Trident University International Bezos Community Medical Center Paper

Trident University International Bezos Community Medical Center Paper

A Sample Answer For the Assignment: Trident University International Bezos Community Medical Center Paper

Title: Trident University International Bezos Community Medical Center Paper

Trident University International Bezos Community Medical Center Paper

Copyright 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 3: Financial Analysis and Management Reporting 51 that compare the organization’s present ratios, trends, and percentages to those of other, similar organizations.1 The third step of financial analysis, using perspective and judgment to make decisions, takes into account the information obtained in the first two steps, in addition to information derived from the decision maker’s unique perspective and judgment, to make the decision.

Decisions that may at first appear to be contrary to the information provided in the first two steps may make perfect sense based on pressures from internal and external constituents, including medical staff, employers, regulators, donors, and others. The example of a fictional facility, Bobcat Hospital, will be used to illustrate the financial analysis concepts in this chapter. Balance Sheet The balance sheet shows the organization’s financial position at a specific point in time, typically at the end of an accounting period (see exhibit 3.1). The balance sheet presents the organization’s assets, liabilities, and net assets (or shareholders’ equity in for-profit organizations) and its relationships, which are reflected in the following accounting equation: Assets = Liabilities + Net Assets Assets are economic resources that provide or are expected to provide benefit to the organization.

Current assets are economic resources that have a life of less than one year (i.e., the organization expects to consume them within one year). Current assets are listed on the balance sheet in order of liquidity. Cash is money on hand and in the bank that the organization can access immediately. Temporary investments consist of money placed in securities with maturities up to one year, such as commodities and options. The category receivables, net—made up of patient accounts receivable, net of allowances for contractual allowances, charity care, and bad debt—represents money due to the organization from patients and third parties for services already provided. Inventory is the cost of food, fuel, drugs, and other supplies purchased by the hospital but not yet used or consumed. Prepaid expenses are expenditures made by the hospital for goods and services not yet consumed or used in hospital operations (sometimes referred to as deferred expenses), such as rent and insurance premiums. Noncurrent assets are economic resources that have a life of one year or more (i.e., the organization expects to consume them over a span longer than one year). Plant and equipment, net consists of economic resources, such as land, buildings, and equipment, minus the amount that has been depreciated over the life of the buildings and equipment (which is called accumulated depreciation). Long-term investments are economic resources that the hospital owns, such as corporate bonds and government securities, and intends assets Economic resources that provide or are expected to provide benefit to the organization. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 3:34 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition Account: s3642728.main.ehost 00_Nowicki (2339) Book.indb 51 5/17/17 10:57 AM 52 Exhibit 3.1 Bobcat Hospital Balance Sheet as of December 31, 2016 and 2017 (in thousands) Introduction to the Financial Management of Healthcare Organizations 2017 2016 ASSETS Current assets Cash Temporary investments Receivables, net Inventory Prepaid expenses Total current assets $ 124 45 3,536 175 32 3,912 $ 280 30 3,717 140 40 4,207 Noncurrent assets Land, plant, and equipment Accumulated depreciation Plant and equipment, net Long-term investments Other noncurrent assets Total noncurrent assets 6,980 –1,730 5,250 609 113 5,972 6,580 –1,660 4,920 990 109 6,019 Total assets 9,884 10,226 LIABILITIES AND NET ASSETS Current liabilities Accounts payable Notes payable Accrued expenses payable    Deferred revenues Estimated third-party adjustments Current portion of long-term debt Total current liabilities $ 302 345 871 10 137 184 1,849 $ 370 335 408 15 224 178 1,530 Noncurrent liabilities Long-term debt, net of current portion 3,600 3,500 Total liabilities 5,449 5,030 NET ASSETS Unrestricted net assets Temporarily restricted net assets Permanently restricted net assets 3,285 750 400 3,896 700 600 Total net assets 4,435 5,196 Total liabilities and net assets $9,884 $10,226 EBSCOhost – printed on 1/15/2023 3:34 PM via TRIDENT UNIVERSITY. All use subject to https://www.ebsco.com/terms-of-use 00_Nowicki (2339) Book.indb 52 5/17/17 10:57 AM Chapter 3: Financial Analysis and Management Reporting to hold for more than one year. Other noncurrent assets include assets limited as to use (by contracts with outside parties) and goodwill, which represents the amount above fair market value based on an entity’s future earning potential. Liabilities are economic obligations, or debts, of the organization. Current liabilities are economic obligations, or debts, that are due within one year. Accounts payable are amounts the organization owes to suppliers and other trade creditors for merchandise and services purchased from them, but for which the organization has not yet paid. Notes payable are short-term obligations for which a formal contract has been signed, such as a short-term loan. Accrued expenses payable are liabilities for expenses that have been incurred by the hospital but for which the hospital has not yet paid, such as compensation to employees. Deferred revenue is money received by the hospital but not yet earned by the hospital, such as registration fees for an educational program not yet provided. Estimated third-party adjustments are approximations of how much money the organization will be required to return to third-party payers due to overpayments to the organization. Current portion of long-term debt is the amount of the organization’s long-term debt (not including interest) that is expected to be paid within one year. Long-term liabilities are economic obligations, or debts, that are due in more than one year. Long-term debt, net of current portion is an economic obligation, or debt, that is due in more than one year, minus the amount that is due within one year. Net assets is the current AICPA-approved term for the difference between assets and liabilities in not-for-profit healthcare organizations2 and represents the owner’s (community’s or religion’s) and others’ (donors external to the organization) financial interest in the organization. Unrestricted net assets include net assets that have not been externally restricted by donors or grantors, such as the excess of revenues to expenses from operations. Unrestricted net assets include net assets that are contractually limited by the governing body, such as proceeds of debt issues, funds deposited with a trustee and limited to use by an indenture agreement, and funds set aside under self-insurance arrangements and statutory reserve requirements. Temporarily restricted net assets include donor-restricted net assets that the organization can use for the donor’s specific purpose after the organization has met the donor’s restriction, such as the passage of time or an action by the organization. Permanently restricted net assets include donor-restricted net assets with restrictions that never expire, such as endowment funds. In fiscal years beginning after December 15, 2017, organizations will be expected to present net assets in two categories instead of three: “net assets without donor restrictions” and “net assets with donor restrictions.” Generally accepted accounting principles (GAAP) will require organizations to disclose the amount, purpose, and type of board restrictions for net assets without donor restrictions, and GAAP will require organizations to disclose the nature and amount of donor restrictions for net assets with donor restrictions (Connor and Mosrie 2016). 53 liabilities Economic obligations, or debts, of the organization. net assets The difference between assets and liabilities in a not-for-profit organization, which represents the owner’s and others’ financial interests in the organization. EBSCOhost – printed on 1/15/2023 3:34 PM via TRIDENT UNIVERSITY. All use subject to https://www.ebsco.com/terms-of-use 00_Nowicki (2339) Book.indb 53 5/17/17 10:57 AM 54 Introduction to the Financial Management of Healthcare Organizations Shareholders’ equity is the current AICPA-approved term for the difference between assets and liabilities in for-profit healthcare organizations; it represents the ownership interest of stockholders in the organization. Shareholders’ equity is also called stockholders’ equity, owners’ equity, or net worth and comprises common stock and retained earnings. Common stock is money invested in the organization by its owners. Retained earnings result from income earned by the organization from operations minus dividends (distributions of earnings paid to stockholders based on the number of shares of stock owned). Explanatory notes for the balance sheet and the other financial statements should identify extraordinary events, as well as certain required provisions, and should be presented following the financial statements. In fiscal years beginning after December 15, 2018, public organizations and not-for-profit organizations that have issued securities that are traded or listed on an exchange or over-the-counter market will be expected to present the effects of all leases on the balance sheet (the deadline for all other organizations is fiscal years beginning after December 15, 2019). ASU 2016-02, Leases (Topic 842) intends to increase transparency and comparability among organizations by requiring all organizations, not just healthcare organizations, to present the effects of both financial leases and operating leases on the balance sheet (historically, organizations have not presented the effects of operating leases on the balance sheet). The organization should recognize a liability (lease payments) and a right-of-use asset on the balance sheet (Connor and Mosrie 2016). S tat e m e n t o f O p e r at i o n s The statement of operations, called the income statement in for-profit organizations, summarizes the organization’s net revenues, expenses, and excess of net revenues over expenses (called income before taxes in a for-profit organization) over a period of time (see exhibit 3.2). The relationship of the statement of operations to the balance sheet can be best expressed by the following expanded accounting equation: Assets = Liabilities + Net