Why Overhead Matters
Key Takeaways
- Dental practice value is driven by profitability, not just collections.
- Small improvements in overhead can materially impact a practice’s value over time.
- Owners should adddress overhead years before a sale is on the horizon.
Most dental practice owners have a general sense of what their business is worth. Often, dental practice value is estimated based on a benchmark, such as percentage of collections.
But that estimate rarely tells the full story.
According to NDP and 7 Pillars managing partner Christy Ratcliff, CPA, CVA, overhead is an important driver of dental practice value. Manage it well, and it can increase what your practice is worth. Ignore it, and it can erode value over time.
Why Averages Fall Short
Sometimes there is a disconnect between what a dental practice is worth and what the owner thinks the practice is worth.
That’s because owners often base their valuation expectations on simple averages used in financial planning. For example, for retirement planning, an orthodontic practice might be estimated at 80% of annual collections.
“For owners, the practice is often a significant part of their retirement plan, so not plugging something in, even if it’s an average, would be a mistake,” says Christy.
But when it comes to an accurate valuation for a doctor-to-doctor sale, it starts with understanding cash flow and risk.
“We typically analyze average cash flow from the last two to three years, then normalize expenses to reflect the true operating cost of running the business over that time period,” says Christy. “That means removing one‑time, personal and discretionary expenses and focusing only on core operating costs. The cost of doing dentistry.”
How Overhead Impacts Value
Practices with stronger profit margins—driven by more efficient overhead—tend to command higher values as a percentage of collections. Those with higher overhead and lower profitability will typically see a lower value.
To see how this plays out, it helps to look at a simple example.
Consider a practice generating $1.5 million in annual collections. Using the 80% benchmark mentioned earlier, an owner might expect the value to be around $1.2 million.
In reality, the range of value can be much wider.
Based on actual valuations, practice values can span from approximately 64% of collections on the low end to 96% of collections on the high end. Applied to a $1.5 million practice, that’s a range of roughly $960,000 to $1.44 million . A doctor who calculated 80% may have the wrong expectations.
That’s a difference of nearly half a million dollars between practices with the same top-line revenue.
What drives that gap is not collections alone. It comes down to profitability of the practice. An efficient overhead drives up value.
What Drives Value Higher and Where Risk Comes In
Some specialties can command higher valuations even with lower profit margins. Orthodontics is one example.
Part of this is supply and demand. There are typically fewer orthodontic practices for sale with more buyers competing for them. But demand alone does not create a premium.
“An orthodontic practice has a contracts receivable balance, which is steady, predictable cash flow. That’s something that doesn’t exist in other specialties. Orthodontic premiums aren’t automatic–they are supported by strong contracts receivable, healthy overhead and stable production. Without those fundamentals, the expected premium often isn’t there,” says Christy.
Risk is also a factor in how practices are valued.
Variability in production, reliance on a single provider and less predictable revenue streams can increase risk and lower value. Practices with more consistent and repeatable revenue are generally viewed more favorably.
Small Changes in Overhead Can Meaningfully Impact Value
Managing overhead does not require dramatic change to make a difference.
Reducing overhead by even a few percentage points can have a meaningful impact on valuation. Each incremental improvement strengthens cash flow and supports long-term value.
That is true regardless of practice size. Even in a single‑doctor practice, modest improvements can translate into measurable gains over time.
For that reason, Christy encourages owners to focus on overhead well before a transition is on the horizon. Beginning this work three to five years out allows those improvements to compound with enough time to make a difference and puts more cash in your pocket during that time period. Small changes, such as working with Elite Dental Alliance to reduce supply costs, can go a long way.
Looking for a more in-depth discussion? Check out this episode of the Transition Talk podcast, hosted by Christy and CWA Partner Charles Loretto.
CWA is ready to answer your questions about practice profitability. Contact our team today.
