Diagnosis-Related Groups 'Break-Even Analysis'

Break-even Analysis

Grace L. Harden

University of Phoenix

January 30, 2011

Break-even Analysis Getwell Clinic on Beach Street concentrates care and treatment of three different types of patients listed as DRG-M, DRG-J, and DRG-P. Dr. Barkley is the new director of the satellite office and has requested that statistical break-even points be completed for each DRG. He would also like information on which DRG is the most profitable to promote in the growing practice. Diagnosis-Related Groups (DRG) is a classification process in which health care organizations can separate patients into like categories even though patients have such broad differences. These classifications could be demographics, treatment, age, or diagnostic groupings. This helps determine the resources
needed for patient treatment and the costs associated with the treatment. Understanding the breakdown of patient groupings managers can review them and better understand the services rendered, and if a service should be added or concluded from the practice. Managers will also be able to determine if maximum advertising will need to take place to reach capacity, or if the service is already reaching capacity. “Break-even analysis determines the volume at which a program or service is just financially self-sufficient. At lower volumes, losses would occur, at higher volumes, profits would be earned. Break-even analysis is a managerial tool that is based on the relationships among cost, volume, and profit of a health care organization. The break-even analysis technique provides managers with information regarding the financial viability of proposed and existing programs and services.” (Finkler, Ward & Baker, 2007, p. 100) Furthermore, healthcare organizations must review break-even analysis as a tool that drives costs and aids with management decisions.
Table 1
Break-even Analysis
|DRG |Proportion |Price |Weighted Average Price |
|M |50% |1700 |850 |
|J |30% |2600 |780 |
|P |20% |900 |180 |
| | | | |
| | | |Total 1810|

|DRG |Proportion |Price |Weighted Variable Cost |
|M |50% |1000 |500 |
|J |30% |1200 |360 |
|P |20% |600 |120 |
| | | |
|
| | | |Total |
| | | |980 |

Weighted Break-even points
|DRG |Proportion |Total Patient |Weighted Break-even points |
|M |50% |2073 |1037 |
|J |30% |2073 |621 |
|P |20% |2073 |415 |
| | | | |
| | | |Total |
| | | |2073 |

|DRG |Fixed Cost |Price |Variable Cost |Number of Patients |
|M |500,000 |1700 |1000 |715 |
|J |280,000 |2600 |1200 |200 |
|P |110,000 |900 |600 |367 |

Contribution Margin
|DRG |Price |Variable Cost |Contribution Margin |
|M |1,700 |1000 |700 |
|J |2,600 |1200 |1400 |
|P |900 |600 |300 |

“The difference between the price and the variable cost is referred to as the Contribution Margin (CM) because it is the amount that each extra sale contributes toward fixed costs and profits after covering it variable costs” (Finkler, Ward & Baker, 2007, p 102). The DRG with the highest CM is the most profitable showing the amount of revenue that is extra to the variable cost. Looking at the above DRG analysis, it is concluded that DRG J generates $1400 per patient; however, the procedure also takes 5 hours to complete. The contribution margin renders $280 when you take $1400/5rs. In the case of DRG M, the CM/hour will render $350 when you take $700/2hr. Substantial extra capacity from DRG M will generate the highest contribution margins per hour. “The most profitable patients are those with the highest CM, if we compare the extra revenue from an extra patient with the extra variable cost for that patient, the greater the difference the better off that DRG is” (Finkler, Ward & Baker, 2007, p.112). Contribution Margin per hour
|DRG |CM |Time |Unit CM |
|M |$700 |2 |350 |
|J |$1,400 |5 |280 |
|P |$300 |1 |300 |

Break-even analysis is a useful tool in health care organizations that help develop manager’s strategies and decision making abilities to generate revenue. The combination of break-even analysis and DRG system helps allocate costs and tells us how many patients will be needed to cover all the costs for rendering services. “It is critical that total costs be appropriately divided accurately into fixed and variable components before breakeven analysis is done”(Finkler, Ward, & Baker, 2007, p.108). Managers are consistently reviewing costs and ongoing procedures, deciphering the information which is relevant to each cost. It is essential that the information from break-even analyses is comprehended to avoid fatal managerial decisions.