have. Buyers may not have some of the expenses that sellers show on their tax returns. Some of the buyers’ expenses may be more or less than those incurred by sellers.
CASHFLOW ANALYSIS & ADJUSTMENT REPORT
A “Cashflow Analysis & Adjustment” report should be prepared and made available for your potential buyers. Its purpose is to give potential buyers insights into what their incomes might be, if they buy your practice. Buyers are not likely to want to buy a practice until they first understand the income potential that the practice might provide for them. The problem is, many potential buyers cannot determine their income potentials by only reviewing sellers’ tax returns.
There are several important things to consider when preparing the report.
Format. A good format for the report, that is easily understood by most buyers, is shown in this sample.
There are several important things to consider when preparing the report.
Format. A good format for the report, that is easily understood by most buyers, is shown in this sample.
The “Actual” column would show the collections, expenses, and taxable income as they appear on your practice’s tax return. The “Adjustment” column would show the adjustment being made. The “Adjusted” column shows the adjusted collections, expenses, and pre-tax cashflow income potential. The report as shown would be followed by notes that explain the reason for each adjustment. The notes would correspond with the red numbers in the far-right column in the above sample.
Who Should Prepare The Report? If you error in preparing the report, you might inadvertently show greater income potential than that which actually exists for buyers. That could expose you to potential legal claims following your sale. For that reason, your report should be prepared by either a highly experienced dental practice broker or your CPA. If your CPA prepares the report, he / she will need to consult with you before preparing the report, to get your insights into some of your expenses.
Adjusting Expenses. Your broker or CPA should guide you in terms of which expenses to adjust, why to adjust them, and how much to adjust them. Each expense line item should be evaluated to determine if the expense will be different for your practice buyer.
Amounts of expenses that provide a benefit for you should be adjusted out of the expenses’ total, because they are really an elective use of profit, by you, to provide a benefit for yourself. This might apply to amounts for health insurance premiums that specifically pay for your health insurance, or to amounts of your practice’s retirement plan contributions that are specifically for you. Notice in the sample above that expenses related to providing an automobile for the practice owner are adjusted out. If you have expenses for elective items or services, that are not in any way necessary for operation of your practice at its current level of production, they should be adjusted to $0.00.
EBITDA. The adjusted expenses column should end up being in EBITDA format, which means Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA format might also be called Pre-Tax Cashflow income. In this format, non-cash expenses such as depreciation are eliminated from consideration. Your CPA or an experienced practice broker will be able to handle this conversion for you. Converting from taxable income format to EBITDA format results in a cashflow estimate that only includes expenses that the buyer will actually have to pay.
Factor In The Buyer’s Purchase Loan Payments. Your buyer will have purchase loan payments. Using your asking price and current interest rates, calculate the total annual purchase loan payments (both principal and interest) for repayment of the loan over 10-years. Add a line on the report so that the buyer’s annual purchase loan payments are factored into the adjusted expenses. This lets the buyer see what the pre-tax cashflow income potential is after paying both the practice’s operating expenses and the practice purchase loan payments.
Use Disclaimers. This is a legal issue. There is a reason that so many documents and contracts include “the fine print”. In the case of practice sales, the goal is to reduce the risk of legal claims against sellers if buyers do not achieve financial results equal to or more favorable than those shown in the adjusted cashflow reports. In our brokerage work we have disclaimer language that we use when we prepare these reports for our selling clients. However, our company is not a law firm. Therefore, if you are preparing this type of report yourself, or having your CPA prepare it, we do not and cannot offer legal advice as to what should be in your disclaimers. Consult your attorney about this issue. Follow your attorney’s advice. That said, subject to your attorney’s confirmation, correction, and additions, among some the things that might be addressed in disclaimer language are the following:
Who Should Prepare The Report? If you error in preparing the report, you might inadvertently show greater income potential than that which actually exists for buyers. That could expose you to potential legal claims following your sale. For that reason, your report should be prepared by either a highly experienced dental practice broker or your CPA. If your CPA prepares the report, he / she will need to consult with you before preparing the report, to get your insights into some of your expenses.
Adjusting Expenses. Your broker or CPA should guide you in terms of which expenses to adjust, why to adjust them, and how much to adjust them. Each expense line item should be evaluated to determine if the expense will be different for your practice buyer.
Amounts of expenses that provide a benefit for you should be adjusted out of the expenses’ total, because they are really an elective use of profit, by you, to provide a benefit for yourself. This might apply to amounts for health insurance premiums that specifically pay for your health insurance, or to amounts of your practice’s retirement plan contributions that are specifically for you. Notice in the sample above that expenses related to providing an automobile for the practice owner are adjusted out. If you have expenses for elective items or services, that are not in any way necessary for operation of your practice at its current level of production, they should be adjusted to $0.00.
EBITDA. The adjusted expenses column should end up being in EBITDA format, which means Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA format might also be called Pre-Tax Cashflow income. In this format, non-cash expenses such as depreciation are eliminated from consideration. Your CPA or an experienced practice broker will be able to handle this conversion for you. Converting from taxable income format to EBITDA format results in a cashflow estimate that only includes expenses that the buyer will actually have to pay.
Factor In The Buyer’s Purchase Loan Payments. Your buyer will have purchase loan payments. Using your asking price and current interest rates, calculate the total annual purchase loan payments (both principal and interest) for repayment of the loan over 10-years. Add a line on the report so that the buyer’s annual purchase loan payments are factored into the adjusted expenses. This lets the buyer see what the pre-tax cashflow income potential is after paying both the practice’s operating expenses and the practice purchase loan payments.
Use Disclaimers. This is a legal issue. There is a reason that so many documents and contracts include “the fine print”. In the case of practice sales, the goal is to reduce the risk of legal claims against sellers if buyers do not achieve financial results equal to or more favorable than those shown in the adjusted cashflow reports. In our brokerage work we have disclaimer language that we use when we prepare these reports for our selling clients. However, our company is not a law firm. Therefore, if you are preparing this type of report yourself, or having your CPA prepare it, we do not and cannot offer legal advice as to what should be in your disclaimers. Consult your attorney about this issue. Follow your attorney’s advice. That said, subject to your attorney’s confirmation, correction, and additions, among some the things that might be addressed in disclaimer language are the following:
- Language that clearly states that the report is not a projection of or promise of the future income potential of the buyer.
- Language that states that the report is provided only to help potential buyers understand the practice’s current expenses.
- Language that states that the results for a buyer will vary from both the practice’s current results and the adjusted cashflow presented in the report.
- Language that states that the buyer, in consultation with his / her accountant, should produce their own collections, expenses, and income projections, based on how the buyer intends to operate the practice.
- Language that states that future financial results obtained by a buyer will depend on, among other factors, the buyer’s clinical skills, production capabilities, management ability, patient retention, and methods of operating the practice.
- Language that states that the estimated purchase loan payments are based on interest rates and repayment terms anticipated to be available at the time of preparation of the report, but the buyer’s actual loan payments will depend on the interest rate and repayment term that the buyer is able to obtain at the time of the sale.
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