Hospital Budget Steps

FORMULATING AND MANAGINGA HOSPITAL’S

CLINICAL CARE BUDGET:A TWELVE-STEP PROGRAM

THE CRIMSON GROUP, INC.

David W. Young, D.B.A.Professor of Management

Healthcare Management ProgramPublic and Nonprofit Management Program

Boston University School of Managementand

PrincipalThe Crimson Group, Inc.,Cambridge, Massachusetts

22 July 2004THE CRIMSON GROUP, INC.

Step 1. Define the Organizational StructureStep 2. Determine Cost Drivers and Controlling Forces

for Each DepartmentStep 3. Forecast Revenue from Clinical Care

DepartmentsStep 4. Define Clinical Pathways and Step-Function &

Fixed Costs for Clinical Care DepartmentsStep 5. Determine Variable Cost per Resource UnitStep 6. Estimate Service Department Step & Fixed CostsStep 7. Calculate Variable Cost per Case TypeStep 8. Compute the Surplus (Deficit) for Each Clinical

Care DepartmentStep 9. Compute Contribution to Hospital OverheadStep 10. Estimate Administrative Service CostsStep 11. Compute Hospital’s Clinical Surplus (Deficit)

THE FIRST ELEVEN STEPSOne-Time

One-Time

Annual

One-Timeplus Annual

Updates

Annual Updates

FormulaDriven

FormulaDriven


Step 1.Define the Organizational Structure

Hospital

AdministrativeService

Departments PatientService

Departments Clinical Service

Departments Clinical

CareDepartments

BillingFiscalLegal

Development

DietaryLaundry

HousekeepingPlant MaintenanceMedical Records

RadiologyPathology

AnesthesiologyPharmacy

Social Services

SurgeryMedicineOb/Gyn

PediatricsEmergency


Step 2.Determine Cost Drivers and Controlling

Forces for Each Department


Departments

PatientService

Departments

Clinical Service

Departments

ClinicalCare

Departments

Billing Bill Admission

Examples Cost Driver Controlling Force

Legal Hour Request

Dietary Meal Day of careLaundry Pound Day of CareMedical Records Record Admission

Radiology Procedure MD OrderPathology Test MD OrderPharmacy Prescription MD OrderSocial Services Hour MD Order

Surgery AdmissionMedicine Case (by DRG) AdmissionEmergency Case type Visit

Case (by DRG)

Clinical Care Department #nClinical Care

Department #2

Total RevenueDepartment #nTotal Revenue

Department #2

Clinical Care Department #1

Payer Mixand Prices

Budgeted RevenueDepartment #1

Case Type n Case Type BNumber of cases

of DRG A

Step 3.Forecast Revenue from Clinical Care

Departments


Forecasts Forecasts

Fiscal AffairsDepartment Fiscal AffairsDepartment


Step 4.Define Clinical Pathways and Step-Function& Fixed Costs for Clinical Care Departments

DepartmentalStep Function

and Fixed Costs

DRG nDRG B

DRG A

Average LOSRadiology procedures

Lab testsPharmacy

Etc.


Department #2Clinical Care Department #1

From Step 3

Budget

BudgetedClinicalPathways


Step 5.Determine Variable Cost per Resource Unit

PatientService

Departments Clinical Service

Departments

ServiceEfficiency Protocols

(e.g., minutes per medical record)

Wage rates andSupply unit costs

Variable cost perResource unit

ClinicalEfficiency Protocols

(e.g., minutes per x-ray)

Wage rates andSupply unit costs

Variable cost perResource unit

BudgetedAmounts

Step 6.Estimate Service Department Step-Function

and Fixed CostsEach Patient

servicedepartment

Each Patientservice

department

Each clinical service

department Each clinical

servicedepartment

Service Need Forecasts(e.g., number of meals, pounds oflaundry, hours of housekeeping)

Step-function andfixed costs needed to

meet needs

Service Need Forecasts(e.g., number of x-rays, lab tests,

pharmacy requests)


meet needs

Fixed cost budgetfor department #nFixed cost budget

for department #2Step and fixed cost budgetfor department #1



BudgetedAmounts


Budgetedvariable cost

For DRG nBudgeted

variable costFor DRG B

Step 7.Calculate Variable Cost per Case Type

Patientservice

departments Clinical service

departments

Variable cost perresource unit

Variable cost perresource unit

Average LOSRadiology procedures

Lab testsPharmacy

Etc.

