When Profit isn’t Profit: How to boost your practice valuation by understanding addbacks

20 Apr 2021 - Simon Palmer - Vet Practice Sales Vet Practice Valuations

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 or valuer 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 personal non-clinical CPD (including travel, accommodation and meals associated).

2.      Owner’s insurances (TPD, life, income protection, etc., are addbacks. Building and business insurances are not).

3.      Family members (spouses and kids) who might be overstated in the wages and super

4.      Non-business-related travel and motor vehicle expenses.

5.      Non-business-related accounting (for the vendor’s personal or other business interests) that may be mixed in with the business’s accounting bills.

6.      Owner’s personal telephone, mobile and internet that might be mixed in with the business’s telephone and internet.

Non-recurring expense addbacks

Any one-off improvements to the practice that may appear in the P&L and won’t in the future be added back, so as to show a buyer a “truer” profit position. Examples of expenses that fall into this category include:

1.      Equipment purchases

2.      Finance interest, lease and loan repayments (as these will not continue post sale)

3.      One-off repairs

4.      Legal bills

Other common profit adjustments

There are 2 other common and significant adjustments that should be assessed in a Vet’s financials when profit is calculated. These are:

1.      Owner vet’s salary and super.

The owner of a business can choose to pay themselves whatever they want. Often, for simplicity’s sake, a vet owner of a veterinary practice will decide to take a nominal salary and profits, instead of calculating a market salary and super for themselves.

As a result, when calculating the profit of a practice run by an owner operator vet, the vendor’s compensation needs to be adjusted to reflect the “market rate compensation” that a non-owner vet would receive for that clinical and managerial 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 at arm’s length.

 

Conclusion

Even with a list of addback 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 expenses are sometimes mixed in with the business phone expenses). However, spending the time to understand expense addbacks 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 check with a specialist Vet accountant or Valuer.