Assets + (Net Revenue – Expenses) revenues The amounts earned by the organization or sometimes donated to it. where the permanent accounts of the balance sheet, which are accounts that carry balances forward to the next year, relate to the temporary accounts of the statement of operations, which are accounts that zero out at the end of each year. To zero out the net results of the statement of operations at the end of the year, the net results are transferred to unrestricted net assets on the balance sheet (or to retained earnings on the balance sheet of a for-profit organization). Revenues are the amounts earned by the organization or sometimes donated to it. Gross patient services revenue is the total amount of charges for patients utilizing the hospital, regardless of the amount actually paid. Deductions from gross patient services EBSCOhost – printed on 1/15/2023 3:34 PM via TRIDENT UNIVERSITY. All use subject to https://www.ebsco.com/terms-of-use 00_Nowicki (2339) Book.indb 54 5/17/17 10:57 AM Chapter 3: Financial Analysis and Management Reporting REVENUES Gross patient services revenue (non-GAAP) Provision for contractual adjustments (non-GAAP) Provision for charity care (non-GAAP) Net patient services revenue Provision for bad debt allowance Net patient services revenue less provisions for bad debt Premium revenue Other operating revenue Total operating revenue EXPENSES Salaries, wages, and benefits Supplies, drugs, and purchased services Depreciation and amortization Interest Total operating expenses 2017 2016 $13,031 –4,209 –420 8,402 –600 7,802 $12,610 –4,083 –408 8,119 –4,763 7,643 400 440 $ 8,642 0 447 $ 8,090 4,980 3,080 471 113 8,644 5,278 2,956 443 109 8,786 OPERATING INCOME NONOPERATING INCOME Investment income –2 –696 $ 95 $ 85 EXCESS OF REVENUE OVER EXPENSES Unrestricted net assets Temporarily restricted net assets Permanently restricted net assets 93 3,285 750 400 –611 3,896 700 600 4,435 5,196 55 Exhibit 3.2 Bobcat Hospital Statement of Operations (in thousands) through December 31, 2016 and 2017 CHANGES IN NET ASSETS Total changes in net assets revenue include amounts deducted from total charges to account for contractual allowances and charity care. Net patient services revenue is money generated by providing patient care minus the amount the organization will not collect as a result of discounting charges per contractual agreement and providing charity care. For financial reporting purposes, patient services revenue does not include provisions for charity care because charity care was never intended to result in cash flow. GAAP in 2010 required that organizations report the amount of charity care recorded at cost along with the method of determining cost and the organization’s EBSCOhost – printed on 1/15/2023 3:34 PM via TRIDENT UNIVERSITY. All use subject to https://www.ebsco.com/terms-of-use 00_Nowicki (2339) Book.indb 55 5/17/17 10:57 AM 56 expenses Amounts of resources used by the organization. Introduction to the Financial Management of Healthcare Organizations charity care policy in notes to the financial statements. (Bad debt is the accounting recognition of how much money the organization has billed but will not collect; the amount reported must be based on charges. Bad debt should not be confused with charity care. Bad debt expense reflects the amount for which the organization provided services with the expectation of payment. Charity care reflects services the organization provided with no expectation of payment.) Net patient services revenue minus provisions for bad debt includes net patient service revenue minus the amount the organization will not collect as a result of bad debt. In 2012 GAAP moved bad debt from an operating expense to a deduction of revenue to account for the patient’s inability to pay deductibles for high-deductible health policies (which the organization knows at time of service). In 2016 the AICPA Revenue Recognition Task Force for Healthcare proposed, but did not require, new guidance for presenting bad debt. After recording revenue at the amount the organization expects to be paid, bad debt would then be recognized in two categories: classic bad debt (the organization believes the patient is able to pay, but the patient does not pay) would be recorded as a bad debt expense under operating expenses; and an implicit price concession (the organization believes the patient is unable to pay, but the patient is not eligible for charity care, and the organization recognizes a write-off based on internal policy). The proposed new guidance for presenting bad debt would allow organizations to group patients with similar characteristics, such as true self-pay or high deductible (Connor and Mosrie 2016). Premium revenue is money generated from capitation arrangements that must be reported separately from patient services revenue because premium revenue is earned by agreeing to provide care, regardless of whether care is ever delivered. Other operating revenue is money generated from services other than health services to patients and enrollees. It may include revenue from rental equipment and office space, sales of supplies and pharmaceuticals, cafeteria and gift shop sales, and so on. Often the test for whether revenue is considered other operating revenue or nonoperating revenue is whether the revenue was generated in support of the organization’s mission statement. Why is it important to distinguish between operating and nonoperating revenue? Because for a not-for-profit hospital, income derived from operations is not taxed, but income from unrelated businesses, such as the gift shop, may be taxed as unrelated business income. Net assets released from restrictions used for operations, while not reflected in Bobcat Hospital’s statement of operations, consist of money previously restricted by donors that has become available for operations. Expenses are the amounts of resources used by the organization. The category of operating expenses represents resources used on operations to generate revenue in support of the organization’s mission statement. These expenses can be listed by functional classification (organizational division), such as nursing department and support department, which is useful for internal purposes, or by natural classification, under such categories as salaries, wages, and benefits or supplies, drugs, and purchased services, as is the case with Bobcat Hospital’s statement of operations, which is useful for external purposes. EBSCOhost – printed on 1/15/2023 3:34 PM via TRIDENT UNIVERSITY. All use subject to https://www.ebsco.com/terms-of-use 00_Nowicki (2339) Book.indb 56 5/17/17 10:57 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 13: Strategic and Operational Planning 1. Strategic planning: determines the organization’s overall direction in the next three to ten years 2. Operational planning: converts the strategic plan into the next year’s objectives 3. Budgeting: converts the operating plan into budgets for revenues, expenses, and cash 4. Capital budgeting: converts the operating plan into budgets for capital expenditures 299 Strategic planning and operational planning are discussed in the following sections of this chapter. Budgeting is covered in chapter 14 and capital budgeting in chapter 15. As shown in exhibit 13.1, the corporate planning process consists of 22 steps that progress through the four stages within the planning horizon. S t r at e gi c P l an ni n g Strategic planning forces managers to anticipate where they want the healthcare organization to be in three to ten years; to identify the resources that will be necessary to get there; and to preview the provision of healthcare services at the end of the planning horizon. Strategic planning also provides the starting point for the operating plan and budget. The governing board has the overall responsibility for strategic planning for the organization, but it should actively seek input from the organization’s stakeholders, which are those constituents with a vested interest in the organization. Certainly, the community (which may be represented by the board members), the medical staff, and organization employees should provide input. While a strategic plan is mandated by both Medicare and The Joint Commission, healthcare organizations sometimes offer excuses for not fully engaging in the planning process. Excuses range from a lack of time to a rapidly changing future. Paradoxically, if organizations spent more time planning, they would end up having more time to execute the plans. Organizations with serious planning processes position themselves to control the turbulent future, rather than simply react to it. Often financial management, including the chief financial officer (CFO), is not involved in the planning process until the budgeting stage. The CFO might be viewed as an impediment to the vision needed for the strategic plan to work. However, the CFO is necessary to provide input to the strategic financial plan—that is, the ability of the organization to fund the capital and operating costs necessary to make the strategic plan successful. strategic planning Long-range planning that anticipates where an organization will be in three to ten years. T he P l an ni n g P r o c e s s The planning process involves 13 steps, as outlined in the sections that follow. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 299 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 300 Introduction to the Financial Management of Healthcare Organizations Exhibit 13.1 Corporate Planning Process Stage Strategic Planning Planning Horizon 3–10 years out, revised annually 1. Validate mission and strategic interpretations. 2. Assess the external environment. 3. Assess the internal environment. 4. Formulate the vision. 5. Establish strategic thrusts, or goals. 6. Identify critical success factors. 7. Develop primary, or core, objectives. 8. Develop the strategic financial plan. Operational Planning 1 year out 9. Develop secondary, or department, objectives. 10. Develop policies. 11. Develop procedures. 12. Develop methods. 13. Develop rules. Budgeting 1 year out 14. Project volumes. 15. Convert volumes into revenues. 16. Convert volumes into expense requirements. 17. Adjust revenues and expenses as necessary. Capital Budgeting 1–3 years out 18. Identify and prioritize requests. 19. Project cash flows. 20. Perform financial analysis. 21. Identify nonfinancial benefits. 22. Evaluate benefits and make decisions. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 300 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 13: Strategic and Operational Planning 301 S t e p 1: V a l i d at e M i s s i o n a n d S t r at e g i c I n t e r p r e tat i o n s The first step in the corporate planning process—also the first of the eight steps in the strategic planning stage—is for the executive management team, which includes the governing body and the CEO, to validate the organization’s mission. The mission is a broad statement of organizational purpose that can be easily communicated throughout both the organization and the community. Because mission statements are broad, organizations should not need to change them frequently; mission statements should survive to the end of the planning horizon. A study of more than 200 Fortune 500 companies identified common characteristics of effective mission statements (Pearce and David 1987). The mission statements ◆◆ target customers and markets, ◆◆ indicate the principal services delivered by the organization, ◆◆ specify the geographic area in which the organization intends to operate, ◆◆ identify the organization’s philosophy, ◆◆ confirm the organization’s self-image, and ◆◆ express the organization’s desired public image. Strategic interpretations provide the means for executive management to interpret the mission statement by recognizing the changing character of the healthcare industry and the changing needs of the community. Strategic interpretations may also prioritize organizational purposes when the mission statement includes multiple purposes that might conflict when operationalized. Strategic interpretations are seldom directly stated in any form and are more often represented in the actions of executive management. For instance, executive management may show a preference for one purpose over another through the budget allocation process. S t e p 2: A s s e s s t h e E x t e r n a l E n v i r o n m e n t The second step in the corporate planning process and the strategic planning stage is to assess the external environment, including factors that might have an effect on present or future performance. To maintain objectivity and guard against vested interests, a governing body or outside consultants should be responsible for assessing both the external and internal environments. The first part of the assessment should include a determination on the direction of the industry as a whole by investigating national trends. Some of the current national trends for the healthcare industry include EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 301 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 302 Introduction to the Financial Management of Healthcare Organizations ◆◆ decreasing reimbursement from federal and state health programs as government tries to slow rising healthcare costs; ◆◆ increasing popularity of managed care programs (and capitation), especially among payers including employers; ◆◆ increasing consolidation as a result of competition; ◆◆ continuing expansion into businesses outside the traditional healthcare industry; ◆◆ increasing growth in outpatient care, preventive care, and innovative alternative delivery systems; ◆◆ declining numbers of rural and public teaching hospitals; and ◆◆ decreasing numbers of uninsured patients as the Affordable Care Act (ACA) is implemented and more people are insured. The second part of the external environment assessment should determine the direction of the local market and should investigate the following elements: ◆◆ Demographic and socioeconomic characteristics of the primary and secondary service areas and their effect on present and future utilization patterns ◆◆ Key economic and employment indicators and their effect on present and future utilization patterns ◆◆ Patient migration patterns, to determine from where patients and potential patients come ◆◆ Market share statistics for key competitors, to determine market strengths and weaknesses ◆◆ Competitor profiles, including strengths and weaknesses, use by service, use by payer, exclusive and other managed care contracts, extent of horizontal and vertical integration, potential expansion plans, and cost comparisons ◆◆ A managed care profile, to determine present and future managed care penetration ◆◆ A physician profile, to determine numbers, ages, and specialists available in the market Any significant differences between national trends identified in the first part of the external environment assessment and the local trends identified in the second part of the EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 302 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 13: Strategic and Operational Planning 303 external environment assessment should be thoroughly analyzed to determine the reasons for the differences. S t e p 3: A s s e s s t h e I n t e r n a l E n v i r o n m e n t The third step in the corporate planning process and the strategic planning stage is for the governing body or outside consultants to assess the internal environment, including factors that might have an effect on performance either now or in the future. The first part of the assessment should determine the direction of the organization by investigating organizational trends. Some of the organizational trends for analysis might include ◆◆ patient composition, including utilization patterns (i.e., patient days, outpatient visits, admissions, discharges, lengths of stay, age, payer, patient origin); ◆◆ medical staff composition, including use patterns by specialty, age, practice (solo versus group), admissions, lengths of stay, and board certification; ◆◆ agreements with payers and managed care organizations; ◆◆ a financial assistance policy that is readily available to the public; ◆◆ financial ratios, including liquidity, profitability, activity, capital structure, and operating ratios (see chapter 3); and ◆◆ Joint Commission quality measures and safety indicators. Some organizations use a SWOT (strengths, weaknesses, opportunities, and threats) analysis to assess the internal environment. A SWOT analysis forces the organization to identify its strengths and weaknesses during internal assessment. Then the organization identifies opportunities for additional market penetration with existing or new programs and threats from competitors that might reduce the organization’s chances for success (Dunn 2016). The ACA requires tax-exempt hospitals to complete a community health needs assessment every three years and to make the assessment, along with audited financial statements, available to the public. The assessment must include a treasurer review of community benefit and an explanation for why certain community health needs are not being addressed. The presumption is that community health needs should be met and financed with the difference between tax savings and the cost of providing community benefit. S t e p 4: F o r m u l at e t h e V i s i o n The fourth step in the corporate planning process and the strategic planning stage is for the executive management team to formulate a vision—a view of the future that the team EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 303 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 304 Introduction to the Financial Management of Healthcare Organizations members think gives the organization the best chance of accomplishing its mission. Executive management bases its vision on the information obtained from assessing the external and internal environments. It must communicate its vision throughout the organization. Effective vision statements have certain characteristics in common, as described in the still-timely text Thriving on Chaos: Handbook for a Management Revolution (Peters 1988). They should ◆◆ be inspiring first of all to employees, but also to customers; ◆◆ be clear, challenging, and about excellence; ◆◆ make sense to the community, be flexible, and stand the test of time; ◆◆ be stable, but change when necessary; ◆◆ provide direction in a chaotic environment; ◆◆ prepare for the future while honoring the past; and ◆◆ be easily translated into action. S t e p 5: E s ta b l i s h S t r at e g i c T h r u s t s strategic thrusts Broad statements of significant results that an organization wants to achieve related to its vision. Also called The fifth step in the corporate planning process and the strategic planning stage is for executive management to establish strategic thrusts, or goals, which are broad statements of significant results that the organization wants to achieve related to its vision. Strategic thrusts should be limited in number, stable and enduring, and, taken together, comprehensive to the point that they provide meaningful results for all components of the organization’s mission (Dunn 2016). goals. S t e p 6: I d e n t i f y C r i t i c a l S u c c e s s F a c t o r s critical success factors Subgoals of a plan, monitored during performance management to measure progress of the overall plan. The sixth step in the corporate planning process and the strategic planning stage is for executive management to identify critical success factors that will measure progress toward achieving the plan (Dunn 2016). The assessment of the environment should introduce both strategic thrusts and critical success factors. Critical success factors are organization specific, but most healthcare organizations will include critical success factors from the following areas: ◆◆ Inpatient use and market share ◆◆ Outpatient use and market share ◆◆ Managed care use and market share ◆◆ Medical staff profiles and activity levels ◆◆ Accessibility indicators EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 304 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 13: Strategic and Operational Planning 305 ◆◆ Cost-effectiveness indicators ◆◆ Efficiency indicators ◆◆ Quality indicators S t e p 7: D e v e l o p P r i m a ry , o r C o r e , O b j e c t i v e s The seventh step in the corporate planning process and the strategic planning stage is for executive management to develop primary, or core, objectives that support the strategic thrusts or goals. Primary objectives should encompass the entire organization. Organizations have several primary objectives; the real challenge lies in balancing them. See exhibit 13.2 for a sample strategic plan. Mission Our mission is to be the nursing home of choice in our community by providing highquality, competitively priced skilled nursing services. Interpretation To provide a skilled nursing facility to those living in our community in a cost-effective manner to ensure financial survival. Exhibit 13.2 Sample Not-forProfit Nursing Home Strategic Plan Vision Our vision is to expand our services in the next five years to include a residential care facility and a hospice facility while maintaining a high-quality, cost-effective skilled nursing facility. Strategic Thrusts 1. To provide high-quality skilled nursing care 2. To provide cost-effective skilled nursing care 3. To expand service without harming quality or increasing costs Critical Success Factors 1. Continued accreditation 2. Continued licensure 3. Continued favorable physician relations 4. Cost increases not to exceed 3 percent per year 5. Residential care facility and hospice to open within five years Primary Objectives 1. Initiate total quality management