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CHAPTER 7
Managing Financial Operations
Revenue cycle (billing and collections)
Receivables management
Cash and marketable securities
management
Inventory (supply chain) management
Operational monitoring and control
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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Financial Operations
 Financial operations involves the dayto-day oversight of tasks such as billing
and collections (revenue cycle), cash
management, and inventory
management.
 The specifics are highly dependent on
the type of provider (hospital versus
medical practice versus nursing home,
and so on).
 Thus, the focus here is on fundamental
concepts as opposed to details.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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The Revenue Cycle
The revenue cycle is defined as all
activities associated with billing and
collecting for services.
In general, revenue cycle management
should ensure that:
Patients are properly categorized by payer.
Correct and timely billing takes place.
Correct and timely payment is received.
The revenue cycle includes the
activities listed on the next slide.
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The Revenue Cycle (Cont.)
 Before-service activities:
• Insurance verification
• Certification of managed care patients
• Patient financial counseling
 At-service activities:
• Insurance status verification
• Service documentation/claims production
 After-service activities:
• Claims submission
• Third-party follow-up (if needed)
• Denials management
• Payment receipt and posting
 Monitoring and reporting:
• Monitoring
• Review and Improvement
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
7-5
The Revenue Cycle (Cont.)
 In revenue cycle management, each of the
identified activities is closely monitored to
ensure that:
 The correct amount of reimbursement is
collected on each patient.
 Reimbursements are collected as quickly as
possible.
 The costs associated with the revenue cycle
are minimized consistent with rapid and correct
collections.
 Two important keys to good revenue cycle
management are information technology
and electronic claims processing.
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Receivables Management
If a service is provided for cash, the
revenue is immediately received.
If the service is provided on credit, the
revenue is not received until the
receivable is collected.
Receivables management, which falls
under the general umbrella of the
revenue cycle, is extremely important
to healthcare providers.
 Why?
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Accumulation of Receivables
 Suppose Valley Clinic contracts with an
insurer whose patients use $2,000 in
services daily and who pays in 40 days.
 The clinic will accumulate receivables at
a rate of $2,000 per day.
 However, after 40 days, the receivables
balance will stabilize at $80,000:
Receivables = Daily sales × Average collection period
40
=
$2,000 ×
=
$80,000.
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7-8
Cost of Carrying Receivables
 Valley Clinic must pay its expenses (i.e.,
labor and supplies) before it receives its
payment.
 Suppose Valley Clinic uses bank financing
that has an interest rate of 10% to pay its
costs (finance its receivables).
 The annual cost of carrying the receivables
is $8,000:
$80,000 × 0.10 = $8,000.
 What two factors influence the dollar
cost of carrying receivables?
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Monitoring Receivables
 It is important that healthcare managers
continuously monitor the firm’s
receivables to insure that:
 Payment is received promptly
 Receivables quality does not deteriorate
 Monitoring methods include:
 Average collection period (ACP), often called
days in patient accounts receivable
 Aging schedules
 Receivables are monitored both in the
aggregate and by specific payer.
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Cash Management
The goal of cash management is to
hold the minimum amount necessary
to meet liquidity requirements. Why?
The primary cash management
technique is float management:
Acceleration of receipts
Disbursement control
The cost of cash management
initiatives must be balanced by
corresponding
benefits.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
7 – 11
Float Management
 Float is the difference between the cash
amount on the bank’s books and the
amount on the firm’s checkbook.
 Suppose Family Healthcare writes $2,000 in
checks daily. It takes 6 days for these to be
received and clear the banking system, so the
bank balance is $12,000 greater than the
checkbook balance.
 Family Healthcare receives $3,000 in checks
daily which are cleared in 3 days, so the
checkbook is $9,000 greater than the bank.
 Thus, the float is $12,000 – $9,000 = $3,000.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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Acceleration of Receipts
Float is maximized by accelerating
receipts and slowing disbursements.
Some techniques used for receipt
acceleration are:
Deposit checks received daily
Lockboxes
Concentration banking
Automated clearinghouses
Federal Reserve wire system
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Disbursement Control
Disbursement control is the “flip side”
of receipt acceleration.
Some techniques used for disbursement control are:
Payables centralization
Master and zero-balance accounts
Controlled (remote) disbursement
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
7 – 14
Short-Term Securities Management
Businesses hold short-term
(marketable) securities for two
primary reasons:
As an interest earning substitute for
cash.
As a temporary repository for cash being
accumulated to meet a specific need.
In reality, cash and short-term
securities are managed
simultaneously.
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Short-Term Securities (Cont.)
In general, short-term securities are
chosen on the basis of safety.
Protection of principal is primary
Amount of return is secondary
Specific securities used depend on the:
Expected holding period
Size of the business
Some examples are:
Short-term treasury securities
Money market funds
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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Discussion Items
What marketable securities might be
held by a business that:
(1) Keeps $50,000 in reserve to meet
unexpected cash outlays.
(2) Is accumulating $100,000 to make the
next quarterly income tax payment.
