When Showing Profits Beats a Tax Break

Many practitioners work closely with their CPAs. They are careful track and itemize operation deductions to maximize their tax savings. The less one has to pay the government, the better. Maximizing your eligible tax deductions improves your operation’s cash flow. Even though the tax return

reports operating losses, this tax strategy generally benefits small operations in their early years. When it comes to Exit Planning, this tactic may not be the best approach.

As you begin to view exiting the practice, Enterprise Value becomes more important that tax savings. For most small practices, every dollar of operating profit is worth, on average, $2.40 in Enterprise Value. So, $1,000 in extra operating profit could mean an increase in Enterprise Value of $2,400. In the time leading to exiting the practice, reducing discretionary spending and operating more cost-efficient should be the emphasis, not maximizing tax deductions. Some argue that expensing as much as possible through the practice is still the better approach. Buyers adjust for these extra expenses through their recasting process (i.e., converting tax statements into economic statements). What this view fail to realize is that such a strategy puts the Seller at a negotiation disadvantage. The Seller must explain why one’s tax returns do not represent economic reality. Poor tax returns could lead to heavy price discounting by Buyers or, even worse, not attracting Buyers who would normally consider purchasing the practice.

Use sound business judgment in your Exit Plan. Good judgement should promote rational business-only spending, minimize waste, and discourage unnecessary discretionary spending. Does the proposed activity drive profitability and, in turn, enterprise value? Does it enhance the practice's reputation or quality of service? Is the spending needed to cure an existing detriment to the practice (e.g., antiquated technology) so to preserve Enterprise Value? Focus on these earnings impact activities when developing your Exit Plan. Visit us to learn more.