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