program 2. Initiate patient satisfaction surveys 3. Initiate physician satisfaction surveys 4. Initiate reengineering program to improve processes and reduce costs 5. Build residential care facility 6. Build hospice facility EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 305 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 306 Introduction to the Financial Management of Healthcare Organizations S t e p 8: D e v e l o p t h e S t r at e g i c F i n a n c ia l P l a n The eighth step in the corporate planning process and the last step in the strategic planning stage is for the governing body and CEO to develop the strategic financial plan. The strategic financial plan is the link between the strategic plan, which looks three to ten years out, and the operating plan, which looks one year out. In essence, the strategic financial plan is the quantification of a series of strategic planning policy decisions that will answer whether the organization can make progress toward accomplishing its strategic plan over the next ten years. These decisions are based on the answers to the following questions regarding the five-year planning horizon (Berger 2007): ◆◆ How much cash should the organization have five years from now (days cash on hand ratio)? ◆◆ How much debt can the organization afford to take on five years from now (debt service coverage ratio)? ◆◆ What profitability targets are necessary to meet the cash and debt metrics identified (operating margin and excess margin ratios)? ◆◆ What is the required level of operating change necessary to meet the profitability targets identified (projected increases in net revenues and decreases in operating expenses)? ◆◆ What are the organization’s strategic capital requirements over the next five years (five-year capital spending projection)? ◆◆ What is the financing method for the capital necessary to meet the capital requirements identified (debt, equity, lease, or philanthropy)? All of the industry ratios identified earlier can be obtained by rating agencies, which might rate the hospital in the future if part of the financing will be dependent on bonds. Progress toward these ratios is also an excellent way for the governing board to evaluate the CEO on an annual basis (Nowicki 2004). V al u e o f S t r at eg i c P la nn i ng The value of strategic planning lies in its systematic approach to dealing with an uncertain future. Many organizations become disillusioned with strategic planning when their plans are not met. These plans often have too narrow a focus—the narrower the focus, the less likely an organization is to accomplish the plan. Strategic planning that establishes the organization’s overall direction without attempting to be specific has the following benefits: EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 306 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 13: Strategic and Operational Planning 307 ◆◆ It integrates the mission, vision, strategic thrusts, and primary objectives as described in the strategic plan with the secondary objectives, policies, procedures, methods, and rules of the operating plan. ◆◆ It provides a process and time frame for making strategic decisions. ◆◆ It provides a framework for the operating plan, budget, and capital budget. O p e rati o na l P l an ni n g For the strategic direction of the organization to be useful, the organization’s managers must translate the strategic direction into small, measurable steps to be taken during the next year. Operational planning is the process of translating the strategic plan into a year’s objectives. Budgeting is the process of expressing the operating plan in monetary terms and is covered in chapter 14. Many organizations have difficulty determining where strategic planning ends and operational planning begins, and where operational planning ends and budgeting begins. Three characteristics distinguish strategic planning from operational planning: 1. Planning horizon: Strategic planning is for the next three to ten years, and operational planning is for the next year. 2. Principal participants: The governing body and executive management develop the strategic plan; the department managers develop or have significant input in the operational plan. 3. Objectives: Strategic planning lists primary objectives common to the entire organization, and the operating plan lists secondary objectives by division or department. operational planning The process of translating the strategic plan into a year’s objectives. S t e p 9: D e v e l o p S e c o n d a ry , o r D e pa rt m e n t , O b j e c t i v e s In the ninth step in the corporate planning process—the first step in the operational planning stage—department managers develop secondary, departmental objectives to support the strategic plan of the organization (Berman, Kukla, and Weeks 1994; Dunn 2016): ◆◆ Department objective setting should be participative. Meaningful employee participation in planning improves both morale and the chances of meeting objectives. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 307 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 308 Introduction to the Financial Management of Healthcare Organizations ◆◆ Department objectives should be rigorous but attainable. The department will not progress if the objectives are easily attainable, but the department may not attempt objectives that seem too difficult. ◆◆ Department objectives should be verifiable and/or measurable to ensure progress and to reward those responsible for the progress. For Joint Commission accreditation purposes, the manager and subordinates should discuss desired outcomes and their indicators. One method of developing department objectives is Peter Drucker’s management by objectives (MBO), introduced during the 1950s (Drucker 2008). In a nutshell: (1) the manager provides subordinates with a general overview of the work to be accomplished in the coming year, (2) the subordinates propose objectives, and (3) the objectives are negotiated until final agreement. Reported advantages of MBO include directing work activity toward organizational goals, reducing conflict and ambiguity, providing clear standards for control and performance appraisals, and improving motivation. MBO is not without disadvantages, including burdensome procedures and paperwork; overemphasis on quantitative objectives at the possible expense of qualitative objectives; suboptimization of performance; and illusionary participation, which means that managers give the perception of participation, but the participation lacks meaningful substance, often because the subordinates sense that decisions have already been made. S t e p 10: D e v e l o p P o l i c i e s The tenth step in the corporate planning process—the second step in the operational planning stage—is for department managers to develop policies (broad guides to thinking) that provide subordinates with general guidelines for decision making. Policies are the most common type of plan at the department level (Dunn 2016). According to Dunn, good policies have the following characteristics: ◆◆ They are issued by top management and provide managers with general guidelines for decision making. ◆◆ They are flexible, so managers can apply them to normal and abnormal circumstances.2 ◆◆ They are stated simply and clearly. Policies should not require complex interpretation. ◆◆ They are communicated so that both managers and subordinates are aware of them. Most policies are written, which helps ensure consistent understanding. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 308 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 13: Strategic and Operational Planning 309 ◆◆ They are consistent with one another. Inconsistency among policies or in the application and enforcement of policies will affect morale and will likely detract from accomplishing objectives. Inconsistencies frequently occur in the enforcement of organizational policies between departments, and they can have dire consequences.3 S t e p 11: D e v e l o p P r o c e d u r e s The eleventh step in the corporate planning process—the third step in the operational planning stage—is for department managers and supervisors to develop procedures, which are guides to action. Procedures are derived from policies, but they are considerably more specific. Procedures identify in a step-by-step fashion how to accomplish a policy. Good procedures are the result of a detailed analysis of how best to accomplish the intent of the policy. Good procedures provide the manager or supervisor with a consistent and uniform performance appraisal. S t e p 12: D e v e l o p M e t h o d s The twelfth step in the corporate planning process—the fourth step in the operational planning stage—is for department managers and supervisors to develop methods to accomplish the procedures. Methods are detailed, uniform actions with specific instructions and predictable outcomes. S t e p 13: D e v e l o p R u l e s The thirteenth step in the planning process—the fifth and final step in the operational planning stage—is for department managers to develop rules, which are statements that either require or forbid an action or inaction. The manager or supervisor has some flexibility in the application and enforcement of policies, procedures, and methods—but not rules. Good rules are those that everyone sees as clearly necessary for the proper order and functioning of the department. E va l uat i n g P l an P e r f o r ma nce The governing body of the organization should review the strategic plan on an annual basis and evaluate the CEO based on progress in accomplishing primary objectives. Likewise, executive management should review the operating plan, probably on a monthly or quarterly basis. It should also evaluate department managers on the basis of their progress in accomplishing secondary objectives and compliance with policies, procedures, methods, and rules. The Joint Commission requires that hospitals have a planned, systematic, hospital-wide approach to process design and performance measurement, assessment, and improvement. The relevant standard requires leaders to “establish priorities for performance improvement” (Joint Commission 2016) in the following ways: EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 309 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 310 Introduction to the Financial Management of Healthcare Organizations 1. Leaders set priorities for performance improvement activities and patient health outcomes. 2. Leaders give priority to high-volume, high-risk, or problem-prone processes for performance improvement activities. 