Cost Management & Financial Performance December 14-15, 2015

Time to Eat Your Veggies

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

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

Types of Costs

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.

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

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

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.

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

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

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

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 14

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 $50,000 Fixed Expenses $ 100 margin = 500 Visits per Period (Breakeven) 15

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

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

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

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

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

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?

Organizational Planning, Budgeting and Control 22

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

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

Bedford Clinic Variance Analysis 25

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

Bedford Clinic Flexible Budget Report 27

Bedford Clinic Flexible Variance Report 28

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