Chapter 5 Cvp
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Transcript of Chapter 5 Cvp
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Managerial Accounting: Cost Behavior and Profit Analysis
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Managerial AccountingSupport decisions in the organizationCost and ProfitCost allocationPricingPlanning and budgeting
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Cost MeasurementAccounting versus Economic costsCosts per servicePer member per monthProgram costs, Departmental costsCapital CostsOrganization related (direct and indirect)Volume related (fixed and variable)
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Direct CostsRelationship to sub-unit being analyzed and volume of services providedIf the service department closed, these costs would disappear.
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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.
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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
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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.
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Cartwright Financial Management
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
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Cartwright Financial Management
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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
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Cartwright Financial Management
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Cost behavior modelTotal costs depend on volumeRevenues depend on volumeHence, we can examine the behavior of profit as revenues and costs change with volume.
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Cost-Volume-Profit AnalysisImportant to determine profits for capital projects, determine pricing and service decisions, determine future management responses to change adverse situations
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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.
Cartwright Financial Management
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Cartwright Financial Management
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
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Profit(CVP) AnalysisCost-Volume-Profit AnalysisEvaluate future courses of actionMost be based on forecastsInherent risk that the future will not conform to the forecast
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Cartwright Financial Management
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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
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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
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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
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Cartwright Financial Management
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
Atlanta Clinic CVP Graphical Model
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Cartwright Financial Management
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Atlantic Clinic: CVP Graphical Model
VolumeFixed CostVariable CostTotal CostTotal RevenueProfit
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
Atlanta Clinic CVP Graphical Model
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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)
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Contribution MarginUnit revenue - per unit variable costDoes not include fixed costsAfter fixed costs are covered, there will be a profit.
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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.
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Cartwright Financial Management
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 ($71.82 x 69,165)4,967,430
Fixed costs4,967,462
Profits (net income)$(32)
contribution rate is (100 - 28.81)
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Cartwright Financial Management
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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
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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.
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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.
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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
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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
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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.
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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?
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Impact of rejecting proposalGoing to lose market share of 25,000Still have large fixed costs.Will not break even.
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Cartwright Financial Management
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 ($71.82 x volume)3,591,000
Fixed costs4,967,462
Profits (net income)$(1,376,462)
Would lose 25,000 patient visists
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Impact of Accepting the ProposalTwo revenue streams must be studiedUndiscounted revenueDiscounted revenueWhat happens to bottom line?
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Cartwright Financial Management
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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)$4,386,500
Fixed costs4,967,462
Profits (net income)$(580,962)
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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.
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Cartwright Financial Management
Chart1
4967462049674620
4967462250000056719622166750
4967462450000062355623900150
4967462550000065173624766850
4967462650000067991625633550
4967462750000070809626500250
4967462850000073627627366950
4967462950000076445628233650
Fixed cost
Total Revenue
Total cost
Peachtree
Atlanta Clinic CVP Graphical Model
Sheet1
Atlantic Clinic: CVP Graphical Model
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
Atlanta Clinic CVP Graphical Model
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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
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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.
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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.
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CVP in a Capitated EnvironmentGet Upfront payment of $7,500,000Now has insurance function for a covered population. Controlling utilization is the key.
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Cartwright Financial Management
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Atlantic Clinic: CVP Graphical Model Capitation
VolumeFixed CostVariable CostTotal CostTotal RevenueProfit
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
Atlanta Clinic CVP Graphical Model
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Cartwright Financial Management
Chart2
496746275000004967462
496746275000005671962
496746275000006235562
496746275000006517362
496746275000006799162
496746275000007080962
496746275000007362762
496746275000007644562
496746275000007926362
496746275000008208162
Fixed cost
Total Revenue
Total cost
Atlanta Clinic CVP Capitation
Sheet1
Atlantic Clinic: CVP Graphical Model
VolumeFixed CostVariable CostTotal CostTotal RevenueProfit
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
Atlanta Clinic CVP Graphical Model
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Under CapitationProfits increase with fewer visitsUtilization constraints are profitableCriticisms exist of the incentives in capitation contracts.
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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
Cartwright Financial Management
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Cartwright Financial Management
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
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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.
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Capitated Pro-Forma P&L StatementsStatement shows profit declining when volume increasesContribution margin becomes a $28.18 because no revenue contribution
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Cartwright Financial Management
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 variable costs ($28.18 x volume)1,949,0702,113,5002,324,850
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
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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.
Cartwright Financial Management
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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
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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
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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.
Cartwright Financial Management
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Cartwright Financial Management
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 variable costs ($112.72 x volume)1,949,0422,113,5002,324,850
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
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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%
Cartwright Financial Management