PHHE 453 Prescott College Public Health Worksheet
Problem 3 – Chapter 5 Assume that a radiologist group practice has the following cost structure: Fixed costs Variable cost per procedure Charge (revenue) per procedure $ $ $ 420,000 285 650 Further assume the practice expects to perform 7,500 procedures in the coming year. a. construct the practice’s base case projected Profit and Loss (P&I) Statement Total Revenue Total Variable Cost Total Contribution Margin #VALUE! Total Fixed Costs Profit (net income) b. What is the practice’s Breakeven Point? Breakeven Volume = Fixed Costs/Contribution Margin Per Unit Revenue Per Unit $ 650 Variable Cost Per Unit $ 285 Contribution Margin Per Unit volume 7,500 Fixed Costs $ 420,000 Breakeven Volume visits c.(1) What volume is required to provide a pretax profit of $100,000 Breakeven Volume (With Profit) = (Fixed Costs+Profit)/Contribution Margin Per Unit Revenue Per Unit $ 650 Variable Cost Per Unit $ 285 Contribution Margin Per Unit Profit volume 7,500 Fixed Costs $ 420,000 Breakeven Volume visits c.(2) What volume is required to provide a pretax profit of $200,000 Breakeven Volume (With Profit) = (Fixed Costs+Profit)/Contribution Margin Per Unit Revenue Per Unit $ 650 Variable Cost Per Unit $ 285 Contribution Margin Per Unit Profit volume 7,500 Fixed Costs $ 420,000 Breakeven Volume visits Problem 3 – Chapter 5 PROBLEM 5.4(abc) – General Hospital, a not-for-profit acute care facility, has the following cost structure for its inpatient services Fixed costs Variable cost per procedure Charge (revenue) per procedure $ $ $ 12,500,000 550 2,855 The Hospital expects to have a patient load of 15,000 inpatient days next year. a. construct the practice’s base case projected Profit and Loss (P&I) Statement Total Revenue Total Variable Cost Total Contribution Margin #VALUE! Total Fixed Costs Profit (net income) b. What is the practice’s Breakeven Point? Breakeven Volume = Fixed Costs/Contribution Margin Per Unit Revenue Per Unit $ 2,855 Variable Cost Per Unit $ 550 Contribution Margin Per Unit volume 15,000 Fixed Costs $ 12,500,000 Breakeven Volume visits c.(1) What volume is required to provide a profit of $800,000 Breakeven Volume (With Profit) = (Fixed Costs+Profit)/Contribution Margin Per Unit Revenue Per Unit $ 2,855 Variable Cost Per Unit $ 550 Contribution Margin Per Unit Profit volume 15,000 Fixed Costs Breakeven Volume visits c.(2) What volume is required to provide a pretax profit of $500,000 Breakeven Volume (With Profit) = (Fixed Costs+Profit)/Contribution Margin Per Unit Revenue Per Unit $ 2,855 Variable Cost Per Unit $ 550 Contribution Margin Per Unit Profit volume 15,000 Fixed Costs Breakeven Volume visits Chpt 5 – Cost Structure VOLUME Variable cost rate Total Variable Costs Fixed Costs Total Costs Average cost per visit $ $ $ $ $ 5000 25 125,000 300,000 425,000 85 Chapter 5 Excel Table Total Costs = Total Fixed Costs + Total Variable Costs VOLUME 75,000 70,000 80,000 Total Fixed Costs 4,967,462 4,967,462 4,967,462 Total Variable Costs 2,113,500 1,972,600 2,254,400 Total Costs 7,080,962 6,940,062 7,221,862 Variable Cost Rate = Total Variable Costs/Volume Total Variable Costs 2,113,500 Volume 75,000 Variable Costs Rate 28 Cost per Visit Profit Analysis Revenue Total Costs Profit 94 99 90 7,500,000 7,080,962 419,038 7,000,000 6,940,062 59,938 8,000,000 7,221,862 778,138 Chapter 5 Excel Table Contribution Margin = Differece between Variable per unit costs and profit Per Unit Total Revenue Total Variable Cost TOTAL CONTRIBUTION MARGIN Fixed Costs Profit 100 28.18 71.82 Volume 75000 7,500,000 75000 2,113,500 75000 5,386,500 4,967,462 419,038 Chapter 5 Excel Table Breakeven Volume = Fixed Costs/Contribution Margin Breakeven Volume (With Profit) = (Fixed Costs+Profit)/Contribution Margin Revenue Per Unit 100 Revenue Per Unit 100 Variable Cost Per Unit 28.18 Variable Cost Per Unit 28.18 Contribtion Margin 71.82 Contribtion Margin 71.82 volume 75000 volume 75000 Profit 100000 Total Revenue Total Variable Costs Fixed Costs Volume ####### ####### ####### 69,165 visits Total Revenue Total Variable Costs Fixed Costs Volume ####### ####### ####### 70,558 visits 5-1 CHAPTER 5 Cost Behavior, and Profit Analysis Managers of healthcare businesses have many responsibilities, including planning, budgeting, and overseeing routine operations. All of these activities require information—a great deal of information—which is created by the business’s managerial accounting system. This chapter begins the coverage with a focus on costs and profits. Copyright © 2012 by the Foundation of the American College of Healthcare Executives 10/27/11 Version 5-2. PHHE 453 Prescott College Public Health Worksheet
Financial Vs. Managerial Accounting
■ Financial accounting:
● Uses organizational (aggregate) data
● Designed for use by external parties
● Primarily historical
● Must adhere to external standards (GAAP)
■ Managerial accounting:
● Uses organizational and sub-unit data.
