Financial Statement Analysis (Part One of Three)

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Transcript

Jonathan:

Welcome to the Tooth and Coin podcast, where we talk about your adventure of being a dental practice owner. In these episodes, we're going to be talking about problems that you will likely face as a practice owner, as well as give an idea about actionable solutions that you can take so that you can get past this problem in your practice. Some of these concepts are really big ones, some of them are very specific, but we hope that these episodes help you along with your journey. Now a very important piece for you to understand is that this is not paid financial advice, this is not paid tax or legal advice. We are not your financial advisors, we are not your CPAs. This is two CPAs talking about informational and educational content to help you along with your journey. It's a very important piece for you to understand.

Jonathan:

Another thing that you need to know is if you enjoy today's content, join us on the Facebook group. So we've got a Facebook group that is active with dentists that is going to have content talking about what we're talking about today to continue the discussion. Agree with us, don't agree with us, have a story to tell, have something to share, join us on the Facebook group. If you go to Facebook and you search for Tooth and Coin podcast, click on it to join it and be able to join us there. Finally, if you need some more help, we're developing a list of resources that are going to be centering around our topics of discussion to be able to help you a little bit more than what the content is doing. So if you'd like access to that whenever it becomes ready, all you have to do is text the word toothandcoin T-O-O-T-H-A-N-D-C-O-I-N to 33444.

Jonathan:

Again, that's toothandcoin, all one word, no spaces to 33444. Reply with your email address and we'll email you instructions on how to get into the Facebook group, as well as add you to a list to be able to send you those resources when they're available. And if they're available, we'll go ahead and send them to you as well. So onto today's episode, hope you enjoy it.

Joseph:

Hello, ambitious dentist. And welcome to another exciting episode of the Tooth and Coin podcast. I'm your host Joseph Rugger joined by Jonathan VanHorn. We are at episode number 10 and today we're going to talk about financial statements. Everybody's most exciting, most exhilarating topic that you could ever imagine is financial statement analysis. Jonathan, welcome to the show.

Jonathan:

Yeah, exactly. I talk about financial statements at night after dinner with my wife with a big old glass of wine and she just loves it. It's a big topic of conversation in our house. It's amazing. Not really. She does not like it. She does not listen to those things.

Joseph:

Everybody's topic of conversation right before bedtime is financial statement and financial statement analysis. Well, so Jonathan, we were talking a couple of weeks ago and I was talking to you about a job interview that I was sitting in one time and I was getting interviewed by a guy to take over a financial position for a company. And he asked me a question. He said, "What is your favorite financial statement and why?" So I think that'd probably be a good place to start. What are the three financial statements that are out there? Or are there two financial statements? Or are there one? Whenever we say financial statements, I'd say most of our clients, most of our dentists probably only typically think about one financial statement and that would be the profit and loss. But when we say there's three main financial statements or three recognized financial statements, what are those specific financial statements and what are they called?

Jonathan:

Yeah. So the three most common are going to be your balance sheet, profit and loss statement, cashflow. All three of those have different names that you can call them. I've had people be confused and like, "What's our profit loss? I've only ever heard of the income statement." Or, "What's the statement of income?" Or all those other things. They're the same thing in general, it's the balance sheet, there's your profit and loss or income statement and then the statement of cashflow. Those are the three main ones. And in terms of your question, to me, the financial statements, while there are three separate ones, really to get a fuller grasp of what's going on from a financial picture, you kind of have to be able to look at all three of those at once and be able to read what each of those are saying intertwined with a bit of education.

Jonathan:

It's not something that you can just intuitively look at for most situations of I'm looking at the balance sheet, I'm looking at the statement of cashflow and looking at the P&L. And all of a sudden, "I know everything about this business," and that just doesn't exist. And one of the big problems in the dental industry is there's a lot of misconceptions around what's on those financial statements. And on one side of the coin you have people that think that they're completely worthless, and then on the other side there are people that think that the financial statements are supposed to have every answer that exists about your practice. And neither of those answers are correct. The financial statements are great and they tell you a lot about the business, but you have to understand what's going on and you have to understand what you're looking for in each of those financials, in order for you to be able to actually get any value out of those financial statements.

