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1 The seminar and/or webinar and materials that you will view were prepared for general information purposes only by Baker Tilly and are not intended as legal, tax or accounting advice or as recommendations to engage in any specific transaction, including with respect to any securities of PNC, and do not purport to be comprehensive. Under no circumstances should any information contained in the presentation, the webinar, or the materials presented be used or considered as an offer or commitment, or a solicitation of an offer or commitment, to participate in any particular transaction or strategy. Any reliance upon any such information is solely and exclusively at your own risk. Please consult your own counsel, accountant or other advisor regarding your specific situation. Neither PNC Bank nor any other subsidiary of The PNC Financial Services Group, Inc. will be responsible for any consequences of reliance upon any opinion or statement contained here, or any omission. The opinions expressed in these materials or videos are not necessarily the opinions of PNC Bank or any of its affiliates, directors, officers or employees. PNC is a registered mark of The PNC Financial Services Group, Inc.( PNC ) 2013 The PNC Financial Services Group, Inc. All rights reserved. Baker Tilly Virchow Krause, LLP Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International.

2 Keep Reducing Personal and Practice Debt Chris VanStraten, CPA Partner, Baker Tilly Baker Tilly Virchow Krause, LLP Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International. 2

3 Agenda > The role debt plays in your life > Understanding true cost of debt and leverage > Time Value of Money concepts > Down payments and impact on rates > Best uses of excess cash > Tax advantages of debt > Impact of debt on ownership and financial statements > Considerations in evaluating debt financing structures > Case studies > Debt pay-off and saving guidelines 3

4 The Role Debt Plays > Your goal should be wealth maximization during your lifetime. > This means different things for different people. > Debt can enable you to purchase something that increases your long term wealth (Practice, real estate, etc.) but requires a capital outlay (Leverage) > The key is to manage that debt, always staying on track with long term wealth creation. > Understanding interest costs vs. capital appreciation. 4

5 Facts about debt > Many graduating dental students have $200,000+ in student loan debt ($400,000 for private school students) > Average loan to buy a practice is $450,000 > Personal debt includes mortgage, home loan, auto loans, etc. > It can be daunting to face this much debt. Debt Amount Cost Over Lifetime Value remaining Student Loan (15 yrs at 5%) $200,000 $ 284,686 $ 0 Practice Loan (10 yrs at 5.5%) $450,000 $ 586,042 $ 450,000 Car Loan (5 yrs at 3%) $ 35,000 $ 37,734 $ 5,000 Mortgage (30 yrs at 4%) $350,000 $ 601,542 $ 350,000 Total $835,200 $1,607,487 $ 805,000 5

6 Facts about debt Poll Question #1 6

7 Time Value of Money A dollar today is worth more than a dollar tomorrow. Save and invest early in life (investment doubles every 9 years on average) > Analysis of interest costs 200,000 student loan over 15 years at 3.8% $1,459 monthly payment $62,694 in interest paid Instead, let s say you try to pay down this debt to rid yourself of it and pay $2,500 per month > Save $31,697 in interest > Pay off in 7 years 8 months (nearly ½ of time!) > Note trade off with investment returns (discussed later) 7

8 Time Value of Money 8

9 Leverage vs. Interest Rates In general, leverage and interest rates have an inverse relationship > The less down payment you have, the higher the interest rate > This holds true for total debt to income ratio as well. Lenders will become wary of lending you money if you have too much debt. 9

10 Determining best use of cash If I have $5,000, should I invest this or pay down debt? > Other option is to spend it (buy a car, clothes, etc) In financial terms, you have to look at interest rates vs. expected rate of return. > If you expect to get 5% return on an investment, and have a 4% loan, you re financially better off investing the money vs. paying down debt faster. (assumes tax rates on income and deductions are the same) Psychology of being debt free does not always match with this decision. 10

11 Facts about debt Poll Question #2 11

12 Tax Advantages of Debt > Interest expense is tax deductible leading to savings on your tax bill. i.e. $20,000 interest expense could lead to $7,000 in tax savings (assumed 35% combined rate) Note that principle payments on debt are not deductible, just the interest portion. > You are allowed to depreciate the asset purchased, even if it is financed. i.e. you finance an equipment purchase of $100,000. You may be able to utilize this entire amount as a deduction even though you haven t paid anything out of pocket yet. The immediate deduction is many times more valuable due to time value of money. > Though financing is sometimes required, interest expense is still money out of your pocket, regardless of tax savings. > End goal is wealth maximization, compare net cash out to income produced over the long-term, with taxes considered. 12