● Designed for use by managers.
● Primarily forward-looking.
● Does not adhere to external standards. 5-3 Cost Classifications
■ Cost measurement is a critical part of managerial accounting.
● In fact, there is an entire field of accounting called cost accounting. PHHE 453 Prescott College Public Health Worksheet
● Unfortunately, there is no single definition of the term cost. Different costs are used for different purposes.
■ Costs are classified in two major ways. In this chapter, we focus on the relationship of costs to volume. 5-4 Cost Classifications (Cont.)
■ The relationship between costs and the volume of services provided is called cost behavior or underlying cost structure.
■ If the underlying cost structure is known, managers can forecast costs at different levels of patient volume.
■ In this context, costs may be:
● Fixed, which are independent of volume
● Variable, which depend on volume
● Semi-fixed, which partially depend on volume 5-5 Cost Classifications (Cont.)
■ In the long-run, all costs are variable, and hence these cost classifications hold only in the short-run, say, for one year.
■ Also, no costs are fixed throughout an infinite range of volumes. Thus, the concept of cost classifications according to volume must be applied within some relevant range of patient volume. 5-6 Cost Structure Example: Walk-In Clinic Variable Costs Per Visit Fixed Costs Per Year Clinical supplies $20 Other supplies 5 Variable cost rate $25 Facilities $ 30,000 Salaries 190,000 Overhead 80,000 $300,000 Total Fixed Variable Total Average Volume Costs Costs Costs Cost 1 $300,000 $ 25 $300,025 $300,025 100 300,000 2,500 302,500 3,025 200 300,000 5,000 305,000 1,525 1,000 300,000 25,000 325,000 325 5,000 300,000 125,000 425,000 85 10,000 300,000 250,000 550,000 55 25,000 300,000 625,000 925,000 37 Note: The relevant range is this example is unrealistic. 5-7 Cost Structure Example (Cont.)
■ Consider a volume of 5,000: ● ● ● ● ● Fixed costs = $300,000. Variable cost rate = $25. Total variable costs = $125,000. Total costs = $425,000. Average cost per visit = $85.
■ Now consider a volume of 10,000: ● ● ● ● ● Fixed costs = $300,000. Variable cost rate = $25. Total variable costs = $250,000. Total costs = $550,000. Average cost per visit = $55. 5-8 Graphical Cost Structure Costs ($) Total Costs Fixed Costs Total Variable Costs Volume (Number of Visits) 5-9 Profit (CVP) Analysis
■ Profit analysis, also called cost-volume-profit (CVP) analysis, is a technique used to assess the effects of alternative volume assumptions on costs and profits. PHHE 453 Prescott College Public Health Worksheet
● Why is such information valuable to health services managers? 5 – 10 Profit Analysis Example Atlanta Clinic has forecasted the following cost data on the basis of 75,000 expected visits: Fixed costs Total variable costs Total costs $4,967,462 2,113,500 $7,080,962 5 – 11 Profit Analysis Example (Cont.) What is the variable cost rate? Variable cost rate = Total variable costs Volume = $2,113,500 75,000 = $28.18 per visit. 5 – 12 Profit Analysis Example (Cont.) What is Atlanta’s cost behavior model? Total costs = Fixed costs + Total variable costs = $4,967,462 + ($28.18 x Volume) . For example, at 70,000 visits: Total costs = $4,967,462 + ($28.18 x 70,000) = $4,967,462 + $1,972,600 = $6,940,062. 5 – 13 Profit Analysis Example (Cont.) Cost/Volume Summary: Volume = 70,000 TC = $4,967,462 + $1,972,600 = $6,940,062. Volume = 75,000 (Base Case) TC = $4,967,462 + $2,113,500 = $7,080,962. Volume = 80,000 TC = $4,967,462 + $2,254,400 = $7,221,862. 5 – 14 Profit Analysis Example (Cont.)
