Administrators want to evaluate its financial feasibility, but, as the newest member of the team, they first want to hear your input. Estimated fixed costs are $1 million, and the estimated net reimbursement level is $1,500 per procedure. Physicians and other provider salaries on a direct basis are $340 per procedure, and total operating expenses will add another $160 per procedure. Calculate the breakeven point for this potential new service line.
Break-even Point = Fixed Costs (FC)/ Contribution Margin (CM)
CM= Selling Price –Variable Costs
For this case, the Selling Price is the same as the net reimbursement level = $1500 per procedure
Delegate your assignment to our experts and they will do the rest.
Variable Costs = $ (340 + 160)
= $ 500
Therefore the Breakeven Point = $ 1000, 000/ $ (1500-500)
= $ 1000, 000/1000
= 1000 procedures
If Simi Regional discovered a way to reduce the total initial investment to $600,000, causing the average pricing level to fall to $1,200 and the other assumptions to stay the same, how many procedures would be required to break even?
Breakeven Point = FC/CM
= $600,000/ $ (1200-500)
= $600,000/700
= 857.14
Breakeven Point = 858 Procedures
Assuming that the hospital conservatively estimates that it can deliver 1,000 procedures in the first year, which option should be chosen? Is it financially feasible to purchase, install, and employ the new radiology line? Or should the new radiology service be canceled?
Due to the contribution margin of $700 as a result of changes in the investment, the company will either gain a profit or loss of:
$700*1000-$1000, 000
= -$ 300,000
So basically the company’s loss will be $300,000
Therefore, the new radiology line should be canceled.
Using the breakeven analysis, and your own research on the proposal, provide a written recommendation to the executive leadership team and the Board of Directors regarding the benefit (or lack thereof) of proceeding with the purchase and further developing the service line for Simi Regional Hospital.
The provision of state-of-art health care often requires the use of various medical equipment and Simi Regional Hospital is not an exception. Decisions regarding their purchase can be complicated especially where the feasibility of a project has to be decided (Lehoux, Miller, Daudelin & Urbach, 2016). Based on the breakeven analysis above for instance, the new radiology line should be canceled because it brings a loss to the hospital. Arriving at the decision, however, can be difficult especially because there is no revenue generation but may be a basic necessity depending on the services of the health care center. Unfortunately, the decision to cancel the new radiology service line will be based on the ability to rationalize that it is not a sound investment other than its practicability. Therefore, taking into consideration that the breakeven analysis results in a loss of $300,000 for the organization, it should be canceled.
At its core breakeven analysis entails finding the point at which a firm will cover its costs of production or break even. Often the breakeven analysis technique is used in making decisions of whether to proceed with a project. Simi Hospital is no exception. Based on the outcome of the breakeven analysis of the Simi administrators will be able to arrive at the solution of whether to continue or do away with the project
Just like any other organization, the objective of Simi Regional Hospital is to make profits or rather avoid losses upon the purchase, installation, and employment of the new radiology service line. Therefore the first step is that the business should know at what point their sales revenue will enable them to break even. Based on the evaluation of the financial feasibility of the project, it was established that Simi Regional Hospital needs 1000 procedures in order to break even. As such as long as the hospital sells 1000 units its revenue minus expenses will be equal to zero. Therefore, one recommendation I would make for the company is to realistically look at its costs of production and the revenue it is likely to acquire to determine whether it can sell 1000 units on an annual basis. It is through the determinant of units that the organization can sell that they will be able to determine whether they can make profits and breakeven (Gurley-Calvez & Williams, 2020).
Another recommendation is to find ways to reduce the breakeven point. It is worth noting that for Simi Regional Hospital, breakeven analysis is more than just recovering the total cost by revenue. Furthermore, a minimum breakeven point can be considered optimal for the organization. Therefore the hospital should incorporate means of reducing the breakeven point such as cost analysis, price analysis, margin analysis, and outsourcing (Shrotriya, 2019). The total cost of the new radiology line, for instance, can be decreased by eliminating both the unwanted fixed and variable costs. Sequentially, the profitability will increase and the break-even point reduce. Also, keeping control over the price by reducing discounts that could be offered as a result of the service being new in the hospital will accelerate the breakeven point. Another means would be to outsource the radiology services from another hospital. This will concert the fixed value into a variable cost charged per unit and this will consequentially reflect on the breakeven point.
It is also worth noting that the best decision is to cancel the new radiology service line because the breakeven analysis is dependent on assumptions made for average per-unit revenue, and average per-unit cost and fixed costs, all of which are rarely exact (Nagarajan &Visagamoorthi, 2018). At its core, the average per-unit revenue refers to the price that the company will receive per sale of units. This will require the organization to build its forecasts first so as to arrive at this number. To get this number the hospital will have to average for their break-even analysis. The uncertainty and assumptions do not make the new radiology service viable and feasible. The average cost per unit, on the other hand, is the variable cost of each unit of sales. It also relies on forecast making it unreliable to predict the actual breakeven point. Based on the fact that the breakeven point is based on hypothetical assumptions or rather forecasts, it might be hard to use it as a reliable technique of determining the feasibility of the new radiology service line.
The final recommendation is for the company to think of the fundamental principles of capitation financing such as per health plan enrollee or the fixed payment that will be paid to the provider of the new radiology service line for a particular set of services within during a certain time. Given that the hospital is to fix the total revenue under capitation, then the Board should think at what time the facility is likely to achieve the breakeven point. Clearly, based on the capital of the equipment to be purchased, Simi Regional Hospital is likely to break even when the total costs for covering the health services for the new radiology line will be equal to the total amount that will be paid for the purchase of the equipment (Farmer et al, 2016). If costs are below the capital is below the capital to be paid, the hospital will realize profits and sequentially breakeven. However, if costs exceed the capital there will be losses incurred. Therefore it will not be necessary to continue with the new radiology line project.
References
Farmer, S. A., Shalowitz, J., George, M., McStay, F., Patel, K., Perrin, J., & McClellan, M. (2016). Fully capitated payment breakeven rate for a mid-size pediatric practice. Pediatrics , 138 (2), e20154367.
Gurley-Calvez, T., & Williams, J. A. (2020). Where is the Break-even Point for Community Health Workers? Using National Data and Local Programmatic Costs to Find the Break-even Point for a Metropolitan Community Health Worker Program. Medical Care .
Lehoux, P., Miller, F. A., Daudelin, G., & Urbach, D. R. (2016). How venture capitalists decide which new medical technologies come to exist. Science and Public Policy , 43 (3), 375-385.
Nagarajan, K., & Visagamoorthi, D. (2018). Use of Break-even analysis in financial appraisal of projects. Indian Journal of Public Health Research & Development , 9 (11), 2098-2105.
Shrotriya, V. (2019). Break Even Analysis–The Concept and its Utility.
