First Month - Sellers AR and AR Credits
A short instructional talk by Wes Read (CPA, CFP®) about how accounts receivable (AR) and AR credits are treated in dental practice acquisitions. He defines AR, explains an age-bucket discounting method to value outstanding receivables (example: $295,000 gross AR discounted to about $137,500 using declining collection rates by age), and gives three practical ways to handle incoming checks post-closing (endorsement/stamp, joint account, or seller deposits then remits — with endorsement preferred). He also covers when the buyer does not purchase AR (remit receipts and commonly charge ~5% processing fee) and how AR credits should reduce sale price or AR purchase price.
Chapters
Hey there, associates. Welcome back. We're going to talk about a subject that comes up in every single dental acquisition that occurs and it, and it relates to the accounts receivable. Accounts receivable is what a. When you own a practice, it's the amount of money you expect to receive from either patients or from the insurance companies for treatment already provided to the patient. And you basically build it, you just haven't received it yet. And that's called accounts receivable. Now, when you buy a dental practice, sometimes you include the accounts receivable in the purchase and sometimes you don't. And how you handle that from an accounting standpoint is really important to make sure everybody gets paid what they should be getting paid. Let me just quickly explain how the price of accounts receivable is calculated. You know that when you buy a dental practice, the vast majority of the time you're buying the assets of the dental practice. You're not buying the stock of the seller, you're buying the assets. Well, assets are things like the chairs and the equipment and the furniture and then the goodwill, which is the intangible asset you can elect to then buy also another asset, which is the future deposits from accounts receivable. How do you calculate that? Let's say somebody has total accounts receivable outstanding of $295,000. So really good balance of accounts receivable that the doctor is expecting to collect in the future. But notice that a dollar that is, let's say 120 days outstanding is worth a lot less than a dollar that is a week outstanding. Why? Because if somebody hasn't paid in 120 days, there's a very, very high chance that it's never going to be paid at all and that it needs to be written off. So you're not going to pay dollar for dollar.
For a dollar that is most likely not going to come in. So you go down this scale where AR that's expected to be, that's only 0 to 30 days outstanding, meaning the treatment was just done in the past 30 days. You're expecting to collect on most of that. You should be collecting on 98 to 100% of that as a healthy rate. Once you go down to 31 to 60 days, you should be expecting to collect most of that 61 to 90, a good chunk of that, if not most of that. Once you start to get past 90 days and 120 days good luck, the probability starts to go way down. You're even talking about contacting a collections agency at that point. So you can see this table that is on the screen where in each bucket there's the amount of accounts receivable total is 295. But which bucket is the largest? The one that's greater than 120 days. Which simply means that for the past, I don't know, 20 years, that this doctor's own, this dental practice, they've been aggregating people who haven't paid and that goes in is greater than 120 days. Some of that might be 3,000 days, for all I know. And the chance of you collecting on that, pretty much nothing. And so you're going to pay a lot less for that. So under the column that says rate, you can see how much that is a reasonable amount in my experience, that you might pay for that bucket of ar. So zero to 30, you might pay 85% of that. So you might pay $85,000 for that first bucket. Then you might pay 75% of $30,000 for tier two and 50% or $5,000 for tier three and so forth. A lot of times you don't even want to buy greater than 90 or greater than 100 days because the probability is so low. So you discount the price. You see that in the next column, what the price that you would pay is. So if you go to the bottom, you'll see there's $137,500 that you would pay if the seller agreed to this discounting algorithm. You would pay $137,000 for $295,000. Now, notice the discount on the right hand side and that the discount on the last bucket is really huge because again, you're not planning to collect that portion. There's another reason why you want to discount it. Because now the seller gets their money right now. They don't have to wait a week, they don't have to wait a month, they don't have to wait two months. They get their money right now, and that's a benefit to the seller. And so you're going to discount the price a little bit because they get their money right now. The other thing too is just that probability, that risk of not collecting it means there needs to be that discount. And then lastly, you're also collecting. You're actually paying staff members to process the receipt and do the mechanics around the deposits. And that doesn't take a lot of time, but that takes up some time, and you're paying the staff wages to do that. So that's a third reason why you would discount the purchase of the accounts receivable. Alright, now when you go into the purchase, let's start off with the scenario that you do buy the accounts receivable. Let's say the purchase price was a million dollars