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Books & Benchmarks

How Do Financial Statements Impact a Practice’s Valuation? Part 2 

by | Dec 16, 2023

Last week, we talked about how having clean and clear financial statements can simplify the practice valuation process. When determining valuation using the Benefit Stream x Multiplier formula, it’s easy to see how financials affect a buyer’s ability to forecast their potential benefit stream. This week, let’s explore how clear financials and overall reporting can impact the multiplier component of the equation. 

What’s In A Multiplier? 

Multiplier formulas are usually applied to EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization),  as in “PE offered me seven times EBITDA.” At a technical level, multipliers can be thought of as the inverse of a capitalization rate, which is the return an investor expects. So, a 5x multiplier implies a 20% demanded return, 4x a 25% return, and so on.

Different assets or businesses demand varying rates of return for a simple reason: risk. The higher the risk, the more return investors demand. And therefore, the lower the multiplier will be. Let’s consider the baseline “safe” risk against which all other assets are compared: US Treasury Bills (T-Bills). T-Bills are so safe that their interest rate is called the “Risk-Free Rate of Return.” 

To sum it up, lower-risk investments have higher multipliers, and higher-risk investments have lower multipliers. Sometimes, different investors may assign different risk rates and multipliers to the same asset.   

What Increases Risk? 

A good way to identify risk factors a buyer may see in your practice is to ask, “How likely is it that someone else could generate the same revenue and profit in this practice if I wasn’t the owner?” Anything that would hold the practice back if you weren’t there is a risk. That’s what we call operational risk. 

Changing local demographics, team instability, and abnormal results (including abnormally high performance!) can all increase a buyer’s perception of risk. Even a buyer’s self-assessment of their ability to run your practice can affect their multiplier. Ever wonder why private equity consolidators pay higher prices than private ODs?  That’s why. 

When it comes to bookkeeping, record keeping can also impact buy-side risk. If a buyer isn’t confident in understanding the overhead and profitability of a practice, it increases the risk they’ll associate with taking over. The same can be said for patient records, employee records, job descriptions, policies and procedures, and more. These are not just things to beef up as you prepare to sell but should be an ongoing effort throughout the life of a practice. 

Airlines learned long ago the importance of keeping the interior of the plane clean and well-maintained—even things like the tray tables. Even though tray tables have nothing to do with the mechanical bits that keep a plane airborne, a dirty tray table can cause passengers to wonder how conscientiously the airline maintains the rest of the plane. 

Clear record-keeping not only helps buyers know their expected income but also gives them confidence that your practice is well-run. The more confident a potential buyer is that they know what they’re getting into, the easier it will be to offer a higher multiple. So, if you’re looking to increase your practice’s value, make sure to maintain accurate books. Reach out to our team of expert bookkeepers today to learn how Books & Benchmarks can help you keep your books clean and up-to-date!

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