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CHAPTER 5
Managerial Accounting Basics, Cost Behavior, and Profit Analysis
Copyright © 2008 by the Foundation of the American College of Healthcare Executives
6/7/07 Version
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Managerial Accounting
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Cost Classifications
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Is there a difference between a cost and an expense?
Discussion Item
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Cost Classifications (Cont.)
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Cost Classifications (Cont.)
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What are some examples of fixed and variable costs, say, for a hospital’s clinical laboratory?
Discussion Item
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Cost Structure Example: Walk-In Clinic
Variable Costs Per Visit Fixed Costs Per Year
Clinical supplies $20Facilities $ 30,000
Other supplies 5Salaries 190,000
Variable cost rate $25Overhead 80,000
$300,000
Total
Fixed Variable Total Average
Volume Costs Costs Costs Cost
1 $300,000 $ 25 $300,025 $300,025
100 300,000 2,500 302,500 3,025
200 300,000 5,000 305,000 1,525
1,000 300,000 25,000 325,000 325
5,000 300,000 125,000 425,000 85
10,000 300,000 250,000 550,000 55
25,000 300,000 625,000 925,000 37
Note: The relevant range is this example is unrealistic.
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Cost Structure Example (Cont.)
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Graphical Cost Structure
Costs
($)
Volume
(Number of Visits)
Total Costs
Fixed Costs
Total Variable Costs
What is the slope of the total variable costs line?
What is the relationship between total costs and total variable costs?
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Profit (CVP) Analysis
Why is such information valuable to health services managers?
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Profit Analysis Example
Atlanta Clinic has forecasted the following cost data on the basis of 75,000 expected visits:
Fixed costs
Total variable costs 2,113,500
Total costs
$7,080,962
$4,967,462
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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.
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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.
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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.
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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 $100. What does the clinic’s cost and revenue structure look like graphically?
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Graphical Profit Analysis
Revenues and Costs
($)
Volume
(Number of Visits)
Total Costs
Fixed Costs
Total Revenues
Where are profits and losses?
Where is the breakeven volume?
Where is 75,000 visits?
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Forecasted (Projected) Profit and Loss
(P&L) Statement
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Base Case P&L Statement
Total revenues ($100 x 75,000)$7,500,000
Total VC ($28.18 x 75,000) 2,113,500
Total CM ($71.82 x 75,000)$5,386,500
Fixed costs 4,967,462
Profit$ 419,038
VC= Variable costs.
CM= Contribution margin.
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Base Case P&L Statement (Cont.)
What happens to the average cost per visit as volume increases?
Why?
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Contribution Margin
What is the total contribution margin?
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Breakeven Analysis
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Breakeven Analysis (Cont.)
What is the accounting breakeven for Atlanta Clinic? There are two approaches to answer this question:
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.
P&L Approach
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Breakeven Analysis (Cont.)
Note that the P&L approach can be recast in a contribution margin format.
CM x V= Fixed costs
$71.82 x V= $4,967,462
V = $4,967,462 / $71.82= 69,165 visits.
P&L Approach (Contribution Margin Format)
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Graphical Breakeven Analysis
Revenues and Costs
($)
Volume
(Number of Visits)
Total Costs
Fixed Costs
Total Revenues
69,165
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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.
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Operating Leverage
DOL = Total CM / EBIT, where
EBIT = Earnings before interest and taxes.
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Operating Leverage (Cont.)
DOL = Total CM / EBIT
= $5,386,500 / $419,038
= 12.85.
What does the DOL tell Atlanta’s managers?
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Operating Leverage (Cont.)
Using DOL:
Visits
67,500
75,000
82,500
Profit
-$119,612
$419,038
$957,688
-10%
+10%
-128.5%
+128.5%
What does a high DOL mean?
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Profit Analysis Under Discounted FFS
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P&L Statement with 70,000 Visits
Total revenues ($100 x 70,000)$7,000,000
Total VC ($28.18 x 70,000) 1,973,600
Total CM ($71.82 x 70,000)$5,027,400
Fixed costs 4,967,462
Profit $ 39,938
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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) 2,113,500
Total CM ($69.15 x 75,000)$5,186,500
Fixed costs 4,967,462
Profit$ 219,038
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Graphical Profit Analysis
Revenues and Costs
($)
Volume
(Number of Visits)
Total Costs
Fixed Costs
Old Total Revenues
New Total Revenues
69,165
71,836
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Marginal (Incremental) Analysis
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Base Case P&L Statement
Total revenues ($100 x 75,000)$7,500,000
Total VC ($28.18 x 75,000) 2,113,500
Total CM ($71.82 x 75,000)$5,386,500
Fixed costs 4,967,462
Profit$ 419,038
VC= Variable costs.
CM= Contribution margin.
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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) 2,254,400
Total CM ($69.32 x 80,000)$5,545,600
Fixed costs 4,967,462
Profit$ 578,138
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Graphical Profit Analysis
Revenues and Costs
($)
Volume
(Number of Visits)
Total Costs
Fixed Costs
Old Total Revenues
New Total Revenues
69,165
84,928
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Marginal (Incremental) Analysis (Cont.)
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At this point, the numerical analysis indicates that the offer should be accepted. Considering all the factors relevant to the decision, what should Atlanta Clinic’s managers do?
Discussion Item
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Profit Analysis Under Capitation
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Analysis Based on Visits
Revenues and Costs
($)
Volume
(Number of Visits)
Total Costs
Fixed Costs
Total Revenues
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Analysis Based on Visits (Cont.)
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Graphical Analysis Based on Members
Revenues and Costs
($)
Volume
(Number of Members)
Total Costs
Fixed Costs
Total Revenues
Note: Average utilization is assumed regardless of volume.
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Analysis Based on Members (Cont.)
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Discussion Items
What do the graphs tell managers about the importance of utilization management:
Under FFS reimbursement?
Under capitation?
What do the graphs tell about the importance of the number of members under capitation?
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The Impact of Cost Structure on Risk
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Graphical Analysis under FFS
Revenues and Costs
($)
Volume
(Number of Visits)
Total Costs
Total Revenues
=
TotalVCs
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Graphical Analysis Under Capitation
Revenues and Costs
($)
Volume
(Number of Visits)
Total Costs
Fixed Costs
Total Revenues
=
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What are the implications of the previous two slides for managerial decision making?
Discussion Item
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Do you have any questions?
Conclusion