An understanding of EBITDA and other financial measures

Financial Analysis

Valuing a business is important for anyone who owns one. There are many models that do that however for the purpose of selling a practice, the typical models are one of two.

1. Percent of Revenue – this measure is usually a percentage of the collections (revenue) in a given period (trailing 12 months usually) and the percentage agreed upon will vary based on a number of factors like age of practice, size of practice, practice growth rate, economic conditions and more. We see that number fluctuate between 60% and up to 100% depending on the practice. This model is typically used for smaller practices where a doctor is buying out another.

2. EBITDA multiple – this measure is usually a multiple (4 through 7 times) of the calculated trailing 12 month EBITDA after adding back in deductions that would not continue after the sale. Net income typically has expenses that are tied to the owners and would not be part of the new P&L once sold. Those expenses get added back to the EBITDA number to give a better understanding on the real cash available from operations. 

With all that in mind, when selling the practice, especially the larger practices where the EBITDA is greater than $500k for the trailing 12 months, the buyers are typically corporate (DSO). By tracking your trailing 12 month EBITDA and adding back in the most common add backs, you can get an idea of what your practice might be worth to a corporate outfit. By looking at the trailing 12 months of collections and your historical trends, you can get a comparison of the value should you look at selling to another doctor. In all cases, whether you desire to sell or not, knowing your value is beneficial.

Understanding Financial Terms


EBITDA (earnings before interest, taxes, depreciation, and amortization) is a measure of profits and is used to analyze and compare profitability between companies and industries. It helps equalize comparisons of companies who may have different tax rates and debt loads. It is NOT defined in generally accepted accounting principles (GAAP), so while helpful in many ways, it's not a good stand alone measure. It's formula is [Earnings (aka Net Profits) + Interest + Taxes + Depreciation + Amortization = EBITDA].

By adding back the interest and taxes, you take away the two hard cost items that vary greatly between businesses based on financing choices and where they are located regarding tax jurisdictions. By adding back the depreciation and amortization, you separate out the usefulness of assets because of varying accounting options to deduct those expenses. Overall, it normalizes the earnings to just the operations of the company rather than all the financing and accounting decisions that can change the earnings picture greatly. 

As a measure of profits there are key drivers that can positively influence it:

  • Increase Income/Revenue/Collections
    • Increase # of people you serve (more volume)
      • Add/buy locations
      • Increase marketing
    • Increase average dollars per person served (offer more to same people)
      • Increase fees
      • Add products/services
  • Decrease expense items
    • Improve efficiency of operations (better, faster, cheaper with no loss in quality improvements)
    • Reduce personnel expenses 
    • Reduce cost of goods sold
    • Reduce supply waste
    • Outsource low efficiency services (anything you can't do well without significant cost and low return on effort)
Income Statement (Profit & Loss Statement)

The income statement (aka P&L statement) is one of the big 3 statements used in all industries. The P&L statement is a financial statement that summarizes the revenues, costs, and expenses incurred during a specified period. In other words, it sums the operating and non-operating revenue and subtracts from that the operating and non-operating losses in a given period (typically monthly, quarterly, annually). The income statement can be calculated on a cash basis or an accrual basis. In the small business world, it's more often than not done on a cash basis. The cash basis simply records each dollar received in or paid out as it happens. In the accrual method, you recognize the revenues and expenses in the period you incurred them and you ignore when you get paid or when you pay someone. Both are defined by GAAP and both are acceptable to the IRS. You can even switch from one to the other but not whenever you want, there are rules governing that. To manage a business, using the accrual basis for your books is the best way to ensure you understand the health of the business based on the efforts you put forth in a given period. But for tax purposes, it's often more advantageous to use the cash method to reduce you tax liability and kick the tax can down the road. Both sets of books are maintained in many businesses so managers can do their job and money can stay with the business longer.

The income statement follows a general form that begins with an entry for revenue, known as the top line, and subtracts the costs of doing business, including the cost of goods sold, operating expenses, tax expenses, and interest expenses. The difference, known as the bottom line, is net income, also referred to as profit or earnings.