3. Leaders reprioritize performance improvement activities in response to changes in the internal or external environment. Budgeting, the next step in the corporate planning process, begins once the strategic and operating plans have been approved; budgeting consists of converting the operating plan into monetary terms. C hap t e r K e y P o i n t s ➤➤ Planning is the process of deciding in advance what must be done in the future. ➤➤ Planning can be classified several ways: by planning horizon, by management approach, and by design characteristics. ➤➤ Corporate planning has replaced facility planning for most healthcare organizations. ➤➤ Corporate planning consists of four major stages: strategic planning, operational planning, budgeting, and capital budgeting. ➤➤ Strategic planning looks three to ten years into the future and consists of several sequential steps: validating the mission and strategic interpretations; assessing the external environment; assessing the internal environment; formulating the vision; establishing strategic thrusts, or goals; identifying critical success factors; developing primary, or core, objectives; and developing a strategic financial plan. ➤➤ The value of strategic planning lies in its systematic approach toward dealing with an uncertain future. ➤➤ Operational planning is the process of translating the strategic plan into the next year’s objectives and consists of several sequential steps: developing secondary, or department, objectives; developing policies; developing procedures; developing methods; and developing rules. ➤➤ The governing body of the healthcare organization is responsible for evaluating the progress of the strategic plan; the executive management of the healthcare organization is responsible for evaluating the progress of the operating plan. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 310 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 13: Strategic and Operational Planning 311 Discussion Questions 1. What is the definition of planning? Of strategic planning? Of operational planning? What are examples of each? 2. What are the planning horizons for strategic planning and operational planning? 3. How would you explain the various management approaches to planning? 4. How would you describe each step, in order, in the strategic planning process? 5. How would you describe each step, in order, in the operational planning process? 6. How do you imagine organizations that do not engage in meaningful strategic planning would look? 7. Who is responsible for evaluating the progress of the strategic plan and the operational plan? Notes 1. Strategic planning for the organization is the responsibility of the governing board, which often contracts the preparation of the plan to outside consultants rather than organization employees. With a planning horizon of three to ten years, employees would be likely to produce plans with vested interests, rather than a clear picture of where the organization is going. For instance, how many employees would plan to diminish or eliminate their functions, even if that seemed like the right thing to do? 2. Managers must be cautious about indiscriminately granting exceptions to policy. Although a manager wants to treat subordinates and patients with mercy, the manager must also seek justice, or fair play. The following two questions may help managers resolve the frequently faced dilemma of mercy versus justice: Can the manager afford to grant everyone with similar extenuating circumstances an exception? How can the manager make sure that the other subordinates or patients know about the exception, are encouraged to apply for the exception if circumstances warrant, and are supportive of the manager’s decision to grant the exception? (See Nowicki 1998.) 3. In St. Mary’s Honor Center v. Hicks (1993), Melvin Hicks, a black prison guard, sued a Missouri prison for civil rights violations. Hicks, who had been fired for exceeding the prison’s absenteeism policy, claimed that other guards who were white had exceeded the absenteeism policy but had been given exceptions. Although Hicks lost in a 5–4 decision (the majority felt that Hicks had not proven intentional discrimination and the action could have been the result of poor management), the case had a chilling effect on the indiscriminate granting of policy exceptions. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 311 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. CHAPTER 14 BUDGETING In healthcare today, a mission that focuses only on quality is only half a mission. Richard L. Clarke (2009), former president of the Healthcare Financial Management Association Learning Objectives After completing this chapter, you should be able to do the following: ➤➤ Define and understand the importance of budgeting ➤➤ Identify the prerequisites to the budgeting process ➤➤ Explain the types of budgeting ➤➤ Outline the steps in the budgeting stage of the corporate planning process 312 EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 312 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 14: Budgeting 313 I n t r o d uc t i o n In The Zero-Base Hospital, M. W. Person emphasizes the need for budget skills for every management position in the healthcare organization: To function effectively in the healthcare industry in the foreseeable future, managers will need to develop specific financial skills. They will need to acquire an appreciation of volume, expense, and revenue relationships. They will need to become familiar with cost-containment strategies for their particular corner of the market. Most of all, they will need to cultivate an intimate knowledge of the details that define their operations and drive their costs, such as utilization statistics, seasonal trends, staffing models, productivity analysis, supply alternatives, inventory management, make/lease/buy options, physician practice patterns, and rate setting. (Person 1997, 67) In short, healthcare managers must learn how to budget. Considering that most managers in healthcare organizations are specialists in fields other than financial management and that, as specialists, they have little or no formal education in budgeting, their records of accomplishment to date have been commendable. However, with healthcare costs and rapidly changing demographics at the center of public debate, and with prospective payment limiting the ability of organizations to “just raise rates” to cover expenses, tomorrow’s healthcare managers clearly must do more work with fewer resources. D e fi ni t i o n o f B u d g e ti n g Budgeting is the process of converting the operating plan (discussed in chapter 13) into monetary terms. In addition to converting the operating plan into monetary terms for planning purposes, budgeting is an important way for managers to exert control. Budgets become a control standard against which superiors can easily measure the performance of subordinates. Budgeting is also an excellent opportunity for the finance staff to educate the nonfinance department managers about the relationship of revenues, expenses, and capital expenditures to the overall financial well-being of the organization. Sequentially, budgeting occurs after the steps in operational planning (described in chapter 13) have been completed. Budget information therefore does not bias operating information, especially in not-for-profit healthcare organizations. Department managers should prioritize objectives in the operating plan based on community need, not organizational profitability. budgeting The process of converting the operating plan into monetary terms. P r e r eq ui s i t e s t o B u d g e ti ng Before effective budgeting can begin, the organization must meet several prerequisite requirements, the first four of which were introduced in chapter 13 related to planning (Berman, Kukla, and Weeks 1994; Herkimer 1988): EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 313 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 314 Introduction to the Financial Management of Healthcare Organizations 1. A sound organizational structure that ensures management accountability for the budgeting process 2. A well-defined chart of accounts that corresponds with the organizational structure 3. Prompt and accurate accounting systems that ensure financial responsibility for the budgeting process 4. A comprehensive management information system that captures nonfinancial information for each department 5. A budget director who is responsible for coordinating the budget process and who serves as chair of the budget committee 6. A budget committee that is responsible for establishing a budget manual and a budget calendar and assisting department managers in developing their department budgets. Budget committees usually consist of senior managers who represent the department managers in their divisions. 7. A budget manual that includes necessary strategic planning information; the organizational structure; the chart of accounts; a list of budget committee members who can assist department managers; budget forms and instructions; budget assumptions regarding items such as anticipated growth, inflation, and employee raises; and a budget calendar with important completion dates 8. The previous year’s data regarding volumes, revenues, and expenses T y p e s o f B u d g e ts Budgeting can be classified by management approach and by design characteristics. Many of the following budget classifications also apply to planning and were introduced in chapter 13. M a n a g e m e n t A pp r o a c h Budgets can be classified by management approach, either with top-down or bottom-up budgeting. In top-down budgeting, as in top-down planning, senior management develops the budget with little or no input from department managers. The advantage of this design is that senior management may be in the best position to objectively view the future; the disadvantage is that budget implementation may be difficult if subordinates have little or no input. In bottom-up budgeting, subordinates develop the budget and submit it to senior management for approval. The advantage to bottom-up budgeting, as with bottom-up EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 314 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 14: Budgeting 315 planning, is the commitment to the budget by those who developed it. The disadvantage is that subordinates may not be in the best position to view the future. In most cases, a combination of top-down and bottom-up designs is used—senior management decides on budget parameters, and subordinates submit plans within those parameters. D e s i g n C ha r a c t e r i s t i c s Budgeting can also be classified by design characteristics; these characteristics also apply to the design characteristics of planning (described in chapter 13). Incremental Versus Zero-Base Budgeting Incremental budgeting requires budgeting only for changes such as new equipment, new positions, and new programs. Incremental budgeting assumes that all current operations, including positions and equipment, are essential to the continued mission of the organization and that all current operations are working at peak performance. The