Pharmacy Cash Flow Instruments and Maine Financial Discount Rates

By Brad MacLiver
Authorship and profile at Google


When a Maine (ME) pharmacy is considering selling a cash flow instrument such as the pharmacy’s receivables, or a pharmacy business note, the price the Maine pharmacy owner receives will reflect how much time is involved before the Buyer/Investor/Funder of the cash flow instrument will recoup his principal investment and the desired rate of return the Investor needs to make it desirable to take the risk of buying the pharmacies cash flow instrument.
                    
To entice an Investor to shift the risk of holding the cash flow instrument from the pharmacy owner in ME to the Investor, there is typically a financial incentive for the Investor. The incentive is the rate of return, which is required to compensate for the Investors perceived risk. The risk is based on the credit of the cash flow instrument’s Payor, previous payment history, seasoning, interest rate, and other variables. Discount rates may change depending on the circumstances of the cash flow instrument, the economy, etc.

If the Maine pharmacy owner or an investor could take the cash flow instrument to the bank and cash it in at face value, the asset would hold more value. However, since this can’t happen the risk of holding the cash flow instrument makes it worth less than face value.

Time Value of Money: The concept of cash being more valuable to have a dollar today instead of tomorrow is based on the Time Value of Money (TVM). Most business people are aware of the TVM and how it is fundamental to both personal and corporate decision making, but to make sure we are on the same page, we will cover the basics of TVM.

TVM assumes that money earns interest over time. Therefore, as the cliché says time is money, and because of this we can compare money at different points in time that have different values and call them equal.

Within the same reasoning the reverse is true. An investor will not pay $1.00 today for a dollar that won’t be collected until next year, or 10 years from now. Today’s dollar will be discounted to reflect risk, inflation, the strength of the economy, etc.

In addition to principal amounts and interest rates, cash flow instruments like Pharmacy Business Notes in Maine are originated within a certain time period. The TVM can be looked at as if it were on a sliding scale; the earlier the Note is paid off, the smaller the interest amount becomes. When the Note is paid early, you don’t get to collect the compounded interest amount, which would have accumulated if you had waited the full time period. The Note has already been written and the terms set. Unlike a loan where the rate of return needed to cover the risk is added to the loan amount. An investor cannot go back to the buyer of your business and change the terms of the note. Therefore, the investor looks at the portion of the note, which is going to be purchased and subtracts the rate of return needed to justify the risk. This is called Discounting. The amount of the discount is contingent on the risk.

If you want an investor to advance you money, you will no longer have any risk because you have transferred it to the Investor. To compensate the Investor for accepting the risk of holding the note, the Investor will discount the note, and pay you an amount equivalent to the time and risk involved.

The price you receive when selling your note will be the discounted rate according to the basic TVM principals minus the amount that allows an investor to justify the risk.                               

If a note is a length of several years, it may be beneficial for you to sell only a portion of the note. Because the payments from a month in the 5th year will hold less value than payments collected this year, it is beneficial to you to only sell the number of months that you need to obtain the cash that meets your current financial needs. You can always sell more payments at a later date if you need additional funds. Determine what cash you really need and we will calculate the number of months we will purchase to meet your needs.

Although it involves a much shorter period of time, understanding discount rates is the same when selling a Maine pharmacy’s accounts receivables.


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To learn more about pharmacy finance, cash flow financing, business loans for local drug stores visit www.PharmacyValuations.com or the Tips and resource web site www.BuyingAndSellingPharmacies.
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EBITDA and Maine Pharmacy Acquisitions

By Brad MacLiver
Authorship and profile at Google


EBITDA is an acronym for earnings before interest, taxes, depreciation and amortization and is often used to measure the value of some businesses including some in the pharmacy industry. EBITDA can also be used in the comparison of similar companies. Drug store and pharmacy owners in Maine who are considering either buying a pharmacy or selling their drug store should have an understanding of EBITDA and how it affects pharmacy valuations.

Generally, EBITDA makes it easier to evaluate various companies and to compare them against industry averages by removing the non-core and irregular operating costs, such as interest, which can vary depending on the management’s choice of financing, taxes which can fluctuate depending on acquisitions or losses from prior years, and arbitrary factors of depreciation and amortization. Many in the pharmacy industry also use the EBITDA method.

The EBITDA formula can be used as a guideline when valuing larger companies, or when comparing the profitability of large similar companies in the same industry.

For the effective use of EBITDA, these larger companies should possess significant assets, have heavy amortization schedules, or bear substantial amounts of debt. Considering independent pharmacies in Maine (ME) don’t meet that criteria, this formula is not a useful measure as the sole means for valuing pharmacies for acquisition purposes.

Six easy steps for Maine pharmacy owners wishing to calculate their store's EBITDA:

1. Calculate net income by obtaining total income and subtract total expenses.
2. Determine the total amount of taxes paid to federal, state, and local governments.
3. Compute interest fees paid to companies or individuals for the use of credit, or capital.
4. Establish the cost of depreciation (the expense recorded to allocate a tangible asset's cost over its useful life).
5. Determine the cost of amortization (the expense for consumption of the value of intangible assets, such as goodwill, patents, and copyrights, over a specific period of time, or the asset's expected life.
6. Add #1 through #5.

EBITDA calculation example:
1. Net Income            3,000
2. + Taxes paid            900
3. + Interest Expenses     600
4. + Depreciation          300
5. + Amortization          150
6. = EBITDA              4,950

EBITDA Drawbacks:
1. It can be a misleading number when it is confused with cash flow.
2. It can make even completely unprofitable firms appear financially healthy.
3. The numbers are easily manipulatable.
4. They can overlook cash requirements for growth in accounts receivable.
5. They can miss cash requirements for growth in inventories.
6. They are not factual when valuing small companies.
7. They are ineffective for companies with few assets, small amounts of debt, or low depreciation or amortization schedules.

An example of the drawbacks of EBITDA:
During the 80s, EBITDA was used as a way to look at cash flow during due diligence for an acquisition. This was used to calculate whether or not a company had the ability to service their debt. By factoring out interest, taxes, depreciation, and amortization, they can allow an unprofitable business to appear financially healthy. This method of valuation was used quite often during the dotcom era to value unprofitable businesses with few assets and little earnings. The results from this method caused many to go bust, a blaring example of misapplying EBITDA.

Pharmacy business consultants, who are knowledgeable about performing pharmacy business valuations, will use EBITDA during ME specialty pharmacy valuations, but this is only as part of a larger formula when computing values for specialty pharmacies especially those who have a niche in HIV, disease management, long term care, etc. EBITDA should not be used, however, as part of the usual formula for standard retail pharmacy valuations for acquisitions.

The EBITDA number for a specific existing pharmacy in ME is, for  most purposes, important when the existing ownership is establishing their store value for the purposes such as establishing a line of credit, borrowing, creating a Trust, and stock values.  EBITDA does not, however, have the same importance when selling a Maine pharmacy. This is because the buyer will not have the same expenses as the seller.

Buyers may not have the same tax base, interest expense, or depreciation schedule. It is thusly important that the buyer calculate an estimated EBITDA that is specific to their operating model, business systems, buying power, cost of operations, etc., not the sellers. It should also be noted that EBITDA assumes that the buyer will acquire all of the assets, working capital, accounts receivable, and liabilities. Those assumptions do not hold true regarding an acquisition of a Maine pharmacy. Instead of the EBITDA number, pharmacy buyers should be focusing on sales, gross profit, cash flow, and customer mix.

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