Valuations, a good method for certain financial situations

December 1, 2007

If you find yourself in the midst of a buy-in, payout, or sale of your practice, a practice valuation may be worth considering. Typically goodwill is the largest value involved; even though a significant amount of hard assets are also involved. Therefore, it's important to factor in the impact of hard assets on your practice valuation.

Key Points

If you find yourself in the midst of a buy-in, payout, or sale of your practice, a practice valuation may be worth considering. That's the latest advice from Mark E. Kropiewnicki, JD, LLM, and Daniel M. Bernick, JD, MBA, both of The Health Care Group, Inc. in Plymouth Meeting, PA, who presented on "Practice valuation and goodwill: What's behind door number three?"

"The need for valuation may arise in the following scenarios: in the merger context between two ophthalmology practices, when two spouses (doctor and wife or doctor and husband) are getting divorced and there's dispute over the value of the ophthalmology practice, and in cases of lost earnings due to disability, for example," says Bernick, a principal of The Health Care Group and Health Care Law Associates.

There are three basic components to valuing an ophthalmology practice: hard assets (e.g., medical and office equipment), accounts receivable (work performed in the past represents an asset), and goodwill (i.e., sum of all intangibles in the practice).

Therefore, it's important to factor in the impact of hard assets on your practice valuation. First, practices must consider how to go about valuing the equipment in the ophthalmology practice. Bernick describes two conceptual approaches. "The first and most straightforward approach would be to have somebody come and tell us the value of each item in our practice. Theoretically that sounds like a good idea. But in practicality, to try to have one person with market experience appraising every piece of equipment and item in your office is not feasible," he explains.

Instead, many people might opt for the second approach, which is based on book value. This essentially represents what is shown on your tax return, according to Bernick. A corporation would have a schedule showing the balance sheet of the practice. A line item applies to the original purchase costs of all equipment and leaseholds in the practice. From that, all tax depreciation taken to date on the items listed would be subtracted. The purchase price minus the depreciation results in the book value for tax purposes.

"The problem with book value is that most of the time it far understates the true value of your equipment. If you were to buy a piece of equipment for $10,000 and you were to expense that, which you are allowed to do under IRS rules, the book value of that item immediately is zero, because you have fully deducted it," Bernick says. "That really isn't appropriate. The same would apply to items in your practice that would depreciate over a 5-or 7-year useful life under IRS rules. Therefore, adjustments are recommended.

When valuing your practice, the first step related to adjustments is to take back all items that were expensed on your balance sheet and put them back on the sheet, Bernick explains. To arrive properly at a good value for hard assets, the assets must be added back to the book value.

The second adjustment is to restate depreciation. Bernick recommends depreciating equipment, for example, on a slower basis. Practices can continue to write off hard assets very quickly for tax purposes to get the deduction, but should have a different approach for valuation purposes, which entails restating depreciation. Assume a minimum value for each asset of 20% of original cost. If you are using a 10-year useful life for items in your practice and the item is still in use, then it should at least have a value of 20% of the original cost.

After adding up all modified book value items, subtract the debt to arrive at a final net value.

The above calculations cover most hard assets, according to Bernick. Consider also making an adjustment for inventory. For example, if you keep a significant number of optical frames or inventory of contact lenses, determine how these will be added to the mix. One method is the physical inventory. When you select a date of valuation, you would physically count up all containers and frames and know what the cost per item is. "That may be difficult to assess because with your frames, they have different costs. Plus the inventory changes from day to day," Bernick says.