advantages of incremental budgeting are its ease, the minimal time commitment required to prepare the budget, and the support of a larger organizational culture. The main disadvantage is the assumption that all current operations are essential in a healthcare environment that is changing rapidly. Conversely, zero-base budgeting takes nothing for granted and requires rejustification for existing equipment, positions, and programs, as well as justification for new equipment, positions, and programs.1 Therein lies the principal advantage of zero-base budgeting: In a rapidly changing environment where reimbursement is moving away from cost-based approaches and moving toward prospective payment per case or per enrollee, zero-base budgeting can eliminate unnecessary costs and improve margins. Disadvantages are numerous and include the large time commitment, employee fear and anxiety, and the administrative and communication requirements (Person 1997). incremental budgeting Budgeting only for changes, such as new equipment. The assumption in incremental budgeting is that the current budget is already optimal. zero-base budgeting Budgeting that requires all operations to be justified anew; nothing in the current budget is assumed to be already optimal. Comprehensive Versus Limited-in-Scope Budgeting Comprehensive budgeting integrates all the budgets into one document. The advantage is the recognition that capital affects operations. Limited-in-scope budgeting segregates the budgets. Most organizations integrate the budgets at the executive management level of the organization, but the issue is at what level of the organization the budgets should be integrated. For instance, many healthcare organizations do not show department managers revenue information because they believe that the department managers will not understand the difference between billed revenue and collected revenue, or that the organization uses department revenue to cover expenses in departments that do not generate revenue. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 315 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 316 Introduction to the Financial Management of Healthcare Organizations Another reason department managers might not be shown revenue information is because department managers cannot effect changes in revenue, which is a function of volumes ordered by the physicians multiplied by rates set by the chief financial officer. A similar case can be made regarding whether department managers should be shown indirect expenses. Fixed Versus Flexible Budgets Fixed budgets assume that volumes, related revenues, and variable expenses remain constant during the year. Fixed budgets are easy to project, but they are unrealistic for healthcare organizations whose volumes fluctuate during the year and whose variable expenses, which are dependent on volumes, account for about half of an organization’s operating expenses (Kalman et al. 2015). Flexible budgets take into account fluctuations in volumes, at least within ranges expressed as probabilities, and adjust variable expenses accordingly. Discrete Versus Continuous Budgets Like discrete plans (discussed in chapter 13), discrete budgets apply to a fixed period of time, usually a year. At the end of the year, a new budget begins. Discrete budgets are relatively easy to prepare, but budgeting in 12-month increments can be difficult because circumstances often change. Furthermore, discrete budgets can be challenging to some managers who know that if they are efficient and spend less than originally budgeted, they may receive less money in the following year’s budget. Continuous budgets, sometimes called rolling budgets, are updated continuously so that year end never occurs. Department managers who manage wisely roll over their efforts to the next month.2 S t e p s i n t h e B u dget ing S ta ge The budgeting stage is a key part of the corporate planning process that was introduced in chapter 13. The entire process has 22 steps (illustrated in exhibit 13.1), the first 13 of which encompass the strategic planning and operational planning stages discussed in chapter 13. The four steps of the budgeting stage are discussed in this chapter. The final five steps, which make up the capital budgeting stage, will be covered in the next chapter. S t e p 14: P r o j e c t V o l u m e s The fourteenth step in the corporate planning process—the first step in the budgeting stage—is to project volumes for the budget year. This step is often called the statistical budget, and it is sometimes part of the operating plan. Typically, the budget committee will give its projections of the organization’s production units to department managers in the budget manual. Department managers use the organization’s production units to calculate EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 316 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 14: Budgeting department production units that are specific to each department. For instance, the radiology department manager must be able to determine how many radiology procedures are generated for every 100 admissions. Production units are the best measures of what an entity is producing. For example, hospitals produce patient days and admissions (both of which are called production units), but neither reflects severity of illness or the volume of outpatient work produced by the hospital. The unit used to show severity of illness (SOI), a factor that affects resource consumption, will vary—many hospitals have adopted diagnosis-related groups (DRGs) or another severity index.3 Regarding the volume of outpatient work produced by the hospital, either outpatient work needs to be captured separately as outpatient visits and with the related revenues and expenses, or the inpatient production unit must be adjusted to reflect outpatient work produced. Regardless of which production units are chosen by the organization, the units must be reported by payer to project both gross and net revenues by payer. Each department should have a production unit that best measures what the department is producing. Radiology, for example, produces radiology procedures. However, this production unit, like patient days for the hospital, does not reflect the complexity of the procedure and the related resource consumption. To show complexity of the procedure, most departments have developed a relative value unit (RVU) that reflects relative complexity and related resource consumption (refer to chapters 8 and 9 for information on developing RVUs).4 If the hospital can tell the radiology department manager how many of each DRG it is projecting, the radiology manager should be able to project the number and type of procedures. In addition to serving as a basis for projecting volumes for budgeting purposes, department production units are used to (Herkimer 1988) 317 production units The best measures of what an entity is producing. For example, patient days and admissions are both considered production units for a hospital. ◆◆ measure and evaluate department productivity, ◆◆ measure and evaluate employee productivity, ◆◆ serve as the basis for calculating the cost of each procedure (see chapter 8), ◆◆ serve as the basis for calculating the charge for each procedure, and ◆◆ serve as the basis for determining staffing requirements and staffing schedules. To project future volumes under conditions of uncertainty, most managers rely on forecasting, which is the process to determine what alternative scenarios are likely to occur in the future, given what managers know about the past and present. According to the classic work of Reeves, Bergwall, and Woodside (1984), to forecast, the manager must first prepare the forecast content, which is a description of the specific situation in question. Next, the manager must prepare the forecast rationale, which is an explanation of how the situation will evolve from its current state to its forecasted state (Reeves, Bergwall, and Woodside 1984). EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 317 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 318 Introduction to the Financial Management of Healthcare Organizations In preparing the forecast content, the manager first identifies content items, which are descriptions of important occurrences, such as admissions, patient days, and outpatient visits. Next, the manager must measure the current status of content items. The final step of the forecast content is to identify the expected state of the content items in the future budget period. Although forecast content often produces quantifiable data, the manager also must consider the effect of the following subjective factors on the forecast content (Reeves, Bergwall, and Woodside 1984): ◆◆ Political factors ◆◆ Social factors ◆◆ Economic factors ◆◆ Technological factors ◆◆ Personal health factors ◆◆ Environmental health factors A manager may use several forecasting techniques to prepare the forecast content, including the use of experts, causal models, and time-series methods. Use of Experts The use of experts depends on the manager’s ability to identify and secure the services of appropriate experts. Then, the manager must consider the advantages and disadvantages of using experts in preparing the forecast. Using experts is usually quick and relatively inexpensive. However, different experts may develop different, yet valid, opinions about the future. Which expert is correct? To address this disadvantage, managers can choose a variety of models to obtain their opinion (Reeves, Bergwall, and Woodside 1984): ◆◆ A task force brings together several experts who provide collective input. ◆◆ The Delphi technique gathers information from a group of dispersed experts with anonymity and limited interaction. ◆◆ The Delbecq technique, or nominal group process, is similar to the Delphi technique, except that the group of experts meets face-to-face for discussion and to present and defend their forecasts. ◆◆ Questionnaires are used to gather responses to questions from a large group of experts. ◆◆ Permanent panels maintain a group of experts who can be used for several forecasts over time. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 318 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 14: Budgeting 319 ◆◆ Essay writing obtains opinions from experts in a format that can be used for preparing the forecast rationale. ◆◆ Computer-facilitated group processes can reveal and “parallel process” more contributions from a greater number of participants than is possible using manual facilitation techniques alone. In addition to relying on expert opinion regarding the future, a manager may apply probability statistics to the expert opinion. Another derivative of using expert opinion is the program evaluation and review technique (PERT). This technique requires estimates of optimistic (O), pessimistic (P), and most likely (ML) future scenarios. These three estimates are weighted to calculate an expected value that equals (O + P + 4ML) 6 Causal Models The manager may use causal models when the forecast variable is dependent on a causal, or independent, variable. The most common statistical method used in causal models is regression analysis, which mathematically describes an average relationship between a forecast variable and one or more causal variables. For instance, the manager can use a regression line based on past volumes over time to predict future volumes. Problem 14.1 demonstrates the use of regression lines. * PROBLEM 14.1 Linear Regression and Estimation If a hospital emergency department had the following history of volumes, what would be the projected volume for 2018? Year Volume 2013 10,000 2014 10,500 2015 10,200 2016 10,400 2017 10,600 (continued) EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 319 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 320 Introduction to the Financial Management of Healthcare Organizations * PROBLEM 14.1 Linear Regression and Estimation (continued) Using the HP10BII, the inputs would be as follows: Keys Display Description 0.00 Clear statistical registers 2013 INPUT 2013.00 Enters year 10,000 ∑+ 1.00 Enters volume and displays first pair of data entered 2014 INPUT 2014.00 Enters year 10,500 ∑+ 2.00 Enters volume and displays second pair of data entered 2015 INPUT 2015.00 Enters year 10,200 ∑+ 3.00 Enters volume and displays third pair of data entered 2016 INPUT 2016.00 Enters year 10,400 ∑+ 4.00 Enters volume and displays fourth pair of data entered 2017 INPUT 2017.00 Enters year 10,600 ∑+ 5.00 Enters volume and displays fifth pair of data entered 2018 INPUT 2018.00 Enters year ŷ,m 10,670 CLEAR ALL Displays predicted volume associated with last year➤ entered Copyright 2000 Hewlett-Packard Development Company, L.P. Reproduced with permission. Hewlett-Packard Company makes no warranty as to the accuracy or completeness of the foregoing material and hereby disclaims any responsibility therefore. The coefficient of determination, symbolized by R 2, indicates the proportion of the variance of the forecast variable that is explained by the regression statistic. When given a choice between two or more regression statistics, the manager should select the statistic that maximizes the coefficients of determination. The causal variables in regression may include time, leading economic indicators, demographic factors, or any other variables that might exhibit a causal relationship with the forecast variable. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 320 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 14: Budgeting A measure of the statistical contribution of a causal variable to regression’s causal power is the beta coefficient, which indicates the relative importance of each of the causal variables in explaining or predicting changes in the forecast variable. In multiple regression, the manager can use beta coefficients to decide which causal variables to retain and which to exclude. The manager should be cautioned regarding one flaw in multiple regression: multicollinearity, which is the phenomenon that occurs when causal variables relate to each other in addition to the relationship to the forecast variable.5 ✓ 321 MINI-CASE STUDY Suppose that you are the new chief executive officer at Memorial Hospital. Memorial is a nonprofit hospital with 300 beds and is located in a busy metropolitan area directly adjacent to a large university. Memorial is the only hospital within a 20-mile radius of campus, but construction on a new, competing hospital has just started within 5 miles. Identify three forecast content items. How will they be measured? What is the expected status of the content items in the future? Which forecasting techniques should you use? Why? Time-Series Methods The manager may use time-series methods when the past behavior of a variable is available to predict the future behavior of the variable. Time-series methods do little to account for causal relationships; rather, they attempt to identify historical patterns that are likely to be repeated in the future. The manager may use regression for long-term forecasts and time-series methods for forecasts of less than one year. Many series of data collected over time will exhibit trend, seasonal, cyclical, horizontal, and random patterns. A trend pattern exists when the value of the variable consistently increases or decreases over time. A seasonal pattern exists when the value of the variable fluctuates according to a seasonal influence, such as hour of the day, day of the week, week of the month, or month of the year. A cyclical pattern is similar to a seasonal pattern; however, the length of each cycle is longer than one year and cycles vary in length. A horizontal pattern exists when the variable’s value does not change over time. A random pattern exists when the variable’s value changes, but in no predictable way (Berenson and Levine 1993). After preparing the forecast content, the manager must prepare the forecast rationale, which is an explanation of how the situation will evolve from its current state to its forecasted state. The forecast rationale clarifies the result of the forecasting process, provides a basis for evaluating the forecasting process, and provides a basis from which future forecasts can be made (Reeves, Bergwall, and Woodside 1984). S t e p 15: C o n v e rt V o l u m e s i n t o R e v e n u e s The fifteenth step in the corporate planning process—the second step in the budgeting stage—is to convert volumes into patient revenues. Managers must consider whether the organization should budget revenues before or after the expense budget is completed. EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 321 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 322 cost-led pricing Setting prices after costs have been projected. price-led costing Reducing costs after prices, or effective prices (i.e., collections), have been determined by the payers. Introduction to the Financial Management of Healthcare Organizations Historically, healthcare organizations have determined their expense budgets first and then set rates in their revenue budgets to cover the expenses, which is called cost-led pricing. However, healthcare organizations that are facing increasing proportions of fixed payment arrangements, such as prospective payment and premium payment (which essentially dictate the rate to the organization), may decide to calculate revenue first, which is called price-led costing. The organization then must adjust expenses to match the projected patient revenues. To project gross patient services revenues, projected production units are classified by payer and then multiplied by the projected charge that, at this point, usually includes a projected increase. Next, net patient services revenue is determined by deducting contractual allowances and charity care allowances and bad debt, if the organization recognizes significant portions of patient revenues at the time of service, even though the organization does not assess the patient’s ability to pay at time of service. To project total revenues from operations, net patient services revenue is added to premium revenue, other revenue (e.g., parking, catering), and net assets released from restrictions and used for operations. Other projected changes in net assets that would be reported at the bottom of the statement of operations may also be available for operations (see the “Statement of Operations” section in chapter 3). S t e p 16: C o n v e rt V o l u m e s i n t o E x p e n s e R e q u i r e m e n t s staffing mix The proportional combination of fulltime, part-time, and temporary employees in a department. skill mix The proportional combination of particular skilled positions in a department. The sixteenth step in the corporate planning process—the third step in the budgeting stage—is to convert volumes into expense requirements: labor expense with benefits, nonlabor expense, and overhead expense. Department managers should have budget histories that indicate labor expense with benefits per production unit. They should also have budget histories for nonlabor expense per production unit, which includes supplies, travel, and repairs. The budget director should have budget histories for overhead expense for the organization. Department managers should review the labor expense with benefits per production unit to determine whether they can reduce expenses. Senior management determines the benefits package (approximately 32 percent of wages for a full-time employee),6 but department managers can reduce benefit expenses by using part-time and temporary workers. Part-time employees usually receive benefits in proportion to the number of hours worked (approximately 16 percent of wages for a half-time employee), and temporary workers usually receive only the benefits required by law (approximately 12 percent of wages). Department managers must decide on the appropriate mix of full-time, part-time, and temporary workers. Part-time and temporary workers are less expensive to the department manager, but continuity of patient care may suffer if the manager uses too many part-time and temporary workers. Many department managers staff their minimum needs with full-time workers, moderate needs with part-time workers, and maximum needs with temporary workers (see exhibit 14.1). Staffing mix is the proportional combination of full-time, part-time, and temporary workers and should be reviewed by the department manager; department skill mix, which EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 322 Account: s3642728 5/17/17 10:58 AM 323 Exhibit 14.1 Staffing Mix Temporary workers Production Units Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 14: Budgeting Part-time workers Full-time workers Time is the proportional combination of skilled positions, should also be reviewed by managers. Most departments have a variety of tasks requiring a variety of skills performed by a variety of positions paid a variety of wages. The department manager’s job is to match the tasks to the positions in the most cost-effective manner possible. After the department managers have reviewed staffing mix and skill mix and have made any necessary changes, they must consider the effect of employee raises on their expense budget. The budget committee should provide department managers with information regarding cost-of-living raises, merit raises, and bonuses. Cost-of-living raises are designed to protect employees from inflation by increasing pay in proportion to the rate of inflation. The use of these raises is declining because inflation has been low and employee spending is not all inflation prone. However, if the organization uses a cost-of-living raise, the raise is administered to all employees at the same time. The effect of cost-of-living