Valuation of Physician Practices by David Cranford & Shannon Farr

1. Valuation of Physician
Practices
Proceed with Caution!
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2. Forensic and Valuation Services Section
DISCLAIMER
The views expressed by the presenters do not
necessarily represent the views, positions, or opinions
of the AICPA or the presenter’s respective
organization.
These materials, and the oral presentation
accompanying them, are for educational purposes
only and do not constitute accounting or legal advice
or create an accountant-client or attorney-client
relationship.
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3. Forensic and Valuation Services Section
Panelists
David Cranford, CPA
Decosimo Advisory Services
DavidCranford@decosimo.com
423-756-7100
Shannon Farr, CPA/ABV/CFF
Decosimo Advisory Services
ShannonFarr@decosimo.com
423-756-7100
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4. Forensic and Valuation Services Section
Focus of Today’s Presentation
In this webcast, experts in physician practice
consulting and valuation will discuss the unique
operational and financial aspects of physician
practice and the related implications on valuation.
Practical applications for use in the valuation of
physician practices will be provided.
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5. Forensic and Valuation Services Section
Basic Concepts Underlying
Physician Practice Revenue
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Primary Care – Internal Medicine, Family Practice and
Pediatrics
• Revenue is based almost completely on the office visit and related office
testing
• How many patients is the physician going to see?
What type of patients is the physician going to see –
Primary Care physicians can specialize
• Hospitalists
• Dermatology
• Endocrinology
• Allergy / Immunology
• Other

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Basic Concepts Underlying
Physician Practice Revenue
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Testing – What makes economic sense?
• Pediatrics – Strep, CBC
• Internist – Wider range of chemistry profiles,
chest x-rays
• Specialists - Procedures

7. Forensic and Valuation Services Section
Basic Concepts Underlying
Physician Practice Revenue
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Invasive – Surgeons and Specialists
• Revenue is based on the procedures – If they are not in the
operating room, cath lab or outpatient procedure room, they
are not generating income
• Usually have high end diagnostic services
• MRI
• CT Scanner
• Endoscopy
• How many procedures are performed
• Maintain an office to accept referrals, screen patients and
follow up visits
• Efficiency of schedule drives revenue

8. Forensic and Valuation Services Section
Three most common payment methods that health
plans use to pay physicians are:
• Fee for service – physicians are paid for every visit and test that
they provide based on the usual and customary charges of
physicians in the local area
- Uncommon – seen in out of network payments
• Discounted fee for service - physicians are paid for every visit
and test they provide based on a fee schedule
- Most common
• Capitation - physicians are paid a fixed amount per enrollee, not
per service, on a monthly basis for the patients assigned to them
or the group
*Note - Physicians maintain a schedule of charges based on CPT
codes that exceed the rates paid by payors. This is done to
maximum payments based on a charge.
Basic Concepts Underlying
Physician Practice Revenue
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9. Forensic and Valuation Services Section
Payment Adjustments:
• Withhold - a percentage of the capitation or fee-for-service
payment is withheld by the payor to decrease risk of loses
where patient premiums do not cover payments to providers.
Withhold funds may be paid to physicians based on a contracted
formula.
• Retrospective utilization target – Physicians are incentivized to
control utilization and provide fewer and/or less costly services.
Provide early detection and treatment to lower total cost of care.
Physician payments can be adjusted based on the contracted
goals or removed from the payor health.
Basic Concepts Underlying
Physician Practice Revenue
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Payment Adjustments:
• Payor Bonuses - physicians can be paid extra payments at the
end of the year for keeping the health plan's payments,
particularly to specialists and hospitals, below a pre-determined
budget or utilization target.
- May also be determined from measures of patient
satisfaction, access and outcomes of care. In some bonus
systems, physicians may have to return payments to the
health plan if utilization is above a target.
• Retrospective payor audits - Health insurers sometimes perform
audits of payments they make to physicians. An insurer may
conduct a retrospective audit for several reasons, including high
service volume, coding issues (E&M upcoding), and medical
necessity.
Basic Concepts Underlying
Physician Practice Revenue
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11. Forensic and Valuation Services Section
Basic Concepts Underlying
Physician Practice Revenue
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The practice income can include revenues other than
patient collections
• Investment in ambulatory care centers
• Medicare/Medicaid payment for Electronic Health Record
implementation
• Rental income from subletting of office space
• Investment income
• Medical record copying
• Expert testimony
• Other
On a cash basis, reported income on reporting period
can be impacted by collection of accounts receivable
related to prior periods.

