Accounts receivable in a dental practice valuation

Let’s talk about accounts receivable (AR). Sound boring? Okay, let’s put it another way. Let’s talk about free money.

What is accounts receivable?

Account receivable is the money owed to a practice by its patients, which the patients have not yet paid. Often, the AR is available to purchase along with the practice itself. The question is, should you buy it? We’ll get to that in a minute.

First, let’s look at how to use AR as an analysis tool to evaluate a practice’s health.

What should I look for in AR?

We’ve given you some solid guidance for practice collections and overhead, letting you know approximately where those numbers should fall. Unfortunately, there is no “right” number for outstanding AR. 

However, to really get a sense of how efficient and effective the office is at collecting payment, look for trends

• Aging trends. Balances should be highest in 0-30 days and drop off in 31-60 and 61-90 day categories. Spikes in 90+ days are common.
• AR to collections ratio. Compare AR balance to monthly and annual collections. High ratio indicates potential issues collecting payments.
• Timing of report. Ask when the report was pulled. Month-start reports may show inflated balances before bills are collected.
• Collection effectiveness. Review rates and consistency. High AR could signal poor front office collection processes. This could be an area where you can improve profitability with some adjustments.
• Bad debt. Look at uncollectible accounts written off. High amounts can warrant lowering valuation.
• Terms. Assess patient payment terms. Longer terms tie up cash flow and inflate AR.
• Staff. Evaluate staff skills and training in collecting patient payments efficiently.

Sometimes sellers will bill at the first of the month and pull the report at the end so the balance looks larger. If it seems high to you, ask. 

(In case you haven’t noticed a common thread of advice across this website, I’ll be a bit more obvious: Just because you see something concerning, don’t run for the hills yet. Always ask follow up questions. You may just ask the right ones and get your dream practice!)

Should I buy the AR?

Accounts receivable can be a good window into a practice’s operational and financial health, but should you acquire them when you buy the practice?

I recommend that if you have the opportunity to purchase them, you should (not every seller wants to sell them). If done correctly, it’s like buying cash for a discount. 

For example, if the 0-30 day balance is $120,000 and you buy that at 85%, you just bought $120,000 for about $100,000.

The same reason I recommend purchasing is often the same reason sellers don’t want to give them up. The seller may not want the lower rate, so they opt to have you collect them on their behalf for a fee, usually about 5%.

If you’ve ever gone through the process of buying a home, you know that you are approved for how much house you are allowed to buy. 

The wonderful thing about a practice loan compared to a housing loan is that a bank will typically give you working capital in addition to your purchase loan.

This working capital is either extra cash or money to buy the outstanding accounts receivable, but not both.

The accounts receivable are purchased in about 50% of sales for any number of reasons, such as seller preference, the buyer hitting their lending capacity, or the buyer deciding to use that working capital towards something else or keep it if they’re concerned about inefficient staff members.

Often we hear concerns, “What if the patient doesn’t want to pay me because I’m the new guy?” 

This is not a common scenario; however, there are always some rotten apples. If there is a difficult family that will only pay the doctor that has provided their care the last 12 years, you can opt to buy all the outstanding accounts receivable excluding that family’s.

Whether you choose to purchase AR or collect for a fee, make sure those terms are written very clearly in your offer.

At the very least, just look at the outstanding accounts receivable. You can find very helpful information about the office even before spending a few days shadowing.

More about AR

I was talking to a broker years ago and learned something so mind-blowingly stupid that I was speechless. You should know about it, too, in case it comes up in a transition you’re involved in.

Usually, the buyer gets AR at a discount and is happy to pay extra because it’s like buying a stack of cash with a shorter stack of cash. The seller likes it because it’s a clean break from the business. They get the price of the practice, PLUS some extra for the bills they haven’t collected, and they can walk away into the retired dentist sunset.

But some sellers didn’t want to sell the AR. And on some deals, it didn’t make sense to me. I was confused.

Until I learned something new about brokers.

Some brokers will charge the sellers EXTRA for AR that are sold as part of the deal.

Most brokers charge a percentage of the sales price of the practice. The standard amount is 10%, though that number can vary. Thus, if a seller pulls a deal together at a sales price of $1 Million, the broker’s take would be $100,000.

Some brokers say that if you, the buyer, purchase the AR—that amount gets tacked on to the sales price.

So, if the sales price of the practice was $1 Million, and the AR cost was an additional $75,000—some brokers apply their 10% fee to the $1,075,000, bumping up their fee by $7,500.

Ridiculous.

But now it makes more sense why some sellers don’t want to sell the AR.

I’m still trying to decide if a broker doing something like this falls into what I’m calling the bad broker category. Either way, it’s dumb.

And now you know an additional question you can ask a broker or seller if you’re having trouble negotiating the AR on your deal.

Need help with your dental practice valuation?

Brian Hanks has years of experience coaching dentists through the process of purchasing a practice. He’s a seasoned dental CPA and coach, and can save you hundreds of hours, pounds of stress, and (potentially) tons of money.

Contact Dental Buyer Advocates for a free consultation with Brian.

Also, check out our extensive checklist. It outlines all the steps involved in a dental practice acquisition, and it’s free!