EBITDA Everything You Need to Know About It

Welcome everybody to another episode of the Dental Boardroom podcast. This episode today relates to a subject around the dental practice valuation. So I'm also going to include this on my Dental Practice Sale podcast as well, so you'll see it show up in both podcasts. What I want to talk about today is this term called ebitda E B I T D A. The reason why I bring this up is even though it might sound like a cryptic Egyptian term, it actually stands for something very important in business in general at all levels, small and big. But also, and especially here in the dental space, as you know, DSOs have been on the prowl for a good decade or more looking to consolidate or roll up dental practices. Now, I'm not going to go in to all the reasons why dental practices are consolidating right now, but this is a term that I've had many clients ask me about over the past 10 years. Wes, what is my EBITDA? And so I will usually go through their P and L and I will come back and I will give them an explanation of what is their ebitda. Now, whether or not you're selling, I do think that you should understand what this term means, and that's because you're a business owner. Now, there may be some associates listening out there as well. I do think this would be valuable for you as well. Just getting educated on the business side of dentistry, which is really what I'm aiming to do here on the Dental Boardroom podcast and the Dental Practice Sale podcast is I just want you to become first as effective CEOs or business managers of your dental practice. Because it is a business. It's yes, it's a practice, but it is a business with all the features of a standard, typical business. You've got a tax id, you've got payroll, most of you have debt, you've got financial reporting, you've got taxes, you have benefits and a retirement plan. You have budgets, you have a bank account for your business, you have payroll. You have all of these components and that make up a business. I mean, if you really think about it, Amazon, Apple, Exxon Mobile, doesn't matter, Ford, they all have a lot of the same elements of a business as you have. Payroll being a huge one, for example, marketing being another one, accounting and finance costs, legal costs being others. And you don't have inventory.

Thank the heavens for that because inventory is a complicated aspect to accounting and business finance. But most of you are not selling product, you're selling a service. Now, therefore, as a business owner, all you CEOs of your dental practice. I do think you need to understand what this term is, whether or not you sell to a dso. And I'm playing agnostic on that. That is your decision. I've done a lot of podcasts trying to educate you on, on what it means to sell to a dso, the advantages and disadvantages of doing that and ultimately you choose whether or not that is a good decision. Now at Practice cfo we are really focused on the private practice doctor. We believe that a private practice doctor, even today when competition is extremely high and insurance companies are reimbursing an inadequate amount, it feels like relative to the cost and especially the increased cost in your dental practice. I still believe, and not only do I believe, I see it firsthand. Dentists making incredible amounts of profit in their well run dental practice. And I've also seen the opposite too. Working really hard, but just not taking home enough to justify all of the stress and the labor of running a dental practice. A lot of it comes to how well we're managing that as a business, as a leader, as, as a manager, as a communicator, as a culture creator, as a process creator. All of those things that make up great businesses, they all apply to a dental office. They apply here at Practice CFO with my team, I go through these same things. There are common aspects to every business. Well, every business can be value. Most businesses that have cash flow to them, a positive cash flow are going to have a value meaning that a could potentially sell or in the case of a dental practice virtually. In every case you can sell a dental practice just like you can sell a home. Now, the valuations of the dental practices are very unique to the dental industry and every industry has valuations and the valuations really can be nuanced to that industry. For example, a dental practice is going to have a different valuation than a CPA practice. And within dental, an orthodontic practice is probably going to have a different type or calculation of evaluation than say an oral surgery practice. Are you looking to buy or sell a dental practice? If you're a seller, how do you find a strong list of potential buyers? There's no MLS or Zillow for dental practice sales. In such a fragmented market, many dentists selling their practice field discouraged. That's why I built practiceOrbit.com practice orbit is modernizing how dental practices are bought and sold. It's a platform technology. Y' all know them, Zillow, Airbnb, Uber and OpenTable, just to name a few. These technologies do two things. First, they help match buyers and sellers by centralizing the marketplace. Second, once the match between buyer and seller is made, these technologies help them navigate the sale to a successful close. Here are a few of the features inside a Practice Orbit users can determine a reasonable sale price for practice in just minutes. All they need is the most recent business tax return. Practice owners can use the directory to find important service providers like practice brokers, attorneys, accountants and bankers. Practice owners and their brokers can invite those service providers into the platform so all parties are coordinating the sale together. Practice owners will have a beautiful digital listing of their practice, like a home on Redfin. And importantly, the listing will be anonymous and personal information like your address, name and pictures are only released after an NDA is signed and approved by you or your broker. Practice buyers can create saved searches to be auto notified when new listings come on the platform that fit their desired specialty and location. And hey, dental practice brokers, you can list all your practices on the site for free. By doing so, you'll get access to Practice Orbit's large pool of buyers, all of whom have created profiles and saved searches to be autonotified. When new listings come for sale, you can use the platform to introduce your listings to a targeted set of buyers. Additionally and optionally, you can use the platform tools such as a built in NDA, a customizable loi, and a workflow tool to navigate the sale from LOI to closing. In fact, you can manage all your listings on the system, from listing the practice to NDA, to loi, and finally to closing the deal. Create your free account today@www.practancyorbit.com.

