You’re close to signing an LOI (letter of intent) on a dental practice. The broker has sent three years of tax returns, a production summary, and a one-page recast, which is the broker’s adjusted profit number after the seller’s personal expenses get added back. It looks clean, and at first glance the numbers hold up.
The broker’s package is built to sell the practice. Our job is to tell you whether to buy it, and a quality of earnings review is how buyers get that answer.
We’ll walk through what a good quality of earnings for dental practice and which findings should change your offer or stop the deal.
What Is A Quality Of Earnings Report For A Dental Practice?
A quality of earnings report is an independent look at whether the profit a practice reports is real, and whether it will still be there after you take over. It tests the assumptions underneath the tax returns and the broker’s recast.
We call ours a practice purchase consultation. We go through the P&L line by line with the buyer and ask whether each number is legit, starting with what the owner pays themselves and what the front office costs to run.
The review is done for you, and the findings go to you and your deal team. It usually takes a few weeks and a few thousand dollars, which is small next to the price of a practice. That starts with understanding what the broker’s package is built to do.
The Broker’s Package Supports The Dental Practice’s Asking Price
We’re not saying the broker is hiding anything. The package exists to support the asking price, and it usually includes tax returns, a production-by-provider summary, an overhead breakdown and an adjusted EBITDA figure (earnings before interest, taxes, depreciation and amortization).
The seller and broker agreed on those adjustments, and nobody has tested them yet. EBITDA is a great starting point, but it’s the first dirty version of the X-ray. You still need a cleaner image before you know what you’re looking at, and our post on EBITDA for a dental practice covers how that figure gets built.
We see a lot of buyers come to us with P&Ls that were done incorrectly, and some are so far off they don’t represent a true business. The gap between the seller’s adjusted EBITDA and the number that survives review is usually where the negotiation moves. The first thing we look at is collections.
Dental Practice Collections Tell You More Than Production
Production is what the office billed. Collections are what reached the bank account after insurance write-offs, refunds and balances nobody paid, and a buyer pays a multiple on profit that comes out of collections.
We had a doctor buying a practice who got to sit with the seller and look at the schedule. It was completely full and booked out for weeks, which was very exciting, until we started going through the P&L and the collection number wasn’t there. A full schedule doesn’t mean the money is being collected.
We see plenty of practices collecting around 89% to 92% of what they produce, and a well-run office with good systems can get to about 95%. A practice well below that has a collections problem you’d be buying, so the review should show whether it’s getting better or worse over the last 12 to 24 months.
Payer mix matters too. That’s the split between fee-for-service patients and the insurance plans the office takes, and a shift toward lower-paying plans can keep production growing while collections stay flat.
Owner Compensation Is The First Dental Practice Number We Test
Most broker packages lead with doctor’s discretionary income, which assumes you’ll personally be the one producing. We think that’s the wrong way to look at it, because it has you thinking like an employee from day one.
The test we always give buyers goes like this. If you bought the practice, put an associate in your chair and went to Hawaii for four years, would there be money in the bank when you got back? If there would, you bought a business, and if you have to be there because nobody else could take over your production at an associate’s pay, you bought a job with golden handcuffs.
So the review backs out whatever the seller pays themselves and replaces it with what you’d pay an associate to do the same dentistry. We usually model that at about 32% to 33% of the doctor’s production, and whatever profit is left after that is the number the price should be based on.
Once owner pay is fixed, the rest comes down to the add-backs and the costs that never made it onto the P&L.
Why Do Add-Backs Change What A Dental Practice Is Worth?
Add-backs are expenses the seller ran through the practice that a new owner wouldn’t have, like a personal car, personal life insurance, or a family phone plan. They get added back to profit, so every one of them raises the price you’re paying.
The review checks each add-back, and it also looks for the opposite problem, which is costs that are missing or priced below market. We’ve seen this plenty of times: the dentist’s spouse runs the front office as office manager for $10 an hour, so the numbers look great on paper, and EBITDA looks strong. Then you buy the practice and hire an office manager at real industry rates, and your EBITDA drops.