(3) Is accumulating $1,000,000 that, along
with new debt financing, will be used to
purchase a MRI system in a year or so.
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Inventory Management
Inventory management, also called
supply chain management or materials
management, is important to providers
because medical supplies are critical to
patient services.
Inventories consist of base stocks plus
safety stocks.
The goal of inventory management is
to meet operational needs at the lowest
cost.
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Inventory Management (Cont.)
Some inventory management
techniques now being used by
providers include:
Just-in-time systems
Stockless systems
Consigned inventory systems
In addition, some providers have
contracts with suppliers that are priced
on the basis of the amount of medical
services provided or even capitated.
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Monitoring Operations
 Healthcare managers must monitor
operations to ensure that the business
operates efficiently and meets
performance goals.
 For the most part, monitoring involves a
set of metrics that measure various
aspects of financial and operational
performance.
 Here we will introduce just a few
commonly used hospital metrics that
focus
on managing operations.
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7 – 20
Outpatient Revenue Percentage
Net outpatient revenue
Outpatient revenue percentage =
x 100.
Total revenue
Measures the percentage of total (net) revenue due to outpatient
services. A high or low value is not necessarily bad—it just measures
the reliance on outpatients (as opposed to inpatients and other patient
sources) as a source of revenue. Of course, if outpatient services are
more profitable than inpatient services, then a higher value would
mean greater overall profitability. Note that the ratio is multiplied by
100 to convert the decimal form to a percentage.
Similar metric: Inpatient revenue percentage
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Medicare Percentage (Inpatient)
Medicare discharges
Medicare percentage =
x 100.
Total discharges
Measures the percentage of discharges due to Medicare patients. In
other words, the hospital’s reliance on Medicare patients. Because
government payers generally are considered to be less generous than
other payers, and because Medicare patients on average have longer
stays than younger patients (and hence higher costs), a high
Medicare percentage is considered a negative indicator. Also, high
reliance on Medicare (and other government insured) patients means
that the hospital will be affected to a greater degree by political rather
than economic decisions.
Similar metrics: Medicaid percentage; managed care percentage.
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Occupancy Rate
Average daily census
Occupancy rate =
x 100 .
Number of beds
Measures inpatient volume as a percentage of the number beds.
The higher the occupancy rate, the better, unless it is so high that the
hospital does not have the capacity to deal with emergency
situations. To raise the occupancy rate, hospitals can (1) increase
admissions, (2) increase length of stay (which makes no sense under
many reimbursement schemes), or (3) decrease the number of beds.
Note that number of beds can be measured either as licensed beds
or staffed beds. Also, note that this measure is sometimes just called
occupancy.
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Length of Stay (LOS)
Total annual patient days
Length of stay =
.
Total discharges
Measures the average number of days that an inpatient stays in the
hospital. Because most reimbursement is independent of length of
stay (LOS), the shorter the LOS, the lower the cost of treatment and
hence the greater the profitability of inpatient services. Note that this
measure is often called average length of stay (ALOS).
Similar metric: Adjusted length of stay (adjusted by the all-patient
case mix index [CMI], which accounts for the differences in patient
diagnoses.
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Price per Discharge
Net inpatient revenue
Net price per discharge =
.

Total discharges
Measures the amount of net revenue per discharge. Because
allowances have been deducted, net price per discharge measures
the actual amount of revenue (reimbursement) per discharge. This
indicator is a measure of the market’s assessment of the value of the
inpatient services as opposed to the hospital’s assessment.
Similar metric: Adjusted price per discharge, which incorporates case
mix and local wage index.
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7 – 25
Cost per Discharge
Total inpatient operating expense
Cost per discharge =
.
Total discharges
Measures the average cost of each inpatient stay. Regardless of the
reimbursement methodology, lower costs of service lead to higher
profitability, all else the same. Note that this ratio can be adjusted for
wage and case mix differentials by multiplying the denominator by
the wage and all-patient case mix indexes.
Similar metric: Adjusted cost per discharge, which incorporates case
mix and local wage index.
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7 – 26
Profit per Discharge
Inpatient revenue  Inpatient operating expenses
Profit per discharge =
.
Total discharges
Measures the amount of profit earned on each inpatient discharge. Low
values (including negative values) can be traced either to high inpatient
costs or low inpatient reimbursement, or both. Obviously, a lack of
inpatient profitability can spell financial trouble for hospitals. However,
lack of inpatient profitability can be offset (in whole or partially) by
outpatient care profits and/or nonpatient care revenues such as
contribution and grants.
Similar metric: Adjusted profit per discharge, which accounts for case mix
and local wage index.
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FTEs per Occupied Bed
Inpatient FTEs
FTEs per occupied bed =
.
Average daily census
Measures the productivity of labor devoted to inpatient services as a
function of the number of patients. Because the provision of inpatient
services is labor intensive, labor productivity plays an important role in
inpatient costs. Of course, in addition to the number of patients, the
intensity of services provided also affects the requirement for labor
resources. Thus, this ratio often is adjusted for case mix differentials
by multiplying the denominator by the all-patient case mix index.
