A specialist in the accounting field should normally always be called on for such an evaluation.
The determined value by a specialist in this field is called “fair market value. The excess earnings valuation is a method which is often used by accountants to arrive at fair market value of a medical practice.
Documents that a qualified person will need are:
·The medical practice's balance sheet as of the prescribed valuation date.
·The medical practice's historical income statements for the past three years. (Again this sounds a bit like real estate, does it not?)
To calculate the fair market value there are steps that must be followed to arrive at a crediable valuation. Here is that formula that is liekly to be used:
1. A determination of the date to be used for the valuation of the practice is the staring point. However, if the valuation is being prepared for a divorce, shareholder dispute or bankruptcy, the court will set the valuation date.
2. If the practice owns the building the valuation must separate the value of the real estate from the value of the practice. A real estate appraiser should be used for the real estate portion. The it is necessary to determine whether adjustments need to be made to the amounts reported on the practice's balance sheet. Does the accounts receivable include bad debt that must be written off? If so, this is one adjustment that will need to be addressed. Verify that all liabilities of the practice are accurately reported on the balance sheet. If there are loans or notes payable among the liabilities, record them at the outstanding principal balance as of the valuation date.
3. Accounting 101 will then dictate that the total liabilities as of the date of the valuation will be subtracted from the value of the practice's net tangible assets
4. In the next step determine the practice's normalized cash flow using the historical income statements. For each year, add back in officers' compensation, nonrecurring expenses, depreciation and noncompulsory expenses. Aftesr calculating the average normalized cash flow you will determine whether the result is reasonable based on the practice's performance.
5. Oh but now comes an important consideration: Is the officers’ compensation reasonable? One must subtract reasonable officers' compensation from the average normalized cash flow determined in Step 4. Reasonable officers' compensation can be found by carefully searching available databases online or calling the local medical society to obtain medical journal studies information. The adjusted (if required) figure represents the practice's normalized cash flow after officers' compensation.
6. Calculate the reasonable return on net tangible assets. To do this, multiply the net tangible assets calculated in Step 3 by the rate of return associated with those assets. A good rule of thumb is the rate at which the practice borrows from banks.
7. Subtract the return on net tangible assets calculated in Step 6 from the normalized cash flow calculated in Step 5. This represents pre-tax excess earnings, (or in real estate “cash flow”).
8. But what will after-tax earnings be? For a rather standard calculation you may multiply the pre-tax excess earnings found in Step 7 by 40 percent to calculate the practice's after-tax excess earnings.
9. Assuming the selling physician has generated a lot of patients that think highly of his medical service there is good will that can now be calculated. Good will is a bit subjective. The value of such good will to the practice can be arrived at by multiplying the practice's after-tax excess earnings by the appropriate multiple. So what is an appropriate multiple for a medical practice? This multiple can range anywhere from 1.0 to 5.0 times, depending on the revenues of the practice, the number of physicians and the annual net profit generated.
10. Add the good will calculated in Step 9 and the net tangible assetscalculated in Step 3. This is a net figure prior to the addition of premiums or discounts.
11. A premium may be added on the over all location, the strength of the practice, the non-dependance on government programs for payment, or other factors that determine the special quality of the practice. Conversly, a determination of whether discounts are necessary in the valuation may also then be made. Discounts can include the key man discount, discount for lack of control and discount for lack of marketability. The premiums or discounts are very important issues and must be left to qualified experts on these matters if the ultimate valuation is to survive the scrutinity of the courts.
This is a tricky area for anyone other than one who has been trained and is experienced in medical practice valuation. Onward and upward Lali…. Rob Baird, CA RE License #544165 (One of the oldest, active licenses in CA) 951 515-5855 Email: email@example.com
Mar 29, 2011