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EBSCO : eBook Collection (EBSCOhost) - printed on 5/7/2019 3:24 PM via UNIV OF WEST FLORIDA AN: 285303 ; Cellucci, Leigh W., Wiggins, Carla.; Essential Techniques for Healthcare Managers Account: uwfl.main.ehost

CHAPTER 14

BUD ETIN

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CASE STUDY BRIAN’S BUDGET

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Brian Sage is the manager of the wellness department at Hope Community Hospital, a nonprofit

hospital located on the South Carolina coast. Brian likes working at Hope and is interested in in-

troducing new wellness programs. He has just met with Tony Benton, the chief financial officer

(CFO , and he agrees that Tony’s directives are right on target. The department’s programs, while

beneficial to patients and the community, were over budget last year. Tony is looking to Brian to de-

velop wellness programs, but to do so within the budget. Tony has asked Brian to design a bottom-

up budget that includes growth for new programs, and also considers profit-making activities.

Brian hopes he is up to the job. Tony is right—his department’s expenses have been ex-

ceeding revenues. As a result, Brian knows he will have to ask for additional funds to start up any

new programs. Furthermore, he knows that he and his department staff need to brainstorm about

programs that might generate a profit to cover the educational programs that cost the hospital

money.

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Brian received his undergraduate degree in health education and joined the staff of

Hope five years ago. His primary activities have been to offer exercise and diet classes to pa-

tients and community members. His excellent rapport with patients and his easygoing,

friendly manner fit well with Hope. People like him.

While working at the center, Brian earned his MBA with an emphasis in health serv-

ices administration online. When he received the degree six months ago, he was promoted

to department supervisor. The administration had full confidence in Brian’s ability as su-

pervisor and his ability to grow the wellness department as a community benefit. The pop-

ulation was growing along the coast, and Hope wanted to be the hospital of choice for the

new residents. The wellness department was designed to work with patients and members

of the community. The wellness services would teach people about healthy lifestyles and

market the hospital to the community.

In recent years, the cost of housing along the coast had increased dramatically, and

retirement communities (housing that caters to people over the age of 55 offered finan-

cially well-off older people a beautiful, albeit expensive, place to live. As a result, the peo-

ple who moved into the area are those who have accumulated personal wealth and are ready

to enjoy their retirement years. They also are physically active and in relatively good health,

and they lead healthy lifestyles. They are careful about their diet, do not smoke cigarettes,

and do not abuse alcohol or drugs. Nonetheless, they are aged 65 years or older, and they

have health conditions that reflect their age.

The Hope Community Hospital responded to this population by focusing on the de-

velopment of its cardiovascular unit. Hope recently became one of the first echocardiogra-

phy laboratories in the United States to be accredited by the Intersociety Commission for the

Accreditation of Echocardiography. This recognition illustrates the high standards set by

Hope in the detection and management of heart disease. Now, the hospital administration

has established the goal of developing its wellness program to focus on their cardiovascu-

lar patients, and Brian has been given the task of proposing a budget that reflects this goal

and, at the very least, generates enough revenue to cover its expenses.

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LEARNIN OBJECTIVES

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Aft r studying this chapt r, you will b abl to

� identify specific types of budgets,

� illustrate managers’ use of budgets in the planning process, and

� explain the use of budgets as a control mechanism.

14.1 BUD ETIN BASICS As Brian develops the budget, he will keep in mind the following five points:

Budget

A statement that indi- 1. Who the organization is: What is the mission of the organization? Hope s mission cates financial admin-

is to consistently deliver compassionate, leading-edge healthcare to the people of istration for a set coastal Carolina. The wellness department s mission is to provide the latest in period of time.

health news and information, along with programs, community health events, and a fully equipped health and fitness center to promote healthy lifestyles in the community. Brian, with input from his staff, needs to determine what activities they want to support financially and how well these activities fit with the missions of the organization and the department.

2. What the organizational goals are: What are the future-directed tasks to be com- pleted? Brian has been told that his goal is to develop the wellness department to focus on the cardiovascular population. New budget line items should be directly related to this organizational goal.

3. When the organization wants the goals accomplished: What is the timeline? Brian is developing the budget for the upcoming year.

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Revenue

Income produced by a

unit’s actions.

Expense

Costs incurred by a

unit’s actions.