Sellers with more than one office need extra attention. When a dentist sells one location “to focus on the other offices,” we check where the shared costs are being paid, because lab fees, supplies, the office manager and hygienists who rotate between locations can all sit on the P&L of the office the seller is keeping.
That makes the office for sale look more profitable than it will be under you. Most of the time it’s bad bookkeeping and nobody meant anything by it, but you’d still be paying for profit that isn’t there.
Most add-back findings end up as negotiating points, which is one more reason to get the production reports the day you sign, or before.
A/R Aging Shows How Well A Dental Practice’s Front Desk Collects
Accounts receivable (A/R) aging is a list of what patients and insurance companies owe the practice, sorted by how long each balance has been open. The older a balance gets, the less likely it is to be collected.
In an asset purchase, you usually don’t buy the seller’s A/R, because it stays with the seller. The aging report still tells you how the billing team works, and a pile of insurance claims sitting past 90 days often points to denied claims nobody refiled or credentialing that lapsed.
That’s a process you’ll inherit with the staff even though you won’t inherit the balances, so it belongs in your first-year cash flow projections. If the aging looks bad, we generally recommend asking the seller for a claims history before you settle on how much working capital to bring.
Which Quality Of Earnings Findings Should Make You Walk Away?
Most findings move the price, but a few should make you question the deal itself.
Production that depends almost entirely on the selling dentist is the first one. If the seller isn’t staying on for a transition and most of the doctor production is theirs, you’re paying for relationships with no promise those patients stay. Some patients leave after any sale, and in a practice built around one provider, that loss can wipe out the math.
Flat revenue with strong new patient numbers is another. We’ve looked at practices where plenty of new patients come in every month and the marketing spend is real, yet collections don’t grow, which usually means patients are coming in the front door and leaving out the back.
Then there’s the data itself. Production that won’t reconcile to the tax returns, gaps in the practice management software, or collections that only make sense once the seller explains them are a problem for your bank as well as for you. A bank’s approval is tied to that specific practice’s real numbers, so dirty numbers can shrink the loan along with the value.
If the numbers hold up, the next decision is how the price gets allocated, which is where we come in on the tax side.
Goodwill Allocation And The Quality Of Earnings Review Work Together
The review verifies the earnings, and the allocation decides how you deduct the price once you’ve paid it. After you agree on a final number, it gets split across goodwill, equipment, supplies and any non-compete, and each piece is deducted on its own schedule.
Goodwill is amortized over 15 years under federal tax law. Equipment generally gets written off much faster, so where the equipment values are defensible, a bigger equipment allocation can mean larger deductions in the early years when cash is tightest.
A documented equipment schedule from diligence supports that allocation. Pair the review with a walkthrough of the chairs, imaging, and sterilization so you also see what’s going to need replacing.
Buyers get emotional about an office and forget to price in the upgrades it needs, so add those to the purchase price and use our dental practice valuation calculator to compare different allocation splits.
Both you and the seller file Form 8594 to report the allocation. If you agree on the allocation in writing, that agreement binds you both, so get it right in the purchase agreement instead of fixing it at tax time.
If you’re under LOI or in diligence, the review and the tax structure of the deal need to move at the same time, and that’s how our dental practice acquisition consulting is set up.
Book a call with Virjee Consulting about your practice purchase, and we’ll talk through where you are in the process and what the numbers look like.
If you liked this, you might also like: Dental Practice Financing: 4 Red Flags That Can Sink a Deal
About the Author
Omar Virjee, CPA is the founder of Virjee Consulting, a CPA firm specializing in year-round tax planning and monthly bookkeeping for solo and small-group dental practice owners across the United States. Omar focuses on helping dentists maximize owner take-home pay through proactive tax strategy, S-Corp optimization, dental real estate planning, and clear monthly financials.
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Getting owner pay right is half tax question and half payroll mechanics, and our dental payroll services cover the mechanics side.