raises on the department budget depends on the effective date of the raise. For instance, if the effective date is the first day of the new budget year, the department budget will realize the full effect of the raise. If the effective date of the raise is three months into the new budget year, the department will realize 75 percent of the effect of the raise. Merit raises are designed to motivate employees toward, and reward employees for, meritorious performance. Merit raises as a motivator are dependent on the amount of the raise and the likelihood that superiors will judge performance as meritorious. Merit raises are expensive for organizations because the amount of the raise is built into the employee’s base pay for future years. Organizations typically give merit raises in conjunction with employee performance appraisals on employment anniversaries. Assuming that employment anniversaries occur in equal distribution throughout the year, the effect on the department budget will be 50 percent of the EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 323 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 324 Introduction to the Financial Management of Healthcare Organizations total amount for merit raises, and the budget should be adjusted accordingly. For instance, if the department manager can give 5 percent raises to meritorious employees on their employment anniversaries, and all the department’s employees are meritorious, the annual effect on the department will be 2.5 percent, assuming that 50 percent of the employment anniversaries are in the first half of the budget year and 50 percent of the employment anniversaries are in the second half of the budget year. Bonuses are designed to motivate employees in much the same way as merit raises. However, using bonuses as a motivator is dependent on the amount of the bonus, the likelihood that superiors will judge performance “bonus-worthy,” and the proportion of employees receiving the bonus. For instance, if all employees receive bonuses, motivation resulting from the bonus will be low because everyone receives a bonus. If 1 out of 100 employees receives a bonus, motivation will be low because the chance of being rewarded for bonus-worthy performance is low. However, if 1 out of 7 employees receives a bonus, motivation as a result of the bonus will be maximized because the chances of receiving a bonus are realistic. Organizations typically award bonuses at the end of the budget year, and the funds come from the organization, not the department; budgeting the effect of bonuses, therefore, is relatively easy. After budgeted department wages have been adjusted for changes in staffing mix, skill mix, and employee raises, department managers multiply the budgeted wages and benefits per production unit by the number of production units projected for the budget year to determine the total budgeted wages and benefits for the department. Department managers should have budget histories that indicate nonlabor expense per production unit and should review those figures to determine whether they can reduce expenses. Managers should review supply use to ensure that generic supplies are used whenever possible. The pharmacy manager should provide information on the use of generic medicines and work with the pharmacy committee to maintain a formulary with as many generics and as few brand-name pharmaceuticals as possible. The pharmacy manager should also establish security measures to ensure that narcotics are secure. Department managers should review travel expenses and bring training programs to the organization whenever possible to reduce travel expense. Department managers should review repair expense and maintenance agreements, and replace equipment when feasible. The manager of materials management should provide department managers with an estimate of anticipated cost increases in supplies, repairs, and travel as a result of contract renewals or inflation. After department managers have reduced nonlabor expense wherever possible, department managers multiply the nonlabor expense per production unit by the number of production units projected for the budget year to determine the total budgeted nonlabor expense for the department. Largely, overhead expenses for the organization (such as depreciation, heating and cooling, insurance premiums, and so on) do not fluctuate with production units. Therefore, EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 324 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 14: Budgeting 325 the budget committee determines the overhead expenses for the budget year after reviewing historical data to determine whether adjustments are necessary. S t e p 17: A d j u s t R e v e n u e s a n d E x p e n s e s a s N e c e s s a ry The seventeenth step in the corporate planning process—the fourth and final step in the budgeting stage—is for the budget committee to determine whether budgeted net revenues are adequate to cover budgeted expenses. If budgeted expenses exceed budgeted net revenues, the budget committee may recommend to executive management ways to generate additional revenues or ways to reduce expenses. To cover the budget shortfall, executive management must decide whether to generate additional revenues and consider the possible effect of such action on expenses; whether to reduce expenses and consider the possible effect on quality and patient access; or whether to release funds from unrestricted net asset accounts to cover the loss. E va l uat i n g B u d g e t P e r f orm a nce The governing body of the organization should review the budget annually and evaluate the chief executive officer (CEO) on the basis of organizational compliance with the budget. Likewise, the CEO should review senior management quarterly and evaluate senior managers based on divisional compliance with the budget. Senior management should review department managers monthly and evaluate departmental compliance with the budget. The most common method of evaluating budget performance is variance analysis, which compares budgeted production units, revenues, and expenses to actual production units, revenues, and expenses, typically monthly. Labor variance analysis, including hours and expense, may be completed every two weeks in conjunction with payroll. The variance is the amount of the difference between the actual and budgeted amount: variance analysis An examination of the differences (variances) between budgeted and actual amounts. Variance analysis Variance = Actual – Budgeted requires managers to For production units and revenue, positive variances are favorable and negative variances are unfavorable: and actual amounts do explain why budgeted not match. Revenue variance = Actual revenue – Budgeted revenue For expenses, negative variances are favorable and positive variances are unfavorable: Expense variance = Actual expense – Budgeted expense EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 325 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. 326 Introduction to the Financial Management of Healthcare Organizations Variance analysis ensures accountability by requiring the managers who are responsible for the variances to explain why the variances occurred and what actions are being taken to ensure that favorable variances resume and negative variances do not recur. After the budget has been reviewed and approved, the healthcare organization can enter the capital budgeting stage of the corporate planning process, which will be discussed in chapter 15. To recap the budgeting discussion in the present chapter, exercise 14.1 demonstrates the budgeting steps in a radiology department. * EXERCISE 14.1 Budgeting Exercise The radiology department is developing a budget for DRG 250: Fracture, Sprain, Strain, and Dislocation of Forearm, Hand, and Foot. This year the department saw 1,100 admissions for DRG 250 analyzed in the following way: 50 percent of the admissions were for a hand X-ray (which takes 5 minutes), 20 percent for a foot X-ray (which takes 15 minutes), and 30 percent for a forearm X-ray (which takes 30 minutes). The budget committee is projecting a 9.1 percent increase in DRG 250 for next year, analyzed in the same proportions. The controller states that the charges for a hand X-ray will be $75, for a foot X-ray will be $285, and for a forearm X-ray will be $450. The controller also projects the payer analysis for DRG 250 to be 45 percent Medicare (DRG rate is 80 percent of charges), 35 percent Medicaid (DRG rate is 85 percent of charges), 15 percent managed care (discount is 30 percent of charges), and 5 percent self-pay (self-pay patients pay full charges, but 10 percent of self-pay patients don’t pay their bills and their fees are recorded as charity care). DRG 250 accounts for 25 percent of the radiology department’s labor, supply, and overhead expenses. The department’s labor expenses are $225,000—labor expenses are expected to increase 5 percent next year due to raises. The department’s nonlabor expenses are $185,000—nonlabor expenses are expected to increase 6 percent next year due to inflation. The department’s overhead expenses are $375,000—overhead expenses are not expected to increase next year. Using the budgeting steps, calculate the volumes, collected revenues, expenses, and adjustments for DRG 250 in the radiology department. Step 14: Project Volumes 1. Calculate the current volume for each X-ray procedure. Procedure Admissions Volume Hand X-ray 1,100 × .50 550 Foot X-ray 1,100 × .20 220 Forearm X-ray 1,100 × .30 330 EBSCO Publishing : eBook Academic Collection (EBSCOhost) – printed on 1/15/2023 8:53 PM via TRIDENT UNIVERSITY AN: 1839058 ; Michael Nowicki.; Introduction to the Financial Management of Healthcare Organizations, Seventh Edition 00_Nowicki (2339) Book.indb 326 Account: s3642728 5/17/17 10:58 AM Copyright © 2018. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted under U.S. or applicable copyright law. Chapter 14: Budgeting * 327 EXERCISE 14.1 Budgeting Exercise (continued) 2. Convert the current volumes to RVUs. Procedure Minutes/ * GCD Minutes RVUs/ Procedure Volume Total RVUs 1 550 550 Hand X-ray 5 5/5 Foot X-ray 15 15/5 3 220 660 Forearm X-ray 30 30/5 6 330 1,980 3,190 * GCD = greatest common denominator 3. Calculate the projected volume for each X-ray procedure (1,100 DRG 250 × 1.091 increase = 1,200 DRG 250). Procedure Admissions Volume Hand X-ray 1,200 × .50 600 Foot X-ray 1,200 × .20 240 Forearm X-ray 1,200 × .30 360 4. Convert the projected volumes to RVUs. RVUs/ Procedure Volume Total RVUs Hand X-ray 5 5/5 1 600 600 Foot X-ray 15 15/5 3 240 720 Forearm X-ray 30 30/5 6 360 Procedure Minutes Minutes/ GCD 2,160 3,480 Step 15: Convert Projected Volumes into Projected Revenues 1. Calculate projected gross and net revenues by payer. Medicare Projected Charge Projected Volume % Gross Revenue …

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