Now I'm not going to get into the nuances between the practice types. I'm just going to focus on something that all of them ultimately are trying to uncover as they look at the numbers, they're trying to sort of unearth this number called ebitda. And if you're selling to a private buyer, say a young associate out of dental school a few years is going to buy your practice, they're typically not looking at this term ebitda, but even then it still applies in many ways in understanding what the value of your practice is. Now, if you've been listening to me on this podcast, you know that I will talk often about the the the mentality of staging your practice for a sale. Not because I'm actually trying to get you to sell. But I promise you that if you treat your practice as if you are going to sell in the next 12 to 18 months, you will Be a better business manager because it makes you start to dig in and look at the details of your numbers. And as soon as you start to look at the details of your numbers and you start to understand where your practice needs attention from you. As the CEO of this practice, for example, is your labor cost in alignment with your collections, if not within your labor cost, what's the problem? Is it hygiene pay? Is it an unproductive hygiene? Is it too many administrative staff at the front desk? What is it? Or is it simply we are not getting enough collection out of your team? That's one small example how, when you really understand your numbers and understand how you're doing relative to the industry as a health benchmark, you can start to focus on those areas of your P and L to improve them. Because when you do go to sell your business, at the end of the day, it doesn't matter how long you've owned it. It doesn't matter how much blood, sweat and tears you put into it. I'm sorry to say I don't mean to break any hearts, it just doesn't matter. It doesn't matter how shiny and glossy it is, it just doesn't matter. What matters is cash flow. Cash flow is what drives the valuation of a dental practice. Cash is king. If I'm a buyer and I buy your dental practice, I'm going to have to come out of pocket money or most likely get investor money, or I'm going to have to get traditional financing through a bank. That's called debt financing. If I get money from an investor, that's called equity financing. And, or there's just personal financing. Really there's one of those three personal financing out of my pocket, debt financing from a traditional bank, which is how generally a private practice buyer buys the dental practice. That's how it's historically been done, but lately, especially with DSOs, you have these private equity companies where there's a lot of money slushing out there looking for a home in, in the space of, of the private markets. And, and that's called equity funding. And in every case, in every case, ultimately the buyer wants to know, simply put, if I buy the practice, what am I going to take home, cash wise? Now, if you're a dentist, you want to calculate what am I going to take home before paying myself? If you're not a dentist, you want to calculate what am I going to take home after paying a dentist as an employee? Now, I would never do this and I am not a dentist, but if I were to buy a Dental practice. I'm clearly not a dentist, so I'm going to have to pay an associate as an employee or 1099, probably an employee of the practice, to do the clinical production. And if I'm doing that, I want to know after paying my full overhead of labor, labs, supplies, facility, marketing and admin, those are the six categories on a P and L. After I pay that and then after I pay an associate, which theoretically is inside of the labor category, what is left? What's left? What cash at the end of the month is left. Add up for all 12 months for the year, what cash is left for the year. So that ultimately, sort of conceptually is what EBITDA is. I just call it your cash flow profit, which distinguishes it from your financial statement profit. If you look at your P and L, your profit and loss that your accountant, bookkeeper, or CPA gives you, if you look at that number, the very bottom of it, it's going to give you a net income. Now, the only value of the number at the bottom of your P and L, the only value out of that is, is because ultimately that's what flows on your, on your. That, that, that's the, that's the profit of your corporation and that's what flows out on your K1. Assuming you're an S Corp, which most of you are or should be, unless you're a partnership, then you're a 1065. But same thing, partnership or S Corp doesn't matter. At the bottom of your P and L, it flows out to your personal tax return, your personal 1040 tax return on this thing called your Schedule E2. And it lands there and it gets added with. If you're an s Corp, your W2 income and those two things combine to equal your taxable income. Now, you may have other things like stocks, bonds, real estate, properties, a spouse with income, yada, yada, all that stuff. But I'm just talking about from your dental practice, the main two components that determine your taxable income is the net profit from your corporation that flows out on your K1 and your W2. The sum of those two things. Okay, so going back to the subject at hand. If I am a buyer of your dental practice and I care about cash flow profit, what I'm going to do is I'm going to go get your P and L for the last three years and I'm going to, I'm going to put it in an Excel spreadsheet, I'm going to change it up, I'm going to reformat it and Sift out a bunch of stuff and add a few things to ultimately determine a projection of what I'm going to take home as my roi, my return on investment. So if a practice, if a dentist is buying a practice, their ROI or return on investment is once they do the production and of course, the hygiene as well. And after paying off the labor lab facility, admin and marketing, after they pay off those expenses, what's left to the doctor to pay? The doctor's current lifestyle, the doctor's future lifestyle, I. E. Sales, savings, the debt in the practice, and the taxes. And there's one other thing that we business owners love to do, which is run personal expenses through the business that we believe have a business element to them, like our car, like a travel plan, where we do a little bit of sort of dental networking, like some of our Amazon and our Costco expenses, a lot of that sort of slush stuff. We tend meals, we tend to run through the business in order to get a tax deduction. And you all know what I say, toe the line, don't cross it. But I do believe in toeing the line because taxes are a massive friction to becoming financially independent. And as you know me, I'm a financial planner. I'm all about financial independence practice. CFO is all about financial independence. Everything is to drive financial independence. So we do want to toe the line when it comes to taxes. All right, so let's explain this EBITDA term a little bit since it's clearly important, especially, especially in the institutional space of dental practice ownership. Institutional meaning DSOs or what? Sometimes I'll hear as DPOs, dental partnership organizations. I should do a podcast on the difference between a DPO and a dso. That would be a good one. All right. Sorry. I get distracted sometimes on ideas. I love doing podcasts. I always look for great ideas. By the way, please email me if you have some really good ideas or things you would love to learn about in the. On the business side of dentistry. You can reach out to Wes practice cfo.com. all right, what does EBITDA stand for? EBITDA stands for earnings before interest, taxes, Depreciation and amortization. So