● What do Atlanta’s managers learn from the data on the previous slide?
● Now, suppose that the average revenue per visit is expected to be $100. What does the clinic’s cost and revenue structure look like graphically? 5 – 15 Graphical Profit Analysis Revenues and Costs Where are profits and losses? Where is the breakeven volume? ($) Total Revenues Where is 75,000 visits? Total Costs Fixed Costs Volume (Number of Visits) 5 – 16 Forecasted (Projected) Profit and Loss (P&L) Statement
■ The projected P&L statement uses cost structure information along with the revenue forecast and projected volume to forecast profitability. ■ Although it looks like an income statement, it does not have to follow GAAP.
■ Because it is a forecast, it can be influenced by managerial actions. 5 – 17 Base Case P&L Statement Total revenues ($100 x 75,000) $7,500,000 Total VC ($28.18 x 75,000) Total CM ($71.82 x 75,000) Fixed costs Profit VC = Variable costs. CM = Contribution margin. 2,113,500 $5,386,500 4,967,462 $ 419,038 5 – 18 Base Case P&L Statement (Cont.)
■ Note that base case total costs equal fixed costs plus total variable costs or $4,967,462 + $2,113,500 = $7,080,962.
■ Thus, Atlanta’s average per visit cost is $7,080,962 / 75,000 = $94.41.
● What happens to the average cost per visit as volume increases.
● Why? 5 – 19 Contribution Margin
■ The contribution margin is defined as the difference between per visit (unit) revenue and the variable cost rate.
■ It is the amount of each visit’s revenue that is available to:
● First cover fixed costs.
● Flow to profit when fixed costs are covered.
■ In this illustration, the contribution margin is $100 – $28.18 = $71.82. 5 – 20 Breakeven Analysis
■ Breakeven analysis is performed in many different finance contexts. PHHE 453 Prescott College Public Health Worksheet
■ Here, it is used to determine the breakeven volume, defined as that volume needed for an organization (or service or program) to be financially self-sufficient.
■ There are two types of breakeven:
● Accounting breakeven (zero profit)
● Economic breakeven (with profit) 5 – 21 Breakeven Analysis (Cont.) What is the accounting breakeven for Atlanta Clinic? There are two approaches to answer this question:
● Projected P&L approach
● Graphical approach P&L Approach Total revenues – Total VC FC = Profit ($100 x V) – ($28.18 x V) – $4,967,462 = $0 $71.82 x V = $4,967,462 V = $4,967,462 / $71.82 = 69,165 visits. 5 – 22 Breakeven Analysis (Cont.) Note that the P&L approach can be recast in a contribution margin format. P&L Approach (Contribution Margin Format) CM x V = Fixed costs $71.82 x V = $4,967,462 V = $4,967,462 / $71.82 = 69,165 visits. 5 – 23 Graphical Breakeven Analysis Revenues and Costs ($) Total Revenues Total Costs Fixed Costs 69,165 Volume (Number of Visits) 5 – 24 Breakeven Analysis (Cont.) What is the economic breakeven if the desired profit level is $100,000? CM x V = Fixed costs + Profit $71.82 x V = $5,067,462 V = $5,067,462 / $71.82 = 70,558 visits. Note that the accounting breakeven is 69,165 visits. The additional number of visits needed is 1,393. 1,393 x CM = 1,393 x $71.82 = $100,000. 5 – 25 Profit Analysis Under Discounted FFS
■ Suppose Atlanta Clinic is confronted with a situation in which a payer contributing 5,000 visits wants a 40 per cent discount. PHHE 453 Prescott College Public Health Worksheet
■ Atlanta’s managers might want to drop the contract because a $60 per visit payment is less than the $94.41 average per visit cost.
■ But, further analysis is required. 5 – 26 P&L Statement With 70,000 Visits Total revenues ($100 x 70,000) $7,000,000 Total VC ($28.18 x 70,000) Total CM ($71.82 x 70,000) Fixed costs Profit 1,973,600 $5,027,400 4,967,462 $ 59,938 5 – 27 P&L Statement With Discount Visits Undiscounted revenue ($100 x 70,000) $7,000,000 Discounted revenue ($60 x 5,000) 300,000 Total revenues ($97.33 x 75,000) $7,300,000 Total VC ($28.18 x 75,000) Total CM ($69.15 x 75,000) Fixed costs Profit 2,113,500 $5,186,500 4,967,462 $ 219,038 5 – 28 Graphical Profit Analysis Revenues and Costs ($) Old Total Revenues New Total Revenues Total Costs Fixed Costs 69,165 71,836 Volume (Number of Visits) 5 – 29 Marginal (Incremental) Analysis
■ Suppose Atlanta Clinic is approached by a new insurer.
