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Forcing the Value to Cash Flow

By Greg Auerbach, MBA

Have you gone recently to purchase a car and asked the question of how much will the car you want will cost? The salesman doesn’t give you the price of the car anymore, but does let you know that there are financing terms that will allow your monthly payments to fit into your budget. No matter how many times you ask, the total cost of the car is almost never revealed! The salesman knows that confronting you with the total cost of the car is usually beyond the ability of most purchasers today, but if he can reduce that cost to a manageable monthly figure, you will drive out in that new car.

All practice finance companies look to the cash flow of a practice to repay the acquisition loan. The industry standard is that the practice for moderately priced practices today is a 7 year financing term. Some may finance for 10 or more years to accommodate the buyer’s cashflow, but still want the analysis to be able to pay back the loan over no more than 7 years. If the cash flow does not support those requisites, the practice either is priced too high, or is the wrong one for the doctor.

We have recently seen that some transactions are predicated on ideas which must have been learned from the car salesmen. If the cash flow of the practice will not support the needs of the doctor, why not simply extend the payments for up to 15 years? Well that sounds like it should work, doesn’t it? If you can reduce your monthly payments enough, anybody can certainly afford to buy the practice. In looking at the numbers, consider the following table:

Principal Amount
$500,000.00
$500,000.00
$500,000.00
Interest
8.0%
8.0%
8.0%
Term
7yr (84mo)
10yr (120mo)
15yr (180mo)
Monthly Payment
$   7,793.11
$   6,066.38
$    4778.26
Total Interest Paid
$154,621.00
$227,965.57
$360,086.88
Total Cost
$654,621.00
$727,965.57
$860,086.88
Cost Differential
– $ 73,344.57
– $205,465.88

By extending your loan from 7 years to 15 years, you will pay an additional $205,465.88 for a $500,000.00 loan! So, while you can afford the monthly payments, you have spent additional money for the original purchase that could have gone into your retirement account.

If the buyer must finance a purchase over 10 to 15 years just to make the cashflow work, the purchase price is probably unrealistic for that buyer. Additionally, if a valuation is predicated on similar financing terms, the validity of the suggested price should be questioned.

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