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Issue #52 - 8.19.08
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You Choose The Practice
When lecturing to young dentists and dental students about practice valuations, I always give them a test to see if they understand the points I raise about the factors affecting practice values. For those of you who have been reading my articles on Practice Valuation, here is an opportunity to see if you would make the right choice on purchasing a hypothetical practice. For comparison’s sake, we have two practices with identical physical characteristics, in the same town and with identical revenue! But that’s where the similarities end. Here are the basic statistics on the two practices.
| A Tale of Two Practices | ||
|---|---|---|
| Practice A | Practice B | |
| Revenue | $725,000 | $725,000 |
| # Active Patients | 2,000 | 1,400 |
| # New Pts./mo | 20 | 10 |
| Overhead | 55% | 63% |
| Net Profit | 45% | 37% |
| Practice Value | $478,500 | $427,740 |
| Your Choice | ??? | ??? |
Although revenue is identical, Practice A has 600 more patients than Practice B. New patient flow is greater by ten patients per month in Practice A. Practice Overhead is higher in Practice B at 63% vs. Practice A at 55% (thus, a lower profit margin in Practice B). Practice A is valued at $478,500 and Practice B is valued at $427,750. Stop here and make a choice! Which practice would you purchase?
I hope that you selected Practice A. Even though the practice’s value is approximately $50,000 higher, you’d be getting more for the additional cost. Here’s why:
- Number of Active Patients. Practice A has substantially more active patients and consequently a greater potential for more dentistry in those records. The size of the active patient base is a key determinant in affecting a practice’s value. So, Practice A gets high marks for a larger patient base.
- Patient Retention. With 600 more patients, there are more opportunities to reactivate patients. Since practice revenues are identical, it’s highly probable that there is significant potential to increase recare revenue in Practice A as well as the amount of incomplete treatment that may await a Purchaser in those additional records. So that’s another plus in the value for Practice A.
- New Patient Flow. It is obvious that a practice that is generating twenty new patients per month shows more promise than a practice generating ten new patients. Therefore, the value should be higher.
- Operating Overhead. National statistics show that a general practice’s overhead averages between 63% and 65%. Practice A is well below those national averages and that is a real plus for its value.
- Net Profit. Since Practice A has a 45% profit margin versus 37% profit margin for Practice B, there is a significant differential in cash flow. To further underscore this point, look at the Net Income differential over a twenty-year projection.
| 20 Year Projection | ||
|---|---|---|
| Practice A | Practice B | |
| Annual Net Income | $326,250 | $268,250 |
| Total Net Income | $6,525 | $5,365 |
If we take Practice A’s Net Profit over a twenty-year timeframe, without accounting for any increase, this practice would generate almost $1,200,000 more over twenty years than would Practice B. More important, Practice A, as we discussed, has significantly greater potential for growth with twenty new patients per month plus a larger patient base by 600. So by applying effective reactivation strategies and effective retention management, there exists the potential for an even greater differential than what we’ve stated above. In the end, you may pay more for Practice A, but the differential is well worth it.
If you were to take out a ten-year loan, Practice A’s monthly payments would be $5,572 versus Practice B’s at $4,901, as seen in this example:
| Debt Service Comparison | ||
|---|---|---|
| Term - 10 Years Rate - 7.2% |
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| Practice A | Practice B | |
| Monthly Payment | $5,572 | $4,980 |
| Annual Payments | $66,860 | $59,770 |
| Total Payments | $688,600 | $597,700 |
This is a difference of about $600 per month. Total principal and interest payments for purchasing Practice A would cost you about $71,000 more than Practice B. This is a small price to pay to gain a minimum of an additional $1,000,000 in earnings over your career.
At the end of the day, what matters most in making a purchase decision is the income stream that you are purchasing. In this example, Practice A is the clear winner!
Dr. Thomas L. Snyder is Managing Partner of The Snyder Group, LLC, a nationwide practice transition and financial management consulting firm. With more than 75 years of experience in the field, The Snyder Group can provide you a full range of services relating to practice transition matters and retirement planning. They can be reached directly at 1.800.988.5674.
If you would like additional help, email Dr. Snyder at drsnyder@thedentistsnetwork.net.
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