What is the Appraisal Formula? Doctors often wonder what activity goes into an appraisal. This description should help you to understand a little of the appraisal process. After accumulating the necessary information, we "recast" the earnings for the past 3 - 4 years based on the tax returns. This process adjusts the earnings to what a buyer would likely see according to usual and customary parameters. Among other adjustments, this recasting eliminates equipment leases, depreciation, interest expense, etc., since a practice valuation presumes that all equipment will be owned outright by the buyer after the sale; in other words, the seller must pay-off outstanding liabilities. (Obviously any other arrangements are possible, but they affect the expected sale price of the practice.) From these figures, we calculate an Economic Earnings factor via a weight-averaging method, giving more weight to more recent periods. Separately, we establish the present value of equipment, furniture & fixtures, leasehold improvements, and inventory. Typically we require input from equipment vendors. We consider lease terms, inventory ratios compared to standards, investment totals relative to practice production, etc. The total of all of these adjusted figures is the value of Tangible Assets. We then use several computation methods to meld the value of tangible assets and earnings with a determination of the value of goodwill. The two most significant methods are called Cost Replacement and Capitalization of Excess Earnings. The value range so determined is then tested against various potential purchase scenarios to validate the "buyability" of the practice based on the expected cash flow. The final value range is then set and the report is issued. Much of the information we gather forms a set of checks and balances as we move along. Having done many appraisals, and having been involved with buyers and sellers in dozens of actual sale transactions, we are clear about what buyers will and will not accept, and on what lenders are willing to support. A practice must demonstrate a sustained level of profitability to have merit in the marketplace; it must make good long-term economic sense as both an investment and a livelihood. |