Similar metric: Adjusted FTEs per occupied bed, which accounts for
case mix and local wage index.
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Interpreting the Metrics (Ratios)
A raw metric number, such as an
occupancy rate of 58.0%, is very
difficult to interpret.
Managers use:
Comparative analysis, such as
comparing to the hospital industry
average of 62.3%.
Trend analysis, such as noting that the
last five years occupancy (oldest first)
was 61.1%, 60.7%, 59,7%, 58.8%, and
58.0%.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
7 – 29
Key Performance Indicators
and Dashboards
Key Performance Indicators (KPIs) are
a limited number of operational (and
financial) metrics that measure
performance critical to the success of
an organization.
Dashboards are a way to present an
organization’s KPIs (often as gauges)
that allow managers to quickly
interpret the indicators.
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7 – 30
Dashboard Example
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Conclusion
This concludes our discussion of
Chapter 7 (Managing Financial
Operations).
Although not all concepts were
discussed in class, you are
responsible for all of the material in
the text.
 Do you have any questions?
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
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CHAPTER 6
Planning and Budgeting
The planning process
Budget decisions
Budget types
Operating budget example
Flexible budgeting and variance
analysis
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The Planning Process
 The strategic plan is the foundation of the
planning process. It contains the:
 Mission statement
 Values statement
 Vision statement
 Goals
 Objectives
 The operating, or five-year, plan is the “how
we expect to meet our objectives” portion
of the planning process.
 The planning process takes place more or
less continuously throughout the year.
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Operating (5-Year) Plan Format
Chapter 1: Mission, values, vision, and goals
Chapter 2: Corporate objectives
Chapter 7: Functional area plans
A. Marketing
B. Operations
C. Finance
D. Administration and human resources
E. Facilities
Note that the plan is most detailed for the first year.
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Financial Plan Format
C. Finance
1. Current financial condition analysis
2. Capital investments and financing
a. Capital budget
b. Financing plan
3. Financial operations
a. Overall policy
b. Cash budget
c. Cash and marketable securities management
d. Inventory management
e. Revenue cycle management
f. Short-term financing
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Financial Plan Format (Cont.)
4. Budgeting and control (first year only)
a. Revenue budget
b. Expense budget
c. Operating budget
d. Control procedures
5. Future financial condition analysis
 What are the keys to an effective planning
process?
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Budgeting Basics
Budgets are detailed plans, expressed
in dollar terms, that specify how
resources will be used over some
period of time.
Budgets may be developed and applied
to any level within an organization:
Aggregate
By department
By service line
By contract
By the nature of the expenditure
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6-7
Budgeting Basics (Cont.)
To be effective, budgets must not be
thought of as financial staff tools, but
rather as managerial tools.
Budgets are used for:
Planning
Communication
Control
There are three decisions that must be
made regarding a business’s budgeting
process. (See next 3 slides.)
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Conventional vs. Zero-Based Budgets
Traditionally, health providers have used
the conventional approach to budgeting.
The old budget is the starting point.
Typically, only minor changes are made.
Changes often are applied equally.
In zero-based budgeting, each new
budget is started from scratch.
 What are the advantages and
disadvantages of each approach?
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6-9
Budget Timing
All organizations use annual budgets
to set standards for the coming year.
Most also use quarterly (or more
frequent) budgets to ensure timely
feedback and control.
Not all budget types have to follow the
same timing pattern.
Out-year budgets are more for
planning than for control purposes.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6 – 10
Top-Down vs. Bottom-Up Budgets
 Top-down budgets:
 Begin at the finance department with senior
management guidance.
 Are sent to the departments for review.
 Bottom-up budgets:
 Begin at sub-unit (departmental) level.
 Are reviewed and compiled by the finance
department.
 Are approved by senior management.
 What are the advantages and
disadvantages of each?
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6 – 11
Revenue Budget
Most businesses have a:
Revenue budget
Expense budget
Operating budget
The revenue budget uses volume and
payment data to forecast revenues.
The end result is a revenue forecast:
In the aggregate
By department
By service
By diagnosis (or other clinical basis)
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6 – 12
Expense Budget
The expense budget combines
volume data with detailed resource
utilization data to forecast expenses.
To be most useful, expenses must be
broken down into fixed and variable
components.
Like revenues, expenses must be
forecasted at multiple levels.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6 – 13
Operating Budget
For larger organizations, the
operating budget, which focuses on
projected profitability, combines
information from the revenue and
expense budgets.
Smaller organizations may use a
single operating budget in place of
multiple budget types.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6 – 14
Operating Budget Illustration
Consider the 2012 operating budget of
Carroll Clinic shown on the following
four slides. This budget was created at
the end of 2011.
