Chapter 5 Cvp

Managerial Accounting: Cost Behavior and Profit Analysis

Cartwright Financial Management

Managerial AccountingSupport decisions in the organizationCost and ProfitCost allocationPricingPlanning and budgeting


Cost MeasurementAccounting versus Economic costsCosts per servicePer member per monthProgram costs, Departmental costsCapital CostsOrganization related (direct and indirect)Volume related (fixed and variable)


Direct CostsRelationship to sub-unit being analyzed and volume of services providedIf the service department closed, these costs would disappear.


Indirect CostsUse of shared resourcesSpace, information systems, utilities, housekeeping, maintenance, medical records, and general administrationAlso called overhead costs.If service department closed, the costs still remain.


Fixed Versus Variable CostsVariable costs are related to activity, utilization, or volume.Fixed costs are predetermined.short-term staffing, equipment, facilities and information systems. Over time even fixed costs will change.Contractual obligations


Total CostsFixed plus VariableAverage cost = Total cost/unit of activityAs activity increases, average cost declines as fixed costs are spread out over more activity units.



Sheet1

Table 5.1 Cost behavior Illustration: Fixed and Variable Costs

Variable Cost per TestFixed Costs Per Year

Laboratory Supplies$10Labor$100,000

Other fixed Costs50,000

$150,000

Total

FixedVariableTotalAverage

VolumeCostsCostsCostsCost Per Test

0$150,000$0$150,000----

1150,00010150,010$150,010.00

50150,000500150,5003,010.00

100150,0001,000151,0001,510.00

500150,0005,000155,000310.00

1,000150,00010,000160,000160.00

5,000150,00050,000200,00040.00

10,000150,000100,000250,00025.00

15,000150,000150,000300,00020.00

20,000150,000200,000350,00017.50

Sheet2

Sheet3


Sheet1

Cost Behavior Illustration: Fixed Semi-fixed, and Variable Costs 5.2

Variable Cost per TestFixed Costs per TestSemi -Fixed Costs

Laboratory Supplies$10Labor$100,000Increase in Labor costs$35,000

Other fixed Costs50,000above 15,000 tests

$150,000

TotalTotal

FixedSemi-FixedFixedVariableTotalAverage

VolumeCostsCostsCostsCostsCostsCost Per Test

10,000150,000$0150,000100,000250,000$25.00

14,000150,0000150,000140,000290,00020.71

15,000150,0000150,000150,000300,00020.00

16,000150,00035,000185,000160,000345,00021.56

20,000150,00035,000185,000200,000385,00019.25

Sheet2

Sheet3

Cost behavior modelTotal costs depend on volumeRevenues depend on volumeHence, we can examine the behavior of profit as revenues and costs change with volume.


Cost-Volume-Profit AnalysisImportant to determine profits for capital projects, determine pricing and service decisions, determine future management responses to change adverse situations


Pro-Forma Profit and Loss StatementProjection of profit (net income) given initial base case assumptions can be done with a CVP analysis.This is a forecast.Profit is calculated on the basis of assumed expected volume, price, and costs.



Sheet1

A Clinic: 2005 Base Case Pro-Forma P&L Statement

Total Revenues ($100*75,000)$7,500,000

Total variable costs ($28.18*75,000)2,113,500

Total contribution margin ($71.82*75,000)$5,386,500

Fixed Costs4,967,462

Profit (net income)$419,038

1. Based on 75,000 patient visits

2. Breakeven point is 69,165 patient visits.

Solve TR - $100xVisits = 0

TC - FC -28.18xVisits = 0

Sheet2

Sheet3

Profit(CVP) AnalysisCost-Volume-Profit AnalysisEvaluate future courses of actionMost be based on forecastsInherent risk that the future will not conform to the forecast



Sheet1

Atlanta Clinic: Forecasted Cost Data for 2005 (75,000 visits)

Variable CostsFixed CostsTotal Costs

Salaries and Benefits:

