Posted on Aug 12, 2013
Image Credit: © Dreamstime.com
Posted on Aug 12, 2013
In our last installment, Dental Practice Appraisal: What You Need to Know, Part 1, we took a closer look at the market value method of measuring value in a dental practice. Within that method, we investigated how the average annual revenue of the practice played a key part in determining market value (and greatly informed the list price) of the dental practice.
A complete dental practice appraisal encompasses many factors, and I encourage you to consult with an NAPB dental practice broker when contemplating that step. However, the intention of this article is to illuminate the income-based method and consider how this viewpoint measures value within a dental practice.
As we discussed, dental practice valuations can be somewhat puzzling. In an effort to simplify the process, let’s focus on one component—income—as a means of measuring the dental practice value. The income-based method is popular because it is often the best way to assign an accurate evaluation of the average annual revenue to the practice.
The income method takes into consideration both the history of the financial health of the practice as well as financial projections for the future. The income approach also measures the potential ROI (return on investment) in terms of the buyer’s ability to have a certain level of income and also a sense of possibility that they are taking on when purchasing this particular practice. In other words, ability to generate income is a primary consideration. Is the practice on a course to continue to do well? Or, will it need some serious TLC before it’s operating smoothly again? When focusing on income instead of market value, it is a bit easier to assess how quickly the buyer can pay down their loan when investing into a practice.
At the simplest level, income looks at a practice from the inside out whereas market looks at the practice from the outside in.
Typically, a dental practice is listed for approximately 125% – 175% of its average, adjusted net income. We define adjusted net income as total income after paying all operating expenses. For this calculation, anything paid directly to the current owner (such as pension plans, any salaries, personal taxes, etc.) are not included in the figure. So, if a practice brings in an annual revenue of $750,000 and the adjusted net income is $345,000 ($345,000 x 150%), then the value of the practice is approximately $517,500.
As we discussed with market value, it certainly seems simple enough. And it certainly provides a good starting point. It’s a calculation that allows you to look at a listing price and quickly get a sense of whether the seller is in a reasonable ballpark when selling their dental practice.
However, I recommend taking advantage of a free consultation with a local dental practice broker to gather knowledge about successful dental practice transitions.