Profit

Total income or cash

flow minus expendi-

tures.

Excess of revenue over

expenses

In a nonprofit organiza-

tion, the remaining

cash after revenues

minus expenses.

Statement of

operations

A statement that

shows the revenues,

expenses, and income

of an organization.

4. Where the organization wants the staff to focus: What is the priority of goals to be attained? Staff input regarding priority of services would help Brian determine what cash outlays he should request in the budget.

5. How the manager accomplishes (1) through (4) and stays within the budget.

Managers, however, can only do the who, what, where, when, and how if they know what they can and cannot afford to do. An understanding of their revenues and expenses allows managers to help their employees meet organizational goals and fulfill the organi- zation s mission. Knowledge of budgets—what they are, what they are used for, and how to develop and defend them—is key for healthcare managers. If managers are well informed about the cost of running a department and they know what is being asked of their de- partment, they are better able to deliver a plan of action that responds to the who, what, when, where, and how.

Brian has been charged to develop an annual operations budget that includes (1) anticipated revenue from future services and (2) expenses that reflect the activities neces- sary to provide those services. His budget is a written plan expressed in numbers (dollars and cents) that projects revenue (dollar amount earned from services provided) and ex- penses (resources needed to provide the services) for the upcoming year. Since Brian is re- sponsible for adhering to the budget, he plays a significant role in its preparation and monitoring. Figure 14.1 illustrates the wellness department s operating budget from the previous year, which does not include the cardiovascular directive. The services provided by the department for health education and wellness did not generate enough revenue to cover expenses (the department incurred $10,400 more than it earned). Fortunately for Brian, the department s mission is defined as a community benefit and thus, his depart- ment does not need to generate a profit. However, Brian should determine how to at least meet his expenses and, if possible, to generate an excess of revenues over expenses (that is, make a profit).

As he prepares the budget, Brian should take into account factors that may change demand for the services of the wellness department. The growth of the retirement com- munity along the beach area leads to an expected increase in demand for wellness programs for active seniors. Brian should remain realistic and project revenues and costs that are practical and are a good fit with the organization as a whole.

He also should consider the Hope Wellness Center s current economic status by referring to the center s statement of operations (see Figure 14.2). Overall, the state- ment of operations indicates that Hope s growth reflects the population growth along the coast and that Hope is in a good position to develop new projects that meet its mis- sion to the community. Its patient revenue growth is reflected by its commitment to

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I Revenue and Income

A. Inpatient Charges $425,000

B. Outpatient Charges 150,000

C. Fitness Center Dues 25,000

D. Continuing Education 12,000

Conference

E. Community Education -22,000

Programs

F. Foundation Monies 12,500

Total Revenue $602,500

II Expenses

Direct Expenses

Salaries

Honorarium for Continued

Education Conference

Equipment for Fitness Center

Materials and Supplies

Equipment Service Contracts

Advertisement/Public Relations

Total Direct Expenses

Indirect Expenses

Employee Benefits (23%

Administration (Allocated 2%

Equipment Depreciation

Equipment Maintenance and

Repairs

Custodial (Allocated 3%

Total Indirect Expenses

Excess of Revenues over Expenses

$400,000

500

4,500

62,000

1,600

600

$469,200

$92,000

$28,000

$1,200

$7,500

$15,000

$143,700

($10,400

FI URE 14.1 Wellness Depart- ment Operating Budget 2008–2009

the cardiovascular center initiative and the positive response from the community. From 2006 to 2008, net patient service revenue (gross patient service revenue minus contractual allowances minus charity discounts) and premium revenue earned from capitated contracts steadily increased because of service expansion. Other revenue (gift shop, cafeteria) and net assets (donor restricted to unrestricted in operations) have in- creased because of the growth in patient volume and visitors and the increased foun- dation operations to raise donations. Expenses increased as well to respond to the growth initiative.

