Medical Practice Valuation – Rule of Thumb

September 7, 2021

medical practice valuation rule of thumb

If you are a private health physician with your own practice, you might have heard about how a medical practice is valued based on the industry’s rule of thumb. Typically, the rule of thumb is based on multiples of sales amount – for instance, 1 to 1.5 times the annual gross revenue or a set fee per patient.

Medical Practice

Medical practice valuations using the rule of thumb are common in the US, which has some advantages as well as some disadvantages. The method is commonly used for medical practices, dental practices, and professional services firms.

The thing is, no two medical practices, or any two businesses for that matter, are alike even when the annual revenue and sales are identical. In this article, we dive into the whole process of medical practice valuation, the pros, and cons of using the rules of thumb, and the role they serve during the valuation process.

Overview

Selling or buying a practice is one of the biggest financial transactions in a doctor’s career. For a young physician entering into their first private practice, it would possibly be the biggest investment of their life. And for a retiring physician, valuing their practice would decide the amount of sweat equity amassed over their career.

There can be several reasons you want to sell your practice, including, retirement, succession, strategic planning and organic growth, partnership dispute, and divorce. Since this is not a small transaction, the process is fraught with perils and it is important to avoid the many pitfalls associated with it.

One of the biggest pitfalls when selling a medical practice is to avoid buyers that have weak financial standings. It is imperative to have a strong team of financial advisors in place to help you avoid financially troubled buyers. 

Determining the Financial Value of Your Practice

When doing a market value analysis of medical practice, a variety of factors are taken into account first before proceeding towards giving a sale value right away. Two practices, even if in the same locale with the same specialty, would not necessarily have the same fair market value compensation.

The relative efficiency of the practice is taken into consideration, as well as the profitability and the number of patients that the practice receives. In a nutshell, valuing a medical practice is very similar to selling any other business; the buyer is looking for a return on their investment in the form of cash flow and potential growth.

Other factors that are taken into account when determining the financial valuation of a medical practice include patient accounts receivable, financial and tangible assets, intangible assets, goodwill, and office building. Tangible assets incorporate all the equipment and furniture, prepaid insurance, and cash.

Valuation of Medical Practice Using the Rule of Thumb

In the not-so-distant past, rules of thumb were consistently used to value medical practices. The rules are typically expressed as benchmark calculations, multipliers, or simple formulas to arrive at a conclusion regarding the value of a business or practice.

Medical Rule

Today, given the current economic volatility in the healthcare sector, rules of thumb are not the ideal method for valuing any medical practice. They can still be used for general internal sanity checks, but in no circumstance are they a reliable source to put a final valuation for the practice. Moreover, they are fraught with legal liability should the deal sour, and such benchmarks generally hold little to no weight with the IRS.

Pros

– Low Cost: By using a rule of thumb to value a medical practice, the buyer or seller is saved from the cost of involving a professional in the process.

– Time-Saving: Since you can arrive at a valuation figure relatively quicker using an acceptable rule of thumb, the whole process of selling or acquisition takes less time.

 Cons 

– Limited: Valuation derived from the rule of thumb is not an economically derived conclusion. The rule is limited when it comes to determining the earning potential of practice, and uses only the most recent year’s revenue. A professional valuation expert or accountant will consider at least five years’ data about financial performance.

– Timing: Times change, which means that a particular rule of thumb that was used to value a practice twenty years ago will not be a valid means to value the same business today.

What are the 3 ways to value a business?

In the broader perspective, there are three general ways to value a business name, the market approach, the asset approach, and the income approach.

Market Approach

Precedent transactions and public company multiples are used as a benchmark to value the business, however, there are limitations to this approach. It is difficult to find information on companies that are private.

Asset Approach

This approach assumes that a buyer would not pay more for the assets of medical practice than the cost to emulate those assets. This approach is based on factual data and money spent.

Income Approach

Income

Uses the financial information of the company to estimate fair market value. This type of approach is disadvantageous for start-up businesses in the early days of the business as the cash flow may be low vs a company that has been in business for several years and has a lot more to show regarding its financial history. 

Other Considerations

Alright, so you finally know the crevices and crooks of the medical practice valuation process. Based on our experts, these are the additional factors that you need to take into consideration:

  • Location and Overhead cost: If you are considering an acquisition, you need to take into account the location as that will affect the staffing cost and the total overhead that you would be paying. Salaries are going to be higher in places where the cost of living is high, and vice versa.
  • Competition: Owning a professional medical practice where the competition per capita is lower has its advantages. Even though the overall client base is limited in rural areas or less dense states, there is still an influx of patients more than a physician receives in developed cities.
  • Financial Statements: If you are an individual considering an acquisition in Toronto and have concerns about business valuation, ask the seller for financial statements, and if it is an incorporated business, the corporate tax returns. Ideally you will want to have access to the previous five fiscal years’ financial information.

Still unsure? Reach out to UControl Billing and speak with our financial experts, with a record of providing specialized financial and billing services for specific needs.

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