Running Head: BUDGET MANAGEMENT ANALYSIS

Budget Management Analysis of Valley Medical Center Shari Spencer HCS/571 February 7, 2011 Debbie Vaughn

BUDGET MANAGEMENT ANALYSIS Budget Management Analysis

Valley Medical Center (VMC) is a publically owned healthcare network and in alignment with its mission and vision work toward managing its operations in a fiscally responsible way. VMC management uses careful planning and sound business practices to attempt to maintain a financially strong organization and ensure adequate funds to provide the needed healthcare to the community it serves (VMC, 2011). Effective financial control has a large impact on a hospital's bottom line. The cost variance of an operating expense is the amount of money that was actually spent on a specific expense compared to the actual budgeted amount for a specific period of time. The cost variance for an expense is figured by subtracting the actual expense from the budgeted cost of a specific expense item. According to Cleverley and Cameron (2007, p.354), cost variance analysis is of great potential importance to the health care industry. The use of cost variance analysis requires a system or method of setting standards used in the budgeting process and a related system of cost accounting. Cost variances can signal that a potential or actual problem exists in an organization and can also suggest or point to a possible cause. From a cost variance analysis management can explain why actual expense costs are different from the budgeted values. Looking at a variance analysis is a part of an organizations cost-control process also. Cost Variances of Actual VS Budgeted Expectations According to Cleverley and Cameron (2007) a cost variance analysis is the comparison of the actual amount spent on an expense for a specified period and a standard. For the purposes of looking at VMCs operating expenses, the standard will be the budgeted amount and the amount spent in the previous month. Cost variances for five expenses incurred during the month of November 2010 were

BUDGET MANAGEMENT ANALYSIS analyzed. The operating expenses analyzed were for salaries and wages, professional services, supplies, utilities, and bad debt. Table I: VMC Operating Expense Cost Variance Analysis Nov. 2010 Actual $13,610,86 6 $195,833 $13,610,86 6 $532,341 $3,913,262 Nov. 2010 Budgeted $13,997,84 1 $326,268 $13,997,84 1 $450,783 $2,758,374 Variance Nov. 2010 +$386,975 favorable +$130,435 favorable +$386,975 favorable -$81,558 unfavorable $1,154,888 unfavorable Year to Date Actual $149,723,91 0 $3,850,397 $44,406,399 $4,168,824 $27,487,996 Year to Date Budgeted $152,785,20 2 $4,787,096 $42,603,119 $4,958,610 $29,992,510

EXPENSES

Year to Date Variance +$3,061,292 favorable +$936,699 favorable -$1,803,280 unfavorable +$789,786 favorable +$2,504,514 favorable

Salaries & Wages Professional Services Supplies Utilities Bad Debt

As the VMC cost variance results show, VMC management must monitor not only monthly cost variances, but should also monitor year to date to better explain the financial expenses occurring and whether they are on or near budgeted costs. Possible Reasons for Variances Salaries and wages. Wages and salaries make up the major portion of compensation costs in all industries (Nathan, 1987). According to Berger, (2005) the total labor costs in hospitals constitute more than half of the healthcare facilities total revenue. Fitch Ratings reported in August 2004 that across its 215 rated not-for-profit hospitals, the labor ratio was 52.2 percent (Berger, 2005, para 1). According to Cleverley and Cameron (2007) the health care industry is labor-intensive and the salary and wages expense is the product of the volume of

BUDGET MANAGEMENT ANALYSIS services multiplied by the staffing ratio multiplied by the wage rate. A possible reason for the variances in the salaries and wages expense is that it is difficult to predict the need for staffing

throughout the areas of VMC when attempting to budget for wages and the budgeted amount is based on historical data along with an increased needs assumption. Professional services. The potential for variances in professional services costs can be large or small due to the unpredictability of needs in this category. VMC does not list the professional services inclusive in this category on its statement. Often placed in this budgetary category are items such as economic advisors, specialized repair technicians, furniture refinishers, outside information technicians and consulting firms. Supplies. The reason for cost variances in the supplies expenses can include wastage, poor utilization (ordering of the supplies VS used or remaining in inventory), theft and variability of needs. The budgeted figure is based on historical data and increases in costs of the supplies. Utilities. Utility expenses are not controlled by the organization, but instead are influenced by outside markets. The budgeted amount for utility expenses are derived from historical data and known variances. Rate changes can occur within a budgetary time frame which may have been unpredictable. Bad debt. Bad debt not only includes unpaid healthcare reimbursements for care, but also includes charitable care. Bad debt expense variances occur intermittently from month to month related to general economic conditions and the fluctuations in severity of patient care needs. Strategies to Align with Budget Expectations Efforts to manage the budget and align expenses and budgeted expectations begins with establishing a culture of accountability. Management must have a resolve and be accountable

