Posted: July 13th, 2021
Why would X and Ys total revenue curve be flat in Capitation?
A cost volume profit chart, which is commonly referred to as a CVP chart, is a graph that represents the cost-volume-profit analysis conducted in managerial accounting (Gapenski, 2012). It is a graphical representation that portrays the relationship that exists between the cost of the units produced by an organization and the volume of units produced, using total costs, fixed costs, and the total sales. The CVP analysis is a technique used in management and accounting to analyze the effect of the volume of sales and the production costs on the operating profit of a business organization. A CVP shows how the operating profit is affected by the changes or fluctuations in the fixed costs, variable costs, the selling price of units, and the sales mix of various products (Gapenski, 2012).
The CVP graphs provided show the relationship between the various costs for two competing companies that are operating in a fee-for-service environment. According to the CVP graphs provided, firm Y has greater fixed costs while firm X has higher variable costs. Firm Y has a higher per-unit revenue than Firm X. In terms of the contribution margin, the charts show that Firm Y has a greater contribution margin than Firm X. In addition, Firm X clearly needs a higher volume of sales to reach its breakeven point. There are various methods or environments that are used for paying firms. In a fee-for-service environment, a firm is paid for all services and tests that it provides on the basis of the customary and usual charges of firms in an environment.
In a discounted fee-for-service environment, a firm is paid for all tests and services that it provides on the basis of a fee schedule that is predetermined – a discount of the customary or usual price charged in the environment (Gapenski, 2012). In a capitated environment, a firm is paid a fixed amount of money and not per service, on a monthly basis. From this description, we can interpret that firms in a fee-for-service environment make more revenues compared to firms in both discounted fee-for-service and capitated environments. This is because they are paid in full for each service they provide.
Firms in discounted fee-for-service environments make higher revenues than those in capitated environments as the revenues can increase with an increase in the services provided (Sutherland, Crump, Repin, & Hellsten, 2013). In capitated environments, the revenues of firms remain fixed regardless of the services provided. Therefore, if Firm X and Firm Y, shown in the CVP Charts provided, were to operate in a discounted fee-for-service market environment, their respective slopes of the total revenue lines would remain upward sloping. However, the total revenue lines would slope upwards at a slower rate. This would ultimately result in a decrease in the total revenues of the firms.
If Firm X and Firm Y were to operate in a capitated environment, their total revenue curves or lines would be flat. This is because, in such an environment, the total revenues of a company do not depend on the number of services or the amount of work that a company conducts but by the agreed upon, fixed, amount that is paid every month or year (Sutherland et al., 2013). The total revenues of both firms would, therefore, remain constant. Firm X, in all the different types of environments, would be in the best position to grow its business, as most of its costs are variable and not fixed.
Gapenski, L. C. (2012). Healthcare Finance: An Introduction to Accounting and Financial Management, 5th Ed. Chicago: Health Administration Press.
Sutherland, J. M., Crump, R. T., Repin, N., & Hellsten, E. (2013). Paying for hospital services: A hard look at the options (CD Howe Institute Commentary No. 378).
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