When NextLevel evaluates a dental practice’s total worth, one of the key parts of the equation is a formula called EBITDA:
- Earnings Before Interest, Taxes, Depreciation, and Amortization
With the new year beginning, some dentists may be taking a deeper look at the viability of their practice and their plans for retirement. Whether selling your practice to a DSO or private buyer or simply taking the pulse of your practice for optimization, EBITDA can create a clear picture of your financial reality and arm you with the information you need to drive decision-making. What is EBITDA and why is it so important to the appraisal of your business? Read on as I break down the basics of this valuable tool.
What is EBITDA?
In the broadest sense, EBITDA represents the financial performance of your practice. The purpose of the formula is to remove variables from the practice’s total earnings and create an authentic understanding of its worth. Let’s take a look at each component of the acronym to better define what it means:
Earnings, in this formula, are what the practice generates after your expenses are subtracted, but before variable expenses are taken out. Variable expenses include interest and taxes.
The amount of interest you pay each year is on any debt you carry. This amount can vary from year to year or even month to month. If a dentist acquires new debt, it can be higher and if they pay off existing debt, it can drop. That is why it’s removed from the final picture of the practice’s financial wellness.
Taxes are what you pay the government on your earnings after all credits and deductions are applied. This is another variable expense that cannot be predicted and is also dependent upon the decisions of the owner of the practice and not the actual operating expenses.
The loss of value that occurs over time with assets. Depreciation is usually caused by the gradual wear and tear — technicians using the x-ray machine daily or a drill that is used on thousands of patients. Different equipment will be at different levels of depreciation, which makes it difficult to predict when determining value.
Installment debt with diminishing interest and growing principle. Like interest, this expense can shift and is not factored in the EBITDA definition of earnings.
With this breakdown, you can begin to understand the logic behind the equation. The central profitability of the company, minus variable expenses that might not impact a different owner with different options making different choices.
Why is EBITDA So Important?
EBITDA is a critical tool for dentists who wish to know the net profit of their business. The reasons to assess your EBITDA can vary from dentist to dentist, so I’ve shared the two most common ones:
- The dentist is trying to sell the practice.
EBITDA is critical when a dentist is selling their practice because it is the formula that buyers use to determine the amount of their offer. It adds back in deductions that are typically based on the independent decisions of the current owner.
–A new owner might have an incredible CPA who reduces the tax burden significantly.
–A DSO might have newer equipment that shifts the depreciation fact.A dentist looking to sell wants a practice that drives demand with a clear presentation of profitability.
- The dentist is trying to improve the practice’s financial returns.
Another reason to review a practice’s EBITDA is to get clarity about the performance of your practice.
–If you were to sell your practice today, would you get a satisfying ROI?Your EBITDA can also identify pain points in your practice and show you where you are struggling. –How large would your return be if you lowered your tax burden or cut down your debt?When you see the earnings with all those variable expenses added back in you may recognize some key areas of improvement.
Mastering Your Earnings
Increasing the profitability of your practice can occur when a dentist increases revenue, reduces expenses, or both.
- Reduce Expenses
This is one of the most common methods that dentists will turn to first when improving practice profitability. Many make the mistaken assumption that changing suppliers or reducing the number of disposables used will make the dramatic changes necessary. In fact, it really involves tackling the ITDA and chipping away at those expenses that cut into your cash.
Hire an incredible CPA to help you tackle that tax burden. A good CPA could save you tens of thousands of dollars each year — you can’t do that buying cheaper cotton pads.
- Increase Revenue
Increasing revenue is an even better way to support your business goals and it is understandably one that many dentists balk at. That’s because it requires change and change is difficult for most people.
The first step is a shift in mindset. Instead of getting mired in the minutiae of daily operations, you delegate those tasks and turn your focus to finding new streams of income, adding on new staff, increasing case acceptance, expanding operations and even opening other practices.
Interested in more tips on improving the success of your practice?
Check out our blog for new insights into strengthening your practice, increasing your income, and taking more time for yourself. NextLevel also offers free consultations for dentists who want to take the next steps in transforming their practice.