E, B as in boy, I T as in Tom, D as in dog and A. Ebitda. Ebitda. E B, I, T, D, A. Say it. Say it for me, people. E, B, I, T, D, A ebitda. EBITDA stands for what? Earnings before the following Earnings before interest, taxes, depreciation, and amortization. Let's go through these a little bit. All Right. So you have earnings out of your business. That's earnings is not revenue. Let's not confuse those two things. Revenue is top line. Revenue is your collections. Earnings is after you pay for your core operating expenses, your labor, that's operating, your labs and supplies, that's operating, your facilities, that's operating, your marketing, that's operating and your administrative expenses like accounting, merchant processing, utilities, phone bill, uniforms, yada yada, that's all administrative expenses. Then you have these things that are non operating, which means they don't relate to the ongoing day to day operations of your business. Interest is one of them. EBITDA I interest. Why is that not operating? Because interest is has nothing to do with running the day to day of your practice, of your operations. Interest is simply how you acquire things in your business. Now you could say, well if I take out a loan to buy an X ray machine, of course that affects the nature of my business. Well, that is true. But if you go to sell your practice, guess what? That loan is not being assumed by the buyer. You are keeping that loan and you've got to take the proceeds and pay that off. Debt is what's called a financing activity, not an operations activity. It is a financing activity that is different. Let's go on to the next one. Taxes. Earnings before interest. Taxes. Taxes obviously is not an operating activity. Taxes is simply what you pay for having a business and living in the great US of A. Taxes. And there's various types of taxes. Taxes, since they don't relate to your operating processes, taxes should not be included when calculating the cash flow profit of the business. Let's go on the next one. Depreciation. What is depreciation? Depreciation is when you buy. How do I say this in a way that's very easy to understand? When you buy. In accounting we call it a capital asset. When you buy an asset which is simply something that you essentially could resell. So if you buy a dental chair for $8,000, that is an asset. And instead of that going on your profit and loss statement, it goes on your balance sheet. Because your profit and loss statement is showing income and expenses. Your balance sheet is showing things that you own and things that you owe. So what you what you own that you could resell and what you owe your debt. And the difference between them, which is called book equity, which I talked about that in a prior podcast. Go for it and listen to that if you want to learn more about the P and L and the balance sheet. But depreciation is when you buy that dental chair for $8,000. The IRS does not let you take that $8,000 and deduct it as an expense automatically on your P and L. Instead it goes in your balance sheet and then you take a little bit of that $8,000 and you get to deduct it every year on your P and L over a five year period, in that case, five years for that type of equipment that you bought and it leaks into your P and L as a deduction called depreciation. So a very simple sort of mathematical calculation here is if you buy a dental chair, I'm going to bump that up from 8 to 10,000. Just, just for the math, you buy it for $10,000, you get to depreciate it over five years. $10,000 divided by five years is 2,000. So every year there's going to be $2,000 on your P and L that you get a deduction for. Now it doesn't work so straight line like that. It's more like in the first year it might be 3500 and then 3000 and then 1800. It has a, it has a different allocation across the years. But you get my main point there, that depreciation is dripping in the deductibility of that asset that you bought. Other examples are X ray machines, CAD cams, build out on your, on your practice and adding a new, a new operatory, adding a roof on your building is, is, is a, is an asset and those get depreciated. Now you may also know that if you buy these, the government does allow you this ability to front load a hundred percent of that purchase into the current year. In other words, you sort of sandwich all that depreciation in the year that you bought it. So you actually do get to deduct that $10,000. And that is, that's called Section 179 depreciation. So when it comes to the EBITDA, if I'm buying your practice, I don't care about depreciation because when I buy it, I am not going to carry on your depreciation schedule and I'm going to have my own new schedule that when I buy your practice I will get to deduct the equipment that I buy over a new five year period that's under my depreciation timeline. And so anything that's not relevant to me as a buyer I want to sift out. And depreciation is one of them. Amortization is essentially the same thing. And this is the last item on the EBITDA is Amortization. Amortization is the deduction of the goodwill when the practice was bought. That's pretty much the only time you see amortization is or goodwill is when you buy a dental practice. So those of you listening to me that bought your dental practice, let's say you bought it for a million dollars, you probably had somewhere around 7 to $900,000 of the purchase price, was categorized by your attorneys as an intangible asset, in other words, an asset you can't touch. And that's called your goodwill. And the goodwill is deducted by the buyer over a 15 year period. And so amortization has nothing to do with the ongoing operations and cash flow profit of the business. This is you as a buyer simply getting a deduction little by little over a 15 year period for having bought the practice. Now if I buy the practice from you, I'm going to have my own amortization schedule that starts back over, but based on the amount of goodwill that was in my legal agreement for buying the practice. So to summarize EBITDA earnings before a few items that don't relate to the operations of the business, they are earnings before interest, taxes, depreciation and amortization. And for those of you watching on YouTube, I am sharing my screen currently and with a PowerPoint and you can see this here at the very top. Top. Do you ever feel lost in your practice finances? And how about your personal finances? Ever wonder where your hard earned money goes and why you're not seeing the financial progress you work so hard for? If so, listen up. As a dental CPA and financial planner, I've created our company Practice CFO just for you. With almost two decades of experience, Practice CFO integrates great CPA services like it can accounting and tax with customized financial planning, both business and personal. Think of it this way. Our dental focused CPA services give us the x rays we need to clinically plan your global finances and be effective financial planners. It's a highly customized approach we call the CFO model. Historically, having a CFO or chief financial officer was an advantage of large corporations operations only. But today Practice CFO gives that same advantage to private dental practice owners. As a client of Practice cfo, you'll be assigned one of our dedicated CFO advisors. You'll receive insightful financial reports each month, have regular financial review meetings, reduce taxes, grow your wealth and feel more in charge of your numbers. Because we believe that in the competitive landscape of dental practice ownership today, you have to be an effective business owner, not just a capable Clinician. Reach out to learn more at www.practicecfo.com.

