When a dentist first begins thinking about selling a practice, one of the first documents we review is the practice’s financial information.
And that often leads to a question:
“If my tax return says I only made this much, how can my practice actually be more profitable?”
The answer frequently involves add-backs.
Understanding add-backs is important for sellers because the income shown on a tax return or profit-and-loss statement doesn’t always reflect the true economic benefit of owning the practice.
It’s also important for buyers, because not every expense labeled an “add-back” should automatically be accepted.
What Is an Add-Back?
An add-back is generally an expense that appears on the practice’s financial statements but would not necessarily continue under new ownership.
When analyzing a practice, we start with its reported income and then examine the expenses to determine which are legitimate ongoing operating costs and which may be:
- Owner-specific
- Discretionary
- Non-recurring
- Personal in nature
Those expenses may be added back to reported income when calculating the practice’s normalized profitability.
The goal isn’t to make the practice look more profitable than it really is.
It’s to answer a more useful question:
What would this practice reasonably earn for a new owner under normal operating conditions?
A Simple Example
Suppose a practice reports $150,000 in income.
During the financial analysis, we identify:
- $10,000 of personal automobile expenses
- $8,000 in owner-specific retirement or insurance expenses
- $7,000 for a one-time consulting project
If those expenses would not continue for a buyer, some or all of them could potentially be added back.
That could result in normalized earnings of approximately $175,000 rather than the $150,000 appearing on the financial statement.
That difference matters.
Not only can it affect the value of the practice, but it also helps a buyer understand the cash flow available to support:
- Their compensation
- Practice acquisition debt
- Future investment in the practice
Common Add-Backs in Dental Practices
Every practice is different, but there are several categories we frequently examine.
Owner-Specific Expenses
A practice owner may legitimately run certain expenses through the business that are associated specifically with that owner.
Depending on the circumstances, these could include portions of:
- Automobile expenses
- Cell phone expenses
- Travel
- Continuing education
- Insurance
- Retirement contributions
The important question isn’t simply whether the expense appears on the tax return.
It’s whether a new owner would need to incur that same expense to operate the practice.
Family Members on Payroll
This is another area that requires careful analysis.
A spouse, child or other family member may be employed by the practice. Sometimes that person performs an essential role and is paid a market-rate salary.
In that situation, the expense is legitimate and shouldn’t simply disappear from the analysis.
In other cases, a family member may be:
- Paid substantially above market
- Performing a limited role
- Receiving compensation despite having little involvement in the practice
The appropriate adjustment isn’t necessarily to add back the entire salary.
Instead, we need to determine:
What would it reasonably cost a buyer to replace the work being performed?
If a family member earns $80,000 for a position that would normally cost $50,000 to fill, the potential adjustment may be $30,000—not $80,000.
That distinction is important.
One-Time Expenses
Practices occasionally incur expenses that are unlikely to recur.
Examples might include:
- Unusual legal or consulting fees
- A one-time office project
- Certain extraordinary repair expenses
If an expense truly is non-recurring, it may be reasonable to normalize it.
But again, context matters.
A supposedly “one-time” expense that appears every year isn’t really a one-time expense.
Not Every Expense Is an Add-Back
This is where sellers can sometimes become overly optimistic.
An expense doesn’t qualify as an add-back simply because the seller doesn’t like seeing it reduce profitability.
The buyer will still need:
- Staff
- Dental supplies
- Laboratory services
- Rent or occupancy costs
- Insurance
- Utilities
- Technology
- Other normal operating expenses
Those costs don’t disappear when ownership changes.
And some expenses may require only a partial adjustment rather than being eliminated entirely.
That’s why simply going through a tax return and circling everything that looks personal isn’t an adequate profitability analysis.
Why Documentation Matters
A buyer, and ultimately the buyer’s lender and advisors, will want to understand the adjustments being made.
If we identify an unusual expense, we should be able to explain:
- What it was
- Why it appears in the financials
- Why it shouldn’t continue under new ownership
- How the adjustment was calculated
The stronger the documentation, the more credible the normalized earnings become.
That’s particularly important when an adjustment is significant.
Why Add-Backs Matter to Sellers
For a seller, properly identifying add-backs can prevent the practice from being undervalued.
A dentist may look at a tax return and think:
“My practice isn’t very profitable.”
But the financial statements may include legitimate discretionary or owner-specific expenses that obscure the actual economics of the practice.
A proper analysis helps tell the complete financial story.
Why Buyers Should Pay Attention, Too
Buyers should understand add-backs rather than simply accepting a broker’s or seller’s calculation.
Ask:
- Is this expense truly discretionary?
- Will I incur something similar?
- Is the adjustment recurring?
- Is the amount reasonable?
- Is there documentation supporting it?
A legitimate add-back helps reveal the practice’s true earning potential.
An overly aggressive add-back can do exactly the opposite.
The Bottom Line
A dental practice’s tax return tells us what was reported for tax purposes.
It doesn’t always tell us exactly what a new owner can expect to earn.
That’s why determining practice profitability requires more than looking at the bottom line.
It requires understanding the story behind the numbers.
Properly identifying and documenting add-backs allows sellers to present the true economics of their practice while giving buyers a clearer picture of the opportunity they’re considering.
Thinking About Selling Your Dental Practice?
If you’re considering selling your dental practice in New Jersey or Eastern Pennsylvania, understanding its normalized profitability is an important first step in determining value.
American Practice Consultants can help you evaluate your practice’s financial performance and understand how a prospective buyer is likely to view it.
Contact us for a confidential conversation about your practice and your transition goals.
