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CHAPTER 6 Planning and Budgeting

The planning process

Budget decisions

Budget types

Operating budget example

Flexible budgeting and variance analysis

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The Planning Process

The strategic plan is the foundation of the planning process. It contains

a mission statement,

a values statement,

a vision statement,

goals, and

objectives.

The operating, or five-year, plan is the portion of the planning process that outlines how the organization expects to meet its objectives.

The planning process takes place more or less continuously throughout the year.

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Operating (Five-Year) Plan Format

Chapter 1: Mission, values, vision, and goals

Chapter 2: Corporate objectives

Chapter 7: Functional area plans

A. Marketing

B. Operations

C. Finance

D. Administration and human resources

E. Facilities

Note that the plan is most detailed for the first year.

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Financial Plan Format

C. Finance

1. Current financial condition analysis

2. Capital investments and financing

a. Capital budget

b. Financing plan

3. Financial operations

a. Overall policy

b. Cash budget

c. Cash and marketable securities management

d. Inventory management

e. Revenue cycle management

f. Short-term financing

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Financial Plan Format (cont.)

4. Budgeting and control (first year only)

a. Revenue budget

b. Expense budget

c. Operating budget

d. Control procedures

5. Future financial condition analysis

What are the keys to an effective planning process?

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Budgeting Basics

Budgets are detailed plans, expressed in dollar terms, that specify how resources will be used over some period.

Budgets may be developed and applied to any level of an organization:

Aggregate

By department

By service line

By contract

By the nature of the expenditure

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Budgeting Basics (cont.)

To be effective, budgets must not be thought of as financial staff tools, but rather as managerial tools.

Budgets are used for

planning,

communication, and

control.

Three decisions must be made regarding a business’s budgeting process. (See the next three slides.)

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Conventional vs. Zero-Based Budgets

Traditionally, health providers have used the conventional approach to budgeting.

The old budget is the starting point.

Typically, only minor changes are made.

Changes often are applied equally.

In zero-based budgeting, each new budget is started from scratch.

What are the advantages and disadvantages of each approach?

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Budget Timing

All organizations use annual budgets to set standards for the coming year.

Most also use quarterly (or more frequent) budgets to ensure timely feedback and control.

Not all budget types have to follow the same timing pattern.

Out-year budgets are more for planning than for control purposes.

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Top-Down vs. Bottom-Up Budgets

Bottom-up budgets

begin at subunit (departmental) level,

are reviewed and compiled by the finance department, and

are approved by senior management.

Top-down budgets

begin at the finance department with senior management guidance, and

are sent to the departments for review.

What are the advantages and disadvantages of each?

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Revenue Budget

Most businesses have

a revenue budget,

an expense budget, and

an operating budget.

The revenue budget uses volume and payment data to forecast revenues.

The end result is a revenue forecast

in the aggregate,

by department,

by service, and

by diagnosis (or other clinical basis).

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Expense Budget

The expense budget combines volume data with detailed resource utilization data to forecast expenses.

To be most useful, expenses must be broken down into fixed and variable components.

Like revenues, expenses must be forecasted at multiple levels.

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Operating Budget

For larger organizations, the operating budget, which focuses on projected profitability, combines information from the revenue and expense budgets.

Smaller organizations may use a single operating budget in place of multiple budget types.

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Operating Budget Illustration

Consider the 2008 operating budget of Carroll Clinic, shown on the following four slides. This budget was created at the end of 2007.

The budget is divided into four parts:

Volume assumptions

Revenue assumptions

Cost assumptions

Pro forma P&L statement

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2008 Operating Budget (Parts I and II)

I. Volume (Number of Visits)

A. Payer A 9,000

B. Payer B 12,000

C. Total 21,000

II. Reimbursement (Average Payment Per Visit)

A. Payer A $100

B. Payer B $ 90

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2008 Operating Budget (Part III)

III. Costs

A. Variable Costs:

Supplies $ 315,000

B. Fixed Costs:

Labor $1,035,000

Overhead 500,000

Total $1,535,000

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2008 Operating Budget (Part IV)

IV. Pro Forma P&L Statement

Revenues:

Payer A $ 900,000

Payer B 1,080,000

Total revenues $1,980,000

Variable costs $ 315,000

Fixed costs 1,535,000

Total costs $1,850,000

Projected profit $ 130,000

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Variance Analysis

Variance is the difference between the actual results and the budgeted (standard) value.

Variance analysis is a technique applied to budget data to

identify problem areas, and

enhance control.

Why is variance analysis so useful to health services managers?

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Simple Variance Analysis Example

To illustrate variance analysis, we will use Carroll Clinic’s forecasted 2008 budget presented in slides 15-17 as the simple (original) budget.

