Financials and the Importance of Being Ready for the Sell
Keeping financials up to date and knowing the ins and outs of one’s business is an excellent way to constantly have a healthcare business prepared for a sale when the time comes. Although the process of staying on top of the financials of a business may seem labor intensive, when the completion of a healthcare transaction occurs, the diligence placed in the regular examining of the business will have paid off.
Michael J. Reilly, CPA/ABV, CVA, partner in charge of the tax and valuation departments at Dannible and McKee, LLP says financial records are extremely important in terms of if a healthcare business like urgent care has good financial records, it gives the buyer a lot of confidence that looking at the business, it really decreases the amount of due diligence they have to do.
“A lot of times there are year-end adjustment postings, and a lot of times those don’t get made in the records; those get made through an outside accountant and they don’t filter through to the accounting records. Sometimes the accounting records don’t match up with what the outside accounts do. For example, you might have internal financial statements and the accountant does tax returns. The accountant does the tax returns and makes certain adjustments and now the tax returns don’t agree with your internal records. It is really important to make sure that your financial records tie out with your tax returns so that they are all posted and everything is completed on a timely basis,” Reilly says.
“The other part of financial records is that you want them to be consistent. Generally, when the buyer is looking at a practice, they are looking at not just the most recent year, but they are going to go back three to five years. If they see a lot of inconsistencies, it could be due to sloppy accounting and record keeping. It makes them a little bit nervous.”
Curtis Bernstein, partner with Pinnacle Healthcare Consultingthinks that if owners don’t keep their financial statements clean and really have a true picture of what is going on in their business, it makes it more difficult to manage the business as a whole.
“A lot of owners of privately held businesses don’t worry about their financials as long as they are making a profit. They let the accuracy of the financial statements slide. At the end of the day, they could do a lot better if they were keeping their financial statements clean and managing their business effectively,” Bernstein says.
If an owner of a healthcare business is not staying on top of their financials it is possible to overvalue the business and ruin the deal.
Bernstein says that this mistake is always a possibility because a lot of people feel a sentimental value which may be more value than the actual value of the company. With regard to not managing financials, if they were to take a true look at the value of their business and if they were to look at things on their financials and not the cash flow that the entity was earning, they may actually have a lower value than what it is worth, and they may not make as much if they don’t fix those financials or work with a professional that has the ability to review those financials and figure out what some of the concerns might be.
“A lot of times, if a business owner does not record depreciation, and therefor they might overstate the business income which would overstate the value. The consequences would be if you are going to provide prospective information to the buyer, the buyer is going to rely on that information. They are going to do their own due diligence and realize the records are not in shape. Therefore the transaction may shun the buyer and make them feel that the venture is too risky to continue on with.
The records are very important because it minimizes the diligence that buyers have to do, but it also gives them a confidence level. If they see that you have sloppy records, they may just walk away from you,” Reilly says.
As far as expenses in general, when looking at one-time or startup expenses, Bernstein says it is a great idea to create a separate category on income statements within your operating expenses related to startup, breaking out legal costs associated with a one-time litigation, for example.
“Anything you can do to separate those one-time expenses, definitely makes it easier for the buyer to better understand why those may be nonrecurring and why there may be additional value there in the future, or additional cash flow when those expenses are not incurred again,” Bernstein says.
Bernstein goes on to explain that the cost of running the business as a whole is something that should also be examined.
“I think some of those decisions are made on a consistent basis. That is part of reviewing your financial statements, understanding your trends, etc. You should be looking at financial statements quarterly, you should be looking at trends weekly, and making decisions simultaneously in those reviews,” Bernstein says.
“If you are looking for a larger decision, I would say every six months you should be looking at your supply costs and other costs of all your services…any area where you want to make sure you control your cost.”
When examining financial statements and comparing them to prior years, Reilly says if someone is looking at an owner’s financials they are putting more weight on the recent year and less weight on the prior years. However, they have got to look at both.
“You might have a great 2015 compared to 2014, but 2016 could be more like 2014. I think you want to demonstrate a steady level of income or at least some sort of moderate growth, where each year there is an increase in growth or profitability,” Reilly says.
Bernstein says when benchmarking for an urgent care center, staffing is always a big thing to examine, as well as case volumes, staff as a percent of revenue, all discretionary expenses, legal, accounting, office supplies.
“It is always good to benchmark them, not just year over year but also to compare it to peers and see why your business expenses may be higher or lower. With some cases, just the cost of living in certain markets can drive costs higher, another reason may just be inefficiency,” he says.
Jennifer Reedstrom Bishop, principal, Health and Nonprofit Chair for Gray Plant Mooty Law Firm says that one thing owners should pay attention to and what potential buyers will examine is how many days cash on hand the organization has, and if the amount is within industry norms.
According to Bishop, owners should perform benchmark checks in order to make sure that their base cash on hand is within industry norms. Bishop says that ignoring this will show errors in the business’ practice and could put a damper on a potential sale during the due diligence process.
“Looking at accounts receivable, in the healthcare world there is lots of room for games to be played with regard to how accounts receivable are displayed on a balance sheet. You have to make estimates of what the right contractual allowance is, to be presenting what your actual accounts receivable are on your balance sheet. You want to be looking and understanding how they are making those calculations and it also drives you into asking questions about their payor mix, if they have a lot of self-pay etc.
If they have a lot of self-pay, those are usually harder to collect and it leads to how much bad debt they have. That bad debt calculation also comes into play when you have co-pays and deductibles because it is harder to collect from individuals than from payors,” Bishop says.
If you have an interest in learning more about the subject matter covered in this article, the M&A process or desire to discuss your current situation, please contact Blayne Rush, Investment Banker at 469-385-7792 or Blayne@AmbulatoryAlliances.com.