What Elements Drive Continuous Improvement Projects Success in Healthcare Discussion

Module Overview #3
Health care organizations are mandated by federal regulations to make
meaningful use of health information technology which is translated into the
application of health information systems, processes, and resources. Such
application of health information systems is intended to improve patient
outcomes, reduce cost, and enhance efficiency.
When implementing a healthcare information system for a medical clinic, here are
some of the lessons learned: (a) The data must be migrated intact; (b) proper
training is essential for all staff members; (c) security concerns must be
addressed for all stakeholders, and (d) third-party personnel must stay engaged
until the new systems is working per expectations.
Mobile technology in the healthcare industry enables the healthcare professionals
to offer service when and wherever needed; they also get timely and secure
access to the critical information.
Discussion #3: Impact of Technology in Healthcare
The integration of technology into health care has afforded many benefits, but also
has created many challenges. Health information has bridged gaps in access,
communication, and patient outcomes. Oppositely, health information has shifted
health care delivery to be non-traditional, created challenges with security of
information, and adoption. The advancement of technology is rapid and being
implemented into the health care sector as soon as developments are approved.
While forward advancement is advantageous, it is important that health care
leaders continuously monitor complications to ensure they do not negatively
impact patient care and out weight the benefits to health care delivery.
For this discussion:
1. Discuss how technology has influenced the evolution of the health care
industry.
2. Describe three advantages (benefits) of technology in health care and three
disadvantages (challenges) of health care technology.
3. As a leader of a health care organization, what are key some factors that
should be considered when incorporating and implementing new technology
into the facility?
Discussion Assignment Expectations
•
•
Support discussion ideas with peer-reviewed material garnered from at least one
scholarly article.
When applicable, provide references and citations in APA Style.
Reading Requirement:
The 7 Categories of Healthcare Information
Technology https://selecthub.com/medical-software/7-categories-healthcareinformation-technology/
The Importance of Health Information Technology in Developing
Areas https://openmrs.org/2017/07/the-importance-of-health-information-technology-indeveloping-areas/
The 7 Categories of Healthcare Information
Technology https://selecthub.com/medical-software/7-categories-healthcareinformation-technology/
The Importance of Health Information Technology in Developing
Areas https://openmrs.org/2017/07/the-importance-of-health-information-technology-indeveloping-areas/
Module Overview
In this final Module, we’ll walk through the various components of resource
allocation in the healthcare environment. Given the competition that exists in the
current healthcare market as well as the volatility in the economic market,
planning and budgeting are critical for survival. Strategic planning briefly comes
into play here, as the strategic plan will provide the starting point for your
operating plan and budget.
After reviewing the financial side of strategic planning, the financial side of
operational planning will be reviewed. Operational planning allows us to translate
the organization’s strategic plan into our yearly objectives – which are essential
to be aware of to be able to take steps towards consistently accomplishing. We
will then cover budgeting in the healthcare environment, which is the expression
of the operating plan in monetary terms. Budgeting and related financial skills
are necessary skills for all healthcare managers to possess, if they are to
effectively administer in their respective areas. They must understand and
appreciate the relationships between volume, expense, and revenue. They must
be able to identify appropriate measures of cost-containment in their particular
setting. For many healthcare settings, it is that hands-on, intimate knowledge of
the details of the setting that defines the operations and drives the costs –
details such as service utilization statistics, seasonal trends, demographic
shifting, staffing models, productivity analysis, supply alternatives, inventory
management, make/lease/buy options, physician practice patterns, political
factors, and rate setting.
With healthcare costs and transparency at the center of public debate, and with
prospective payment limiting the ability of healthcare providers/organizations to
simply raise their rates to cover their expenses, current and future healthcare
managers must find ways to accomplish more work with fewer resources. Each
of these items will be addressed in the background readings, and your skills in
these areas will be developed.
This last Module closes with a look to the near-future of healthcare reform, and
what this means in both financial and economic terms. From access, to cost, to
quality of care – where have we come from, and where are we headed? This
type of hindsight and foresight is invaluable as you use your new skills to fulfill
today’s healthcare management positions.