Assume it is now January 2009, and the operating results for 2008 have been compiled. These actual (realized) results are shown on the next slide along with a simple variance analysis.

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2008 Results (Parts I, II, and III)

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2008 Results (Part IV)

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Simple Variance Analysis Interpretation

Profitability was $22,500 (17.3 percent) below standard.

Revenues were $47,500 (2.4 percent) greater than expected.

However, costs were $70,000 (3.8 percent) greater than expected.

Higher revenues were attributed to Payer A, which had higher than expected volume and reimbursement.

Costs were higher across the board.

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Flexible Variance Analysis

The variance analysis just performed is a simple analysis in that it compares actual results with initial (beginning of year) assumptions.

We can glean additional information by constructing a flexible budget, which is based on the initial budget but is adjusted (flexed) to reflect actual (realized) volume.

Now, the variances will reflect financial performance differences other than those that stem from volume forecast errors.

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2008 Results (Parts I, II, and III)

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2008 Results (Part IV)

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Flexible Variance Analysis Interpretation

Profitability was $70,000 (39.4 percent) below standard.

Revenues were $7,500 (0.4 percent) less than expected.

However, costs were $62,500 (3.4 percent) greater than expected.

When volume is considered, both revenues and costs were less than expected.

Management needs to work on

increasing reimbursement rates (especially with Payer B), and

controlling costs.

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Variance Analysis Example Recap

In practice, variance analysis typically is much more detailed than that presented in this illustration.

Also, variance analysis is applied to operating data, such as census, labor hours, number of outpatient visits, and so on, often on a weekly (or even daily) basis.

Is all this work worth it?

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This concludes our discussion of Chapter 6 (Planning and Budgeting).

Although not all concepts were discussed, you are responsible for all of the material in the text.

Do you have any questions?

Conclusion

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Simple

Actual

Variance

Budget

Results

Dollar

(Visit)

Percentage

I. Volume (Number of Visits

)

Payer A

9,000 10,000

1,000

11.1

Payer B

12,000

(500

)

(4.2)

Total

21,000

,500

500

2.4

II. Reimbursement (Per Visit)

Payer A

$100 $105

Payer B

$ 90 $ 85

($5)

(5.6)

III. Costs

A. Variable Costs:

Suppl

ies

315,000 $

320,000

5,000)

(1.6%)

B. Fixed Costs:

Labor

$1,035,000 $1,050,000

($15,000)

(1.4)

Overhead

500,000

550,000

(

,000

)

(10.0)

Total

$1,535,000

$1,600,000

(

$65,0

)

(4.2)

IV.

Forecasted

P&L Statement

Simple

Actual

Variance

Budget

Results

Dollar

(Visit)

Percentage

Revenues:

Payer A

$ 900,000 $1,050,000

$ 150,000

16.7%

Payer B

1,080,000

977,500

(102,500

)

(9.5)

Total

revenues

$1,980,000

$2,027,500

47,500

2.4

Variable costs

$ 315,000 $ 320,000

5,000)

(1.6)

Fixed costs

1,535,000

1,600,000

(65,000

)

(4.2)

Total

costs

$1,850,000

$1,920,000

(

70,000

)

(3.8)

Profit

$ 130,000

$ 107,500

(

22,500

)

(17.3)

Flexible

Actual

Variance

Budget

Results

Dollar

(Visit)

Percentage

I. Volume (Nu

mber of Visits)

Payer A

10,000 10,000

Payer B

Total

21,5

21,500

II. Reimbursement (Per Visit)

Payer A

$100 $105

Payer B

$ 90 $ 85

($5)

(5.6)

III. Costs

A. Variable Costs:

Supplies

$ 322,500 $ 320,000

$ 2,500

0.8%

B. Fixed Costs:

Labor

$1,035,000 $1,050,000

($15,000)

(1.4)

Overhead

500,000

550,000

(

0,000

)

(10.0)

Total

$1,535,000

$1,600,000

(

$65,000

)

(4.2)

IV.

Forecasted

P&L Statement

Flexible

Actual

Variance

Budget

Results

Dollar

(Visit)

Percentage

Revenues:

Payer A

$1,000,000 $1,050,000

$ 50,000

5.0%

Payer B

1,0

,000

977,500

(57,500

)

(5.6)

Total

revenues

,000

$2,027,500

(

$ 7,500

)

Variable costs

$ 322,500 $ 320,000

0.8

Fixed costs

1,535,000

1,600,000

(65,000

)

(4.2)

Total

costs

,85

$1,920,000

(

)

(3.

)

Profit

$ 177

$ 107,500

(

)

(

)