The budget is divided into four parts:
Volume assumptions
Revenue assumptions
Cost assumptions
Pro forma P&L statement
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6 – 15
2012 Operating Budget (Parts I and II)
I. Volume (Number of Visits)
A. Payer A
B. Payer B
C. Total
9,000
12,000
21,000
II. Reimbursement (Average Payment Per Visit)
A. Payer A
B. Payer B
$100
$ 90
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6 – 16
2012 Operating Budget (Part III)
III. Costs
A. Variable Costs:
Supplies
$
B. Fixed Costs:
Labor
Overhead
$1,035,000
500,000
Total
315,000
$1,535,000
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6 – 17
2012 Operating Budget (Part IV)
IV. Pro Forma P&L Statement
Revenues:
Payer A
Payer B
Total revenues
Variable costs
Fixed costs
Total costs
Projected profit
$
900,000
1,080,000
$1,980,000
$ 315,000
1,535,000
$1,850,000
$ 130,000
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6 – 18
Variance Analysis
A variance is the difference between
actual results and the budgeted
(standard) value.
Variance analysis is a technique
applied to budget data to:
Identify problem areas
Enhance control
 Why is variance analysis so useful to
health services managers?
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6 – 19
Simple Variance Analysis Example
To illustrate variance analysis, we will
use Carroll Clinic’s forecasted 2012
budget presented in Slides 15-17 as the
simple (original) budget.
Assume it is now January 2013, and
the operating results for 2012 have
been compiled. These actual (realized)
results are shown on the next slide
along with a simple variance analysis.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6 – 20
2012 Results (Parts I, II, and III)
Simple
Budget
Actual
Results
I. Volume (Number of Visits)
A.
Payer A
B.
Payer B
C.
Total
9,000
12,000
21,000
10,000
11,500
21,500
1,000
(500)
500
11.1%
(4.2)
2.4
II. Reimbursement (Per Visit)
A.
Payer A
B.
Payer B
$100
$ 90
$105
$ 85
$5
($5)
5.0%
(5.6)
320,000
($ 5,000)
(1.6%)
$1,050,000
550,000
$1,600,000
($15,000)
( 50,000)
($65,000)
(1.4)
(10.0)
(4.2)
III. Costs
A. Variable Costs:
Supplies
B. Fixed Costs:
Labor
Overhead
Total
$
315,000
$1,035,000
500,000
$1,535,000
$
Variance
a
Dollar (Visit) Percentage
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6 – 21
2012 Results (Part IV)
IV. Forecasted P&L Statement
Revenues:
Payer A
Payer B
Total revenues
Variable costs
Fixed costs
Total costs
Profit
Simple
Budget
Actual
Results
$ 900,000
1,080,000
$1,980,000
$ 315,000
1,535,000
$1,850,000
$ 130,000
$1,050,000
977,500
$2,027,500
$ 320,000
1,600,000
$1,920,000
$ 107,500
Variance
a
Dollar (Visit) Percentage
$ 150,000
(102,500)
$ 47,500
($
5,000)
(65,000)
($ 70,000)
($ 22,500)
16.7%
(9.5)
2.4
(1.6)
(4.2)
(3.8)
(17.3)
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6 – 22
Simple Variance Analysis Interpretation
 Profitability was $22,500 (17.3%) below
standard.
 Revenues were $47,500 (2.4%) greater than
expected.
 Costs were $70,000 (3.8%) greater than
expected.
 Higher revenues were due to Payer A,
which had both higher than expected
volume and reimbursement.
 Costs were higher across the board.
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6 – 23
Flexible Variance Analysis
 The variance analysis just performed is a
simple analysis in that it compares actual
results with initial (beginning of year)
assumptions.
 We can glean additional information by
constructing a flexible budget, which is
based on all initial budget assumptions
but then adjusted (flexed) to reflect actual
(realized) volume.
 Now, the variances will reflect financial
performance differences other than those
that stem from volume forecast errors.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6 – 24
2012 Results (Parts I, II, and III)
Flexible
Budget
Actual
Results
I. Volume (Number of Visits)
A.
Payer A
B.
Payer B
C.
Total
10,000
11,500
21,500
10,000
11,500
21,500
II. Reimbursement (Per Visit)
A.
Payer A
B.
Payer B
$100
$ 90
$105
$ 85
$5
($5)
5.0%
(5.6)
320,000
$ 2,500
0.8%
$1,050,000
550,000
$1,600,000
($15,000)
( 50,000)
($65,000)
(1.4)
(10.0)
(4.2)
III. Costs
A. Variable Costs:
Supplies
B. Fixed Costs:
Labor
Overhead
Total
$
322,500
$1,035,000
500,000
$1,535,000
$
Variance
a
Dollar (Visit) Percentage
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6 – 25
2012 Results (Part IV)
IV. Forecasted P&L Statement
Flexible
Budget
Revenues:
Payer A
Payer B
Total revenues
Variable costs
Fixed costs
Total costs
Profit
Actual
Results
$1,000,000 $1,050,000
1,035,000
977,500
$2,035,000 $2,027,500
$ 322,500 $ 320,000
1,535,000
1,600,000
$1,857,500 $1,920,000
$ 177,500 $ 107,500
Variance
a
Dollar (Visit) Percentage
$
50,000
(57,500)
($
7,500)
$
2,500
(65,000)
($ 62,500)
($ 70,000)
5.0%
(5.6)
(0.4)
0.8
(4.2)
(3.4)
(39.4)
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6 – 26
Flexible Variance Analysis Interpretation
 Profitability was $70,000 (39.4%) below
standard.
