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The Value of a Practice Depends on Its Health
This article by By Terry Flanagan, DC, DABCO, MPH, MBA first appeared in Chiropractic Economics

Moving into or out of a professional practice is likely to be one of the largest and most stressful financial transitions in which you will ever participate. Whether buying or selling a practice, the question “what is it worth?” always has to be considered. With a close look at how the practice operates, you can begin to find the answer to this question.

Think of the practice as a living, breathing entity that has risk factors (the operating structure), has vital signs (the financial ratios) and has wellness factors (the management structure). One way to determine the value of a practice is to approach it in much the same way you would evaluate the clinical status of a patient. To come to a conclusion about the overall health status, you must first evaluate the current condition.

One of the ways to determine the health of the practice is to grade the level of operational risk. Careful and honest consideration of how the practice operates will give an idea of how it functions on a daily basis. The following areas should be evaluated and rated on a high risk to low risk scale:

Referral Sources

Assessing risk factors helps evaluate practice health.
Practice Location

Practice Demographics

Amount of Competition

Income Efficiency

Operating Efficiency

Staff Efficiency

Just as patient’s vital signs give clues to their respiratory, circulatory and cardiac health, a business has vital signs that give clues to its financial health. The financial vital signs are called ratios and give insight into the ability of the business to meets its short-term and long-term financial responsibilities. The ratios will also give an indication when the business is overloaded with debt and is in danger of not being able to survive the future.

Physical vital signs are compared against a health industry “gold standard” (i.e.; blood pressure of 120/80). The financial ratio vital signs are compared to industry benchmarks in order to determine where the practice stands in relation to its peers. The financial statements that are commonly used to develop business ratios are the Balance Sheet and the Income Statement

Balance Sheet and Income Statement financial ratios are determined by dividing specific financial item by another financial item. A short list of common ratios and the industry benchmarks are seen below:

Industry Your Clinic
Current Ratio= Current Assets

Current Liabilities
1.2x
Quick Ratio= Accounts Receivable + Cash

Current Liabilities
1.0x
Receivables Turnover= Net Sales

Average Accts Receivable
15.5x
Coverage Ratio= Net Income (pre-tax) + Interest

Interest
8.0x
Other financial ratios are presented as a percentage of operating income. In this case, the ratios are developed by dividing the category by the total amount of the operating income:
Industry Your Clinic
Cost of Operations/Operating income 10.9%
Advertising/Operating Income 1.4%
Doctor’s Compensation/Operating Income 13.3%
Operating Margin/Operating Income 3.4%
Depreciation/Operating Income 1.3%
Employee Benefits/Operating Income 1.5%
The management structure of a practice is easily compared to the wellness factors a physician would look for when evaluating a patient. Wellness factors are a combination of healthy activities undertaken with a focus on positive short-term and long-term outcomes. Management activities that strengthen the practice structure reduce its risk and act as stabilizers during the up and down fluctuations of the normal business cycle. Management structures that add value and reduce risk are:
Valuation includes numerous tangible and intangible factors. Depth of Management

Financial Management

Financing

Earnings

Asset Utilization

Areas that will make the practice healthier are, coincidently, areas that also make the practice more valuable through increased profitability and ease of management. As you rate the practice’s operational health, consider your answers from a “franchise” type scenario. The value of a franchise is largely based on the strength of their operational system. The operating system continues to work effectively and efficiently, even during personnel changes. A clinic’s operating system is the supporting framework of the business and should also be able to work effectively as a stand alone function. This is especially important during a transition from one physician to another. Poor systems and old technology create a riskier step for a new buyer and will have less value when compared to a progressive, well run clinic. Better systems lower overall risk and improve the health, and therefore the value, of the practice.

Just as a patient’s lifestyle can influence a large amount of control over their health status, the individual physician’s “operational lifestyle” can exert a large amount of control in determining the going concern value of a practice. Creating a practice that has high value takes planning and an understanding of the interrelationship between the various building blocks. A practice with strong operational value drivers will improve the bottom line, will create a more valuable practice to sell and will be a healthier practice to buy. And as you tell your patients, reducing the risk means a better chance of a long and productive life.



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