Budgetedvariable costfor DRG A



Department #nClinical Care Department #2Clinical Care Department #2Clinical Care

Department #1Clinical Care Department #1

From Step 5

From Step 4

Case Type n Case Type BNumber of cases

of DRG A

Step 8.Compute the Surplus (Deficit) for Each

Clinical Care Department


Minus total step functionand fixed costs

for Department #n Minus total step function

and fixed costsfor Department #2

Minus total step functionand fixed costs

for Department #1


For DRG nBudgeted

variable costFor DRG B

Budgeted variable costFor DRG A

Minus total budgeted variable costs for

Department #n Minus total budgeted

variable costs forDepartment #2

Minus total budgetedvariable costs forDepartment #1

Equals Department #n’s contribution to hospital’s

surplus (deficit) Equals Department #2’s

contribution to hospital’s surplus (deficit)

Equals Department #1’s contribution to hospital’s

surplus (deficit)

From Step 7

From Step 4

From Step 3

Total RevenueDepartment #n

Total RevenueDepartment #2

Budgeted RevenueDepartment #1


for department #2Step and fixed cost budget

for patient service department #1


for department #2Step and fixed cost budget

for clinical servicedepartment #1

Total contribution fromclinical care departments

Minus step and fixed costsof clinical service

departments

Minus step and fixed costs of patient service

departments

Equals contributionto hospital’s administrative

service departments

Department #n’s contribution to hospital’s

surplus (deficit) Department #2’s

contribution to hospital’s surplus (deficit)

Department #1’s contribution to hospital’s

surplus (deficit)

Step 9.Compute Contribution to Hospital Overhead


From Step 8


for department #2


Step 10.Estimate Administrative Overhead Costs

Each administrativeservice

department Each administrative

servicedepartment

Approximate level of activity(e.g., number of legal matters,

personnel actions, financial reports)


meet needs

Step and fixed cost budgetfor department #1

Step 11.Compute Hospital’s Clinical Surplus (Deficit)


Contributionto hospital’s administrative

service departments



Minus total administrative

costs

Equals hospital’ssurplus (deficit)

From Step 10

From Step 9

Minus total administrativeService costs

Equals hospital’ssurplus (deficit)

Minus Departmental step functionand fixed costs

Equals Department’scontribution to hospital’s

surplus (deficit)

Approximate level of activity

Step-function and

fixed costs


Departments

PatientService

Departments

Clinical Service

Departments

ClinicalCare

Departments

Budgeted Revenue

Payer Mixand Prices

Number & type of cases

Average LOSRadiology proceduresLab tests

Pharmacy Etc.

DepartmentalStep Function

and Fixed Costs


Per DRG

Minus step and

fixed costs

Minus step and

fixed costs

Equals contributionto hospital’s administrative

service departments

ServiceEfficiency Protocols

Wage rates and supply unit costs

Variable cost per

resource unit

Service Need Forecasts

Step-and

fixed costs

ClinicalEfficiency Protocols

Wage rates and supply unit costs

Variable cost per

resource unit

Service Need Forecasts

Step-and

fixed costs

Minus totalbudgeted

variable costs

Transfer Prices



A SIMPLE EXAMPLECase Mix

DRG A DRG B DRG C DRG D TotalSTEP 3 FORECAST REVENUE

DEPARTMENT #1PAYER #1Forecast number of cases 60 200 100 50Expected revenue per case $7,350 $1,430 $2,020 $7,650Total Revenue $441,000 $286,000 $202,000 $382,500 $1,311,500PAYER #2Forecast number of cases 100 50 300 150Expected revenue per case $6,800 $1,500 $3,000 $7,400Total Revenue $680,000 $75,000 $900,000 $1,110,000 $2,765,000TOTAL REVENUE $4,076,500