 Revenues were $7,500 (0.4%) less than
expected.
 But costs were $62,500 (3.4%) greater than
expected.
 When volume is considered, both revenues
and costs were less than expected.
 Management needs to work on:
 Increasing reimbursement rates (especially
with Payer B).
 Controlling costs.
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6 – 27
Variance Analysis Example Recap
 Variance analysis in practice typically is
much more detailed than presented in
this illustration.
 Also, variance analysis is applied to
operating data such as census, labor
hours, number of outpatient visits, and so
on, often on a weekly (or even daily)
basis.
 Now, however, you have the picture of
what it’s all about.
 Is all this work worth it?
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
6 – 28
Conclusion
This concludes our discussion of
Chapter 6 (Planning and Budgeting).
Although not all concepts were
discussed in class, you are
responsible for all of the material in
the text.
 Do you have any questions?
Copyright © 2013 by the Foundation of the American College of Healthcare Executives
5-1
CHAPTER 5
Pricing Decisions and Profit Analysis
Pricing
Decisions
Strategies
Profit analysis
Fee for service
Capitation
Impact of cost structure on risk
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5-2
Introduction
 One use of managerial accounting
information within health services
organizations is to:
 Set the prices (and discounts) on services
offered under charge-based reimbursement.
 Determine the financial impact of services
offered when prices are dictated.
 Identify the lowest feasible price when
prices are negotiated.
 In addition, cost and price information
can be combined to conduct profit
analyses.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5-3
Price Setters Versus Takers
 When a provider has market dominance,
and hence can set its own prices (within
reason), it is said to be a price setter.
 In other situations, providers are price
takers:
 Perfectly competitive markets
 Payer dominance
 Government (take it or leave it) programs
 However, in many situations providers
are neither pure price takers nor price
setters and room for negotiation exists.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5-4
Price Setting Strategies
When a provider is a price setter (or
when negotiation is possible), there
are several theoretical bases upon
which prices can be set.
The two most common are:
Full cost pricing
Marginal cost pricing
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5-5
Price Setting Strategies (Cont.)
Under full cost pricing, prices for a
service are set to cover all costs:
Direct costs (fixed and variable)
Overhead (indirect) costs
Economic costs (profit)
 Under marginal cost pricing, prices for
a service are set to cover incremental,
or marginal, costs. Often, this means
recovering only direct variable costs.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5-6
Discussion Items
Can a provider survive if all services are
priced at marginal cost?
What is cross-subsidization, or price
shifting?
Should marginal cost pricing ever be
used?
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5-7
Target Costing
Target costing is a management strategy
used by price takers.
Under target costing:
Revenues are projected assuming prices as
given in the marketplace.
Required profits are subtracted from
revenues.
The remainder is the target cost level.
 What is the primary benefit of target
costing?
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5-8
Profit (CVP) Analysis
Profit analysis, also called costvolume-profit (CVP) analysis, is a
technique used to assess the effects
of alternative volume assumptions on
costs and profits.
 Why is such information valuable to
health services managers?
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5-9
Profit Analysis Example
Atlanta Clinic has forecasted the
following cost data on the basis of
75,000 expected visits:
Fixed costs
Total variable costs
Total costs
$4,967,462
2,113,500
$7,080,962
Note that the “best guess” volume
forecast defines the base case. Also,
Atlanta’s relevant range is 70,000 to
80,000 visits.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 10
Profit Analysis Example (Cont.)
What is the variable cost rate?
Variable cost rate = Total variable costs
Volume
=
$2,113,500
75,000
= $28.18 per visit.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 11
Profit Analysis Example (Cont.)
What is Atlanta’s cost behavior model?
Total costs = Fixed costs + Total variable costs
= $4,967,462 + ($28.18 x Volume) .
For example, at 70,000 visits:
Total costs = $4,967,462 + ($28.18 x 70,000)
= $4,967,462 + $1,972,600
= $6,940,062.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 12
Profit Analysis Example (Cont.)
Cost/Volume Summary:
Volume = 70,000
TC = $4,967,462 + $1,972,600 = $6,940,062.
Volume = 75,000 (Base Case)
TC = $4,967,462 + $2,113,500 = $7,080,962.
Volume = 80,000
TC = $4,967,462 + $2,254,400 = $7,221,862.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 13
Profit Analysis Example (Cont.)
Now, suppose that the average revenue
per visit is expected to be $100. What
does the clinic’s cost and revenue
structure look like graphically?