Discussion #2 : Healthcare Financial Reform Trends – What Do We Need to Know?
Using the required background readings and some independent research in peer-reviewed
sources, please summarize one of the recent healthcare financial trends and/or new pieces
of legislation that will affect future healthcare managers. Present a concise su mmary of the
trend and/or new piece legislation, and discuss its specific financial and economic impact in
200 words. Be as specific as you can in your response, using peer-reviewed sources to
support your summary (not opinions).
Please read attached files name as Discussion #1 Reading
CHAPTER 13
STRATEGIC AND OPERATIONAL
PLANNING
One fundamental misperception is that strategic planning outside of healthcare (in
for-profits) is financially driven, but in not-for-profit healthcare it isn’t because we’re
not sophisticated. The reality is that although there is more financial integration
with strategic planning outside of healthcare, it’s not the case that “they do it right”
and “we don’t.” And healthcare organizations are making good progress in linking
financial planning and strategic planning and closing whatever gap that may still
exist.
Copyright © 2017. Health Administration Press. All rights reserved.
Alan Zuckerman (2007), healthcare industry strategist
Learning Objectives
After completing this chapter, you should be able to do the following:
➤➤ Define and understand the importance of planning
➤➤ Identify the prerequisites to the planning process
➤➤ Explain the types of planning
➤➤ Compare and contrast strategic and operational planning
➤➤ List in order and explain each step in the planning process
➤➤ Discuss the methods used to evaluate the planning process
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I n t r o d uc t i o n
Everyone agrees that planning—especially strategic planning—is critical for economic
survival in today’s turbulent environment. However, planning is a management function
often neglected by healthcare managers. In a 2006 survey of 138 Texas hospitals, 13 percent
did not have a strategic plan; for the hospitals that did have a strategic plan, 50 percent
did not delegate the responsibility for the plan to the chief executive officer (CEO). The
average board member involvement was rated at 4.86 on a 7.0 scale. All three characteristics—existence of a strategic plan, delegation of plan responsibilities to the CEO, and
board member involvement in the development of the strategic plan—had a statistically
significant effect on higher financial performance (Kaissi and Begun 2008).
D e f i ni t i o n o f P lanning
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Planning as a management function is the process of deciding in advance what must be
done in the future. Planning consists of establishing the goals, objectives, policies, procedures, methods, and rules necessary to achieve the purposes of the organization. Planning
precedes, and serves as a framework for, the other management functions of organizing,
staffing, influencing, and controlling. Effective planning is a continuous process; managers
are responsible for planning for the appropriate use of resources in their areas of responsibility in concert with the operational and strategic direction of the organization. In the
absence of effective planning, managers would engage in random activities. In healthcare
organizations where customers demand a high degree of predictable outcomes, such random
activities on the part of managers would have a disastrous effect (Dunn 2016).
P r e r e q u is i t e s t o P la nn i ng
As described in the classic text by Berman, Kukla, and Weeks (1994), before effective planning can begin, the organization must meet certain requirements. First, the organization
must have a sound organizational structure that ensures management accountability for
the planning process. Second, the organization must have a well-defined chart of accounts
that corresponds with the organizational structure. Third, the organization must have a
prompt and accurate accounting system that ensures financial accountability for the planning
process. Fourth, the organization must have a comprehensive management information
system that captures nonfinancial information for each department.
T y p e s o f P l an ni ng
Planning can be classified by the three characteristics of planning horizon, management
approach, and design characteristics.
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297
Planning Horizon
Planning horizon is the length of time management is looking into the future. Strategic
plans look three to ten years into the future. Operating plans look one year into the future.
planning horizon
The length of time
management is looking
into the future.
M a n a g e m e n t A pp r o a c h
Planning can also be classified by management approach, or top-down versus bottom-up
planning. These approaches correspond closely with top-down and bottom-up budgeting,
to be discussed in chapter 14. In top-down planning, senior management, which includes
the division heads or vice presidents, develops the plan with little or no input from subordinates. The advantage of such a design is that senior management may be in the best
position to objectively view the future. The disadvantage of the top-down design is that
plan implementation may be difficult if subordinates have little or no input.
