Financial Indicators for Physical Therapy Practice
Final Part in the Three Part Series
In Part 2 of the series the income statement was used to calculate projected costs for
budgeting, and to project revenue for setting practice goals. In addition, the definition
and importance of contribution margin (also known as profit margin) was explained. In
this last and final part of the series, profit margin will be reviewed and applied to
determine contribution ratio. This ratio is extremely useful when determining your
clinic’s sensitivity to changes in revenue. If your company’s revenue decreases due to
changes in the reimbursement climate, how badly will it affect your bottom line? More
importantly, how much additional revenue needs to be generated to increase net income?
Previously it was stated that contribution margin is the amount of revenue remaining
once total variable costs are subtracted from total revenue. This is the portion of revenue
that is allotted to cover fixed costs and generate a profit. From the contribution margin
the contribution ratio can be determined. The contribution ratio is the total contribution
margin divided by the total revenues generated. For example:
Income Statement
Revenue…………………………………………………$1,000,000
Less Variable Costs………………………………………(500,000)
Contribution Margin……………………………………$500,000
Less Fixed Costs…………………………………………(200,000)
Net Income……………………………………………….$300,000
Contribution Ratio = Contribution Margin/Revenue = $500,000/$1,000,000 = 0.5
This ratio demonstrates how net income will be affected by a change in total revenue,
such as when reimbursement changes. Net income can be quickly calculated by
managers / owners after a positive or negative change in revenue occurs, assuming that
costs stay relatively the same. For example, if the total revenue increases by $100,000;
the contribution ratio of 0.5 would be multiplied by $100,000 to determine the increase in
net income.
Contribution Ratio x Increase in Revenue = Increase of Net Income
$100,000 x 0.5 = $50,000 increase in net income
Contribution ratio can also be used to determine how much additional revenue must be
generated to create a given increase in net income. For example, if your organization
wanted to increase net income by $100,000 annually to cover start-up costs of a new
satellite, the required revenue needed would be calculated as follows:
Desired Increase of Net Income/Contribution Ratio = Required Increase in Revenue
$100,000/0.5 = $200,000
Financial Indicators Part III
Steffes & Associates
July 2008
Finally, the same calculations can be used to determine a decrease in net income
following a decrease in revenue. If your clinic projects a decrease in revenue by $50,000
annually, how much will net income decrease? Some managers may say $50,000,
however by using the contribution ratio, it is determined that net income will decrease by
only $25,000.
$50,000 x 0.5 = $25,000
Try integrating contribution ratio into your clinic’s financial calculations to develop more
accurate projections and reduce financial uncertainty.
Financial Indicators Part III
Steffes & Associates
July 2008