Our thoughts . . . 09-09-07

“NORMALIZATION” OF A P & L

One of the steps we at EMA take in preparing to list a practice for sale is an analysis of the federal tax returns in order to determine the true cash flow and profitability. While doctors and their tax preparers may have taken great pains to find as many legitimate deductions from gross income as possible, our job is to separate necessary operating costs from the “perks” of business ownership. In addition, certain non-cash and expenses that will disappear at closing must be filtered out.

Let’s divide these expenses subject to normalization into three categories: Doctor’s personal expenses, judgment calls and disappearing items.

Doctor’s Personal Expenses: 1. Auto expense – Seller can legitimately write off the new SUV but it is not part of running a dental practice.  2. Continuing Education – Seller may go to Maui every year but Buyer can work CE inserts in Dental Economics.  We adjust to 0.5% of gross or less. 3. Contributions – Purely personal, we adjust to zero. 4. Insurance – Buyer will generally not agree to continue paying health, life and disability for the seller and his family. 5. Retirement Contribution – Buyer will only make one contribution for Seller and that is at closing.  New contributions for the Buyer are discretionary. 6. Travel & Entertainment – This is purely personal and discretionary.

Judgment Calls: In our last column we discussed industry standards for certain overhead categories.  If the practice varies too far from these guidelines, we investigate and adjust accordingly.  Be advised that the adjustments can be both up and down. 1. Supplies – You can buy every new gadget and material you want, but 6% of gross is the standard.  We look at the office model and procedures performed and adjust accordingly. 2. Telephone – Are cell phones and yellow page contracts included?  Adjust and/or re-allocate. 3. Payroll – This is a tricky one that demands careful review.  Are all staff members necessary and productive?  Can the Buyer afford to keep them after the closing?  Are family members included and if so, are they productive and will they need to be replaced? 4. Lab – We sometimes have to adjust this number up as we expect the Buyer to do more lab-dependent procedures.

Disappearing Items: 1. Depreciation – A legitimate non-cash deduction of the return, but not part of the Buyer’s projected expenses. 2. Interest – All items will be delivered free and clear at closing so that Buyer’s only interest expense will be for the general mortgage. 3. Amortization – A cousin of depreciation sometimes broken out to reflect the ongoing goodwill write off the Seller may have as a result of a previous practice merger or acquisition. All of the disappearing items are adjusted to zero.

There are probably as many variations in tax returns as there are accountants preparing them.  Careful analysis is necessary therefore in order to give a potential Buyer an accurate picture of the funds available to pay overhead, taxes, living expenses and debt service.

Steve Wolff, DDS
UMKC Class of 1977