The question of whether to buy or not to buy (or sell) the accounts receivable in a dental practice transition is one of the more common questions we get once the material terms of the transition have been agreed upon.
What is it?
Prior to deciding if you should buy or sell the AR, you first need to understand some of the basic terminology and what accounts receivable is.
Accounts Receivable (“AR”), in the simplest terms, is monies owed for work that has already been performed. The type of practice and collection methods of the practice will play a critical role in determining how large the AR balance is. A heavy insurance-based practice, where the provider is in network with many companies, will likely have a steady and larger AR balance. Contrary, a fee-for-service practice may only have an AR balance if they offer in-house financing.
The report summarizing the balances is called the AR Aging Report. This report shows the AR balance broken out into age. Typically AR is tracked in aged “buckets”: 0-30 days old, 31-60 days old, 61-90 days old, and over 91 days old. This report will often also show the balance owed by insurance companies versus the patient.
It’s important to understand that this report provides you a point in time snapshot of what the AR for the practice looked like when the report was pulled. Monies are likely received and balances added daily, so it is important to review the most recently available AR report during your transition diligence. While the total AR of a practice will likely vary over the course of the month, a practice with a healthy and diligent collection process will have consistent balances when comparing these reports over time. Typically a good rule of thumb is that the total AR balance shouldn’t be more than one month’s collections. The balance and what is “normal” can vary based on specialty and types of insurance accepted.
What if the AR balance is bigger than expected? It is important to note that having larger balances in the older aged “buckets” doesn’t mean the accounts are necessarily uncollectible. It may mean that insurance reimbursements take longer than typical or that patients have been extended longer term credit. The primary goal is to understand how the buckets have changed over time with the intention to better understand the business and collection processes of the office. Smaller AR balances often are a sign of a strong collection practice or can be an indicator of the strength of a practice’s collection process and those team members responsible for the process. .
So I want to buy it…what’s it worth?
Because AR is an amount due to the Seller for work already performed and is such a fluid number, it is rare that the value of this asset is included in the overall practice price or valuation; therefore, this value is calculated separately. The more collectible the accounts receivable balance is, the higher the value – as it presents less risk. Current balances (0-30 days) may be worth 95% or more of the balance, while older balances (90 or 120 days) may be worth as little as 25%, or in some cases, nothing. Unfortunately, in most cases, the only way to understand the collectability of the AR for a buyer is to ask questions and compare reports over time. If the practice has a high “over 90” aged balance, but patients are offered a payment plan for larger cases that cover 6 months, then the balances aged over 90 days may be very collectible (presuming the practice can prove regular payments). For Seller’s preparing to sell, ensuring the accounts receivable balances are well understood and uncollectible balances are written off will ease the transition process.
In most cases, for a Buyer, purchasing the AR is advantageous as it provides an immediate cash flow stream post close as patients pay their balances. For the Seller there is immediate cash flow and it eases the administration of tracking, as a buyer isn’t required to keep two sets of AR (their new AR balances and the Seller’s historical balances) and the Seller gets immediate payment for their work versus relying on the Buyer’s collection.
What if the AR isn’t for sale?
There are many scenarios where the Seller doesn’t wish to sell the AR, or the buyer reviews the AR balances and decides they don’t want to take on the risk and would prefer to get additional working capital versus use the AR as cash flow.
In these instances, the purchase agreement for the practice transition should have detailed collection methods for how AR will be handled post close. A common resolution for this scenario may be that the buyer is responsible for collecting the AR of the Seller for 60-120 days post close, and for the billing and collection efforts. The buyer is then paid a small admin fee for any additional balances collected. This percentage is typically 5% but can be negotiated up or down based on the specifics of the practice and AR balances. How payments are applied, and the buyer and sellers responsibility for each, is generally covered in detail as a guide for collection post close. It is important to remember that each situation is unique. A “typical” resolution agreement may not be in the best interest of each party. It is important to consult your transition advisor and CPA to ensure that the agreement makes sense in your individual transition scenario.
Not selling the AR can be administratively burdensome for the buyer. However, it may be worth it if a buyer doesn’t feel like they fully understand the balances, the balances appear to include uncollectible balances, or if the risk of overpayment is too high. On the other side of the coin, a seller may not wish to sell the AR if they feel like the collectability of the AR is higher than the value the parties can agree too, or they may want to keep that cash flow post-closing to supplement their transition.
As with all parts of the transition, one needs to understand the facts. The AR balance, age, collectability, as well as how they will be handled post sale, are critical to making informed decisions during your transition. In a transition, every component of the puzzle can make an impact on the overall picture…be informed!