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Financial Analysis of Bridgestone Behavioral Health Center Case Study

Shweta Totad, Kiarash Kian Ahmadi, Saleiha Sharif, Kinjal Patel Masters of Global Management, School of Business at Royal Roads University MGMT565: International Accounting Tools for Financial Health Gordon Gunn June 27, 2021

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Shweta Totad, Kiarash Kian Ahmadi, Saleiha Sharif, Kinjal Patel June 27, 2021. Bridgestone Behavioral Health Center Case Study Dear Dr. Thomas Russell, Thank you for selecting our company to investigate the following year’s annual budget of Bridgestone Behavioral Health Center and we will help you with increasing the financial performance through effective management of financial resources. In view of examination of the Bridgestone Behavioral Health Center’s yearly budget for the next year, we investigated the obvious shortcomings in the budget for the coming year. Due to some challenges related to profit of the center for past couple of years, it has been hard to attain a break-even. In this way, we will lead a quantitative investigation of your center and help you through the following reports and recommendations. After a thorough examination of predicted financial reports of the company for the future year, we were able to recognize some significant financial difficulties which the center must be cautious about. The center receives a large amount of government assistance, and also it encounters a variety of issues because the state has enforced various restrictions and limits on its quantity and effectiveness. Medicaid rates don’t increase and annual Medicaid funding is capped. Bridgestone's main source of income comes from Medicaid reimbursements. The federal government reimburses the Board about 60% of their expenses. The other 40% of Medicaid funding is generated through the combination of state and county sources. Bridgestone receives a small percentage of income from its private pay clients, while Medicaid reimbursement is its

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principal source of income. It provides a diverse range of outpatient services including counseling, case management, rehabilitation, and medication maintenance. Although the center benefits from a qualified Executive Director and highly trained professional staff with outstanding expertise, the center’s financials show that it is struggling to reach the breakeven point for the past three years. The projected budget shows the targeted sales volume and revenue of the company for the upcoming year, that states Bridgestone has defined a goal of making the company risk-free. Based on the present situation, we will analyze that even a minor change in operations could damage the profitability of the company. Bridgestone Weighted Average Contribution Margin (WACM) is 70% (WACM= $3,500,000 / $5,000,000 = 70%), which is very high for the center due to high margin contribution rate. Generally, it means that you are making a rather high profit on every dollar spent (or at least should be). A high WACM % also means that Bridgestone is keeping the variable cost at a minimum in comparison to total costs (low variable cost). The WACM% provides us a way to control the actual processes of Bridgestone as it reflects on the services which contribute at a higher rate and which count for a deficit. Therefore, Bridgestone would likely to promote certain services like Urinalysis, Individual and Group Counseling through advertisements and other promotional activities. Fixed cost may be taken as discretionary as well as committed fixed cost. A discretionary fixed cost differs from a committed fixed cost, where a committed cost requires a business to make payments over a certain period of time (such as the lease on an office building) (“Discretionary fixed cost definition”, 2021). Discretionary expenses, however, are nonessential spending which are not related to day-to-day business operations and companies can operate even if there is reduction in the discretionary costs. Therefore, when companies face liquidity

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shortfalls, for a short period of time, they can eliminate or reduce discretionary expenses without experiencing an immediate impact on the productivity of a business (Liberto, 2019). Discretionary expenses are usually connected to promoting or enhancing a company’s position in the market and they are considered as investments in the future. Following are salient discretionary fixed costs (“Discretionary fixed cost definition” 2021): 

Advertising campaigns



Employee training



Public relations



Research and development activities for specific products

Based on the fixed cost and marginal contribution rate, it can be concluded that Bridgestone’s breakeven point is $ 4.991 M ($3,493,700/0.7=$4,991,000). So, the center may take these values as a plan for a modest recovery because of profit $6300 ($3,500,000$3,493,700=$6,500) and the margin of safety of $9000 ($5,000,000-$4,991,000=$9,000). According to the relatively low profit and safety margin of the center, it may face some financial risk for its yearly plan. In order to lower the risk factor, company may increase sales volume of services and programs with high contribution margins, preferably try to decrease discretionary costs and reduce employees pay and other benefits. Bridgestone’s margin of safety is $ 9000 which is very small compared to total revenue, equivalent to 0.18% of total revenue. These numbers and ratios reflect that company represents very high fixed overheads, and profits are not earned until or unless the activity level would be so high to cover the fixed costs. Therefore, Bridgestone can improve it by cutting down the discretionary cost like minimizing cost related to advertising, travel, employee training, office

