Flex Budgets: A Quick Guide For Hospitals

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Hospitals, like most businesses, have budgets. While they all track their performance closely against that budget at the organizational level, many fail to do so with the same rigor at the cost center level, mainly due to lack of dependable reports. In this article, I will explain what flex budgeting is, how it is calculated, and why using it helps the organization.

Before I touch on the mechanics of flex budgeting, I will describe it, for now, as the budget set at the beginning of the year, adjusted (or “flexed”) to the actual volume and mix. Volumes, for the purposes of flex, are charge code volumes, therefore, only direct (i.e., revenue generating) cost centers would be flexed.

First, let me narrow down the focus of the budget discussion. There are different types of budgets, including: capital, operating expense, operating revenue, and volumes (actually, every line account in the financial income statement has a budget). In this article, my discussion only includes the operating expense budget and budgeted volumes, because these two are the essential ones for flex budgeting purposes.

Let me begin with a question. What is a budget? Some people imagine actual money set aside for specific purposes, like you might do if you are saving for a big purchase. In most cases, that is not true. I like to describe a budget as an expectation.

Once a year, during the budget-build process, a hospital forecasts (“expects”) revenue based on projected volumes and payor mix, and that revenue is then used to set expected operating expenses to achieve those volumes. Therefore, a front-line manager in charge of a direct cost center, would be given budgeted dollars and budgeted volumes. Their task, during the year, is to achieve those volumes, within their allotted budgeted dollars. A budget variance report (BVR) is their primary tool to monitor their financial performance.

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For managers to be held accountable for the performance of their cost centers, the numbers in the budget variance reports need to be accurate. If a staff member coded in that cost center works in other areas, those dollars need to be cross charged appropriately. Similarly, supplies ordered by one cost center should not find their way to another cost center’s stock room. While the need to borrow supplies for patient care is understandable, it is important to track those expenses and cross charge appropriately.

Assuming that the dollars in the budget variance report are all where they belong, the question then becomes how has the cost center performed relative to the activity within the period? A BVR alone cannot answer the question since it provides a static view of the financial performance, based on budgeted dollars assigned during the budget build process months earlier. That is where a flex budget comes in.

How many times have you heard managers explain their overbudget condition by stating that their volumes were high? While most times they are probably correct, no one would know for sure unless there is a flex budget report. A monthly flex report tells the manager what their budget should have been, based on actual volume and mix, and the actual expenses would then be measured against that “flexed” budget. Another way of looking at it, the report tells a manager how much of their actual expenses are “justified” by the actual volume and mix.

The calculation of flex is simple. Through cost accounting, each charge code is costed by allocating the budgeted dollars to the budgeted volumes according to resource intensity. The result is the product standard (or budgeted) unit cost. The actual volume is then multiplied by the standard unit cost to come up with the flex budget.

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Many organizations try to mimic a flex report by dividing the budgeted dollars by the budgeted volumes, without accounting for resource intensity, and multiplying that number by the actual volumes. It’s a high level and easy approach. On the surface of it, it seems logical, but the problem with this approach is that all volumes are treated equally. A 5-minute chest x-ray is treated the same as a 3-hour fluoroscopy case. Moreover, the calculation is often applied to the encounter (case) level instead of the individual charge code level. Encounters often include charges from multiple cost centers, but only one of them gets credit for that volume.

A flex report provides important information about the performance of a cost center. It splits the results between labor and supply, and takes into consideration the volume mix (i.e., resource intensity). So, in theory, a cost center could have higher volumes, but flex may calculate a lower budget because the volume was mainly driven by less resource-intensive products. The opposite is also true.

Many hospital administrators and CFOs understand the benefits of flex budgets, but most do not use it, and instead rely on the stripped-down version that I described above. The reason for that is that to do it properly, hospitals need to switch their cost accounting methodology to Activity-Based-Cost (ABC) accounting. In a previous article, I explained that many hospitals use an alternate method of cost accounting called Ratio of Cost-to-Charge (RCC) accounting. It is easier and quicker, but it has shortcomings. I made the argument that ABC accounting is more accurate and can be achieved inexpensively by doing the calculations outside the decision support system.

To do ABC accounting, and subsequently flex budget reporting, line accounts and job codes in each cost center would need to be assigned a cost type. There are seven cost types for direct cost centers; three are variable, and the rest are fixed. Only the variable costs fluctuate with volume and drive flex results.

Each charge code should also be reviewed and assigned a relative value unit (RVU). Labor RVUs are used to allocate variable salary costs and supply RVUs are used to allocate variable supply costs.

Initially, the effort to assign cost types and RVUs is significant, after that it is only a matter of annual “maintenance”. Also, as new charge codes are introduced, they should be assigned RVUs before the cost calculations are run for the month.

I have so far used the terms flex budgeting and flex reporting interchangeably. They are really one and the same. Information from the report adjust the budget. For direct cost centers, flex report results are taken into consideration when reviewing the BVR. Also, annually, during the budget build process, the flex results are incorporated into the following fiscal year’s budget.

So, apart from providing an accurate picture of a cost center’s performance, what are the advantages of flex budgeting? I believe it all boils down to the frontline managers and their buy-in. Once they learn to trust the process and data, they start paying more attention to what is going on in their cost centers.

Flex budget reports help managers become in tune with their BVR and charge codes. They become more aware of the importance of keeping expenses where they belong, and it allows them to look for missed charging opportunities, especially in the patient charge items category. Furthermore, even activities that are not chargeable but resource intensive (e.g., injections in nuclear medicine), can be tracked and accounted for by creating statistical charge codes with RVUs. This is a huge satisfier for many managers.

The bottom line is that flex helps managers at the cost center level manage more effectively, and if the cost centers perform well, the entire organization performs well.

If you are interested in implementing flex budgeting at your hospital, please email me at ELYanalytics@Outlook.com, or call 860-580-5177.

This article first appeared on Experts.com

https://www.experts.com/articles/flex-budgets-quick-guide-for-hospitals-by-sahel-shwayhat