Management and supervision0.0928,687928,687.00

Coordinators442,617.005980631,040,680.00

Specialists0.03860038,600.00

Technicians681,383.005526701,234,053.00

Clerical/administrative71,182.0058240129,422.00

Social security taxes89,622.00163188252,810.00

Group Health insurance115,924.00211081327,005.00

Professional fees325,489.00383360708,849.00

Supplies313,283.00231184544,467.00

Utilities74,000.0045040119,040.00

Allocated costs0.017573491,757,349.00

Total2,113,500.004,967,4627,080,962.00

Sheet2

Sheet3

Cost Behavior ModelTotal cost = Fixed Costs + Total variable costs = $4,967,462 +($28.18 x Number of visits)

$2,113,500/75,000 = $28.18 per visit


Using the EquationVolume = 70,000:TC = FC + VCTC=4,967,462+28.18 x 70,000 = $6,940,062Volume = 75,000:TC = 4,967,462+28.18*75,000 = $7,080,962Volume = 80,000TC = 4,967,462 +$28.18 x 80,000 = $7,221,862



Chart1

496746204967462

496746225000005671962

496746245000006235562

496746255000006517362

496746265000006799162

496746275000007080962

496746285000007362762

496746295000007644562

Fixed cost

Total Revenue

Total cost

Atlanta Clinic CVP Graphical Model

Sheet1

Atlantic Clinic: CVP Graphical Model

VolumeFixed CostVariable CostTotal CostTotal RevenueProfit

04,967,46204,967,4620(4,967,462)

250004,967,4627045005,671,9622500000(3,171,962)

450004,967,46212681006,235,5624500000(1,735,562)

550004,967,46215499006,517,3625500000(1,017,362)

650004,967,46218317006,799,1626500000(299,162)

750004,967,46221135007,080,9627500000419,038

850004,967,46223953007,362,76285000001,137,238

950004,967,46226771007,644,56295000001,855,438

Sheet1

Fixed cost

Total Revenue

Total cost


Sheet2

Sheet3


Sheet1



04,967,46204,967,4620(4,967,462)

25,000.004,967,4627045005,671,9622500000(3,171,962)

45,000.004,967,46212681006,235,5624500000(1,735,562)

55,000.004,967,46215499006,517,3625500000(1,017,362)

65,000.004,967,46218317006,799,1626500000(299,162)

75,000.004,967,46221135007,080,9627500000419,038

85,000.004,967,46223953007,362,76285000001,137,238

95,000.004,967,46226771007,644,56295000001,855,438

Sheet1

000

000

000

000

000

000

000

000

Fixed cost

Total Revenue

Total cost


Sheet2

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Sheet1

Atlanta Clinic: 2005 Base Case Pro-Forma P&L Statement

( Based on 75,000 patient visits)

Total Revenues ($100 x 75,000)7,500,000

Total variable costs ($28.18 x 75,000)2,113,500

Total contribution margin ($71.82 x 75,000)5,386,500

Fixed costs4,967,462

Profits (net income)$419,038

contribution rate is (100 - 28.81)

Sheet2

Sheet3

Contribution MarginUnit revenue - per unit variable costDoes not include fixed costsAfter fixed costs are covered, there will be a profit.


Breakeven AnalysisTotal Revenues - Total Variable Costs - Fixed Costs = Profit($100*volume) - (28.18 * volume) - $4,967,462 = ProfitAt breakeven, set profit equal to 0Solve for volume69,165 visitsVolume greater produces profitVolume lower produces lossProfit for Visits above the breakeven volume can be calculate by multiplying the contributing margin times incremental volume above the breakeven volume.