Okay, let's talk a little bit more about what it is. Now that I've defined, sort of dissected this term ebitda to what exactly it is, I'm going to go on a little bit more to what it is as a sort of definitionally. It measures the operating profit excluding non operating and non cash items. So those see in my screen. You can see that in the second part. It measures the operating profitability and it sifts out the non operational and non cash items which are the interest, taxes, depreciation and amortization. Another way of thinking this is a formula method and it's this EBITDA equals the following net income, which is the very bottom line on your P L. So if you got your P and L for last year, all 12 months, you go to the very bottom line, you're going to add some things to it. You're going to that very bottom line, you're going to add back all the IDA items, the ITDA items, you're going to add back the interest, you're going to add back the taxes, you're going to add back the depreciation, and you're going to add back the amortization and that equals your ebitda. And another way I've heard this said is that it is a proxy for cash flow from your operations. If you could only listen to one sentence from this whole podcast, it's going to be that EBITDA is a proxy or it is the cash flow from the operations. Now, I had to explain what's operational and what's not operational to fully understand that, but that's a very simple one sentence statement of what EBITDA is a proxy for cash flow from operations. So again, if I bought the practice and I'm an investor, what is the cash flow from the business back to me to pay my debt or as a return on my investment? Now, the reason why EBITDA is such a commonly used term in dental practice valuation is because it does the following. It helps normalize earnings for comparison across businesses. I'll say that again, it helps normalize earnings for comparison across businesses. Because if I take the P L of one practice and I take the P and L of an unrelated practice on the other side of town, I can guarantee you these two P and LS are going to be formatted very differently. And I will not be able to do an easy apples to apples comparison on the health, financially or the cash flow from operations. So what EBITDA forces in an analysis is it forces to restructure or reformat the P and L in a way across all practices that it comes, it becomes a trans layer, like a currency translator. It allows us to compare apples to apples across the practices. If I say that practice A has an EBITDA of 300,000 and practice B has an EBITDA of 500,000, well now it's very clear to me that the value of the 500, that the second practice has a higher value because its EBITDA is higher. If I just looked at the two P and LS of those practices, and they might have the same revenue and they have a different expense structure. And it's going to be really hard to tell from these really sloppy P and LS that exist out there to know which one is worth more. But when you take those P Ls and you reformat them to calculate the EBITDA, well, now, now I have a common language that the entire industry uses to know what is the cash flow profit out of that practice. And from there you can start to calculate what is a valuation based on that ebitda. But if you don't have that ebitda, you can't get to the next step in calculating the valuation. All right, EBITDA and dental practice valuation. So if you're looking at my screen, those of you that watching on YouTube, those of you who are listening on your podcast, I will just explain it here. It standardizes earnings and it's useful for comparison for comparing practices. Number one. Number two, it removes owner specific discretionary expenses. I want to talk about that one. EBITDA removes owner specific discretionary expenses. These are those expenses that are personal in nature and cloud the true profitability of the dental practice. And that is some of those items I mentioned earlier. But I'm going to add a couple more here. If you put your kids on payroll, which we do this all the time at practice cfo, we put our a lot of the kids on payroll, give them a job description, pay them what is the standard deduction on the 1040 and, and then you shift essentially in this year $15,000 from the parent's tax bracket to the child's essentially free tax bracket, and you get to bank on that spread, which is usually somewhere around $1,500 to $3,000 depending on that spread, and also the state that you live in. So we do that often if somebody has four kids and they're say six, up to 14 years old, we put them on that's probably going to save somewhere around 12 to 15 thousand dollars for the year. Now, the kids aren't really necessary in the dental practice, operationally speaking. So if I'm a buyer, I'm going to say, whoa, whoa, whoa, okay, let's go ahead and remove those expenses. And those expenses or the amount of those expenses get added back to the net income of the dental practice to the net income at the bottom line of your P and L. Those expenses get added back. So pretend you just, you just scrape those off the P and L, those payroll costs to your kids. In this current example, you scrape those off the P and L. And what happens to your bottom line Profit, it goes up because you just removed expenses. If you remove expenses, your profit goes up. If your profit goes up, the valuation goes up. These things are called add backs. You're adding back expense or amounts of expenses are being added back to the profit, thereby increasing the, the profit. Increasing the profit increases the valuation. So if you're selling your practice, you want add backs, you want to find every expense that isn't a true business operation and you want to pull it out and say, hey, buyer, this is not a true business expense. You're not going to have to pay this when you buy my practice. And by doing that thorough vetting that thorough due diligence of your cash flow of your P and L, usually you do it by going through this accounting document called your general ledger, which lists every single transaction for the year and you make sure that you pull them all out. Other discretionary expenses. If you are an owner and you're maximizing your 401k plan, and let's say you're putting in every year as an employer contribution to yourself. Let's say you're putting in 35, $40,000 that is going to be added back because if I buy your practice, I'm not going to be paying 35, $40,000 into your 401k as an employer benefit. That's strictly a tax planning and retirement planning strategy, which we do it all day long here at practice CFO for our clients that we set up 401s for a lot of clients, if they're really cash flowing and maybe a little bit older, in their 50s or 60s, not no longer in their 30s or 40s, they might have a defined benefit plan. Defined benefit plans, you can put in 100, 200, up to sometimes 400,000 in this per year. Well, that's an expense in your P and L. It's not operational. So I'm going to Back that out and therefore the profits are going to go up when you back that out. But a lot of the other