- When Profit isn't Profit: How to boost your practice valuation by understanding add-backs
So, you’ve decided to sell your practice and after years of blood, sweat and tears, doing whatever’s necessary to build it into the success it has become, you want to make sure you get top dollar for it.
One of the primary indicators of the price that a buyer will be willing to pay is profit, and yet often when a buyer looks at the tax return for a business that is for sale, the profit looks underwhelming. What many naïve buyers don’t appreciate, is that the profit in a tax return can be (and often is) understated, as it will usually include many legitimate expenses that will either:
- be personal in nature and go away once the company is in the hands of the new owner, or
- are “one-off expenses” and won’t be incurred again.
To get the best possible result when your practice is assessed for sale, the business owner, their accountant and/or their broker needs to locate these expenses and add them back to the bottom line, in order to show a buyer the business’s true profit position.
Owner’s Personal Expense Add-backs
These add-backs include any expense relating to the owner that the business wouldn’t pay if the owner were an employee. Examples of these personal expenses that are sometimes mixed in with practice expenses include:
1. Owner’s CPD (including travel, accommodation and meals associated).
2. Owner’s AHPRA, ADA Subscriptions/licenses/memberships (as these are usually paid by dentists individually, rather than by the practice).
3. Owner’s professional indemnity insurance (as these are usually paid by dentists individually, rather than by the practice).
4. Owner’s insurances (TPD, life, income protection, etc., are add-backs. Building and business insurances are not).
5. Family members (spouses and kids) who might be overstated in the wages and super
6. Non-business-related travel and motor vehicle expenses.
7. Non-business-related accounting (for the vendor’s personal or other business interests) that may be mixed in with the business’s accounting bills.
8. Owner’s personal telephone, mobile and internet that might be mixed in with the business’s telephone and internet.
Non-recurring expense add-backs
Any one-off improvements to the practice that may appear in the P&L and won’t be added back in the future, so as to show a buyer a “truer” profit position. Examples of expenses that fall into this category include:
1.Signage, branding or website upgrades
2. Equipment and fit-out depreciation
3. Finance interest, lease and loan repayments (as these will not continue post sale)
4. One-off repairs
5. Legal bills
6. Severance payments (redundancy or paying out leave entitlements)
7. Short-term overstaffing. This sometimes occurs in anticipation of a staff member leaving or going on maternity leave, or while a staff member is on long service leave
Other common profit adjustments
There are 2 other common and significant adjustments that should be assessed in dentist’s financials when profit is calculated. These are:
1. Owner dentist’s clinical salary/commission
The market rate compensation for a dentist working in a dental practice is usually a commission of 35-40% x (the receipts for their clinical work less the lab fee associated with that work).
However, the owner of a business can choose to pay themselves whatever they want. Often, for simplicity’s sake, a dentist owner of a dental practice will decide to take a nominal salary and profits, instead of calculating a market commission for themselves.
As a result, when calculating the profit of a practice run by an owner operator dentist, the vendor’s compensation needs to be adjusted to reflect the “market rate compensation” that a non-owner dentist would receive for that clinical work.
2. Rent (if the property is owned by the vendor)
Sometimes, the owner of the practice is also the owner of the premises.
Often, when this occurs, the owner can under or overpay rent to themselves if they wish.
To calculate the true profit position, we need to adjust the rent to the market rate that would be charged if the landlord and tenant were unrelated and arm’s length.
Even with a list of add-back categories, a business owner may find it difficult to locate them. Personal and non-recurring expenses are usually mixed in with the other expenses and need to be found, isolated and quantified (for example, the owner’s personal mobile phone bill is sometimes mixed in with the business’s phone expenses). However, spending the time to understand expense add-backs is time well spent, as it can make a massive difference to the price that is achievable for your practice upon sale. This article should give you a guide on where to start your search for these expenses, but it is recommended that you go through it in detail with a specialist dental accountant or broker.
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