South Florida Hospital News
Sunday October 13, 2019
Quote

test 2

June 2019 - Volume 15 - Issue 12

Subscribe

Advertisements

NovaMPH.jpg

The Importance of Revenue Trends and Underlying Metrics

As a member of a consulting firm, we are approached to value various types of entities. In addition to a valuation where we are seeking to determine value at the present day, there are often times whereby we are called upon to review the valuations of others or review prior transactions. It is in the review process that we are reminded of the importance of carefully reviewing the underlying books and records of an entity. This article is intended to remind one of the importance of understanding the revenue composition of the subject company and the basic metrics of an entity.

A basic theory of the income approach in business valuation, is that the income to be capitalized is the expected future income. This means that historical earnings may have little or no bearing on future expectations, yet it is not uncommon to find a weighting of prior year’s results being used as a proxy for future income. If one encounters a weighting of prior years, it is important to understand the reason for it. In addition it behooves the reader to ask questions about future revenue. It is very unusual to find expected future revenue equating to a weighting of prior years’ results.
 
There are instances where reliance on past results will render an incorrect result. If there has been a fundamental change in an entity’s revenue stream, past results are of little value. For example, if the historical results include revenue from ten physicians, and retirement or attrition has caused there to be eight physicians generating revenue in the foreseeable future, then valuing the practice using the revenue of ten physicians is incorrect. Therefore, it is important to understand the facts and circumstances surrounding the valuation at the valuation date.
 
It is important to understand the composition of the revenue when performing a valuation. For example, in the valuation of an ambulatory surgery center, knowing the trend in patient count and the number of patient visits is vitally important. It is also important to know the revenue associated with each of the revenue streams, whether it be pain management or orthopedic. It is not enough to just look at the top line revenue. This is because there could be instances where the number of overall cases has dropped but because of a change in the type of service being provided (which yield higher reimbursement amounts) the overall revenue remains essentially unchanged. As a result, someone who did not understand the composition of revenue, could have been lulled into thinking that the practice is relatively unchanged, when in fact the overall case load has declined.
 
Other metrics to give careful consideration to include net revenue per case, earnings before interest and taxes (EBIT), as well as earnings before interest taxes depreciation and amortization (EBITDA) margins. For each of these it is helpful to show their respective trends over time, so that there is a clear sense of not only the case or work load, but the margins associated with the entity being analyzed.
 
Let’s assume that the EBITDA margin was 40% five years ago but there has been a gradual decline in it so that the current percentage is 34%, which equates to a $6,000 decline in EBITDA for every $100,000 of revenue. On patient revenue of $5,000,000 that 6% decline in EBITDA margin equates to a $300,000 decline in funds to distribute or reinvest. It is important to understand the reasons for the EBITDA erosion. Just as it is important to understand the expected revenue trend moving forward, it is also important to understand the anticipated EBITDA margins moving forward as well.
 
The takeaway from this should be to always keep a close eye on the topline figure of a practice and understand its composition as well as to understand the net profitability as measured by things such as EBITDA.

Thomas Reck, Partner, WithumSmith+Brown, PC, can be reached at treck@withum.com.

Share |