Selling your healthcare services company involves careful planning and preparation. One common challenge in the sale process is ensuring documentation and data are in place to support historical financial reporting. Potential buyers will conduct various levels of financial due diligence, ranging from verifying cash deposits and disbursements to performing a quality of earnings (QOE) assessment.
As a seller, you must have a solid understanding of your company’s financial position and the analyses likely to be conducted by an interested buyer before entering into a sale process. Performing a sell-side QOE assessment can help you to better substantiate historical financial performance and uncover potential issues ahead of the buyer’s due diligence process.
In Part 1 of the Transaction Considerations series, PYA explains the benefits of a sell-side QOE assessment and shares focus areas to best showcase your company’s strengths.
Benefits
- Increased credibility
- Identification of issues and solutions
- Streamlined due diligence process
Increased credibility: In today’s transaction environment, buyers are placing increased scrutiny on a target company’s past and expected financial performance. Engaging an independent third party to analyze your company’s financial reporting creates credibility by providing an unbiased perspective about its operations.
Identification of issues and solutions: This assessment helps uncover potential issues relating to revenue recognition practices, one-time adjustments, and irregular expenses. Once identified, these areas can be investigated to determine if internal processes are in need of improvement, updates should be made to existing accrual methodologies, or additional information can be provided at the onset of a sale process to anticipate barriers and overcome due diligence surprises.
Streamlined due diligence process: Performing a sell-side QOE assessment streamlines the transaction process by gathering many of the supporting data that are needed for the buyer’s financial due diligence.
Focus Areas
- Revenue recognition
- Supporting documentation for operating expenses
- Forward-looking adjustments and non-recurring items
Revenue recognition: The most important area of a QOE assessment in healthcare services is revenue recognition. A QOE assessment will typically analyze revenue by procedure, provider, payer, and location, as applicable. Additionally, an assessment will provide insight into collection rates and collection timelines.
Depending on the historical basis of accounting (cash basis versus accrual basis), other procedures may be applied to better understand revenue:
Cash to Accrual Conversion: Buyers will often expect to see accrual-based financial reporting, meaning revenue must be converted from a cash basis (when payment was received for a service) to an accrual basis (when payment should be reported based on when the service was delivered).
Accrual Validation: If your company is already reporting on an accrual basis, the QOE assessment will use the historical period under review to perform a look-back analysis. This process helps to understand how closely historical estimates correlate with actual collections performance.
Supporting documentation for operating expenses: The expense structure of many healthcare services entities primarily consists of salaries, employee benefits, supplies, real estate lease expenses, and certain outsourced vendor arrangements (i.e., billing and collections, electronic medical record/practice management systems, etc.). A sell-side QOE assessment helps to document supporting information for these items and instill confidence in reported operating expenses. This level of documentation can be achieved through readily available reports such as payroll registers, provider contract arrangements, real estate lease arrangements, and detailed vendor spend reports.
As with revenue reporting, presenting operating expenses on an accrual basis is equally important. A sell-side QOE assessment will include cash-to-accrual conversion or accrual validation of expenses depending on the historical basis of accounting.
Forward-looking adjustments and non-recurring items: Non-recurring items are events that happen only once, such as a major change in information technology systems or a disruption in service due to unexpected circumstances beyond the control of the business. Forward-looking adjustments account for recent changes in the business, such as hiring a new provider, offering new services, or opening a new location. You must carefully analyze and assess each of these factors to ensure a strong explanation supports how and why these events have impacted, or will impact, your business in the future.
In summary, conducting a sell-side QOE assessment may require additional effort at the outset, but it can ultimately expedite the sale process. The assessment provides a roadmap for engaging potential buyers, who will also carry out their own financial due diligence, and strengthens your position in negotiations regarding revenue and expense items that could become hurdles. Sell-side QOE assessments also serve to showcase your company’s strengths and unique differentiators.
PYA’s national Transaction Advisory Services practice routinely assists healthcare services entities with QOE assessments and other transaction needs. We have been honored to serve numerous clients over the last four decades ranging from serial acquirers and sellers such as national consolidators of health services and multi-billion-dollar health systems to individual physician practices. For assistance, our executives are happy to help.
