Efr ch8 breakevencostfind_sr2.11

CHAPTER 8: COST-FINDING, BREAK-EVEN, AND CHARGES • Differentiate between direct and indirect costs

relevant to nursing care settings• Explain how to incorporate volume in

calculating total variable costs• Give at least two examples of projects where

a break-even analysis might be useful• Describe and critique at least two methods

for setting prices in health care settings

COST ALLOCATION

COST DRIVER CRITERIA

• Measurable in units relevant to the cost center

• “Fair”—related to the actual amount of indirect resource use by the cost center

• Allows for cost control by the cost center

COST-FINDING

DIRECT DISTRIBUTION METHOD OF COST ALLOCATION • Relatively simple, but ignores indirect costs

generated by nonrevenue cost centers• Identify all direct costs for each cost center

(operating expense budget)• Classify cost centers as profit or cost centers• Determine cost drivers using accepted criteria • Allocate costs using the overhead rate• Allocate costs using cost pools 5

STEP-DOWN METHOD OF COST ALLOCATION • Identify all direct costs for each cost center• Classify cost centers as nonrevenue or revenue

cost centers• Determine cost drivers using accepted criteria • Select the order of entering cost centers into the

step-down process, beginning with nonrevenue cost centers

• Remove cost centers from step-down procedures when all their costs are allocated

• Calculate total indirect costs and total costs allocated to each revenue cost center

ACTIVITY-BASED COSTING (ABC)

CODING SYSTEMSMDCs and DRGs: •Identify average patient resource consumption by diagnosis CPT® and HCPCS Codes:•Coding specific services, procedure, and products by the amount of resources requiredRBRVS and RVUs:•Assign costs to the value of the physician’s work, the practice expense, and malpractice liability insurance

CODING SYSTEMS (CONT’D)Omaha System:•Combines information for problem classification, the intervention plan and outcomes rating, used by nurses and other health professionals in settings across the continuum of careOutcome and Assessment Information Set (OASIS):•Required by Medicare for home health agencies (HHAs). Data items address adult home health areas such as health status, functional status, the support system, and client sociodemographics 9

BREAK-EVEN ANALYSIS

• Principle – profits and costs change with change in volume

• Cost-volume-profit (CVP) analysis• Factors include fixed costs, variable costs,

price, payor mix and product mix• Formula to find p*, q* – where price or

volume covers costs of production

• Fixed Costs – remain constant• Variable Costs – vary• Total Cost = TFC + TVC

WHAT ARE THE TOTAL AND PER-EXAM COSTS?

Number of Exams

Total Fixed Cost

Fixed Cost per Exam

Variable Cost per Exam

Total Variable Cost

Total Cost Total per-Unit Cost

1 $10,000 $10,000 $10 $10 $10,010 $10,010

200 $10,000 $50 $10 $2000 $12,000 $60

500 $10,000 $20 $10 $5000 $15,000 $30

AS THE VOLUME OF EXAMS INCREASES, WHAT HAPPENS TO:• Total fixed costs?• Per-unit fixed costs?• Per-unit variable cost?• Total variable cost?• Total cost?• Per-unit cost?

AS VOLUME INCREASES:

Total Fixed Cost

$5,000

$10,000

$15,000

0 200 400 600

Volume

Fixed Cost Per Exam

0 200 400 600

Volume

Variable Cost Per Exam

0 200 400 600

Volume

Total Variable Cost

$2,000

$4,000

$6,000

0 200 400 600

Volume

($) $6000

Total Cost

$0$5,000

$10,000$15,000$20,000

0 200 400 600

Volume

0 500 1000

Volume

Total Per-Unit Costs

COST VARIATION RELATED TO VOLUME

Total Costs Per-unit Costs

Fixed No change Change

Variable Change No change

TOTAL COST = TOTAL FIXED COST + TOTAL VARIABLE COST• TVC varies with volume—TFC does not• TVC = VCU x UOS• Example:VC per exam = $10UOS (volume) = 1, 200, 500TVC = VC x UOS = ?

TVC = VCU X UOS

Number of Exams

Variable Cost per Exam

Total Variable Cost

1 $10 $10

200 $10 $2000

500 $10 $5000

TOTAL REVENUE

• TR = RU x UOS• As variable cost = cost per unit x volume,• Total revenue = price per unit x volume of

goods sold or delivered• Cost, revenue, and volume data are all needed

to compute a break-even equation

BREAK-EVEN ANALYSIS

• Principle – profits and costs change with changes in volume

• Breaking even: the revenue from selling goods or services equals the total costs of producing goods or services

• Concept: TR = TC, or• RU x UOS = FC + (VCU x UOS)

BREAK-EVEN FORMULAS

Total Revenue = Total Cost

RU * UOS = TFC + (VCU * UOS)

• Break-even volume:

UOS = TFC ÷ (RU – VCU)

• Break-even price (RU):

RU = TC/Q

DATA: BREAK-EVEN W/O PROFIT

Volume Total Cost Total Revenue

100 $15,000 $11,000

200 $12,000 $12,000

500 $11,000 $15,000

BREAK-EVEN WITH PROFIT TARGET• Profit: revenues must cover costs and profit• TR = TC + Profit• RU x UOS = TFC + (VCU x UOS) + P• Break-even volume with profit target:UOS = (TFC + P) ÷ (RU – VCU)

BREAK-EVEN ANALYSIS FOR PROFIT

Number of Exams

Total Fixed Cost

Total Revenue

Total Cost Profit or Loss

100 $10,000 $8000 $11,000 -$3000

200 $10,000 $12,000 $12,000 $0

500 $10,000 $18,000 $18,000 $3000

CONTRIBUTION MARGIN

• Unit Contribution Margin = Unit Price - Unit Variable Cost

• Total Contribution Margin = Unit CM x UOS• CM: not profit – per unit $ amount available to first

cover fixed costs, then contribute to profits

UCM = $36 - $10 = $26

TCM = $26 x 500 = $13,000

$13,000 covers FC and $3000 profit for 500 exams

COMPLICATING ISSUES• Product mix• Payor mix• Client mix• Volume forecasting• Changes in prices and costs• Capitation• New financing mechanisms such as bundled

payments for ACOs

CUSTOMER-FOCUSED PRICING• Customer-specific or value-based: set price

based on the value the customer attributes to the product– Need to know the customer– Difficult to justify in economic terms

• Skimming: set high price with inelastic demand so customer is not price sensitive

• Elasticity—extent that a change in price creates change in consumer demand

MARKET-FOCUSED PRICING• Penetration or market share pricing: low price

with elastic demand, expect costs of production to with volume or expect increased competition

• Shadow pricing: set price under or over the competitor(s)—risk perception of collusion or downward price spiral (price war)

• Special offers or discounts: to individual or corporate clients

PROFIT-FOCUSED PRICING METHODS• Cost-plus pricing: set the price at the cost of

production plus a profit margin (break-even)• Target return pricing: set the price to achieve

a targeted return on investment• These methods are relatively simple but don’t

take consumer demand, price sensitivity, or market conditions into account

Efr ch8 breakevencostfind_sr2.11

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