PHHE 453 Prescott College Public Health Worksheet

Problem 3 – Chapter 5Assume 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
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.
● 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 costvolume-profit (CVP) analysis, is a
technique used to assess the effects
of alternative volume assumptions on
costs and profits.
● 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.
■ 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
percent discount.
■ 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 percent 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
= $287.28.
5 – 40
Discussion Items
● What do the graphs tell managers
about the importance of utilization
management:
● Under FFS reimbursement?
● Under capitation?
● What do the graphs tell about the
importance of the number of members
under capitation?
5 – 41
The Impact of Cost Structure on Risk
■ If reimbursement is tied exclusively to
volume (FFS), then the provider’s
financial risk is minimized if all costs
are variable.
■ If reimbursement is exclusively
capitated, then the provider’s financial
risk is minimized if all costs are fixed.
5 – 42
Graphical Analysis under FFS
Revenues
and Costs
($)
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?