Do you know how much your practice is worth?
Low profitability is the reason.
In its Sept. 15 issue, JAVMA published more proof of practice profit decline, showing that our fabled 40 percent net had slipped yet again (2007), down to 25 percent.In many practices, associate compensation as a percentage of personal production is 25 percent. If a solo owner receives that same 25 percent, then he or she is no better off financially for the expense of ownership and the tedium of management than any employed associate.
However, the number of low-value practices is expanding rapidly. Consultants today say these "no-lo practices" (no-value/low-value) are not necessarily small, but are always mismanaged and unable to keep up with client demand for better service, high-level medicine and an attractive facility.
Some practices with low value don't look it. They're modern, beautiful facilities with talented doctors and large support staffs. They provide excellent care with state-of-the-art equipment. They offer better-than-average compensation and benefits and, in the owners' eyes, strong cash flow.
What's wrong? Why aren't these practices selling for more? The short answer: no profit.
Profitability is the key factor when appraising practice value. Whether a hospital is in a state-of-the-art, 10,000-square-foot facility or a decrepit, crumbling pre-Civil War leftover, if it's not profitable it has no value beyond the tangible assets.
Profitability is not easy to determine. Most owners and managers aren't used to figuring profitability and only come face-to-face with the true value of their practices when their appraiser shows them.
Your standard financial or management reports don't show profitability. Neither do your tax return or your profit-and-loss statement. These show cash flow, not profitability.
It doesn't take a rocket scientist to do the math. Profitability is what's left over when you subtract operating expenses from operating revenue.
Many just don't use the right numbers to show true operating revenue and expenses.
Operating revenue and expenses include fees for services and drugs and the cost of medical supplies. These items are listed at fair market value. For ease of comparison with other practices, profitability is stated as a percentage (the profit margin) and is calculated by dividing your operating profits by your gross revenue.
You need to figure out your operating profit, not your taxable income or net income. You need to include any practice owner payments, building and equipment rent — especially if these are owned by the practice owner and then leased back to the practice.
Services provided by family members must have a dollar value to the practice. Depreciation and interest on debt must be included in value after the sale.
Before we go any further, we have to lay to rest the myth that practices are worth a year's gross. This was a decent approximation before many readers were born, but it died somewhere in the 1970s. Let it rest in peace.
Could your practice be worth last year's gross? Possibly, but it's less likely than my running a mile in anything less than an hour. (Unless, of course, a great delicatessen awaited me at the finish line. But, then again, I would be too exhausted to eat.)
A good exercise would be to separate your real estate from your practice in any estimation of value. Real-estate appraisers consider your land and building.
This discussion is strictly about the practice that lives in the real estate. I have been valuing practices for 20 years and have spent a considerable time as an expert witness for those who have overpaid for a practice that could not support the payments or a doctor whose spouse thought that half a year's revenue was what he or she should get in a divorce settlement.
Next month, we'll look at many of the mistakes sellers make when they fix a value in their heads of what their practices will provide for them in retirement.