Sheet4

Atlanta Clinic: 2005 Base Case Pro-Forma P%L Statement

( Based on 69,165 patient visits)

Total Revenues ($100 x 69,165)$6,916,500

Total variable costs ($28.18 x 69,165)1,949,070

Total contribution margin ($71.82 x 69,165)4,967,430


Profits (net income)$(32)

contribution rate is (100 - 28.81)

Sheet1

Sheet2

Sheet3


Sheet4

Table 5.6 Atlanta Clinic: 2005 Projected Pro-Forma P&L Statement

Number of Visits

69,16575,00082,500

Total Revenues ($100 x volume)$6,916,500$7,500,000$8,250,000

Total variable costs ($28.18 x volume)1,949,0702,113,5002,324,850

Total contribution margin ($71.82 x volume)$4,967,430$5,386,500$5,925,150

Fixed costs4,967,4624,967,4624,967,462

Profits (net income)$(32)$419,038$957,688

Sheet1

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Operating Leverage

A health care provider that has a higher proportion of fixed costs and a lower proportion of variable costs has more operating leverage. A provider with lower fixed costs and higher variable costs has less operating leverage The higher the degree of operating leverage, the greater the potential danger from volume variation If a relatively small error is made in forecasting utilization, there would be large errors in cash flow projections.


Operating LeverageHigh proportion of total costs are fixedSmall change in volume leads to large change in profitFirms with a high degree of operating leverage often have economies of scale.But have high breakeven points, which increases risk of losses. Hospitals are the usual example of such a firm.


Degree of Operating LeverageThe degree of operating leverage (DOL), is defined as the percentage change in operating income (or EBIT) that results from a given percentage change in salesThe DOL is an index number which measures the effect of a change in utilization on operating income, or EBIT.DOL = (EBIT2-EBIT1)/EBIT1/(Q2-Q1)/Q1


Calculating DOLChange in EBI ($957,688 -$419,038)/419,038 =$538,650/$419,038 = 1.285 (128.5%)Change in Utilization (82,500-75,000)/75,000 = 7,500/75,000 = .1000 (10.00%)128.5%/10% = 12.85


Calculating DOLGapenski also uses the following calculation in book and in problem set:

Total Contributing Margin / EBIT $5,386,500 / $419,038 = 12.85

Same answer as previous slide.


CVP Analysis in a Discounted Fee-for-Service Environment25,000 visits come from Peachtree HMO40 percent discount requested$60 per patientFull cost is $94.41 per visitLose (94.41-60)=$34.41 per patientTotal loss ($34.41 x 25,000)=$860,250Reject?


Impact of rejecting proposalGoing to lose market share of 25,000Still have large fixed costs.Will not break even.



Sheet4

Table 5.7 Atlanta Clinic: 2005 Base Case Pro-Forma P&L Statement

( Based on 50,000 undiscounted patient visits)

Volume =50,000

Total Revenues ($100 x volume)$5,000,000

Total variable costs ($28.18 x volume)1,409,000

Total contribution margin ($71.82 x volume)3,591,000


Profits (net income)$(1,376,462)

Would lose 25,000 patient visists

Sheet1

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Impact of Accepting the ProposalTwo revenue streams must be studiedUndiscounted revenueDiscounted revenueWhat happens to bottom line?



Sheet4

Table 5.8 Atlanta Clinic: 2005 Base Case Pro-Forma P&L Statement

( Based on 50,000 undiscounted patient visits)

Volume =75,000

Undiscounted Revenue($100 x 50,000)$5,000,000

Discounted revenue ($60 x 25,000)1,500,000

Total revenues ($86.67 x 75,000)$6,500,000

Total variable costs ($28.18 x volume)2,113,500

Total contribution margin ($58.49 x volume)$4,386,500


Profits (net income)$(580,962)

Sheet1

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Profit Analysis Atlantic ClinicLosing ($580,962) is better than losing ($1,376,462)Fixed costs are not reduced in the short run so taking the Peachtree contract is sensible.However, Atlanta clinic cannot continue running a deficit. I revenues not restored, than cost cutting will be done to lower fixed costs.



