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# Role provided by break-even point, major HMO, variances

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What is the role provided by break-even point and how would you calculate this point?
Please calculate break-even point in patient days under the provided contract.
What are the limitations of using break-even point and how would you incorporate this point with management strategic planning?

You are attempting to develop a break-even for a capitation contract with a major HMO. Your hospital has agreed to provide all inpatient hospital services for 10,000 covered lives. You will receive \$38 per member per month to cover all inpatient services. It is anticipated that 93 admissions per 1,000 covered lives will be provided with an average length of stay equal to 5.0, or 465 days per 1,000.

You anticipate that your hospital will incur fixed costs, or readiness to serve costs, of \$1,860,000 for these 10,000 covered lives. Variable costs per patient-day are expected to be \$600. Calculate the break-even point in patient days under this contract.
(Essentials of Health Care Finance, 7th Edition. Jones & Bartlett Publishers p. 334).

Should \$1000 be Investigated?

What is the difference between favorable and unfavorable variances and how do you calculate them?
What if \$1,000 difference is unfavorable and should that be investigated?
What if \$1,000 difference is favorable and should that be investigated?

Assume that the budgeted cost for a department is \$10,000 per week and the standard deviation is \$500. The decision to investigate a variance requires a comparison of expected benefits with expected costs. Suppose an unfavorable variance of \$1,000 is observed. The normal distribution indicates the probability of observing this variance is 0.0228 if the system is in control. Furthermore, assume that the benefits would be 50% of the variance and that investigation costs are \$200. Should this variance be investigated? Assume that the variance is still \$1,000, but it is favorable. Should it still be investigated?
(Essentials of Health Care Finance, 7th Edition. Jones & Bartlett Publishers p. 396).

#### Solution Preview

What is the role provided by break-even point and how would you calculate this point?

Breakeven permits you to plan when negotiating prices. By knowing the minimum number of members that enroll that are needed to cover fixed costs (after planning patient days) or the maximum number of patient days that could be tolerated before losing on a contract, it permits you to check the contract for reasonableness.
If you wanted to know how many members are needed to cover fixed costs assuming an average of 93 patient days at a 5 day stay of \$600 per stay, you would take fixed costs and divide by the contribution margin per annual membership:

See excel for better formatting.

per member, per year total
\$ 10,000.00
sales price \$ 456.00 \$ 4,560,000.00
variable costs:
patient stays \$ 27.90 \$ 279,000.00
contribution margin \$ 428.10 \$ 4,281,000.00
fixed costs \$ 1,860,000.00
operating profit \$ 2,421,000.00

breakeven in members needed:
fixed costs = \$ 1,860,000.00 4,344.78 members
contribution margin per member \$ 428.10

While this was not specifically asked, it is a different use for the breakeven analysis. So, breakeven is a way to measure the level of activity needed ...

\$2.19