5 Financial Adjustments That Can Significantly Impact the Value of Your Dental Practice
Two dental practices can generate the same annual revenue and still have meaningfully different indicated values. The reason is that revenue alone does not show what a practice is expected to earn after an ownership change. A valuation looks beyond reported results to understand which expenses and disruptions are likely to continue.
That process is called normalization. For dental practice owners considering a future exit, evaluating DSO interest, or planning for retirement, understanding the adjustments can help clarify what the financial statements say, and what they may not.
What is a normalization adjustment?
Financial statements show what happened during a particular period. A valuation considers what is likely to continue. Normalization adjustments help connect those two perspectives.
Imagine you were buying a dental practice. You would want to understand not only what the current owner spent, but also what you would reasonably expect to spend to operate the practice going forward. That is the central question behind normalization.
The five common areas are owner compensation, rent, one-time expenses, temporary disruptions, and personal expenses. Each adjustment should be considered in the context of the practice’s ongoing operations, not simply because it makes reported earnings look higher.
1. Owner compensation
Owner compensation is often an important consideration in a dental practice valuation. Some owners pay themselves a modest salary or no salary through payroll. That does not necessarily mean they receive no economic benefit. They may take distributions or owner’s draws outside payroll, or receive other benefits.
Compensation may also be structured for tax or financial-planning purposes rather than to show the cost of the services the owner provides to the practice.
From a valuation perspective, the question is not simply, “What salary did the owner choose to pay?” It is, “What is reasonable compensation for the services being provided?” In many transactions, the owner continues practicing for several years after the sale. Understanding the compensation associated with that role helps assess the practice’s ongoing earning power.
The adjustment reflects the reasonable cost of the owner’s work, rather than treating the owner’s chosen payroll amount as the only relevant figure. It is specific to the services being provided and the practice’s circumstances.
2. Rent and occupancy costs
A practice’s current rent may not tell the whole story about future occupancy costs. If the practice leases from an unrelated landlord, the lease terms matter. Owners should understand when the lease expires, whether rent increases are scheduled, and whether renewal options are available.
If the owner also owns the building, rent may be set at a low amount, not charged at all, or intentionally set above market. None of those arrangements is automatically right or wrong. The owner’s objective may be tax planning, while the valuation has a different purpose.
The goal is to normalize rent to what a new owner would reasonably expect to pay to occupy the space. That way, the financial statements reflect a reasonable ongoing occupancy cost rather than only the amount the current owner happens to charge.
3. One-time or non-recurring expenses
A practice may have expenses that are real and appropriate for the year in which they occurred, but are not expected to recur in the same way. Examples include replacing every operatory chair in one year, significant legal fees for a one-time matter, a major office renovation, or a consultant hired for a specific project.
The relevant question is not whether the practice paid the expense. It did. The question is whether a new owner should expect to incur that same expense as part of ongoing operations.
That distinction requires professional judgment. An expense should not be treated as non-recurring just because it was large or inconvenient. The circumstances and the likelihood of continuation need to be considered.
4. Temporary disruptions
Some events can affect a practice’s financial statements without reflecting its long-term earning power. For example, an owner may break a wrist and be unable to practice for several months. An associate may leave unexpectedly, reducing production while the practice searches for a replacement. Road construction may make it difficult for patients to reach the office.
These events may temporarily affect revenue. Part of the valuation process is determining whether the impact reflects a lasting change or a short-term disruption. Any proposed adjustment should be supported by reasonable evidence of the financial impact and the likelihood of recovery. A temporary decline does not automatically qualify as an adjustment; the specific circumstances need to be evaluated before the effect is normalized.
5. Personal expenses
Some expenses may be paid through the practice even though they are not necessary to operate it. Examples include a family cell phone plan, a personal vehicle, club memberships, or personal travel booked to the business.
The question is not whether an owner should have incurred an expense. It is whether a new owner would reasonably expect to incur that same expense to run the practice. If not, the item may be normalized out, added back when calculating normalized EBITDA.
These adjustments should be reasonable and supportable. The objective is to identify costs that do not represent the practice’s ongoing operations, not to criticize how an owner manages personal or business finances.
What is not a normalization adjustment?
Normalization is not a way to add back anything an owner would like to exclude. Adjustments should be reasonable, supportable, and recognizable to a knowledgeable buyer as not representative of ongoing practice operations.
They generally relate to the profit and loss statement, where ongoing revenues and expenses are evaluated. Balance-sheet items, such as owner’s draws or equity accounts, are not considered when calculating EBITDA.
That distinction matters. Compensation recorded through payroll is an expense in the practice’s operating results. Owner’s draws and equity distributions are not EBITDA expenses or add-backs. They are different items, even if both relate to the owner receiving money from the business.
The purpose of normalization is not to make the practice look better. It is to help the financial statements more accurately reflect ongoing earning power.
Normalized EBITDA is not a sale price
Normalization adjustments inform normalized EBITDA: the practice’s earnings after considering items that may not reflect ongoing operations. That figure can contribute to an assessment of indicated enterprise value, but it is not the same thing as a final transaction sale price.
An independent, EBITDA-based assessment provides owners with financial insight and a clearer understanding of the practice. It does not guarantee or determine the price that will be agreed in a future transaction. Learn more about independent business valuations and pre-transaction readiness on our Services page.
Prefer to watch? Jennifer explains these five common financial adjustments in her video, 5 Financial Adjustments That Can Significantly Impact the Value of Your Practice.
Understand the story behind your practice’s numbers
Every practice has a story. The numbers matter, but understanding what sits behind them is essential to a credible valuation. Normalization helps owners distinguish historical results from the costs and earnings that may continue after a change in ownership.
If you are considering an exit in the next few years, or simply want to understand your practice’s financial position, an independent valuation can help you prepare before beginning conversations with buyers. You can learn more about Jennifer Arsenault’s experience with healthcare practice owners (https://executivevaluations.com/experience/) or schedule a complimentary consultation (https://executivevaluations.com/contact/) to discuss your questions.
Author: Jennifer Arsenault, Founder & CEO of Executive Valuations