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 14
Graphical View
Revenues
and Costs
($)
Total
Revenues
Total
Costs
Fixed
Costs
Volume
(Number of Visits)
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 15
Forecasted Profit and Loss
(P&L) Statement
The forecasted P&L statement uses
cost structure information along with
the revenue forecast and projected
volume to forecast profitability.
Because it is a forecast, it can be
influenced by managerial actions.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 16
Base Case P&L Statement
Total revenues ($100 × 75,000) $7,500,000
Total VC ($28.18 × 75,000)
Total CM ($71.82 × 75,000)
2,113,500
$5,386,500
Fixed costs
4,967,462
Profit
$ 419,038
VC = Variable costs.
CM = Contribution margin.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 17
Contribution Margin
 The contribution margin is defined as the
difference between per visit (per unit)
revenue and the variable cost rate.
 It is the amount of each visit’s revenue
that is available to:
 First cover fixed costs.
 Flow to profit when fixed costs are covered.
 In this illustration, the contribution
margin is $100 – $28.18 = $71.82.
 What is the total contribution margin?
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 18
Breakeven Analysis
Breakeven analysis is performed in
many different finance contexts.
In this example, it is used to determine
the breakeven volume, defined as that
volume needed for an organization (or
service or program) to be financially
self-sufficient.
There are two types of breakeven:
Accounting breakeven (zero profit)
Economic breakeven (with profit)
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 19
Breakeven Analysis (Cont.)
What is the accounting breakeven for
Atlanta Clinic? The easiest way to
answer this question is to convert the
P&L statement into an equation.
P&L Equation (Standard Format)
Total revenues – Total VC FC
= Profit
($100 × V) – ($28.18 × V) – $4,967,462 = $0
$71.82 × V = $4,967,462
V = $4,967,462 ÷ $71.82 = 69,165 visits.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 20
Breakeven Analysis (Cont.)
Note that the P&L equation can be
recast in a contribution margin format.
P&L Equation (Contribution Margin Format)
CM × V = Fixed costs
$71.82 × V = $4,967,462
V = $4,967,462 ÷ $71.82 = 69,165 visits.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 21
Marginal (Incremental) Analysis
Suppose Atlanta Clinic is approached
by a new insurer.
This payer is expected to contribute 5,000
additional visits.
However, it wants a 40 percent discount,
resulting in a revenue of $60 per visit.
At a volume of 80,000, the clinic’s
average cost per visit is $7,221,862 ÷
80,000 = $90.27, so Atlanta’s managers
might be tempted to say “no.”
But, more analysis is required.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 22
Base Case P&L Statement
Total revenues ($100 × 75,000) $7,500,000
Total VC ($28.18 × 75,000)
Total CM ($71.82 × 75,000)
2,113,500
$5,386,500
Fixed costs
4,967,462
Profit
$ 419,038
VC = Variable costs.
CM = Contribution margin.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 23
P&L Statement With Added Volume
Undiscounted revenue ($100 × 75,000)
$7,500,000
Discounted revenue ($60 × 5,000)
300,000
Total revenues ($97.50 × 80,000)
$7,800,000
Total VC ($28.18 × 80,000)
2,254,400
Total CM ($69.32 × 80,000)
$5,545,600
Fixed costs
4,967,462
Profit
$ 578,138
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 24
Marginal (Incremental) Analysis (Cont.)
The marginal cost of each visit is the
variable cost rate of $28.18 per visit.
The marginal revenue on the new
contract is $60 per visit, so the
contribution margin is $60 – $28.18 =
$31.82.
Thus, 5,000 incremental visits would add
5,000 × $31.82 = $159,100 to the bottom
line: $419,038 + $159,100 = $578,138.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 25
Discussion Items
How would the analysis change if the
incremental volume was 10,000 visits,
for a total of 85,000, which is outside
of the relevant range?
At this point, the numerical analysis
indicates that the offer should be
accepted. Considering all the factors
relevant to the decision, what should
Atlanta Clinic’s managers do?
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 26
Profit Analysis Under Capitation
Capitation changes the way in which
profit analysis is conducted
Perhaps the best way to see the effects
of capitation is by graphical analysis.
We will examine two approaches to
graphical analysis:
In terms of utilization (number of visits).
In terms of membership (covered lives).
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 27
Analysis Based on Number of Visits
Revenues
and Costs
($)
Total
Revenues
Total
Costs
Fixed
Costs
Volume
(Number of Visits)
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 28
Analysis Based on Visits (Cont.)
On this graph, the profit and loss areas
are reversed from the fee-for-service
graph.
This “perverse” result occurs because
the contribution margin on a per visit
basis is negative.
$0 – $28.18 = -$28.18.
Each additional visit increases costs with
no increase in revenues.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 29
Analysis Based on Number of Members
Revenues
and Costs
($)
Total
Revenues
Total
Costs
Fixed
Costs
Note: Average utilization is
assumed regardless of volume.
Volume
(Number of Members)
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 30
Analysis Based on Members (Cont.)
Now, the profit and loss areas are the
same as on the fee-for-service graph.
