Preparing Behavioral Health Financials for a Quality of Earnings Review
By Kevin Taggart, CM&AP, Managing Partner, Mertz Taggart
At a Glance Buyers and quality of earnings firms examine how a behavioral health business earns its money, whether the records support reported earnings, and whether those earnings can continue. Consistent reporting, documented adjustments and operating context make the financial story easier to evaluate. Preparation should begin before buyers rely on the earnings figure in an offer. |
When a buyer makes an offer, the number behind it depends on your earnings, and a quality of earnings review is how that number gets tested. A firm hired by the buyer examines the earnings, the records supporting them, and how well they reflect the ongoing business. Questions that seemed straightforward while you were running the practice can become more involved when an offer depends on the answer.
As an owner, you know the decisions behind your financial results, why staffing costs changed, which expenses were unusual, and what drove a stronger month. Some of that knowledge may live in the financial records; some may live mostly with you and the people who help run the business. Preparing before you are in the middle of a transaction gives your team a stronger basis for the review that follows.The review examines the earnings, the records supporting them, and how well they reflect the ongoing business. Consistent reporting and well-supported explanations give your team a stronger basis for defending the value being negotiated.
Make it possible to compare one period with the next
Buyers generally want to examine at least two years, plus current YTD of financial results, and
sometimes three. They are looking at how the business has changed over time. To do that, they need reporting that lets them compare the same categories across those periods.
If an expense appears in one category this year and another category next year, the reviewer has to work out what happened before assessing performance. There may be a perfectly reasonable explanation. Keep it with the records so your accountant and transaction team can answer the question without reconstructing it months later.
Someone on your team needs to be responsible for the financial records and available to explain the calculation to your accountant, advisor, and the buyer's reviewers.
Be ready to explain each EBITDA adjustment
Adjusted EBITDA is intended to reflect the business's normalized earnings before interest, taxes, depreciation, and amortization. The calculation may remove certain owner-related or one-time expenses that are not expected to continue after a sale. Those adjustments, commonly called add-backs, can affect the earnings figure used to negotiate the purchase price.
An adjustment needs documentation for both the amount and the reason it belongs in the calculation. What was the expense? When did it occur? Why would removing it give a more accurate view of ongoing earnings? Your accountant and advisor should be able to work through those questions before a buyer's QoE team raises them.
If the explanation depends on an assumption about the operation after closing, make that clear. Reviewers may reach different conclusions about an adjustment, and calling a cost nonrecurring will not resolve the discussion on its own. The underlying records and a reasonable explanation are what give your team a basis for the conversation.
The same thinking applies when recent earnings have improved. Connect the change to what happened in the business. A staffing decision or an operating improvement may help explain the result, but the buyer still needs to understand whether the benefit can continue. Organizing that documentation early puts you in a better position to address the question.
Connect the financials to the way the practice earns revenue
The earnings have to make sense alongside the operation. In a behavioral health practice, services are provided, documented, billed, and ultimately paid for. Questions about clinical documentation or billing can therefore become questions about the revenue a buyer is relying on.
Revenue that depends heavily on one payer or on grants may need additional support. Explain the concentration, any known collection issue, and the history behind grant revenue, including relationships that depend on the owner. If an audit, licensing concern, or accreditation issue could affect earnings, work with the appropriate specialists and your transaction team to establish the financial implications.
Keep the earnings support current
The earnings calculation needs to stay connected to the business as the transaction moves forward. Keep current results alongside the periods already presented so your team can explain whether recent performance supports the earnings a buyer is evaluating.
If performance changes during the sale process, work with your advisor to explain the difference and provide the relevant records. A change in staffing, costs, or collections may require a fresh look at the earnings calculation. The buyer needs to understand its effect on the ongoing business.
Before going to market, review the earnings calculation with your accountant and advisor. Separate adjustments you can already support from those that need more records or depend on an unresolved assumption. That gives the review a clear purpose and shows where more preparation is needed.
Key Takeaways
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If you are considering a sale of your behavioral health business, I’d be glad to talk through where that preparation should begin.
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