DB3 Summer
Notes:
The Balanced Scorecard is an attempt to enhance the value of information and to exploit the capability of information technology to deliver true value to decision-makers. Balanced Scorecards simply state that reporting should be available on those key attributes that really affect performance. More data is of little value if it does not provide information to a decision-maker that can be used to improve the performance of the firm. The Balanced Scorecard allows managers to look at the business from four important perspectives:
Customer
Internal business process
Innovation and learning
Financial
“Dashboard” reporting is a natural subset of Balanced Scorecards and is being increasingly used in almost all sectors of the economy to keep managers focused on critical areas that will affect overall firm performance. The following are the four key elements of dashboard reporting:
What is most important to the firm’s success?
What are the critical drivers that influence performance attainment?
What are the most relevant measures that reflect critical driver relationships?
What relevant benchmarking data is available to assess performance?
If a health care firm’s prices are lower than those of its competitors, price elasticity becomes of less importance.
· Ratio analysis is a common approach for detailed analysis of the financial statements of healthcare organizations. Ratio analysis asks the question: “What is the ratio of one line item to another?” For instance, a question might be: “How many dollars are there in current assets as compared to current liabilities?” As opposed to being limited to just one financial statement at a time, ratios may combine items from several different financial statements.
· Traditionally there are four general categories of ratios: Liquidity, Profitability, Activity, and Capital structure.
Liquidity ratios answer the question: “How well is an organization positioned to meet its short-term obligations?”
Profitability ratios answer the question (as one might expect): “How profitable is an organization?”
Activity ratios answer the question: “How efficiently is an organization using its assets to produce revenues?”
Capital structure ratios answer two questions: 1) “How are an organization’s assets financed?;” and 2) “How able is this organization to take on new debt?”
· Once calculated, the ratios can be compared to some meaningful standard, such as goals, standards, historical levels, and industry levels. Such comparisons yield clues as to how well an entity is functioning and how it might improve its operational performance and financial position.
Ratio analysis formulas:
Return on equity = net income / equity or net assets
Total asset turnover = revenue / assets
Operating margin = operating income / total operating revenue
Days in Accounts Receivables = net patient receivables/ (Net patient service revenue /365)
Long term to debt asset ratio = notes payable / unrestricted net assets
Age of plant = less accumulated depreciation / depreciation
Fixed asset turnover ration = total revenue / net property and equipment
Days cash on hand = (cash and cash equivalents /(total expense -depreciation)/365)
Costs are classified by their traceability (direct vs. indirect), management control (controllable vs. non-controllable), relation to budget (budgeted vs. actual), relation to time (avoidable, sunk, incremental, and opportunity), and relation to activity (fixed, variable, and mixed). These classifications are used to improve the decision-making process by precisely defining cost to make it more relevant to decisions. Regardless of the classification system, however, in most situations, the total value of the costs is the same. Because, in most cases, different concepts of cost simply slice total cost in different ways, there may be underlying relationships among the various concepts of costs. For example, direct costs and controllable costs may be related. In many situations, there are standard “rules of thumb” that may be used to relate cost measures.
An understanding of fixed and variable costs is a crucial element in making such decisions. Fixed costs are costs which do not vary in total but vary per unit over the relevant range. Fixed costs do not change in response to changes in volume, however, fixed costs per unit change with respect to volume. Variable costs are costs which vary in total but do not vary per unit over the relevant range. The relevant range is the range of activity within which the assumptions about the cost behavior are valid.
For example: Fixed costs such as rent or a supervisor's salary will not change in total within a reasonable range of volume or activity. For example, the rent might be $2,500 per month and the supervisor's salary might be $3,500 per month. This total fixed cost of $6,000 per month will be the same whether the volume is 3,000 units or 4,000 units. On the other hand, the fixed cost per unit will change as the level of volume or activity changes. Using the amounts above, the fixed cost per unit is $2 when the volume is 3,000 units ($6,000 divided by 3,000 units). When the volume is 4,000 units, the fixed cost per unit is $1.50 ($6,000 divided by 4,000 units).
When considering how changes in volume affect total fixed costs, it is important to consider the relevant range.
Cost allocation is a way to distribute costs from support departments to revenue producing departments. The order in which the services are allocated makes a difference to the final, all- inclusive costs of each particular revenue department or cost object. In the step down cost allocation method, the order in which support areas are allocated do not affect the organizations total costs.
The break-even equation can be used to determine price, volume, fixed costs, and variable costs per unit, if each of these other factors is known. The break-even point is the volume at which total revenues equal total costs. The break-even equation is: (Price * Volume) = Fixed Costs + (Variable Cost Per Unit * Volume). The results of a break-even analysis are often presented on a break-even chart, which displays total costs, total revenues and volume. The distance between the total cost and total revenue lines on this chart represents the amount of profit or loss the service is experiencing at any particular volume of service. An alternative form of this chart portrays just the difference between the total cost and total revenue line—net income.
An example of a break - even analysis:
Vicki's home health care agency is considering a new product with a fixed cost of $1,000, a charge per unit of $10, and a variable cost of $5.
The break-even point in quantity is the total fixed costs / (charge - variable costs). $1,000 / $10 - $5 = 200 units.
Contribution margin in dollars = charge (revenue) - variable costs. $10 - $5 = $5
Contribution margin percent = cost - variable cost / charge. $10 - $5 / $10 = .50 x100 = 50%
Break-even point in dollars = total fixed costs / contribution margin % = $1,000 / .50 = $2,000
The break-even equation can be applied to capitated situations to determine capitation rates, utilization rates, fixed or variable costs. The break-even equation can also be extended to multi-payer and multi-product situations. In conducting multi-payer analysis, which includes capitated and fixed fee patients, it is important not to adjust revenues for changes in volume, though variable costs may change.
The quantity (Revenues – Variable Costs) is called contribution margin. It is the amount of profit made on each additional unit produced if all other costs (i.e., fixed costs and overhead) remain the same. It is also the amount of incremental income made on each unit that is available to cover all other costs. If the contribution margin is known, a short-cut formula for calculating break-even can be used: Total fixed costs ¸ contribution margin per unit.
In instances where there are multiple services being offered, it is likely that there will be both organizational fixed costs and service-specific fixed costs. Fixed costs that are there just because the service is being provided and would not be there if the service were not offered are called avoidable fixed costs. If a service is covering its own variable and avoidable fixed costs, even though it does not fully cover its full share of other costs (non-avoidable fixed costs and common costs), the organization is better off delivering the service than not, all other things being equal (e.g., there are no better alternatives).
From a hospital's perspective, capitation is most likely to be the highest risk arrangement with a payer.
Defining volumes is the first step in the budgetary process.
Increasing marginal volume for cost payers makes economic sense if fixed costs are high and present cost payer volume is small.