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Professional News Articles : : BUY/SELL by Peter Ackerman, CPA : Rule of thumb valuation, what’s it worth?

Rule of thumb valuation, what’s it worth?

January 6, 2010

As an astute practitioner, you want to always keep a close watch on your practice’s financial picture. Part of that process demands that you be able to reasonably estimate the “fair market value” of your practice at all times. Financial consultants generally agree that for a dental practice, a formal valuation should be completed every five to seven years. 

Fair Market Value is defined as “the price, in cash or equivalent, that a buyer could reasonably be expected to pay, and a seller could reasonably be expected to accept, for the assets of a practice, if the practice were exposed for sale on the open market for a reasonable period of time, buyer and seller each being in possession of the pertinent facts and neither being under compulsion to act.”

Various methods of appraisal have been used over the years. Some of these methods have fallen out of favor and more sophisticated appraisals have evolved. To establish the most accurate value possible, a combination of valuation methods is recommended. 

The Rule of Thumb valuation method tends to be a favorite method among dentists. When asking the questions “What percentage of gross is my practice worth?” or “If a practice is netting $185,000, what is it going for these days?” a practitioner is really asking for a Rule of Thumb valuation. Many practitioners and their advisors are using these methods to value what is often one of their single largest investment assets with no rationale for the ratio picked and often a misapplication of the numbers utilized in the formula.

What is gross in a price to gross ratio, the practice’s collections, production or adjusted production? What is the definition of net income in the price to net ratio, taxable income, adjusted income, or free cash flow? What do you do if these ratios produce wildly different values as so often is the case? How does managed care affect these ratios? What about equipment and technology? Wouldn’t a low overhead office have a higher price to gross value than a high overhead office? Wouldn’t the percentage of hygiene revenues impact practice values?

A study of more than 1,500 dental practice transactions throughout the United States concluded one statistical standard deviation (two-thirds of the 1,500 plus practice sales) had a price to gross revenues figure in the range of 42 percent to 79 percent. This tells us that the mean or average price/gross ratio is a more interesting than meaningful number, since the standard deviation value is so high. The facts indicate the need for a custom evaluation to determine where along the scale of price any particular practice should be valued. 

Substantially more information is necessary than just the determination of gross revenues or an often inaccurate net income figure in order to obtain a reasonable value. Imagine a new patient calling your office in pain requesting a diagnosis over the phone --  no X-rays, no chart, no exam. Utilizing a Rule of Thumb to value a practice is doing the practitioner the same disservice as having your receptionist treatment planning that patient over the phone.

Peter J. Ackerman, CPA, is a certified public accountant, licensed real estate and business broker and national speaker on business issues affecting dentists. He may be reached at peter@adsmidwest.com or www.adsmidwest.com.

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