I Paid Too Much for My Dental Practice

When you finally do graduate and you’re off into the real world of practicing your art, you will probably do a lot of conferring with colleagues who have entered practice ahead of you. You will doubtless hear many opinions on what they did and the outcome of their decisions. You are going to hear a lot of contradictory views in the process. Dentists who started from scratch will tell you it was the best possible move they could have

made, and others will tell you that they wish they had bought a practice instead. Some of your colleagues who bought practices will tell you they got the best deal in the world, while others will tell you they paid too much for their practice.

When dentists buy a practice and things don’t work out financially as they had hoped, many times their first conclusion is that they paid too much. That’s why they didn’t make the income they expected. But in analyzing nearly 1,000 practices over the years, I discovered a few reasons some practices are more profitable than others.

If we are to understand why one practice is more successful than another, cash flow analysis will give us the answer. Cash flow is the measure of financial performance of a practice. This term simply describes all of the financial elements of a venture – the collections, the expenses, the debt service (payments to the bank)

and the net income left over for the owner.

down in the next section, but hang on to the end for some amazing discoveries. You can revisit the numbers later if you wish to prove those astounding conclusions.

At this point, we’re about to enter the world of numbers, but bear with me until the end when we will discover what makes a practice profitable and the part price plays in it. Don’t worry if you get bogged

We will start by examining an actual practice with the following annual statistics:

using the percentage net of gross production is a much more accurate indicator of the efficiency of a practice. My benchmark percentage net of personal production for a buyer’s first year is 30 percent, so at 49 percent net, this practice is far more profitable than the standard practice.

Practice Gross Income...............$628,000 Practice Overhead.................... $332,000 Debt Service............................$ 79,000 Practice Net Income.................. $217,000 Practice Price........................... $399,000

The debt service is for a loan of $429,000 - $399,000 for the practice, plus $30,000 for working capital that the buyer will use to pay expenses until the collections catch up with the production. The terms of the loan are a seven year payback at 7.5 percent interest. The average monthly practice income is $52,000 and the monthly loan payment is $6,600, which is 13 percent of the practice income.

Now let’s compare this practice to another actual practice with the following statistics:

Practice Gross Income..........$657,000 Practice Overhead...............$475,000 Debt Service...................... $ 84,000 Practice Net Income............ $ 98,000 Practice Price......................$415,000

The following major expenses and percentages of revenues for this actual practice are as follows. (The remaining other overhead expenses were less than 1 percent.)

Now let’s look at the effect of price on the cash flow of this practice. If the buyer got a really “good deal” and paid $50,000 less for the practice, the difference in the payment from a full price sale would be only $9,000 per year, or just 1.4 percent of the practice gross income. This small amount cannot financially make or break any practice. The difference in daily production is $3,185 per day versus $3,140, less than one buccal pit restoration per day.

Staff Expense...........................46% Lab.........................................5% Dental Supplies........................5% Office Supplies.........................1% Rent........................................6% Utilities/Phone.........................2% Other......................................2% Advertising..............................1% Bank Charges...........................1% Legal/Accounting......................1% Insurance.................................1%

To discover what actually financially makes or breaks a practice, we need to look past the small difference that price savings can make and find out where the real source of practice financial success lies. The following major expenses and percentages of revenues for an actual practice are as follows: (The remaining other overhead expenses were less than 1 percent.)

Staff Expense.......................22% Lab.....................................7% Dental Supplies....................7% Office Supplies.....................1% Rent....................................5% Utilities/Phone.....................2% Advertising..........................3% Bank Charges.......................2% Other..................................1%

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The major overhead expenses for this actual practice are very low and the purchaser of this practice would earn a 49 percent net of their personal production after all expenses and debt service. Using the percentage of personal production versus

In this second practice, the purchaser nets only 23 percent of their personal production. We can test the theory that the purchaser of this practice paid too much for it, and we’ll see if we can lower the price to a value that will allow the purchaser to earn a successful income from it.

Let’s start by taking one-third off of the price. That should surely provide a much better income – a full 33 percent slash. At the new price of $278,000, the purchaser will now have a net income of $123,000, which is 29 percent of their personal production. This is still not close to the net income of the first practice of $217,000, which is a 47 percent net of their personal production.

Let’s take a full 50 percent off of the price of this second practice and see what happens. Lowering the price to $208,000 will yield a net income of $136,000, which is 32 percent of the purchaser’s personal production. The second practice still does not compare with the first practice’s net income of $217,000 and 47 percent personal net.

Now let’s do the ultimate price reduction – FREE! That’s right, the price is $0! How good can it get! At a price of $0, the second practice will provide a net income of $182,000, which is 43 percent net of the buyer’s personal production,

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still less in dollars and net percent as buying the first practice at its full price.

This vivid, but actual comparison of cash flow in two actual practices drives home the point that practice price is not a prime factor in the success of a practice purchase. Yet practically every buyer concentrates on this relatively minor issue rather than focusing on the primary factor in their financial success, which is the intrinsic practice cash flow.

Notwithstanding, you still do not want to overpay for a practice. But at least we know that there is a better financial outcome even if we overpay for an efficient practice than there would be by getting a “good deal” on an inefficient practice.

Where are the overhead items that can make or break the cash flow of a practice? The main items and an efficient target percentage for them are as follows:

Staff Expense............................28% Lab.........................................10% Dental Supplies.........................7% Office Supplie...........................1% Rent ........................................5% Utilities/Phone .........................2%

Staff expense is one of the easiest items to lose control of. I see practices that give its employees a raise every year, even as the

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practice revenues decrease. Then I see practices that reduce the number of employees only to see their revenues increase. I have spoken to many dentists who admit they are overstaffed, but keep unneeded staff on as a charitable gesture. Sellers are in a better position to overpay staff than a buyer, who has more expenses than most sellers due to debt service for the practice, student loans, a home mortgage, etc.

supplies in that personal items or equipment may be buried in this line item and not be an actual representation of the real expense.

A new owner can adjust the above expenses by controlling the actual expenses they pay and how they approach their accounting methods. But there are other expenses which are very difficult, if not impossible, to control. Rent is such an expense. In practices with high occupancy expense (rent, utilities, telephone), the only way of changing that expense is to move the practice, which is prohibitively expensive considering the cost of leasehold expenses and build outs.

Laboratory expense is an unusual expense – many times the higher the lab percentage, the better the practice, as it is an indicator of the amount of crown and bridge and cosmetics being done. The cost per unit may also drive up this percentage while the practice may not be generating more lab cases. Each dentist needs to assess the balance between the cost and quality requirements that goes into their laboratory expenses.

In examining two actual practices, we have discovered that a practice with efficient cash flow will earn more net income and do it with less effort, even when paying full price, than could be achieved by getting a FREE practice with inefficient cash flow. So when a dentist tells you that they paid too much for their practice, you’ll know that their financial outcome had very little to do with the price they paid, but with the intrinsic cash flow of the practice. Hopefully you will know what to concentrate on in your search for a successful practice. ■

Supplies are another area that can easily get out of balance. Buyer’s must be careful, though, in looking at supply costs on a tax return or Profit and Loss statement, as many times the supply expenses may include equipment purchased and called supplies in order to expense it, rather than depreciate it. Many times items of a personal nature that are not actual practice expenses are deducted in this item.

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