Jonathan:

And I think that's the reason a lot of people have misconceptions and some confusion around the value the bookkeeping brings and things like that. So to me, the answer "What is my financial statement?" It's all of them. And if I had a choice, I'd have all of them plus some practice management information to be able to look at in order to be able to tell what's really happening in a business in terms of the dental field. I think the most correct answer is it depends on the industry because there's a lot of nuances in this. Not only are there different sets of financial statements, there's different ways those financial statements can be reported. There can be an accrual basis, or it can a cash basis, the income tax basis of accounting. There's a bunch of different ways in which those same things can be reported to people. And if you don't really understand how it's being reported to you, you can make some mistakes and not have the full value of it. So what about you? Which one's your favorite one?

Joseph:

It's a good question that the guy asked me at the time and he had a right and wrong answer in his head. And his right answer was a statement of cash flows, which as many accountants knows it's difficult to kind of glean a picture from somebody that's not used to looking at cashflow statements. So anyways. Let's say all I had to say my favorite financial statement is the balance sheet. And I think that'd be a good thing for us to talk about. We could probably spend an hour on each financial statement and trying to analyze how it all comes together. But my favorite financial statement is the balance sheet. And to me, the thing that always sticks out to me about a balance sheet is it is a measure at a specific moment in time.

Joseph:

So what is your balance in your balance sheet accounts as of today, as of the end of last month, as of the end of last year, as of mid-year? It's as a point in time. Which is always kind of one of those things like let's take a snapshot of exactly where our assets sit, our liability sit, our owner's equity sits, at a point in time. And to me, in my small accountant brain, it gets me a chance to figure out what are the assets minus liabilities and what's the book value or the net worth of business. Which is something that I think that a lot of people can wrap their heads around once we kind of put it into some simple terms. So whenever we talk about assets, we talk about liabilities, we talk about owner's equity.

Joseph:

One of the things that I always talked about whenever I was teaching class and teaching students at the college level and teaching accounting 101, they don't really understand how all of it comes into play. So I use the simple example of a home, right? So it's not specific to the business, but it'll kind of help you understand what an asset is, what a liability is and what is the "equity," the owner's equity in that. So we'll just use easy numbers, Jonathan. If you have a house and that you own a house, and that house is valued at $200,000, that is the asset. $200,000 is the value of that house. If you have a mortgage on that house and the mortgage balance, the liability balance on that house is $150,000, right? So we have a $200,000 asset, we have $150,000 liability, then that means the equity... That's something that everybody's going to be familiar with. The equity in your property, in this one specific piece, in this one specific example is $50,000.

Joseph:

So if I wanted to look at a position of strength or weakness, I can look at a balance sheet. I can look at the balance sheet on the asset side, I can look at the liability side, and then I've got kind of the difference. What you own minus what you owe is your worth, your net worth, your net equity, your net owner's equity. That's made up a whole bunch of different complicated things. But it seemed to click with my students whenever I would say, "Think about owning a house and there's going to be a difference," hopefully there's a difference and hopefully it's a positive amount between what your property is worth, your house is worth minus what your mortgage balance is, and that's the equity that's in the property.

Jonathan:

Yeah, exactly. And that's a great way to simplify the assets minus liabilities equals your owner equity, which is what you learn in accounting 101 is A-L=O. There's three main categories that go on the balance sheet. And I agree, the balance sheet is a great way to be able to look at the financial health of a company. It may not be able to tell you trends or net profitability or anything like that, but it can definitely show you the liquidity and it can show you what type of debt ratios are coming into play. And it can also show you how much money is this business actually making from a accounting point of view, not necessarily a cash point of view. That's one of the limitations of these financial things as I said before is that if this balance sheet is set up on the income tax basis of accounting, that owner's equity has a lot of different things that affect it, that it can make those numbers look a little odd.

Jonathan:

And the reason is because that equity number, it rolls over every year and so it's like a running balance. And some people can get kind of confused on it because you can literally have a profitable well ran dental practice and have almost nothing on your balance sheet. Your assets could be, say, $100,000 and your owner's equity could be $100,000 and that practice could be a $2 million practice. So one thing that's an important concept to also introduce is that value does not technically equal the equity. So to take your home value another step further so that people can understand the balance sheet, if that home skyrockets in value... Let's say you bought it for 200,000 and you owe, let's just say, $100,000 and you have a $100,000 owner's equity.

