Based on Reed Hospital – Break Even Analysis, answer the following questions:

    

1. Although you are basically satisfied with the analysis presented in the case thus far, you are concerned about the uncertainties inherent in the revenue and expense data supplied by the Urgent Care Center’s director.  Assess each element in the pro forma profit and loss statement.

o Are any items more uncertain than the others?

o How could uncertainty be worked into the analysis?

o What additional information, if any, might you want to obtain from the Urgent Care Center’s director?

2. Does the Urgent Care Center have any value to the hospital beyond that considered by the numerical analysis just conducted?

3. Do the actions by Baptist Hospital have any bearing on the final decision regarding the Urgent Care Center?

4. What is your final recommendation concerning the future of the Urgent Care Center?

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Reed Hospital – Break Even Analysis

Reed Hospital, an acute care hospital with 300 beds and 160 staff physicians, is one of 75

hospitals owned and operated by Health Services of America, a for-profit, publicly owned

company.

Although two other acute care hospitals serve the same population, Reed historically

has been highly profitable because of its well-appointed facilities, its fine medical staff, its

reputation for quality care, and the amount of individual attention it gives to patients. In

addition to the standard range of inpatient and outpatient services, Reed operates an

emergency department (ED) within the hospital complex and a stand-alone walk in clinic

located across the street from the area’s major shopping mall, about two miles from the

hospital.

According to a Wall Street Journal article, urgent care centers are increasingly visited by

patients who need immediate treatment for an illness, such as the flu or sore throat, or an

injury, such as a nail gun puncture. Urgent care centers are distinguished from similar types of

ambulatory healthcare providers, such as Eds and retail clinics, by the scope of illnesses treated

and the presence of on-site facilities. These centers help mitigate the problems of primary care

physician shortages and already crowded (and typically very expensive) EDs. Urgent care

centers, notes the Wall Street Journal are staffed by physicians, offer short wait times, and

charge between $60 and $200 per procedure. Furthermore, no appointments are necessary,

and evening and weekend hours are frequently available. Finally, many centers offer discounts

to the uninsured, and for those with coverage, copayments are typically less than for ED visits.

Currently, 8,000 urgent care centers are in operation across the United States, including about

1,200 that are hospital affiliated.

Mike Reynolds, Reed’s Chief Executive Officer (CEO), is concerned about the urgent care

center’s overall financial soundness. About ten years ago, all three area hospitals jumped onto

the urgent care center bandwagon, and within a short time, there were five such centers

scattered around the city. Now, only three are left, and none of them appears to be a big

moneymaker. Mike wonders if Reed should continue to operate or close its urgent care center.

The urgent care center currently handles a patient load of 45 visits per day, but it has the

physical capacity to handle up to 85 visits a day. Mike’s decision has been complicated by the

fact that Rose Daniels, Reed’s Marketing Director, has been pushing to expand the marketing

program for the urgent care center. She believes that an expanded marketing effort aimed at

local businesses would bring in the number of new patients needed to make the urgent care

center a financial winner.

Mike has asked Brent Williams, Reed’s Chief Financial Officer, to analyze the options. In their

meeting, Mike stated that he visualizes three potential outcomes for the urgent care center: (1)

close it; (2) continue to operate it without expanding marketing; or (3) continue to operate it

with the expanded marketing effort. As a starting point, Brent collected the most recent

historical financial and operating data for the clinic, which are summarized in Exhibit 1.1. In

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assessing the historical data, Brent noted that one competing center had recently (December

2009) closed its doors. Furthermore, a review of several years of financial data revealed that

the urgent care center does not have a pronounced seasonal utilization pattern.

Exhibit 1.1 – Reed Walk-In Clinic: Historical Financial Data
Monthly Averages

CY 2009 Jan. 2010 Feb.
2010

2009 Jan/Feb
2010

Total

Number of Visits 14,522 1365 1335 1210 1350 1230

Net Revenue $548,747 $36,028 $54,748 $45,729 $54,888 $47,037

Salaries and Wages $154,250 $13,540 $13,544 $12,854 $13,542 $12,952

Physician Fees 192,000 18,000 18,000 16,000 18,000 18,286

Malpractice Insurance 31,440 3215 3215 2620 3215 2705

Travel and Education 5365 538 665 447 602 469

General Insurance 8112 843 843 676 843 700

Subscriptions 189 0 0 16 0 14

Electricity 11,820 1124 1029 985 1077 998

Water 1260 135 142 105 139 110

Equipment Rental 1260 105 105 105 105 105

Building Lease 155,745 12,500 12,500 12,979 12,500 12,910

Other Operating Expenses 103,779 8152 7923 8648 8038 8561

Total Operating Expenses $665,220 $58,152 $57,966 $55,435 $58,049 $55,810

Net Profit (Loss) ($116,473) ($3124) ($3218) ($9706) ($3173) ($8773)

Gross Margin (%) -21.2% -5.7% -5.9% -21.2% -5.8% -18.7%

Next, Brent met several times with the urgent care center’s administrative director. The

primary purpose of the meetings was to estimate the additional costs that would have to be

borne if volume rose above the current January/February average level of 45 visits per day.

Any incremental usage would require additional expenditures for administrative and medical

supplies: estimated to be $3.00 per patient visit for medical supplies, such as tongue blades and

rubber gloves, and $0.50 per patient visit for administrative supplies, such as file folders and

clinical record sheets.

Because of the relatively low volume level, the urgent care center has purposely been staffed at

the bare minimum. In fact, some clinic employees have started to grumble about not being

able to do their jobs well because of overwork. Thus, any increase in the number of patient

visits would require immediate administrative and medical staffing increases. Furthermore, as

the number of visits increases, the urgent care center would have to hire additional staff

members. The incremental costs associated with increased volume are summarized in Exhibit

1.2.

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Exhibit 1.2 – Reed Walk-In Clinic: Monthly Incremental Cost Data

Number of Additional Visits Per Day

0 1 – 10 11 – 20 21 – 30 31 – 40

VARIABLE COSTS

Medical supplies
Administrative supplies

$3 per visit
$.50 per visit

Total variable cost per visit $3.50 per visit

SEMI

FIXED COSTS

Salaries and wages $4000 $5000 $6000 $7000

Physicians fees 10,000 10,000 10,000 20,000

Total monthly semi fixed costs $0 $14,000 $15,000 $16,000 $27,000

FIXED COSTS

Marketing assistant’s salary $3000 $3000 $3000 $3000 $3000

Advertising expenses $4000 $4000 $4000 $4000 $4000

Total Monthly Fixed Cost $7000 $7000 $7000 $7000 $7000

The urgent care center’s building is leased on a long-term basis. Reed could cancel the lease,

but the lease contract calls for a cancellation penalty of three month’s rent ($37,500) at the

current lease rate. In addition, Brent was startled to read in the newspaper that Baptist

Hospital, Reed’s major competitor, had just bought the city’s largest primary care practice, and

Baptist’s CEO was quoted as saying that more group practice acquisitions are planned as the

hospital moves to embrace healthcare reform. Brent wondered whether Baptist’s actions

would influence the decision regarding the urgent care center’s fate.

Finally, Brent met with Rose (Reed’s Marketing Director) to learn more about the proposed

marketing expansion. The primary focus of the expansion would be on occupational health

services (OHS). OHS involves providing medical care to employees of local businesses, including

physical examinations, treatment of illnesses that occur during work hours; and treatment of

work-related injuries, especially those covered by workers compensation. Some of the urgent

care center’s business is already OHS related, but Rose believes that a strong marketing effort,

coupled with specialized OHS record keeping, could bring additional patients to the urgent care

center. The proposed market expansion requires a marketing assistant who will run the effort

for the OHS program. In addition, marketing would incur advertising costs for newspaper,

radio, and TV ads, as well as for brochures and handouts. The incremental costs associated

with marketing are also summarized in Exhibit 1.2.

With a blank spreadsheet on his computer screen, Brent began to construct a model that would

provide the information needed to help the board make a rational, financially sound decision.

At first, Brent planned to conduct a standard capital budgeting analysis that focused on the

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profitability of the urgent care center as measured by net present value or internal rate of

return. But then he realized that the expanded marketing requires no capital investment and

no valid data are available on the incremental increase in visits that would be generated either

by an increasing population base or the expanded marketing. Finally, he remembered that

Mike requested that the analysis consider the inherent profitability of the urgent care center

without the expanded marketing effort.

With these points in mind, Brent thought that a break-even analysis would be very useful in

making the final decision. Specifically, he wanted to develop answers to the following

questions posed by Mike:

1. What is the projected profitability of the urgent care center for the entire year if volume

continues at the current level?

2. How many additional visits per day will be required to break even without the expanded

marketing?

3. How many additional visits per day would be required to break even, assuming that

marketing is expanded?

4. How many additional daily visits would expanded marketing have to bring in to make it

worthwhile, regardless of the overall profitability of the urgent care center?

In addition, Brent wonders if the urgent care center could “inflate” its way to profitability; that

is, if volume remained at its current level, could the urgent care center be expected to become

profitable in, say five years, solely because of inflationary increases in revenues? Finally, Brent

is concerned about whether the analysis was giving the urgent care center full credit for its

financial contributions to Reed Hospital. Brent did not want to change the spreadsheet at this

late date, but he does want to make sure that any additional financial value is at least

considered qualitatively. Overall, Brent must consider all relevant factors – both quantitative

and qualitative – and come up with a recommendation regarding the future of the urgent care

center.

Using the historical data as a guide (Exhibit 1.1), Brent constructed a pro forma (forecasted)

Profit and Loss Statement for the clinic’s average month for all of 2010, assuming the status

quo. With no change in (volume) utilization, is the clinic projected to make a profit?

Here is his reasonable estimate of the average monthly cash flows:

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Pro Forma (Forecasted) Profit and Loss Statement
For the Urgent Care Center’s Average Month

Number of Visits 1,350

Net Revenue $54,888

Salaries and Wages $13,500

Physicians Fees 18,000

Malpractice Insurance 3,215

Travel and Education 602

General Insurance 843

Subscriptions 14

Electricity 1000

Water 130

Equipment Rental 105

Building Lease 12,500

Other Operating Expenses 8,000

Total Operating Expenses $57,909

Net Profit (Loss) ($3,021)

Gross Margin (%) -5.5%

Here is the logic Brent used in creating these flows.

First, he used the January/February 2010 average for the number of visits and net revenue,
because the case states (1) that urgent care center’s usage is not seasonal and (2) that a
competitor recently closed its doors. These facts lead him to conclude that the most recent
historical data is the best estimate for the future. For the remaining cash flows, he used the
2009 average month data, the January/February 2010 average, or the combined average,
depending on which historical amount he thought most representative of the future.

Then Brent considered the urgent care center’s situation without the new marketing program.
How many additional daily visits must be generated to break even? He constructed a break-
even graph that can be included in his report.

Number of Additional Visits Per Day

0 5 10 15 20 25

Total Monthly Visits 1350 1500 1650 1800 1950 2100

Total Daily Visits 45 50 55 60 65 70

Net Revenue Per Visit $40.66 $40.66 $40.66 $40.66 $40.66 $40.66

Total Net Monthly Revenue $54,888 $60,987 $67,085 $73,184 $79,283 $85,381

Total Current Costs $57,909 $57,909 $57,909 $57,909 $57,909 $57,909

Total Incremental Costs 0 14,525 15,050 16,575 17,100 18,625

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Current + Incremental Cost $57,909 $72,434 $72,959 $74,484 $75,009 $76,534

Monthly Profit (Loss) ($3021) ($11,447) ($5874) ($1300) $4274 $8847

Gross Margin (%) -5.5% -18.8% -8.8% -1.8% 5.4% 10.4%

Breakeven occurs between 15 and 20 incremental visits (50 and 65 daily patient visits). Figure 1
contains a plot of the data. We see that breakeven occurs at 17 incremental daily visits, so at 62
patient visits per day, the urgent care center is expected to turn a profit without the new
marketing program.

The Brent assumed that the new marketing program is implemented. Here is his tabular data if

the new marketing program is implemented:

Number of Additional Visits Per Day
0 5 10 15 20 25
Total Monthly Visits 1350 1500 1650 1800 1950 2100
Total Daily Visits 45 50 55 60 65 70
Net Revenue Per Visit $40.66 $40.66 $40.66 $40.66 $40.66 $40.66

Total Net Monthly Revenue $54,888 $60,987 $67,085 $73,184 $79,283 $85,381

Total Current Costs $57,909 $57,909 $57,909 $57,909 $57,909 $57,909

Total Incremental Costs 7000 21,525 22,050 23,575 24,100 25,625

Current + Incremental Cost $64,909 $79,434 $79,959 $81,484 $82,009 $83,534

Monthly Profit (Loss) ($10,021) ($18,447) ($12,874) ($8300) ($2726) $1847

Gross Margin (%) -18.3% -30.2% -19.2% -11.3% -3.4% 2.2%

With the proposed marketing program, the added costs push the break-even point out further.
Now, breakeven occurs at 24 incremental daily visits (69 visits per day).

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Then Brent focused solely on the expected profitability of the proposed marketing program.
How many incremental daily visits must the program generate to make it worthwhile? (In other
words, how many incremental visits would it take to pay for the marketing program,
irrespective of overall urgent care center’s profitability?) He constructed a graph showing the
expected profitability of the proposed program versus incremental daily visits.

Focusing on the incremental cash flow analysis paints a somewhat different picture. Here, the
incremental revenues from adding additional patient visits per day are compared directly with
the incremental costs of the marketing program and the variable and semi-fixed costs
associated with increased patient load. We see that incremental costs will be covered when 21
additional patients are seen daily. Thus, if the marketing program can generate 21 or more
incremental visits, it will pay for itself. See Figure 3.

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Note that the urgent care center will not break even at this level of incremental daily visits. We
have already determined the break-even point with the new marketing program to be 24
incremental visits. Thus, 21 visits will pay for the marketing effort, but it will not make up for
the existing profit shortfall.

Although you are basically satisfied with the analysis thus far, you are concerned about the
uncertainties inherent in the revenue and expense data supplied by the urgent care center’s
director. Assess each element in your Question 1 pro forma profit and loss statement. Are
any items more uncertain than the others? How could uncertainty be worked into the
analysis? What additional information, if any, might you want to obtain from the urgent care
center’s director?