Chart1

4967462049674620

4967462250000056719622166750

4967462450000062355623900150

4967462550000065173624766850

4967462650000067991625633550

4967462750000070809626500250

4967462850000073627627366950

4967462950000076445628233650

Fixed cost

Total Revenue

Total cost

Peachtree


Sheet1


Peachtree

VolumeFixed CostVariable CostTotal CostTotal RevenueProfitRevenues

04,967,46204,967,4620(4,967,462)0

25,000.004,967,4627045005,671,9622500000(3,171,962)2,166,750.00

45,000.004,967,46212681006,235,5624500000(1,735,562)3,900,150.00

55,000.004,967,46215499006,517,3625500000(1,017,362)4,766,850.00

65,000.004,967,46218317006,799,1626500000(299,162)5,633,550.00

75,000.004,967,46221135007,080,9627500000419,0386,500,250.00

85,000.004,967,46223953007,362,76285000001,137,2387,366,950.00

95,000.004,967,46226771007,644,56295000001,855,4388,233,650.00

Sheet1

Fixed cost

Total Revenue

Total cost

Peachtree


Sheet2

Sheet3

Breakeven Point under AcceptanceThe average revenue per visit is $86.672/3*$100+1/3*$60New Breakeven is 84,928 visits$4,967,462/$(86.67-28.18)$4,967,462/58.49Use new lower contribution margin


Evaluating the AlternativesNot AcceptLoss will be ($1,376,462)AcceptLoss will be ($580,962)Can you make a counteroffer? It will all depend on market conditions.Your best strategy may be to accept. Gain $795,500 in the short run.


Marginal Analysis: Short-Term Versus Long-Term ImplicationsNow suppose the Atlanta clinic forecasted only a volume of 50,000Peachtree offer 25,000 at $60 per visitsShould you accept?Yes, each visit adds a positive $31.82 to recovering those pesky fixed costs.Will others exit? Become more dominantWill other payer's demand discount? Lose revenue in next round.


CVP in a Capitated EnvironmentGet Upfront payment of $7,500,000Now has insurance function for a covered population. Controlling utilization is the key.



Sheet1

Atlantic Clinic: CVP Graphical Model Capitation


04,967,46204,967,46275000002,532,538

250004,967,4627045005,671,96275000001,828,038

450004,967,46212681006,235,56275000001,264,438

550004,967,46215499006,517,3627500000982,638

650004,967,46218317006,799,1627500000700,838

750004,967,46221135007,080,9627500000419,038

850004,967,46223953007,362,7627500000137,238

950004,967,46226771007,644,5627500000(144,562)

1050004,967,46229589007,926,3627500000(426,362)

115,0004,967,46232407008,208,1627500000(708,162)

Sheet1

000

000

000

000

000

000

000

000

000

000

Fixed cost

Total Revenue

Total cost


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Sheet3


Chart2

496746275000004967462

496746275000005671962

496746275000006235562

496746275000006517362

496746275000006799162

496746275000007080962

496746275000007362762

496746275000007644562

496746275000007926362

496746275000008208162

Fixed cost

Total Revenue

Total cost

Atlanta Clinic CVP Capitation

Sheet1



04,967,46204,967,46275000002,532,538

250004,967,4627045005,671,96275000001,828,038

450004,967,46212681006,235,56275000001,264,438

550004,967,46215499006,517,3627500000982,638

650004,967,46218317006,799,1627500000700,838

750004,967,46221135007,080,9627500000419,038

850004,967,46223953007,362,7627500000137,238

950004,967,46226771007,644,5627500000(144,562)

1050004,967,46229589007,926,3627500000(426,362)

115,0004,967,46232407008,208,1627500000(708,162)

Sheet1

000

000

000

000

000

000

000

000

000

000

Fixed cost

Total Revenue

Total cost


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Under CapitationProfits increase with fewer visitsUtilization constraints are profitableCriticisms exist of the incentives in capitation contracts.