13 Impact of Debt on Ownership > Debt payments can consume large amounts of cash-flow > Important to manage your lifestyle to enable debt payments to be made timely, and maybe even faster than scheduled. > Large amounts of debt can make financing equipment purchases or emergency funding difficult. > Your wealth is reduced by outstanding debt. A reduction in debt increases your wealth. 13

14 Impact of Debt on a Financial Statement > Income vs. Cash Flow. > Cash vs. Wealth Creation. > Liquidity risk and future purchases. > Interest deduction / Principle reduction. Standard Model Profit & Loss Fees Collected 733, Expenses: Accounting 7, Advertising 2, Bank Charges 3, Bank Loan 56, Bonus 12, Dental Supplies 48, Lab Fees 78, Meals & Entertainment 9, Wages 341, Total Expenses 731, Profit 2, ADCPA Model Profit & Loss Enhanced Management Format - Summary Fees Charged (Memo) 737, Fees Collected 733, Operating Expenses (Personnel, Production, Facility, G&A) 161, Net Income Before Other 572, Other Expenses: (Equip., Financing, Associate, Fringes) 315, Net Income Before Doctor 256, Doctor Compensation: (Salary, P/ Tax, Retirement Plan) 254, Net Taxable Income 2,

15 Shopping for Debt > When looking for financing in your personal or professional life, consider different options. > Long-term vs. short-term vs. cash flow (chart) > Negotiate fees and prepayment penalties. > If you can afford the extra payments, shorter term lower rate financing maximizes wealth in the long run (assuming rate of return on investments is constant). > Some lenders have financing specific to dental practices that may make ownership financially feasible. > Terms may be negotiable. Long-Term vs. Short Term Debt & Cash Flow Considerations $400, Yr. (6.5%) $400, Yr. (5.5%) $400,000 7 Yr. (4.5%) Monthly Payments $ 3,484 $ 4,341 $ 5,560 Total Interest Expense $227,197 $120,926 $ 67,045 Total Cash Outlay $627,197 $520,926 $467,045 15

16 Paying Down Debt If debt has you worried, it is important to have a plan to pay down your debt and stick to it. Snowball Method > Start by paying off the debt with the lowest principle balance. Do this by making extra payments, to the extent you can afford to. Make the minimum payment on other debts. > Once that debt is paid off, take the amount you were paying on that debt and apply all of it to your next lowest principle balance debt. > Keep doing this until all debts are paid Avalanche Method > Pick the highest interest rate debt to payoff first. Once done, apply those payments to the next in line. Work your way down hill like an avalanche to the lowest rate debt. 16

17 Case Study #1 Invest or pay-off early Assume you buy a $450,000 practice with fully financed at 5.5% over 10 years resulting in a $4,884 monthly payment. Also assume you can invest and earn an average of 7% on your investments. If you have an extra $12,000 per year of income after expenses, should you pay down your loan or invest the excess? See table below for net worth comparisons after 5 years. Year 1 Extra Paid Towards Loan Year 10 Extra Paid Towards Investment Year 10 Practice 450, , ,000 Investment ,593 Practice Loan 450, , ,675 Net Worth 0 262, ,918 *tax rates on investments and mortgage interest expense assumed equal in both scenarios. Note: Interest rates on debt or investments have a direct correlation with risk. In this case, your investments must carry a higher risk to you then your mortgage does to your bank. Therefore, you can increase your net worth faster by investing any excess money instead of paying down your mortgage. 17

18 Case Study #2 Interest Costs on Debt You are purchasing a new practice for $500,000, 100% financed through a bank. After qualifying for the loan, your banker tells you there are a few options available that are essentially the same except for the interest rate and term. The options are as follows: 1)7 Year Loan at 4.5% with a $6,950/month payment 2)10 Year Loan at 5% with a $5,303/month payment 3)15 Year Loan at 5.5% with a $4,085/month payment At first glance, the 15 year loan looks appealing, however, it is important to consider total costs of the financing. Total interest costs on each loan are: 1) 7 Year Loan = $ 83,807 2)10 Year Loan = $136,394 3)15 Year Loan = $235,376 If the practice produces enough cash flow to service the 7 year debt at $6,950/month, you could save $151,569 compared to the 15 year loan! 18

19 Case Study #3 Utilizing Debt to make an Investment You ve been approached by an equipment representative who wants you to buy a digital imaging system for $130,000. The claim is that the machine will allow you to do better dentistry including expanding your current offerings. In the end, he tells you that your production will go up by a conservative estimate of $35,000/year. The bank offers you a 5 year loan at 6% to purchase the equipment. After tax considerations, is it a good investment? Notes: 1)Assumes a marginal tax rate of 40%. 2)Equipment will be fully expensed in first year. 19

