The volume of physician practice mergers and acquisition (M&A) transactions is on pace to increase by approximately 37% in 2018 as compared to prior year1.

As these physician practice transactions continue to become more prevalent, it is important to have an understanding of key financial issues that are common throughout the majority of practices, regardless of specialty. These physician practice deals can be challenging from a financial due diligence perspective given the general lack of a finance / accounting function within practices and the cash-basis nature of many practice financials.

Key items to consider when evaluating physician practice transactions

  • Cash to accrual conversion – As the majority of physician practices typically operate on a cash basis of accounting, a standard component of a quality of earnings analysis includes converting the Company’s books from cash to accrual basis. This conversion would consider items such as: accounts receivable, supplies inventory, accrued payroll, and accounts payable. While the most significant part of this cash to accrual conversion relates to accounts receivable and accrued provider compensation (both discussed in below sections), it is also important to understand the historical supplies inventory balances, unaccrued non-provider compensation, and other operating payables when evaluating the working capital necessary to operate the practice.
  • Quality of revenue analysis – In order to estimate historical accounts receivable, a cash waterfall analysis will need to be performed utilizing the Target’s historical claims and payment data. This analysis will present historical cash collections by date of service, which will allow you to analyze collections trends over time and anticipate any future collections. Performing this analysis at a disaggregated level (e.g., by location, provider, payor, procedure, etc.) will allow you to identify trends and anomalies that otherwise may not be apparent when analyzing the cash waterfall on a consolidated basis. Items that may become apparent when analyzing the waterfall on a disaggregated level could include changes in the chargemaster, changes in payor rates, and periods of disruptions in service/billing. If anomalies such as these are identified, the cash waterfall analysis may need to be adjusted to normalize the impact of these outliers. When analyzing the results of the cash waterfall analysis, it is important to understand the trending of charges and payments over the historical period (e.g., increases in volume of charges typically result in a positive cash to accrual EBITDA adjustment).
  • Provider compensation – It is common practice for providers to be compensated based on a production basis (i.e., based on a percentage of collections for services rendered). Based on the results of the provider-disaggregated waterfall analysis and the terms of the provider employment agreements, this production-based compensation can be recomputed on an accrual basis as part of a quality of earnings analysis. It is important to understand the Target’s historical production-based payment schedule. If there is a significant lag between when the compensation is earned (i.e., when the service is performed) and when the compensation is paid to the provider, there could be a significant exposure related to earned but unpaid provider compensation.
  • Owner compensation – The terms of owner compensation are typically renegotiated as part of a potential transaction. As owners may receive the majority of their historical compensation through equity distributions (i.e., no income statement impact), the revaluation of owner compensation (to a production-based arrangement as discussed in the section above) generally results in a significant reduction to the historical reported EBITDA of the physician practice. Conversely, if the owners’ historical compensation has been through payroll (i.e., impact to the income statement), the revaluation of post-transaction close owner compensation may result in a meaningful decrease in payroll expense and an increase in pro forma EBITDA of the physician practice.  It is important to consider the terms of the post-close employment arrangement with the owner and the impact of that pro forma compensation when building your investment model.

Overall, the financial due diligence of physician practices could prove challenging given the general cash basis nature of accounting. However, understanding the key issues and analyses needed to address these issues will help ensure a successful transaction.

Need confidence in your healthcare M&A process? Ask these 10 questions.

Given ever-changing accounting complexities coupled with accounting resource limitations at most healthcare organizations, buyers unfortunately cannot take the reported financial information at face value for what future expected earnings will be post-close. As part of the financial due diligence process, at a minimum a buyer should consider the following key items to determine the sustainability of earnings, and if EBITDA (earnings before interest, taxes, depreciation and amortization) is an adequate metric to determine the seller’s ability to generate cash flow.


  1. Do cash receipts per the bank statement(s) support net revenue reported on the financial statements and collections per the patient billing/accounting system?
  2. How are charges and collections trending by payor during the historical period (e.g., are collection rates increasing or decreasing)?
  3. Have there been any recent contract changes that will impact earnings post-close (e.g., payor / managed care contracts, professional services agreements, outsourced billing/collections)?
  4. Is there a shift in payor mix that will impact reimbursement trends post-close (e.g., increase in self-pay patients, increase in self-pay after insurance amounts for deductibles and co-payments, change in governmental payor mix)?
  5. Has there been a change in service mix (e.g., increase in lab fees or growth in ancillary services) that overshadows the performance of the legacy business?


  1. Are there any non-recurring expenses recorded in the historical financial statements (e.g., owner compensation or rent expense not reported at fair market value, start-up costs / de novo costs) or changes in cost structure?
  2. Are all operating costs required to run the business accurately reflected in the reported financials (e.g., is a cash-to-accrual conversion required)?
  3. How does historical compensation and benefit structure for clinicians and other key employees (including the consideration of contractor usage) compare to expected compensation and benefit plans for these employees (and contractors) post-close?
  4. Will there be upcoming capital expenditures or other investments required to continue growing the business?
  5. Have there been any significant medical malpractice claims against the seller or its clinicians?

Overall, the quality of revenue and earnings analyses are critical steps in the acquisition process that will allow the buyer to better assess each of the reported aspects of the business. Along with this earnings analysis, an in-depth understanding of the balance sheet accounts will give the buyer the confidence in future expected earnings and cash flows of the acquired business.

For more information, contact Brian Marynowitz at or 615-309-2321. Learn more about our Transaction Advisory Services.

1Source: According to an article published in Q3 2018 from Irving Levin Associates, Inc., there have been 153 physician practice acquisitions by private equity firms through August 2018 compared to 168 transactions for all of 2017. We annualized 153 transactions over the first eight months of 2018 to estimate the total increase for the year.