On a per member basis, the
contribution margin is positive.
Each additional member contributes
positively to profits.
If per member annual revenue is $400 per
member and variable costs (based on 4
visits) is 4 x $28.18 = $112.72 per year, the
contribution margin is $400 – $112.72 =
$287.28.
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 31
Discussion Items
What do the graphs tell managers
about the importance of utilization
management:
Under FFS reimbursement?
Under capitation?
What do the graphs tell about the
importance of the number of members
under capitation?
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 32
The Impact of Cost Structure on Risk
If reimbursement is tied exclusively to
volume (FFS), then the provider’s
financial risk is minimized if all costs
are variable.
If reimbursement is exclusively
capitated, then the provider’s financial
risk is minimized if all costs are fixed.
To illustrate, consider Atlanta Clinic
(assuming an unlimited relevant range).
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 33
Graphical Analysis under FFS
Revenues
and Costs
($)
Total
Revenues
Total
Total
VCs = Costs
Volume
(Number of Visits)
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 34
Graphical Analysis under Capitation
Revenues
and Costs
($)
Total
Revenues
Fixed
Total
Costs = Costs
Volume
(Number of Visits)
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 35
Discussion Item
What are the implications of the
previous two slides for managerial
decision making?
Copyright 2013 by the Foundation of the American College of Healthcare Executives
5 – 36
Conclusion
This concludes our discussion of
Chapter 5 (Pricing Decisions and
Profit Analysis).
Although not all concepts were
discussed in class, you are
responsible for all of the material in
the text.
 Do you have any questions?
Copyright 2013 by the Foundation of the American College of Healthcare Executives
Copyright  2013 by FACHE
6/15/12
Case 4
Better Care Clinic
(Breakeven Analysis)
Fairbanks Memorial Hospital, an acute care hospital with 300 beds and 160
staff physicians, is one of 75 hospitals owned and operated by Health
Services of America, a for-profit, publicly owned company. Although there are
two other acute care hospitals serving the same general population, Fairbanks
historically has been highly profitable because of its well-appointed
facilities, fine medical staff, and reputation for quality care. In addition
to inpatient services, Fairbanks operates an emergency room within the
hospital complex and a stand-alone walk-in clinic, the Better Care Clinic,
located about two miles from the hospital.
Todd Greene, Fairbanks’s chief executive officer (CEO), is concerned about
Better Care Clinic’s financial performance. About ten years ago, all three
area hospitals jumped onto the walk-in-clinic bandwagon, and within a short
time, there were five such clinics scattered around the city. Now, only three
are left, and none of them appears to be a big money maker. Todd wonders if
Fairbanks should continue to operate its clinic or close it down.
The clinic is currently handling a patient load of 45 visits per day, but it
has the physical capacity to handle more visits–up to 60 a day. Todd has
asked Jane Adams, Fairbanks’s chief financial officer, to look into the whole
matter of the walk-in clinic. In their meeting, Todd stated that he
visualizes two potential outcomes for the clinic: (1) the clinic could be
closed or (2) the clinic could continue to operate as is.
As a starting point for the analysis, Jane has collected the most recent
historical financial and operating data for the clinic, which are summarized
in Table 1. In assessing the historical data, Jane noted that one competing
clinic had recently (December 2012) closed its doors. Furthermore, a review
of several years of financial data revealed that the Fairbanks clinic does
not have a pronounced seasonal utilization pattern.
Next, Jane met several times with the clinic’s director. The primary purpose
of the meetings was to estimate the additional costs that would have to be
borne if clinic volume rose above the current January/February average level
of 45 visits per day. Any incremental volume would require additional
expenditures for administrative and medical supplies, estimated to be $4.00
per patient visit for medical supplies, such as tongue blades, rubber gloves,
bandages, and so on, and $1.00 per patient visit for administrative supplies,
such as file folders and clinical record sheets.
1
Although the clinic has the physical capacity to handle 60 visits per day, it
does not have staffing to support that volume. In fact, if the number of
visits increased by 11 per day, another part-time nurse and physician would
have to be added to the clinic’s staff. The incremental costs associated with
increased volume are summarized in Table 2.
Jane also learned that the building is leased on a long-term basis. Fairbanks
could cancel the lease, but the lease contract calls for a cancellation
penalty of three months rent, or $37,500, at the current lease rate. In
addition, Jane was startled to read in the newspaper that Baptist Hospital,
Fairbanks’s major competitor, had just bought the city’s largest primary care
group practice, and Baptist’s CEO was quoted as saying that more group
practice acquisitions are planned. Jane wondered whether Baptist’s actions
should influence the decision regarding the clinic’s fate.
Finally, in earlier conversations, Todd also wondered if the clinic could
“inflate” its way to profitability; that is, if volume remained at its
current level, could the clinic be expected to become profitable in, say,
five years, solely because of inflationary increases in revenues? Overall,
Jane must consider all relevant factors–both quantitative and qualitative-and come up with a reasonable recommendation regarding the future of the
clinic.
