Today’s Veterinary Business provides information and resources designed to help veterinarians and office management improve the financial performance of their practices, allowing them to increase the level of patient care and client service.
Issue link: https://todaysveterinarybusiness.epubxp.com/i/856474
13 August/September 2017 • TODAYSVETERINARYBUSINESS.COM but calculating profitability is not as simple as adding five numbers together. Every veterinary practice is unique, and every practice owner has distinct financial objectives. In calculating the profitability of veterinary practices, the goal is to remove some of the variability created by decisions made to mit- igate taxes, service debt, replace and upgrade equipment, or fund specific activities or charities. Equipment One problematic aspect of an EBITDA calculation relates to adding back depreciation expense without subtracting an amount for routine equipment replacement. Depre- ciation is a method by which a business writes off major purchases. The cost of the equipment pur- chased from year to year can vary significantly, and since U.S. tax law has allowed first-year write-offs of as much as $250,000, it is easy to understand why adding back depre- ciation expense makes sense when evaluating a business. What EBITDA fails to consider is the critical expense related to ongoing investment in equipment replacement and upgrades. While equipment purchases may fluctu - ate dramatically from year to year, a practice that does not regularly invest in new equipment and technology will struggle to achieve a competitive advantage in the marketplace. Veterinary hospital profitability calculations include an annual equipment acquisition allowance that varies somewhat based on practice type. Owner Compensation and Benefits Usually, hospital owners decide how much to pay themselves as well as what benefits they will re- ceive, sometimes based on recom- mendations from their CPA. Due to the diversity of needs of these owners, as well as tax-mitigation strategies, owner compensation varies significantly from practice to practice. EBITDA does not reflect what a different owner would pay herself, nor does it account for differences in benefits provided. Veterinary valuation experts al- ways analyze owner compensation and may adjust that compensation up or down to reflect what another owner should reasonably expect to receive in compensation. This calculation is based on the substitution principle. At its sim- plest, this principle analyzes a situation by substituting a standard value for the actual value. For our pur- poses, we want to replace the actual spending on owner salary and benefits with the amount that would be paid to an associate veterinarian or manager to do the same work that the owner is doing. If the practice owner is a veterinarian, an apprais- er will substitute the owner's salary with the amount that would be paid to an associate with similar experience to generate the same level of production. A substitution also is made for the owner's role in managing the practice and what a manager would be paid to do the same things. This adjustment will increase profitabil- ity if the owner is paid more than others would receive. Profitability will decrease if the owner is paid less than what others would earn for the same work. Many small businesses hire members of the owner's family, and veterinary hospitals are no excep- tion. Sometimes those family mem- bers are paid handsomely. Other times they are paid a pittance or not at all. Practice appraisers will adjust profitability to reflect what a third party would be paid to do the same work. EBITDA does not address fam- ily member compensation. Facility Rent Facility rent is another area that may vary somewhat when the practice owner is also the owner of the real estate on which the practice operates. Again, largely de- pendent on tax- mitigation strate- gies determined by the hospital owner's CPA, the amount the practice pays for facility rent may or may not reflect the fair market value of the property. Practice owners may pay signifi- cantly more or sig - nificantly less than what an unrelated party would expect to pay to rent the practice's facility. This is a common tax strategy employed by owner veterinarians, but it is not ad- dressed by the EBITDA calculation. Other Considerations Several more areas that reflect a practice owner's personal values and interests can affect profitability but not EBITDA. Examples include discretionary spending on resort CE, charitable contributions, tithing, personal vehicles, or tickets to sport- ing or cultural events. When a clear division between the owner's personal spending and the expenses of the business is absent, profitability will be artificially low. An appraiser will try to determine if personal expenses are mixed with business expenses and then adjust expenses where necessary. Even so, the owner should have the discipline and be mindful of paying personal expenses personally. Today's World Several buyers active in the vet- erinary market use multiples of EBITDA to determine the price they are willing to pay for a specific veterinary practice. As a result, the term EBITDA is becoming widely used in the media. While EBITDA is a useful mea- sure of business performance for publicly traded companies, it is more difficult to apply to privately held businesses that do not follow strict accounting guidelines. Your practice's EBITDA does not reflect true practice profitability. Veterinary hospital owners make decisions every day with more emphasis on patient comfort and care and less regard to profit- ability and sales price. While EBITDA is used by more than one practice consolidator, it is not the most accu- rate method for calculating profit- ability or practice value. If someone offers to buy your practice for a multiple of EBITDA, you may be leaving money on the table. Money Matters columnist Leslie A. Mamalis is the owner and senior consultant at Summit Veterinary Advisors. Learn more at www.summitveterinaryadvisors.com. When a clear division between the owner's personal spending and the expenses of the business is absent, profitability will be artificially low. WHAT TO FACTOR IN EBITDA Profitability Net income Interest Income taxes Depreciation expense Amortization expense Equipment replacement Owner comp/benefits Family working in practice Facility rent Charitable contributions Other discretionary spending