Are you considering buying a practice and afraid you may be paying too much? Are you confused by the maze of formulas or methods for valuing a business? When it comes to buying a practice or any business we always suggest that you follow the cash. Cashflow is really the lifeblood of any business. Most practices are “owner-operator” businesses meaning that the owner’s discretionary earnings represent the profit of the business. This is true for most small businesses with revenues under $1 million per year. In other words these practices do not offer enough free cash flow as an absentee owner to pay a salary for a doctor and a manager. (Businesses with little or no profits would be valued differently)

Calculating Price

CashFlow is King (or Queen)

What does cashflow have to do with the selling price? Using a reverse engineering method the available cashflow is separated into two categories; salary and debt service. The cash remaining after subtracting a reasonable amount for your salary provides the maximum cash available to service the debt. Most banks will allow a sufficient cushion when providing a loan so as not to over extend the buyer.

The Opportunity Cost of Money

Imagine we are locked in negotiations with a seller over a $30,000 gap. The seller has already reduced his price and will not drop any further. As the buyer we must decide whether to walk away or compromise. Emotionally we may believe the price is too high. However, the consequences of not purchasing the practice include loss of equity (employees do not build equity in a business) or a possible loss of higher income. The real question is whether I can afford an extra $350 per month in loan payments and will the existing cashflow of the business support the increased payment? More importantly, how easily can I increase the monthly revenue by at least $350? Can you think of five ways to increase revenue by $350 per month?

Using the opportunity cost of money, buyers can leverage their buying power and help bridge the gap in compromising on a selling price. For example; a 10-year bank loan with an extra monthly payment of about $350 translates to a present value of about $30,000. This provides the seller with the additional $30,000 cash upfront. We are not suggesting that seller’s should increase the selling prices or that buyers should simply pay higher prices. However, we are suggesting that an extra $350 a month is not going to make any difference in the long run. Your negotiations will go smoother and the goodwill created with the seller will most likely create an even better transition. It’s not always how much you pay, but how much you benefit from the opportunity. There are always risks in every opportunity. However, most people never recognize the loss from a missed opportunity. This hidden loss can be much more substantial than $30,000 or $350 per month.

To obtain a practice appraisal or to read more about practice valuation methods click here