● This payer is expected to contribute 5,000 additional visits.
● However, it wants a 40 per cent discount, resulting in a revenue of $60 per visit.
■ At a volume of 80,000, the clinic’s average cost per visit is $7,221,862 / 80,000 = $90.27, so again Atlanta’s managers might be tempted to say “no.” 5 – 30 Base Case P&L Statement (Review) Total revenues ($100 x 75,000) $7,500,000 Total VC ($28.18 x 75,000) Total CM ($71.82 x 75,000) Fixed costs Profit VC = Variable costs. CM = Contribution margin. 2,113,500 $5,386,500 4,967,462 $ 419,038 5 – 31 P&L Statement With Added Volume Undiscounted revenue ($100 x 75,000) $7,500,000 Discounted revenue ($60 x 5,000) 300,000 Total revenues ($97.50 x 80,000) $7,800,000 Total VC ($28.18 x 80,000) Total CM ($69.32 x 80,000) Fixed costs Profit 2,254,400 $5,545,600 4,967,462 $ 578,138 5 – 32 Graphical Profit Analysis Revenues and Costs ($) Old Total Revenues New Total Revenues Total Costs Fixed Costs 69,165 71,660 Volume (Number of Visits) 5 – 33 Marginal (Incremental) Analysis (Cont.)
■ The marginal cost of each visit is the variable cost rate of $28.18 per visit.
■ The marginal revenue on the new contract is $60 per visit, so the contribution margin is $60 – $28.18 = $31.82.
■ Thus, 5,000 incremental visits would add 5,000 x $31.82 = $159,100 to the bottom line: $419,038 + $159,100 = $578,138. 5 – 34 Discussion Item At this point, the numerical analysis indicates that the offer should be accepted. Considering all the factors relevant to the decision, what should Atlanta Clinic’s managers do? 5 – 35 Profit Analysis Under Capitation
■ Capitation changes the way in which profit analysis is conducted
■ Perhaps the best way to see the effects of capitation is by graphical analysis.
■ We will examine two approaches to graphical analysis: ● In terms of utilization (number of visits).
● In terms of membership (covered lives). 5 – 36 Analysis Based on Visits Revenues and Costs ($) Total Revenues Total Costs Fixed Costs Volume (Number of Visits) 5 – 37 Analysis Based on Visits (Cont.)
■ On this graph, the profit and loss areas are reversed from the fee-for-service graph.
■ This “perverse” result occurs because the contribution margin on a per visit basis is negative.
● $0 – $28.18 = -$28.18. ● Each additional visit increases costs with no increase in revenues. 5 – 38 Graphical Analysis Based on Members Revenues and Costs ($) Total Revenues Total Costs Fixed Costs Note: Average utilization is assumed regardless of volume. Volume (Number of Members) 5 – 39 Analysis Based on Members (Cont.)
■ Now, the profit and loss areas are the same as on the fee-for-service graph.
■ On a per member basis, the contribution margin is positive.
● Each additional member contributes positively to profits.
● If per member annual revenue is $400 and the variable cost rate (based on 4 visits per year) is 4 x $28.18 = $112.72 per year, the contribution margin is $400 – $112.72 = $287.28. 5 – 40 Discussion Items
● What do the graphs tell managers about the importance of utilization management:
● Under FFS reimbursement? PHHE 453 Prescott College Public Health Worksheet
● Under capitation?
● What do the graphs tell about the importance of the number of members under capitation? 5 – 41 The Impact of Cost Structure on Risk
■ If reimbursement is tied exclusively to volume (FFS), then the provider’s financial risk is minimized if all costs are variable.
■ If reimbursement is exclusively capitated, then the provider’s financial risk is minimized if all costs are fixed. 5 – 42 Graphical Analysis under FFS Revenues and Costs ($) Total Revenues Total VCs = Total Costs Volume (Number of Visits) 5 – 43 Graphical Analysis under Capitation Revenues and Costs ($) Total Revenues Fixed Costs = Total Costs Volume (Number of Visits) 5 – 44 Discussion Item What are the implications of the previous two slides for managerial decision making? PHHE 453 Prescott College Public Health Worksheet
