Interest Rates Affect on Practice Values – Why now is a good time to sell
Interest Rates Affect on Practice Values – Why now is a good time to sell.
By Rod Johnston, MBA, CMA
Some of you may remember that in October of 1981, interest rates on home loans were 18.91%. Over the years, interest rates have gone up and they have gone down. In the early 2020’s, we saw some home mortgage rates go as low as 2.81%. If you were wise, you borrowed as much as you could at that time and bought a house, even though you may already have one. Coincidentally, home prices typically don’t follow interest rates. In fact, there have been periods of time over the past fifty years where interest rates have gone up and the average house price also went up. The same isn’t true for the value of practices.
When I first got into helping doctors sell their practices in the early 2000’s, interest rates for practice loans were about 7.5%. Most of the terms on those loans were 7-year terms. Meaning you had 7 years to pay off or amortize the loan. What does that mean for practice values? Banks determine how much they will lend based on cash flow after debt service. Debt service is the amount of your monthly loan payments.
To calculate cash flow, you start with the net income on last years’ tax return. Banks typically use 2-years tax returns, brokers when valuing a practice use 3 years of tax returns. I’m using one year’s tax return to keep it simple. You take the last year’s net income and then add back the non-operational expenses in the business. Those expenses are those that may not be necessary to run the business. Expenses could include gifts to employees, a continuing education class you took in Hawaii to get a vacation along with the CE, or meals you expensed for business. You can stop those expenses and still run your practice.
This gives you an adjusted net income. You then subtract your annual debt service to get the cash flow number. The banks then divide the cash flow after debt service by the annual debt service to get a debt service ratio number which should be above 1.2 times the debt service. So, if your cash flow is $120,000 and your debt service is $100,000, your debt service ratio is $120,000/$100,000 = 1.2 times your cash flow. Anything lower than that and the loan would be rejected, or you would need to figure out how to make the numbers work to get the debt service ratio up.
What does this have to do with practice values? Well, if interest rates go up, that’s going to cause a buyers debt service payments to go up. An increase in debt service will result in a decrease in cash flow after debt service. This will result in the debt service ratio going down and possibly dropping below the threshold of 1.2 times cash flow after debt service. The same goes for the term of the loan. Some banks now have 15- or 20-year terms on their practice loans. This reduces the debt service payments as the loan is spread out over more years. The result is a decrease in annual debt service payments which improves cash flow. A bank with a 7-year term may not get the loan approved, but a bank with a 15-year term may be able to do it.
Brokers know all this stuff. When good brokers do their valuations, they’ll do a check to make sure the bank will be able to finance the practice at a certain value. So, they’ll do a debt service ratio calculation and if it falls below 1.2 times debt service, then they should lower the value to price it correctly.
The good news is that there was a recent drop in practice loan interest rates. Interest rates on practice loans are between 5% and 5.5% at the moment. As a seller, this means values can be pushed a bit as the cash flow after debt service is improved with lower interest rates. A practice valued at $950,000, may now be worth over $1 million or even more. Because the lower interest rate resulted in lower debt service payments which helped increase the debt service ratio.
It’s good news for the buyers as well. Lower interest rates can lower their monthly payments as well. This may help them get into a practice that they may not have been able to purchase in the past as the ratio now works. This can be especially good in a startup scenario or in larger practices.
In summary, just remember that when interest rates are low, which they are at the moment, it’s a good time to have your practice valued and put on the market. It’s also a good time to be a buyer as your payments could be reduced.
If you would like a free consultation on the value of your practice, or to discuss a possible transition in the future, please reach out to one of the Omni brokers. We are always glad to help. Phone calls are always free and if you do a valuation with us today, we will update them for free in the future.
Read MoreThe Benefits of Practice Ownership
By: Kim Ford
In today’s market, we encounter fewer veterinarians coming out of veterinary school with the ambition to own and operate their own practice. Several new graduates are lured into a false narrative believing practice ownership is not a career option that would benefit them financially or in their goals to achieve work-life balance in their chosen profession. In truth, there are multiple reasons why a veterinarian may choose to own and operate their own clinic.
One is versatility and flexibility, practice ownership allows a veterinarian to make their own schedule, creating a greater work-life balance. You also have the flexibility to choose your staff and adjust the work schedule in the practice to maximize your time.
Secondly, independence in owning the practice allows the veterinarian to practice medicine the way they want to practice without outside influence. The veterinarian chooses their staff, creates the schedule, and controls pricing and services offered. These are only a few of the items but having freedom of ownership can be extremely rewarding.
Building on the rewards of flexibility and independence, most veterinarians find owning their practice fulfilling and take pride in ownership. They take pride in the client relationships they can build within their community. It is very satisfying to be able to practice medicine the way you choose and structure your practice according to your vision.
Last, but not least is the financial aspect of owning your own veterinary hospital. There is a greater increase in income potential that comes with practice ownership. A veterinarian’s annual income as a practice owner is much higher than working as a salaried employee. Additionally, practice ownership creates a sellable asset when a veterinarian feels it is time to move to another project, career choice, or retirement.
