Background Information
The case study provided shares insights on an ultrasound investment project for increased revenue generation that the Sooner Health Network (the Network) intends to undertake. According to data from the case scenario, the Network is affiliated to the Sooner Health System (the System) that receives a revenue income from patient referrals from the Network. Upon investigation, the System discovers that patient services are better rendered at the Network, because of subsequent low operational costs, enhanced physician and patient satisfaction, better convenience for convalescents, and improved efficiency for physicians, as evinced upon the installation of imaging equipment at one of the Network location. Therefore, the System’s management proposes the installation of ultrasound machines in the three Network locations for more revenue collection but have to consider two different alternatives.
Alternative 1 constitutes of procuring ultrasound equipment for $100,000 for each Network location, which will amount to $300,000. However, the supplier has indicated that he is willing to give a 5% discount upon purchase of the aforementioned machines (Unit 4 Assignment, n.d.). In contrast, alternative 2 will comprise purchasing one ultrasound machine to serve all three Network localities, at a single cost of $100,000. However, alternative 2 must include van operations, which will cost $40,000, with the total costs for the option mentioned above amounting to $140,000 for year 0 of operations (Unit 4 Assignment, n.d.). Other costs include $1000 for the three ultrasound machines’ maintenance annually, $1500 for wear and tear of the equipment if a single unit is purchased (Unit 4 Assignment, n.d.). Per year, the Network expects to conduct 2400 ultrasounds, with an estimated 50 procedures on a weekly basis (Unit 4 Assignment, n.d.). The Network’s revenue management cycle entails scheduling for appointments, patients checking in, ultrasound testing, patients checking out, film processing, reading of patients’ films, billing and collection, performing general administration duties, and where alternative 2 is included, transportation, setting up, and breakdown of the ultrasound equipment. In my analysis, option one is more viable compared to alternative 2 for the below reasons.
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Recommendation
In the first year of operation, ultrasound equipment will cost $100,000 per unit. If the Network purchases 3 machines, it will incur a cost of $300,000, at a discount of 5%, which will amount to $285,000. Considering the cost of maintenance for the machines, the total cost will be $288,000 per year for every year after the first year of operation. Annually, the Network anticipates to have 2400 procedures, implying that the average variable cost (AVC) per unit will be $285,000/2400=$118.75 for year one if three ultrasound machines are purchased for each location, and $288,000/2400=$120 for every year after the first of operation ( Lee, 2016) . The Network also estimates that the locations will attract at least 50 procedures weekly, implying that the AVC per week is $288,000/50=$5760 for the last for years, and 285,000/50=$5700 weekly for the first year of investment. However under alternative 1, the Network does not incur any additional costs, such as fuel for the van, time to set up equipment, and movement from one location to another. If one ultrasound machine is purchased, its total cost would be $100,000, an additional maintenance cost of $1500, van cost at $40,000, and vehicle maintenance cost of $1000. In the last four years of operation, alternative 2 would have an AVC of $142,500/2400=$59.375 annually and $140,000/2400=$58.33 for the first year. Weekly, the AVC would be $142,000/50=$2840 for the last four years, and $140,000/50=$2800 for the first year of the project’s operation. Even though alternative 2 appears to be cheaper, the revenue collected would be less because each revenue cycle would be longer, resulting in negated patient experience, less physician efficiency, and reduced quality of patient care ( Roden, 2012) . Unforeseen factors, such as heavy traffic, unexpected van breakdown, or fatigue of the ultrasound technician would significantly jeopardize operations in all three Network locations, which would in turn affect the revenue cycle. Therefore, I would recommend that option1 be considered, for its potential to attract a higher patient volume, a higher return on investment, enhanced patient and physician satisfaction, and more revenue.