common ones, as I mentioned before, are your meals, entertainment, your car costs, some of your travel. Sometimes you'll label things as continuing education. Wed and really is a continuing education, things like that. Those are called owner discretionary expenses. Sometimes I call them perks or just slush. Slush expenses, those you really want to add them back. So if you format your financial statements right, whether you're selling tomorrow or selling in 10 years, doesn't matter, is you push all of those expenses down to the very bottom of your P and L and don't let them get mixed in with, with your true labor and your true supplies and labs and your true facility costs, marketing and admin. That way everything up above in those categories is actually operating expenses. And so if you take your collections less those true expenses. Sorry, you take your collections less those true expenses, you get to a number that I call your operating income and your operating income, that is the punchline of the P and L. Check out my analysis on or my my podcast episode on understanding your numbers and I do a deep dive into understanding your P and L. The operating income is critical. And then below the operating income, I put your pay as a doctor, I put any family on payroll, I put all those slush expenses I told you about, all the EBITDA stuff goes down there. Interest, taxes, depreciation, amortization, all that goes down there. That way the operating income is a true reflection before paying you, the owner, but it's a true reflection of the cash flow profit of your business. Now if you took that operating income and then you paid yourself, let's say, 31% of your collections, if you're a GP, what's left? Then essentially that becomes your EBITDA at that point. All right, I want to go on to. Now why or how is this used in the valuation? So if you think about the valuation, it's really. If you distill it down into two main exercises. Number one is unearth the ebitda. Reformat the calculation on your P and L to calculate the ebitda. That's number one. Number two is multiply the EBITDA by a number to get to the valuation. And often in dental. So now I'm moving away a little bit past the EBITDA into the valuation, taking that ebitda, multiplying it by a standard number gets you the valuation. What is that standard number? In dental practices, it's usually somewhere on the very, very low end, 3.5. Up to for general dental practice, doing sort of an average amount somewhere between 800,000 and let's say 1.5, 1.7 million. It's usually going to be somewhere between, honestly, it's going to be somewhere between four and a half. And six is generally where I see it. Five and five and a half, probably the most common. If you are a bigger practice and let's say you're doing 4 or 5 million in collections and your, and your EBITDA is, let's say 800,000 or a million dollars, that's a bigger cash flow right there. And institutional money, DSOs that are buying it, they would prefer to get more EBITDA in one transaction. In other words, they would rather buy one practice that has 800,000 in EBITDA than four practices with 200,000 in EBITDA. Just mechanically, it's a lot less work when you buy one practice and get that ebitda. So what happens is they're willing to pay a higher multiple. So instead of paying, let's say, 5, they may be willing to pay 6.5 or 7 for that practice that just has the higher cash flow because it's like they're getting two or three for one transaction. And because of that, they're willing to sort of migrate up that number. It's called a multiple, that five or that five and a half, that's called the multiple. So the EBITDA times the multiple equals the the valuation of the dental practice as these sort of institutional or DSOs go through this calculation. And so these are two levers, if you're thinking, how can I get my valuation up? Well, number one is you can get your cash flow from operations up, that is your EBITDA up. Or two, you can negotiate a higher multiple or you do both and that's how you get your valuation up. Now, this is critical for DSOs and for PE groups. I also think this is valuable. Again, I'm not promoting selling to a DSO or PE group. I am simply explaining the concepts so that you are educated on this subject. But even if you are not selling to a dso, even if you're not selling at all right now, I think that you should understand or calculate every year what is your ebitda. Trust me, it will make you so much more keenly thoughtful about your numbers. And when you're thoughtful about your numbers, you just find this motivation to run your practice. Well, I find it in my case, every month on about the 5th, I review my full P&L for practice CFO up and down. I have sort of certain targets, I have certain analytics I run. And at the very bottom you can is in ebitda and I am not selling. I have no interest in selling. But that number gives me a measure like my stock price. It's almost, yeah, it's almost like my stock price. And my stock price is now a way that I can track my progress over time as the CEO of Practice cfo. Okay, and let me now go on to a simple example. Here's a simple example for those of you watching on YouTube here. Sample valuation and inputs and calculations. So step one, we get the financials. Revenues are 1.2 million, the net income. So the very bottom line of the P and l is 250,000. Now we do the add backs and the add backs are the owner salary above a market rate. So let's say that I, the doctor, this is my practice, I did 1.2 million. And let's say that I paid myself $300,000. However, if I sold and I hired an associate to replace my production, if you run the math, let's say that equals 200,000. You pay them 30% of their production. Let's say that equals ends up being $200,000. So I was paying myself 300,000, but really my replacement would be 200,000. So I get to add back a hundred thousand dollars spread. So that's called the owner salary above a market rate. And a lot of times you'll do that because you're trying to max say a 401k or a defined benefit plan. And so you, you jack your own W2 as the business owner way up to allow you to fund more into those. That's the main reason and pretty much the only reason you're going to want to really have a high, high W2 as a business owner. Okay, the next add back I have on the screen is your personal travel. That's 10,000. Let's add that back and then let's add back the EBITDA stuff. Depreciation 20,000, amortization 5,000. Interest expense 15,000. Taxes 30,000. Now I don't have it here, but there might be other stuff. Costco, Amazon stuff I buy for my house, car stuff, some other items like kids on payroll. If that were the case, I would be adding that back here as well. In this simple example, I'm leaving those out. So now if my net income was 250,000 and then I add back all of those items, it ends up being that my true EBITDA is 430,000. Now that's a big difference. That's also that that was like 80% increase from net income. This is why the add backs are so critical. The EBITDA stuff is so critical because you can get your