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Understanding The Numbers: Performing Financial Due Diligence
So you’ve found your dream practice. Great location, perfectly designed treatment rooms, top of the line equipment. The selling dentist and you have the same patient care philosophy. It doesn’t get any better than this.
But to ensure you’ve made the right decision, it’s critical to perform a financial due diligence before you sign on the dotted line. Your CPA is generally the ideal person to perform this procedure. For the best possible outcome, use a CPA who specializes in working with dentists and who has reviewed many practices.
There are two major procedures your CPA will perform -- a bank deposit analysis and a net cash flow analysis.
Bank Deposit Analysis: The largest asset you are purchasing when you acquire a dental practice is the practice goodwill – the sum of all the intangible attributes of the practice such as environment, philosophy and patient treatment. Nevertheless, if the practice grosses $600,000 per year, you want to see receipts of $600,000 going into the bank.
Review the receipts for at least the last two years from several perspectives. First, obtain copies of the seller’s production and collection reports by month. Independently compare the collections with the amounts shown on the seller’s accounting records (usually the general ledger prepared by the seller’s CPA or the seller-prepared records, typically maintained on QuickBooks). Next, total the bank deposits made to the seller’s bank account and compare all of the numbers to the seller’s tax returns. If there are major discrepancies between any of these sources, it’s wise to investigate.
Cash Flow Analysis: It is critical to determine how much net income you can expect after paying the loan payment to the bank or lending institution. Your CPA will start with the net income from either the profit and loss statement or tax return, and then add back the owner’s salary and fringe benefits such as automobile and pension, as well as depreciation and interest expense. This will determine the practice’s true net profit. The monthly loan payment will be subtracted from that number to determine the net income you can expect.
Important Points: Always review the payroll reports for the practice for the last two years. Ask if the seller’s spouse is working in the practice. CPA’s often tell their professional dental clients not to pay a salary to their spouse so they can avoid unnecessary payroll taxes. But remember, if you buy the practice you will have to replace the non-paid spouse with a paid employee.
Also, if the office property is owned by the seller, you’ll need to adjust the net profit by the expected change in rent when you buy the practice. The seller’s rent expense is often set to maximize tax benefits.
In reviewing cash flow, look for high expenditures in office materials, repairs and maintenance, meals and entertainment, etc. This may signal that the seller is running expenses of a more personal nature through the practice.
In conclusion, make sure your CPA does a thorough review of the numbers before you buy to ensure that you understand the financial impact of the purchase. It is relatively easy to complete a practice purchase transaction, but much more difficult to get out of a practice that doesn’t “pencil out” after the fact.
Statements of opinion not necessarily endorsed by ADA Member Advantage, ADA Business Enterprises, Inc., or the American Dental Association, or any of its subsidiaries, counsels, commissions, or agencies.
|Arthur S. Wiederman, CPA, CFP, is President of Wiederman & Associates in Tustin, California, a CPA firm dealing exclusively with dentists. A graduate of California State University, Long Beach, Art specializes in tax and financial planning, helping doctors meet their business and personal financial goals. He has led courses on Dental Practice Financial Management at professional organizations and colleges throughout the country. Mr. Wiederman can be reached at email@example.com or 714-259-0505.|
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