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supplies, or R&D costs. The center may improve its financial health by boosting up sales volume or adopting a more profitable service mix. Following is the detailed analysis of sales mix and contribution margin of each service offered by Bridgestone: -

Se r

Services

Revenue ($)

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Assessment

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Urinalysis 1,155,500 406,250 Case 480,000 10,000 Management Group 845,000 142,000 Counseling Individual 1,090,000 122,000 Counseling Crisis 210,000 31,000 Intervention Intensive 226,500 200,250 Outpatient Medical 160,000 200,000 Somatic Methadone 120,000 96,000 Maint. Ambul 543,000 260,000 Detox Total 5,000,000 1,500,000

3 4 5 6 7 8 9 10

170,000

Sales Relative Mix CM CM Contributio (%) Ratio Total Ratio n Margin ($) (sales (%) Variable (%) (Revenue - volume (CM/ Cost ($) (CM/ TVC) /total Revenue) TCM) sales volume) 32,500 137,500 5.32% 80.9% 3.93% 749,250

15.37%

64.8%

21.41%

470,000

7.98%

97.9%

13.43%

703,000

37.26%

83.2%

20.09%

968,000

15.97%

88.8%

27.66%

179,000

2%

85.2%

5.11%

26,250

2.66%

11.6%

0.75%

-40,000

1.06%

-25.0%

-1.14%

24,000

10.65%

20.0%

0.69%

283,000

1.73%

52.1%

8.09%

3,500,000

By going through the detailed analysis of services mix, it comes to know that one of the services namely medical somatic showed negative contribution margin ($160,000 - $200,000 = -$40,000). Therefore, the center should preferably suspend medical somatic services because its negative contribution deeply affects the overall proficiency of the center. However, if center

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faced problem in discontinuation of this service due to certain government regulations, then the center may go for option of outsourcing the medications of medical somatic. This ultimately helps the center to reduce the variable overheads. Analysis report of service mix depicts that the center has to put more focus on expanding services of Group Counseling ($703,000), Individual Counseling ($968,000), Urinalysis ($749,250), and Case Management ($470,000) because in total these four services are contributing approx. 71.41% of the total revenue and 82.59 % contributing relative to total contribution margin of the center. Crucial element in budgeting service enterprises is correlating professional staff with expected services. Therefore, one way to reduce the costs is to decrease the staff, however, there are some problems regarding understaffed organizations such as lost revenue because client needs for service cannot be met and loss of professional staff due to excessive workloads. Rather than this, the center should promote the off-campus programs as they can be major source of some revenue. The services which can be provided in the off-campus program can be Case Management, Individual Counseling, Crisis Intervention, Ambul Detox. whereas Group Counseling and Patient Assessment can be provided in corporates. These services can generate high profits as they have high contribution margin and can be provided off-campus. One suggestion is that these services may be offered virtually so as to attract customers who lives outside the region. This step will reduce your relevant discretionary costs such as travel and transportation costs. Additionally, it is better to hire bilingual staffs who can help patients of different languages.

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Finally, based on our detailed analysis here are some of the recommendations for improving the current operation of the center that can help you to effectively monitor its future performance: 

Assist the management in addressing productivity and staff attendance issues which may be associated with mental health or drug abuse challenges.

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Promote better supervision techniques to the employees whose performance is declining due to psychological or other medical problems.

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Help the management by establishing new policies and laws for a drug-free work environment and emergency plans to deal with psycho-social challenges.

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Hold monthly and quarterly review sessions to control the budget and ensure that service volume and profit will be met.

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Arrange regular staff training and development programs that may help to strengthen their expertise and knowledge. And also increase their capacity to adopt new technologies and methods.

References

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Budgeting in non-manufacturing companies. (n.d.). Wiley Plus. learn.wileyplus.com/courses/76150/modules/items/22709458 Discretionary fixed cost definition. (April 12, 2021). Accounting tools. accountingtools.com/articles/what-is-a-discretionary-fixed-cost.html#:~:text=A %20discretionary%20fixed%20cost%20is,reported%20profitability%20of%20…. Kucic, A. R., Sorensen, J. E., & Victoravich, L. M. (2010). Bridgestone behavioral health center: Cost-volume-Profit (CVP) analysis for planning and control. https:doi.org/10.4135/9781526427830 Liberto, D. (May 6, 2019). Discretionary Expense. Investopedia. investopedia.com/terms/d/discretionary-expense.asp Luenendonk, M. (2019, September 19). Break-Even Analysis: What, Why, and How. Cleverism. www.cleverism.com/break-even-analysis.

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Annexure –‘A’ SOLUTION:

1. What is the weighted average contribution margin (WACM) percentage for Bridgestone’s next annual budget? The weighted average contribution margin is the calculation of average volume of the products/ services which generates revenue to cover the fixed expenses of the company Here, WACM ratio = Contribution Margin / Total Revenue Contribution margin (given in the supplementary resources)

3,500,000

Total Revenue (given in the supplementary resources)

5,000,000

WACM ratio= Contribution Margin/Total Revenue

0.7

WACM ratio = 70% 2. What does a high weighted average contribution margin (WACM) percentage mean for the management of Bridgestone? WACM is the technique to see how the management is performing. WACM focus on the variable costs. As calculated, WACM ratio is 70% which is considerably high that means the variable costs are 30% of the whole revenue and company is earning high percentage of what is spending on variable cost. It also helps the management to be more focused on cost-effective solutions by making necessary adjustments to reduce variable costs even further.

3. Is Bridgestone able to plan for breakeven or a modest over-recovery of expenses (or profit) for the next year? If the Center achieves breakeven or a modest over-recovery

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and you are concerned about events that could cause a potential loss, what would you try to change? (You may consider both on-and off-campus programs.) Break even in $ = Fixed Cost /WACM Ratio = 3,493,700/70% = $ 4,991,000 Break even in units = Fixed Cost /WACM = 3,493,700/46.57 = 75015 WACM = Total Contribution Margin / Total Units of Service = 3,500,000/75,150 = 46.57 And now, let's calculate the profit = Contribution Margin - Fixed costs = 3,500,000 - 3,493,700 = $ 6300 Yes, they can plan for break even for next year. To increase the profit, they can reduce the variable cost, setup for off campus programs for government organizations and other charitable organizations to reduce the fixed costs and gain higher revenues, decrease discretionary costs like employees' salaries and benefits, consulting charges, transportation charges and other office supplies.

4. A useful component of CVP analysis is the margin of safety for service revenue that can be calculated as a dollar amount ($) or as a percentage (%). What is Bridgestone’s

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projected margin of safety for next year? Interpret your answer in terms of what it means to Dr. Russell. Margin of Safety = Current Sales (Revenue) - Break even Sales Current Sales (Revenue)

$5,000,000

So, let's calculate Break even sales first, Break Even Sales = Fixed Costs/Contribution Margin Ratio Fixed Costs

$3,493,700

Contribution Margin Ratio Break Even Sales =

0.7 $4,991,000

MARGIN OF SAFETY = $9,000 Hence, it is assumed that margin of safety is $9000, which indicates that company is performing very low in terms of profit making. It says that Dr. Russell should focus on increasing the contribution margin by decreasing variable cost and/or reducing the discretionary fixed costs in order to lower the break-even point. The margin of safety ratio is very low, 0.18% ($9000/ $5,000,000) of the revenue and small extra expenses could lead to the operating losses.

5. Fixed costs can be discretionary or committed. Using your judgment based on the discussion in the case, identify which costs are likely to be discretionary. Assuming that

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management is able to decrease discretionary fixed costs by 10%, what would be the impact on Bridgestone’s break-even point revenues? Fixed costs (discretionary costs) include salaries and benefits, consulting fees, transportation, other costs and office supplies whereas, rent and deprecation counted as committed costs. new 10%

Scenario Summary Fixed cost original

decrease Changing Cells: Consulting Fees Transportation Office supplies Other Result Cells: Total Fixed Cost Breakeven

174,685 104,811 69,874 524,055

157,217 94,330 62,887 471,650

$ 3,493,700 $ 4,991,000 Difference in breakeven Percentage change

$ 3,223,597 $ 4,605,138 $ 385,862 7.73%

The break even in dollars has decreased by 7.73 percent after a 10% reduction in discretionary fixed costs.

6. As Bridgestone operates during the next year, do some services deserve more attention than others? (Hint: What is their relative contribution to the WACM % and to the total contribution margin? Which services?) As mentioned in the resources, the services like Urinalysis, group counselling, individual counselling, and case management are popular among other services and have high number of patients footfall rather than other services So, calculating the relative contribution of these services as counted below: WACM = contribution margin/ Total revenue a. Urinalysis service's WACM = 749,250/5,000,000 = 0.1499 = 14.99%

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So, now, the relative contribution to WACM will be 14.99/ 70 = 21.4% or Urinalysis service's CM / Total CM = 749,250 / 3500000 = 21.4% b. Group counselling service's WACM = 703,000/5,000,000 = 0.1406 = 14.06% So, now, the relative contribution to WACM will be 14.06/ 70 = 20.09% or Group counselling service's CM / Total CM = 703000 / 3500000 = 20.09% c. Individual counselling service's WACM = 968,000/5,000,000 = 0.1936 = 19.36% So, now, the relative contribution to WACM will be 19.36/ 70 = 27.66% or Individual counselling service's CM / Total CM = 968,000 / 3500000 = 27.66% d. Case Management service's WACM = 470,000/5,000,000 = 0.094 = 9.4% So, now, the relative contribution to WACM will be 9.4/ 70 = 13.43% or Case Management service's CM / Total CM = 470,000 / 3500000 = 13.43% These services are contributing up to 82.59% of the total contribution margin, therefore, these services should be focused more. 7. How can the budgetary weighted average contribution margin (WACM) percentage be used to help control the actual operations of Bridgestone? The weighted average contribution margin is the calculation of average volume of the products/ services which generates revenue to cover the fixed expenses of the company. It is used for the projection of the profit levels and sales volume. WACM ratio is helpful to Bridgestone as it enhances the insights on what will be the optimum level of the sales mix and its combination of different services to maintain and boost its profitability. 8. If a budgetary weighted average contribution margin (WACM) percentage has been developed with an expected level of revenue and a planned fixed cost and the budgetary WACM percentage is in fact achieved in the next (future) time period, could the organization still face losses if the total revenue drops below the budgeted level or total fixed costs increase beyond the budgeted levels? Can you explain how losses still might

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occur even though the planned WACM percentage is being realized in the future time period? WACM percentage measures the percentage of valuable cost incurred by the company for each dollar of revenue. So, if total fixed costs increase, the company might still face loses even though WACM percentage remains constant. This is because net profit (loss) equals to WACM Total Fixed Cost. With a decreased revenue, valuable costs also reduce proportionately, therefore, WACM ratio remains constant but the center will face a loss because the amount of WACM will diminish.

9. Can you demonstrate with numeric examples how financial losses might occur? Describe the effects of the following three possible scenarios:

a. What is the financial impact if Bridgestone’s group counseling unit of service volume decreases by 10% during the first quarter?

Scenario Summary

Original Group 10% Decrease value

Loss

Counselling Volume Changing Cells: Unit of service Private Payments Medication Test Other VC Result Cells: Rate Revenue T. VC C. M Annual Profit

7,000 1,250 $35,000 500

6,300 1,125 $31,500 450

$30 $ 210,000 $35,500 $175,750 $6,300

$30 $ 189,000 $31,950 $158,175

$ (21,000) $ (3,550) $ (17,575)

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Quarterly profit $1,575 Quarterly Loss $ (16,000) The group Consulting service volume decreases by 10% in the first quarter. This will result in decrease in revenue and variable cost for Group Counse...