1. Cost Management & Financial Performance December 14-15, 2015

2. Time to Eat Your Veggies

3. Financial Reporting vs. Managerial Reporting
Externally focused
Must follow externally imposed rules (GAAP)
Consolidated financial information about the organization as a whole.
Historical orientation
Used to assess the overall financial health of the organization at a point in time
Cost Reporting
Internally focused
No mandatory rules
Unconsolidated financial and nonfinancial information about various components of the organization
Focus on the future
Used for planning and control 3

4. Class Learning Objectives
Understand how Children’s costs are classified, allocated and reported, and which costs you can control and which ones you cannot.
Learn how breakeven and contribution margin analysis can be used to manage departmental profitability, and how it will change under value-based payments.
Learn how flexible budgeting can be used to provide clear, actionable explanations for the causes of budget variances.
Understand the integration of cost management with performance improvement and mission effectiveness. 4

5. Types of Costs

6. How Departmental Costs are Classified
All Children’s departmental costs are classified along two dimensions:
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.
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.

7. 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 7

8. 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.
Facilities
Management
Cardiology
Human
Resources
Surgery
Central
Admin.
General
Pediatrics

9. 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.

10. Cost Classification Exercise
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
Indirect 10

11. Children’s Revenue Center Costs by Patient Type January through June, 2015
Gross
Revenue
($ 000)
Net
Direct
Costs
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

12. Children’s Revenue Center Costs by Financial Class January through June, 2015
Gross
Revenue
($ 000)
Net
Direct
Costs
Direct Margin
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)
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

13. Breakeven Analysis

14. 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 14

15. Breakeven Scenario Per Unit Percentage of Collections
Collections per Visit $ %
Variable Cost per Visit %
Collection less Variable cost $ %
Monthly Fixed Expenses
rent $ 7,000
salaries ,500
depreciation ,500
Total Fixed Expenses $ 50,000
$50,000 Fixed Expenses $ 100 margin
= 500 Visits per Period (Breakeven) 15

16. Breakeven Graph Collections $150 Collections Variable Exp. 50
Margin $ 100
Fixed Exp. $ 50,000
Collections
Office Visits 16

17. Breakeven Graph Collections $150 Collections Variable Exp. 50
Margin $ 100
Fixed Exp. $ 50,000
Collections
Office Visits 17

18. General Hospital Breakeven 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.
What is the hospital’s expected net profit? What is its breakeven point?
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?
Assuming it has no charge flexibility, how much more volume would be required to earn a profit of $3 million?
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? 18

19. Fee for Service Breakeven
Revenue $
Profit
Total Costs
Fixed Costs
Breakeven
Service Volume 19

20. Episode Based Payment Breakeven$
Total Costs
Revenue
Profit
Fixed Costs
Breakeven
Service Volume 20

21. Carlsbad Home Care Cutting Costs vs. Improving Productivity
Draw your own conclusions about which costs are variable, semi- variable and fixed.
What is Carlsbad’s break-even number of visits?
What are your recommendations to the Director?

22. Organizational Planning, Budgeting and Control22

23. Planning and Control Toolkit
Long 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. 23

24. The Operating Budget Focuses on projected profitability (P&L)
Top down vs. bottom up
Revenue Budget
case mix and volume
reimbursement
non-patient revenues
Expense Budget
direct vs. indirect
fixed vs. variable 24

25. Bedford Clinic Variance Analysis25

26. Bedford Clinic What You Would Like to Know
How much of the $10,000 (favorable) variance was due to the variance in:
patient volume
reimbursement
cost of supplies
cost of labor

27. Bedford Clinic Flexible Budget Report27

28. Bedford Clinic Flexible Variance Report28

29. 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. 29