Jonathan:

If the value of that home went up to $350,000, you still only bought that thing for 200,000, right? But you now have equity of 250,000 because you still only owe $100,000, but the value is higher. So your basis is $200,000 minus $100,000 in liabilities equals your basis is a $100,000. But your value is $150,000 above that. But in the accounting world for the income tax basis of accounting, you don't write up basis to what the value actually is. You just keep it at what your basis is, because that's what we're trying to track on an income tax basis of accounting. So if you're looking at your balance sheet and you're like, "Oh no. I only got $150,000 in assets and nothing else and then $150,000 in equity." You may have a business that's worth a whole lot more than that. And that's just what we call a book tax difference.

Jonathan:

If we were being very, very, very, very, very, very, very, very thorough, and spending a lot of time on your books and you're paying us a lot of money to make those write-ups and adjustments to actual value, having evaluation done every year and having everything be written up to the value of the practice, then the balance sheet would say those things, but that can be kind of like a hidden thing inside of a balance sheet.

Jonathan:

So I think that's an important point to get across too, is that the balance sheet shows you a lot of really cool things and also, there can be things that can be a little bit misleading. So when we're talking about the differences in equity, the equity section is the area that always gets kind of confusing to people. So be careful around that piece. But let's talk about what you look for on a balance sheet to see a healthy dental practice, so to speak. Yeah. Let's just focus on dental practices rather than talk about other industries and things like that.

Joseph:

Yeah, sure. So whenever you look at a balance sheet, as Jonathan mentioned, there's three sections. There's assets, liabilities, and owner's equity. And inside of the balance sheet, most balance sheets are going to sub-categorize all of those different sections. So in your asset section, you're going to have something that's called a current asset. So a current asset is something that can be converted to cash or is cash, can be converted to cash in a year or less. So this would be how much cash is in the practice checking account. Do you have a certificate of deposit? Do you have a savings account? So these things all can be turned into cash either immediately or certainly in less than one year. So those are current assets. And then you've got your longer term assets and you may have some property, you may have some equipment.

Joseph:

All of those things are going to fall into a separate section of the asset section of the balance sheet. So whenever I'm looking, kind of initially, and I'm taking a quick glance, I'm going to look at current assets. And I'm also going to look at the flip side of that, which is a current liability. So when we talk about a current liability, it's the same one year rule. So the current liabilities are things that are due in less than one year. So think real simple terms like your credit card, that's due within 30 days, right? If you're tracking your accounts payable through your balance sheet, that would be a current asset because that's going to be due in less than a year. Versus a long-term liability, maybe your ten year practice loan, that's going to be at a different section.

Joseph:

So one of the financial metrics that a lot of banks are going to look at when they're trying to evaluate your financial strength as a practice... And again, this is an imperfect system, there's a tons of different ways to value different pieces. But they're going to look at what's called a current ratio. And it's very simple, your current assets divided by your current liabilities. So just to give you an easy example, if I've got a $100,000 of cash in the practice checking account and I have an accounts payable balance, credit card balance, all of that, all my current liabilities added up to a hundred thousand, then I have a current ratio of one. And what that simply means is if all of those got called today, all of those liabilities, the bank called, the credit card called, the line of credit, all that stuff gets called today. You can pay all of your bills times one.

Joseph:

If you had, for example, $200,000 in the practice checking account and a $100,000 in liabilities or current liabilities then you could do that twice. So that would be a current ratio of two to one. I mean, when you look at financial statements, Jonathan, I think that a lot of people look at different pieces. I mean, it's easy for me to say that if you have less cash on hand than you do in credit card debt, that's a problem and we need to work through that. But what are some of the kind of healthier things that you're looking for? And we just talked about current assets divided by current liabilities. Or basically, if we're going to super simplify it down, cash divided by bills that are out there. What are you looking for?

Jonathan:

Yeah. On the balance sheet specifically, the first thing.... So another thing that is important for people to realize in terms of balance sheets, is that everything is listed in the form of liquidity. So the most liquid assets are listed first instead of the assets in your balance sheet. And the way the balance sheet is set up is there's the assets set, what are called just assets overall, and those are broken up into current long-term assets and other assets. And then there's a liability section, which liability section it's supposed to be listed in order of how soon that debt is due. So the first thing that I look at the very top, which is the most liquid thing, which is cash, cash is always going to be your most liquid thing all the time.

