There’s a lot that goes into deciding whether or not you’re going to buy a practice and how much you should pay for it. With that in mind, let’s talk about the relationship between collections and overhead.
It can be such a beautiful marriage, but like any other relationship, they both have to be stable to make the marriage work and make it to that coveted 50 year mark.
I wrote in an earlier post about some benchmarks to make sure an office’s collections are stable so now I want to go a little deeper into overhead stability.
As a general rule, I recommend looking for practices that have a profit margin of approximately 40%, or in other words, 60% overhead. This is close to the average profitability of dental practices in the United States.
The majority of the time, anything below 40% profit margin or above 60% overhead (61.7% to be exact) isn’t as well run as it should be.
I’m going to tell you right off the bat that looking at the profitability of the practice is a lot more difficult than just looking at the “net income” reported on the seller’s Profit & Loss statements (which you will soon be an expert at reading).
To see the true profitability, you have to deduct the Seller-specific expenses, like travel, meals and entertainment, and the owner’s salary.
So what do you look at? How do you know what parts of the business to look at? What makes up office overhead?
There are four main subcategories of office expenses to look at when assessing office overhead: General Wages (Staff Expenses), Facility Costs, Supplies & Labs, and Advertising. (Be sure to stick around because in the next few weeks, we’ll be going into these categories in much greater detail.)
Just like with a low collecting office, don’t assume that you can just walk in Day 1 and make all these changes to instantly see lower overhead and subsequently higher profit margins.
That being said, think hard about what you can change quickly (Supplies & Labs and Advertising), what is hard to change (General Wages/Staff Expenses) and what is permanent (Facility Costs) because overhead is a huge factor in valuing the office and submitting an offer.
There are multiple methods in which a practice can be valued. Each method has its own formula and takes certain factors into account.
At Dental Buyer Advocates, we use a combination of the market-based approach and the income-based approach. I’m not going to go into detail about these methods here; however, I am going to touch a little on overhead and the income-based approach so you can understand just how important it is to find an office with stable management.
The income-based approach is essentially assessing the value of the office based on how much money you will make after all your business expenses. This method is heavily influenced by the overhead of the office, both positively and negatively.
If the office’s overhead is higher than 61.7%, then the value of the office starts to drop. Every percent higher than the benchmark will substantially decrease the worth of the office.
Though this seems bleak, the opposite is true. If the overhead is even the smallest percentage below the benchmark, you’ll see a spike in office value. Essentially, the better managed the office overhead is, the more money in your pocket at the end of the day.
At the end of the day, why not stack the deck in your favor? Don’t worry, it’s not cheating. It’s just smart business planning.