Practice Value – Part 1
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(Part I: Establishing Cash Flow)
It is amazing how many times I hear that veterinary practices are valued by using a percentage of their gross income. It is a simplistic and inaccurate method, often suggested by financial companies and veterinarians alike.
However, someone with business appraisal knowledge would rarely consider this method an option.
The basic element in determining the value of a business is the portion of income from operations that the owner can spend in a discretionary manner. Generally, this amount includes the owner’s salary and payments of debts. Ideally, some money would be left afterwards for saving. This amount, called “adjusted net cash flow”, is the net income left from gross operating income before payment of taxes, interest and principal. It basically represents the total taxable income adjusted for various expenses, some of which could be:
1. Owner benefits, such as salary, insurance, retirement plan, car expenses, travel, club memberships, etc. ;
2. Major repair/remodelling expenses;
3. Expensed purchases of equipment;
4. Expenses with equipment lease, and interest (The practice would be appraised clear of debt);
5. Unusual/atypical management adjustments;
6. High or inadequate rent for the facility.
After the adjustments, left over expenses would be those generated by current practice operations. In a small animal practice with proper management expenses required for daily operation would fall in the area of 33-37 percent of the gross income. These percentages decrease at various rates in practices with very high or very low gross revenues.
The adjusted net cash flow is the starting point of all income-oriented practice appraisals. Various types of earnings will be calculated from this amount and capitalized. It is also used to calculate ratios for financial scenarios, investment returns, and income after debt. The adjusted net cash flow is also used in a series of considerations for the purpose of obtaining a prudent and practical figure after applying the relevant finance terms.
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