Jonathan:

Usually, the next thing is going to be something like AR inventory equipment, and then other assets like intangibles and things like that will be listed. But I always look at cash. I mean, that's the first thing. Because if I look at a practice and the cash equals $20,000, unless this is a startup, this practice could have some issues going further. There's a lot we can't answer yet. So in terms of a math concept, this is a not enough information type thing. But if I'm looking at a balance sheet that has very little amount of cash, there's some liquidity issues. What happens if a machine goes down and we're going to have to take on debt? If we do have to take on additional debt in order to do that and that can exacerbate the cash problem.

Jonathan:

So the first thing I look for is cash. I look at how liquid is this business because that can give you a lot of signs and that gives you a lot of context for what you're going to look at when you look at the other pieces of the practice. So the next thing that I'll look at is the current debt. The liabilities that are likely to have to come up soon. Like you said, if cash is less than credit card debt, then that's a big red flag, we've got some issues here, we've got a cash issue. Because that should not be the case in most dental practices, you should not have more credit card debt than cash. From a financial theory perspective, the interest on your credit card debt will eat away at your cash faster than your cash will sit there.

Jonathan:

So the value of that cash will go down, the interest on the credit cards would go up and you're going to have a problem that's just going to get worse before it gets better. So yes. That's a big issue for most dental practices. If I'm looking at a balance sheet just to kind of analyze how the business is doing. And another thing that I want to really, really quickly hone in on because we didn't preface this. We're just analyzing a practice in terms of looking at someone who has a practice and how well that practice is doing, we're not looking at this in terms of buying a practice because what the old owner did and how good they were at saving money does not affect the new owner.

Jonathan:

This is not a specific situation that we're talking about. We're looking to buy a [inaudible 00:19:00] that. Because to be honest with you, I don't think I even look at balance sheets whenever I'm analyzing practices to purchase, but when I'm looking at a clients'... If a client says, "Hey, how's my business doing?" I will look at a balance sheet in that regard because it can help me guide them better with what it is they're needing to do. Whereas if we're buying a business, I don't really care what the old owner was doing, I only care what the new owner's going to do. So there's a little bit different of a situation there. And you don't buy the credit card debt when you buy a business, so who cares if they had $100,000 in credit card debt?

Jonathan:

That could show us something in terms of a spending issue, but the spending on that liability would be affected in the P&L under expenses, so we'd also be already taking that into consideration when we look at the P&L, which we'll get to that in a bit. So anyway. So yes. Cash and then I'll look at short-term liabilities. And then I look at total debt. I mean, how much do we actually have in debt in this office? Because that's a big thing. It's a big deal. You need to know how much money in debt this practice has because if you don't then it's the same thing. Is this a problem that's just spiraling out of control? Is this just we're investing in the practice heavily and we're using other people's money to do that? If so, that's fine, but I don't like seeing a whole lot of debt and seeing cash and credit card debt being flip-flopped.

Jonathan:

It shouldn't be a negative balance there and we're taking on consistently more debt. The only way I could say that that would be worth it would be is if for whatever reason you're.... I don't know. If you knew that you bought X machine, X machine would be bringing you more money. That's really the only way that that'd probably be making sense. So that's what I look at on the balance sheet. I do look at equity a bit just because I'll have to see if it's an escort for how much in distributions we're taking. Equity has the net income on there, but unless it's something financially in our firm created, I don't really even look at the owner's equity because I just assume that it's going to be wrong.

Jonathan:

As you can say, Joseph and I have talked before, before he joined our firm. He was like, "I had no idea that so many firms didn't know how to do bookkeeping," right? And we demand a very high quality of bookkeeping service from our company and for our clients' benefit because we believe in what's on those financials. So basically, unless it's a trusted source for that financial statement, I don't even look at it on the equity side because most of the time it's wrong. And so my assumptions of being correct... Usually cash and liabilities are usually right. We've definitely seen people come in with debt and their debt is negative $800,000 and we're like, "This is great. We're going to have some work to do on this one." So that happens. But anyway. So that's really what I look for on the balance sheet as a whole. What about you? Is there anything else that you look for on balance sheet?

Joseph:

One of the things I love to do with balance sheets is I love to compare them and see. So most of your accounting softwares that are out there or if you have financial statements that are generated, this is basically a book value of your practice that you can look out over time. When I'm doing a financial statement analysis or a client asks me how I'm doing and I kind of really want to dig in, I'll do a balance sheet as of the 31st of last month, then I'll compare that to the prior three months. Or I may put it at 1231 and compare it to the prior three years, and let's see over time what's going on with cash, what's going on with debt, what's going on with owner's equity. And of course, that's also under the assumption, Jonathan, that I'm looking at a good set of books. As you and I have talked many times, we can take a look at a balance sheet a lot and say, "Something's not right there. There shouldn't be a negative upside down balance in an accounts payable account. That's not right."

