Colonoscopy With a Nun, and Confusion About Fixed Costs
A colonoscopy is easy- it’s the prep the day before that’s hard.
Let’s just say that the prep “clears the way” for the procedure, and move on…
So I’m in a bed hooked up to an IV watching TikTok videos on my phone- the Doctor is running behind on procedures. Nurses are sitting at desks at one side of the room, and beds are on the other side, separated by curtains.
One of nurses says:
“Sister Margaret? I’ll call Sister Ruth and tell her that you’re ready to go.”
Sure enough, Sister Margaret walks up to the nurse’s desks from the bed next to me. She’s wearing a scarf around her head, and the simple clothes of a religious order.
At that moment, two other nurses walk over to me.
“Ready to go?”
“Sure”, I say. “Now that I’ve seen a Nun, the timing can’t get any better.”
This posts discusses the medical costs, the breakeven formula, and why so many people don’t account for fixed costs correctly.
Managing huge costs
The US spends 17.3% of our gross domestic product (GDP) on healthcare, which is a staggering amount. My procedure was at an Ambulatory Surgical Center (ASC)- a facility for outpatient surgery. The cost to start an ASC ranges from $3 million to $8 million, and millions more to operate the business.
Allocating these costs accurately is critical in order to generate a profit.
The problem is often fixed costs.
To explain the fixed cost issues, let’s start with the breakeven formula.
Understanding the breakeven formula
The break-even formula can be stated in several ways, but the most common version is:
[(Sales price per unit) x (Units sold)] – [(Variable cost per unit) x (Units sold)] – (Fixed costs in total dollars) = $0 Profit
Here’s an example:
Julie owns Sterling Furniture, and she is analyzing her breakeven point on a dining room table product line. Sterling sells each table for $500, the variable costs per unit are $380, and total fixed costs equal $200,000.
Here is the breakeven point, assuming that “X” equals units sold to break even:
$500X – $380X – $200,000 = $0 Profit
$120X - $200,000 = $0
$120X = $200,000
X = 1,667 units
Julie must sell 1,667 units to cover all of the dining room table product line costs and break even. She can also change any of the variables in the formula and calculate breakeven based on new assumptions. If, for example, she increases the price per unit, the number of units to reach breakeven will be lower.
The issue with fixed costs
You see that sales and variable costs are calculated per unit, while fixed costs are listed in total dollars. This distinction is important, because once you pay for all fixed costs, they no longer impact the formula.
To illustrate, here’s the wrong way to handle fixed costs.
Assume that Sterling assigns fixed cost at $120 per unit. If Sterling sells 2,000 units, fixed costs total ($120 X 2,000 units), or $240,000.
But that’s not possible.
Once fixed cost spending hits $200,000, the costs end.
Fully covering your fixed costs can lead to high profitability.
Leveraging fixed costs
The more revenue you can generate from an asset, the better. If a plumber owns a $30,000 truck carrying $10,000 in equipment, he has a $40,000 total investment. If he works on 200 plumbing jobs a year, he gets more out the investment than doing 150 jobs a year.
Special orders also explain the benefits of fully covering fixed costs.
Let’s assume that Sterling Furniture gets a call from a customer in the last few weeks of the year. The customer asks Julie for a quote on a furniture order.
What are Julie’s costs for the order?
At this point in the year, fixed costs have already been paid for with prior sales. Sterling’s only costs are variable costs of $380/ unit. Julie does not incur fixed costs to fill the order.
The lesson
When you use the breakeven formula, use fixed costs in total dollars, not per unit. Fixed costs may not be incurred for every unit produced or sold- they end at some point.