Valuing Medical Practices – Accounts Receivable
When using the asset approach to value a medical practice, one of the medical practice’s most valuable assets will most likely not appear on the historical financial statements. What asset are we talking about? The answer is accounts receivable.
Most professional services, including medical practices, use the cash basis of accounting. Under the cash basis of accounting, accounts receivable do not appear on the financial statements because they reflect the future receipt of cash for previously rendered services. Utilizing this method of accounting, the medical practice only needs to recognize income when cash has actually been received.
When valuing a medical practice using the asset approach, it is important for the valuation analyst to include the accounts receivable in his or her analysis. However, valuation analysts need to realize that medical practices do not generally collect 100% of their accounts receivable. Depending on the mix of payors and contracts, a medical practice may only collect between 50% and 60% of its account receivable. Thus, when adding the accounts receivable to the fair market value balance sheet, a valuation analyst must take into account the collection rate for the medical practice in order to not overstate the value of the accounts receivable.