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By definition, a nonprofit is not profit motivated. Its objective is to render as much suitable service as possible while expending as few dollars as possible with the resources available to it. Ideally, the goal is to break even; revenues should equal costs. If a nonprofit generates too much of a surplus, it may not receive the same funding as last year because contributors feel their support is no longer needed. On the other hand, if it produces a deficit, it may risk survival.

Financial planning becomes a major aspect of what a nonprofit does. Cost-volume-revenue (CVR) analysis, together with cost behavior information, helps nonprofit managers prepare useful planning analyses. CVR analysis deals with how revenue and costs vary with a change in service level. It looks at the effects on revenues of changes in certain factors, such as variable costs, fixed costs, prices, service level, and mix of services. By studying the relationships of costs, service volume, and revenue, management is better able to cope with many planning decisions.

Break-even analysis, an integral part of CVR analysis, determines the break-even service level. Break-even point--the financial crossover point when revenues exactly match costs--does not show up in financial reports. Nonprofit financial managers, however, find break-even point a useful measurement. It reveals which programs are self-supporting and which are subsidized.

CVR analysis tries to answer the following questions:

* What service level or units of service are required to break even?

* How do changes in price per unit, variable costs, fixed costs, and service volume affect surplus?

* How do changes in program levels and mix affect aggregate surplus or deficit?

* What are some of the break-even strategies available?

Revenues for nonprofit entities are typically--

* grants from governments

* grants from private sources

* cost reimbursements and sales

* membership fees

* public contributions received directly or indirectly

* legacies and memorials

* other revenue such as investment income (e.g., interest, and dividends).

For management purposes, each type of revenue is grouped into its fixed and variable parts. Fixed revenues are those that remain unchanged regardless of the level of service, such as gifts, grants, and contracts. For example in colleges, donations, gifts, and grants have no relationship to enrollment. Variable revenues are the ones that change in proportion to the volume of activity. In colleges, tuition and fees are variable in relation to the number of students. Different nonprofit entities may have different sources of revenue: variable, fixed, or a combination of both.

Analysis of Cost

For external reporting purposes, costs are classified by function such as payroll, occupancy, and office and by programs and supporting services. But for managerial purposes, such as planning, control, and decision making, further classification of costs is desirable, e.g., by behavior. Depending on how a cost reacts or responds to changes in levels of activity, it may be viewed as variable or fixed. This classification is made within a specified range of activity, called the "relevant range." The relevant range is the volume zone within which the behavior of variable costs, fixed costs, and prices can be predicted with reasonable accuracy.

Typical activity measures for service levels at various types of nonprofit organizations are shown in Exhibit 1.

As with a typical break-even analysis, costs must be categorized as either variable or fixed. Simple definitions follow:

Variable Costs. These costs vary in total with changes in volume or level of activity. Examples include supplies, printing and publications, telephone, and postage and shipping.

Fixed Costs. These costs do not change in total, regardless of the volume or level of activity. Examples include salaries, accounting and consulting fees, and depreciation.

Nonprofit fixed costs are subdivided into two groups. Direct or program-specific fixed costs are those that can be directly identified with individual programs. These costs are avoidable or escapable if the program is dropped. Examples include the salaries of the staff whose services can be used only in a given program or depreciation of equipment used exclusively for the program. Common fixed costs continue even if an individual program is discontinued.

CVR Analysis with Only Variable Revenue

In order to compute break-even and perform various CVR analyses, it is necessary to consider contribution margin. The contribution margin is the excess of revenue over the variable costs of the service. It is the amount of money available to cover fixed costs and generate surplus. The contribution margin ratio is the contribution margin as a percentage of revenue or one minus the variable cost ratio. For example, if variable costs are 40% of revenue, then the contribution margin ratio is 60%.

To illustrate the various contribution margin concepts, assume that Los Altos Community Hospital (LACH) has an average revenue of $250 per patient day. Variable costs are $50 per patient day. Total fixed costs per year are $650,000. The expected number of patient days is 4,000. The projected statement of revenue and expenditures is shown in Exhibit 2.

Break-Even Analysis

The break-even point represents the level of revenue equal to the total of the variable and fixed costs for a given volume of output service. Break-even point in units is equal to the fixed costs divided by the unit contribution margin and in dollars to the fixed costs divided by the contribution margin ratio.


Units = -------------------------

(P ­ Unit VC)

Using the data from the LACH example, where the unit CM = $250 ­ $50 or $200 and CM ratio = 80%, the break-even point in units = $650,000/$200 or 3,250 patient days.

Break-even point in dollars = $650,000/0.8 or $812,500. Or, alternatively, 3,250 patient days x $250 = $812,500.

Determination of Target Surplus

Besides determining the break-even point, CVR analysis determines the volume necessary to attain a particular level of surplus. The formula is--

FC + target surplus

Target surplus level = --------------------------------------

Unit CM

Using the same data given for LACH, assume the hospital wants to accumulate a surplus of $250,000 per year. Then, the target surplus service level would be as shown in Exhibit 3.

