Managing Costs and Revenues

Nancy Shanks, PhDSuzanne Discenza, PhD

Ralph Charlip, FACHE, FAAMA

What is Financial Management?It is the process of:

Providing oversight of the healthcare organization’s day-to-day financial operations

Planning the organization’s long-range financial direction

Increasing the organization’s revenues and decreasing its costs

Major Objectives of Financial Management

Generate a reasonable net income.

Set prices for services.

Facilitate relationships and manage contracts

with third party payers.

Record and analyze cost information.

Prepare, audit, and disseminate the

organization’s financial reports.

Invest in long-term capital assets.

Major Objectives Continued

Ensure that payroll is covered and that suppliers

are paid.

Protect the organization’s tax status.

Respond to government regulators, external

auditors, accrediting agencies, and quality

consultants.

Control financial risk to the organization.

Tax Status of Healthcare Organizations For-Profit, Investor-owned

Serve private interests and pay taxes.

Goal is to maximize profits for the owner.

Not-for-Profit

Serve public interests and are tax-exempt.

Goal is to provide community benefit and

optimal patient care (including the indigent).

2 types: 1. Business-oriented (private)

2. Government-owned

Financial Governance – In Order of Responsibility:

Governing Body, or Board of Directors

Chief Executive Officer (CEO)

Chief Financial Officer (CFO)

Controller

Treasurer

Internal Auditor

All Managers in the Healthcare Organization

Managing Reimbursements from Third Party Payers

Methods Used by Private Health Plans

Retrospective – determined after service delivery

Charges

Charges Minus a Discount

Cost Plus

Prospective – determined before service delivery

Per Diem

Per Diagnosis

Capitation

Managing Reimbursements Cont. Methods Used by Medicare and

MedicaidReimbursements to Hospitals

Contractual AllowancesDiagnosis-Related Groups

(DRGs) Case Mix, or Patient Mix

Reimbursements to PhysiciansResource-Based Relative Value

System (RBRVS)Capitated managed care plans

Reimbursements to Other Providers

Reimbursements by The Uninsured

Those without insurance are billed for full charges

Has resulted in the rise of personal bankruptcies,

due to inability to pay such large sums of money.

Uncompensated Care – 2 Major Types:

*Bad Debt – no payment received for billed

services; written off by the organization.

*Charity Care – organization provides care,

knowing the patient will be unable to pay.

Controlling Costs

Importance of Cost Accounting in Providing

Managers with Information:

To estimate and manage their costs.

To set charges and analyze profits.

To make decisions regarding adding, enhancing,

or eliminating services.

To provide methods for classifying, allocating, and

determining product costs.

Classifying Costs – Frequently-Utilized Methods By Behavior

Fixed costs

Variable costs By Traceability

Direct costs

Indirect costs

Full costs By Decision Making Capability

Controllable costs

Uncontrollable costs

Cost Allocation Cost allocation involves the determination of

the total cost of producing a healthcare service through assigning costs from non-revenue-producing departments into revenue-producing departments.

Purpose is to:Ensure patients are paying only for services and products received.

Separate costs at the unit-of-service level to allow managers to measure changes in intensity & case mix, and to identify inefficient functions.

Determining Product Costs

More recent methods for determining product

costs tend to cross department lines of

responsibility.

Activity-based costing, for example, is more

accurate than prior methods of cost allocation,

because costs are determined on the basis of cost

drivers, the activities involved in generating

a unit of service.

Setting Charges

Charges are “published prices” (Pam Pohly).

However, there is a wide disparity between

published prices and contract prices, since most

third party payers negotiate lower rates with

healthcare providers.

Prices, on the other hand, involve the money

actually spent, involving perceived value of the

services and the other opportunities foregone by

consumers to acquire the services.

Determinants of Setting Charges/Prices Consider legal and regulatory issues. Establish pricing goals and objectives. Estimate the economic market conditions

involving supply and demand. Estimate costs and the break-even point. Consider policies of third party payers. Consider other competitors in the market. Consider the effects of over- and under-pricing. Take into consideration allowable costs. Utilize pricing tactics.

