Buying or selling a dental practice is a significant decision that requires careful consideration of various financial aspects. After all, understanding the target company’s financial state will dictate your actions and help you understand if this represents a good deal or not. Whether you are a dentist looking to expand your practice or a seasoned practitioner contemplating retirement, dental due diligence is key to guaranteeing a smooth transition.
As we explained in previous blog posts, different types of due diligence are required in the dental industry as a part of a comprehensive process. Neglecting any aspect could lead to wasted time, money, and potential loss of the deal itself. In this context, financial due diligence, also known as accounting due diligence, is probably one of the most important steps while conducting this process.
The Importance of Financial Due Diligence
Financial due diligence is essential for both sellers and buyers in the M&A process. For sellers, it serves as a strategic tool for preparation, enabling them to identify and address potential issues. This not only results in a more attractive and transparent presentation to potential buyers but also sets the stage for more streamlined negotiation proceedings.
On the buyers’ side, financial due diligence is instrumental for risk assessment, allowing a comprehensive identification and evaluation of financial risks associated with the target company. Moreover, it helps with an accurate valuation, ensuring that the purchase price aligns with the true value of the business. Overall, this process is essential for ensuring a transparent and successful transaction for both parties.
What Financial Aspects Are Reviewed During Dental Due Diligence?
Income Statements
Income statements provide a summary of the revenues, expenses, and profits or losses over a specific period. This financial statement is commonly used by companies to evaluate their financial performance and assess their profitability. It allows stakeholders to understand the company’s revenue sources, expense breakdown, and ultimately its overall financial health.
Balance Sheets
A balance sheet is one of the three primary financial statements used to assess the financial health and position of a business. It provides a snapshot of a company’s financial condition at a specific point in time, reviewing its assets, liabilities, and equity.
Assets represent valuable resources controlled by the company, while liabilities denote external obligations, categorized as current and non-current. Equity, encompassing common stock, retained earnings, and additional paid-in capital, reflects the residual interest in assets after deducting liabilities. Analyzing the balance sheet helps potential buyers understand the company’s financial structure, liquidity, and overall financial stability.
Cashflow
These statements provide a detailed account of a company’s cash inflows and outflows during a specified timeframe. Analyzing cash flow components helps potential buyers understand the company’s financial sustainability and its ability to generate cash to cover operating expenses, service debt, and invest in future growth.
Positive cash flow means the company is making more money than it is spending, which shows that it is financially strong and flexible. On the other hand, negative cash flow can raise concerns about the company’s ability to pay its financial obligations.
Operating Margin
Operating margin is an important financial metric that calculates the operating income (or profit) as a percentage of the total revenue. The operating income represents the earnings generated from the company’s primary business activities, excluding interest and taxes. It shows how much of the revenue becomes operating profit, helping us understand how well the company is controlling its operational costs.
Gross Margin
Gross margin is the percentage obtained by subtracting the direct production costs from the total revenue. It’s a key financial indicator that allows stakeholders to understand how profitable the main services are. Direct costs for dental services include expenses for supplies, lab fees, and staff involved in patient care. Analyzing gross margin trends over time helps to understand cost management, competitive pricing, and profit generation from primary services.
Interest Coverage
The interest coverage ratio measures a practice’s ability to meet its interest obligations on outstanding debt. It is calculated by dividing the company’s earnings before interest and taxes (EBIT) by its interest expenses. A higher ratio means better financial stability and lower risk of default, while a lower ratio may indicate challenges in managing debt. Lenders and investors often view a low-interest coverage ratio as a red flag, especially if there are adverse economic conditions or unexpected challenges.
Asset Turnover
Asset turnover is a financial ratio that assesses the efficiency of a dental practice in generating sales from its assets. It is calculated by dividing the total revenue of the practice by its average total assets. “Assets” refers to all the resources owned or controlled by the practice, including equipment, facilities, and other operational resources. A high asset turnover ratio reflects effective resource optimization, indicating that the practice is minimizing waste and operating with a leaner structure. This can lead to cost savings and improved financial performance.
Tax Analysis
The assessment of taxes in due diligence provides insights into the financial burden imposed by existing and potential tax liabilities. This includes identifying any outstanding tax payments, potential disputes with tax authorities, or upcoming tax obligations. Here it’s important to analyze both, direct and indirect tax liabilities.
The first one includes income taxes payable by the company. This involves a detailed review of the company’s tax returns, financial statements, and other relevant documents to ensure compliance with tax laws and regulations. It also involves scrutinizing the accuracy of tax calculations, deductions, and credits claimed by the company. The second one encompasses taxes that are not directly related to the company’s income but may affect its operations and financial position, like value-added tax (VAT), sales tax, customs duties, and other consumption-based taxes.
It’s important to note that we listed some of the main aspects reviewed during financial due diligence, but other indicators might be included depending on the case. Dental due diligence is a multifaceted process that requires a meticulous examination of various aspects. Whether you are a buyer looking to expand your dental practice or a seller considering retirement, a thorough understanding of the financial health and operational efficiency of the practice is crucial. Conducting comprehensive financial due diligence can provide valuable insights into factors and potential risks that can inform your decision-making process.
Looking for dental due diligence guidance? Our Dental CPA experts are here to help you navigate this complex process. From a thorough analysis, our team specializes in comprehensive financial due diligence tailored to the unique needs of your dental practice. Contact us today!
