– Doyle Watson, DVM, Simmons & Associates Southeast
It continues to impress me the number of times I hear veterinary practice value being based solely upon some percentage of gross income. This concept is often suggested by some finance companies as well as veterinarians, but rarely by those who are familiar with business appraisal methodology.
The underlying foundation of value begins with a determination of the total amount of income from operations that is available for the owner to spend at the owner’s discretion. Typically this figure pays the owner a reasonable salary and services debt. Hopefully there would also be some left over to save. This is the net income remaining from gross operating revenues before taxes, principal and interest are paid. At Simmons & Associates, we refer to this figure as the “Adjusted Net Cash Flow.”
This “cash flow” is the total of the taxable income on the Tax Return plus certain adjustments made back to cash flow for expenses that typically fall in one of the following categories:
- Owner benefit: Compensation, Health or Life Insurance, Retirement programs, Auto in a small animal practice, Travel, Civic clubs, and others appropriate.
- One-time remodeling or major repair expenses.
- Equipment purchases that were expensed.
Interest and equipment lease expenses (Practice is appraised free and clear of all debt).
- Management adjustments considered unusual or atypical.
- Excessive or insufficient facility rent.
After these adjustments are made to Cash Flow, the remaining expenses are those which would be considered necessary for daily practice operation. In the well-managed small animal practice, this figure is typically 33-37% of gross — less to varying degrees in very high and low grossing practices.
This Adjusted Net Cash Flow figure is the Simmons & Associates’ jumping off point for all the income approaches toward practice evaluation. From here, various types of “Earnings” are calculated and appropriately capitalized; various ratios are calculated for prudent finance scenarios; returns on investment and after-debt incomes are calculated; and a myriad of other considerations made to ensure that the final value figure is prudent and workable once today’s real-life terms of finance are applied.