One of our primary responsibilities as a practice manager is to sustainably maximize shareholder value (profit). Whether you have full access to the accounting and play a role in major financial decisions or have limited governance over categories like human resources, inventory or marketing, your actions can shape profit and ultimately the practice’s value.
When I participated in a formal practice valuation, I found great satisfaction watching the fruits of my revenue and budgetary efforts validated and multiplied into tangible practice worth. So many abstract concepts — culture, client satisfaction, goodwill, reputation — contribute to a practice’s true success. But for a number cruncher like me, a practice’s finances are the motivating concrete component we use to help keep score. When an owner’s retirement plan hinges on practice value, the score matters.
Rules of the Game
Calculating true practice value is a complex task best left to a certified valuation analyst. Our report included various valuation methods, including the income approach and debt-service model. Ultimately, our fair market value was best calculated using the market approach, a multiple of adjusted EBITDA (earnings before interest, taxes, depreciation and amortization). I admit I do not fully understand all of it, but the process clearly showed the vital need when preparing for a valuation to manage the practice with EBITDA in mind.
Managerial Accounting
While determining EBITDA seems relatively straightforward, even in the most cleanly accounted veterinary practices, calculating true profit for the sake of valuation takes some adjustments. The practice’s financial accounting provided to an accountant determines tax liabilities and creates important third-party business documents. The bulk of management, however, is better served through internally focused managerial accounting where metrics for budgeting, cash flow, accounts receivable and inventory efficiency can be accurately derived.
Managerial accounting also can be used to normalize or adjust EBITDA to find a true and comparable profit useful for forecasting and estimating value. I accomplish this with a simple Excel spreadsheet that permitted me to review several years of color-coded, notated accounting side by side and at a glance. My worksheet includes budgets as a percentage of revenue, actual over/under figures, and explanations of anomalies such as one-time, sped-up or delayed payments in any given fiscal year. When reviewing midyear, I can prorate annual expenses and take care to notice where the closing date falls within the payroll cycle, allowing us to most accurately predict year-end profitability.
When adjusting a financial income statement for managerial accounting, many line items can come into play, including rent, owner compensation, family-member employment, donations and personal expenses. Money Matters columnist Leslie Mamalis explained the pitfalls and considerations of these categories in her article “Using EBITDA Can Be Tricky.” (Read it at http://bit.ly/35gKSE5.) Having a strong understanding of which expenses are normal, which are necessary parts of the business, and which are discretionary or made to capitalize on taxation strategies helps to better determine what the practice’s adjusted EBITDA is and what changes need to be made to improve it.
What’s the Multiplier?
Once you have worked through finding the EBITDA, similar to what a professional would use for valuation, the next step is determining the multiplier applicable to your hospital. Veterinary Practice Partners (VPP) publishes a free guide that breaks down and explains the factors used when assigning a multiple, from 5 to 8, to value individual small animal general practices. These factors include:
- Annual revenue.
- Revenue growth.
- The selling veterinarian’s production.
- Real estate costs.
- Client income demographics.
- Product/service mix.
- Profit margin.
- Employee turnover rates.
VPP assigns its highest multiples to practices whose:
- Income is greater than $2.5 million.
- Annual revenue growth is greater than 6%.
- Associate veterinarians are key income drivers.
- Real estate expenses are less than 5%.
- Client demographics show a high income.
- Service sales are greater than 80%.
- Profits are 15 to 20%.
- Turnover is low. (Veterinary industry turnover averages 23% over all positions, according to the American Animal Hospital Association’s new “Compensation and Benefits, Ninth Edition.”
Conversely, practices are considered for a low multiple when:
- Annual revenue is less than $1.4 million.
- Revenue growth is under 2%.
- The selling veterinarian is the primary producer.
- Real estate expenses exceed 9% of revenue.
- The practice serves a low-income demographic.
- Product sales represent more than 30% of revenue.
- Profit is less than 10%.
- Turnover is high.
Bottom line: A practice generating $1.5 million in annual revenue could have a valuation difference of over $1 million, depending on performance in those key business metrics.
Building Value
While the price and terms of a practice sale are largely out of a manager’s hands, what is within our control is to make decisions and recommendations during the regular course of business so that practice owners have the opportunity to command a premium. It is prudent to know that a formal valuation will look at figures and trends from the past three complete tax years. Profit-minded decisions need to be set in place several years before a sale is initiated if the goal is full-value realization.
Which of VPP’s points of consideration is the weakest in your practice? Regardless of how much time is left before a valuation takes place, it is always the right time to work on improving the health of the business.
When strategic goals are aligned, improving the metrics in areas like employee turnover, the product/service income mix and greater leverage of associate veterinarians can take years of trial and error. Likewise, sustained top-line revenue, profit margins and dependable growth require a strong understanding of market demand, employee culture, operational efficiency and community reputation.
These core areas of business do not have easy, one-size-fits-all answers, and they require dedicated management-minded personnel. When done well, decisions and actions made now can translate into million-dollar ideas when the time comes for a sale.