BUDGET MANAGEMENT ANALYSIS

about the budget targets they set. Managers should be evaluated and held accountable in annual review in which salary increases and job security can be affected. Meeting budgets should be a managerial requirement. Department managers should focus on expenses and not gross revenue. Every dollar saved is a dollar to the bottom line. Department budgets should reflect cost savings opportunities as well as cost-cutting. According to Clark (2005, p. 2), rolling budgets are important in re-forecasting year-end results. When cost variances exceed budget expectations early in the year, managers should hold to those early gains throughout the year. Monitoring of variances should require corrective action plans be put into place. Variance explanations should be required monthly, and corrective action plans should be required within one week of variance reports (Clark, 2005, p.2). Salaries and wages. One strategy for VMC to manage their labor costs and the variances of salaries and wages is to use a spread sheet to monitor labor productivity. Berger (2005) suggests that a three step program would help. The three steps are: to determine the current labor ratio (salaries, contract labor, and fringe benefits divided by total revenue, including nonemployee labor costs, such as agency fees and purchased services); set positive overall labor ratio goals (a ratio less than the median); and develop a labor productivity system that will help your organization determine the level of hours needed per unit of service. Healthcare organizations can use commercial products to generate these reports automatically, or they can develop a spreadsheet on their own. Professional services. As previously stated, professional services expenses can be unpredictable. There are some professional services that are predictable related to planned programs or projects and service contracts for equipment. Some expenses within this category are discretionary that may be able to move to another time period if budgetary constraints are an

BUDGET MANAGEMENT ANALYSIS issue.

Supplies. One strategy to both keep unused inventory down and supply expenses in line with the budgeted amount would be to develop and maintain a strict inventory monitoring system in combination with a Just-in-time inventory ordering policy. Since supplies may not be covered under price contracts, inflationary adjustments or raw material price fluctuations may make budgetary variances large at times. Utilities. To accurately budget for utilities, information concerning potential or planned rate increases and regulatory fees should be sought out and included. Another strategy to keep the utilities expense in alignment with the budgeted expectation is to maintain a conservation minded staff. Bad Debt. One method to align the expenses incurred through bad debt and the budgeted expectations is to set up a system that will identify patients on admission who will require financial assistance. Patients identified can be offered an opportunity to apply for charity care or to set up a self-pay plan. In setting up a system that identifies patients on admission needing financial assistance, an organization will be collecting accurate data and classifying the financial status of a patients account focusing follow-up efforts on those able and agreeing to reimbursements. Benchmarking Techniques Among the tools used by hospitals for cost management are cost data and benchmarking. Benchmarking is a performance improvement method that has been used for centuries. When used in the healthcare industry, benchmarking has the potential to improve the efficiency, costeffectiveness, and quality of healthcare services. Benchmarking is about comparisons, learning from the outcomes of the comparison, and learning how to do the job better. The purpose of