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FI URE 14.2 Hope Community Hospital Statement of Operations (in

thousands)

Unrestricted Revenues, Gains, and Other Support

2008 2007

Revenue

Net patient service revenue $ 84,250 $ 77,650

Premium revenue $ 9,800 $ 8,700

Other revenues $ 8,700 $ 8,078

Net assets released from restrictions for operations $ 300

2006

$ 65,750

$ 7,500

$ 6,700

Total revenues, gains, and other support $ 103,050 $ 94,428 $ 79,950

Expenses

Salaries and benefits

Medical supplies and drugs

Insurance

Depreciation

Interest

Provision for bad debts Other expenses

Total Expenses

$ 54,490

$ 28,770

$ 8,300

$ 4,600

$ 1,850

$ 1,600 $ 2,750

$102,360

$ 49,750

$ 25,650

$ 8,150

$ 4,430

$ 1,900

$ 1,400 $ 2,500

$ 93,780

$ 42,750

$ 19,350

$ 7,950

$ 3,750

$ 1,825

$ 1,100 $ 2,450

$ 79,175

Operating income

Investment income

$ 690

$ 3,800

$ 648

$ 3,400

$775

$ 2,500

Excess of revenues over expenses $ 4,490 $ 4,048 $ 3,275

Incremental budgeting

Creating a financial

statement that is in-

creased or decreased

according to previous

expenditures for a set

period of time.

14.2 THE BUD ETIN PROCESS Four different forms of budgeting are used for planning and control: incremental, rolling, ac- tivity-based, and zero-based. If Brian were to employ incremental budgeting, he would examine last year s operations budget and add or subtract a percentage, based on expenditures. Since he has been given the new growth directive, he would estimate what percentage budget increase the department would need to fulfill the organizational goal. An advantage to incremental budg- eting is that it is time efficient; however, it does not allow for an evaluation of costs incurred.

Zero-based budgeting refers to building the department s budget starting from $0.00. The manager does not refer to last year s budget as in incremental budgeting. Rather, the process requires each budget item to be justified. If Brian were to use zero-based budg- eting, he would, in essence, “forget” about last year and provide a detail of resources needed to accomplish the goals fully in the upcoming year.

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Rolling budgeting refers to the development of an annual budget that is reviewed in a specified timeframe (monthly or quarterly) and updated. A benefit of this practice is that the budget is constantly revised to reflect recent activities; however, it is time con- suming. If Brian were to employ rolling budgeting for his department, he would estimate revenue and costs for the upcoming year and reevaluate the budget at monthly or quarterly intervals.

Activity-based budgeting involves allocating costs to each activity performed on behalf of the patient. Thus, instead of a budget that has a line item based on the depart- ment s costs (such as salaries and supplies), the budget item reflects the performance inputs and the costs associated with each activity (such as costs incurred to deliver the cardio ex- ercise classes). Thus, Brian could classify activities as primary or secondary and those that added value to the patient and community and those that did not. Then, he could deter- mine on which activities the department should spend more or fewer resources.

14.3 DEFININ REVENUES AND COSTS The focus of financial controls for managers in for-profit healthcare organizations is to generate profits for the stockholders or owners. In nonprofit healthcare organizations, the focus is to generate profits for reinvestment in the organization. Both foci rely on the man- agement of revenues and expenses. As Hope is a nonprofit, Brian s budgeting process is not focused on growing profits; nonetheless, Hope must generate revenues and control costs to remain in business. The wellness department delivers community benefits through health-centered educational programs and fitness center activities. Hence, operating rev- enues are concentrated in inpatient and outpatient services, program fees, and fitness cen- ter dues. Other revenues include donation funds and the interest from the donations.

Brian also knows that it is important to classify the costs of doing business so he may understand where the profit is made and where costs may be controlled. Costs may be fixed or variable, direct or indirect. A fixed cost is a cost that does not vary according to use (such as number of patients). To elaborate, one of the programs that Brian and his staff are considering is having exercise trainers lead cardio exercise classes at the fitness center. It does not matter whether ten people or 50 people attend the cardio fitness class; Brian needs to allocate resources to pay for the trainer. So the trainer s salary for the class is a fixed cost. Brian also plans to give each person attending the cardio fitness class a personal package of heart-healthy items. How many packages he puts together depends on the num- ber of people in the class. Hence, the personal heart-healthy package cost is a variable cost: It will change as the volume changes. If Brian has 12 people in the class, he needs to purchase supplies for 12 packages. If he has 20 people in the class, he needs to purchase supplies for 20 packages.