cash flow from, from profits way up there and the higher it is, the better the valuation. So the adjusted ebitda here is 430,000. Now let's say we take a multiple here. This is a fairly conservative multiple, but we take that multiple of 430,000 and we, and we multiply it by that multiple of 4.5 and that is 1.935 million. So the practice doing 1.2 million is valued at 1.935 million. Now that feels a little flush to me, meaning a little bit high since I've seen a lot of DSO sales in a private practice. This practice would probably sell for closer to maybe a million, maybe 1.1. A bit of a stretch there, but maybe rarely does it get up to 100% of collections. On rare occasions it might if the overhead is really low. But. So then you're going to ask me, well, why would the ebitda derive a 1 point, essentially a 1.9 million valuation and a private practice 1.1? Well, here's why. If you were to sell to a private practice for 1.1 million, a private buyer, I should say it's because you essentially can walk away tomorrow. Buyer gets a loan, the bank finances it, they give you your 1.1 million, you, you walk, you keep the cash in your checking account and you're done. You may stay back and work and be paid as an associate of the buyer. That's fine. But that's, that's irrelevant to the conversation here. If you sell to a dso, what they're probably going to do is pay you a million down and then they're going to say the remaining 900,000 is contingent upon a few things. It's contingent upon you maintaining your collections over the next two years. It's contingent upon you staying for at least three to five years. It's contingent upon no liabilities emerging after the sale that we did not know about. And it's contingent upon various things. And if those things are sort of met, then the rest of that payout of 900,000 will come usually over a one to two year period. So that's, that's the catch. The DSOS bill pay you more, but there are more strings attached and a lot of times those strings may not be worth the extra amount, but that's A personal decision. And you know what? Every DSO is a little bit different. Their culture is different, the systems are different. How much they make you change your practice operationally is different. Some make you change your practice management software, some don't. Some may make you terminate employee, some won't. Some may make you outsource your billing to, some won't. Some may make you consolidate your supply ordering with theirs, some won't. Now a true dso, a good dso, a good aggregator, is going to do what I always say actually creates value. And that's centralizing the operations of multiple practices. If they don't do that and you do everything essentially the same, then all they're doing is they're what I call assembling EBITDA across practices. And the more EBITDA they get, they buy it for a multiple of, let's say five and then they go and sell it for a multiple of 10 because they went around and sort of aggregated a lot of it into a bundle and then sold it to a bigger fish. And that is a game. It is a game that's played out there every day in the dental space and in the roll up space all around us in many other industries. That's the nature of private equity in many ways is to do that. And so I will always say the true economic value really is created when you centralize the operational structure to get benefits of economies of scale, which is basically benefits of being big. So that is a sample valuation or calculation of the EBITDA calculation and the multiple here and an explanation of why institutional money, I.e. dSOs tend to pay better than a private practice sale. Even though many cases, many dentists have regretted that because all those strings attached ended up making it them in a worse off situation after the fact. So you just got to be very educated. Ultimately you make that call. I just want you to be fully educated on it. As a defender of you a little bit, I'm a defender of the private practice space. Practice CFO loves working with pri. With private practice owners, we believe they can make more money as a private practice owner than working for a dso. Generally speaking.

Especially if you're running your practice right, really, really well. Now There are some DPOs, dental partnership organizations out there that own a minority interest. And there's one I'm very familiar with that I'm sort of consult with a lot called SPP Dental. They take a minority ownership and so the doctor still owns the majority of it. Sometimes they only take a 20%, 30% stake in it and that way The Practice gets access to scale and sort of the partnership and camaraderie of a larger group. But the doctor is still the private practice owner. So there are some kind of hybrid models out there as well for some dental practice owners. Okay, the last thing I'm going to do is show you. As many of you know, I have a software called Practice Orbit. And if you want to sort of get a decent idea of what your practice is valued at, this is a free way of getting. What I'll compare it to is a Zestimate. We all know Zillow and how Zillow coined this term when they came out called the Zestimate. And they essentially banked off the MLS and consolidated all the data from the mls, the multiple listing services that real estate people use in order to create estimated values using that, that data, all the sales data. And so what Practice Orbit does is it doesn't do it first fully automatic, but if you have your tax return within about two minutes, you can have a pretty good low, medium and high valuation or price estimate of your practice. I am not a certified valuation expert. Practice Orbit is neither a certified valuation expert. However, as a dental CPA and advisor and having been in hundreds of dental transitions, I created this software and I think it's pretty darn accurate. And so far as I see practices sale, this has proven to be quite accurate. And it goes even the next step and calculates what do you take home after paying your debt, your taxes, your broker and selling expenses. At the end of the day, that's the number that matters. So what I want to do is give a quick demo on how that works. Those of you that can see my screen on YouTube, you will see it right here. Let me actually pull it up. For those of you who are not on YouTube, I will explain this to you. Let me just find the right that I place for this. Oh yeah. So if you go to practice orbit.com www.practiceorbit.com you will come to a place that says my dashboard. You can create a free. It's always free for, for you to create your account. And I don't use it for, for marketing purposes or selling nothing like that. And when you are in on your dashboard there's a menu on the left. If you're not selling your practice, most of them don't apply. But at the very bottom on the left it says Price Estimator. Now in order to get there you do have to fill out your profile, which is very simple, but please do that. And then you go to Price Estimator on the bottom left. And there are three simple sections. The very first one, as you can see on my screen.