Joseph:

So I like to look at things over time. So hopefully you've got a good set of books that you're looking at and you can look and see what's happened to cash over time. If cash goes up $50,000 a month and equity stays the same and we look down and it's because we've taken $50,000 out in shareholder distributions every single month. That's a good problem to have is cash is increasing, distributions are coming out and we're still increasing our overall position. So I like to look at the comparative and see kind of what's going on and what happens. If I see a big, huge decrease in cash of $25,000 in a given month, I may see, "Oh, look at that. I bought a $25,000 piece of equipment. Well, that makes sense," right? That's not money that went out the door because we spent too much money on overhead. That's a piece of equipment that hopefully is going to increase our bottom line.

Joseph:

So that's one of my favorite ways to look at a balance sheet is to just compare it to the prior couple of periods and see. And you can look at it, if you wanted to do a quarter by quarter and see what 12 31 looked like, versus 9 30, versus 6 30, versus 3 31, just see how things have progressed over time. Those are the ways that I'm looking at. And I'm also looking at the same stuff that you mentioned, which is looking at the cash position and looking at the liability position and seeing what that looks like. There's a ton of financial statement ratios that are out there. One reason that banks and financial institutions like to look at ratios is it puts everybody on the same level.

Joseph:

So $900,000 of debt for dental practice is not the same as $900,000 worth of debt for a publicly traded company that's huge like a Walmart or a Google, right? Those are not good indicators, right? If you looked at cash in the bank account, my $100,000 is not comparable to Walmart's $100,000 in their cash account. So that's why banks and a lot of financial institutions look at ratios because we can compare what's the debt to equity? What's the debt to assets? What is the current ratio? What's the quick ratio? All of these different things can basically put everybody account on the same playing field to figure out what kind of cash position they are. So my quick easy one to go on is looking at that current assets divided by current liabilities and making sure that that's more than one. And trying to figure out what's that looking like over time?

Joseph:

We have clients that start out and for one reason or another they have to take out a practice loan and that practice loan doesn't cover everything that they need. So they've got to look at other forms of debt, whether it's a high interest rate debt or it's a credit card they had to take out in advance on a credit card. We see some of these things that happen over the course of time. What you want to see is as you look back at 2018, 2019, 2020, 2021, 2022, you want to see progress in each one of these things. And if you continue to have an upside down assets versus current assets versus current liabilities, I know that we've got a problem and we've got a problem that we need to fix because we don't have any profitability because if we have profitability, we'd probably be able to pay down some of those debts.

Joseph:

And certainly a bunch of stuff goes into all of those different pieces. You may be taking too much out in owner's draws are spending too much on CE or any of these other things. And one of the things that you mentioned early, Jonathan, was the concept of all of these financial statements work in conjunction with each other. You can't just look at a balance sheet and know everything there is to know about practice. You can't just look at a P&L and figure out if that's a good office or not. You can't just look at a cashflow statement and say, "Well, that's everything you need to know."

Joseph:

We were talking before the call, what if they had five huge cases in the month of December that jacked up their P&L, but all five of those cases that came through they were super POd by the time that they left the office and they'll never come back again and we're not going to have those five cases. So there's a ton of different things that you've got to look at and evaluate in the overall health of the practice. I really like the balance sheet because it gives us a point in time. It lets us see what do we own minus what do we owe. And we want to see that number increasing over time.

Jonathan:

Yeah, I agree. I love the fact that since it is a picture of time, you can look at two different pictures. It's kind of like on Facebook, I look at the pictures of my kids and when I look at them now, I look at the difference that they've had and what changes and things like that, right? It's a fun thing to do to be able to see how they've changed. And the business, hopefully, when you look at the things that have changed they've happened in a good way and they're going to be fun to look at too. So yeah. Definitely look at the balance sheet. And when we do that, I do that for our firm and I do that for a lot of things of comparing it period over period, because like I said, the snapshot in time doesn't really tell you the whole picture. The balance sheet over time will tell you a lot more. So I agree.

