Cost Management & Financial Performance

December 14-15, 2015

Time to Eat Your Veggies

Financial Reporting vs. Managerial Reporting

Financial Reporting

1. Externally focused

2. Must follow externally imposed rules (GAAP)

3. Consolidated financial information about the organization as a whole.

4. Historical orientation

5. Used to assess the overall financial health of the organization at a point in time

Cost Reporting

1. Internally focused

2. No mandatory rules

3. Unconsolidated financial and nonfinancial information about various components of the organization

4. Focus on the future

5. Used for planning and control

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Class Learning Objectives

1. Understand how Children’s costs are classified, allocated and reported, and which costs you can control and which ones you cannot.

3. Learn how breakeven and contribution margin analysis can be used to manage departmental profitability, and how it will change under value-based payments.

4. Learn how flexible budgeting can be used to provide clear, actionable explanations for the causes of budget variances.

5. Understand the integration of cost management with performance improvement and mission effectiveness.

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Types of Costs

How Departmental Costs are Classified

All Children’s departmental costs are classified along two dimensions:

1. Direct or Indirect¨ Direct costs are those that are directly traceable to the activities or output of a

particular department. These are costs over which the departmental manager has some degree of control.

¨ Indirect costs are those costs allocated to a department. These are costs over which the departmental manager has no control.

2. Variable, Semi-Variable or Fixed¨ Variable costs vary in direct proportion to output or services rendered.¨ Semi-Variable costs vary with changes in output but, unlike a variable cost, do not

vary in direct proportion

¨ Fixed costs stay the same as output or service level changes.

Types of Departments

For cost reporting purposes, Children’s has two types departments (centers)

¨ Revenue Centers are those departments that are directly responsible for generating revenues, e.g., delivering billable medical services. Examples include:

cardiology surgery general pediatrics

¨ Service Centers are those departments that perform activities that support the Revenue Centers, but are not responsible for directly generating revenues. Examples include:

facilities management human resources central administration

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Allocating Service Center Costs

¨ In cost reporting, the direct costs of each Children’s service centers must be fully allocated to the revenue centers using the appropriate cost driver.

¨ For the revenue centers, these allocated costs are referred to as indirect costs.

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Facilities Management

Human Resources

CentralAdmin.

Cardiology

Surgery

GeneralPediatrics

Allocating Children’s Service Center Costs

The basis of allocation of any service center’s cost is always arbitrary, and it can vary from one organization to another. For example:

The cost of Facilities Management might be allocated by the amount of space used by each revenue department.

The cost of Human Resources might be allocated by the number of employees in each revenue department.

The cost of Central Administration might be allocated by the payroll of each revenue department.

The choice of allocation basis is made by the Finance Department.

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.

Cost Classification Exercise

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¨ Service centers have only direct costs. Revenue centers have both direct and indirect costs.

¨ The direct costs of both types of centers can further be classified as variable, semi-variable or fixed.

Service Center Costs Revenue Center Costs

Direct¨ Variable¨ Semi-Variable¨ Fixed

Direct¨ Variable¨ Semi-Variable¨ Fixed

Indirect

Children’s Revenue Center Costs by Patient TypeJanuary through June, 2015

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GrossReven

ue($ 000)

Net Reven

ue($ 000)

DirectCosts

Direct Margin

Indirect Costs

Net Income

CHPG $15,012 $4,911 $9,738 ($4,827) $9,216 ($14,042)

Day Surgery $109,238 $37,319 $23,728 $13,951 $11,682 $1,909

Emergency $142,463 $56,521 $20,283 $36,238 $11,123 $25,115

Home Care $3,069 $939 $3,651 ($2,713) $1,294 ($4,007)

Inpatient $726,935 $329,419 $154,032 $175,387 $77,763 $97,623

Observation $135,705 $52,062 $22,957 $29,104 $11,949 $17,155

Outpatient $268,319 $104,072 $91,837 $12,235 $56,450 ($44,215)

All Patients $1,400,741 $585,243 $326,228 $259,015 $179,477 $79,538

Children’s Revenue Center Costs by Financial ClassJanuary through June, 2015

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GrossReven

ue($

000)

Net Reven

ue($

000)

DirectCosts

Direct Margi

n

Indirect

Costs

Net Income

Commercial $464,815 $281,058 $104,536 $176,523 $58,184 $118,338

Medicaid $346,514 $99,357 $88,614 $10,744 $47,669 ($36,925)

Medicaid Managed Care

$553,975 $199,437 $118,757 $80,681 $66,287 $14,394

Other $55,438 $5,389 $14,322 ($8,932) $7,337 ($16,269)

Total $1,400,741 $585,243 $326,228 $259,015 $179,477 $79,538

Breakeven Analysis

Breakeven Analysis

Breakeven analysis is the study of the effects output volume has on revenue, expenses, and net income. It assumes that:

expenses can be categorized into fixed, variable, and semi-variable categories;

the behavior of revenues and expenses are (reasonably) linear over some relevant range;

no expected changes in operating efficiency or productivity; and

case mix remains (relatively) constant.