Members and CapitationVolume is now interpreted as membersRevenue line is rising by $400 per member annuallyMember are good as long as utilization is controlled. Per visit cost reductions are good for the bottom line



Chart1

496746204967462

496746210000005249262

496746220000005531062

496746240000006094662

496746250000006376462

496746260000006658262

496746269000006911882

496746280000007221862

496746290000007503662

4967462100000007785462

Fixed cost

Total Revenue

Total cost

Members

Atlanta Clinic: Breakeven Point Under Capitation in Insurance Terms

Sheet1

Atlantic Clinic: Breakeven Point Under Capitation in Insurance Terms

VolumeFixed CostPM Var CostTotal CostTotal RevenueProfit

0.04,967,4620.04,967,4620.0(4,967,462)

2,5004,967,462281,8005,249,2621,000,000(4,249,262)

5,0004,967,462563,6005,531,0622,000,000(3,531,062)

10,0004,967,4621,127,2006,094,6624,000,000(2,094,662)

12,5004,967,4621,409,0006,376,4625,000,000(1,376,462)

15,0004,967,4621,690,8006,658,2626,000,000(658,262)

17,2504,967,4621,944,4206,911,8826,900,000(11,882)

20,0004,967,4622,254,4007,221,8628,000,000778,138

22,5004,967,4622,536,2007,503,6629,000,0001,496,338

25,0004,967,4622,818,0007,785,46210,000,0002,214,538

PM cost28.18*4=$112.72

PMPM is$400.00

Sheet1

Fixed cost

Total Revenue

Total cost

Members

Atlanta Clinic: Breakeven Point Under Capitation in Insurance Terms

Sheet2

Sheet3

Capitation and InsuranceRevenue is $400 per year ($33.33 PMPM)Variable cost per member is 4 x $28.18 =112.72 Based on 4 visits of utilization per memberNote utilization is good under fee-for-serviceUnder capitation, control both utilization and cost per visitAlways want to control overhead.


Capitated Pro-Forma P&L StatementsStatement shows profit declining when volume increasesContribution margin becomes a $28.18 because no revenue contribution



Sheet4

Atlanta Clinic: 2005 Pro-Forma P&L Statement Under Capitation

Number of Visits

69,16575,00082,500

Total Revenues$7,500,000$7,500,000$7,500,000


Total contribution margin$5,550,930$5,386,500$5,175,150

Fixed costs4,967,4624,967,4624,967,462

Profits (net income)$583,468$419,038$207,688

Sheet1

Sheet2

Sheet3

Breakeven Point Under CapitationTotal Revenues Total Variable Costs Fixed Costs = Profit$7,500,000 - (28.18 x volume) - $4967,462 = $0 $28.18*volume = $2,532,538 volume = 89,870Below this volume in visits results in a profit and above results in a loss.


The higher the proportion of fixed costs the higher the operating leverageIn fee-for- service, small cut in volume leads to large cut in bottom line profitabilityA higher fixed cost structure leads to larger decreases in profitability and more risk.In capitation, small cut in volume leads to small increase in profitability. A higher fixed cost structure leads to reduced risk


Number of Members and Breakeven AnalysisAssume 4 visits per memberVariable cost is $112.72 per member$28.18 x 4TR TVC FC = Profit(400xMembers) ($112.72xMembers) - $4,967,462 = $0$287.28 x Members = $4,967,462Members = 17,291


Utilization and Breakeven AnalysisIf utilization increases from 4 to 4.4, variable cost pre member increases to 4.4x28.18=123.99. Breakeven point is now at 17,997If utilization decreases to 3.69, variable cost per member declines to 3.96 x 28.18 = 103.98. Breakeven point is now at 16,781.



Sheet4

Atlanta Clinic: 2005 Pro-Forma P&L Statement for Members

Number of Members

17,29118,75020,625

Total Revenues ($400 x Members)$6,916,400$7,500,000$8,250,000


Total contribution margin$4,967,358$5,386,500$5,925,150

Fixed costs4,967,4624,967,4624,967,462

Profits (net income)$(104)$419,038$957,688

TVC =$112.72

TR =$400.00

Sheet1

Sheet2

Sheet3

Operating Leverage and MembersA 10 percent increase in members from 18,750 to 20,625 results in 128.5% increase in profits [(957,688-419,038)/419,038] = 128.5%A decline of membership to 17,291 (the breakeven point), results in a decrease of profit of 100%[(419038-(-104)/419,038] = 100.0%


Documents

Chapter 5 Cvp