Margin of Safety

The margin of safety is a measure of difference between the actual level of service and the break-even service level. It is the amount by which revenue may drop before deficits begin, and is expressed as a percentage of expected service level (see Exhibit 3).

The margin of safety is used as a measure of operating risk. The larger the ratio, the safer the situation, since there is less risk of reaching the break-even point.

Assume LACH projects 4,000 patient days with a break-even level of 3,250. The projected margin of safety is--

4,000 ­ 3,250

---------------------------- = 18.75%


Some Applications of CVR and What-If Analyses

The concepts of contribution margin and the contribution income statement have many applications in surplus/deficit planning and short-term decision making. Many what-if scenarios can be evaluated using them as planning tools, especially utilizing a spreadsheet program such as Microsoft Excel and Lotus 1-2-3. Some applications are illustrated below using the LACH data.

As noted earlier, LACH has a unit contribution margin of $200, a contribution margin ratio of 80%, and fixed costs of $650,000. Assume that the hospital expects revenues to go up by $250,000 for the next period. How much will surplus increase?

Using the contribution margin concepts, the impact of a change in the service level on surplus or deficit can be computed quickly. The formula for computing the impact is shown in Exhibit 3.

The income will go up by $200,000, assuming no change in fixed costs.

Given a change in service units
(e.g., 500 patient days) instead of dollars, then the formula becomes as shown in Exhibit 3.

CVR Analysis with Variable and Fixed Revenues

Many nonprofit organizations have both fixed and variable revenues. In this situation, the formulas developed previously need to be modified. For example, ACM, Inc., a mental rehabilitation provider, has a $1,200,000 lump-sum annual budget appropriation to help rehabilitate clients. The agency charges each client $600 a month for board and care. All the appropriation must be spent. The variable costs for rehabilitation activity average $700 per patient per month. The agency's annual fixed costs are $800,000. The agency manager wants to know how many clients can be served. The number of clients, or units of service (U), are calculated as shown in Exhibit 3.

What if, despite a budget cut to $1,080,000 but with everything else remaining the same, the manager does not reduce the 333 clients served? How much more do the clients have to be charged for board and care to break even? (See Exhibit 3).

The monthly board and care charge must be increased from $600 to $630 ($7,559/12 months).

What-if scenarios can be easily analyzed using popular spreadsheet software.

Program Mix Analysis

Most nonprofit companies are involved in multiservice, multiprogram activities. Break-even and CVR analyses require additional computations and assumptions. Program mix is an important factor in calculating an overall break-even point. Different rates and different variable costs result in different unit contribution margins. Break-even points and CVR relationships vary with the relative proportions of the programs offered, called the program mix.

By defining the product as a package, the multiprogram problem is converted into a single program. The first step is to determine the number of packages that need to be served to break even. The following example illustrates a multiprogram, multiservice situation.

Cypress Counseling Services is a nonprofit agency offering two programs: psychological counseling (PC) and alcohol addiction control (AAC). The agency charges individual clients an average of $10 an hour for counseling provided under the PC program. The local Chamber of Commerce reimburses the nonprofit organizations at the rate of $20 per hour of direct service provided under the AAC. The nonprofit organization believes that this billing variable rate is low enough to be affordable for most clients and also high enough to derive client commitment to the program objectives. Costs of administering the two programs are shown in Exhibit 3.

There are other fixed costs that are common to the two programs, including general and administrative and fund raising, of $255,100 per year. The projected surplus for the coming year, segmented by programs, is shown in Exhibit 4.

First, based on program-specific data on the rates, the variable costs, and the program mix (50,000 hours for PC and $40,000 hours for AAC), we can compute the aggregate value as shown in Exhibit 5.

We know that the total fixed costs, direct plus common, for the agency are $555,100. Thus, the package or aggregate break-even point is--


--------------------- = 9,100 packages


The company must provide 45,500 hours of PC (5 x 9,100) and 36,400 hours of AAC (4 x 9,100) to avoid a deficit as shown in Exhibit 6.

Management Options

CVR analysis is useful as a frame of reference, vehicle for expressing overall managerial performance, and planning device via break-even techniques and what-if scenarios. In many situations, management will have to resort to a combination of approaches to reverse a deficit, including--

1. selected changes in volume of

2. planned savings in fixed costs at all

3. some savings in variable costs

4. additional fund drives or grant

5. upward adjustments in pricing

6. cost reimbursement contracts *

Jae K. Shim, PhD, is a professor and Michael Constas, PhD, an associate professor at the College of Business Administration, California State University, Long Beach

By Jae K. Shim and Michael ConstasHOW TO COME OUT EVEN

In Brief

No Profits and No Losses

Nonprofit organizations can have problems with either profits or losses. Insuring that a nonprofit comes as close as possible to break even requires an understanding of the various relationships that exist among costs, service volumes, and revenues, whether fixed or variable. The authors describe some of those relationships and offer up some formulas and several practical examples of how the required results can be forecast.

The principals are at first quite simple, but where multiple programs are involved they move quickly into complex formulas and the need for spreadsheet software. But they make a strong case for proper planning in the management of nonprofit organizations.

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