As you can see on my screen. Okay, annual collections is very easy. Just take what were your annual collections last year or over the past rolling 12 months. So if you're in July, go ahead and take from July of the prior year to June that you just finished and use the rolling 12 months. The most recent 12 months is always the most valuable or relevant financial information when valuing a dental practice. But if you want to be simple about it, just to get a ballpark, just get your P and L from last year or go into your practice management software and pull up a collections report for last year and put it in. Now, ideally I would use your P and L because that reconciles to the bank and ultimately it's what hits the bank checking account as collections that is what a buyer is going to rely on. So I'm going to go ahead and put in here 1.5 million, so 1.5 million. And then you choose what type of dentist you are. Endodontist, general dentist, oral surgeon, et cetera. And the reason why I do that in the system is because there are different multiples based on the specialty. And wherever there is more recurring predictable income, that's going to have a higher multiple. So orthodontists tend to have higher multiples because they have contract receivables, fairly predictable income stream. A general dentist has hygiene recall, so more predictable. Endodontist and oral surgeons generally a little bit less predictable. So those tend to have a slightly smaller multiple still selling very well. And so choose your specialty. I'm going to, I'm going to put in here general dentist and I'm going to click this little arrow for the next, the next portion put in your state. I'm going to go ahead and put in California and then choose what type of business you are from a tax standpoint. Are you a C Corp, Are you a sole proprietor or are you a partnership? So most of you are going to be S Corp. So I'm going to click on that. And in this blue box down here you can click on the 1120s, which is the tax return for the S Corp. If you click on that, you can see it will open up the page, the only page really that you need when you're doing this. It's very easy. And then you see on this tax return on this one page all these boxes on the right, box 1, 2, 3, 4, etc. That's what you're going to need in order to do this. If you are a partnership, you click partnership and then click on the 1065, which is the tax return for a partnership, and it will show you the page that you want there. So I'm going to go back to S Corp and then I'm going to scroll down and it's going to ask you to fill in six boxes from that tax return, in this case, box seven. So I'm going to use an imaginary tax return. And box seven says owner compensation. And the owner compensation is 200,000. That's the owner's W2 that they paid themselves, themselves through payroll. The interest. I'm going to get into a little bit of this EBITDA stuff. So the interest, remember ebay? The interest. Let's say the interest on my debt was 12,000 for the year. Then I get into depreciation again in the EBITDA stuff, depreciation for the year. Let's say my depreciation was 20,000. Pension expense, that's the 401k. Let's say that the employer pension expense that I funded was 50,000. Now, theoretically, what you do is you'd say, okay, of the 50, 40 went to me, the owner, 10 went to the staff, and you would want to put in 40,000 here. So I'm actually going to do that. I'm going to put in 40,000. You can talk to your accountant or what's called your TPA, who does the end of your work on your 401k to see what portion went to you and what portion went to your stat on the amortization. This is where, this is one area where usually you have to go to the a supporting schedule to the box 19 and it will say box 19. Usually right next to it, it'll say, go to Statement 1. Scroll down on your tax return, you'll find Statement 1. And then in that list you go down to the amortization and you put in what that is. Now, if you've owned your practice for more than 15 years, your amortization is going to be zero. And so I'm going to put zero here. Let's say I've owned my practice for more than 15 years. Otherwise, put whatever is in your tax return that says amortization. And then let's say the net income on my tax return was 150,000 on box 21. Now, the last thing you got to do in this section is answer this simple question. How aggressive were you during this year in running the following types of expenses through the practice for Tax purposes, things like your personal Amazon and Costco. Automobile, food, travel, phone, entertainment, etc. And you got three simple options. I ran a lot through the practice. I ran some through the practice, and I ran very little through the practice. Just how aggressive are you in that? You know, if you're constantly pulling out your business credit card every time you go on Amazon, you're probably more aggressive. If you're buying your car and running it through your business, you're probably a little bit more aggressive. And so what I do, instead of making you go through your, your financial statements and your, your bank statements to itemize all those out, which can take you a long time, I make this pretty simple because we're generally just trying to get a decent ballpark here. And so I'm going to put. I ran some through the practice, some of these personal perks, slush expenses through the practice. Now, before I click this update button to calculate the valuation, in order to know what my net proceeds are, I'm asking you to enter in what is your practice debt? Now, exclude your auto debt, because that's kind of a personal debt. So remove that. Let's say your practice debt is 350,000. Maybe it's some equipment loan, maybe it's still some of your acquisition loan. But I'm going to say on your balance sheet, you still owe the banks 350,000 for all the items in your practice. Then if you were to sell and you sell through a broker, and let's say the broker charges you 8%, now I can move that up or down. Some brokers charge 10, some brokers get a little bit closer to 5. I'm going to go ahead and use 8% here, which is, I think, a fairly reasonable number. And I'm going to click update. Now, it's going to take all that information and I'm going to update it. And now at the bottom, it calculates this awesome table with a low median and high valuation. I'm just going to start off with the median here highlighted in purple Median estimated