VMG Health was engaged through External Counsel on behalf of their client to perform a quality of earnings (QoE) analysis to support a fair market value (FMV) opinion by VMG Health related to the acquisition of an ambulatory surgery center (ASC). VMG Health’s financial due diligence (FDD) team performed a quality of revenue (QoR) analysis as a component of the QoE, in which the FDD team analyzed and tested the ASC’s accrual basis revenues.
Situation
The target ASC historically accounted for their revenues on a cash basis, recognizing revenue when cash was received. During the period analyzed by the FDD team, the target ASC changed revenue cycle management (RCM) systems and began accounting for what they believed to be all revenues on an accrual basis. The FDD team’s QoR procedures uncovered that the target ASC was still receiving a significant amount of cash on a monthly basis related to aged attorney lien business performed outside of the analyzed period, and that their accountant continued to book these cash receipts to the financial statements on a cash basis. Through further investigation, the FDD team noted that the target ASC’s attorney lien service line had contracted significantly in the recent fiscal years, and no longer materially contributed to the target’s service line mix on an accrual basis in recent periods.
Solution
As a result, when VMG Health’s FDD team adjusted these attorney lien cash receipts back to their date of service (accrual basis), the vast majority were pushed out of the period analyzed in the QoE analysis and, subsequently, not included in the FMV opinion. The adjustment from cash basis to accrual basis, along with the material change in service line mix related to the reduction of attorney lien business, resulted in a net decrease to diligence adjusted revenue of approximately one-third of the target ASC’s reported revenues. VMG Health’s FDD team held discussions with the target ASC’s management team to walk through the findings in detail, resulting in the target ASC’s agreement with VMG Health on the restatement of revenues to be truly accrual basis in the last-twelve-month (LTM) period.
Success
VMG Health incorporated the corrected, accrual–basis EBITDA figures from the FDD team into their FMV opinion, which allowed them to properly state earnings for the purposes of determining a purchase price for their client. VMG Health’s process ensured their client fully understood where the target ASC stood financially as of the transaction date, but more importantly ensured their client did not severely overpay for the target ASC.