Sensitivity Analysis
The taskforce manager fears that the System’s finance team did not consider uncertain costs, such as increased ultrasound equipment purchase cost, the cost of billing and collecting payments from patients for every unit of machine procured, the overall cost of proffering administration duties, and the cost of transportation, set up, and breakdown for every unit of ultrasound machine. Therefore, each of the costs must be upgraded by 10 and 20%, to factor in additional operational costs that would possibly deter operations in the future. If the current cost of ultrasound machines is $100,000, a 10% increase in cost would imply that each equipment unit costs $110,000, and an extra 20% increase in cost would mean that each machine costs $120,000. Therefore, alternative A would cost ($110,000*3) =$330,000 at a 10% extra cost, and ($120,000*3) = $360,000 at 20% increased cost. If the 5% discount is applied, the total cost of supplies for equipment 1 is at 10% is $313500, and $342,000. However, the total cost of supplies would be $110,000 at 10% and $120,000 at 20% for alternative 2, because the Network would only require one machine for all three locations. Similarly, the transportation, set up, and breakdown cost would be $1,000 at the current cost, $$1100 at 10%, and $$1200 at 20%. Additionally, operation costs per weekly session at 10% if all three locations have ultrasound equipment would be an average of $316500/50=$6330 at 10% and $345000/50=$6900 at 20% percentage price increase per unit of equipment for alternative 1. At alternative 2, the Network would incur an AVC of $152500/50=$3050 at 10% and 162500/50=$3250 at 20%, having factored in the cost of procuring a van, vehicle maintenance cost, and annual equipment maintenance cost. Further, the general administration costs for all three locations would rise from 100% to 110% at 10% and 120% at 20% increased operational costs.
If the useful life of the equipment were 3 years, the total cost of operation for alternative 1 would be constant at $285,000/2400=$118.75 for annual operations and $288,000/2400=$120 for the three subsequent years. In total, the annual average variable cost of operating the ultrasound machines for three years annually if alternative 1 were picked would be ($240 + $118.75 + $240 )= $598.75. For weekly operations, the average variable cost would be 285,000/50=$5700 for the first week, and $288,000/50=$5760 for every subsequent year. In total, the weekly AVC would be ($5700 + $5760 + $5760) = $17, 220 weekly for the next 3 years. If alternative 2 were picked and the equipment’s lifespan was 3 years, the average annual variable cost would be $140,000/2400=$58.33 for the first year, and $142,500/2400=$59.375 for the subsequent two years. In total, the AVC for three years would be ($58.33 + $59.375 + $59.375) = $177.08 for annual operations. Similarly, weekly operations would have an AVC of $140,000/50=$2800 for year one, and $142500/50 =$2850. In total, the average variable cost for weekly operations for alternative 2 for 3 years would be ($2800 + $2850+ $2850) = $8500.
Similarly, for alternative one, the first annual operation would be 285,000/2400=$118.75 for the first year, and $288,000/2400=$120 for the subsequent 6 years. In total, the total average variable cost for annual operations for the three centers would be $118.75 + ($120*6) = $838.75. Similarly, weekly operations for the first year would be $285,000/50 = $5700 and $288,000/50=$5760 for 6 years. The total average variable cost for weekly operations in 7 years for alternative 1 would be $5700 + ($5760*6) = $40, 260. However, alternative 2 would generate an AVC of $58.33 + ($59.375*6) = $414.58, and $2800 + ($2850*6) = $19, 900.
In my opinion, the alternative chosen does not depend on the wear and tear of ultrasound equipment. Instead, critical factors such as patients’ convenience, a shorter revenue cycle, reduced costs of operation, physician efficiency, and capacity to attract a higher volume of clients for more revenue generation. Therefore, alternative 1 is best because it provides the benefits highlighted above, while alternative 2 would result in long billing cycles, increased administrative costs, enhanced patient discomfort, and significant physician inconveniences ( Roden, 2012) . Finally, while the discount rate is enticing, it is not the most determining factor for selecting either alternative. In contrast, the Network would have a better Consumer Assessment of Healthcare Providers score if it considered alternative 1 over 2, which is not based on the equipment’s discount.
References
Lee, R. T. (2016). Fixed and Variable Costs: When Accounting Is the Opposite of Cash Flow Reality. The Journal of Corporate Accounting and Finance , 27 (4), 31-35. https://doi.org/10.1002/jcaf.22158
Roden, K. (2012). Practitioner application: Hospital financial management: What is the link between revenue cycle management, profitability, and not-for-Profit hospitalsʼ ability to grow equity? Journal of Healthcare Management , 57 (5), 339-341. https://doi.org/10.1097/00115514-201209000-00008
Unit 4 Assignment . (n.d.).