20 Case Study #3 (cont.) Cash Flow Analysis Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Additional Income 35,000 35,000 35,000 35,000 35,000 35,000 Debt Service: Principle (22,992) (24,400) (25,905) (27,503) (29,200) - Interest (7,165) (5,757) (4,252) (2,654) (958) - Tax savings/(expense) 40,866 (11,697) (12,299) (12,938) (13,617) (14,000) Cash Flow 45,709 (6,854) (7,456) (8,095) (8,775) 21,000 Net Present Value at 8% = $31,840 Tax Analysis Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Additional Income 35,000 35,000 35,000 35,000 35,000 35,000 Equipment Purchase (130,000) Interest Expense (7,165) (5,757) (4,252) (2,654) (958) - Net Income (102,165) 29,243 30,748 32,346 34,042 35,000 Tax Rate 40% 40% 40% 40% 40% 40% Tax (Savings) (40,866) 11,697 12,299 12,938 13,617 14,000 Note: In this scenario, the additional after tax income plus immediate tax savings from accelerating depreciation cover the cost of the equipment over the 5 year payback period. After 5 years, your practice would net an additional $21,000 of cash flow for the remaining life of the equipment. Example does not account for repairs or maintenance. 20

21 Case Study #4 Time Value of Money Your 28 years old, recently out of school and you buy your own practice, a house and a new car. With all of these expenses it seems difficult if not impossible to adequately save for retirement at this time. You wonder, I ll make good money in the future, can I just catch up later when things calm down? You ve decided you ll need $3 million to retire, and you wish to retire at age 55. The table below illustrates the power of saving early in regards to saving for retirement. You can reasonable expect a 6% return on investment and tax implications are assumed equal in all scenarios. Age to Start Saving Yearly Savings Needed Age 55 Savings 28 $ 45,883 $3,000, $ 80,094 $3,000, $ 127,250 $3,000,000 By waiting just 7 years to start saving, you would have to nearly double your savings rate to get to the same desired savings at retirement, 12 years leads to nearly a tripling of savings rate! By starting at age 28, the ending balance of $3,000,000 is made up of $1,238,838 of contributions you ve made and $1,761,163 of income earned on the investment. However, by waiting until age 40 you ve contributed $1,908,750 of the $3,000,000, meaning you ve had to contribute nearly $700,000 more, even though you have 12 less years to do so! 21

22 Debt and Savings Rules of Thumb *Capital to income ratio is the estimate of how much savings you should have relative to your income. The savings ratio is the estimated percentage needed to be saved to be at this level of savings. *Your goal should be to keep your mortgage amount compared to your income below the ratio given. For example, a 35 year old making $100,000 should have a mortgage of $190,000 or less. 22

23 Debt Guidelines > Good debt relates to things that appreciate over time (education loans, practice loans, etc.) Favor this over bad debt used to purchase depreciating assets (auto loans, credit cards). > Try to keep your total debt payments to less than 35% of your income. > Pay debt and bills timely to keep a good credit score. > Only apply for credit you need, too many credit cards can hurt your credit score. (But there is a happy medium.) > Consolidation of debt can make your life easier and possibly save you money. Consider consolidating student loans as well. > Make sure you have insurance to manage your debt risk so you and your family are secure if you become disabled or die unexpectedly. 23

24 Thank you! Any questions? 24

25 Disclosure The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party. 25

26 The seminar and/or webinar and materials that you will view were prepared for general information purposes only by Baker Tilly Virchow Krause. LLP and are not intended as legal, tax or accounting advice or as recommendations to engage in any specific transaction, including with respect to any securities of PNC, and do not purport to be comprehensive. Under no circumstances should any information contained in the presentation, the webinar, or the materials presented be used or considered as an offer or commitment, or a solicitation of an offer or commitment, to participate in any particular transaction or strategy. Any reliance upon any such information is solely and exclusively at your own risk. Please consult your own counsel, accountant or other advisor regarding your specific situation. Neither PNC Bank nor any other subsidiary of The PNC Financial Services Group, Inc. will be responsible for any consequences of reliance upon any opinion or statement contained here, or any omission. The opinions expressed in these materials or videos are not necessarily the opinions of PNC Bank or any of its affiliates, directors, officers or employees. PNC is a registered mark of The PNC Financial Services Group, Inc.( PNC ) 2013 The PNC Financial Services Group, Inc. All rights reserved.

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