What is Goodwill?
This "intangible" figures
heavily in a practice's worth.
BY BRAD RUDEN, M.B.A., Phoenix, Ariz.
buying into a practice as a partner or purchasing a practice outright, the most
difficult aspect of any practice's worth is its goodwill value. Part of the
difficulty in assigning value to goodwill is the inherent intangibility of
goodwill -- how does one assign value to something that can't be seen or
touched? Many approaches and techniques are available for us to use to ascertain
goodwill value and we'll explore them here.
establish a definition
practices, goodwill is typically defined as:
- Established office procedures
- Practice reputation and name recognition
- Staff training and experience
- The likelihood of patient retention
- Office location
- Patient demographics
- Financial condition
- Departing doctor's non-compete clause
- Transition assistance for the new owner.
These elements are intangible because although
they've contributed to the success and worth of a practice, their values are not
recorded in the practice's financial statements. These elements have
institutional value due to their ability to help transfer patient volume and
revenue from one owner to the next.
In past years, when
reimbursements were high, "rules of thumb" were commonly accepted as
approximations of goodwill value. However, the continued encroachment of managed
care and declining reimbursements demand that more scrutiny be paid to items
such as goodwill. This brings us again to the issue of how to measure the worth
of something that isn't recorded in financial statements.
the goodwill elements outlined above are not directly recorded in financial
statements, one can argue that their impact on a practice is still reflected in
the practice's profitability.
Just as a
poor reputation, unattractive office location or questionable financial
practices will negatively affect a practice's ability to generate revenue, a
good reputation, prime office location or solid financial protocols will have a
positive effect on a practice's revenue stream.
is a service industry and, as in any service industry, the value of a business
lies in its ability to generate revenue from the services provided; the
intangible value of an optometry practice is directly related to the amount of
revenue generated from providing optometric services. In other words, goodwill
becomes a salable asset when it's viewed as the expectation of future profits
accruing to someone other than the present owner.
this in mind, I propose that one approach is to view goodwill as a function of
profitability above and beyond average income. My position is that if a practice
can generate higher- than-average income for its doctors, then it's reasonable
to assume that a fair amount of goodwill is present. Inversely, if a practice is
generating lower-than-average income, then it makes it much more difficult to
argue for goodwill.
approach identifies goodwill as a function of cash flow and profitability. By
doing this, we take the intangible aspect of goodwill and make it tangible. We
have taken the components that help contribute to the success of the practice
and tied them to the practice's revenues. In this way, practices that have
profitably negotiated their way through the recent changes and fluctuation in
the marketplace will have maintained, or possibly increased, their goodwill
value, while those practices that are losing profitability are seeing their
values decrease. Accepting this approach, you can take several steps to
"prove" the goodwill value of your practice.
First, track all personal or
discretionary expenses in the practice. These are items that don't contribute to
ongoing operations but are expenses that benefit the owner(s) of the practice.
The cost of these expenses are "un-wound" from the financials to
identify the true operating overhead of the practice as well as to ascertain its
true financial benefits to the owner(s).
discretionary expenses most easily targeted for review are travel,
entertainment, all forms of insurance coverage (property, health, auto,
professional liability, etc.), and any inflated family wages. If you own the
practice and real estate through separate corporations, match the rental
payments to the current market rates.
accomplish this type of analysis, you should maintain complete, accurate
financial statements as well as other supporting documents/appendices for
review. These should provide an overview of the practice's monthly/annual
operations and portray an accurate picture of its financial health.
it in context
Once you have identified
the true overhead and financial gain of the practice, compare the resulting
figure to state, regional and national averages for similar practices. If your
practice is generating income and benefits equal to or greater than the national
average, then you can make a sound argument that goodwill is a justifiable asset
in the sale of your practice. A premium price is paid for premium performance.
As I stated earlier, there
are many approaches and techniques used to ascertain goodwill value. Even if a
practice isn't generating income in excess of an average income figure, there's
often still a sound basis for some minimal goodwill. The argument for minimal
goodwill in an underperforming practice can be bolstered by addressing other
aspects such as number of medical charts, outline of established business
procedures (which may reduce overhead or create a competitive advantage), a
history of key staff members staying with the practice, an overview of
transferable managed care contracts, etc. These are benefits which can accrue to
a new owner and may not be reflected in a practice's financial records.
goodwill really means
practices will always have some goodwill value and less successful practices
will have a more difficult argument to make. For a practice to maintain or
increase its intangible value to a potential partner or owner, it should do
everything possible to maintain its profitability. After all, goodwill means
nothing if it can't be translated into real income or benefits for the
Ruden works for MedPro Consulting. You can contact him at (602) 274-1668 or at firstname.lastname@example.org.
Optometric Management, Issue: February 2004