Direct costs are those that are associated with an activity. Indirect costs are those that are not associated with a specific activity. To determine whether costs are direct or indirect,

Zero-based budgeting

Creating a financial

statement for a set pe-

riod of time that re-

quires each budget item

to be justified according

to the unit’s goals.

Rolling budgeting

Creating a statement

that indicates financial

administration that is

reviewed in a specified

timeframe (monthly or

quarterly) and updated.

Activity-based

budgeting

Creating a statement

that focuses on the

manager’s allocating

costs to each activity

performed on behalf of

the unit’s responsibili-

ties (such as patient

care).

Fixed costs

Expenses that will be

incurred regardless of

volume.

Variable costs

Expenses that will

change as the volume

changes.

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Direct costs

Expenses associated

with a specific activity

provided by a unit.

Indirect costs

Expenses that are not

associated with a spe-

cific unit activity.

Brian may ask, “If this specific something did not exist, would the cost still exist?” For ex- ample, “If this exercise class did not exist, would the costs still exist?” If the answer is “yes,” it is an indirect cost. If the answer is “no,” the cost is direct. To illustrate, the cost of exercise mats is a direct, variable cost to the wellness department. The number needed varies accord- ing to the number of attendees, and the cost would not exist if the exercise center did not exist. To further illustrate, indirect costs (such as electricity needed for lights, air conditioning, etc.) are associated with the hospital as a whole and may be prorated by time allocated to specific departments. They are costs that cannot be specifically attributed to an individual project. See Table 14.1 for an illustration of costs that pertain to the wellness department.

Classifying costs associated with the wellness department allows Brian not only to know what is being spent and why, but also to explain and justify his budget. If he budg- ets for new equipment, he can explain why that particular equipment is needed to fulfill the goal. Projected usage and the acquisition of items may enhance patient care and attract new patients to the hospital.

Also, if Brian classifies costs as direct and fixed, indirect and fixed, direct and variable, and indirect and variable, he gains an understanding of what costs are allocated to his depart- ment, which helps him determine whether these allocations are fair. Rawls (2001) presents justice as fairness, and Brian can determine the fairness of the allocated costs only if he is aware of the actual versus allocated costs incurred to the department. Last year, his department was responsible for 3 percent of Hope s custodial care expenses. As he plans for the upcoming year s growth initiative, he may find that his department needs to assume responsibility for a larger allocation of the custodial care costs. This should be reflected in the proposed budget.

With the budget information and the program planning Brian and his staff will ad- dress, he will be well equipped to prepare, propose, and defend the budget for the wellness department. He will become knowledgeable about the cost of running a department; he will know what is being asked of the wellness department employees; and his department will be better able to deliver a plan of action that responds to the who, what, when, where, and how for Hope Community Hospital.

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TABLE 14.1 Cost Classifications for Hope Wellness

Department Direct Indirect

Fixed Brian’s salary Custodial contracted serv-

ices (allocated portion

Variable Heart-healthy packages Repairs of equipment in

fitness center

http:costisdirect.To

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DISCUSSION QUESTIONS

EXERCISE 14.1

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� With reference to the budget presented in Figure 14.1, construct an incremental budget

for the wellness center. What percentage increase/decrease did you select? Defend your

choice of percentage increase/decrease. Now, with reference to your budget, construct

a rolling budget. What are the advantages of using an incremental budget for planning?

What are the advantages of using a rolling budget?

� Offer three examples of direct and indirect costs in a healthcare facility. Why is it im-

portant to differentiate between the two?

� Refer to the following list and identify whether the cost is fixed or variable. If you were

trying to contain costs, which set of costs would you try to reduce first? Why?

Costs of tongue depressors

Costs of occupational therapists’ salaries for fiscal year 2008–2009

Costs of contracted-per-patient occupational therapists’ salaries

Costs of rent for the wellness center’s exercise site

FAIR ALLOCATION?

Cassie Clemson, the clinic manager for the women’s center, and Manuel Wentworth, the

clinic manager for pediatrics, met with Tracey Farmer, the manager of radiology. Tracey had

requested the meeting. The mammography unit, a division of radiology, was housed in the

same building as the women’s center and pediatrics. The women’s center offices and ex-

amination and waiting rooms occupy about 40 percent of the building space. The offices

and examination and waiting rooms in pediatrics are about the same size as those in the

women’s center, but pediatrics also has a play center for children, so it takes up about 45

percent of the building space. The mammography unit occupies the remaining 15 percent.