STEP 4 DEFINE CLINICAL PATHWAYS AND STEP-FUNCTION AND FIXED COSTS FOR DEPARTMENTSTEP 4 A DEFINE CLINICAL PATHWAYS DRG A DRG B DRG C DRG D

Resources from Clinical Service Departments No. of patient days per case 10 5 6 12 No. of x-rays per case 5 1 2 3 No. of CBCs per case 10 5 3 12Resources from Patient Service Departments No. of meals per case 30 15 18 36 No. of pounds of laundry per case 15 7.5 9 18 No. of medical records per case 1 1 1 1

STEP 4 B STEP FUNCTION AND FIXED COSTS AT FORECAST VOLUME AND MIX Step-function costs (e.g., nursing) $1,000,000 Fixed costs (e.g. departmental administration) 1,500,000 TOTAL STEP AND FIXED COSTS AT ESTIMATED VOLUME AND MIX $2,500,000


STEP 5 DETERMINE VARIABLE COST PER RESOURCE UNITSTEP 5A CLINICAL SERVICE DEPARTMENTS DRG A DRG B DRG C DRG D

CLINICAL EFFICIENCY PROTOCOLS No. nursing minutes per patient day 60 40 50 40 No. technician minutes per x-ray 40 40 40 40 No. technician minutes per CBC 20 20 20 20 No. units of nursing supplies per patient day 10 3 5 8 No. units of supplies per x-ray 3 3 3 3 No. units of supplies per CBC 4 4 4 4WAGE RAGES AND UNIT SUPPLY COSTS Cost per minute for nurses $0.50 $0.50 $0.50 $0.50 Cost per minute for x-ray technicians $0.20 $0.20 $0.20 $0.20 Cost per minute for lab technicians $0.20 $0.20 $0.20 $0.20 Cost per unit for nursing supplies $3.50 $3.50 $3.50 $3.50 Cost per unit for x-ray supplies $5.00 $5.00 $5.00 $5.00 Cost per unit for CBC supplies $2.00 $2.00 $2.00 $2.00VARIABLE COST PER RESOURCE UNIT IN CLINICAL SERVICE DEPARTMENTS Patient day $65 $31 $43 $48 X-Ray $23 $23 $23 $23 CBC $12 $12 $12 $12

STEP 5B PATIENT SERVICE DEPARTMENTS DRG A DRG B DRG C DRG DSERVICE EFFICIENCY PROTOCOLS No. minutes per meal 10 10 10 10 No. minutes per pound of laundry 1 1 1 1 No. minutes per medical record 5 5 5 5 No. units of ingredients per meal 5 5 5 5 No. units of laundry supplies per pound 3 3 3 3 No. units of supplies per medical record 2 2 2 2WAGE RAGES AND UNIT SUPPLY COSTS Cost per minute for meals $0.25 $0.25 $0.25 $0.25 Cost per minute for laundry $0.15 $0.15 $0.15 $0.15 Cost per minute for medical records $0.30 $0.30 $0.30 $0.30 Cost per unit for dietary supplies $1.50 $1.50 $1.50 $1.50 Cost per unit for laundry supplies $0.30 $0.30 $0.30 $0.30 Cost per unit for medical record supplies $1.00 $1.00 $1.00 $1.00VARIABLE COST PER RESOURCE UNIT IN PATIENT SERVICE DEPARTMENTS Meals $10 $10 $10 $10 Laundry $1 $1 $1 $1 Medical Records $4 $4 $4 $4


STEP 6 ESTIMATE SERVICE DEPARTMENT STEP AND FIXED COSTS AT FORECASTED VOLUMESTEP 6A STEP FIXED TOTAL

Nursing $350,000 $700,000 $1,050,000 Radiology 250,000 800,000 1,050,000 Laboratory 320,000 600,000 920,000Total $3,020,000

STEP 6B STEP FIXED TOTAL Dietary $180,000 $600,000 $780,000 Laundry 100,000 400,000 500,000 Medical Records 150,000 300,000 450,000Total $1,730,000

STEP 7 CALCULATE VARIABLE COST/CASE DRG A DRG B DRG C DRG DFrom Clinical Service Departments Nursing $650 $153 $255 $576 Radiology 115 23 46 69 Laboratory 120 60 36 144From Patient Service Departments Dietary $300 $150 $180 $360 Laundry 16 8 9 19 Medical Records 4 4 4 4TOTAL VARIABLE COST PER CASE $1,204 $397 $530 $1,171

STEP 8 COMPUTE THE SURPLUS (DEFICIT) FOR EACH CLINICAL CARE DEPARTMENTRevenue $1,121,000 $361,000 $1,102,000 $1,492,500Minus Variable Costs 192,680 99,219 211,980 234,280Equals Contribution to Step and Fixed $928,320 $261,781 $890,020 $1,258,220 $3,338,341Minus Step and Fixed Costs 2,500,000Equals Contribution to Clinical and Patient Service Step and Fixed Costs $838,341

CLINICAL SERVICE DEPARTMENTS

PATIENT SERVICE DEPARTMENTS


STEP 9 COMPUTE CONTRIBUTION TO HOSPITAL OVERHEADContribution from Clinical Care Departments (assumes 10 with same contribution) $8,383,413Minus Step and Fixed Costs of Clinical Service Departments 3,020,000Minus Step and Fixed Costs of Patient Service Departments 1,730,000Equals Contribution to Hospital Overhead $3,633,413

STEP 10 STEP FIXED TOTAL Legal $250,000 $300,000 $550,000 Human Resources 300,000 600,000 900,000 Fiscal Affairs 300,000 850,000 1,150,000Total $2,600,000

STEP 11 COMPUTE HOSPITAL'S CLINICAL SURPLUS (DEFICIT)Contribution to Hospital Overhead ` $3,633,413Minus Estimated Administrative Costs 2,600,000Equals Hospital's Surplus (Deficit) $1,033,413

ESTIMATE ADMINISTRATIVE SERVICE COSTS

What if this is not enough?


Step 12.Fix It

Step 1. Define the Organizational StructureStep 2. Determine Cost Drivers and Controlling Forces

for Each DepartmentStep 3. Forecast Revenue from Clinical Care

DepartmentsStep 4. Define Clinical Pathways and Step-Function &

Fixed Costs for Clinical Care DepartmentsStep 5. Determine Variable Cost per Resource UnitStep 6. Estimate Service Department Step & Fixed CostsStep 7. Calculate Variable Cost per Case TypeStep 8. Compute the Surplus (Deficit) for Each Clinical

Care DepartmentStep 9. Compute Contribution to Hospital OverheadStep 10. Estimate Administrative Service CostsStep 11. Compute Hospital’s Clinical Surplus (Deficit)


Step 12.Fix It

Step 3. Forecast Revenue from Clinical CareDepartments

Step 4. Define Clinical Pathways and Step-Function &Fixed Costs for Clinical Care Departments

Step 5. Determine Variable Cost per Resource UnitStep 6. Estimate Service Department Step & Fixed Costs

Step 10. Estimate Administrative Service Costs

Cost Driver Option

Case Mix

Resources Per Case

Cost Per Resource Unit

Fixed Facility Costs

Volume

ConsequencesOPTIONS AND CONSEQUENCES

Reduce the incidenceor don’t treatcertain diagnoses

Treat certain case typeswith a more cost-effectivemix of resources

Provide resources in aless expensive way

Invest in lower costcapital, reducesize/salaries ofadministrative staff

Don’t treat all patientswith certain diagnoses

Morbidity may improve, or some patients will suffer and/or die prematurely.

More outpatient care andshorter lengths of stay inhospitals. Perhaps fewer testsand procedures.

Lower wages, lower supplyprices, greater efficiency.Result is fewer staff and/ordifferent skill mixes.

Less technology, feweradministrators, less qualifiedadministrators.

Some patients will sufferand/or die prematurely.


NUMBER OF CASES VERSUS COST PER CASE

LOW MODE HIGH OUTLIERS

NUMBEROF

CASES

COST PER CASE


NUMBER OF CASES VERSUS COST PER CASE

NUMBEROF

CASES

COST PER CASE

LOW MODE HIGH OUTLIERS


BUT

Example of New Inpatient Utilization Pattern

48 YEAR OLD PRESENTING WITH ATYPICAL CHEST PAIN,POSITIVE SMOKING AND FAMILY HISTORY, AND NORMAL EKG

CURRENT PATTERN

Admit to TelemetryALOS = 2.2 days

$2,800

Daily EKG x 3 $225

Enzymes andFull Bloods

$175

Cardiology Consult $150

Echo $350

Thallium Stress Test $450

$4,150TOTAL COST

OPTIONAL PATTERN

Admit to Observation UnitALOS = 23 hours

$1,000

EKG x 2 $150

Enzymes andLimited Bloods

$75

Cardiology Consult $150

Echo $350

Non-Thallium Stress Test $125

$1,850TOTAL COST

AT AN INCIDENCE RATE OF 5/1000, THE PURCHASERWOULD SAVE $3.5 MILLION ANNUALLY


THE PROBLEM:

THEIR COST SAVINGS AREYOUR REVENUE REDUCTIONS!


WHAT ARE THE IMPLICATIONS OF STEP 12FOR DEPARTMENTS OF PATHOLOGY?


WHAT HAPPENS, FOR EXAMPLE, WHEN THECLINICAL PATHWAY FOR ALL PATIENTS

WITH DRG AUSES LIMITED RATHER THAN FULL BLOODS?

OR WHEN THE PATHWAY FOR ALL PATIENTSWITH DRG B

CALLS FOR 2 RATHER THAN 5 CBCs?

BUT BUDGETING IS NOT ENOUGH.

ANYONE CAN BALANCE A BUDGETTHE HARD PART IS BALANCING THE

ACTUALS!

TO DO THAT YOU NEED AWELL-DESIGNED REPORTING

SYSTEM


SPENSER REHABILITATION HOSPITAL REPORTING HIERARCHY(In Thousands of Dollars)

For Month of June 2002

FIRST LEVEL REPORT: MACRO PROGRAM ANALYSISFor Board and Senior Management

Over or VARIANCE ANALYSIS

Actual (under) budget Contribution Margin

This Year This Year Revenue Revenue Expense Expense

Surplus (Deficit) Month to date Month to date Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost

Inpatient-Weberg $2,110 $12,030 $(315) $35

Inpatient - SRH 24,525 147,280 (710) (2,590) (50) (320) 150 (90) 60 (250) (150)

Outpatient 1,235 7,570 (125) (210)

Research 1,180 7,045 95 75

Education 3,590 18,960 (235) 245

Ambulance 4,120 25,175 160 (320)

Development 2,245 13,680 180 (160)

Administration 3,630 22,965 (70) (730)

Total direct $42,635 $254,705 $(1,020) $(3,655)

SECOND LEVEL REPORT: PRODUCT LINE ANALYSISFor Board and Senior Management

Over or VARIANCE ANALYSISInpatient - SRH Actual (under) budget Contribution Margin


Month to date Month to date Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost

Product Line Brain Injury $5,340 $35,845 $(625) $(1,380)

Spinal Cord Injury 3,310 19,605 (30) (620) (10) (50) 200 (100) 100 (50) (20)

