How to Utilize Cost Benefit Analysis for Equipment Acquisitions

Part of growing a practice involves an ongoing investment in technology and equipment that helps with diagnosis, billing, and overall efficiency. However, when it comes to purchasing equipment, many practitioners fall into the trap of buying things that they feel are needed but are actually not needed when considering their bottom lines.

Here is how to use a Cost Benefit Analysis (CBA) to properly gauge whether a piece of equipment will produce a net benefit to a practice from a revenue aspect. Before using CBA, however, it’s important to understand the “why” behind it.  

Measure the Right Metrics
Far too often, practice owners focus on vanity metrics, such as gross revenue, while Free Cash Flow (FcF) is a much more meaningful metric to determine whether you are running a successful business. The equation for Free Cash Flow is as follows:

Free Cash Flow = 

Sales Revenue – (Operating Costs + Taxes) – Required Investments in Operating Capital

From this equation, we can make a few simple observations regarding increasing Free Cash Flow. We can either: 

1. Increase our sales revenue 
2. Decrease our costs
3. Decrease our taxes  

Here’s the beautiful thing about CBA: we can do all three of these once our analysis is complete.

The Four Steps of Cost Benefit Analysis
Cost Benefit Analysis is defined as a systematic process of evaluating the desirability of a decision by weighing its potential benefits and costs. It generally follows a four-step process:

1. Define the framework for the analysis.
2. Identify and classify costs and benefits.
3. Draw a timeline for expected costs and revenue.
4. Monetize costs and benefits to understand when break even points occur. 

Putting the Steps into Practice
Let’s walk through an example with an often hotly debated piece of equipment, the OCT. In this example, we will simplify a few numerical values in order to keep the math and overlying concepts easy to understand.

First, let’s define the framework for the analysis by stating that the OCT we are interested in has a $60,000 price tag. We know that reimbursement codes 92132, 92133, and 92134 can be used, and we can identify 200 active patients who can be billed for an OCT in our EHR. Our next step is to identify our costs and benefits. For bringing in an OCT, we can create a list of costs and benefits that are both tangible and intangible:

With a global understanding of the OCT and its role in our practice, we can now plan a timeline for implementation in which we map expected costs and revenue. As we go about this, we can also monetize each of these values.

• Staff time per usage (@ $20/hr) – 15 min = $5/patient – $500/100 patients  
• Doctor time per usage (@ $60/hr) – 5 min = $5/patient – $500/100 patients
• Biller time per usage (@ $15/hr) – 3 hrs/100 patients – $45/100 patients
• Avg. Maintenance cost per year – $200
• Energy cost per usage – $0.25 – $0.25 x 100 patients – $25
• Footprint – 10 sq ft @ $30 sq ft/yr lease = $300/yr 
• Property tax – not applicable in this instance
  

So, if we calculate all of these together, our total cost per year to run the OCT on 100 patients comes to:

$500 + $500 + $45 + $200 + $25 + $300 = $1,570/year

This is certainly not a huge amount, but it is enough to be considered significant. 

With all of this in mind, consider the  OCT  Cost Benefit Analysis for the next five years. Our goal is to ascertain when both instantaneous and overall breakeven points happen. We will calculate our Return on Investment (ROI) at the end of each year and utilize the following simplifications/assumptions:

• Revenue of $50 per patient, with a constant year-to-year growth of $5,000 per year utilizing the OCT, starting with $10,000 in the first year.
• Our practice grosses $1M per year and is subject to an 8.83% corporate tax.
• Utilizing the Straight-Line Method (see image below), we note a $7,857 depreciation of the machine per year which results in $3,300 of tax savings per year. (Please note that this is an oversimplified approach. Always consult with a qualified tax professional/CPA when calculating depreciation for your practice)

Digging into the Numbers: The Five-Year CBA

Year 1: 

Revenue = $10,000

$7,857 depreciation → $3,300 tax savings

(assume $1M gross, 8.84% Corp Tax)

ROI = Net Profit/Cost of Investment x 100

​(where Net profit = total revenue – total cost)

Year 1: ROI = [ ($10,000 + $3,300) – ($60,000 + $1,570) ]

               $60,000                                  x 100

ROI = -80.45%

After one year, we are heavily in the red with our new investment. However, this should come as no surprise with such a steep initial capital expenditure.

Year 2: 

Revenue = $15,000 (vs $10,000 in year 1)

$7,857 depreciation → $3,300 tax savings

(Assume $1M gross, 8.84% Corp Tax)

Year 2: ROI = [ ($25,000 + $6,600) – ($60,000 + $3,140) ]

   $60,000                                  x 100

ROI = -52.57%

After two years, we notice a little less red, but we are still losing money on our OCT.

Year 3: 

Revenue = $20,000 (yearly $5,000 increase)

$7,857 depreciation → $3,300 tax savings

(Assume $1M gross, 8.84% Corp Tax)

Year 3: ROI = [ ($45,000 + $9,900) – ($60,000 + $4,710) ]

     $60,000                                  x 100

ROI = -16.35%

After three years, we have a little hope of putting our heads above water. Although still losing money, the OCT is coming close to breaking even.

Year 4: 

Revenue = $20,000 (yearly $500 increase)

$7,857 depreciation → $3,300 tax savings

(assume $1M gross, 8.84% Corp Tax)

Year 4: ROI = [ ($70,000 + $13,200) – ($60,000 + $6,280) ]

        $60,000                                  x 100

ROI = +28.2%

Four years into ownership, we have officially broken even and turned a profit with our OCT! However, we need to take that with a grain of salt. This is an instantaneous break-even value. Remember that for over three years, we were losing money on our machine.

Year 5: 

ROI = [ ($100,000 + $16,500) – ($60,000 + $7,850) ]

         $60,000                                  x 100

ROI = +81%

Five years into ownership, we start to reap real profits. We are very much in the green, and with that plentiful bounty of revenue, we are able to achieve an overall break-even point.

Now that we’ve completed our five-year CBA analysis, let’s look at some of the shortcomings of our example that would pop up in the real world:

• We assume equal tax burden and rates year after year.
• We assume a constant growth curve.
• We did NOT account for increase in salaries, nor the increase in hours needed for seeing more patients.
• We assumed we’d be buying the device in full. How about financing?

Most practices probably won’t have $60,000 lying around in a bank account to make a large capital expenditure. Thus, most will utilize some sort of financing, most likely over a period of five to ten years to fund the purchase. With associate terms and APR, we would expect both instantaneous and overall break-even points to be pushed out another one to two years.

Purchasing equipment is not nearly as simple as “buy it and watch it print money.” A thorough CBA can uncover a lot of details that go into how a capital investment can affect a practice’s bottom line. It is important to get all the details on a piece of equipment and understand how it fits into your practice’s workflow before pulling the proverbial purchase trigger. Due diligence through a Cost Benefit Analysis can determine whether that shiny machine will be a building block towards higher profits or an expensive paperweight.