Ask Andi: How important and difficult is it to determine unit costs? What is activity-based costing? And how does that come in to play?
In medical services, track and improve unit costs if you want to make more profit. In a nutshell, the truth is in the numbers. And the numbers don’t lie. But you have to know which numbers to look at.
Making money with unit costs
Let’s start with unit costs. A unit cost is figured by simply adding up what it costs to produce your goods or services, divided by the number of units you produce and sell. If you sell more than one kind of product or service, you can look at overall unit costs, as compared to specific individual unit costs.
First, establish your model, relating the cost of doing business to units sold. Look at total potential unit cost, based on total potential units that could be produced and sold. And the actual unit cost is based on actual activity produced and sold. For instance, if the medical provider’s office is 100% booked, that would be the total potential number of units that could be sold. It is unlikely that the facility will be fully booked 100% of the time, with cancellations and no-shows, gaps in slow periods, and days when staff is out. The actual unit cost, then, would be based on the number of units the company actually sells in a given period.
What do I include when determining the unit cost? You want to include both direct costs, such as specific labor and materials that you know go into producing and delivering your product or service, indirect costs, and profit. In the case of our medical service provider, the direct costs are labor, minimal charges for materials used up during treatment, and the cost of a treatment room. Indirect costs include overall rent and electricity less any cost already assigned for treatment rooms, excess labor, such as the time providers stand around between treatments, overhead labor such as reception, billing, and administrative staff, all other overhead costs, and marketing/selling costs. Profit is the total amount the company expects to make, after all, costs, for a given period.
Make the business more competitive
You need to allocate costs appropriately, in order for your numbers to have meaning. However, once you? ve set up and agreed to the model for allocating costs, the hard work is mostly done. From there on, it is simply a matter of updating the costs and units produced and sold, insuring your inputs are correct and letting the model run.
Activity-based costing comes into play when you are figuring out how to allocate your indirect and overhead costs and profit. It is a way of assigning costs that typically get lumped together, and relating them to the actual activity, or output, of the business. In setting up your model to allocate overhead and indirect costs and profit, you may want to tap into the advice of your accountant, your controller or bookkeeper, as well as your sales, marketing, and operations staff.
One of the challenges is fairly allocating overhead and indirect costs and profit. For example, our medical service provider will have to decide if a 15-minute treatment consumes as much overhead as a one-hour treatment. It may take as much effort to schedule, bill, prepare the room, and clean up the room, regardless of the length of treatment.
Profit may need to be allocated differently, based on the value customers place on the services provided. Your sales and marketing staff may be able to advise you, based on their understanding of customer needs and desires. In the case of our medical service provider, they find that the length of treatment is less of a driver in determining profit, than is the relief the patient perceives resulting from treatment. Consequently, they should consider allocating profit based on customer demand for services provided.
Setting a goal for each unit produced cost gives you something to focus on. Figure out the point at which the business realizes its greatest profit per unit sold. Use your unit cost model to figure out hours of operation. Whether to stay open later, open earlier, or add weekend hours to be more profitable.
Pair the unit cost model with activity-based costing to help identify products or services that don’t measure up. Determine if they cost more to produce than customers are willing to pay. Factor overhead, variable costs, and profits into the mix. Use the model to evaluate price increases per treatment. This can add up to big dollars, when multiplied by all of the treatments provided in a year. Compare the results. Consider price increase vs. selling more profitable treatments at current or higher prices.
Knowing if a product is profitable, helps focus its efforts and make choices. Improve profitability. Produce more units. Disburse overhead costs over a greater number of transactions. Profit may go up if marketing dollars focus to educate potential clients on value. So they are willing to pay more. Sales may focus on getting more customers in the high-profit treatments. Operations may look to reduce cost/unit by reducing waste.
Put staff on per diem hours to increase productivity. Add staff to reduce overtime. Schedule treatments closer together. Additionally, look at how services are sold and booked. Be sure that the most profitable services, get priority. Minimize low-profit services, or remove them altogether. Or made more profitable.