Understanding Replacement Reserves in View of Storm Season
- The topic of replacement reserves is often confusing for medical practice owners:
- How much should be set aside for replacement reserves?
- Should replacement reserves be included in net operating income?
- How do replacement reserves impact cap rates and value?
What are Replacement Reserves?
Replacement Reserves are funds set aside that provide for the periodic replacement of building components that wear out more rapidly than the building itself and therefore must be replaced during the building’s economic life (short lived items).
These components typically include the replacement of the equipment, furniture, hardware, software, file storage and most assets that are part of your practice.
Now, with the advent of hurricane season in the South and East, tornadoes in the Midwest and the myriad of natural occurrences everywhere in between, an “anticipatory disaster reserve” can now be justified. This is all handled within your budgeting process, i.e. Sources & Uses of Funds.
How much should be set aside for replacement reserves? You should start by working with your insurance agent, what is the “risk rating” in for your area and adjust replacements accordingly. A good rule of thumb is to:
- Estimate replacement value along with shipping, labor and training
- Subtract the insurance coverage
- Add 30 days Gross Earnings (based off your prior years 1120)
- Include 3X marketing expense to recapture lost market share.
Replacement reserves are an important line item in any healthcare business. Capital expenditures are necessary for Continuity of Income. Yet, many people gloss over the reserves for replacement line item and often exclude it completely from the NOI calculation. The fact is that, if you include it after Earnings and before Tax it will not affect your capitalized value and it will demonstrate sound management and planning which is critical for your sustainability. This is also an excellent time to “put adversity to work for you” and get up to speed with your practice analysis, diversity of income and compliance measures including payment performance programs.
Some medical practices never manage to establish a budget, and many others establish a budget and never look at it again. As GPA Capital receives a loan request, we have a discovery session which can reveal too much overhead in proportion to the revenue being generated. Failure to identify the problems, and provide appropriate solutions, results in a working capital shortage and inability to meet current debt service not to mention future debt service for practice improvements, practice expansion, and may cause diminished practice value whether selling, purchasing or refinancing.
The science is to understand and implement an easy to maintain flexible budget and not a static budget. Assure that you seek qualified help to create continuous budgeting, not rolling. The art is to use this tool to identify and create diversity and continuity of income. To bring these two together, you must have a flexible, continuous budget which will then open your horizons to predictive financial modeling and achievement of your financial goals.
GPA Capital recently updated its “assessment of threats to physicians’ independence” we now share the results of our Physicians’ Independence Research Update.
The bottom line… most physicians are finding it hard to compete in the current healthcare environment and at the same time, they would rather “not” go to work for someone else, retire, or worse yet, sell their practice for pennies on the dollar because it’s not generating the income it should be. Not only is our survey revealing, but so are the comments gleaned from our team of experts.
Consistent with debt coverage and additional cash available at the end of the month, GPA Capital has put together a program which specifically addresses the concerns of today’s independent physicians.
Looking forward to serving your capital needs for your new office, acquisition, expansion or refinance. Complete this short form [Express Loan App] and get it back me, (confidentially, of course). 24 hour loan approval in most cases.
Written by: Jim Tate
We have reflected in earlier posts the critical importance of achieving a high MIPS score. Reimbursement, practice value, and professional reputation are all directly impacted by a MIPS score. Here is yet another collateral impact of a MIPS score: the ability to obtain and maintain a loan. A tip of the hat to my friends in the healthcare finance business over at Grice, Pope and Associates who alerted me to this pearl of wisdom.
First, a little financial loan lesson from Wikipedia on the infamous debt service coverage ratio:
“The debt service coverage ratio (DSCR), also known as “debt coverage ratio” (DCR), is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity’s (person or corporation) ability to produce enough cash to cover its debt (including lease) payments. The higher this ratio is, the easier it is to obtain a loan. The phrase is also used in commercial banking and may be expressed as a minimum ratio that is acceptable to a lender; it may be a loan condition. Breaching a DSCR covenant can, in some circumstances, be an act of default.”
So there you have it. The DSCR is based on the documented ability to have enough cash flow to repay a loan. Although there is variation among lenders, a DSCR greater than 1.2 is good enough to obtain a loan. Many providers and practices will find if they are below 1.2 they will have difficulty getting a loan. If your cash available to service a loan should drop, as might occur when a low MIPS score suddenly triggers a reduction in Part B reimbursement, you might be in trouble. You could face difficulty in obtaining a new loan. Even worse, if you have an existing loan with DSCR covenant, you could immediately be in default. In 2019 potential Part B negative adjustments can be up to 4% and will increase 9% in 2022. Forewarned is forearmed.
The reasons to make a priority of achieving a high MIPS score continue to mount. Next week I’ll have another one for you.
High deductibles with increased co-pays are making Working Capital (cash flow) harder to come by. We see this at GPA Capital by the increased number of calls looking for long-term loans. However, many times we are able to help practices with a debt free solution that provides – and even increases – their cash flow.
In the past, Medical Factoring has only been available to hospitals and other large facilities. However, GPA Capital and our investors have created a Factoring Program tailored to small and medium healthcare practices. [1 minute video].
For clarity of the problem and multiple solutions, we dove tailed the summary above with this family physician’s actual case study. Next week we will give you some pointers on how to compete with the “big box” national dental chains moving into your area.
We look forward to serving your capital needs through our wide range available options. Simply complete this short Working Capital Form to get started.
CMS estimates that 58% of Medicare Part B billing comes from providers who will be subject to the MIPS program. What you do the remainder of 2017 will affect your reimbursements in 2019 and very well can cause increase or decrease in your patient population. GPA Capital announces its MIPS web page for our readers and clients. As financiers, it’s critical not only to provide capital by loans, but also revenue enhancements, reduced costs and revenue boosters.
Get started here: [Learn]
Considerations often overlooked when financing, particularly when planning your exit:
1. Direct access to the decision maker. 24 hour approval capability.
2. Obtain a practice analysis to maximize to your business value.
3. Survey the capital markets to assure the best rate/terms and loan structure.
4. Make sure you are using all revenue sources available for your specialty.
5. Make sure you are compliant and paying zero for merchant fees
GPA Capital recently arranged a $375,000 loan for the acquisition of a 30-year-old dental practice in South Florida. The operating Dentist was retiring and the existing office manager of 20 years purchased the business. The Manager partnered with one of the existing 1099 employed Dentist. GPA Capital arranged 90% financing on the purchase of the business and provided an additional $40,000 in operating capital to the new owners. Prior to the practice valuation GPA Capital implemented a strategy for cost savings, patient growth and revenue enhancement. Here is a white paper worth your reading [CLICK]
We look forward to serving your capital needs through our wide range available options. Simply complete this short Telephone Appointment Request to get started.
Announcing the GPA Capital Blog where GPA will be bringing you news on Financing, Revenue Enhancements, Compliance and other topics that are important to you, our physician clients. As our loyal readers and followers, we will share with you our global and proprietary access to state-of-the-art Financial Solutions to meet your challenges.