Jonathan:

In terms of the other things, just a really quick thing in terms of when you're looking at cash, a way that I try and take this concept for cash is not only do I like to have more cash than I do short-term liabilities, I also like to have enough cash to equal, at least, one to two times what your breakeven costs are going to be on a monthly basis. And I'll use that. So this is going to be a two-part episode. This is episode 10 of the balance sheet. We'll do episode 11 will be the profit and loss. And so we'll move over to the profit and loss now, but you use the break even point to basically use as a metric to take versus your cash amount, to see how much cash you have to be able to sustain kind of a rainy day fund, so to speak.

Jonathan:

So I like, at least, a hundred to 200% of your breakeven point being in your business bank account with the caveat of you also need more cash than you have short term liabilities. And so probably honestly, the best thing to do is to have your cash, net cash, which would be your total cash minus your short-term liabilities. That amount should be two times your breakeven point. I think that's a very healthy amount of money to keep in there. Anything extra, then a lot of the times in a single owner dental practice that might get funneled out to the owner and then gets reinvested in other places in their personal lives to be able to help with their wealth building and things like that. So let's talk about the P&L, what do you like about the P&L? What is it that gets you going in the morning whenever you see a really nice P&L?

Joseph:

Yeah. Good Thought. So the P&L, the profit and loss, the income statement, if we're talking nonprofit, statement of activities, right? There's all these different fancy names for it. But it's basically, are we running a profitable business? Is this business making any money? So I think that there's a couple of different kind of old terms that I've heard kind of mentioned out there. So one of them is that revenue is vanity. Like, "Oh, look at me. I'm a $1.4 million practice. Congratulations. Look at how awesome. Let me pound my chest about my $1.4 million practice." Revenue is vanity and profit is sanity. If you have a $1.4 million top line, Jonathan, but you spend 1.8 a year, that's not a good practice. I'd much rather have a $800,000 practice that spends $400,000, right? So revenue, top line, sales, collections, whatever you want to call your top line, revenue is vanity and profit is sanity.

Joseph:

So I have a tendency to kind of quickly scan and look at what's top line revenue look like and quickly scan at the bottom and figure out what the bottom line income is. As I'm sure you'll probably be able to tell our listeners like, "If that's just quickly where I'm going, what are some different pieces to that that may not tell me the whole picture if all I do is hop straight to the bottom line in a dental practice?" I mean, the vast majority of our clients and the people we work with for the most part are single owner practices. What's the harm in just looking at top line? Top line's 1.6, bottom line is $10,000 or $50,000 or pick a number. What's missing in that piece of the picture that's not giving them a full picture.

Jonathan:

So again, I'm probably going to beat this like a dead horse, is that the first thing is that you got to make sure their financial statements are really accurate because if they're not, then you're going to be pounding sand to try and get any actual information off of those things. So to me, the net income or the net taxable income or whatever you want to call it, net profit, whatever it is, it has to be set up in a format that you can understand and quickly pull out information that is discretionary in nature. One of the things that happens super commonly in dental practices is that there's a lot of discretionary expenses. So for example, let's say... Obviously, every person's situation is different, but some people for example take, say, a $290,000 wage.

Jonathan:

And the reason being is that that's what they think their compensation should be. Maybe it's a percentage of their production, it's a percentage of revenue, maybe it's just a flat amount, but a lot of the times when they have wages of those amounts, when they're paying themselves, has something to do with a 401(k) that's in the practice, so that they can have a profit sharing plan. When the calculation is being done, they get a maximized amount being contributed from their employee and the employer deduction. And then whenever they do the profit sharing amount calculation, they usually get a pretty favorable amount going towards them if they set it up in that way. I've seen dental practices that have came through, they set that up and they are literally spending $150,000 more than they have in profit on the owner's compensation. So the net income says a negative $140,000 in net income because the owner payrolled themselves 290,000.

Joseph:

Doesn't sound like a net loss to me.

Jonathan:

Exactly. So that's the danger of doing that is you have to know what's discretionary and what's realistic. If you're really analyzing a business and seeing how profitable is this business, it's a complicated answer because the owner should be compensated, obviously. But if that person taking $290,000 in wages, top line revenue is, say, I don't know, 800,000 and they only produced... I'm not saying only as in it's a bad thing. I'm saying only in terms of the conversation. And they only produce, say 600,000 and they took out almost 50% of their production in wages, not to mention payroll taxes and everything that goes along with that benefits.