Managing Working Capital Definition: “Total current assets,” or short-term

assets that can be converted to cash in one year

(Nowicki), versus “current assets plus current

liabilities” (McLean).

Primary Sources of Working Capital:

*Permanent working capital

*Net income, or profits

*Temporary working capital, including equity,

or net assets; short-term debt, or loans; and

trade credit from delayed payments to vendors.

Purposes of Working Capital Management

To increase revenues & reduce expenses by:Making capital assets (buildings, etc.) productive by managing current assets (labor, etc.).Conserving cash by cutting financing costs to take advantage of short-term investments.Managing cash flow or amount of inflows & outflows.Managing the liquidity of the organization.

To enhance “good will” toward the organization:By paying vendors and employees on time.By demonstrating to lenders that the organization is

“credit worthy.” To undertake changes that add value to the

organization.

Managing Accounts Receivable Definition: Current assets, created in the course of

doing business, consisting of revenues recognized,

but not yet collected as cash (McLean). AR generally provide no interest, and their

collection become less likely as time passes. AR comprise about 75 % of a healthcare provider’s

current assets (Zelman et al.). Having large dollar amounts in AR means lost

opportunities for other investments. There are other costs associated with AR, including

carrying costs, delinquency costs, & collection costs.

Managing Accounts Receivable Continued

The primary goal of managing AR is to reduce the collection period, or “days in AR.”

There is interdependence among almost all departments of a healthcare organization in reduction in the AR collection period.

Healthcare providers often need to receive cash advances on outstanding AR to continue operations. 2 methods used to finance AR:

1. Factoring receivables – selling at a discount.2. Pledging receivables as collateral to negotiate a line of credit to cover temporary cash shortfalls.

Managing Materials and Inventory Importance of Materials Management:• Delivery of appropriate patient care.• Provision of cost control. A non-productive asset,

inventory loses value over time.• Improvement of the organization’s bottom line,

through best pricing and reducing over-utilization. Methods for Stocking Inventory:Just-in-time (JIT) – Products are literally delivered to

the provider “just in time” for use; decreases holding costs and obsolescence.

ABC Inventory Method – Each supply item is assigned to one of 3 groups & is thus monitored according to cost.

Basic Tenets of Materials Management

Develop close relationships with distributors, who

control availability, pricing, and receiving schedule. Understand the costs of inventory, including

purchasing costs, ordering costs, carrying costs, stock-

out costs, and overstock costs. Calculate the economic order quantity (EOQ) and

reorder point (RP) to know the right quantity of items

to be ordered at the right time. Create an in-service training program for the

management team regarding procedures for requesting

purchase orders, negotiations with vendors, etc.

Managing Budgets

Definition: The plan for turning the objectives of the organization into a program for earning revenues and controlling expenditures. Involves all managers.

Major Types of Budgets:Operating budget, or cash budget – Annual

budget that is a forecast of cash inflows, outflows, and net lending or borrowing needs.

Expense budget Revenue budgetCapital budget - Plan for expenditures for

long- term assets whose useful life is more than a year.

Capital Budgeting

Basic questions that need to be answered:

Does this asset at least pay for itself?

Does the asset add value to the organization?

Types of items included in Capital Budgets:

Land acquisition

Facility construction, acquisition, renovation

Routine capital equipment used in clinical areas

Information technology infrastructure &

upgrades

Acquisition of staff physicians

Capital Budgets Continued

Wish List submitted to managers and proposals

submitted by managers to Finance Department. Rules Utilized to Make Capital Budgeting

Decisions

Accept/Reject

Capital rationing – Those selected have

highest profitability index.

Non-criteria-based – Safety valve allowing

purchase “no matter what.” Approval by Administration and Governing

Body

Summary

Managing costs and revenues in healthcare

organizations is a complex process involving

understanding of:

The interrelatedness of multiple processes

The interplay of many departments

The importance of external influences

Managers at all levels of the organization are

involved in addressing these functions.