BUDGET MANAGEMENT ANALYSIS

benchmarking is to help an organization initiate changes and advances in its performance so that it can survive in a competitive marketplaceA healthcare organization can determine what areas need improvement and set realistic goals for improvement by comparing and analyzing comparable data. Three benchmarking techniques that can support the avoidance of budget variances include benchmarking with departmental or unit financial data, utilizing data from month to month, or comparisons of year to date data. The data comparisons can be utilizing historical benchmarking, internal benchmarking, or competitive benchmarking or a combination of more than one type of benchmarking. Using any of the techniques or types of benchmarking requires the gathering of data, but from different sources. First in the process is to identify which technique(s) will be used and what defining data should be gathered. Historical benchmarking. In historical benchmarking the data gathered is from the organizations current month or years data and the previous few months to years. According to Finkler and Ward (2006) benchmarking in this way will enable the organization to discover favorable or unfavorable trends that have developed or are developing over time and to see any areas that have drastic cost variances occurring. Competitive benchmarking. Competitive benchmarking can be comparisons made between internal departments or units of the organization or externally organizations that are competitors. Internal competitive benchmarking can reveal if one department is effectively controlling the cost variances better than another and offer insight into cost saving methods used. Competitive benchmarking is valuable in pinpointing why one department or organization is doing better than the other by seeing where the benchmarking ratios differ. The information gained from the comparison can lead to a plan for improvement or the insight that the cost

BUDGET MANAGEMENT ANALYSIS variances are confirmed to be favorable.

External or industry-wide benchmarking. Comparisons of data with the industry that the organization belongs to assists in the understanding of whether the organization falls within the norm or above or below the norm of the industry as a whole. This type of benchmarking technique does not compare or break down the data to just comparable or competitive organizational data (i.e. size of company, profit or non-profit, rural or non-rural, number of beds). The data collected may offer more specifics about the organization for then further benchmarking to occur. The benefit of using an industry-wide benchmarking technique to avoid budget variances is to understand the comparative position the organization is in whatever the current economic climate that all industry-wide organizations are in and make changes based on other organizations methods utilized to maintain favorable cost variances. Historical and internal data is more readily available and much easier and cost effective to collect. Historical and internal data combined with competitive data will increase the understanding of trends that have been developed or are developing and offer a wider look at comparative values to point to areas that need performance improvement. External data for competitive and industry-wide benchmarking is not as readily available to gather. Competitors may not easily offer their financial data. Public and non-profit organizations data is available for the asking or may be published on the internet. Often the financial data is gathered, the ratios are computed, and then published and sold by consulting firms to organizations wanting to compare themselves. Conclusion Of the 5 expense variances benchmarked internally, for VMC for November 2010, half showed favorable variances. VMC probably has in place action plans and utilizes strategies

BUDGET MANAGEMENT ANALYSIS within the budgeting process to assist the organization in controlling and improving possible variances of actual expenses in alignment with budgeted expectations. Benchmarking VMCs

year to date for the same expenses shows all expenses examined with favorable variances except for supplies, which benchmarked with a favorable cost variance for the month of November, but not for year to date allowing for the possibility of a return to a favorable variance for December or end of year if cost saving measures begin immediately. Applying benchmarking techniques can help healthcare organizations understand and improve their processes and the factors that influence quality, cost, and excellence. Benchmarking can help healthcare organizations determine whether their cost-reduction goals are attainable or even appropriate given their patient populations care needs and other factors. . Applying benchmarking techniques can help healthcare organizations understand and improve their processes and the factors that influence quality, cost, and excellence. Benchmarking can help healthcare organizations determine whether their cost-reduction goals are attainable or even appropriate given their patient populations care needs and other factors.

BUDGET MANAGEMENT ANALYSIS References Berger, S. (2005). Analyzing your hospital's labor productivity. Healthcare Financial Management. Retrieved from http://www.allbusiness.com/laboremployment/compensation-benefits-wages-salaries/10568493-1.html

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Clark, J. J. (2005). Improving hospital budgeting and accountability: a best practice approach: if your organization is struggling to achieve its budget targets, your budget process itself may be the culprit. Healthcare Financial Management. Retrieved from http://www.allbusiness.com/accounting/budget/481878-1.html Cleverley, W. O., & Cameron, A. E. (2007). Essentials of health care finance (6th ed.). Sudbury, MA: Jones and Bartlett. Finkler, S. A., & Ward, D. M. (2006). Accounting fundamentals for health care management. Sudbury, MA: Jones and Bartlett. Nathan, F. (1987). Analyzing employers' costs for wages, salaries, and benefits. Monthly Labor Review. Retrieved from http://www.questia.com/googleScholar.qst;jsessionid=329F2F9AD0C665C7F025 711BF2A07422.inst1_1b?docId=5001683384 Valley Medical Center (2011). Financial information. Retrieved from http://www.valleymed.org/About_VMC/Financial_Information.htm