Purpose of the Break-Even Analysis
A fundamental financial concept, the break-even point, aids healthcare organizations in determining the minimal level of activity necessary to pay all expenditures and prevent losses. It is the point at which all revenue and expenses are equal, leaving no profit or loss (Cleverley et al., 2011). The break-even point is a valuable benchmark for managerial decision-making and financial planning. Organizations may determine the financial feasibility of their business and make educated choices regarding price, volume, and resource allocation by determining this point. The break-even point is determined using the formula:
Break-even point (in patient days) = Fixed costs / Contribution margin per patient day.
Calculation of the Break-Even Point in the Case Study
Assignment 7 in Chapter 14 of Cleverley et al.’s Essentials of Health Care Finance specifies a capitation contract. To determine the break-even point in patient days, both fixed and variable inpatient service costs must be considered.
The fixed cost: readiness to serve cost of 10,000 covered lives, which equates to $51,860,000.
The variable costs (VC):
- VC per patient day is $5,600.
- Length of stay/1000 lives is 465 days.
- Number of patient-days per 1,000 covered lives = 465 days × (93 admissions/1,000 covered lives) = 43,245 patient-days/1,000 covered lives.
Total cost per 1,000 covered lives = Fixed costs + (Variable cost per patient-day × Number of patient-days per 1,000 covered lives)
= $51,860,000 + ($5,600 × 43,245) = $293,912,000.
Break-even point (in patient-days) = $293,912,000 / $5,600 = 52,490 patient-days.
Limitations of Break-Even Analysis and Strategies to Overcome Them
The shortcomings of break-even analysis include making assumptions about costs and revenues, oversimplifying company operations, ignoring non-financial issues, and failing to consider the amount of time needed to achieve the break-even point. These elements may compromise accuracy and leave out essential components of strategic planning and decision-making (Cleverley et al., 2011). Consider several possibilities, do a sensitivity analysis, connect with strategic goals, and periodically evaluate and adapt your strategy to include the break-even point (Cleverley et al., 2011). This thorough method guarantees a more exhaustive examination, detects dangers, promotes non-financial objectives, and enables prompt adjustments to retain competitiveness and sustainability.
Reference
Cleverley, W. O., Song, P. H., & Cleverley, J. O. (2011). Essentials of health care finance (7th ed.).