  • Operating Revenue is the revenue you earn for providing the services. In dentistry, we call that production or more often adjusted production due to insurance adjustments for various plans you accept. If you are using cash basis accounting (which is very common), then you would use the collections or cash received to determine revenue. 
  • Non-operating Revenue is the revenue you earn through non-core business activities. It would include things like interest from money in the bank, royalties you might partake in, rental income from business property if it's part of the same legal structure and other items not part of the core business. It would be recorded either at the time the sale happens (accrual) or the when you collect the cash for it (cash).
  • Other Income is the revenue you get from the sale of long-term assets (vehicle, equipment, furniture, etc) which are one-time non-business activity items. Unless you finance the deal, it's the same period because you are usually getting paid at the time of the sale.
  • Primary Activity Expenses are all your normal operating expenses and often include things like: cost of goods sold, selling, general and administrative expenses, depreciation, amortization, personnel, utilities and more. You would recognize those in the period they happen (accrual) or when you paid them (cash) depending again on your accounting method chosen.
  • Secondary Activity Expenses are your non-core business activities like interest paid to the business for loans you make.
  • Losses as Expenses are all expenses that go towards the loss when selling long term assets, one time, or other unusual costs. it would even be where you fight off a lawsuit.

In dentistry, we use it to depict the following key parameters:

Collections (income), personnel, laboratory, dental supplies, office supplies, marketing and net income. We do so because those are the main categories that impact our efficiency, effectiveness and overall profitability.  

Balance Sheet

A balance sheet is a financial statement that reports a company's assets, liabilities and shareholders' equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure. It is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders.

Assets = Liabilities + Shareholders’ Equity

Assets are classified as either current or long term.

Current Assets (can convert to cash in less than 1 year) can include:
- cash and cash equivalents
- accounts receivable
- inventory for sale
- prepaid expenses

Long term Assets (generally can't be liquidated in under 1 year) can include:
- long term investments
- fixed assets like land, equipment, buildings, etc.
- intangible assets like intellectual property, goodwill, etc
- depreciation on tangible assets
- amortization on intangible assets

Liabilities are the money owed to others. They too are classified as either current or long term.

Current Liabilities (are due within 1 year) can include:
- current portion of long term debt
- bank debts (lines of credit, credit cards, etc)
- interest payable
- wages payable
- accounts payable

Long-Term Liabilities (are due more than 1 year from now) can include:
- long term debt (notes)
- long term obligations

Shareholders' Equity is what remains after all payments have been made.
- retained earnings are monies kept and not paid out to shareholders
- treasury stock
- paid in capital (additional PIC)

Statement of Cash Flows or Cash Flow Statement

The statement of cash flows, or the cash flow statement, is a financial statement that summarizes the amount of cash and cash equivalents entering and leaving a company.

The cash flow statement (CFS) measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses.

Its structure follows the cash from operating, investing and financing activities.

Cash from operating activities can include:
- receipts from sales
- interest payments
- tax payments
- bill payments
- salary and wage payments
- rent payments
- any other type of operating expenses
- changes in AR
- changes in inventory for sale
- add back depreciation taken in period
- add back amortization taken in period

Cash from investing activities can include:
- purchase/sell assets
- loans to vendors
- loans to customers (financing plans)
- any change to equipment assets, or investment positions get recorded here

Cash from financing activities can include:
- dividends
- repay debt principle
- pay shareholders/owners
- cash in when adding cash to the company
- cash out when taking cash away from the company

Working Capital (NWC) or Net Working Capital

Working capital, also known as net working capital (NWC), is the difference between a company’s current assets, such as cash, accounts receivable and short term notes receivable, and its current liabilities, such as accounts payable. Net operating working capital is a measure of a company's liquidity and refers to the difference between operating current assets and operating current liabilities.

If a company has a ratio below 1, it may have trouble growing and getting access to more capital. If a company has a ration greater than 1, it may have an easier time growing and getting adequate capital to do so. These companies should also look at how much of their current assets are likely to convert vs how much is at risk (failure to collect on A/R and customer loans.

Free Cash Flow

Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a business. At the most fundamental level, a company’s ability to create value for shareholders is determined by its ability to generate positive cash flows, or more specifically, maximize long-term free cash flow (FCF).

Debt Service Coverage Ratio:

Even profitable companies can fail if their operating activities do not generate enough cash to stay liquid. This can happen if profits are tied up in outstanding accounts receivable and overstocked inventory, or if a company spends too much on capital expenditures.

Debt Service Coverage Ratio = Net Operating Income / Short-Term Debt Obligations (also referred to as "Debt Service")

Free Cash Flow

To understand the true profitability of the business, analysts look at free cash flow. It is a really useful measure of financial performance – that tells a better story than net income — because it shows what money the company has left over to expand the business or return to shareholders, after paying dividends, buying back stock, or paying off debt.

Free Cash Flow = Operating Cash Flow - Capital Expenditures