Many dentists find it difficult to ascribe a certain value to their dental practice, despite years of experience in the field. Sadly, a dentist’s proficiency in the clinic doesn’t translate to the level of financial literacy needed to calculate their practice value. If you’re currently in this situation, things are about to get pretty straightforward. In this article, we will discuss dental practice evaluations to help you put a price on your practice.
There’s no universally accepted way to go about this. That is why you can go to the negotiations and come back either shortchanged or with enough value for your practice. However, there are several methods to go about this. We will discuss the three most common ones here. From our discussion, you can select the best fit for your practice and attach the appropriate value. Before we begin, you must understand that a business’s value is directly proportional to the cash flow, the risks involved in the investment, and the returns on investment. Let’s dive right into the discussion properly.
To use this method, you must first learn to calculate your income. Here, income refers to the net income before tax. There are two subdivisions of the method. These are the capitalized earnings method and discounted cash flows method. To use the capitalized earnings method, you need to calculate the net income for your practice in the previous year. You may also do an average of the net income for the last few years instead. Divide the figure by a cap rate. You may do your research on this, but the dental industry standard is between 25%-31%.
Based on the capitalized earnings method, let’s calculate the value of a dental practice that grossed about $2 million in 2020. Net income was $500,000 and if we divide this by a 28% cap rate, we get a practice valuation of about $1.6m.
The discounted cash flows method projects 10 years of net income, then calculates the value in the present. Of course, this has to be as objective as possible. Hence, the practice needs to have an appreciable growth rate over the previous years. This is combined with the costs of practice each year and is discounted by the assumed cost of capital plus a risk premium. In the dental industry, this ranges from 23%-31%.
To use either of the income-based methods, a practice needs to have a steady stream of patients and a track record of appreciable growth. Buyers who are well exposed to dental practice valuation prefer this method for solid dental practices.
This method is quite straightforward. It considers tangible assets such as dental equipment, chairs, real estate, and intangible assets like intangible (practice goodwill) assets. However, several practices do not have a sizeable portion of their value in tangible assets. Hence, using this method can be difficult especially when trying to appraise practice goodwill which can constitute as much as 80%-85% of a dental practice. A dental practice with several real estate holdings can be valued easily with this method. If this is not the case, this method is best used to compare to other methods of valuation.
This method uses market data obtained from other dental practices in your area. Now, the market data is not even the profit of your practice or other practices. It takes into account the historical collections of the practice multiplied by a collection’s multiplier (which often ranges between 60% and 80%), then incorporates this with the data from the other practices. The problem here is quite evident. A method that fails to consider profit is not good enough. Moreover, your dental practice needs to be in a metropolitan area for the best valuation, regardless of your profit.
We hope that this discussion has given some insight into the ways you can value your dental practice. Remember that your dream retirement plan is incomplete without the best value for your dental practice.