Financials in Dental Practice Valuations

One of the key pieces of information you’ll need to get when buying a dental practice is the financials of the practice you want to buy.

Ah, the “financials.”

What does that word mean anyway?

Buying a dental practice can feel like it has a language all its own sometimes. I swear finance people in particular – but lawyers, too – come up with multiple words for the same concept just so they can use the fancy version to sound smart and keep dentists confused and willing to pay them!

For example, you don’t want bonds you want “fixed income”. (They’re the same thing.)

Want to talk about stocks? Let’s talk “equities” instead. (Same thing again.)

(You dentists do it, too. My crown “failed”? YOU failed as my dentist. You see a “margin”? I don’t. I see a gap.)

Banks, brokers, accountants, and consultants mean one of two things when they say the word “financials” in a practice transition:

1. Business Tax Returns
2. Profit and Loss Statements

At their core, financials can tell you the most about a business and are the most important piece of the puzzle to get your hands on before you make the decision to buy. You want the financials of a business so you can see how much money is coming in, how much is going out, and how well the practice compares to other dental practices for sale.

If you need to guess, usually the term “financials” means the monthly profit and loss statements but sometimes it means the tax returns. Sometimes it means both.

Confused yet?

Let me give you a quick download on what these two types of “financials” are, why you’d want these documents, and what to look for once you get them. Let’s start with business tax returns.

Business Tax Returns & What to Look For

You’ll generally know you’re looking at a tax return when you pick up the document. The look is distinctive with boxes and lines you don’t typically see elsewhere. Look in the top left-hand corner of the tax return to see the type of tax return you’re reading and it can tell you a lot about a seller.

Types of Tax Returns

You’ll almost always see one of three types of tax returns:

• 1120S – This is a tax return for an s-corp, or an LLC filing as an s-corp. This is the most common type of business tax return dentists file. It generally means they have a good accountant and have someone advising them through tax issues. There are a few major states (hello, California!) where you won’t see these as often.
• Schedule C – Technically this is a “schedule” (not a return) that’s filed with a doctor’s personal tax return, but it’s similar to an 1120S and probably means the doctor is running their dental practice as a sole proprietorship. These doctors tend to be do-it-yourselfers and don’t get a lot of outside coaching and advice.
• 1065 – This is a tax return that a partnership will file. If you see one of these, you know there are multiple owners of a dental practice and you’ll need to understand how the providers and owners (usually the same thing, but not always) get paid.

What Valuable Information Tax Returns Contain

Tax returns are the most reliable source of information about the financial health of a dental practice for a few reasons. The information they contain must be gathered, sorted, and presented annually at a minimum.

All the information is standardized, making it easier for an outside individual (you or an auditor) to understand what is happening with the money in a practice.

Generally, the information is trustworthy as well. It’s been verified by someone with a PTIN (Preparer Tax Identification Number), usually a CPA who says they believe the information is correct. Plus, the IRS has that pesky ability to fine and jail people who put incorrect information on a tax return.

What to Look For on a Tax Return

Look for three things when you pick up a tax return for a practice you’re considering buying. First, look for the income and expenses of the business. You want to know how much money is coming in the door (collections) and what expenses the practice had during the year. How much did they pay employees? The supply and lab companies? Their advertising consultant? Etc. How much was left over for the owner of the business after all the expenses were paid?

Second, look for ownership of the business. This is almost always the name of the doctor who’s also on the website, but you can verify there aren’t any silent partners or other providers with an ownership interest by looking at form K-1 on most of the return types above.

Third, you can look for anything weird. To most dentists, EVERYTHING in a tax return looks weird. But a qualified transitions accountant can look through a return and spot details like recent big equipment purchases, pending litigation, family members on payroll, ownership changes, practice debts, and other information crucial to understand before you buy a business.

Profit & Loss Statements (Financials) and What to Look For

In contrast to tax returns, you might get a profit & loss (P&L) statement from a seller or broker. P&Ls come in many shapes and sizes. There are no standardized rules as to the formatting of P&Ls. But, these can be more valuable to a practice buyer for two key reasons.

First, P&Ls usually have the most detailed financial information. For example, rather than just listing “employee wages” on a tax return, typically a P&L will break out the number into salaries, payroll taxes, 401k match, Christmas bonuses, CE paid for, etc.

The formatting of a P&L can also tell you a little about a seller. Is the information organized with the most important and largest expenses (employee costs and lab/supply bills) near the top of the page? Or is that info buried and hard to see? Are the negative numbers listed with the expenses (a negative expense means that someone walked into the practice and handed the doctor money…that’s typically called ‘collections’)? If so, does that mean the doctor is doing their own bookkeeping and possibly doing other things that can be reasonably outsourced?

A second good reason to get P&Ls is they are usually updated monthly. This means you can get up-to-date financial information on the practice pretty quickly. If you’re looking at practices in August, you can see a few prior years’ tax returns AND you can see the current year’s P&L and see how the business is doing this year.

Ultimately, You Want Both Types of Financials

Before you buy a dental practice, you’ll want to get your hands on both tax returns and profit and loss statements for the last three years. This gets you the benefits of both types of data. You get the standardization and trustworthiness of the tax returns that the IRS also has with the detailed, up-to-date information from the P&Ls.

Plus, after you see lots of these documents you can talk to other dentists about “financials” and feel confident that you’re the only one who knows for sure exactly what you’re talking about.

If you ever need a hand interpreting financial information you’re seeing on a practice you want to buy, don’t hesitate to reach out. I’d be happy to help.

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