Valuing a Dental Practice What Do You Need to Know

August 24, 2020, Linda Clinic

If you are interested in purchasing a new dental practice or selling off your existing one, you will perform a valuation. There are numerous ways to carry this out. However, this can make the process confusing for people who are new to dental practice management.

This guide will go through the different methods so that you can determine which valuation approach is right for you. Let’s start by looking at the importance of valuation.

Why you need to perform a valuation for your dental practice

A valuation can provide you with an accurate assessment of how much your dental practice is worth. This figure will then be used during negotiations between the buyer and seller.

On the buyer’s end, understanding the value of the dental practice you are about to purchase informs you whether or not the deal is within your budget. It also lets you know whether or not you are making a good investment.

On the seller’s end, understanding the practice’s value can help with financial planning for the future. If you know how much your operation is worth, you can start planning for your retirement and other future investments you wish to make.

Valuation methods

There are plenty of valuation methods to choose from when assessing how much your dental practice is worth. Each method offers its advantages and drawbacks when coming up with an accurate value estimate. The most popular methods are discussed below.

Using capitalized earnings

You can perform an income-based valuation method by reviewing your capitalized earning. To use this method, dentists will need to calculate the average net income their practice generates. This can be derived using post-tax earnings from the last year, or by taking an average of earnings from multiple years.

Your net income is calculated by taking your average annual net receipts and deducting operating costs, collections, and compensation costs from them. The resulting figure is then divided by the cap rate. This cap rate is usually 20% to 30% (i.e: 0.2 to 0.3) in the dental industry.

So if your net income is $150,000, at a cap rate of 25% your practice’s value will be 150,000/0.25 = $600,000.

Discounted cash flows method

This is another income-based valuation method. The discounted cash flows method projects the next ten years of your net income and uses it to calculate the net value of the income in the present. This cash flow projection is based on a realistic growth rate for operation costs and collections for each year.

Once the incomes have been calculated, they are discounted by the price estimate for the capital and the risk premium (around 25% to 31% in the dental industry). This method is useful for dental practices that have been around for a while and are able to demonstrate their growth for many years.

Net asset value method

You can also assess the value of your practice by looking at appraised value of its tangible and intangible assets. In this case, your tangible assets refer to dental equipment and the building itself. The value of these assets should take depreciation into account.
You will also need to estimate the value of your intangible assets such as the practice’s name and reputation. This can be tricky to do, as the share of tangible to intangible assets will rely on multiple factors, such as demand, location, and patients.

This method could be useful for dentists with high value real estate, but it should never be used in isolation. Pairing it with another valuation method could give you a clearer estimate.

Market based valuation method

This method can help you analyze collection trends quickly. Start by calculating a percentage of the average annual net receipts over the last three years. This can be done using seller market data for other dental clinics in the area.

You should find that your percentage ranges between 50% and 80% of your average annual net receipts. So a practice with annual net receipts of $800,000 would have a value between $400,000 and $640,000

However, this method may not be suitable for everyone, as finding sales data for similar dental practices can be difficult.

How can I estimate the “true” value of my practice?

The aforementioned methods can give you a rough estimate of your practice’s value, but they are unlikely to give you its true value. This is because this figure is usually composed of risk and net income. If your practice has a higher risk, buyers are less likely to be interested in it.

By looking at the aforementioned valuation methods, you can see that the value of a practice is usually determined by looking at a minimum of three years profit/loss statements and tax returns. However, the most important determining factor will be your cash flow for the previous year.

If you are still unsure about coming up with an estimate for your practice, you can use the help of a dental practice consulting firm. The consultants at these firms have experience performing valuations and can guide you through the challenges associated with this process.

What are some ways to increase my practice’s value?

There isn’t much you can do to increase your practice’s value at the last minute. However, if you intend to sell it within the next two or three years, there are a few things that could boost its value.
This includes:

1. Investing in modern dental equipment.
2. Swapping out the existing furnishings for better ones.
3. Maintaining the floors, walls, and roofing of your building.

It’s best to try these methods as soon as possible, as they may improve your return on investment when you finally do decide to sell your practice. So get in touch with a dental practice consulting firm and learn if your practice is actually worth as much as you think it is.

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