Group shares how to analyze practice in purchase process

January 24, 2012

By Christopher Wolfe, O.D., Practice Advancement Committee member

Becoming a practice owner through the purchase of a practice can be a daunting task. However, a thorough understanding of the factors impacting the purchase feasibility, practice value, appraisal approaches and tax implications of buying a practice can allow you to proceed with a clear analysis of a practice.

Once you have decided to purchase a practice it is important to evaluate if the purchase of a particular practice makes sense. It is important to consider the existing practice’s reputation, managed care participation, physical condition, equipment, and computer system. Other factors to evaluate are patient volume, new to existing patient ratio, patient retention, patient recall and communication systems.

It is also important to understand the drawing area of the practice as the economic climate of this area can impact the practice. This drawing area will be larger for rural areas, and smaller for urban areas, and subsequently the optometrist to population ratio will be smaller for rural areas (4,000 to 6,000/OD) than for urban areas (25,000 to 45,000/OD).  These numbers take into account the greater density of providers who often duplicate the services of an OD, including ophthalmologists and opticians.

When looking at the economic climate of the drawing area, one should consider factors such as employment rate, population growth rate, growth of other businesses (including health care businesses), population age, per capita income and economic indicators. A quick search through Wikipedia can yield answers to many of these questions. There are also companies such as e-site (www.esite-usa.com/whatwedo.php) that specialize in understanding the “who, where, and why” of a particular location.

The employment and population rate can trend together or separately. For example, if the drawing area has a high unemployment rate with a skilled labor force and a new company builds a local facility the population rate may stay stable but the employment rate will increase.

Conversely, if a local employment rate is high and a new company builds a local facility requiring skills that are not endemic to that particular area an influx of new people may occur in order to fulfill the needs of the new company. 

If health care and retail businesses are investing in infrastructure and manpower this may be a sign that the population in that given area is expanding. 

If the area in consideration consists of families with young children, consider adding products and services that cater to this demographic.

Other economic indicators to evaluate include: how many new businesses open and are successful, how many new homes are being built, what is the value of these homes, and is there a specific industry that the drawing area is dependent on or is there diversity of industry.

When evaluating the value of a practice, it is important to consider the following areas:

  • Gross Collected Income: How much total money does the practice collect for the goods and services it provides? Detailed information from the previous three years is important and comparing that information with changes in the cost of living and growth of other regional practices.
  • Net Income: How much money is left over after all the overhead is paid? The ratio of net income to gross income is important and should be between 25 percent and 35 percent if the practice dispenses glasses and contacts. This ratio will likely be higher for practices that do not dispense, due to a reduction in the overhead costs. Projections of income, expenses, potential profit and financing requirements are fundamental considerations in practice acquisitions.

The three primary financial statements, income statement (profit and loss statement), balance sheet and cash flow statement, are all tools with different purposes that may be used to help assess the financial health of the business side of an optometric practice.

The income statement shows how profitable a practice is and is represented in its simplest form by the following formula: Net profit = Revenue – Expenses.  The balance sheet provides a glimpse of a practice’s financial health at any given point by reporting the cumulative results of all previous decisions that influenced the finances and operations to that time.

The balance sheet shows the assets owned by the practice, the debt obligations owed, and the equity (net worth) the owner has invested in the practice. The balance sheet is represented by the following formula: Assets = Liabilities (debt) + Owner’s equity (net worth).

The cash-flow statement reveals the source and uses of practice income for any given period. It is the definitive account of cash-flow status because it is generated using the cash basis method of accounting. In this method, income is reported when received and expenses are reported when paid.

  • Practice Services: What services does the office currently provide? Does the office primarily deliver routine examinations or does it offer medical evaluations and procedures, specialty contact lenses, vision therapy, vision rehabilitation services, etc. This can tell one if there are significant areas to continue to grow.
  • Practice Location: Is the practice accessible and viewable to current and new patients?  Many of the above areas of analysis hinge on the location of the practice, so this is obviously not something to overlook.
  • Patient Records: Having an established patient base is the greatest advantage to purchasing an existing practice. In evaluating the practice, determining the likelihood that the patient will return is the hardest factor to assess. Patient records, in and of themselves, have no value. Possession of the patient records with name, address, phone number, and all prior vision health history allows patients the comfort that the new practitioner can continue their care. The new practitioner may then internally market to an existing patient base. Patients who have been to the practice within two years are the most valuable, whereas patients who have not been to the practice in five or more years have almost no value to the practice. Because the evaluation of gross income is over a period of three years, it is likely helpful to assess the number of patients who have had full exams during this period, giving more weight to the previous two years. 
  • Transition Period: How long will the selling practitioner and/or staff remains with the practice?  The length of time a seller is able to remain to provide a smooth transition affects the practice value significantly. This will help the new practitioner become familiar with the current office procedures and patients.
  • Physical Resources:  What the style and condition of the office furnishings, equipment, and inventory?  Are the physical resources leased or fully paid for, and are they in good working condition? The decor, tenure, quality of operation, and the degree to which it is equipped may significantly determine whether or not a practice should even be considered.
  • Accounts Receivable: How much and how outstanding is the money owed to the practice?  Will one purchase the accounts receivable (newer accounts are worth more than older accounts) or let the selling practitioner collect on them during the transition period?

A systematic analysis of a practice can help a prospective buyer enter into the purchase of a practice with all the information they will need to make a wise investment.

Conducting proper due diligence of an existing practice under consideration for purchase can yield the rewards of a higher potential of income, equity ownership, flexibility and control over one’s life, and financial/estate planning for the future when contrasted to starting up a new practice.

The author used “Business Aspects of Optometry: Association of Practice Management Educators” as a resource in compiling this article.

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