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From the VetPartners Experts: The Value of Good Financial Documents

May 8, 2019 at 7:12 pm
Ed Antes

Now that tax season has come and gone, I am starting to enter my busy season of performing and updating practice valuations. Every year when this happens, I am always amazed by the diversity of the quality of the documents I receive and by how much people may or may not take creative liberty with their deductions. The purpose of these ramblings isn’t to delve into the potential legal or ethical implications of these things, but rather to discuss how your practice value may be hindered if your financial reports aren’t quite up to snuff.

Will the quality of your financial documents raise a red flag?

The quality of the documents I see highly depends upon the preparer and the level of service paid for. Usually the worst documents I see are those from clients who have chosen not to engage the services of someone who specializes in such tasks (i.e., an accountant). I have on occasion been presented with hand-written tax returns and ledgers. (For the record, most banks that I am familiar with will immediately say “no” to a prospective buyer if the practice they are considering buying has hand-written financial documents. This is regardless of how well-qualified the buyer may be and how well the practice appears to be doing.)

Other common issues I see that potentially raise a red flag (even when the documents have been prepared by licensed individuals) are:

  • Lack of a Cost of Goods Sold section — Some accountants may argue that this isn’t truly necessary, but when I see this section lacking on either a tax return or a profit and loss (P&L) statement, it is an immediate clue to me that I may be in for a sloppy ride in figuring out what is what.
  • Lack of consistency of categories from year-to-year — Most buyers and valuators will contemplate several years of historical financial data when performing their analysis. If one year you have “diets” as its own category and another year it is buried in the “Drugs and Supplies” category, it causes confusion.
  • Lack of (or too much) delineation in your categories — Just like Goldilocks, you want to find the amount that is “just right.” If you are combining large chunks of expense categories that would be relevant to a buyer (e.g., combining lab expenses, drugs, cremation, and radiology all into “medical supplies”) or if you are delineating too aggressively (e.g., instead of having Diets-Hills, Diets-Royal Canin, Diets-Purina, you should simply combine them all into “Diets”).
  • Financial documents not “tying” together — This is likely the most egregious. If your tax return, P&L, and payroll reports/W-2s don’t all fit together, it casts a shadow of doubt over everything that is being presented. For example, if your payroll expense is $120,000 on your P&L, $125,000 on your tax return, and $115,000 according to your payroll reports, these important documents don’t all “tie” together. Sometimes, these discrepancies are due to benign reasons that can be figured out, but other times it is due to sloppy bookkeeping or accounting. In the latter scenario, it discredits everything that is being presented.

Will your deductions actually make you lose money?

When it comes to how much or how little some people choose to run personal or questionable expenses through their practices, I generally see a bell curve of how much they want to stretch in expensing something that may not pass the sniff test for the IRS. On one end of the spectrum, I see a few of the “honest Abes” who don’t take any liberties at all, and, on the other, I see things that would make me not be able to sleep at night if it were me. (Side note: I was once told by a reliable source about a veterinarian who expensed his entire home mortgage, principal and interest, through his practice.) Most clients are right in the middle.

It is fairly common to see a big chunk of meals and entertainment, auto expense, and travel/CE be discretionary and not be a true expense for the next owner. This is so common, in fact, that most analysts will ask how much of some of these categories are discretionary right away, and most of the larger buyers and lenders to smaller buyers will add a portion or all of these categories back right away depending on the circumstances of the practice operations. The same can be said for over/under paying yourself in wages or over/under paying yourself in rent. These are items that most experienced folks who do what I do or similar to what I do expect and know how to adjust.

Where the trouble comes is when practice owners are burying other expenses that aren’t typical within the practice expenses.  Things like paying their housekeeper through the practice and placing it under “Janitorial” or placing the weekly expense to their local warehouse club under “Office Supplies,” even though 95% of what was purchased was for their home and not their business. When this happens, it is difficult to ferret out these expenses. And, even if you do, there may be a level of distrust from your prospective buyer.

By saving some dollars in taxes (approximately 33 cents on the dollar depending on where you live) you have robbed yourself of anywhere between $4 and $9 (or even more) on the dollar of practice value. An example would be that in the previous year you expensed approximately $30,000 of personal expenses through the practice, which saved you approximately $10,000 in taxes.  If your practice is valued at a 5x multiple (what determines that is a discussion for another time), then you lost $150,000 in practice value (5x $30,000).  In essence, you stepped over proverbial dollars to pick up dimes by choosing to save $10,000 in taxes versus capturing an extra $150,000 in sales price.

Financials that make sense and are consistent and clean will deliver a higher value to your practice, and maybe more importantly, the ability to consummate a sale at all.

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Ed Antes
Ed Antes, MSM, has been specializing in practice brokerage and valuations for the past 7 years, during which time he has helped facilitate the successful transition of ownership of dozens of practices. Prior to that, he was the regional sales manager for Bank of America Practice Solutions, specializing in working with veterinarians in the southwest. Ed is also a member and past chairman of the Arizona Veterinary Medical Association's Allied Committee and has taught various business-related collegiate classes previously at the University of Akron and now at Midwestern University in Arizona. Ed can be reached by email: ed@dvmadvisors.com or by phone: 480-677-0458.

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