The Breakeven Point is the level of output at which revenues equal expenses and net income is zero

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Breakeven Scenario Per Unit Percentage

of Collections

Collections per Visit $ 150 100%Variable Cost per Visit 50 33%Collection less Variable cost $ 100 67%

Monthly Fixed Expenses rent $ 7,000 salaries 40,500 depreciation 2,500

Total Fixed Expenses $ 50,000

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$50,000 Fixed Expenses $ 100 margin

= 500 Visits per Period (Breakeven)

Breakeven Graph

0 100 200 300 400 500 600 700 800 900 1000$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

$160,000

Fixed Ex-penses

Collectio

ns

Office Visits

Collections $150

Variable Exp. 50

Margin $ 100

Fixed Exp. $ 50,000

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Breakeven Graph

0 100 200 300 400 500 600 700 800 900 1000$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

$160,000

Fixed Ex-penses

Collectio

ns

Office Visits

Collections $150

Variable Exp. 50

Margin $ 100

Fixed Exp. $ 50,000

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General HospitalBreakeven Analysis

General Hospital is a small, not-for-profit acute care facility with the following cost structure for its inpatient services:

Fixed Cost $12,000,000 Variable Cost per Inpatient Day $800 Revenue per Inpatient Day $1,200

The hospital expects to have a patient load of 35,000 inpatient days next year.

1. What is the hospital’s expected net profit? What is its breakeven point?

2. Assuming the hospital has upside flexibility on its charges, how much would it have to raise its daily rate to earn a profit of $3 million?

3. Assuming it has no charge flexibility, how much more volume would be required to earn a profit of $3 million?

4. Assume 20% of the hospital’s inpatient days come from a managed care plan that wants a 15% discount from its current posted charges. Should the hospital agree to the proposal?

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Fee for Service Breakeven

Service Volume

$Revenue

Total Costs

Fixed Costs

Breakeven

Profit

019

Episode Based Payment Breakeven

Service Volume

$

Revenue

Total Costs

Fixed Costs

Breakeven

Profit

0

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Carlsbad Home CareCutting Costs vs. Improving Productivity

1. Draw your own conclusions about which costs are variable, semi- variable and fixed.

2. What is Carlsbad’s break-even number of visits?

3. What are your recommendations to the Director?

Organizational Planning, Budgeting

and Control

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Planning and Control ToolkitLong Term

Mission. The organization’s business purpose and focus; why it exists. What it provides, to whom, and how.

Vision. What the organization is expected to achieve or become in the mid- or long-term future.

Strategic Plan. The strategies and tactics by which the organization will achieve its business purpose.

Intermediate Term

Operating Plan. Detailed plan for meeting the organization’s objectives over the next 3-5 years. The first year of the operating plan is frequently the annual operating budget.

Capital Budget. A projection of the organization’s capital investment needs and how those needs will be financed.

Short Term

Cash Budget. A forecast of cash receipts and disbursements over a 6-12 month period of time.

Operating Budget. A detailed projection of estimated revenues, expenses and net income over a one year period.

Variance Analysis. An examination and interpretation of the difference between actual and budgeted or targeted levels of performance.

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The Operating Budget

Focuses on projected profitability (P&L)

Top down vs. bottom up

Revenue Budgetcase mix and volumereimbursementnon-patient revenues

Expense Budgetdirect vs. indirectfixed vs. variable

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Bedford Clinic Variance Analysis

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Budget

REVENUES

Number of visits 21,000

Reimbursement $100

Total Revenues $2,100,000

EXPENSES

Variable Expenses

Supplies $315,000

Labor $935,000

Fixed Expenses

Overhead $500,000

Total Expenses $1,750,000

Profit (Loss) $350,000

Actual Variance

22,000 1,000

$105 $5

$2,310,000 $210,000

$345,000 ($30,000)

$1,105,000 ($170,000)

$500,000 $0

$1,950,000 ($200,000)

$360,000 $10,000

Bedford Clinic What You Would Like to Know

How much of the $10,000 (favorable) variance was due to the variance in:

1. patient volume

2. reimbursement

3. cost of supplies

4. cost of labor

Bedford Clinic Flexible Budget Report

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Budget Actual Variance

REVENUES

Number of visits 21,000 22,000 1,000

Reimbursement $100 $105 $5

Total Revenues $2,100,000 $2,310,000 $210,000

EXPENSES

Variable Expenses

Supplies $315,000 $345,000 ($30,000)

Labor $935,000 $1,105,000 ($170,000)

Fixed Expenses

Overhead $500,000 $500,000 $0

Total Expenses $1,750,000 $1,950,000 ($200,000)

Profit (Loss) $350,000 $360,000 $10,000

PER VISIT

Reimbursement $100.00 $105.00 $5.00

Supply Expense $15.00 $15.68 ($0.68)

Labor Expense $44.52 $50.23 ($5.70)

Contribution Margin $40.48 $39.09 ($1.39)

Bedford Clinic Flexible Variance Report

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Volume Variance

Actual - Budgeted # Visits 1000

Budgeted Contribution Margin $40.48

Volume Variance $40,476

Pricing Variance

Actual - Budgeted Price per Visit $5.00

Actual # Visits 22,000

Pricing Variance $110,000

Supply Expense Variance

Budgeted-Actual Exp. per Visit ($0.68)

Actual # Visits 22,000

Supply Variance ($15,000)

Labor Expense Variance

Budgeted - Actual Exp. per Visit ($5.70) Acutal # Visit 22,000 Labor Variance ($125,476)

Total Variance $10,000

Lessons Learned on the Front Line

All costs (direct, indirect, fixed, variable,) eventually have to be paid, and always from revenue producing departments. Benchmark all departments, particularly non-revenue ones.

Most organizational knowledge is on the front line, at the patient interface, so operational budgeting is more effective if done “bottom-up.”

Most budgeting errors are in overestimating revenues. Cost estimates are likely to be more accurate. Carefully review revenue assumptions and require realistic action plans for achieving all revenue projections.

Don’t negotiate pricing (contracting, discounting, etc.) unless your know your true total cost for delivering the service.

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