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Basic Concepts of Expenses Generally
Present in a Physician Practice
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Physician practices are generally operated on a cash
basis. Accordingly, expenses are presented in the cash
basis financial statements when paid. Large payments
paid annually are generally not amortized. Examples of
large expenses are malpractice and property taxes.
Non-Provider expenses can range from 45% - 65% of
revenues based on specialties

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Basic Concepts Underlying
Physician Practice Revenue
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Revenues can be impacted by changes in payor
methodologies – requirement to use contracted lab of
payor, bundling of charges, precertification of diagnostic
testing (MRI),etc.
Delays in payments from payors can be impacted related to
the following:
• Denied claims
• Appealed claims
• Timely filing of claims
• Precertification of procedures and referrals
• Program audits of Medicare/Medicaid

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Basic Concepts Underlying
Physician Practice Revenue
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Insurance plans with high deductibles /HSA
(Health Saving Accounts) are impacting both
volumes and collections significantly
Difference between charge amount and fee
schedule not recognized until payment is
received.
• This difference is called a contractual adjustment.
• It is not the same as a bad debt.
• Accurate reporting dependent upon correct employee input.
• Large number receivable balances make error search
and discovery difficult.

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Basic Concepts Underlying
Physician Practice Revenue
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Credit balances reported in revenue. In the case of a
tax basis taxpayor, taxes would be paid in the year the
credit occurred and income reduced in the year the
credit refunded.
The use of Nurse Practioners (NP), Physician Assistants (PA),
Orthopedic Assistants, Certified Nurse Midwife (CNM) are
becoming more common in physician practices. The billings
for these services is complex and highly regulated

16. Forensic and Valuation Services Section
Basic Concepts Underlying
Physician Practice Revenue
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CPT Codes
• Charges coded as CPT – ICD-9 codes commonly used
codes (ICD-10 transition is very expensive and most
providers have not upgraded to the ICD-10)
• Current procedural terminology, registered trademark of the
AMA
• Describes why the service was provided
• Describes the service that was rendered for billing purposes
• Used by insurers to determine the amount of reimbursement a
practitioner will receive from the insurance company

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Basic Concepts Underlying
Physician Practice Revenue
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ICD-CM Coding Rules
• List the principal diagnosis first
• If diagnosis is not established, code for symptom – Don’t code
for “rule-out” diagnosis
• Don’t code a diagnosis that does not apply to the present visit
• Preventative E/M codes linked to V codes

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Basic Concepts Underlying
Physician Practice Revenue
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CPT Code History Exam Management Time
99211 Minimal Minimal Minimal 5 minutes
99212 Problem
focused
Problem
focused
Straightforward 10 minutes
99213 Expanded
problem
focused
Expanded
problem
focused
Low complexity 15 minutes
99214 Detailed Detailed Moderate
complexity
25 minutes
99215 Comprehensive Complex High
complexity
40 minutes

19. Forensic and Valuation Services Section
Basic Concepts of Expenses Generally
Present in a Physician Practice
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Significant non-physician expenses
related to Physician Practices include:
• Staff salary expense
• Malpractice insurance – based on physician
specialty and region of the country
• Rent
• Property taxes – (if not included in the rent)
• Information Technology/Electronic Health Records
• Marketing cost – (increasing due to competition )

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Basic Concepts of Expenses Generally
Present in a Physician Practice
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Physician practices can be categorized as
follows:
• Operating Expenses – Fixed
- Rent
- Contracted services
- Cleaning services
- Insurance
- Property taxes
- Utilities
- Other

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Basic Concepts of Expenses Generally
Present in a Physician Practice
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Physician practices can be categorized as
follows:
• Operating Expenses – Variable
- Medical supplies
- Contracted lab services
- Office supplies
- Transcription
- Marketing & advertising
• Staff Salaries and Benefits
- Salary
- Payroll taxes and insurance
- Health insurance
- 401k and/or profit sharing

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Basic Concepts of Expenses Generally
Present in a Physician Practice
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Physician practices can be categorized as
follows continued:
• Equipment leases
• Equipment Financing (interest expense and depreciation)
• Provider compensation
- Salaries or draws based on corporate structure
- Benefits (including pension)
- Other expenses (including personal)

23. Forensic and Valuation Services Section
Federal Physician Self-Referral Law, aka “Stark” &
Federal Anti Kickback Statute
Establish requirements for healthcare transactions
which include:
• Fair Market Value
• Not based on volume or value of referrals or other business
generated between the parties
• Commercial Reasonableness
Applicable Health Care Laws
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24. Forensic and Valuation Services Section
Compensation and Regulatory Issues
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Post transaction compensation structure
factors into the practice valuation.
• Health systems cannot pay for a revenue stream twice –
once with the “purchase” and then on-going in the
physician compensation plan
Fair market value and commercial
reasonableness (addressed earlier) must also
be considered with regards to physician
compensation

