2. MANAGING COSTS AND REVENUES
Chapter 10
MANAGING COSTS AND REVENUES

3. 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 (both internal and external)
Increasing the organization’s revenues and decreasing its costs

4. 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.

5. Major Objectives (cont’d)
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.

6. Tax Status of Healthcare Organizations
For-Profit, Investor-owned
Serve private interests and pay taxes.
Goal is to maximize profits for the owner.
Must also serve the community.
Not-for-Profit
Serve public interests and are tax-exempt.
Goal is to provide community benefit and optimal patient care (including the indigent)
Two types: Business-oriented (private), and government-owned
Must also turn a profit for sustainability

7. For-Profit Attributes
Serve private interests.
Pay state and federal income tax.
May participate in political campaigns.
Motivated by profit.
Have a limited obligation to provide indigent care.
Able to issue stock to raise capital.

8. Not-For-Profit Attributes
Exempt from taxes.
Primarily serves community or public interests.
May not participate in political campaigns or influence legislation.
Must provide designated amounts of community benefit and indigent care.

9. Financial Governance – In Order of Responsibility:
Governing Body, or Board of Directors/Trustees
Chief Executive Officer (CEO)
Chief Financial Officer (CFO)
Controller
Treasurer
Internal Auditor
All managers in the healthcare organization

10. 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

11. Managing Reimbursements (cont’d)
Methods Used by Medicare and Medicaid
Reimbursements to Hospitals
Contractual Allowances
Diagnosis-Related Groups (DRGs)
Case Mix, or Patient Mix
Reimbursements to Physicians
Resource-Based Relative Value Scale (RBRVS)
Capitated managed care plans
Reimbursements to Other Providers

12. 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

13. 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.

14. 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

15. 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 and case mix, and to identify inefficient functions.

16. 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.

17. Setting Charges
Charges are “published prices,” however, 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.

18. 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.

19. Managing Working Capital
Definition: “Total current assets,” or short-term assets that can be converted to cash in one year (Nowicki, 2004), versus “current assets plus current liabilities” (McLean, 2003).
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.

20. 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 and outflows.
Managing the liquidity of the organization.

21. Purposes of Working Capital Management (cont’d)
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.

22. Managing Accounts Receivable
Definition: Current assets, created in the course of doing business, consisting of revenues recognized, but not yet collected as cash (McLean, 2003).
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., 2003).
Having large dollar amounts in AR means lost opportunities for other investments.
There are other costs associated with AR, including carrying costs, delinquency costs, and collection costs.

23. Managing Accounts Receivable (cont’d)
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.
Two methods used to finance AR:
Factoring receivables – selling at a discount.
Pledging receivables as collateral to negotiate a line of credit to cover temporary cash shortfalls.

24. 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.

25. Managing Materials and Inventory (cont’d)
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 three groups and is thus monitored according to cost.

26. 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.

27. 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 budget
Capital budget - Plan for expenditures for long-term assets whose useful life is more than a year.

28. 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

29. Capital Budgets (cont’d)
Wish List submitted to managers and proposals submitted by managers to Finance Department.
Methods (“Decision 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

30. 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.