Stroke Rehabilitation 3,115 18,085 90 (135)

Post-polio Rehabilitation 5,740 33,635 (65) (640)

Pediatric Rehabilitation 7,020 40,110 (80) 185

Total direct $24,525 $147,280 $(710) $(2,590)

(710)

(30)


SPENSER REHABILITATION HOSPITAL REPORTING HIERARCHY

(In Thousands of Dollars)For Month of June 2002

THIRD LEVEL REPORT: DRG ANALYSISFor Senior Management and Program Managers

VARIANCE ANALYSISSpinal Cord Injury Over or Contribution Margin

Actual (under) budget Revenue Revenue Expense Expense

This Year This Year Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit CostMonth to date Month to date

DRG 1 $895 $5,400 $119 $75 0 0 200 (150) 50 160 (91)DRG 2 1,030 7,000 176 (50)

DRG 3 760 4,500 (160) (350)

DRG 4 625 2,705 (165) (295) Total $3,310 $19,605 $(30) $(620)

FOURTH LEVEL REPORT: DRG ANALYSIS BY PHYSICIAN

For Program Managers and Physician ChiefsVARIANCE ANALYSIS

Spinal Cord Injury Over or Contribution Margin

Actual (under) budget Revenue Revenue Expense ExpenseThis Year This Year Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost

DRG 1 Month to date Month to date Physician 1 $245 $1,300 $(35) $(65) 0 0 150 (100) 50 (40) (45)

Physician 2 300 1,775 20 120 Physician 3 150 780 35 165

Physician 4 200 1,545 99 (145)

Total $895 $5,400 $119 $75 0 0 200 (150) 50 160 (91)


(35)

(40)

SPENSER REHABILITATION HOSPITAL REPORTING HIERARCHY(In Thousands of Dollars)For Month of June 2002

FIFTH LEVEL REPORT: PHYSICIAN ANALYSIS BY DRGFor Director of Medical Staff

Over or VARIANCE ANALYSIS Actual (under) budget Contribution Margin


Physician 1 Month to date Month to date Price Payer Mix Volume/Mix Volume/Mix Net Utilization Unit Cost

DRG 1 $245 $1,300 $(35) $(65) 0 0 150 (100) 50 (40) (45)

DRG 2 90 560 (25) (50)

DRG 3 75 350 (20) (80)

DRG 4 45 280 15 95

DRG 5 35 110 (5) (30)

Total $490 $2,600 $(70) $(130)Physician 2 Etc.

SIXTH LEVEL REPORT: DRG ANALYSIS BY PHYSICIAN AND COST CENTERFor Physician Chiefs and Physicians

UTILIZATION VARIANCE ANALYSIS BY DEPARTMENTSpinal Cord Injury Over or

DRG 1 Actual (under) budget Routine

This Year This Year Lab Rad Pharm. PT Care Other Total

Month to date Month to date

Physician 1 $245 $1,300 $(35) $(65) 10 (50) 20 50 (50) (20) (40)

Physician 2 300 1,775 20 120

Physician 3 150 780 35 165

Physician 4 200 1,545 99 (145) Total $895 $5,400 $119 $75


WHAT MIGHT A REPORTING SYSTEMWITH SOME OF THESE CHARACTERISTICS

LOOK LIKE IN A DEPARTMENT OFPATHOLOGY?

THAT’S THE ISSUE IN LOMITA HOSPITALTHE CRIMSON GROUP, INC.

• REPORTING HIERARCHY WITH DRILLDOWN CAPABILITY

• VARIANCES BETWEEN BUDGET ANDACTUAL RESULTS COMPUTED BY COSTDRIVER

• IDENTIFICATION OF INDIVIDUALS WHOHAVE RESPONSIBILITY

• PERFORMANCE COMPARED TO PEERS


PLEASE KEEP IN TOUCH

David W. Young

[email protected]

www.davidyoung.org

www.thecrimsongroup.net

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