Practice Valuations 101, part 1/3
We are demystifying eyecare practice valuations in this three-part series! Are you in the position to buy, sell, or buy-into a practice? In this first part, Erich will walk you through reconstructing the financial statements and understanding Earnings Basis Measures. Watch the video and scroll to the bottom of this page to play with the calculators!
Understanding Financial Statements & Earnings Basis Measures
Accurate estimation of an eyecare practice value depends upon financial performance. While historical financials are important, business value relies upon the ability of the practice to continue producing desired economic benefits for its owners.
Private practices, as many closely held companies, are managed to minimize taxable income. Therefore, the practice's historic financial statements, such as its Income Statements and Balance Sheets, require certain adjustments to reconstruct the historic financial statements with earnings basis measures in order to reveal the true economic potential and earning power of the subject business.
The earnings basis measures utilized to value a modern eyecare include:
• Seller's discretionary cash flow (SDCF).
• Adjusted Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA).
• Net cash flow.
Seller's Discretionary Cash Flow (SDCF) is defined as:
1. Pre-tax business earnings.
2. Plus non-operating expenses (less non-operating income).
3. Plus non-recurring expenses (less non-recurring income).
4. Plus depreciation and amortization expense.
5. Plus interest expense (less interest income).
6. Plus owner-operator salary.
7. Adjust compensation of other owners to market value.
This is also referred to as the Seller's Discretionary Earnings (SDE).
Adjusted EBITDA is defined as:
1. After-tax business net profit.
2. Plus interest expense.
3. Plus taxes.
4. Plus depreciation & amortization expense.
5. Plus owner-operator salary.
6. Less replacement of owner-operator salary.
Net cash flow is defined as:
1. After-tax business net profit.
2. Plus depreciation and amortization expense.
3. Plus interest expense.
4. Plus cash flows from Operating Activities.
5. Plus cash flows from Investing Activities.
6. Less cash flows from Financing Activities.
With accurate financial statement reconstructions and forecasts, and calculation of earnings basis measures-- Seller's Discretionary Cash Flow (SDCF), Adjusted EBITDA, and Net Cash Flow-- the subject practice valuation is ready to begin!
Related Calculators
Income Statement Reconstruction
Adjustments to Income Statement
Balance Sheet Reconstruction