Before you buy a dental practice, you should carefully review the business’s financial records to assess its current financial health, potential for growth, and suitability as an investment. Let’s explore the ins and outs of how to analyze a dental practice’s financials, and why you should consider getting help from an experienced dental practice attorney.
Start with the Right Financial Documents
First, you should know which financial documents to review during due diligence in a dental practice acquisition. The most important documents to request in due diligence include:
- Profit and loss statements for the last three to five years
- Current balance sheets
- Tax returns for the last three to five years
- Production and collection reports
Do not rely on a seller’s offer to provide a summary statement of their financials, but instead request copies of the same documents that the practice uses to monitor its financials and file tax returns. You should also watch out for common red flags that suggest the information you’ve been given is inaccurate or insufficient, such as a lack of reliable financial records, the seller’s delay in producing records, or inconsistencies between documents.
Look at Revenue Production vs. Collection
For businesses like dental practices, there is a critical distinction between gross production and net collection. Gross production refers to the total value of services rendered to patients when billed at full fee. Net collection refers to the amount of revenue actually collected from patients and insurance after adjustments, discounts, and write-offs. Although a high gross production may look impressive on paper, it is the net collection that represents the actual cash coming into the business. A large disparity between gross production and net collections may indicate issues with the practice’s ability to collect invoices, such as problems with insurance companies or a patient base that cannot afford services.
Analyze Expenses and Overhead
A review of a dental practice’s financials should also involve analyzing the business’s expenses and overhead. The primary expense categories for dental practices include:
- Property lease or mortgage payments
- Utilities
- Equipment lease payments
- Monthly service subscription fees (e.g., practice management, billing, or patient records software)
- Staff wages and benefits
- Supply costs (e.g., treatment materials, disposable treatment equipment, PPE)
- Lab fees
- Equipment maintenance costs
- Facility upkeep expenses
Unusually low expenses in the form of below-market labor costs, maintenance bills, or rent may indicate hidden costs or other issues that will require capital investment, such as high staff turnover or deferred maintenance.
Assess Cash Flow and Profitability
Relatedly, you should consider the overall profitability of the practice, including factors such as:
- The stability and predictability of revenue – does the practice have steady cash flow throughout the year, does the cash flow go through cyclical ups-and-downs, or does the business have irregular cash flow?
- The growth of the patient base – does the practice have a steady patient base, or has it continued to attract new patients, and has it experienced consistent growth?
- The ability of the cash flow to support expenses – does the practice require infusions of capital or operational loans?
Once you’ve answered these questions, you can determine whether the practice’s cash flow will consistently support loan payments, what recurring expenses you should prepare for, if you can meet your desired profit margin, and whether you will have revenue to fund future growth.
Reviewing Balance Sheets and Uncovering Hidden Liabilities
By reviewing a dental practice’s financials, you can also identify potential issues with the business, including:
- Outstanding accounts receivable and the likelihood of collecting those accounts (depending on account age)
- Valuation of equipment and other depreciating assets, and those assets’ remaining useful life (which may indicate a need for immediate capital investment)
- Outstanding leases, loans, and other long-term obligations
- Unpaid taxes or contingent liabilities
Contact Our California Dental Law Firm Today
Before you buy a dental practice, be sure you know how to analyze its financial records so you can assess the business’s financial health. Polished Legal can help you make the right decision for your financial future. Contact us today for an initial consultation with an experienced dental attorney in California to learn more about the best practices involved in dental practice valuations.