In bottom-up planning, subordinates develop the plan and submit it to senior management for approval. The advantage to bottom-up planning is the commitment to the
plan by those who developed it. The disadvantage is that subordinates may not be in the
best position to view the future.1
In most cases, a combination of the top-down and bottom-up designs is used, with
senior management deciding on plan parameters and subordinates submitting plans within
those parameters.
D e s i g n C ha r a c t e r i s t i c s
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Planning can also be classified by design characteristics, which also correspond closely with
the design characteristics of budgeting, as will be discussed in chapter 14.
incremental planning
Planning only for
Incremental Versus Zero-Base Planning
Incremental planning requires planning only for changes, such as new equipment, new
positions, and new programs. Incremental planning 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 are
the ease of incremental planning, the minimal time commitment required to plan, and
the support of a larger organizational culture. The principal disadvantage of incremental
planning is the assumption that all current operations are essential in a healthcare environment that is changing so rapidly.
Conversely, zero-base planning takes nothing for granted and requires rejustification
for existing equipment, positions, and programs, as well as justification for new equipment,
positions, and programs. Therein lies the principal advantage of zero-base planning: In
changes, such as
new equipment.
The assumption in
incremental planning is
that current operations
are already optimal.
zero-base planning
Planning that requires
all operations to be
justified anew; nothing
is assumed to be
already optimal.
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a rapidly changing environment where reimbursement is moving away from cost-based
approaches toward prospective payment per case or per enrollee, zero-base planning can
eliminate unnecessary programs and improve operations. Disadvantages include the large
time commitment required, employee fear and anxiety, and significant administrative and
communication requirements (Person 1997).
Comprehensive Versus Limited-in-Scope Planning
Comprehensive planning integrates the strategic plan and the operational plan into one
document. The advantage is the recognition that short-term objectives affect long-term
goals. Limited-in-scope planning segregates the plans. Most organizations integrate the plans
at the board and executive management level of the organization, but the issue is the level
at which the plans should be segregated.
Fixed Versus Flexible Plans
Fixed plans assume that volumes, and related revenues and variable expenses, remain constant during the year. Fixed plans 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 plans take into account fluctuations in volumes, at least within
ranges expressed as probabilities, and adjust variable expenses accordingly.
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Discrete Versus Continuous Plans
corporate planning
A business planning
Discrete plans apply to a fixed period of time, usually a year. At the end of the year, a new
plan begins. Discrete plans are relatively easy to prepare, but it can be difficult to plan things
in 12-month increments because circumstances often change. Furthermore, discrete plans
can be challenging to some managers who know that if they exceed objectives at the end
of the year, they will receive new, more rigorous objectives for the coming year. Continuous
plans, sometimes referred to as rolling plans, are updated continuously so that year end never
occurs. Department managers who manage wisely roll over their efforts to the next month.
approach based on
market needs. It
consists of four major
stages: strategic
planning, operational
planning, budgeting,
and capital budgeting.
C o r p o r at e P l ann ing
Most healthcare organizations have moved away from facility planning—planning based
on their own needs—which was popular under retroactive, cost-based reimbursement.
They have instead adopted a business planning approach based on market needs, called
corporate planning. Corporate planning consists of four major stages (see exhibit 13.1):
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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.
Copyright © 2017. Health Administration Press. All rights reserved.
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.
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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
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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.
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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
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◆◆ 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
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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
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◆◆ 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
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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
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◆◆ 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
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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
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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
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◆◆ 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
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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
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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)?
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◆◆ 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:
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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
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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.
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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.
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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.
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◆◆ 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.
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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:
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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.
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➤➤ 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.
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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?
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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.
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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
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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
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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.
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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):
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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
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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).
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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.
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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
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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
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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.
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◆◆ 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).
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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.
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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.
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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
Copyright © 2017. Health Administration Press. All rights reserved.
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)
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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
Copyright © 2017. Health Administration Press. All rights reserved.
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.
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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?
Copyright © 2017. Health Administration Press. All rights reserved.
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.
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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).
Copyright © 2017. Health Administration Press. All rights reserved.