Table 1
Better Care Clinic
Historical Financial Data
Daily Averages
CY 2012 Jan/Feb13
Number of visits
41
45
Net revenue
$1,524
$1,845
Salaries and wages
Physician fees
Malpractice insurance
Travel and education
General insurance
Utilities
Equipment leases
Building lease
Other operating expenses
Total operating expenses
$
428
533
87
15
22
41
4
400
288
$1,818
$
451
600
107
0
28
36
5
417
300
$1,944
Net profit (loss)
($
($
2
294)
99)
Table 2
Better Care Clinic
Incremental Cost Data
Variable Costs:
Medical supplies
Administrative supplies
Total variable costs
$4.00 per visit
1.00
$5.00 per visit
Semifixed Costs:
Salaries and wages
Physician fees
Total daily semifixed costs
$ 100
267
$ 367
Note: The semifixed costs are daily costs that apply when volume increases by
11 visits above the current level of 45. However, the physical capacity of
the clinic is only 60 visits per day.
QUESTIONS
1. Using the historical data as a guide, construct a pro forma (forecasted)
profit and loss statement for the clinic’s average day for all of 2013
assuming the status quo. With no change in volume (utilization), is the
clinic projected to make a profit?
2. How many additional daily visits must be generated to break even?
3. Thus far, the analysis has considered the clinic’s near-term
profitability, that is, an average day in 2013. Redo the forecasted profit
and loss statement developed in Question 1 for an average day in 2018,
five years hence, assuming that volume stays constant (does not increase).
(Hint: You must consider likely changes in revenues and costs due to
inflation and other factors. The idea here is to see if the clinic can
“inflate” its way to profitability even if volume remains at its current
level.)
4. Suppose you just found out that the $3,215 monthly malpractice insurance
charge is based on an accounting allocation scheme which divides the
hospital’s total annual malpractice insurance costs by the total annual
number of inpatient days and outpatient visits to obtain a per episode
charge. Then, the per episode value is multiplied by each department’s
projected number of patient days or outpatient visits to obtain each
department’s malpractice cost allocation. What impact does this allocation
scheme have on the clinic’s true (cash) profitability? (No calculations
are necessary.)
5. Does the clinic have any value to the hospital beyond that considered by
the numerical analysis just conducted? Do the actions by Baptist Hospital
have any bearing on the final decision regarding the clinic?
6. What is your final recommendation concerning the future of the walk-in
clinic?
3
Assignment: Better Care Clinic Case Study Instructions
Analyzing the cost structure and performing a breakeven analysis, as
well as making recommendations based on the results of these
analyses, are important skills in health care financial accounting. This
case study assignment is designed to give you practice in developing
these skills and justifying recommendations based on them.
Description
This case study will be based on the Better Care Clinic Case Study.
Read the case study before beginning, then write a report which is
organized into the following sections:
Section 1: Overview of the company’s current situation.
•
•
Analyze the current financial situation: Complete an analysis of the
clinic’s current operations required to achieve breakeven as well
as targeted profitability percentages. Use the case questions as a
foundation to address this requirement.
Identify significant current problems and issues: State clearly and
succinctly without repeating the facts of the case unless necessary
for emphasis.
Section 2: Analysis and Evaluation
Analyze the market comparison with other external forces as a part of
the competitive landscape:
•
•
Identify and discuss the financial impact on the clinic with
competitive forces as well as other downstream impacts
Identify the potential challenges with the increased competition
Analyze the Internal Environment:
•
•
Prepare the clinic’s analysis for breakeven along with the targeted
profitability. Use the case questions as a foundation to address this
requirement.
Identify and discuss the clinic’s keys to success and measurement
tools and timelines.
Section 3: Recommendations and Action Plan
Make a set of definite recommendations based on the analysis. There is
more on this in the “Guide for Case Analysis” page in this module.
•
•
•
Identify the financial objectives associated with your
recommendations
State how the recommendations solve the problems and issues
identified in Section 1.
State how the recommendations fit with the current financial
capabilities as well as other benefits to the decision.
Section 4: Appendices
•
•
Financial information: Analysis in tabular format with the targeted
profitability
Key Success Factors and Timelines
Attachments must be analyzed, summarized, and conclusions drawn
within the body of the report. Do not include any attachment that you do
not analyze, summarize, and provide conclusions for, especially articles
and reams of financial information. Remember to be succinct, concise,
and summarized. Place appendices in the order of appearance of
analysis and discussion. For additional guidance on how to prepare this
report please refer to the “Guidelines for Case Analysis” link (located in
the Activities page).
Format
Your report should be about four to six pages (1,000-1,500 words) in length, and no
more than eight pages (2,000 words), not including appendices. For formatting, double
space the report. Use ¾- to 1-inch margins, and use a standard 10- to 12-point font.
Use headings and subheadings according to APA style guidelines
(see https://owl.english.purdue.edu/owl/resource/560/16/ for reference). Submit your
report as a Word document to the assignment submission folder.

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