The Journey to Dental Practice Ownership
Many dentists will have the opportunity to realize a long-term goal of practice ownership, which in most cases requires bank financing if they are purchasing an existing practice. And while there is great reward in practice ownership, the journey is filled with numbers.
Your bank will look into the financial details of the practice you are considering, as well as your own personal finances, before making a lending decision. If you have a lot of student loan debt, you may wonder if the bank will even be interested. Fortunately, the answer is yes, so long as your cash flow can cover both your personal and practice debt. From a high level, dental practice financing requests will be approved when the practice generates enough cash flow to support the debt maintenance for both practice and personal debt.
Let’s walk through an example to see how the numbers would likely be reviewed by an underwriter:
In letter A, the practice collected $1 million. This is the cash-based practice revenue that we find in the tax return. In letter B, we have subtracted all business deductions from the receipts to arrive at the net-taxable income. Again, this number is taken directly from the tax return.
Letter B represents income for the practice according to the tax return. In order to properly understand the practice’s ability to produce cash, we need to go through the normalization process. This involves adding back discretionary expenditures that are not necessary to the operation of the practice, including expenses that are non-cash or accounting allocations (e.g., depreciation and interest expenses). Letter C line items are common addbacks to determine adjusted cash flow.
Finally in letter D, we have the cash flow. In this example, the practice is capable of generating $410,000 cash. This is the amount required to support debt maintenance for the owner, including both business and personal obligations.
So let's determine the amount needed to pay the practice debt. In this example, assume we finance the entire purchase price of $700,000. We will also assume the debt will be amortized over 10 years at a fixed interest rate of 4.5%. This leads to a monthly payment of $7,255, totaling $87,056 annually (letter E).
Letter F represents cash available to the practice owner after debt associated with the practice purchase has been paid.
From a numbers perspective, this is the basic analysis that the bank considers when processing your financing request. By determining the practice cash flow, they can then determine whether this cash flow can support the debt repayment and provide enough income to support personal obligations.
Now let’s move on to the personal debt analysis.
The bank will request the completion of a personal financial statement (PFS), which is your personal balance sheet listing your assets, liabilities, and net worth. The bank will also pull your credit to determine and corroborate all your personal debt.
In our example, letter G is the cash available from the practice and letter H lists all personal obligations. Letter I is the total of personal obligations and letter J is the remaining cash. The bank will examine your debt-to-equity ratio, which in this example is letter I divided by letter G (in this case, 17%). A debt-to-equity ratio less than 40 – 45% should be the target.
As is made evident in the example presented above, it all boils down to cash flow. The cash generated for the dental practice must support the debt maintenance of the practice and you personally.
How we can help
There’s a lot to consider when making the decision to purchase a dental practice. And it’s difficult to know where to start. CLA can help. Our health care professionals understand the process and can provide the tools necessary to guide you every step of the way. From identifying a practice to the purchase closing, we can support the development and execution of your operational and financial goals.