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Owner pay and practice profit are not the same number
A dental practice owner is paid twice: once for doing dentistry, and once for owning a business. Most confusion about whether a practice is “profitable” comes from mixing those two up, or from comparing a figure that includes debt with one that does not.
Hypothetical example Every figure here is an example you can edit. None of it is a lender offer, a market average or a customer result.
Five measures, in the order they usually get confused
- Collections
- Cash the practice actually received. It is not production (what was done), not charges (what was billed), and not revenue net of anything. Two practices with identical collections can have wildly different earnings.
- Clinical compensation
- What the owner earns for the dentistry the owner personally performs. If the owner stopped treating patients, an associate would have to be paid to do that work. That makes it a cost of running the practice, not a return on owning it.
- Business earnings (often called EBITDA)
- What the business earns after all operating costs including a market rate for the owner’s clinical work, and before interest, tax, depreciation and amortization. This is the measure most often used with a multiple in a valuation discussion, which is exactly why it is worth defining carefully.
- Cash after debt service
- Business earnings minus the full loan payment, principal and interest. Interest is an expense; principal is not, but both leave the account. This is the number that determines whether ownership feels tight.
- Return on invested cash
- Cash after debt service divided by the cash the buyer actually put in. A small down payment can produce a high percentage return and a thin monthly cushion at the same time. Leverage magnifies both directions.
A hypothetical bridge from collections to return
Every figure below is an assumption chosen to make the arithmetic legible. It is not an average, a benchmark, or a target. Your practice’s numbers will differ, and the useful part of this table is the order of the steps, not the amounts.
| Step | Amount | What it means |
|---|---|---|
| Collections | $1,200,000 | Cash actually received in the year. Not production, and not billed charges. |
| Less operating expenses | ($810,000) | Staff, supplies, lab, rent and other overhead. 67.5% of collections in this illustration only. |
| Earnings before any owner clinical pay | $390,000 | What the business produced before paying anybody for the owner’s own chairside work. |
| Less clinical compensation for the owner | ($234,000) | 30% of $780,000 of owner production in this illustration. This is pay for dentistry, not a return on the business. |
| Business earnings (illustrative EBITDA) | $156,000 | What is left for the owner as a business owner, before financing. Interest, tax, depreciation and amortization are excluded by definition. |
| Less annual debt service | ($132,465) | $900,000 at 8.25% over 10 years. Principal and interest together, because the whole payment leaves the bank account. |
| Cash after debt service | $23,535 | The figure that determines whether ownership feels comfortable month to month. |
| Return on invested cash | 15.7% | Cash after debt service divided by $150,000 of the buyer’s own cash in this illustration. |
$234,000 of clinical compensation plus $23,535 of cash after debt service is $257,535. Describing that whole amount as “profit” would overstate the business’s earning power by the clinical component. Describing only $23,535 as “what the owner earns” would understate the owner’s income by the same amount. Both mistakes are common, and they point in opposite directions.
Why the distinctions change decisions
A valuation multiple applied to the wrong number
If the owner’s clinical compensation has not been deducted, the earnings figure includes payment for work someone must keep doing. Applying a multiple to it values the owner’s labour as if it were a business asset. The valuation scenarios tool makes the owner-pay normalization an explicit, visible step for that reason.
Debt service does not appear in EBITDA
A practice can have healthy business earnings and uncomfortable cash flow, purely because of how the purchase was financed. Earnings are a property of the practice; debt service is a property of the deal. The acquisition cash flow tool keeps them in separate lines so a financing problem is never mistaken for an operations problem.
Principal repayment is not spendable cash, and not a loss either
The principal portion of each payment reduces what you owe. It is real value accruing to you, and it is also money you cannot spend this month. Treating it as an expense understates the return on the purchase; treating it as available cash overstates the monthly cushion.
A percentage return says nothing about the size of the cushion
Reducing the down payment in the illustration above would raise the percentage return and lower the monthly cash after debt service. If a slow quarter arrives, the percentage is not what pays payroll. Look at both, and look at the downside case rather than the base case.
Questions worth answering about your own numbers
- Are these collections or production, and for which twelve months?
- What rate would an associate be paid to do the owner’s clinical work, in this location?
- Which expenses in the profit and loss statement are personal rather than operating?
- Does the earnings figure being discussed deduct owner clinical pay, or not?
- Is depreciation being added back while the equipment it relates to still needs replacing?
- What is the full annual debt service, principal included, under the financing actually on offer?
- How much of the buyer’s own cash is going in, including working capital and closing costs?
- What does cash after debt service look like if collections come in ten percent lower?
General information about these measures and their relationships. Not accounting, tax, valuation or investment advice, and not a projection of any practice’s results.
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