Ch. 5 Cost behavior and Profit Analysis

Question 1

Focuses on subunits

Based on assumptions

• Utilization (Volume)
• reimbursement rates
• costs
  
  • Resource use associated with providing or supporting a specific service

Cost classifications:

1. Relationship to the volume of services provided
2. Relationship to the unit (department) being analyzed

Question 2

Cost in terms of activity, utilization, volume.

Volume uncertainty ex: number of patient days, number of visits, number of number of enrollees, number of lab tests etc.

relevent range of volum based on historical data

Fixed Costs

• Known with certainty, regardless of the level of volume within relevant range
  
  • Wages
  • Facilities
  • Diagnostic equipment
  • Information system

Answer 2

Variable Costs

• Directly related to volume
  
  • Clinical supplies
• Variable Cos rate stays the same

Question 3

**Cost behavior / Underlying cost structure **

The relationship between an organization’s total cost and volume

• Used in planning, control and decision making
• Forecasting costs (and ultimately profits) at different volume levels.

Cost behavior Graph:

Slope of the fixed costs = 0

Slope of the variable costs = Rate of the variable costs

The total cost line is the total variable costs line shifted upward by the amount of fixed costs.

Answer 3

Semi-fixed costs: Fixed over some range of volume, but this range is smaller than the relevant range used in the analysis.

Fixed within ranges of volume, but there are multiple ranges of semi-fixed costs within the relevant range

Question 4

Profit Analysis:

• Analyze the effects of volume changes on profit.
• Analyze the effects of volume changes on costs

CVP: Cost Volume Profit Analysis

Effects of alternative assumptions regarding costs, volume, and prices.

To estimate the cost structure: one option is to plot the total costs of the clinic at different volume levels for the past several years and then run a regression

• Slope would indicate the Variable Cost Rate
• intercept would indicate the fixed costs

Add a revenue Component. Price to patient per visit

Answer 4

**Variable Cost Rate: **

Total variable costs / total number of forecasted visits

Total costs =

Fixed Costs + (variable cost rate x total visits)

Question 5

P & L Statement: Forecasted profit for 2012, given the most likely assumptions

P & L base case scenario

Total Revenues = price x assumed volume

Less

Total Variable costs = variable cost rate x assumed volume

Less

Total contribution margin = (price - VCR) x assumed volume

Less

Fixed Costs

=

Profit

Answer 5

Contribution Margin: $ amount per visit available to cover fixed costs

After fixed costs have been covered, any additional visits contribute to the clinic’s profit at a rate of the contribution margin

Total profit = Total Contribution margin - Fixed Costs

Question 6

Breakeven Analysis

Calculate the breakeven volume, at which a business becomes financially self-sufficient.

2 types of Breakeven volume:

1. Accounting breakeven = Volume needed to produce zero profit
2. Economic breakeven = Volume needed to produce a target profit level.

To calculate the Accounting breakeven, set the profit = 0 in the P & L equation

Question 7

High Operating Leverage: If a higher proportion of a business’s total costs are fixed = Relatively small change in volume results in large shifts in profits.

Degree of Operating Leverage: Measure of Operating Leverage =

DOL = Total contribution margin / Profit

Profit = DOL x Total contribution margin

Ex: the DOL for a volume of 75,000 visits, contribution margin of 5,386,500, profit of 419,038 =

5,386,500 / 419,038 = 12.85.

Thus, at a volume of 75,000 visits, each 1% change in volume produces 12.85% change in profit.

10% increase in volume results in 10% x 12.85 = 128.5% increase in profit

Answer 7

DOL leades to economies of scale

High DOL business also have relatively high breakeven points which increases the risk of loss.

High-DOL business suffer large profit declines and potentially large losses if volume falls.

If Volume fell by 7.8% profit would decline by:

7.8% x 12.85 = 100%

Question 8

Capitated Model

Provider taking on the insurance function

• Responsible for the health status (utilization) of the covered population
• Must keep costs lower than collected premium
• Revenue is being driven by the insurance contract (premiums and enrolees)

To decide if the Capitated rate is adequate you need to know:

1. Cost
2. Actuarial (utilization)

Answer 8

Implications for the per member per month utilization rate

• No direct link between volume of service provided and revenues
• Utilization above expected levels will bring increased costs w/o corresponding revenue
• Breakeven Volume:

(Total revenue - total fixed costs) / Variable Cost Rate

• Difficult to control costs: Must control the cost of the visit and the number of visits