Tracey was preparing the mammography budget for fiscal year 2009–2010 and no-

ticed that in previous years, rent, electricity, heat, and water costs had been split evenly

among the three units. That meant that mammography, which only occupied 15 percent of

the building, was paying one-third of the indirect costs.

She proposed to Cassie and Manuel that indirect costs should be allocated accord-

ing to the square footage each department occupies.

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EXERCISE 14.2 DEVELOPING T E BUDGET FOR T E DIALYSIS CENTER

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What do you think Cassie and Manuel will say in response? Consider the hours of

usage and number of clients as factors to consider when allocating costs.

What do you think is a fair allocation for the three units?

Gabe Richards, a dialysis center unit supervisor, reviewed his previous two years of budget-

ing for the center. He noted what had been budgeted and what had been expensed. Then he

subtracted the difference. In some areas, he had budgeted more than he had expensed. In

other areas, he had budgeted less than he had expensed. Look at Gabe’s notes in Table 14.2.

As he prepares the budget for the upcoming fiscal year, what factors should he consider?

Gabe had anticipated that he would be able to operate fully staffed from July 2007

through June 2008; however, the dialysis center was understaffed. How is this reflected in

the budget?

Considering what has happened in the past two years and knowing that the goal is

to have the center fully staffed, fill in the budget numbers for salaries, professional devel-

opment, material and supplies, and equipment for July 2008 through June 2009. What in-

crease, if any, would you propose for the center? Why did you propose what you proposed?

Do you think you could defend your budget effectively?

TABLE 14.2 Budget Expenses for Dialysis Unit Staff Operations (Physicians Not

Included)— abe's Notes

Expensed

Budgeted

Difference

Salaries

$ 1,233,041.57

$ 1,246,870.00

$ (13,828.43

Professional

Development

$ 34,446.10

$ 66,528.00

$(32,081.90

7/06–6/07

Materials and

Supplies

$ 241,001.66

$ 235,000.00

$ 6,001.66

Equipment

Expensed

$ 21,246.66

$ 21,000.00

$ 246.66

Total

$ 1,529,735.99

$ 1,569,398.00

$ (39,662.01

7/07–6/08

Salaries Professional

Development

Materials and

Supplies

Equipment

Expensed

Total

Expensed

Budgeted

Difference

$ 1,425,052.20

$ 1,534,548.00

$ (109,495.80

$ 58,800.00

$ 68,400.00

$ (9,600.00

$ 250,000.00

$ 248,000.00

$ 2,000.00

$ 23,000.00

$ 22,500.00

$ 500.00

$ 1,756,852.20

$ 1,873,448.00

$ (116,595.80

http:someareas,hehadbudgetedmorethanhehadexpensed.In

http:subtractedthedifference.In

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TABLE 14.2 Projected 7/08–6/09 (Continued)

Salaries Professional

Development

Materials and

Supplies

Equipment

Expensed

Total Budget Expenses for Dialysis Unit Staff Operations

Expensed (Physicians Not Budgeted Included)— abe's

Notes

explaintheuseofbudgetsasacontrolmechanism:
Budget:
periodoftime:
Revenue:
unitsactions 1:
unitsactions 2:
unitsactions 1_2:
unitsactions 2_2:
tures 1:
tures 2:
minusexpenses 1:
minusexpenses 2:
ofanorganization:
C h a p t e r 1 4 B u d g e t i n g:
undefined:
undefined_2:
Unrestricted Revenues Gains and Other Support:
Excessofrevenuesoverexpenses:
Incrementalbudgeting:
periodoftime_2:
Zerobasedbudgeting:
totheunitsgoals 1:
totheunitsgoals 2:
quarterlyandupdated 1:
quarterlyandupdated 2:
care 1:
care 2:
Variablecosts:
Directcosts:
providedbyaunit 1:
providedbyaunit 2:
cificunitactivity:
undefined_3:
Direct:
Indirect:
Fixed:
Brianssalary:
Variable:
Hearthealthypackages:
undefined_4:
Doyouthinkyoucoulddefendyourbudgeteffectively:
Difference:
C h a p t e r 1 4 B u d g e t i n g_2:
undefined_5:
Budgeted: