How do you recast finances and clean up a balance sheet?

If you are doing it after the fact, you will make adjustments for one-time expenses and various unnecessary expenditures. This process is called “recasting” or normalizing earnings. These adjustments to income statements and balance sheets allow buyers to appreciate the maximum profitability of the center and the true value of the assets and liabilities. Keep in mind physicians will want to maximize value capture, and buyers will want to minimize it, so potential investors will scrutinize all add-backs. This tug-of-war will be part of the due-diligence process, and you just want to maximize your profits as a starting point.

To start, use the company’s EBITDA for the appropriate period. Then make the adjustments for discretionary items. Doing so will not only remove one-time or extraordinary income and expenses, but also will adjust for accounting anomalies, identify owner compensation, owner “perks” or fringe benefits, non-cash expenses and other items that are common in privately-held businesses.

Below are some of the most common examples of items which could be recast, but nothing short of going through the income statement line by line in search of profits will do.

1. Compensation, both for owners and employees. Not all of the physician owner’s compensation is recast, but the amount of salary or bonus that a physician owner pays to himself and others is largely discretionary, so it can be adjusted. Compensation above and beyond the typical market value can be added back to your pre-tax earnings. So if your main employee is paid above market rate because of their loyalty to you, normalize their pay. Do the same thing for family members employed by the business.
2. Owner perks or fringe benefits. In addition to cash compensation, most ASC owners receive numerous perks or benefits that are not required for the daily operation of the surgery center. For example, while a vehicle may be required, a luxury automobile or SUV is not normally necessary. There may also be discretionary expenses reimbursed to the physician owner which may not be applicable to a new owner and don’t affect the profit performance of the ASC. These include items such as:

  • personal travel and entertainment expenses
  • vehicle expenses beyond what is absolutely necessary
  • unearned family compensation, including wages, vehicles, trips or insurance
  • a large life insurance contract or pension plan
  • personal use assets, such as a sailboat, plane or a condo in Hawaii
  • expenses paid to another company owned by the same seller
  • excess compensation, i.e., compensation beyond what the owner is willing to receive post sale or beyond the amount required to hire competent surgeon

3. Employee-related items. Certain employee-related items may be changed post-sale, so they can be added back to pre-tax earnings.
4. One-time items. Adding back one-time, extraordinary or non-operating income or expenses is meant to remove items which appear in the financial statements, but which are either unlikely to be repeated in the future or are unrelated to the ASC’s operations, so they won’t be incurred by a new owner. Common examples include things such as:

  • donations
  • bad-debt expenses
  • uninsured losses
  • marketing and trial advertisements
  • one-time legal lawsuits

5. Discretionary business practices. Other business expenses which won’t typically be incurred by a new owner into the future, and which may therefore be recast, include:

  • business insurance beyond what is absolutely necessary
  • excess rent (pay close attention to this if you own the underlying real estate)
  • patient incentives
  • overpaid expenses done to reduce taxes
  • lump sum bonuses paid to employees

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Category: Valuating My ASC

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