While accounts receivable (AR) can appear like a typical accounting term, it has more significance to a dental practice buyer or seller than one would think.
In a dental transition, the practice’s AR can be bought or sold. It’s not something that most people think about when they begin the transition process, but this piece can have a huge impact on the overall transition. While there isn’t a right or wrong decision when considering whether to buy or sell it, it can be an advantageous investment in the right circumstances and with the right agreement from both parties.
When making an informed decision about buying or selling the AR, it’s important to consider not only the advantages and disadvantages, but also the key components to AR, including the balance, age and collectability.
Understanding the AR in a Practice
Accounts receivable, in the simplest terms, are monies owed for production that has already been performed. This could be money owed by the patient or money billed and owed to/by insurance. When the AR is sold in the transition, the seller receives a lump sum at closing and is no longer responsible for trying to collect those outstanding payments from patients. Any payments coming to the practice post-close (regardless of when the production was performed) belong to the buyer.
The AR balances are summarized utilizing a report called the AR aging report. This report shows the AR balance broken out into age buckets depending on when the work was completed. Often, the aging buckets appear grouped as balances, such as 0-30 days old, 31-60 days old, 61-90 days old and over 91 days old.
The balance and what is “normal” can vary based on the type of practice, specialty, types of insurance accepted and collection methods.
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 or don’t require full payment before the patient appointment. Smaller, consistent AR balances often are a sign of strong collections or can indicate the strength of a practice’s collection process and the team members responsible for the process.
Putting a Value on the AR
Because AR is an amount due to the seller for work already performed and is a fluid number, the value of this asset is rarely included in the overall practice price or formal valuation. Therefore, the value of the AR is calculated separately.
The overall value of the AR—whether it’s bought or sold—is based on a factor of age as this typically relates to how collectible it is. Each age bucket is assigned a percentage value based on the estimated likelihood of collection. The more collectible the accounts receivable balance is, the higher the value. 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, due to the lower possibility of the patients paying.
The Advantages of Buying or Selling the AR
In most cases, purchasing the AR is advantageous as it provides an immediate cash flow stream on day one after the transition is finalized. It ensures that some sort of cash will come in. If the AR isn’t purchased, the initial cash flow streams for the buyer-now-owner function off working capital, and the buyer must ensure the working capital is large enough to cover expenses.
TAKE NOTE
The practice’s insurance mix has many indicators for cash flow. If it’s a mix of fee-for-service and PPO, then it’s almost certain there’s going to be some cash coming in those first few months. If it’s heavy PPO or Medicaid, there’s going to be longer lead times for billing. Prior to making a decision, it’s important to understand the type of practice, the return times and the cash flow needed to cover those billing times.
For the opposite party, selling the AR means the seller receives immediate payment for their work versus relying on the buyer to collect the payments. As long as the valuation of the AR is fair for the seller, this may be the preferred route. Selling the AR also eases the administration of tracking for both parties as a buyer isn’t required to keep two sets of AR (their new AR balances and the seller’s historical balances).
What if the AR Isn’t for Sale, or the Buyer Decides Against It?
There are many scenarios where the seller decides not to sell the AR. A seller may feel the collectability of the AR is higher than the agreed value of the AR. If they know money is going to come in through the door, they’ll likely want to keep the payment for the work they did. Sellers may also want to keep that cash flow post-close to supplement their transition.
There are also scenarios where the buyer reviews the AR balance and decides not to purchase. They may feel they don’t fully understand the balances and don’t want to assume the financial risk. The AR may appear to include uncollectible balances, the risk of overpayment could be too high, or they may not have access to additional funds to purchase it.
In anticipation of these instances, the purchase agreement for the practice transition should detail collection methods for how the AR will be handled post-close. An experienced transition consultant, like NDP, can offer resolution options that work for both parties.
A Piece of the Full Picture
While the AR is only one piece of the practice transition, every component of the puzzle can make an impact on the overall picture. If you have a question about this specific piece or would like to discuss any portion of the transition process, our advisors are ready to help. Contact our team for a complimentary consultation today.