value 1,086,000. So think about that. The collections were 1.5 million. And it's basically saying 1.1 million. So if I just do that math on my calculator, 1.1 million divided by my collections are 1.5 million. That is 73%. So a lot of you, a lot of you are going to say, wes, isn't that low. I thought dental practices are selling for closer to 85%. Well, some are, but this practice clearly has a high overhead and if it has a high overhead, the profit is less. And ultimately, practices are valued based on their cash flow, not on their collections, but their cash flow after all their overhead. That's why it's a little bit lower here. So median price 1,086,461. The low end, which is 20% below the median, would be 869,000 on the high end, which would be 20% above the median. That's 1.303. Now, a lot of sellers come in here and they say, okay, I want to do a close to the high end. I'm going to do 1.2 million. That seems like a very common place to go. And now what you can do is say, okay, great. This is as a ballpark. I can print this out. If I'm not selling, I can give it to my estate planner so they know about what the valuation of my practice is. I can give it to my financial planner. And as well, if they're doing a retirement plan for me to know what is the value of my dental practice as a personal asset that will help pay for some of my retirement later when I sell it. There's various reasons why you want to do evaluation other than just to sell it. Now, what I do here is I go to the next step and I say, okay, if you can sell for 1,086,000, what do you keep? Well, you got to pay $350,000 in debt. Cause remember, the buyer is buying your assets. They're not buying the stock of your corporation. And because they're buying your assets, you're simply selling your stuff. Your equipment, your chairs, your furniture fixture. And then the intangible asset, which is the remainder of the value of the practice, that's called goodwill. And that goes over into the buyer's entity. And so you take the proceeds of 1,086,000, and now you got to pay off the debt that you still had. That's why it's kind of great if you don't have debt when you sell, because then you don't see this big outflow just to. Just to satisfy the debt. Estimated taxes here, it's 274,000. It's not going to be exact, but it's going to be pretty darn good. Remember, I'm a cpa and we've done taxes on a lot of dental practice sales. I have a pretty good idea of how taxes are calculated on a dental practice sale. We assume an 80% goodwill, 20% equipment, and a marginal, what's called tax basis. When we run the numbers here. Now that's more than probably you want to know, but this software will calculate a pretty good estimate of the taxes. Then I've got the broker fee, which was 8% of the 1,086,000. And then I have selling costs, which are things like paying your attorney and your accountant when you go to sell. So I have that about 10,865. So what do you net? You net $364,424. Now, a lot of you are probably thinking, dang, my $1.5 million practice only netted me 364,000. Yeah, because your overhead's kind of high and you still had debt on the practice, and you're in California that has a 10% tax at the state level and you paid an 8% broker fee. So, yeah, what do you expect? Sorry to sound unempathetic there, but that's how the numbers play out. Now, let's say you had a more average overhead. So I'm going to, I'm going to come up here and I'm going to go back to my level two here and I'm going to update this and say my net income, my net income was actually 350,000, so my overhead isn't so high, which means, therefore my net income is higher. And I'm going to click update. All right, what is it saying now? Well, now it's in 1.296 million, $1,296,461. So what is that as a percent of collections? 1296461 divided by 1.5 million equals 86,000 or 86.4%. So 86%. Yeah, there you go. This practice has low overhead, and so it's selling at the high, at the very much at the higher end of what a private seller would pay for, the private buyer would pay for it. Now, your debt is still the same. That doesn't go up. Your taxes do go up. Your broker fee goes up as well. Your estimated selling expenses for your accounting and accountant and your attorney are probably around the same. But now you're instead of netting a little over 300,000, you're netting 500,000. So that's definitely better than before. Ideally, you don't have any debt. So if I remove that debt, if I remove that debt of 350,000 and I make that zero, now you're taking home 852,000. Now we're talking, people. Now we're talking. All right, then if you want to get a true valuation in Practice Orbit. In my directory I have an independent non broker based valuation expert who is credentialed to do it formally and his name is Mike Size and does a great job. But it's going to be like an 80 page report which is probably going to come around to be somewhere closer is somewhere close to what I've got in here. So. And that's probably going to cost you about 3,500. Not to say you shouldn't. I think it's a very good idea to do that sometimes, but if you're just wanting a general ballpark, this is going to be a great option as a price assessment. Okay, that is the Practice Orbit free price estimator www.practiceorbit.com. you can log in, create your username and password, or just link it up to your Google login and it is free for you there. Practice Orbit allows sellers also to sort of anonymously list their practice. Brokers can use it for their listing. It's really a platform for brokers, sellers, buyers, bankers, attorneys and accountants all to operate in one ecosystem in order to make the platform or the process or experience of selling your dental practice a lot easier. Okay, and everybody, that is the podcast of the day on ebitda. Now I didn't mention here, by the way, EBITDA isn't mentioned here in this calculator. This is more Assuming a private buyer. Maybe I should have stated that earlier. This is really related to a private buyer. If it were a DSO, you could probably bump it up by anywhere from 10 to maybe, I don't know, 10 to maybe 50 or 60%. But just remember all the strings attached that come with a DSO sale, whether that's right or not. For you, that's a personal preference there and experience. Thanks everyone for joining this podcast episode on what is ebitda? What does it stand for, how is it calculated and how does it translate into dental valuations? Thanks for joining.