These are some of the positive aspects to practice ownership. Ownership has its challenges. These challenges begin with financing the purchase or start-up of the hospital or clinic. Despite this hurdle, there are several financing options available to qualified veterinarians. There is the task of managing staff and resources, marketing, and other entrepreneurial duties outside of practicing veterinary medicine. These challenges require work, but they are not as daunting as they initially appear. The rewards that come from ownership are worth the work that goes into the initial investment and organization.
Read MoreReducing COGS in a Veterinary Hospital to Boost Profitability
By: Max Truesdel
In the veterinary industry, managing costs is critical to maintaining profitability. One significant area where veterinary hospitals can improve their financial health is by reducing the Cost of Goods Sold (COGS). Here are some effective strategies to achieve this goal.
- Optimize Inventory Management:
Proper inventory management is essential for reducing COGS. Veterinary hospitals should conduct regular audits to track inventory levels accurately. Implementing an inventory management system can help avoid overstocking or stockouts, both of which can be costly. By ordering supplies just in time and negotiating better terms with suppliers, hospitals can significantly cut down on waste and reduce holding costs. Many practice managers and staff members avoid conducting regular audits, but performing these audits consistently on a quarterly or annual basis can provide valuable insights into the hospital’s ordering habits. This practice helps reduce excess inventory that sits on shelves, costing the hospital money, and instead, optimizes inventory levels to enhance profitability.
- Leverage Bulk Purchasing:
Buying in bulk can lead to substantial discounts from suppliers. Veterinary hospitals can form purchasing cooperatives with other practices to increase their buying power. This strategy not only reduces the unit cost of goods but also strengthens relationships with suppliers, often leading to better service and additional savings.
- Evaluate Supplier Contracts:
Regularly reviewing and renegotiating supplier contracts can lead to cost savings. Veterinary hospitals should compare prices from multiple suppliers and seek competitive bids for high-cost items. Developing a strategic partnership with key suppliers can also lead to long-term cost reductions and more favorable payment terms.
- Implement Standardized Procedures:
Standardizing procedures and protocols can reduce the wastage of medical supplies. Training staff to follow these procedures ensures that materials are used efficiently, minimizing unnecessary consumption. Additionally, using generic drugs and supplies where appropriate can also help reduce costs without compromising the quality of care.
- Invest in Technology:
Investing in technology can streamline operations and reduce COGS. For instance, practice management software can automate inventory tracking, appointment scheduling, and billing processes, reducing the need for manual intervention and lowering labor costs. Telemedicine solutions can also help manage patient care more efficiently, reducing the need for physical resources.
- Monitor and Analyze Costs:
Regularly monitoring and analyzing COGS can help identify areas for improvement. Veterinary hospitals should use financial metrics to track performance and set benchmarks. This continuous evaluation allows for timely adjustments and ensures that cost-saving measures are effective.
In conclusion, reducing COGS is a strategic approach to enhance the profitability of a veterinary hospital. By optimizing inventory, leveraging bulk purchasing, renegotiating supplier contracts, standardizing procedures, investing in technology, and continuously monitoring costs, veterinary practices can significantly improve their financial health while maintaining high standards of patient care.
Read MoreOvercoming Veterinary Student Debt Through Practice Ownership
Overcoming Veterinary Student Debt Through Practice Ownership
By: Max Truesdel
Veterinary students often graduate with substantial debt, which can be daunting.
However, practice ownership presents a viable strategy to overcome this financial
burden. By owning a veterinary practice, veterinarians can significantly increase their
income potential and build equity, offering a path to financial freedom.
The veterinary industry has seen remarkable growth over the past decade, with
increased pet ownership and spending on pet healthcare. This expansion presents a
lucrative opportunity for veterinarians to capitalize on a thriving market. Owning a
practice allows veterinarians to directly benefit from this growth, as opposed to working
as salaried employees where income potential is capped.
One critical step in this process is to find the right practice to purchase. This is where a
business broker becomes invaluable. Business brokers specialize in connecting buyers
with suitable practices, ensuring that the location and operational aspects align with the
buyer’s goals. They provide insights into market trends, financial evaluations, and
facilitate negotiations, making the complex process of purchasing a practice more
manageable and less risky.
Using a business broker also helps to identify practices in high-growth areas, ensuring
better patient flow and higher revenue potential. They can access a wide range of
listings that may not be publicly available, providing more opportunities to find the
perfect match.
Additionally, brokers can assist with due diligence, ensuring that the financial health of
the practice is sound and that there are no hidden liabilities. This thorough vetting
process is crucial for new owners to start on solid ground and focus on growing their
business.
In conclusion, practice ownership is a powerful way for veterinarians to overcome
student debt and achieve financial stability. The veterinary industry’s growth over the
past decade enhances this opportunity, and using a business broker can significantly
ease the transition into ownership. By leveraging the expertise of brokers, veterinarians
can find the right practice, set the stage for success, and turn their debt into a stepping
stone towards a prosperous career.