and you ended up paying $137,000, as you can see here, for the total accounts receivable. There are three ways to handle this because what's going to happen is checks are going to come in the mail and they're going to have Dr. Seller's name on it. And you can't just go and deposit doctor Seller's name in your own bank account, but you bought the accounts receivable, so that's your money. So what do you do? Well, three options. Number one is you have the seller provide a signature, endorsed stamp, and they can get these things sort of manufactured as a stamp with their signature, and you can stamp it as it comes in on the back of the check and it's now endorsed and you can go and deposit that into your own account. Some sellers are okay with that, some sellers are not okay with that. Option number two is you can temporarily open up a joint checking account between you and the seller. Especially if you have sort of a very cordial, positive relationship where there's good trust. You could do that. And you deposit the checks, the AR checks coming in into that joint account, and then you immediately transfer it, or maybe once every couple days, transfer the balance over into your main corporate account that's only in your name. Just remember that if it's a joint account, the seller has the ability to access that account. That's why you want to do transfers pretty consistently. Option number three is you remit the check to the seller who deposits it in his or her bank account and then cuts you a check for the amount that they owe that they cut a check for to make you whole so that you end up getting. That is the last option I recommend because a lot of times I've seen that being the option selected and it takes a while to actually get the seller, who's now over in Hawaii for three months to remit payments over to you, especially if that relationship isn't a strong one. Well, it's possible that you may not get paid at all. So I highly recommend number one and then option number two and option number three, sort of in that order of preference. Now, if you did not buy the accounts receivable, meaning that when those checks come in for treatment, done before closing, done by the seller, that money needs to go to the seller because you didn't buy the Accounts receivable. So you have to remit the AR back to the seller. So that check comes in, you sort of keep it in a stash, maybe in a lockbox, someplace nice and safe. And then once a week or periodically you give it to the seller, maybe the seller drops by to pick it up. But you have to do that. Now. Generally you're going to charge a 5% fee of the accounts receivable that you're processing to the seller. Because again, it's coming in. You're handling inquiries from patients, you're handling inquiries from the insurance company, and you're paying labor time in order to process the receipt of that, even though you're not cashing it. Trust me, your staff is going to spend a little bit of time dealing with that money that's coming in. And you need to be made whole to pay your staff for that. So a very common fee is 5% that you charge the seller. So as the accounts receivable comes in, let's say $10,000 comes in, then you would keep $500 or you have the seller pay you $500 and you would remit them the full $10,000. So it's really important that you have a good system to traffic control the money that's coming in. To know does this relate to AR pre closing or does this relate to AR post closing that I get to keep? Lastly, account credits. This is the inverse or the opposite of accounts receivable. The patient overpaid and now the seller owed patients money. Now, some of the AR credits, which are called AR credits, maybe for, I don't know, a treatment that's 10 years old and the patient has moved to the other side of the country or died. And it's very unlikely that that doctor, the seller, will ever have to pay back that patient. However, the risk shouldn't be on you whether or not that patient's going to come in and demand a refund or demand treatment for work that was already paid that they never received. You get the point? So if you did not purchase the ar, you have to treat the account these AR credits differently. If you purchase the AR or if you didn't purchase, if you did or didn't purchase the ar, if you did not purchase the ar, then the sale price should be reduced by the amount of the AR credits or a ratio of it. For example, if there's $20,000 of AR credits, then you can reduce the price by $20,000. Instead of a million dollars, you're paying $980,000 or perhaps you do a sort of discounted ratio just like we did when you buy the AR and let's say you end up reducing the price by $15,000 then as those patients come in and they want their refunds or they want the treatment then you're going to go ahead and provide that out of your own pocket. Why? Because you ended up paying $15,000 less for the practice. You reduced the price by the amount of AR credits. If you did purchase the accounts receivable then any credits accounts receivable credits should reduce the price you pay for the accounts receivable which only makes sense. You need to net the two together when determining the price of the accounts receivable. This is an important subject because it comes up all the time and it can be an area of conflict if there's not a game plan around the accounts receivable. This hopefully gives you some information, some knowledge to be able to approach that conversation with your team. At the point of buying a dental practice.