25. Forensic and Valuation Services Section
Need for Valuation Services in Healthcare
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26. Forensic and Valuation Services Section
Need for Valuation Services in Healthcare
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27. Forensic and Valuation Services Section
Need for Valuation Services in Healthcare
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28. Forensic and Valuation Services Section
Traditional Needs for
Valuation Services in Healthcare
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29. Forensic and Valuation Services Section
Significant Differences from Business
Valuations of other In Other Industries
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Typically, financial statements are going to be
on the modified-cash or income-tax basis (non
accounts receivable or accounts payable)
It can be difficult to
obtain an accurate
patient accounts
receivable aging
report
The effect of unpaid
credit balances on
revenues (cash
collections) should be
considered
Medical equipment is
typically going to
have been
depreciated on
accelerated tax
methods

30. Forensic and Valuation Services Section
Physician Practice Valuation
Specific Information to Request and Consider
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• Specialties, board certifications, length of
time with practice, years to retirement
The physicians
• Is the practice operating at capacity?
Office/physician
schedule
• In/out of network (access)? Rates?
Managed care
contracts
• Understand the dynamics of historical
physician compensation
Collections/charges
by provider

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Physician Practice Valuation
Specific Information to Request and Consider
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• Mid-levels? Non-physician,
licensed employees?
Non-physician
employees
• Collections/charges by payorPayor mix
• Privileges, call group, medical
directorships, etc.
Hospital
affiliation

32. Forensic and Valuation Services Section
Physician Practice Valuation
Specific Information to Request and Consider
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Patients in the practice
• Zip code reports show the area
patients are drawn from
• Referral reports show how new
patients have come into the
practice.
• Other demographics – how long
have patients been with the
practice? How many new/recurring
patients are seen?

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Physician Practice Valuation
Specific Information to Request and Consider
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CPT/HCPCS code analysis
• “Top 10” codes
• Technical and professional components of
ancillary services

34. Forensic and Valuation Services Section
Physician Practice Valuation
Specific Information to Request and Consider
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Data to Request
• Requested Reports
- Broken down by insurer.
- One type of insurer can have different plans so it may have
more than one amount on the reports.
- Do not want any reports with patients names.
- HIPAA data security requirements apply to “business
associates,” including appraisers – a signed business
associate agreement is recommended.

35. Forensic and Valuation Services Section
Understanding the Practice
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The range of services provided by the practice and whether
those services are provided at the practice or at a hospital
Recent or planned changes in providers
Production considerations – if the entity has non-physician
practitioners (NPPs) understand how they are tracked
Are there any planned changes with regards to production?

36. Forensic and Valuation Services Section
Understanding the Practice
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Production Measures Issues to Consider
Office Visits Number of patients seen in an
ambulatory (office) setting
Encounters Can mean ambulatory
Procedures Can mean every CPT submitted or the
number of times a certain case is
performed
Cases Often comprised of multiple CPT codes
or procedures; assistant surgeon cases
may be reflected
RVUs / wRVUs Impact of modifiers, multiple procedure
discounts

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Physician Practice Valuation Drivers
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The physician’s specialty(ies)
Possession of state-of-the-art technology and equipment
The range of services provided by the practice and whether
those services are provided at the practice or at a hospital
A staff that is familiar with coding and runs the practice
efficiently
Effective use of mid-level providers

38. Forensic and Valuation Services Section
Physician Comp Benchmark Compensation
Data
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American Medical
Group Association
(“AMGA”)
Medical Group
Compensation and
Financial Survey
Includes clinical
compensation
Hospital & Healthcare
Compensation
Service (“HHCS”)
Physician Salary &
Benefits Report
Includes clinical and
medical director
compensation
Medical Group
Management
Association
(“MGMA”)
Physician
Compensation and
Production Survey
Includes clinical
compensation
AMGA HHCS MGMA

39. Forensic and Valuation Services Section
Physician Comp Benchmarking Example
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Allergy/Immunology
Compensation Compensation wRVUs Collections
Mean $ 287,668 4,438 $ 629,018
25th Percentile $ 198,432 3,438 $ 419,867
Median $ 254,386 4,286 $ 564,312
75th Percentile $ 357,457 5,200 $ 807,602
90th Percentile $ 461,637 6,452 $ 1,042,968
Physician Metrics $ 550,000 4,000 $ 450,000
Benchmarks
Mean 47.70% -10.95% -39.78%
25th Percentile 63.92% 14.06% 6.70%
Median 53.75% -7.16% -25.40%
75th Percentile 35.01% -29.99% -79.47%
90th Percentile 16.07% -61.30% -131.77%

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Benchmarking Example – MGMA Data
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41. Forensic and Valuation Services Section
A Sampling of Sources of Information
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BVR / AHLA Guide to
Healthcare Valuation
MGMA / AMGA
Annual Publications
The Healthcare
Acquisition Report
by Irving Levin
Associates
Centers for Medicare
and Medicaid
Services website:
www.cms.gov
American Health
Lawyers Association
publications

