How To Allocate Expenses When Purchasing A Practice

Hello Dr. Hayes, 

I am in negotiations to purchase an existing practice and want to use The Hayes 7 Key Expenses to create my annual operating budget.  

Assuming I borrow the money to buy the practice, in which category would I include my loan payment?   

I really enjoy reading your blog.  

Sincerely,

Thea Shearer, OD

Thanks Thea!

This is a great question because it makes us step back and ask ourselves, “Do we approach this from a tax standpoint or as practice management question?” 

The answer is both. 

For the benefit of new readers, let’s briefly review the Hayes 7 Key Expense Areas on which you are planning to base your annual budget.   

These are the typical norms for expenses in a traditional dispensing OD practice expressed as a percent of collected gross revenue .  

1.              Cost of goods (27% to 33%)

2.              All staff related expenses (15% to 22%)

3.              Occupancy costs (5% to 8%)

4.              Examination equipment (3% to 5%)

5.              Marketing and promotion (1% to 2%)

6.              General office overhead (6% to 9%)

7.              Doctor’s compensation (30% to 40%)

Tax Allocations 

Let's say you agree to pay a total of $400,000 for a practice grossing $600,000. Settling on the price is only half of the negotiations.  

You and the seller must also agree on not just the price, but also on the allocations in three important areas. An example of made up allocations would be:

•                $120,000 - Inventory - Frames, lenses, contacts, supplies

•                $130,000 - Equipment - Chairs, stands, slit lamps, phoroptors, etc

•                $150,000 - Good Will - Basically what you are paying for the patients, also called ‘Blue Sky’. 

While all the numbers above equal $400,000, buyers want to put as much value as possible on the inventory and equipment. Why? Because you can take a reasonably quick tax deduction on those expenses.  

The buyer’s ability to deduct ‘Good Will’ is less favorable as you usually must spread that out over many years. 

The seller on the other hand would like to allocate as much as possible to ‘Good Will’  as he will receive more favorable capital gains tax treatment on what you pay for that portion of the sale.  

Practice Management Allocations

As far as your practice budget, the expenses you incur for inventory, such as frames, lenses and contacts, will go in the obvious place; cost of goods.  

If you buy excess inventory, you should expense it in the year you use it.  

Same for the examination equipment, there is already an expense category set up for that.  

But what about ‘good will’?  Where do we put that?  That’s a judgement call.   

You could look at what you pay for ‘good will’ in a practice purchase as not really an expense, but an investment.   

From a tax standpoint, you are going to write off ‘good will’ over 15 years. So, you could take the approach that you are going to mentally deduct $10,000 ($150,000/10 years) from your net income for the next 15 years.   

Want more detail on this topic?

For a more detailed explanation, click here to read a guest by J R Armstrong, CPA. 

Readers of drhayesblog.com are invited to give feedback by email or Click the red 'Click To Discuss' link below to share your thoughts. How would you handle this situation in your practice? 

Regards,  
Jerry Hayes, OD

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Disclaimer: The information and opinions contained on this site are for discussion purposes only and are NOT intended to serve as legal, accounting or investment advice. ©2010 Jerry Hayes, OD. Not to be reproduced without written permission of the author.