Category: Flex Budget

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.

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.

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

All well run businesses use data to drive their decisions. The higher the stakes, the more accuracy they demand from their data. Hospitals are businesses, even not-for-profit ones, and should conduct their operations like any other business.

The area where hospitals lag far behind other businesses is in cost accounting. Most hospitals simply don’t know for sure how much the cost of care is for a patient encounter (i.e., visit), or an entire service line. They have an idea, but that’s not nearly good enough for the purposes of expanding (or shrinking) a service line or setting prices.

This article makes the case that hospitals can switch to a more accurate cost accounting methodology, and it does not have to cost a lot of money.

Healthcare, in general, is an extremely complex environment with many variables. Providing care to patients is not like running a manufacturing or service business. It is often unpredictable. Two patients with the same symptoms may have two different underlying conditions. Similarly, two patients with the same condition, may respond differently to the same treatment. This results in situations where two patients sharing the same room may cost the hospital different amounts because of their unique resource utilization.

Hospitals do have good cost data, at the aggregate level. Like other businesses, they know exactly what hits their general ledger (GL). It is the process of assigning the costs from the GL to the patient encounters that can be challenging.

Most hospitals adopt a method called ratio of cost-to-charge (RCC) cost accounting. They have the aggregate costs in the GL and charges from their billing system, so they calculate a ratio that they subsequently apply to estimate costs for sub-populations.

The description of RCC above is oversimplified, but it is essentially a top down approach which assumes (often wrongly) that markups are uniform. From the proverbial 30,000 ft view, the cost estimates look good, but as you drop to a few hundred feet view, the costs may look “out of whack”.

A far better cost accounting methodology is the activity-based costing (ABC) method. ABC relies on relative value units (RVUs) to allocate cost center GL expenses to the individual charge codes within that cost center. A patient’s encounter is then costed by adding the costs of the various charges (i.e., activity) incurred by that patient.

Although activity-based cost accounting is more accurate in allocating expenses to encounters and service lines, in 2016, only 29% of hospitals (source: hfma), used that method. What explains that? There are many reasons, including:

1. It is time consuming. All charge codes would need to be assigned RVUs, and all GL accounts and position codes would need to be assigned cost types.
2. The decision support systems that do all the data crunching can be prohibitively expensive, often in the $100,000s of dollars.
3. Many executive decision makers are unaware that there are more accurate cost accounting methodologies. Historically, their cost data may not have been an issue.

Perhaps those executives had been right, at least in the past. After all, no one would want to spend $100,000s of dollars and numerous staff hours to “refine” their calculations when things were working “just fine”. Moving forward, however, they can no longer afford to ignore the potential discrepancies between their calculated costs, and reality.

Healthcare consumers (i.e., patients) are savvier that ever. As insurance companies shift more of their expenses to patients (in the form of deductibles and coinsurance), patients start to shop around for the best prices. A hospital could price itself out of a market simply because it relied on inaccurate cost estimates.

So, what can hospitals do to switch from RCC to ABC accounting? Large hospitals that can afford to purchase a decision support system with ABC accounting functionality should do so. Having the resources to get the most accurate cost data but not acting upon it would be unfortunate, especially since market forces may divert its business elsewhere.

Smaller hospitals, on the other hand, may be able to do the calculations outside of their DSS system. The math is relatively easy, and the calculations can be performed in Microsoft products. Data extracts can be pulled into SQL, Access, and/or Excel to calculate the costs, which can either remain in their database, or be pulled back into the DSS, if the system permits that.

There is no reason for smaller hospitals to continue using rough guesstimates. Today’s desktop computers are very powerful and can easily crunch the numbers. It just takes a little bit of outside the box thinking.

In addition to improved cost accuracy, ABC cost accounting allows hospitals to do flex budgeting, which is the subject of my next article.

For brevity purposes, the article has not addressed the differences between direct and indirect costs, but, in a nutshell, the ABC method can be applied to both. Most hospitals rely mainly on contribution margin analysis (net revenue minus direct costs) when evaluating a service line, because indirect cost allocation is subjective.

If you are interested in switching to the ABC cost accounting method, please email me at ELYanalytics@Outlook.com, or call 860-580-5177.

This article first appeared on Experts.com

https://www.experts.com/articles/hospital-cost-accounting-million-dollar-decisions-guesstimates-by-sahel-shwayhat