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
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Chapter 14: Budgeting
323
Exhibit 14.1
Staffing Mix
Production Units
Temporary workers
Part-time workers
Full-time workers
Copyright © 2017. Health Administration Press. All rights reserved.
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
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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,
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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.
Copyright © 2017. Health Administration Press. All rights reserved.
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
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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).
Copyright © 2017. Health Administration Press. All rights reserved.
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
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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
Copyright © 2017. Health Administration Press. All rights reserved.
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
Rate
Net
Revenue
Hand X-ray
$75
600
.45
$20,250
.80
$16,200
Foot X-ray
285
240
.45 30,780
.80
24,624
Forearm X-ray
450
360
.45 72,900
.80
Procedure
$123,930
58,320
$99,144
(continued)
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328
Introduction to the Financial Management of Healthcare Organizations
*
EXERCISE 14.1
Budgeting Exercise (continued)
Medicaid
Projected
Projected
Charge
Volume
%
Revenue
Rate
Revenue
Hand X-ray
$75
600
.35
$15,750
.85
$13,388
Foot X-ray
285
240
.35 23,940
.85
20,349
Forearm X-ray
450
360
.35 56,700
.85
Procedure
Gross
Net
48,195
$96,390
$81,932
Managed Care
Projected
Projected
Charge
Volume
%
Revenue
Rate
Revenue
Hand X-ray
$75
600
.15
$6,750
.70
$4,725
Foot X-ray
285
240
.15
10,260
.70
7,182
Forearm X-ray
450
360
.15
24,300
.70
Procedure
Gross
Net
17,010
$41,310
$28,917
Self-Pay
Copyright © 2017. Health Administration Press. All rights reserved.
Procedure
Projected
Projected
Charge
Volume
%
Revenue
Gross
Rate
Revenue
Net
Hand X-ray
$75
600
.05
$2,250
.90
$2,025
Foot X-ray
285
240
.05
3,420
.90
3,078
Forearm X-ray
450
360
.05
8,100
.90
7,290
$13,770
$12,393
Total
$275,400
$222,386
Step 16: Convert Projected Volumes into Projected Expense Requirements
1. Calculate current expenses per RVU.
$225,000 × .25 = 56,250 / 3,190 = 17.63 labor expense/RVU
185,000 × .25 = 46,250 / 3,190 = 14.50 supply expense/RVU
375,000 × .25 = 93,750 / 3,190 = 29.39 overhead expense/RVU
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Chapter 14: Budgeting
*
329
EXERCISE 14.1
Budgeting Exercise (continued)
2. Calculate projected expenses per RVU.
Projected labor expense
= 17.63 + 5%
= 18.51
Projected supply expense
= 14.50 + 6%
= 15.37
Projected overhead expense
= 29.39 + 0%
=
Total
29.39
$63.27
3. Calculate projected expenses per procedure.
Procedure
Projected
RVUs
Projected
Expense/RVU
Total Projected
Expense
$63.27
$37,962
Hand X-ray 600
Foot X-ray 720 63.27 45,554
Forearm X-ray
2,160 63.27
Total
136,663
$220,179
Step 17: Adjust Revenues and Expenses as Necessary
1. Determine initial gain/loss.
Copyright © 2017. Health Administration Press. All rights reserved.
Net Revenues
$222,386
Expenses
220,179
Gain/(Loss)
$2,207
2. If the initial determination is a loss, first investigate whether collected revenues can
be increased through a rate increase or improvements in collection efforts. If collected revenues cannot be increased, investigate whether expenses can be reduced.
Usually this involves investigating variable labor expenses and reviewing the mix of
full-time to part-time to temporary as well as a review of skill mix. If collected revenues cannot be increased and expenses cannot be decreased, then management
must decide whether to continue the service at a loss and how that loss is going to
be covered by other profitable services.
Source: Neil Dworkin, PhD, Emeritus Associate Professor of Management, Western Connecticut
State University. Used with permission.
Nowicki, Michael. Introduction to the Financial Management of Healthcare Organizations, Seventh Edition, Health Administration Press, 2017. Pro…