42. Forensic and Valuation Services Section
Use of Cost Approach to
Value Health Care Entities
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Accounts receivable is not on the balance sheet
Must understand when and how gross charges
are reduced to contractual fee schedule in
estimating the value of accounts receivable
If significant, consider use of a medical equipment
appraiser to determine FMV of medical equipment

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Use of Cost Approach to
Value Health Care Entities
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Consider not only the replacement cost, but the
economic obsolescence of any intangibles
• “Economic obsolescence relates to the inability of the
intangible asset owner/operator to generate a fair rate of
return on investment (“ROI”)” (AICPA Forensic and Valuation
Services Section, “Intangible Asset Valuation: Cost Approach
Methods and Procedures,” p. 28)
Accounts payable and other liabilities are likely
not on the balance sheet
Note: Case law may dictate the use of the cost
approach for purposes of marital dissolution

44. Forensic and Valuation Services Section
New Guidance - Cost Approach
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AICPA FVS section issued a new white paper,
“Intangible Asset Valuation: Cost Approach
Methods and Procedures”
Common types of health care intangible assets
identified include, among others:
• Medical, dental and other professional licenses
• Patient relationships
• Patient files and records (manual and electronic)
• Electronic medical records computer software
• Medical and administrative assembled workforce
• Employment and noncompetition agreements
• A professional’s personal goodwill
• An entity’s institutional goodwill
• Many others

45. Forensic and Valuation Services Section
New Guidance of Cost Approach
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Continuing debate among healthcare appraisers
about the use of the cost approach to establish
FMV of intangible assets in physician practices.

46. Forensic and Valuation Services Section
Use of Income Approach to
Value Health Care Entities
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Useful to demonstrate the impact of physician
compensation
Commonly going to see the use of discounted
cash flows over the period specified in the
employment contract
Incorporate post-acquisition physician
compensation arrangements

47. Forensic and Valuation Services Section
Use of Income Approach to
Value Health Care Entities
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Anticipated reimbursement changes can be
modeled in the DCF (advantage over capitalization
of earnings
• Consider payor mix and announced or anticipated changes in
fee schedules along with impact on revenue
• Consider anticipated patient volume trends in conjunction
with understanding of the practice and its providers

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Income Approach Considerations
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Other valuation considerations:
• Ownership of space must be determined to determine
fair market value of rent
• Normalize or project effects of providers recently joining
or departing the practice
• Post-transaction compensation – Derby et al v.
Commissioner)
• Additional ancillary services introduced or discontinued
• Many others

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Effect of Physician Compensation on Value
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Capitalized Value
Ongoing Cash Flow to Invested Capital Comp @ 542,000 $26,000
Capitalization Multiple 6.00
Indicated Capitalized Value of Invested Capital 156,000
Less: Interest Bearing Debt 0
Indicated Capitalized Value of Equity $156,000
Capitalized Value
Ongoing Cash Flow to Invested Capital Comp @ 200,000 $368,000
Capitalization Multiple 6.00
Indicated Capitalized Value of Invested Capital 2,208,000
Less: Interest Bearing Debt 0
Indicated Capitalized Value of Equity $2,208,000

50. Forensic and Valuation Services Section
Use of Market Approach to
Value Health Care Entities
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Thought to potentially include synergies
Hypothetical sale of practice may be inconsistent
with theories underlying determination of alimony
and child support in divorce cases
The Goodwill Registry – rule of thumb? Useful
Information?
Quality of transaction data is generally poor and
limited in number
Almost always an income based or asset based
approach to value

51. Forensic and Valuation Services Section
Use of Market Approach to
Value Health Care Entities
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In some instances involving health care entities
(less likely to be useful in valuing physician
practices), information from publicly held
companies may be helpful.

52. Forensic and Valuation Services Section
Questions
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53. Forensic and Valuation Services Section
For additional information, please visit:
AICPA Forensic and Valuation Services (FVS) Section
www.aicpa.org/fvs
Certified in Financial Forensics (CFF) Credential
Overview
www.aicpa.org/cff
(ABV) Accredited in Business Valuation Credential
Overview
www.aicpa.org/abv
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54. Forensic and Valuation Services Section
See You at the Event!
Visit www.aicpa.org/FVS_CPE_Events to register for the
following face-to face educational opportunities:
AICPA Fair Value Measurements Workshop
• September 19-20, 2011 in New York, NY
AICPA National Forensic Accounting Conference
• September 21-23, 2011 in Chicago, IL
AICPA National Business Valuation Conference
• November 6-8, 2011 in Las Vegas, NV
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55. Forensic and Valuation Services Section
FVS Resources
AICPA Forensic and Valuation Services
www.aicpa.org/fvs
FVS Practice Aids and Other Non-authoritative
Guidance - (members only)
www.aicpa.org/fvspracticeaids
FVS CPE & Events
www.aicpa.org/fvs_cpe_events
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56. Thank You!
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