FMW3HW

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3. Compare and contrast the external financing options that are available for healthcare organizations today.

Reading Assignment

Chapter 4: Understanding Costs

Unit Lesson

This unit will introduce you to the concept of costs in healthcare. For public service organizations and healthcare organizations of all kinds, an understanding of costs is absolutely essential. The better that healthcare managers understand costs, the more accurate their planning will be, and the better they will be able to control spending for the organization within their areas of responsibility. A solid understanding of costs will also improve a manager’s ability to make effective decisions on a day-to-day basis for his or her department. Thus, for many reasons, you need to get a solid understanding of costs. That is what we will seek to provide in Unit III.

First let us face reality, costs in healthcare are complicated. They are considerably more complicated than costs in industries such as manufacturing, construction, or retail. One important emphasis of this unit is on providing a clear understanding of key definitions for widely used cost terms. Such terms include direct costs, indirect costs, average costs, fixed costs, variable costs, and marginal costs.

In this unit, you will come to realize that finance has its own language, and in order to be effective as a healthcare manager, you must be able to speak that language. Otherwise you will find yourself in foreign territory at management team meetings and board of directors meetings. You will also be at great disadvantage when budget time rolls around each year. Accordingly, in this course, we will teach you the language of finance so that you can communicate clearly with the chief financial officer (CFO) and other members of management.

Another focus for Unit III is on understanding how costs change as service volumes change. The relationship between costs and volume has a dramatic impact on the profits or losses incurred by an organization, and this relationship is critical to effective decision making. Healthcare organizations must generate black ink on the income statement in order to survive. That is true for both for-profit and not-for-profit entities, so you must understand the impact of service volumes on costs.

The old story about the Long Island Tailor comes to mind here. It was said that the tailor lost money on every single suit that he produced for clients, but he made it up in volume. Well, clearly that will never work. Losing money on every healthcare service we provide, and then getting busier losing money, will close down the hospital or clinic in a very short time. In healthcare, we need to find a way to provide services for our patients at cost levels which allow some margin of revenues over expenses. This may not be true for every patient that we treat, but it must be true for our patient population overall. Otherwise we could be in a lot of trouble financially, and in a hurry.

Managers who understand the relationship between costs and service volumes can apply the break-even analysis technique—a tool that assists in determining the required volume level for a program or service to be financially self-sufficient. Break-even analysis is crucial for healthcare organizations. There may be many

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UNIT x STUDY GUIDE

Title services which we would like to provide for our community, but we need to be realistic about which ones we can do enough volume in to be profitable.

Let’s look at an example. In a small community, there may be a significant number of patients who need dialysis services, and it would be great to have a dialysis center in that community to accommodate them. The patients or patient families may even be coming forward to their doctors or hospital management to request the service. Dialysis is typically performed three times per week, and having to travel a long distance for the service three times a week can be a true hardship for patients and families. However, if the service volume is not sufficient to support a dialysis program in the community, capital expenditures, supplies, and staffing, then it will fail financially and will wind up providing services for no one. Healthcare organizations need to conduct thorough break-even analysis before entering into any new service today. You will learn how to conduct such an analysis in this course.

Unit III concludes with a discussion of cost measurement. To determine the costs of products or services provided by the organization, it is necessary to allocate costs. Some responsibility center costs are allocated to other centers, and the costs of specific responsibility center costs are allocated to units of service or products within that center. Methods of cost allocation, including step-down allocation and activity-based costing are discussed in this unit. For example, the cost of keeping the hospital clean should be shared among the various departments of the hospital. The maintenance and biomedical engineering services also benefits all departments and should be allocated in some manner to the various departments. These allocations turn out to be a very important consideration, because it can impact the end of year Medicare cost report and can ultimately impact the hospital’s reimbursement rates.

Conclusion

What makes a hospital, clinic, or other medical service financially successful? One important part of success for healthcare organizations is found in attracting patients and driving up service volumes and revenues; that is true. Some of the things that medical facilities do to drive up volumes and revenues include marketing efforts, community involvement, service expansion, and physician recruitment. This latter aspect is absolutely crucial. No hospital administrator ever admitted a single patient to his own hospital—physicians do that. No hospital administrator ever ordered outpatient testing, treatment or rehabilitation—physicians do those things. Thus, a diverse and adequately-sized physician medical staff is crucial for our success. Hospitals do many things today to recruit doctors. One example is paying off the doctor’s student loans over a five to ten year period in exchange for the doctor practicing in the community. Another approach is bridging with the doctor during residency. This means paying for his or her living expenses and tuition during the final years of training, in exchange for a commitment to come to the community and practice after graduation. Bridging has worked for many smaller communities. Doctors drive the boat; never forget that. We must have them to keep the hospital departments busy and to fill up hospital beds.

However, with so much emphasis on building revenue streams, a smart healthcare manager knows that the real key to success is holding down costs while driving up revenue. Creating a spread between revenues and expenses is essential for any healthcare facility. We simply must get black ink on the income statement— period. The brightest and best intentioned healthcare executive in the world will not be in office long if he or she is operating with red ink on the income statement month after month. Drive revenue up, keep costs down, and succeed in your healthcare career.

You will have a better understanding of costs after your studies in this unit.