Jonathan:

So that number may not be what... If you had an associate and they were working for you and you had a practice that someone else was working at and they produced 600,000 out of the 800,000 being brought in. Would you pay them $290,000? Probably not. So it's discretionary, right? So what would be more realistic? And if you're paying them a third, you'd be paying them 200,000. And that would cut that $140,000 loss into 60,000. So it all depends on the practice. There's a lot of different things that go into it, but if you're analyzing a practice [inaudible 00:34:12], what I do is when I look at P&Ls I do a head count of seller's discretionary earnings.

Jonathan:

A lot of people use the term EBITDA in the dental field, which is not really EBITDA because most people never put back in the actual cost of someone to replace the owner. So the correct term of that is seller's discretionary earnings, which basically is you back out whatever was discretionary, which is typically the owner's wages. Is there a family member that's on payroll that is getting 40, $50,000 a year to be an office manager? Are they actually there every day? Are they actually fulfilling all the roles what the office manager would do? Payroll taxes associated with that have to be backed out. Are there any travel expenses for CE, there maybe be more expensive that they wouldn't normally give those same types of reimbursements to an associate to do those types of things with? Are there any types of business entertainment? Are there any types of health insurance that's just for the owner?

Jonathan:

There's tons of different things that can go into that P&L that will be on the P&L if it's properly being recorded, but needs to be pulled out to be able to compare it to other benchmarks of other practices. So that's another reason why I don't really trust a whole lot of the benchmarks that are out there in the dental field because if I don't have the full faith of every CPA that's out there's financial statements, then how am I supposed to have faith in a study that benchmarks using those financials as their basis point?

Joseph:

Yeah. And they're all self-reported too, right? [crosstalk 00:35:54] financial statements, they're self-reported.

Jonathan:

Yeah. So there are generalities and we work with around 250 offices and we see there are just differences in dental practices. So P&L to me is a fantastic thing to look at to have an understanding what's happening. But to me, you have to be financially savvy enough to calculate out that seller's discretionary earnings in order to be able to calculate what the actual profitability of this practice is from a dollars and cents perspective. Once that is done, you would then look at those different key categories, which again, is another area where I find a lot of dental practices financials don't have things properly segmented inside of their financials. So you can't do that. So the presentation of the P&L for dental practices is just as important as the understanding because you and I could look at a financial statement that would come to us and if it's not a really, really well-defined P&L, I mean, we've seen P&Ls that came through that have had 10 expenses on it. And that's all expenses on the P&L. They have nothing else. And this is-

Joseph:

Wages.

Jonathan:

Yeah. Wages, payroll taxes is added on that, insurance is on that. They had a consultant probably in wages, they probably did some recruitment that was in wage. It's just all in one big line item. You can't define anything out of that. So presentation is just as important as well. So what about you? What are other things you like to look at on the P&L? Because I could probably talk about this for another two hours.

Jonathan:

Hey, everybody. Jonathan checking in again here. Just so you know, this episode went really long. This episode is actually a three part episode because there's a lot for us to talk about in these episodes. So make sure you follow up and listen to the following conversations that we'll release over the next couple of weeks. Again, this is a three part episode. This is part one. And we will check in with you on the rest of it going forward. Thanks.

Jonathan:

That's it for today, guys. I hope you enjoyed this episode of the Tooth and Coin podcast. If you are going to be a practice owner or a new practice owner and you're interested in CPA services head on over to toothandcoin.com where you can check out more about our CPA services. We help out around 250 offices around the country. We'd love to be able to have the discussion about how we could help your new practice. We do specialize in new practice owners, so people that are about to be an owner of a practice they're acquiring, about to be an owner of a practice they are starting up, or has become an owner in the past five years. That is our specialty. And we'd love to be able to talk to you about how we could help you in your services with your tax and accounting services.

Jonathan:

And if you enjoyed today's episode, again, go to the Facebook group. Talk to us about what we've talked about. Join in on the discussion and let's create an environment where we can talk about some of these things, so that we can all help each other get through these things together, so that this adventure of business ownership is more fun, more productive, and better in the longterm. Lastly, if you want access to those resources that we are currently building, just text the word toothandcoin to 33444. That's toothandcoin, no spaces, T-O-O-T-H-A-N-D-C-O-I-N to 33444. Reply with your email address, we'll send you the instructions in the Facebook group. We'll send you the resources when they're available and we will see you next week.

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